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Money and Capital Markets
44C h a p t e r
Eighth Edition
Financial Institutions and Instruments in a Global Marketplace
Peter S. Rose
McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu
The Future of the Financial System and the Money and Capital MarketsThe Future of the Financial System and the Money and Capital Markets
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Learning Objectives
To understand the economic, demographic, social, and technological forces reshaping the financial system today.
To study where recent trends in the financial system appear to be leading us and how we may be affected.
To understand how the problems of the financial system today may influence the shape of the financial marketplace of the future.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Introduction
Powerful forces are reshaping the financial system today, as well as the public’s demand for financial services.
These forces for change include powerful new trends within the financial sector itself, major changes in the structure and functioning of the economy, and new social and demographic trends that are altering the public’s need for innovative financial services.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Financial ForcesReshaping the Financial System Today
Financial innovation - the development of new financial services and instruments
Service proliferation - the expansion of the menu of financial services offered
Competition - the intense struggle for the customer’s business
Homogenization - the blurring of the traditional distinctions among the different types of financial institutions
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Financial ForcesReshaping the Financial System Today
Consolidation and convergence - mergers and acquisitions across sectors have created financial giants and decreased the number of firms in the industry
Deregulation - the lightening or elimination of government rules
Globalization - the global expansion of operations and the falling of geographical barriers
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Financial ForcesReshaping the Financial System Today
Harmonization - the coordination of financial and economic policies
Market broadening - the expansion of traditionally local markets to become regional, national, or even international in scope
Securitization - the pooling of loans and the issuance of securities as claims against the loan pool
Greater emphasis on risk management
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Social, Economic, & Demographic Forces and TrendsReshaping the Financial System Today
Aging population - there is a greater need for retirement, tax and estate planning
Changing basic family unit - the rise in the proportion of single-parent households, parents and children living apart, immigrants, and well-educated working women will increase the demand for new forms of housing, daycare facilities, flexible work schedules, and less expensive medical care.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Social, Economic, & Demographic Forces and TrendsReshaping the Financial System Today
Displacement of the manufacturing industries by service industries in more developed economies
Technological innovation - the dissemination and storage of information today is broader, cheaper, faster, and more accurate
Internationalization of markets - such as the formation of the European Community
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Risk in the Financial System:The Challenges and Opportunities
The money and capital markets and the financial institutions that operate within them depend heavily on public confidence.
Ways to promote the strength and viability of financial institutions, and hence public confidence, include government insurance systems capital adequacy regulations market discipline risk-management tools
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Risk in the Financial System:The Challenges and Opportunities
However, the efforts made at promoting public confidence are limited by the information problem - capital market investors can only approximately price the securities of institutions that do not fully disclose their financial condition and prospects.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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New Technology:The Challenges and Opportunities
The technological revolution in information analysis, storage, and transfer is moving at an accelerating pace.
Global integrated electronic networks are changing the design and delivery of financial services: Internet or World Wide Web Cellular telephones and hand-held computers Smart cards
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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New Technology:The Challenges and Opportunities
However, the adjustment of the public to the unfolding technological revolution will probably be slower than the revolution itself.
The areas to watch include: friendliness of the user interface operating costs and service prices ease of technological upgrade data integrity and system security
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Homogenization of Financial-Service Suppliers:The Challenges and Opportunities
Financial-service firms will face increasingly intense competition and price-sensitive customers.
Financial institutions with extensive service delivery systems will have a competitive advantage.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Homogenization of Financial-Service Suppliers:The Challenges and Opportunities
The unfolding new markets will require new financial institutions and instruments, such as credit risk derivatives and additional secondary markets for loans.
New institutions will also be needed to facilitate the continuing trend of securitization, such as those that deal in mortgage-backed securities.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Consolidation and Convergence:The Challenges and Opportunities
Proponents argue that: The elimination of duplication will bring about
substantial savings in operational costs. The broadening of services and customer segments
will accelerate the growth in revenue. The greater diversification will reduce overall risk. The combination of expertise will result in higher-
quality products and services. The greater economies of scale will increase the
affordability of the latest technologies.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Consolidation and Convergence:The Challenges and Opportunities
Opponents point out that: The greater complexities of the firm may increase
its operating costs. The public’s demand for “one stop” financial
shopping may be overestimated. Smaller financial-service companies may have
their own competitive advantage. Smaller financial-service companies may compete
effectively in terms of the range of services available by outsourcing part of their operations.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Financial Services Regulation
The growing consolidation and convergence of financial-service companies poses major new challenges for the regulatory agencies charged with maintaining a competitive, yet safe and stable, financial system.
Different approaches to regulation are possible depending on the organizational structures that are allowed.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Financial Holding Company
InsuranceCompanies,
Underwritersand Agents
Security Brokers,
Dealers and Underwriters
BankingFirms
OtherFinancial-
ServiceCompanies
Financial Services Regulation
Financial Holding Company Model
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Banking or Other Controlling Firm
SecuritiesSubsidiary
InsuranceSubsidiary
Financial Services Regulation
Subsidiary Model
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Holding Company or Parent Firm
Affiliated and/or Subsidiary Companies
Financial Services Regulation
Single Regulator Model - One regulatory agency supervises the operations of the whole financial service firm.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Financial Services Regulation
Functional Regulator Model
Holding Company or Parent Firm
SecuritiesFirm
InsuranceCompanyBank
SecuritiesRegulator
InsuranceRegulator
Bank Regulator
Holding Company Regulator
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Management Coordination
The difficulties of coordination and control in larger and more diversified financial institutions call for: employees who are well trained in coordination
and control skills, strong internal auditing procedures and
management information systems, and continual evaluation of subsidiary firms, profit
centers, and service functions for their contributions to the goals of the financial firm.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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The Future of the Payments System
Tomorrow’s economy and financial marketplace will depend crucially upon the continuing ability of the world’s payments system to function efficiently, speedily, and accurately.
In the U.S., the retail payments system lags significantly behind the wholesale payments system in converting from expensive paper transactions to electronic systems.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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The Future Need forRegulation of Financial Institutions
The recent trend toward deregulation is likely to continue, leading to: reduced barriers to geographic diversification, reduced restrictions on the portfolio choices made
by financial institutions, reorganization of regulatory agencies, and reduced barriers to product-line diversification.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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The Future Need forRegulation of Financial Institutions
However, there are some regulations which will be maintained or even re-emphasized: financial disclosure regulations, privacy protection regulations, regulations pertaining to social responsibility, and regulations that promote a level playing field.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Money and Capital Markets in Cyberspace
A number of web sites are devoted to the changes and trends that are reshaping the money and capital markets. See, for example: http://www.goldmoney.com/ http://www.thebankingchannel.com/ http://www.financetech.com/ http://www.ex.ac.uk/~RDavies/arian/money.html
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Chapter Review
Introduction Forces Reshaping the Financial System Today
Financial Forces Social, Economic, and Demographic Forces and
Trends
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Chapter Review
The Challenges and Opportunities Presented by Recent Trends Dealing with Risk in the Financial System:
Ensuring the Strength and Viability of Financial Institutions
The Effect of New Technology on the Design and Delivery of Financial Services
The Changing Mix of Financial-Service Suppliers Consolidation and Convergence Trends Within the
Financial System
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Chapter Review
A New Role for Financial Services Regulation in an Age of Financial-Service Consolidation and Convergence
Management Coordination within Diversified Financial Institutions
The Future of the Payments System The Future Need for Regulation of Financial
Institutions