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STRATEGIC ALLIANCES IN THE FINANCIAL SERVICES SECTOR: IMPLICATIONS FOR TRINIDADAND TOBAGOAuthor(s): ANNE JOSEPHSource: Social and Economic Studies, Vol. 46, No. 2/3, Special Monetary Studies Issue (Towardsan Efficient Financial Services Industry) (OCTOBER 1997), pp. 199-229Published by: Sir Arthur Lewis Institute of Social and Economic Studies, University of the WestIndiesStable URL: http://www.jstor.org/stable/27866142 .

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Social and Economic Studies 46:2&3 Special Issue (1997) ISSN: 0037-7651

STRATEGIC ALLIANCES IN THE FINANCIAL SERVICES SECTOR:

IMPLICATIONS FOR TRINIDAD AND TOBAGO

ANNE JOSEPH*

ABSTRACT

This paper presents an overview of the policy and economic implications of alliances between various financial institutions and in particular, commercial

banks and insurance companies. A combination of factors, and especially the liberalization of financial activity facilitated by rapid technological advances, has propelled the reordering of the financial services industry. This has produced, inter-alia, new financial instruments and financial

conglomerates; and the transformation has brought not only increased

economic efficiency but also greater risk of financial instability. As a result,

prudential standards have had to keep pace with the changes in the sector.

In Trinidad and Tobago, the industry, is also undergoing financial liberalization, and is expected to follow in the footsteps of its counterparts in the developed countries and to experience similar benefits and risks.

INTRODUCTION

Strategic alliances in the financial services sector represent one of the many outcomes of the rapid transformation the industry has witnessed in recent

years. In the developed countries, structural change and reform took place in

the late 1970s and 1980s. In Trinidad & Tobago, it is a more recent

phenomenon - the late 1980s into the 1990s. A combination of factors and

in particular, the liberalization of financial activity facilitated by technological

The author is an Economist in the Research Department of the Central Bank of

Trinidad and Tobago. The views expressed are those of the author and not necessarily those of the Central Bank.

Pp 199-229



200 SOCIAL AND ECONOMIC STUDIES

innovation has plunged the industry into a brave new world. This has led to

increased competition in the sector which spawned a number of new financial

instruments, increased internationalization of financial activity and the

blurring of barriers which separate the services of one financial institution

from another. The latter has evolved into the establishment of new institutions

(financial conglomerates), which offer a complete range of financial services.

The focus of this paper is to give an overview of the policy and

economic implications of alliances between various financial institutions, and in particular commercial banks and insurance companies. The process of change and the resulting transformation of the industry in Europe and the

United States will be discussed. Similar trends are also taking place in

Trinidad & Tobago and so there are lessons that can be learnt from the

experiences of the developed countries. The paper is divided into six

sections as follows:- as a point of departure, Section I introduces Hill's

classic definition of a service and the several extensions made to this

definition; while Section II traces the process of financial deregulation in

the developed countries and its consequences. The European experience with alliances between banking and insurance is outlined in Section III; this

Section also contains a brief discussion of some studies which measure the

impact of alliances on the efficiency and profitability of the banking sector.

Section IV focuses on financial deregulation in Trinidad & Tobago while

the final Section outlines the lessons to be learnt from events in the developed world as well as some preliminary conclusions and recommendations for

further analysis. A summary which highlights some of the main points of

the paper follows.

I. THE NATURE OF SERVICES WITH

SPECIAL EMPHASIS ON FINANCIAL SERVICES

As the focus of the discussion centers on the financial services sector,

it is perhaps appropriate to begin with a definition of services and the

characteristics that distinguish them from goods. T.P. Hill in his hallmark

article in 1977, defined a service as:

"a change in the condition of a person or of a good

belonging to some economic unit which is brought about



Strategic Alliances in the Financial Services Sector 201

as the result of the activity of some other economic unit with the prior agreement of the former person or economic unit."1

Hill added that the service is measured by the extent of the change in the consumer or the consumer's good, not by the activity of the producer. A

service to a person results in some change in his/her physical or mental condition while a service affecting a good is a change in the state of that

good.2

Bhagwati (1984) widened the concept of services by incorporating the impact of technical changes which allowed for some services to be stored (computer software) and for distance between provider and user

during the acquisition of the service. He noted that economies of scale and

technological innovations can have both a splintering and a disembodiment effect on services. Through economies of scale which prompt specialization, some of these services, normally measured as part of the value added of the

goods production process, are contracted or 'splintered' to outside economic

units e.g. accounting and transport services. The 'disembodiment' effect

arises when the service normally resident in the provider can now be

separated from this unit through technological progress, for consumption by another economic unit located in a different geographical area.3

Financial services may be categorized as those services which affect

both goods and persons.4 For example, through the activity of a banker, there is normally some change to deposits in a bank; in similar fashion, an

insurer can change the mental condition of the insured by offering protection from risk. The financial services industry may be conceived both as a single market for rather similar products and services and as a number of relatively autonomous sectors with their specific history, products, institutions, and

1 Hill, 1977, (pg. 318).

2 Hill ( 1977) contains many useful analytical classifications on services. For example, he makes a distinction between labour and capital services, permanent and temporary services and individual and collective services.

3 Sampson and Snape (1985) refer to this effect as separated services.

4 Hill drew a distinction between services affecting goods and services affecting persons.




regulation (Koguchi,1993). These institutions are involved in both banking and non-banking activities. The banking sector is usually defined to include central bank and commercial banks while the non-banking sector includes insurance companies, pension and mutual funds.5 This industry can best be

defined in terms of its role and function in the economy. The financial sector

which encompasses the banking and non-banking sectors, is considered

critical to economic growth and development because the sector facilitates

financial intermediation. This function makes the sector quite unique and

distinctive from all other types of service industries (Bhatia and

Khatkhate,1975). Through the process of financial intermediation, these institutions harness the surplus of savers for on-lending to borrowers. The

industry offers instruments and incentives (positive yields, security and

liquidity) for consumers and firms to store their wealth. These funds are lent to economic units to maintain, develop and expand the production of goods and services for domestic and export markets.6 One important function of

this intermediation process is the matching of the longer-term requirements of borrowers to the short-term needs of the savers. Another is the allocation

of these funds among borrowers and economic sectors. Issues of the

internal and allocative efficiency of the industry arise, but are not pertinent to this discussion.

The primary role of the financial system in economic growth and

development led to official regulation of the system, particularly the

commercial banks. Supervision normally includes minimum capital ratios,

liquidity requirements, and controls on interest rates and credit. In many

countries, deposit insurance coverage is also provided in order to give

protection to depositors and to assist in maintaining confidence in and

stability of the system.

5 The draft IMF Manual on Monetary and Financial Statistics (1995) defines the

structure of the financial corporations sector to include (1) central bank, (2) other

depository corporations which include commercial banks, merchant banks, credit

unions, girobanks, (3) insurance corporations and pension funds, (4) other financial

intermediaries which include finance companies, unit trusts and financial leasing

companies, and (5) financial auxiliaries which include public exchanges and securities

markets, bureaux de change and financial guarantee corporations.

6 Gurley and Shaw (1955) and Gertler (1988) further explore the interaction between

the Financial Structure and Real Activity.



Strategie Alliances in the Financial Services Sector 203

IL THE EMERGENCE OF THE FINANCIAL CONGLOMERATE

Over the last decade and a half, the financial services industry in the

developed world and more recently in developing countries has changed almost beyond recognition. Three factors - financial liberalization, rapid advances in computer and telecommunications technologies and a favourable

macroeconomic environment - have contributed greatly to the revolution in

the sector. The interventionist policies of the 1970s in the member countries

of the Organization for Economic Co-operation and Development (OECD) were deemed to be not effective largely because they were unable to cope with the many shocks to the various economic systems. The initial oil shock

and subsequent developments created severe problems in both the real and

financial sectors of these economies. In this regard, because of growing

inflationary problems and fiscal deficits, it became critical for policy makers

to have some flexibility in setting interest rates. Deregulation, on the other

hand, was seen as a way to improve efficiency, reduce costs and improve resource allocation (Pera, 1989). These theories very quickly spread to the

financial services sector which is so intricately linked with economic

growth and development. Financial regulations are generally divided into two broad categories:

(i) rate/quantity restrictions which include ceilings on interest rates and

constraints on bank credit; and (ii) "powers" regulations which cover controls

on ownership linkages, lines of business and cross-border market entry

(Blundell-Wignall et al, 1990). The scope, timing and speed of these structural

changes differed from country to country, depending on the conditions

prevailing in the particular financial market. However, there were certain

key features common to the process in virtually all the developed countries.

The removal of quantitative restrictions tended to be more extensive and

pervasive than the second category of regulations. By the early 1990s,

compulsory reserve requirements were largely reduced and controls on

foreign exchange transactions and international capital movements, abolished.

In addition, all ceilings and major constraints on lending were eliminated in

the larger industrialized countries. Restrictions on lending rates were also

lifted with the exception of a few countries, in particular Japan, where

significant control was retained on retail deposit rates. Germany, Canada

and the Netherlands were forerunners in that they removed interest and




capital constraints as early as the late 1950s and 1960s. In the United States, the United Kingdom, and the Nordic countries, the process of deregulation took place relatively quickly and was completed by the mid-1980s (see Table I). However, in southern Europe and Japan, the authorities were more

cautious and the process was more extended.

The extent of deregulation with respect to the "powers" restrictions has

been more limited. There has been some removal of the institutional

boundaries between institutions in Canada, Japan and the United Kingdom. In addition, the Second Banking Directive of the European Community

which came into force on January 1,1993 allows for the mutual recognition of regulatory standards in EC countries, and this implies further liberalization.

Japan and the United States (through the Glass-Steagall Act) remain the

only two OECD countries where commercial banking and the securities

industries are still separated by law.7 Deregulation, however, was more

limited in the insurance industry but by the early 1990s the barriers to the

combination of insurance with banking had been partially lifted particularly in the European countries.

Generally, one can distinguish four different types of alliances in

respect of lines of business in the financial sector. The first occurs between

various forms of credit intermediaries; the second, between commercial and

investment banking; the third between banking and non-financial business; and the fourth between banking and insurance. The focus of this paper is

exclusively on the banking/insurance alliances, however, a few remarks are

in order on the other three forms.

Europe was in the forefront of the deregulatory process in the financial sector while the United States and Japan adopted a far more cautious

approach. In the latter two countries, commercial banks have only been allowed to engage in investment banking with the establishment of separate subsidiaries. These changes were introduced in 1993 in Japan and in 1986 in

the United States. In Canada and most European countries, such restrictions on access to the stock exchange or on acquisition of securities firms have all

been removed. The legal and regulatory segregation between different types

7 In the U.S., efforts are underway to either repeal or modfy this Act (see Asher, ABA

Banking Journal, May 1995 for an interesting discussion of this issue).




TABLE 1. FINANCIAL LIBERALISATION IN TRINIDAD & TOBAGO DURING THE 1970s AND 1980s

Countries

United States

Japan

Germany

France

Rate/Quality Deregulation of Inter mediaries

Already de

regulated in 1970s and 1980s

Controls widely used in 1970s and 1980s

Powers De

regulation Enhancing Competition Between Intermediaries

From the mid 1970s

Strongly con trolled and little

deregulation in 1970s or 1980s.

Cartel-like behaviour evident

Ready availability of short Treasury Bills since 1975, but strong regula tion of inter

mediaries. Cartel

like behaviour evident.

Foreign Exchange Deregulation

Already deregulated in 1970s and 1980s

From 1980


Highly regula ted in 1970s and most of the 1980s-some

recent easing

Italy Credit ceilings used until 1983

Mainly in the late 1970s and

early 1980.

Carried out

gradually through the 1980s

Gradual intro duction of new

instruments,

mainly in 1980s

Being gradually Controls widely carried out mainly used and only from the mid- in late 1980s 1980s. Cartel-like phasing out behaviour evident began




TABLE 1. FINANCIAL LIBERALISATION IN TRINIDAD & TOBAGO DURING THE 1970s AND 1980s - Cont'd

Rate/Quality Countries Deregulation

of Inter

mediaries

Powers De

regulation Enhancing Competition Between

Intermediaries

Foreign Exchange Deregulation

United

Kingdom

Canada

Controls widely used until 1980


Bank cartel broken in 1971, but most

deregulation mid-1980s, especially for

building societies


Removed

controls in 1979


Source: OECD.

of banks has been abolished in the majority of the European countries.

Nonetheless, regulations are more severe with respect to ownership linkages between commercial and non-financial companies. Even in countries such

as France and Germany where significant bank involvement is permitted, there are detailed regulations governing their participation in commerce.8

The reverse is also true as most regulatory authorities do not approve of

the control of banks by non-financial companies.

8 Borio and Filosa (1994, p 9).




The Effects of Deregulation

Increased competition which is one of the objectives of the liberalization

process spread fairly rapidly within the banking sector and between banks and non-bank financial institutions. Because of intense competition, financial institutions came under increasing pressure to improve their efficiency,

market share and profitability. One clear result of this competition was financial innovation especially in terms of a new range of products (e.g. securitization), and institutions (globalization and financial conglomeration or supermarkets). Financial supermarkets result from the merging of business

among various financial institutions, which offer a complete range of financial services.

As the industry began to change, in the wake of the uncertain economic climate of the late 1970s, many corporate customers found that the cost of bank borrowing had risen sharply. In addition there were cutbacks in

options and services. Corporate customers then looked at other financial institutions for access to credit and this began to erode the traditional

banking relationships. The process of disintermediation started

simultaneously when financial intermediation shifted from commercial banks to other depository and non-depository institutions which were regulated by different regulators.9 More attractive instruments such as bonds, notes and

commercial paper were made available to large corporate borrowers. In the case of the latter, they made full use of these products instead of using the services of banks. At the same time households and other savers became

more sensitive to the yields on their investments and followed higher returns offered by mutual funds and other sophisticated products. Non-banks, particularly insurance companies, pension funds, mutual funds and the securities industry have benefitted from this diversification by households and companies.

9 Beside commercial banks, depository corporations include merchant banks, savings banks, mortgage banks and mutua1, funds and investment trusts that are included in national broad definitions of money. The non-depository corporations include insurance companies, pension funds, finance companies and non-financial activities such as real estate leasing.




One of the more innovative products which is being offered and which

results as a fall-out of the disintermediation process is securitization. This can be defined as the substitution of tradable securities for bank loans and

this allows for direct interface between holders and borrowers of loanable

funds through a middleman or underwriter. Other forms of financial

innovation include established markets in treasury bills, certificates of deposit and commercial paper. There was also rapid expansion in such sophisticated instruments as futures, options and swaps. However, there is some risk

attached to these new instruments as evidenced over the last decade during which sharp fluctuations in the prices of these products threatened the

financial strength and earnings of some financial institutions.

Consequences and Implications

There is no strong empirical evidence to support a claim that financial

deregulation and the establishment of financial conglomerates have enhanced the overall efficiency (both internal and allocative) of the financial system in

the developed countries. Hviding(1995) suggests that there are a number of

indicators i.e. volume and costs of bank services that point to some

improvement in internal efficiency. There is also some evidence that

allocative efficiency has also increased. However, in the initial wake of

deregulation, there have been a number of crises in the financial systems in

the United States, Nordic countries and Japan. However, it has been ascertained that these problems cannot be laid solely at the door of liberalization in that other factors including poor macro-economic

management were more probably the cause of these crises.

Arguments for financial conglomeration are justified on the grounds of increased efficiencies derived from economies of scale (lower average costs at higher output levels) and economies of scope (cost complementarities in

multi-product firms). A review of the literature done by Forestieri (1993) indicates that although most studies have not been conclusive, there is a

growing consensus that economies of scale have little relevance to the size of and mergers in the financial system. Other factors such as lower risk from loan diversification appear more dominant in the choice of a particular strategy. As empirical research has so far yielded contradictory results, no




conclusions can be drawn with respect to an assessment of economies of

scope in financial institutions.10

The presence of economies of scale and scope also has negative effects

which give rise to monopolistic behaviour and conflicts of interest. However, the opening up of domestic markets to new entrants and the increased

provision of cross-border services have significantly lessened concerns over

excessive concentration of power. In addition, to minimize conflict of

interest situations, it is generally recommended that the regulatory authorities

enforce a legal and institutional separation of firms where this is likely to

occur. In addition, adequate competition in the market place should encourage the institutions themselves to exercise market discipline by devising internal

management systems that would reduce the scope for conflicts of interest

and ensure that customers are treated fairly.

Financial conglomerates are also vulnerable to contagion risk and

ultimately systemic risk, which are threats to the safety and soundness of the

financial system.11 One method of addressing this problem is to establish

operational barriers or "firewalls" between the different segments of the

conglomerate. These issues are particularly relevant to the commercial

banks as they are the main providers of payment services and the intermediary function. The settlement of transactions is normally conducted through the

payment services provided by the banks and disruption of these services

would impact on the whole economy. Likewise, the intermediary function

could be affected by any hint of risk which could precipitate a crisis of

confidence which could cause a 'run' on a bank leading to default even

though the institution was basically solvent (Borio and Filosa, 1994;.

10 One result from the studies done implies that economies of scope, while relevant

may be difficult to exploit because to identify the specific customer base where these

economies originate is often impossible. Another recommends the separation of the

activities that define a financial institution as a bank.

11 Contagion risk is the transmission of financial problems within the various subsidiaries

while systemic risk occurs when a significant portion of the financial system is

exposed or is liable to be affected by insolvencies and defaults.




HI. ALLIANCES BETWEEN BANKING AND INSURANCE

Bancassurance (Allfinanz to the Germans) generally refers to the

integration of a number of activities in banking and insurance which include

production, distribution, marketing, consumer demand and consumption.

This new phenomenon gained momentum in the late 1980s following the

deregulation of the financial systems in Europe. France and Germany have

been among the first countries to embark on this new activity. Yet commercial

banks have been involved in the insurance industry for decades, through

referral fees and informal arrangements.

Against the background of financial liberalization and heightened

competition in the industry, the market for life insurance grew significantly in some European countries between 1985 and 1990. In sharp contrast, over

this same five-year period, bank deposits showed a declining trend.12 By

extension, this contraction in the deposit base together with a well-developed

branch network may have left many banks with an overcapacity in the

management of their accounts and branches. It became economic for the

banks to expand their product range at the same time that customers began

to demand several products from a single outlet. The commercial banks

perceived that if they could provide a wide range of financial products, they could maintain and perhaps increase market share. For example, a bank

could offer a customer not only a loan for the purchase of a motor car, but

also motor car insurance. Insurance companies were also attracted to this

strategy (Assurfinance) as this was a response to the competition generated

by the banks penetrating their own markets and there were distinct advantages

to widening their activities in order to gain new customers.

Bancassurance has grown and developed rapidly in Germany, France,

the United Kingdom, Denmark, the Netherlands and Spain. Financial

conglomerates which had previously offered banking services and a range

of securities have now widened their range to include insurance products.

12 Bergendahl (1995). In some European countries, the heirs to an ageing population moved their inheritances from savings accounts to higher-yielding securities and

insurance policies. In addition, this demographic factor and the more flexible

retirement age increased the demand for tailor-made pension and life insurance

schemes.




It is estimated that by 1994 there were approximately 200 banking /insurance

groups in the European Community (Borio and Filosa, 1994). It is important to mention that this blurring of the lines between banking and

insurance is strictly in the field of distribution. The production of the service

is still restricted to insurance companies. This means that banks cannot

insure their customers in the name of the bank, implying that insurance

contracts are not the liability of the bank. Therefore, insurance risks associated

with death, fire or disaster are segregated from banking risks such as

liquidity shortages or credit losses. On the other hand, restrictions on

ownership linkages between banks and insurance companies have been less

severe than the in-house production of underwriting contracts which can be

conducted by insurance subsidiaries of banks (see Table 2). In most European countries, banks are permitted to set up insurance

subsidiaries ( also called downstream linkages) with prior approval of the

regulatory authority. Similarly, upstream linkages i.e. insurance companies

investing in banks carry similar restrictions. Japan and the United States

stand in sharp contrast to this liberalized environment. In the latter, banks

and bank holding companies may not own insurance companies, except in

the credit, life and disability insurance fields.13 In Japan, anti-monopoly laws limit financial companies' holdings of equity in domestic enterprises to

5 percent. Regulations were equally strict in Canada until 1992 when new

legislation relaxed the restrictions (Borio and Filosa, 1994). There are many methods available to banks of realizing this convergence

of services. A group approach may entail the establishment of a separate life

insurance firm; the acquisition of a majority or minority shareholding in the

capital of an insurance company; or the setting-up of a joint venture with an

insurance firm. The co-operative approach includes exclusive sales

distribution agreements between a bank and insurance firm or the formation

of brokerage firms. A similar range of methods are open to insurance

companies wishing to penetrate the banking market. The group approach, a

long-term investment, should generate greater initial costs in terms of

communication and computer systems and sales training, but also greater benefits including a share in the dividend income and return on capital.

13 Although national banks are prohibited from selling insurance products, there are

over 20 States where chartered banks are allowed to market these services.



TABLE 2. LINKAGE BETWEEN BANKING AND INSURANCE: LIMITATIONS ON STRUCTURAL OPERATIONS1

fo ro CO O O > > z o m o O z o O c g m o>

Country

Belgium Canada

Denmark France

Germany

Italy

Japan Netherlands Norway

Spain

Creation

Shareholding

of an insurance

subsidiary by a

bank si

f a 1 a a f 1 si a

of a banking subsidiary by an insurance

company al f a

of a bank in an insurance

company

si si a a si

of an insurance

company

in a bank

a si a 1 1 a si

Financial group in which a bank or an insurance

company is the parent company or a company of

the gorup

a a si a si a



TABLE 2. LINivAGE BETWEEN BANKING AND INSURANCE: LIMITATIONS ON STRUCTURAL OPERATIONS1 - Cont'd

Creation

Country

of an insurance subsidiary by a

bank

Sweden

Switzerland United Kingdom

United States

si f Note:

of a banking subsidiary by an insurance

company a si

Shareholding

of a bank in an insurance company

of an insurance

company in a

bank

Financial group in which a bank or an insurance

company is the parent company or a

company of

the gorup

a a a si

a si

a si

allowed limited strictly limited forbidden

Apart from these limitations, most of the OECD countries applied prudential measures. Prior

authorisations are also frequently required.

'As at December 31, 1991.




Attempts have been made to measure the relative efficiency of German

banks since the introduction of Allfinanz. Both Bergendahl (1994) and

Brown and Gardener (1995) use the methods of Financial Ratio Analysis

(FRA) and Data Envelopment Analysis (DEA) as measurement tools.14 The

purpose of the FRA methodology, which uses single inputs and outputs, is to

explore whether the production process has improved or deteriorated over a

time period. Inputs into the production of financial services include the

value of computers and telecommunication services, while loans and deposits

are defined as outputs. Bergendahl used four ratios to measure the impact of

Allfinanz on the German banking system. The results showed that there was

no significant improvement in efficiency in any of the banks tested over the

five-year period, 1987-1991. Although the relative costs of personnel were

substantially reduced for some banks, Bergendahl found that no conclusions

could be drawn about efficiency from this use of FRA.

The methodology of Data Envelopment Analysis (DEA) requires using

multiple inputs and outputs, and provides an assessment of the efficiency of

a decision-making unit in comparison to another unit or the same unit over

different time periods. Bergendahl's choice of inputs included labour costs,

operating costs and the cost of funding gaps and loans, floating and fixed

rate deposits, interbank placements and net margins were chosen as the

output indicators.15 The efficiency scores indicated that the group of banks

that introduced Allfinanz during the sample period showed increased

efficiency, while the others which had already offered these products, maintained a stable level of efficiency. The empirical results indicated that

an extensive standardization of insurance products reduced costs and

improved profitability. A profitability analysis was also done on several German banks and a

Belgium bank by Bergendahl (1995). He identified five key factors

determining the success of Bancassurance: the number of branches, the

14 Brown and Gardner's work is on-going and therefore their conclusions cannot be

presented here.

15 The cost of funding gaps: the cost of sourcing funds on the interbank market;

Interbank placement; the gap in volume between fixed-rate and floating-rate deposits on the one hand and lending on the other. Net margins: this amount includes current

interest margins and non-interest margins.




number of insurance specialists per branch; the number of customers; the

cross-selling ratio; and the degree of learning. The number of branches and

the number of specialists per branch determine the investment cost. The size

of the market is measured by the number of customers and the fraction of

customers who may become buyers of insurance services i.e. the cross

selling ratio, which would influence the growth in commissions. Finally, the

degree of learning required to manage the insurance services, will also*affect

administration costs. Bergendahl concluded that for Bancassurance to be

successful, the activity must generate positive net benefits. This means that

the activity should be conducted based on a combination of small set-up costs, rapid growth in sales commissions, acceptable costs for sales promotion, and low administration costs. The benefits that should accrue to the bank are

customer loyalty through the sale of life insurance and the implied long term association. Another advantage should be the expansion of the customer

base (if the customer is new, traditional bank services can be offered to him). Banks with a large customer base and a moderate number of branches, should reap the largest profits.

IV. FINANCIAL DEREGULATION IN TRINIDAD AND TOBAGO

This country embarked on a programme of structural adjustment and

reform in the early 1990s following the economic malaise of the previous decade. Trinidad & Tobago was not singular in this regard as many other

countries had already begun this process of reform. In essence, structural

adjustment meant an acknowledgement that market forces engendered greater economic efficiency than official regulation and intervention. Therefore a

number of reform measures were implemented including public sector

reform, trade liberalization, exchange rate liberalization and financial

deregulation.




The financial intermediation process in Trinidad and Tobago is carried

out mainly by commercial banks and NFIs.16 The former dominate the

financial system, as they are the most important mobilizers of savings and

the largest providers of personal and commercial loans. The NFIs flourished

in the boom period of 1974-1981 and catered to the financial needs of commerce which were not readily available from the traditional services

offered by the commercial banks. Some of the finance houses had ownership

linkages with business enterprises and as a result were adversely affected

when the economic downturn got underway in the mid 1980s.17 At this time, the banks and the NFIs were governed by two separate pieces of legislation. It was not until 1993, however, that revised legislation was enacted which

brought both types of financial institutions under one umbrella. The Financial

Institutions Act, 1993 (FIA) arose out of the need to strengthen the regulatory and supervisory system in light of the financial risks brought about by

deregulation and the trend towards globalization (Victor, 1993). The Act

also deepened the liberalization process by giving the commercial banks and

non-bank financial institutions (NFIs) greater freedom with respect to the

"powers" deregulation in particular lines of business.

The new legislation provides for both banks and NFIs to perform business of a financial nature, with the business of banking confined to

banks.18 This plus the integration of both classes of financial institutions

under the jurisdiction of a single Act point to the authorities' recognition of the trend towards financial conglomeration. However, in reality, banks and NFIs will continue to maintain their separate identities both in terms of

licensing and the range of services they offer. Financial institutions may invest in commercial enterprises, but this is restricted to 100 percent of the individual institution's capital base. The restriction also covers investment in a single enterprise which is limited to 25 percent of a limited portion of

16 The NFIs are defined to include trust and mortgage companies, finance companies and merchant banks.

17 A detailed overview of the Trinidad and Tobago financial system is provided in The Financial System of Trinidad and Tobago, Central Bank of Trinidad & Tobago, 1994.

18 These two types of business are defined as two distinct areas of business in the

legislation (see Part II, Section 4(2) and 5(2)).




this amount.19 The powers of the Central Bank to effectively supervise financial institutions defined in the Act were considerably enhanced (Victor,

1993). Those powers which are specifically related to the discussion here

include the ability to require financial institutions to supply information on

the performance and activities of affiliated companies. Another stage in the process of financial reform began with the removal

of several forms of quantitative restrictions which were abolished on a

phased basis, starting with the removal of the secondary reserve requirement in 1991. This was followed in 1993 by the elimination of exchange controls on current and capital transactions together with the simultaneous shifting to

a flexible exchange rate regime. By early 1994, the process was finally concluded when all selective credit controls were formally removed.

Impact of Deregulation on Trinidad & Tobago's Financial System

The financial sector has not remained unaffected by either events or the

rapid changes in the international financial systems and markets. In addition, the economic reform programme of the Government which encompassed, inter alia, trade and financial liberalization demanded new strategies from

both the business and financial sectors. Liberalization invariably brings with it increased competition, and for business and exporters in particular, this meant a demand for innovative financial products to support their

outward thrust. For the financial institutions, in order to maintain and

increase market share, it meant diversification, financial innovation and

investment in computer technology. In addition, the commercial banks were

motivated by indifferent growth trends in their core banking activities.

Gross loans grew by an average 1 percent between 1989 and 1995, deposits fared better at 3.5 percent, while the interest margin narrowed from 4.7 per cent in 1988 to 3.6 percent in 1995 (see Table 3). The commercial banks'

share of loans fell from 80.3 percent in 1989 to 75.1 percent in 1995, while

from 19.7 percent to 24.9 percent during the six-year period. Nevertheless

the Unit Trust Corporation (UTC) also offered attractive investment

alternatives for savers such that between 1989-1995, net purchases of units

from the UTC increased on average by 10.8 percent compared with the

banks' deposit growth rate of 3.5 percent.

19 Section 22(2) (j)




TABLE III. SELECTED DATA ON COMMERCIAL BANKS

(SM)

Year Gross Percent Deposits1 Percent Net Loans Change (Adj) Change Interest

Margin

1988 7,249.3

1989 7,429.4 +2.5

1990 7,440.3 +0.2

1991 8,256.3 +11.0

1992 7,996.8 -3.1

1993 8,123.4 +1.6

1994 7,158.3 -11.9

1995 7,662.8 +7.1

7,592.2 4.7

8,080.4 +6.4 4.7

8.461.8 +4.7 4.3

8,866.6 +4.8 4.3

8.270.9 -6.7 4.9

8,731.2 +5.6 4.2

9,355.9 +7.2 3.8

9,620.2 +2.8 3.6

Source: Central Bank of Trinidad and Tobago.

Adjusted deposits less Foreign Currency Deposits. Interest income minus interest expense/average total assets




In response to the increased competition, the commercial banking sector introduced a range of new financial products which include credit cards and new financial instruments (Sergeant and Coker, 1995). The larger commercial banks have diversified into the provision of security services and educational services and have also established a banking presence in some of the other Caribbean territories. They have also penetrated the securities and insurance markets with the offer of mutual funds and annuities to their customers.

Bancassurance in Trinidad & Tobago

In 1995, one of the larger commercial banks (Royal Bank of Trinidad & Tobago Ltd) took a pioneering step and formally entered into a strategic alliance with an insurance company (Barbados Mutual Life Assurance

Society) in order to co-operate in the development of new products and services. Each company, as a result of its presence in other Caribbean

territories, would also be able to offer additional markets to its partner in the alliance. In 1996, approximately one year later, this bank launched a new

company (BancAssurance Caribbean Ltd), a joint venture with another insurance company (Guardian Life of the Caribbean Ltd). The joint venture

was effected through the bank's acquisition of a 50 percent equity share in another insurance company (Crown Life Caribbean Ltd), a wholly-owned subsidiary of its strategic partner. Simultaneously, BancAssurance Caribbean Ltd gained 20 percent equity in NEM (WI) Insurance Ltd. As part of this

alliance, Guardian Life increased its shareholding in the bank by 10 percent and representatives of both sides sit on each other's Boards. The bank also announced that its alliance with Barbados Mutual was terminated as the

arrangement never got off the ground.20

The long-term objective of the new financial institution is to provide a

one-stop shop for personal financial services. To this end, the company introduced two new products at its launching:

20 Both Guardian Life and the Barbados Mutual are themselves involved in several business ventures together.




A Guaranteed Investment Bond which offers a guaranteed return on invested capital at maturity, a currency protection

plan and free death benefits.

Airlife Insurance in which the customer pays one lump sum

and is covered for life (until age 90) in case of accidental

death or permanent disability during air travel; a smaller sum

is payable for travel by land or sea.

Other products are also available and although they are traditional insurance

services, the company announced that they will be packaged in innovative

ways at competitive prices. In addition the joint venture has developed a

package of benefits ( including preferential rates on bank loans and deposits, and rate discounts from the affiliate insurance company) to attract customers.

V. LESSONS FROM THE INTERNATIONAL EXPERIENCE

The motives behind the move to Bancassurance by banks both here and

internationally are analogous to some extent. Deregulation in both

environments has led to increased competition for banks from other financial

institutions. The latter wooed the banks' customer base with innovative

products, offering greater yield and more personalized products and this

caused some stagnation in the growth of their core banking activities. The

banks' rationale therefore has been to seek to provide for the financial and

investment needs of their existing and new customers in as wide a range as

possible. Since there is this convergence, there may also be some lessons

that the financial institutions and regulators in Trinidad & Tobago could

learn from the international practice of Bancassurance. Three lessons will

be outlined here - they relate to structure, culture differences between banks

and insurers and distribution models.

The evidence is not strong enough for one to decide which should be

the most successful strategy to adopt in order to conduct efficient and

profitable Bancassurance business. The German, French and British

experiences revealed that the more successful approach is the establishment

of in-house life insurance subsidiaries through the full or majority purchase of an insurance company. This strategy provides capital to expand and a

unified management with clearly-defined goals and policies. The profit




made from underwriting which is approximately twice the income to be

earned from simply acting as an agent, is available to the bank, the sole or

majority shareholder of the subsidiary. Joint venture alliances and distribution agreements appear to be more

difficult to manage. This is so because in the case of the joint venture, its

management are from two distinct institutions with different cultures which

are not always compatible. For example, insurers require high commissions

while bankers are concerned with spreads. It is critical that the management of the joint venture recognise this and shape their development strategies

accordingly. This concern is of relevance to the local Bancassurance firm. In

addition, possible conflicts may arise through the sale of similar products by the associate insurance company, (NEM(WI) Insurance Ltd). Difficulties

may also arise in the distribution agreements if the insurer's products and

service do not meet the customer's standards and the bank's reputation is

affected by customer dissatisfaction. The returns, of course, are less under

this type of arrangement, as they are based on commission income.

Bancassurance can be divided into two major activities: distribution,

marketing and sale of insurance products and the creation and production of same. Experience has shown that the economic success or failure of the venture is heavily dependent on the former. It is very important therefore to

organise the sales function efficiently in order to gain maximum benefits

from the comparative advantage of the branch network. The sales strategy with respect to personnel, salaries, careers, management controls and physical

location should be clearly outlined. Certain issues must be addressed not

least of which are: the compensation of the sales force (the salary and commission structure); composition of the staff (bank employees, an

insurance sales force or both); and the location of the sales force (should

they be located permanently within the branch or assigned to a number of

branches).

The clear enunciation of policies on these issues is extremely critical because banking and insurance activities possess different sales culture.

Insurance sales personnel require different skills and training, salary and incentive structure in order to achieve and maintain high sales volume. The

British experience has indicated that managers must balance integration

with differentiation of the sales force. The former is needed in order to

present an integrated institution to the customer to make him comfortable in

purchasing all his financial services in one place. Conversely, differentiation




is also required to allow for the differences in sales strategy between banking and insurance to work for the Bancassurance firm (Morgan, 1994).

Research has also revealed that another critical success factor is the sale

of low-cost standardised products by the banks. Distribution of more

complex, personalized insurance services should be left to the specialized skills of the insurance sales force. The former products are basic and easy for both customer and bank employee to understand and for the back office

and management to handle given the retail bank's commodity orientation.

Training costs will also be lessened if the employees are trained to sell these

product types. Commercial banks have an extensive branch network and

therefore their strategies on product design and market segment should be

chosen so as to use this resource efficiently. In the final analysis research has shown that Bancassurance must not be

seen as an end in itself. Rather it is an opportunity for banks and insurance

companies to expand both product range and market bases in order to

increase profitability and to provide competitively-priced services to their customers.

Lessons for Regulators

Highly compartmentalized supervisory frameworks have come under

pressure with the establishment of financial conglomerates. The regulatory authorities have responded with increased vigilance in the European community incorporating into the legislation an obligation to share information among banking, securities and insurance supervisors. However,

implementation has been difficult because this information sharing is not a

tradition among the various regulators, particularly securities and insurance. In addition, the flow of information is hampered by the nature of the

particular conglomerate i.e. the structure and operations may not be

transparent. To this end, the Basle Concordat of 1983 strengthened its

standards by including conditions which are designed to prevent banks from

integrating into excessively opaque groupings.21

21 The Basle Concordat sets out the basic principles for the supervision of international banking groups and their cross-border establish-ments.




The move towards consolidated supervision is ongoing, however, insurance companies are not included as the insurance supervisors view this as impractical.22 At present, consolidation takes the form of attempting to

limit risk from the use of the same capital by different members of the group. Insurance companies remain outside the discussions on the related issue of harmonisation of capital standards as they are not viewed as "financial"

enterprises in EC legislation. However, since deregulation has reduced the

specificity of their operations and heightened the incentive to take risks, some countries have imposed standards on investments of premium income.23 In Denmark, Sweden and Norway, all supervision with respect to banking, securities and insurance have now been merged.

In Trinidad & Tobago, Section 23(2)(b) of the FIA provides for a

financial institution to act as an agent for an insurance company. In 1994, the FIA was amended to provide for the supervision of the bank's insurance activities. This addition is a potential area of conflict as it means that the

joint venture is also subject to the FIA (even though the activity is licensed under the Insurance Act of 1980) which requires different regulatory standards. However, at the present time a financial institution cannot sell insurance products as this clause is not yet enacted under the provisions of Section 70. The inclusion of this provision represents a departure from the

previous legislation and is an acknowledgement by the regulatory authorities of the current global trends and of the need to provide the appropriate regulatory environment. The effective date of this Section has been

postponed in order to give regulators time to put appropriate systems in

place.

The FIA legislation confines the bank's in-house insurance activity to marketing and sale of insurance products. The risk, therefore, is signi ficantly reduced as there is no underwriting activity. However, regulators would have to ensure that bank funds (possibly depositors' funds) do not flow to the subsidiary /alliance through the establishment of appropriate

22 The EC Second Consolidated Supervision Directive, in effect since January, 1993 adopted full consolidation, with reference to financial groups that include credit

institutions.

23 Norway and Canada are two such examples.




regulations (firewalls) separating the banks' traditional from their other

activities. The issue of contagion risk is also pertinent in the event of a crisis

of confidence affecting the bank arising from difficulties in the operations of

the joint venture or the insurance partner. A system of information exchange between insurance regulators and the regulators of financial institutions,

despite its inherent difficulties could provide an early warning system so that

the banks could perform damage control. In view of the expansion into the

regional market by local commercial banks, efforts should be made towards

the regional harmonisation of laws and regulations governing banks. Special attention must be given to the following: the establishment of minimum

accounting standards; an admission policy for banks; and convergence of

solvency ratio requirements (Mair, 1993).24

SUMMARY AND CONCLUSION

The process of deregulation has wrought many profound changes in the

financial services industry over the past decade and ? half. Quantitative

restrictions, in the form of credit and exchange rate controls and ceilings on

interest rates have been dismantled and all but disappeared in the developed countries. However, there has been much more caution with respect to

reform of regulations restricting ownership linkages, lines of business and

geographical location of financial institutions. The momentum of the

liberalization process which also facilitated these developments has led to

financial innovation and increased competition in the sector. It is against, this background that the financial conglomerate, a one-stop shop for financial

services, and Bancassurance, the integration of banking and insurance were

created. Insurance companies have also shown enthusiasm for this activity,

but it is the banks that have led the way. This activity is most common in

France, Germany (where it is called Allfinanz) the United Kingdom, Denmark, the Netherlands and Spain.

24 Mair (1993) outlined other issues that should be addressed such as capital and

liquidity requirements and regulations against unsafe practices. This

recommendation would also entail some amendments to the Insurance Act which

are currently being drafted.




Definitive conclusions as to the success or failure of this activity have

not been made mainly because the phenomenon is still fairly recent.

Experience has shown, however, that the in-house production of insurance

products by a subsidiary of a bank is the most feasible strategy for the

success of Bancassurance. Empirical work has indicated that costs such as

training, administration, and promotion, are also critical factors contributing to the success of the venture.

The liberalization movement sweeping the world has not left the economy of Trinidad & Tobago untouched. Structural reform came to this country in

the late 1980s swiftly followed by financial deregulation. The banks,

galvanized by the new competitive environment, have diversified into the

sale of new financial instruments and lines of business. They have also

expanded into other Caribbean countries. One bank has recently entered

into a joint venture arrangement with an insurance company to conduct

Bancassurance, other banks may follow suit after appropriate assessment of

this first effort. The European experience can provide useful guidelines both

in respect of the conduct of the activity and regulatory issues. The regulatory authorities should consider the implementation of measures such as

in formati on-sharing with insurance supervisors as well as the regional harmonisation of capital standards , in order to minimize risk.

In conclusion, it must be stated that some areas discussed before, such

as the implications of financial conglomeration and the regulatory issues, merit further discussion particularly as they relate to Trinidad and Tobago.

However, the scope of the paper and the relative newness of the activity in

this country precluded more detailed analysis. However further study is

certainly warranted as the phenomenon of Bancassurance develops in Trinidad

and Tobago.




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