MONEY and BANKING LOW GRAPHICS

 


HAS BANKING CHANGED?
 

 


A: "Banking business is the same all around the world and nothing much has changed over centuries. Banks are collecting deposits and use them to provide loans. Their profit comes from the difference of high interest rate on loans and low interest rate paid for deposits. "

B: "You are mistaken. The banking has changed considerably due to numerous financial innovations. Its role within the economic system has also changed and it is not the same in different countries."

Who is right'!
 

 

 Student 1

In reading over statements A and B, I would probably lean more toward agreeing with B; both A and B do speak of what banks and their functions provide. With regard to statement A, banks do collect deposits and use them to provide loans. That is the backbone of why banks exist-- to provide savers an intermediary to lend their money to and to provide people who need money intermediaries to get loans from. However, that only speaks of very traditional commercial banking practices. Over the years, particularly in the second half of the last century, banks have done much more. Statement A also neglects to discuss other services banks provide, as well as investment banking altogether. In addition, although banking business is becoming more entwined and similar throughout the world, each country has its own system and institutions. The person who made Statement B is more correct. Banking has changed considerably due to many financial innovations. For one thing, in the U.S. banks used to only be allowed to function in one state (originally because each state issued its own currency and because people worried that if banks spread from across different states there would be problems with competition). However, today banks can function across states; not only that, many function as national banks and function outside the country as well. Chase is one such example. Furthermore, not only do banks provide loans and [accept] deposits, but they perform many other functions as well. For example, investment banks such as Morgan Stanley provide services to companies that wish to go public [and issue stock for the first time]. They provide financial advice and are actually the first to buy the shares of stock from a particular company, promising a certain price of course. They then sell the stock and make money that way. That is quite different than the traditional forms of banking statement A refers to. In addition, with deregulation, commercial banks and investment banks and their functions are now allowed to merge, thus making banks more diversified in the functions they perform. Banking is also different from country to country. Some country's banking institutions are more independent than their governments than others. Traditionally, Germany is one country that has been very independent and deregulated. Other countries are starting to follow suit, notably Japan. The US's Federal Reserve System is unique. Other countries have different systems. Some have different numbers of people sitting on their board of governors, some regulate banks differently. With the advent of the Euro, many countries have to regulate one currency. That's very different than how it used to be centuries ago, as statement A takes the opposing position. All in all, I would have to agree more with statement B than A. Banking has changed considerably over the years; its role in the economic system is different, and it is different throughout the world.

 

 Student 2

Both the statements, A and B, have very valid points and neither one of them is actually right or wrong. In fact I would say, they are complementary to each other and give a better definition of the role of banks in general.

Taking statement A first, this describes the original function of the bank since its creation. It is an institution, which provides individuals with the facilities to safe-keep their savings in deposits within the bank. With this set of assets, the banks can loan out a certain amount of its capital as loans to individuals or corporations. Providing funds and stimuli for economic growth and development. In order to maintain some earnings, to pay off its employees, debts and bills, banks try to earn some profits through the difference gained from interests on loans and the interests paid on deposits. These functions are the most basic tasks carried out by the banks found throughout the world, and is similarly carried out by the nation.

Statement B was correct in saying that there have been numerous financial innovations since the early beginnings of the first banks in Venice. Innovations like Mutual Funds, Forward Contracts, Futures and Options derivatives and even providing insurance are relatively new. How and what the banks can participate in however vary from nation to nation. For instance, banks in the U.S. , used to mainly deal in savings and providing loans. It wasn’t allowed to participate in offering insurance and securities. American banks weren’t even allowed to have equity in commercial holdings. However this has changed with a new act passed by Congress in 1999, to make U.S. banks more competitive. THE GRAMM-LEACH-BILEY FINANCIAL SERVICES MODERNIZATION ACT WAS PASSED, TO ALLOW BANKS TO UNDERWRITE SECURITIES AS WELL AS INSURANCE. WHILE SIMULTANEOUSLY, SECURITIES AND INSURANCE COMPANIES ARE NOW ALLOWED TO ENTER THE BANKING BUSINESS, IN ORDER TO COMPETE WITH BANKS. THERE IS NO MORE ANY SEPARATION BETWEEN THE ENTITIES.(1)

Yet banks in Europe, for example banks in Germany and Switzerland, all participate in savings, insurance and securities all under one roof. It offers its customers a wide range of services, including real estate, and they were allowed to have equity in commercial holdings. In the case of United Kingdom, the banks took part in traditional banking facilities and also provided services for securities issuing. However it was prevented from providing insurance. Thus the banking roles, varies from country to country.

However, I disagree with B’s inference that the roles of banks in the economy have changed. In fact it continues to provide the services it originally established and set out to accomplish. That is to provide facilities for deposits and loans. Through this, its most important role can be carried out, which is the creation of money to ensure the continual economic growth of the nations. Despite all the new financial innovations, these can be considered subsets of its activities. It is important to note that improper activities from these innovations, which could lead to major losses, could lead to major economic instability. THE BANKS ARE FACING INCREASED COMPETITION DUE TO FINANCIAL DEREGULATION AND INCREASED INFORMATION DISSEMINATION AND ACCESSIBILITY. BANKS ARE LOSING LOANS DUE TO EASIER ACCESS TO FOREIGN CAPITAL MARKETS OR SELF-ISSUING OF SECURITIES. BANKS THEREFORE ARE LOSING REVENUE AND INCURRING LOSSES. ROLES OF BANKS ARE STILL THE SAME, THEY JUST HAVE TO EVOLVE AND LEARN TO BE MORE EFFICIENT AND COMPETITIVE.(2)

References: (1)Mishkin, The economics of Money, Banking and Financial Markets (World Student Series:2002), 289 (2)Mishkin, 276

 

 Student 3

The banking system has considerably changed around the world and more significantly in developed countries. The US banking system is one of the most representative systems in the industrialized world. In the last three decades, the US banking system has changed its investment procedures and its risk management due to changes in government regulation, such as the elimination of regulation Q. Furthermore, external shocks, such as the inflationary period during the 70s and the recession in the 80s, led Banking institutions to alternative ways of investment in order to remain profitable.

During the 70s, inflation was very high in the United States. A loose monetary policy led to very low interest rates. Corporations were borrowing large amounts to finance leverage buyouts (LBOs), WHICH LED TO HIGHER AND HIGH INTEREST BURDEN. At the beginning of the 80s, the FED cut money supply to control inflation, thus increasing interest rates. COMPANIES COULD NOT AFFORD THE INTEREST BURDEN ANYMORE. MEANWHILE, Banking institutions could not increase its interest rates because of regulation Q. Consequently, Banks had to find alternative ways to lend money avoiding the regulation (loophole mining) 1.

One of the main instruments used was financial derivatives, which gave Banks additional profit. MOREOVER, THIS INSTRUMENTS REPRESENTED OFF BALANCE SHEET ACTIVITIES, THUS HELPING BANK CAPITAL REQUIREMENTS. Nonetheless, these instruments were risky and could led to enormous losses.

THE ECONOMIC RECESSION IN THE 80s LED BANKING INSTITUTIONS TO SEEK RISKIER INVESTMENTS. In these period banks would also create alternative types of accounts, such as NOW accounts, in order to avoid regulation and remain competitive. In the 80s the financial market was very competitive because of the rapid growth of mortgage and mutual fund markets. These circumstances of high competition, risky investments and low returns had not happened during the 70s and 60s. In this decades the availability of alternative investments was low relative to the 80s.

The main factors for the change in Banking procedures were the rapid increase of alternative investments, changes in government regulation and external economic shocks. Today Bank conglomerates that have a wide range of alternative ways of investment, which were not highly developed in previous decades. Conglomerates engage in investment and commercial banking, mutual funds, derivatives, etc. Certainly, Bank procedures have changed in the US because of these reasons.

1 FREDERIC MISHKIN, CHAPTER 11, PG 293

 

 Student 4

Based on these arguments, person B is correct. Even though person A is correct in saying that banks’ profits come from the interest rate spread between loans and deposits, banking institutions can earn profits and partake in different realms outside of person A’s traditional banking definition. Due to financial innovations, such as MONEY MARKET mutual funds, commercial paper, and junk bonds, banks have been forced to conduct “off-balance sheet” activities, such as charging fees to their customers and loan sales, to compensate for the loss of business these financial innovations have caused. Due to the difference in regulations in different countries, banks and their functions differ throughout the world. In the United States, the Great Depression caused the passing of the Glass-Steagall Act in 1933, which separated commercial banking from the securities industry. This act was repealed in 1999. Since that time, the United States has seen the formation of financial conglomerates that allow account holders to complete all of their banking and investment needs at one place. There have been banks merging with insurance companies (Traveler’s Insurance and Citibank), banks acquiring mutual fund companies (FleetBoston acquires Liberty Funds Group), and commercial banks merging with investment banks (JPMorgan and Chase to form JPMogranChase). TO ILLUSTRATE THE DIFFERENCE OF BANKING IN DIFFERENT COUNTRIES, COMPARE THE U.S. TO JAPAN. THE JapanESE banking SYSTEM differs very much from the U.S. banking system. Banks in Japan can hold common stock while commercial banks in the U.S. cannot. In fact, U.S. commercial banks cannot even hold debt that is rated junk by Moody’s and Standard & Poors. Also, the securities industry and banking industry are not cross-functional in Japan as they are in the U.S. and Britain. Also, the U.S. has several thousands of banks while many other countries where only a handful of banks exist. Even with the financial conglomeration in the U.S., the U.S. will never be dominated by a couple of banks because of monopoly concerns that our government agencies, like the Securities and Exchange Commission, will confront and prevent from happening.

 

 Student 5

The person quoted in “B” is right FOR THE MOST PART because there have been many financial innovations since the beginning of banking AND THE BANKS ROLE WITHIN THE ECONOMIC SYSTEM HAS DRAMATICALLY CHANGED. The person quoted in “A” was not completely wrong in saying that “banks are collecting deposits and use them to provide loans. Their profit comes from the difference of high interest rate on loans and low interest rate paid for deposits,” but this is only part of the role of banks. Banks may have started out this way, but now there is a lot more to them. There are many different ways people can invest their money with the banks. There are savings accounts, checking accounts, CD’s, etc. Banks also provide loans and mortgages. ONE OF THE MOST SIGNIFICANT CHANGES HAS BEEN THE HUGE VOLATILITY OF INTEREST RATES. THESE LARGE FLUCTUATIONS LEAD TO GREATER UNCERTAINTY ABOUT RETURNS ON INVESTMENTS. THE INTEREST RATE RISK HAS BEEN VERY HIGH CAUSING BANKS TO ISSUE ADJUSTABLE-RATE MORTGAGES WHERE THE INTEREST RATE ON MORTGAGES CHANGES WITH THE MARKET INTEREST RATE. THE INCREASED INFORMATION TECHNOLOGY ALLOWS INVESTORS TO DETERMINE GOOD AND BAD CREDIT RISKS. THIS HAS INCREASED LONG-TERM DEBT SECURITIES AND THE ISSUING OF JUNK BONDS. IT HAS ALSO ALLOWED CORPORATIONS TO ISSUE SHORT-TERM DEBT SECURITIES LIKE COMMERCIAL PAPER MORE EASILY. ANOTHER MAJOR INNOVATION IN BANKING WAS MONEY MARKET MUTUAL FUNDS IN WHICH YOU INVEST A CERTAIN AMOUNT OF MONEY INTO THE FUND WHICH IN TURN INVESTS IT IN STOCKS OR BONDS THAT PROVIDE INTEREST PAYMENTS. MUTUAL FUNDS DO NOT HAVE RESERVE REQUIREMENTS AND CAN PAY HIGHER INTEREST RATES. TRANSACTION AND INFORMATION TECHNOLOGY HAS LED TO SECURITIZATION, THE PROCESS OF TRANSFERRING ILLIQUID ASSETS INTO CAPITAL MARKET SECURITIES. AN EXAMPLE OF AN ILLIQUID ASSET IS A RESIDENTIAL MORTGAGE. FINANCIAL INSTITUTIONS BUNDLE TOGETHER A PORTFOLIO OF LOANS, COLLECT INTEREST AND PAY OUT TO A THIRD PARTY. BANKS have to hold a certain amount of reserves for every transaction that they make WHICH IN A WAY ACTS AS A TAX ON DEPOSITS. THEY ARE A COST ON THE BANK EQUAL TO THE INTEREST RATE THAT WOULD HAVE BEEN EARNED IF THE RESERVES WERE LENT OUT. Banks have to decide who they want to loan money to and how much risk they are willing to take. If they take on too much risk and people do not pay back their loans, their assets can decrease and if they decrease too much, the bank may become insolvent. Over the years there have also been many banks panics where people fear for some reason that the bank is going to become insolvent and everyone rushes to the bank to take out their money. When this happens at once, the bank does not have enough ASSETS to give everyone their money. Again, banks do collect deposits and provide loans, but it is definitely not this simple There have been many laws and acts passed that banks have to follow. THE MCFADDEN ACT OF 1927 did not allow banks to merge or BRANCH WITH banks in other states. IT ALLOWED MANY SMALL BANKS TO STAY IN EXISTENCE BECAUSE LARGE BANKS COULD NOT FORCE THEM OUT. Economists wanted competition between the different banks. People found ways around these laws HOWEVER, and began to move into other states to merge. ONE EXAMPLE IS BANK HOLDING COMPANIES WHICH OWN SEVERAL DIFFERENT COMPANIES. ANOTHER WAY TO AVOID THE BRANCHING RESTRICTIONS WAS WITH NONBANK BANKS. A BANK WAS DEFINED AS A FINANCIAL INSTITUTION THAT MAKES LOANS AND ACCEPTS DEPOSITS. NONBANK BANKS DID ONE OR THE OTHER AND THEREFORE WERE NOT REQUIRED TO FOLLOW BANKING LAWS. ALL OF THESE FINANCIAL INNOVATIONS HAVE MADE BANKS LESS DESIRABLE BECAUSE PEOPLE CAN EARN A HIGHER RATE OF RETURN BY INVESTING THEIR MONEY IN LARGE CORPORATIONS, STOCKS, AND MUTUAL FUNDS. Banking HAS ITS SIMILARITIES AND differences in different countries. The United States has over 8100 commercial banks whereas other countries have FOUR OR FIVE LARGE banks. IN ALMOST EVERY COUNTRY, BANKS ARE REGULATED TO SOME DEGREE BY THE GOVERNMENT, WHICH MEANS THAT THEY MAY BE SUBJECT TO RESTRICTIONS ON INTEREST RATES. WITH FINANCIAL INNOVATION AND DEREGULATION OCCURRING ALL OVER THE WORLD INCLUDING JAPAN, AUSTRALIA, AND EUROPEAN COUNTRIES, THE POWER OF BANKS HAS DRAMATICALLY DECLINED EVERYWHERE. IN CONCLUSION, I FEEL THAT B HAS A BETTER UNDERSTANDING ON THE ROLE OF BANKING AND UNDERSTANDS THE NUMEROUS FINANCIAL INNOVATIONS. HOWEVER, B SAYS THAT BANKING IS “NOT THE SAME IN DIFFERENT COUNTRIES,” BUT IN FACT, MOST COUNTRIES HAVE UNDERGONE MANY SIMILAR FINANCIAL INNOVATIONS CAUSING THE DECLINE IN THE USE OF BANKS ALL OVER THE WORLD.

 

 Student 6

In my opinion, person B has a more sufficient argument. This parallels Schumpeter’s opinions on the role of banks. The banking system in the United States has changed over time. However, it is still unlike any other country’s system. In earlier days, there were heavy regulations on the number of large banks in the United States. Banks were ONLY allowed to OPERATE WITHIN THEIR state lines. This, IN TURN, CREATED many small banks throughout the country, AND FORCED BANKS TO limit competition. THERE IS A VERY FEW NUMBER OF BANKS IN OTHER COUNTRIES, AND EACH ONE IS VERY LARGE. As time has passed, the United States has dropped some of their regulations. Banks are starting to get bigger. THIS IS DUE IN PART BY ALLOWING LOCAL BANKS TO EXPAND AND COMPETE ACROSS STATE LINES. IN RESPONSE TO BRANCHING RESTRICTIONS, THE NUMBER OF BANKS IS ALSO DECREASING. INNOVATIONS SUCH AS BANK HOLDING COMPANIES, NONBANK BANKS, AND AUTOMATED TELLER MACHINES HAVE ALLOWED the banking system TO become more like the rest of the world. Despite a change in the banking system, entrepreneurs have also looked towards these innovations to promote the system’s efficiency. Things such as checks and credit cards have become substitutions as the medium of exchange for money. INCENTIVES FOR ENTREPRENEURS ARE NOT TO INCREASE INVESTMENTS, BUT TO ACHIEVE SUCCESS THROUGH INNOVATION AND THE REDISTRIBUTION OF THE FACTOR OF PRODUCTION FOR BANKING AS A WHOLE (derived from class notes and “best answers” of assignment #1). THIS ALLOWS FOR MORE EFFICIENT INNOVATORS, AND CREATES A NEW POWER FOR THE FINANCIAL SYSTEM. I BELIEVE person A (WHO APPEARS TO PARALLEL Mishkin) is correct in saying that banks serve as a financial intermediary between the lender and borrower. THIS IS HELPFUL TO MINIMIZE THE PROBLEMS OF ASYMMETRIC INFORMATION AND IS VERY IMPORTANT IN ORDER TO STABILIZE THE FINANCIAL MARKET. HOWEVER, I feel their role within the economic system is much greater. As time progresses, innovations AND DEVELOPMENT IN THE BANKING INDUSTRY WILL GENERATE MORE AND MORE efficiency FOR THE ECONOMY AS A WHOLE.

 

 Student 7

In the question, student B is right. Assuming he is talking about the American banking system, he is correct in asserting that “banking has changed considerably due to numerous financial innovations.” Innovations such as money market mutual funds have revolutionized where people store their money. For many households, holding money in banks may no longer be the preferred choice. Now, however, banks as well as other financial institutions offer theses types of investment opportunities. Not only has there been financial innovations such as this one, but also banks size and role has changed from financial innovations and regulations. The best way to examine these drastic changes is to see what has happened since the abolition of the Glass-Steagall Act, and view the way opinions have since changed. After the abolition of the Glass-Steagall Act, banks were able to expand their power and become an “actor” who played more than the traditional role Student A proposes. Banks were now able to act as insurance companies and financial securities sellers. An example of this is the conglomerate Citigroup, one of the biggest mergers in history that although it occurred before the abolition of the Glass-Steagall Act, it helped force the issue. An important question student A might pose to student B is was this a good thing? An answer to this will be discussed later (the best answer Student A’s question to student B would be found in question 5’s answer dealing with the necessity of regulation in banks and financial markets). “The Glass-Steagall Act separated the activities of commercial banks from those of the securities industry… it allowed commercial banks to sell new offerings of government securities but prohibited them from underwriting corporate securities or from engaging in brokerage activities” (Mishikin p250, 259). Banks were also not allowed to enter into real estate and insurance activities. By doing so the Glass-Steagall Act hoped to protected banks from competition. The development of Citigroup represents the general sentiment at the time which was attempting to find loopholes in the law so that banks could become more financial powerful; this was know as “loophole mining” and Mishkin describes it as “coming up with financial innovations that get around these regulations in the banks’ search for profits” (p 253). The key loophole (found by the Federal Reserve in Section 20 of the Glass-Steagall Act, ‘allowing bank holding companies to underwrite previously prohibited classes of securities’) was used by J.P. Morgan, a commercial bank holding company, whom the Federal Reserve allowed to underwrite corporate debt securities and to underwrite stocks (p 259). Pressure came down on Congress from all sides to appeal the Glass-Steagall Act because it prohibited them from being as competitive in the world market with foreign banks. Citigroup is a product of a merger that was the catalyst of the Gramm-Leach-Biley Financial Services Moderation Act of 1999, which “allows securities firms and insurance companies to purchase banks, and allow banks to underwrite insurance and securities and engage in real estate activities” (p 259-260). Citigroup was the outcome of a merger of Citicorp, “the second-largest bank in the United States, and Travelers Group, which was in the insurance business and also owned the third-largest securities firm in the country, Salomon Smith Barney” (p 260). The reason this merger was so revolutionary was not just because of its size, but because under the Glass-Steagall Act it was blatantly illegal. In bold face of the law, the Federal Reserve approved the merger; this directly shows the sentiment of the Fed and United States toward the Glass-Steagall Act. America was fed up with the Glass-Steagall Act and this merger was the straw that broke the camel’s back, forcing Congress to make a decision; their decision: The Gramm-Leach-Biley Financial Services Moderation Act of 1999 (p 260). The history of the United States provides no surprise as to why the United States feared a large central bank with much power, but after many bank panics, it is no wonder the United States saw it as necessary to create the Federal Reserve Bank. The Feds creation will be discussed later. From its birth America has always feared centralized power, this fear manifested itself in a resistance to establishment of central banks. The establishment of the United States central bank, The Federal Reserve, was a response to the need for a control on the amount of money and credit supplied to the economy and supervision of state banks (p 369). The creation of the Fed illustrates a trend in the United States. The US is moving towards larger banks with more financial power, and to the surprise of its opponents, bigger banks (across state lines) has led to more competition. A monopolistic giant has not emerged. Early opponents of large banks feared that big banks would become monopolistic and thus set about regulations to attempt to keep all banks equally competitive. One such regulation was the McFadden Act. “The McFadden Act… was designed to put national banks and state banks on an equal footing effectively prohibited banks from branching across state lines and forced all national banks to conform to the branching regulations in the state” (p 253). The problem with these regulations was that they protected inefficient banks from the competition of larger more efficient banks outside sate lines. The regulations quickly became the enemy of money hungry minds and loopholes were soon found. Three key financial innovations were able to side-step the lines draw by regulations. They were: bank holding companies, nonbanks, and automated teller machines (p 253). The financial innovations helped banks consolidate and merge until ultimately (just as Citigroup represented the death of Glass-Steagall) the McFadden Act was overturned by the Riegle-Neal Interstate Banking and Branching Efficiency Act. The Riegle-Neal Interstate Banking and Branching Efficiency Act allows “bank holding companies to acquire banks in any other state, notwithstanding any state laws to the contrary, but bank holding companies can merge the banks they own into one bank with branches in different states” (p 256). Student B may argue that there is no reason to suspect that large banks will increasing become international banks following the same progression of the US banks after state regulations were lifted. If I had the insight of the benefits of bank mergers student B had back when Fleet Bank acquired Bay Bank (note that Bay Bank first merged with Bank Boston and then Fleet Bank acquired Bank Boston), I would have been much happier. Banks are dynamic and becoming ever more dynamic as the world becomes more international; for this reason student B is clearly correct.

 

 Student 8

Person B is correct. First of all, banks are not the same around the world. Banks and the whole banking system in America are vastly different than the rest of the world, although they are becoming more similar. For example, in Japan banks can underwrite securities and hold large equities in businesses but bank holding companies are strictly illegal. In the US, only recently have banks been allowed to underwrite securities, and it is rare for banks to hold large equities in businesses. Bank holding companies are legal and are common. The regulation of banks around the world also varies around the world. The number of banks varies greatly between countries, with the US having around 8,000 commercial banks while a country like Japan has only a few. The US banking industry has also changed tremendously because of the abolishment of many bank restrictions and there is now a trend toward integration of banks. Until 1994(REIGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT), there were strong restrictions on interstate banking (MCFADDEN ACT, 1927), in order to shield state banks from commercial bank competition. In other countries, restorations on out-of-state banking do not exist, and competition is much freer. A result of this restriction was the bank holding company, and as a result they are much more prevalent in the US. The role of banks in the US has also changed, largely due to the emergence of strong competition from the thrift industry and other financial intermediaries. The amounts of deposits banks hold has been altered by money market mutual funds, because people can now earn interest on checkable deposits, and so are less likely to place their money in accounts where it will earn no interest. This has robbed banks of a “costless” source of funds, and so they have been forced to change their liability management strategies. Also, the emergence of better IT has made commercial much more prevalent because IT lowers asymmetric information problems. Many companies go to commercial paper rather than bank loans in order to raise funds, thus causing banks to restructure their asset management strategies. The repeal of the Glass-Steagall act in (PARTIALLY IN 1989) 1999(GRAMM LEACH BLILEY FINANCIAL SERVICES MODERNIZATION ACT) also allowed banks to do something much different than accepting deposits and loans; they could now underwrite securities. “THEY COULD ALSO UNDERWRITE INSURANCE AND ENGAGE IN REAL ESTATE TRANSACTIONS (MISHKIN, 260)” Investment companies can now purchase banks, such as the CitiCORP-Travelers merger. Overall, while the difference between banks in the US and banks abroad has begun to blur, the US is still different. The ratio of banks in California to that of the nation provides proof that banking in the US will still be different from that of the rest of the world because analysts predict that even with all the mergers taking place, the number of banks in the US will hover around 4000; much larger than any other country.

Reference: Mishkin: The economics of Money, Banking and Financial Markets (c)2003

 

 Student 9

It is hard to say who is right, cause they both are correct on certain accounts. First, obviously the banking business is not the same over the world. As an example, just look at the banking structures of the US versus other countries. They evolved differently. In the US there evolved a very decentralized system of banking, with the creation of the Federal Reserve System, and the lack of a central bank- but instead implemented the services of 12 regional banks. These banks then control their banks in their own in their own districts. Here in the US we have close to 8,000 commercial banks, where as in Japan there are only about 1000. Other banks around the world, such as Germany are also heavily centralized unlike US banks. Person A is correct in saying that banks collect deposits and give out loans- as a matter of fact banks are the primary tool used by business’ to fund them. Banks do most of the funding via loans, not stocks. And it is true that the banks make large sums of money on interest because banks usually loan large quantities of money. But person B is also correct in saying that the Banking Industry has changed considerably> One example of this is the Glass Seagall Act of 1933- which did not allow banks to also act as financial intermediaries. Only in 1999 did they repeal this law. Banks also play a large part in the economic system now. Though the purchase and sale of bonds, the Federal Reserve, can control the money supply, which in turns effect interest rates and inflation- and ultimately controls which investment I choose with my 1 million dollar in question #1. So their role is much more than just deposits and loans. Also the structure of banks are changing as there seems to be a movement of mergers to bring some smaller banks together which in itself has pros and cons. But researchers insist that the merger trend will not end up making the banking structure look like that of other countries. Overall, banks have played, and continue to play an important role in our economic system. Today their role is vital and necessary for an efficient means of transactions.

It is obvious, and I have already mentioned, that banking business is not the same all over the world, however I should have mentioned more in depth about the role of the banking system, (i.e. the Federal Reserve) and what it does. For this I found a found a Joint Economic Committee from the United States Congress. ( Report is at http://www.house.gov/jec/fed/fed/fed-impt.pdf ) The report summarizes the importance of the Federal Reserve, and lists four main reasons for this: “that monetary policy can dominate fiscal policy in certain circumstances, inflation is determined be monetary policy, the Fed influences and stabilizes the financial system.” The report outlines and details the functions and workings of the Fed and monetary policy. In addition I also found an interesting report on the “Financial System and the Role of Banks in the Monetary Policy In the Euro Area.” (Found at http://www.ecb.int/pub/wp/ecbwp105.pdf ) This report directly addresses how the banks in the Euro sector compare to those around the world. For example they say that “most European countries rely much more heavily on bank finance than for example the US.”

They also explore the similarities of the actual banking structure across Europe as opposed to those in Germany or US. They note that, “ The national market concentration as measured by the Herfindahl index is much lower in Germany than in France. . . that in both countries the five largest banks show a similar market share. . . and therefore Germany is characterized by a banking system with many more small banks, a large proportion of which is affiliated to a network.” Some of this newly presented and well-researched concepts might agree with more of what person B was saying – the role within the economic system has changed (as was seen in the Congress Report) and it is also not the same as in different countries ( as seen in later report mentioned.)
 

 

 Student 10

It is true that banks collect deposits and use them to provide loans, as is expressed in statement A. However, the banking business is different in many countries and its role in the economic system has changed due to its increasing relationship to the rising number of financial institutions. The U.S. has a very large number of commercial banks due to the Mc Fadden Act that prevented banks to expand beyond the borders of their states. Europe, on the other hand, has several large banks that dominate the banking business. Although it appears as though such a situation decreases competition, it is perceived that the American banking system is less beneficial to consumers because it supports inefficient banks. The policy restricting banks from opening branches in different states led to innovative bankers to create financial institutions that avoid these restrictions. The emergence of bank holding companies, “nonblank” banks, and ATM’s are a result of these regulations. At the same time, under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, banks have been merging together and acquire other banks, resulting in a decline in the number of banks in America over the past twenty years. Thus, the face of the banking system in America has changed dramatically over the past decades. The rise of financial institutions has also had a significant impact on the banking system, primarily on its role in the economy. When a person wanted to start up a business, she would either use his equity capital or go to the bank and take out a loan on which he would have to pay interest. However, with the emergence of additional financial intermediaries there are more possibilities for the path from savers to profitable investment opportunities. Loans to investment opportunities can now also be provided by private households or other corporations, in the form of bonds or stocks. Although the stock market is given a lot of attention in the media, the market for bonds makes up a larger fraction of corporate funding. Banks have also seen a significant reduction in policies separating commercial banks from other financial service industries. The Glass-Steagal Act of 1933, following the Great Depression, prohibited commercial banks from underwriting or dealing in corporate securities. In 1987, however, the Federal Reserve used a loophole in Section 20 of the Glass-Steagal Act, banks began to enter the business of financial institutions. Approved commercial banks were now able to engage in underwriting activities as long as the revenue didn’t exceed a specified amount, which started at 10% but was later raised to 25% of the bank’s revenue. Finally, in 1999, the Act was completely eliminated by the Leach-Bliley Financial Services Modernization Act of 1999, which allows banks to underwrite insurance and securities and engage in real estate activities. As a result, banks no longer solely rely on interest rates on their loans for profit.

In conclusion, one can say that although the banking system in America has reserved many of its traditional ways, it has definitely undergone serious changes. The Riegle-Neal Act of 1994 encouraged consolidation in the banking industry. Consolidation is stimulated even more by the Leach-Bliley Act of 1999, because consolidation is now not only possible within the banking industry but across financial service activities as well. As a consequence, banks have become larger and more intricate, fully engaging in the financial market.

Source: Mishkin, Frederic S. The economics of Money, Banking and Financial Markets

 

 Student 11

In my opinion both A and B are correct. Banks do collect deposits, provide loans and make profit for interest rates that they charge. At the same time the banking system in US has changed considerably due to financial innovations. When the banks began to form in each state, they were not allowed to have branches in other states. People did not have an option of choosing which bank they wanted to go to because there was only one in the state. This completely eliminated competition between banks and allowed inefficient banks to participate. As the time passed, new financial innovations began to form. For example ATM machines. Since someone else and not the bank own an ATM, the bank could pay a fee for using it. The courts allowed because this was not considered branching. INNOVATIONS SUCH AS BANK HOLDING COMPANIES, WHICH ARE CORPORATIONS, THAT OWEN MORE THAN ONE COMPANY END UP WORKING WITH DIFFERENT BANKS SO THEY ALSO AVOID BRANCHING RESTRICTIONS. Due to this type of innovations the banks avoided restrictions for branching. This led to greater competition and more efficient markets. ALSO MANY BANKS HAVE BEEN MERGING TOGETHER AND REDUCING THE CHANCE OF default OF LOANS IN DIFFERENT STATES. ALSO FINANCIAL DERIVATIVES FORMED WHICH ARE RISK REDUCTION TOOLS. THERE ARE THINGS SUCH AS FUTURE MARKETS AND FORWARD CONTRACTS AND OPTIONS, WHICH ARE AGREEMENTS BETWEEN TWO PARTIES ABOUT BUYING OR SELLING STOCKS. Now there are many innovations that make markets efficient. For example US banks allow European banks to hold their assets in banks and Europeans banks do not have to pay reserve requirement like all US banks do. This is useful for US so that Europe does more financial activities with America. Also the creation of Eurodollars in England for example where America keeps its assets. This way there are no reserve requirements for US. THE EXCHANGE RATES BETWEEN THE COUNTRIES, THE INTEREST RATES AND BASICALLY THE WHOLE ECONOMY IS INFLUENCED BY BANKS AND THE TRANSACTIONS THEY DO IN THE WORLD TODAY. So in a way the banks work by charging interest rates to make profit as person A said but at the same time person B is right because many things regarding the banks changed greatly.

 

 Student 12

Person B is correct. Statement A is easily disproved by several facts: Some countries have central banks, others do not. In the US, banking has changed over time with the Federal Reserve Act and subsequent acts that have changed what banks can do and what instruments exist to provide trust in the banking system. WITH DEVELOPMENTS IN CONSUMER BEHAVIOR, BANKS ARE PROFITING NOT ONLY FROM THE DIFFERENCE BETWEEN INTEREST EARNED AND PAID, BUT ALSO FROM PROVIDING SOLUTIONS FOR E-COMMERCE AND OTHER GROWING TRENDS. THE BANKING INDUSTRY IN THE U.S. AND ABROAD HAS BECOME MORE CONSOLIDATED AS BANKS BECOME MORE VAST IN THEIR OFFERINGS.

IN THE UNITED STATES, WHERE THE FEDERAL RESERVE IS INDEPENDENT FROM THE GOVERNMENT, UNLIKE IN SOME OTHER COUNTRIES WITH CENTRAL BANKS, BANKING HAS CHANGED THROUGHOUT THE YEARS. With the recent Glass-Stegal Act in the US, banks can do more than just make loans and attract savings deposits. They can now provide money-market accounts and investment services. Also, banks can now operate outside of the state in which they were established. The Federal Reserve Act established twelve regional banks, established open-market operations, and policy on the Fed’s lending of money to individual banks at a discount. They establish the Federal Funds Rate, which is the rate at which banks can make short-term loans to other banks. This is necessary so that banks can meet their “reserve requirements” also set by the Fed. Given the money multiplier, banks lend out more money than they have deposited in the bank at a given time. After the bank runs in the early nineteenth century, the Fed REQUIRED BANKS TO HOLD IN RESERVES A CERTAIN PERCENT OF MONEY LOANED.

Government regulation of banks in the US has changed over history to ensure that consumers always have “trust” in banks and their money. Thus, banking has changed over centuries. Furthermore, banks have accumulated financial innovations such as debit cards and ATM’s, which make deposits even more liquid. These two innovations alone provide more opportunities for banks to profit by charging consumers and merchants for the increasing convenience that corresponds to greater liquidity.

The examination of the US banking system alone is enough to validate statement B and to disprove statement A. However, the mere fact that the US system is different from baking in other countries further supports statement B. With time and banking technological improvements and financial innovations, banks have helped to facilitate a global economy, where assets can change hands between a person in the US and a company in Europe with the click of a button. More changes in the banking system will come with future innovations in financial markets.

 

 Student 13

I think “B” is right for a number of different reasons. Banking has changed considerably due to numerous financial innovations. Less and less people are putting their money into commercial banks, IN such as checking and savings accounts, because of the other options of where you can store your money and earn more interest. The first innovation is the money market mutual fund. This is where people can invest small amounts of money into a number of different stocks. The mutual fund collects all the money and buys large blocks of stock that would cost the regular citizen a very large sum of money TO INVEST IN OTHERWISE. The public gets a diversified portfolio with low risk and a higher interest rate than a savings account. You can also write checks on the account WHICH MAKES IT SIMILAR TO A CHECKING ACCOUNT, so you don’t need to invest large amounts of money into a checking account at a commercial bank. Short-term debt instruments provide people with a place to invest with low risk and high interest rates. With the improvement of technology more information is available to people about company’s financial positions. SO MANY LARGE COMPANIES THAT WOULD USUALLY TAKE SHORT TERM LOANS FROM BANKS, NOW BORROW MONEY FROM THE PUBLIC BY ISSUING COMMERCIAL PAPER, ACCORDING TO MISHKIN. Junk bonds are becoming more popular because people are discovering that some companies get bad ratings, only have the bad rating because nobody really knows about them not because they have a large default risk. Securitization is also becoming popular, IN WHICH banks are making illiquid assets liquid by bundling together loans such as mortgages and selling them as securities and people are investing in them also rather than putting their money directly into a savings account. ACCORDING TO MISHKIN DIVERSIFICATION LOWERS THEIR RISK, AND THEY ALSO GUARANTEE PEOPLE PRINCIPAL PAYMENTS AND INTEREST PAYMENTS. People are also buying commercial notes from large corporations because of the high-speed technology now available. The largest factor that has changed the role of the banks has been the computer and the availability of the information to the public about low-risk investments that offer better interest rates and rate of return then the commercial banks. So banking doesn’t not play as large a role as it did many years ago. THESE FINANCIAL INNOVATIONS REALLY ATTRACTED IN THE FIRST PLACE BECAUSE UP UNTIL 1994 WITH THE RIEGLE-NEAL ACT BANKS WHERE NOT ALLOWED TO AWARD INTEREST ON CERTAIN ACCOUNTS, SO INVESTING YOUR MONEY IN COMMERCIAL BANKS WAS EXTREMELY UNATTRACTIVE. SUCH THINGS AS NOW AND SWEEP ACCOUNTS BECAME VERY POPULAR TO AVOID THE REGULATIONS. EVEN WITH THE REMOVAL OF THE REGULATION THIS JUST INCREASES THE BANK’S COST OF ACQUIRING FUNDS OR LIABILITIES. WHEN REGULATION Q WAS REMOVED WHICH REMOVED THE INTEREST CEILINGS IN 1980 BANK FAILURES INCREASED BY A LARGE NUMBER, BECAUSE BANKS COULD NOT KEEP UP WITH THEIR INTEREST PAYMENTS THAT THEY HAD NOT INCURRED BEFORE. Other countries banking systems are also very different. Many countries such as London have a few large banks that hold most the money and provide many options for investments. Because the United States has many regulations on banks they can’t do as many things as the commercial banks outside the United States. Until very recently commercial banks could not underwrite securities. Commercial banks in other countries play a much large role in the economic system of their country because of the regulations put on banking. In other countries also the stock markets are not as large and all encompassing so the public feels safer by just putting their money into savings in the bank. OTHER COUNTRIES ARE NOW SEEING THEIR FINANCIAL MARKETS EXPAND LITTLE BY LITTLE. THE DECLINE OF BANKING IN OTHER COUNTRIES IS BEGINNING BUT IS NOT AS FAR ALONG AS THE UNITED STATES. COMMERCIAL BANKING IN OTHER COUNTRIES STILL PLAYS A MAJOR ROLE IN THEIR ECONOMIC SYSTEM. ONE MAJOR THING THAT IS THREATENING OTHER COUNTRIES COMMERCIAL BANKING IS THE FOREIGN BANKING INDUSTRY THAT HAS LESS REGULATIONS ALONG WITH FOREIGN FINANCIAL MARKETS. JAPAN HAS EXPERIENCED A LARGE AMOUNT OF DEREGULATION TO THE BANKING INDUSTRY WHICH HAS CAUSED A NUMBER OF COMMERCIAL BANKS TO COLLAPSE BECAUSE THEY BOUGHT MANY SECURITIES AND REAL ESTATE AND THEN THE MARKET WENT BAD LEADING TO THEIR COLLAPSE. All in all the role of banks in the United States is different than the role of the banking in other countries. BUT I DO BELIEVE THAT YOU WILL SEE THE BANKING INDUSTRY IN ALL COUNTRIES BECOME SIMILAR IN THE FUTURE.

 

 Student 14

The banking business around the world has most certainly evolved over the past century and is definitely not a static industry. Two major factors involved in the change of the banking system are financial innovations and the globalization of the economy. From 1934 to about the early 1980’s, the number of banks in the economy was very stable. All of a sudden, changes in regulation and financial innovation caused a precipitous decline in their number. THE ROLE OF BANKS DEFINITELY HAS CHANGED, BUT THE STRUCTURE OF THE INDUSTRY ALSO CHANGED. THE ALLEVIATION OF RESTRICTIONS INCREASED THE RELATIVE COMPETITION IN THE INDUSTRY AND THIS RESULTED IN BOTH BANK FAILURES AND NUMEROUS MERGERS AND CONSOLIDATIONS. Many bank CONSOLIDATIONS occurred as the Glass Steagall act eroded and as financial innovations put increasing pressure on bank’s profitability. The largest factor in business finance stems from bank loans and this factor has not changed. This is just about the only thing about banks that has remained static. Financial innovations arise in time due to the desire to increase profitability, reduce risk, changes in demand and supply conditions, or for reasons of avoiding regulations. Money market mutual funds, JUNK BONDS, THE COMMERCIAL PAPER MARKET, AND SECURITYZATION HAVE DECREASED THE TRADITIONAL ROLE OF BANKS and many other factors have been taking away banks’ business. WITH THE IMPROVEMENT IN INFORMATION TECHNOLOGY IN THE 1970s, MANY INVESTORS WERE BETTER ABLE TO PICK GOOD INVESTMENTS AND STAY AWAY FROM THE LEMONS. JUNK BONDS, PIONEERED BY MICHAEL MILKEN, PROVIDED INCREDIBLE RETURNS WITH MUCH LESS RISK THAN EXPECTED. THE COMMERCIAL PAPER ISSUED BY LARGE CORPORATIONS PROVIDED A SLIGHTLY HIGHER INTEREST RATE THAN BANK DEPOSITS, AND ASSUMED ONLY A TINY BIT MORE RISK. IN ADDITION, SECURITYZATION TRANSFORMED ILLIQUID ASSETS INTO CAPITAL MARKET SECURITIES. ALL OF THESE THINGS DRASTICALLY REDUCED THE CONVENTION ROLE OF BANKS AND FOREBODED DISASTER. Until 1960, the interest rates were kept at a low, but soon they began to rise and this began the decline in the role of banks. As the interest rates rose for the next few decades and during the price level skyrocketing at the time of the oil embargo in 1973, people’s opportunity cost of leaving their money in low paying deposits increased. This led to disintermediation and banks were failing rapidly. This problem led to bank panics and the crisis (bank) of 1980. Widespread bank failures created negative incentives for the banking industry. Bankers would feel pressure and see declining profitability and thus assumed riskier projects. This created moral hazard and was worsened by the introduction of FDIC and other government safety nets. While these safety nets did protect consumer deposits and prevented bank panics, it cost the government a lot of money in increased moral hazard. Moral hazard also occurred in other institutions and caused the S & L scandal and subsequent bailout. As a result of this decline in profitability, consolidation increased, and banks did use their liabilities in new and riskier ways. The FDICIA did alleviate some of these problems, but largely the industry is still very dynamic. A trend towards reducing trade barriers and globalization also dramatically altered the industry. Government regulation was not able to control multinational banks and thus banks were able to avoid reserve requirements and other regulations like regulation Q. More international financial innovations like the advent of the Eurodollar and Eurocurrencies also dramatically changed the industry. WHILE MANY EXPERTS TRULY BELIEVE THAT THE INDUSTRY WILL SOON BE CONTROLLED BY JUST A FEW HUNDRED BANKS, A MORE PROMINENT VIEW IS THAT THE CONSOLIDATION SURGE WILL SETTLE DOWN. BOTH THE CONSOLIDATIONS AND A SYSTEM OF NATIONWIDE BANKING TEND TO INCREASE COMPETITION AND DRIVE THE WEAKER FIRMS OUT OF THE MARKET. THIS NOT ONLY RAISES THE EFFICIENCY OF THE INDUSTRY, BUT CONTINUES TO MAKE IT MORE DYNAMIC. As one banker said it best, even though bankers wear black suits, the industry is quite dynamic.

 

 Student 15

Speaker B is correct. The deregulation of banking activities have allowed banks to expand into the financial markets. They are no longer limited to simply offering checking and savings deposits and often merge with larger investment banks in order to provide a wide variety of financial services. Speaker A neglects the fact that in the United States the traditional way of making a profit (paying low interest on deposits and charging high interest on loans) is declining. Just as deregulation expanded the activities of banks, it also allowed investment banks to provide services that were traditionally in the domain of regular banks (loans, deposits, etc.) Consider this for example, you can use your JP Morgan Chase checking account to make a withdrawal to pay for shares within a mutual fund that JP Morgan manages. In summary, in the United States and in many developed countries, the traditional banking system is gradually being replaced by the innovation of investment bank/bank mergers. The new role of these merged institutions is to conduct traditional banking services/ provide market information and provide investment opportunities

 THE TRADITIONAL BUSINESS OF BANKING IS BECOMING LESS PROFITABLE AS -THE STOCK MARKET IS GAINING INCREASING IMPORTANCE AS FUND PROVIDERS . EVENT THOUGH BANKS REPRESENT APPROXIMATELY 30 % OF ALL FUNDS PROVIDED. THIS FIGURE IS DECLINING -THIS TREND HAS BEEN ACCELERATED IN RECENT YEARS BY THE PROCESS OF DEREGULATION. WHICH HAS MAINLY TAKEN EFFECT IN THE FOLLOWING FORMS: REPEAL OF GLASS-STEGALL ACT OF 1999. -TRADITIONAL BANK ACTIVITIES RECEIVED A BLOW BECAUSE THIS REPEAL ALLOWED FINANCIAL FIRMS TO EXPAND INTO TRADITIONAL BANK ROLES -ANOTHER IMPORTANT TREND UNDERMINING THE TRADITIONAL BUSINESS OF BANKS IS THE PREVALENCE OF MERGERS --> CAUSED BY THE REPEAL OF THE GRAMM-LEACH-BILILEY LAW IN 1999. -SO NOW WE SEE MORE BANKS AND SECURITY FIRMS MERGING -EXAMPLE JP MORGAN CHASE -TO PROBE A'S ARGUMENT A LITTLE MORE , A FAILS TO CONSIDER THAT IT IS BECOMING COSTLY FOR BANKS TO PROVIDE INTEREST PAYMENTS ON CHECKING ACCOUNTS. AS THE PROFITABILITY OF TRADITIONAL BANKING DECLINED, MORE BANKS OFFERED INNOVATIVE SERVICES SUCH AS CURRENCY EXCHANGE. -ALSO IN RESPONSE TO HIGHER RETURNS BANKS OFFERED HIGHER RATES OF INTEREST ON THEIR MONEY MARKET ACCOUNTS WHICH ARE NOT SUBJECT TO RESERVE REQUIREMENTS. -EXAMPLE TODAY CITIZENS' BANK OFFERS 1.30% ON THEIR CHECKING ACCOUNT BUT 3.30% ON THEIR MONEY MARKET ACCOUNTS -UNITED STATES NOW CONVERGING WITH OTHER DEVELOPED COUNTRIES AS THE BANKING INDUSTRY IS LESS SEGMENTED BETWEEN THE SECURITIES AND BANKING INDUSTRIES

 

 

 

 

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