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It follows that globalisation can be defined as the evolution of markets and institutions such that geographic boundaries do not limit financial transactions. It is obvious that there are economic, political and cultural aspects of globalisation. In this context, we refer primarily to the situation where geographic barriers to trade and financial markets activity have been eliminated and this has allowed a gradual intensification in the interconnections and integration between financial markets and financial institutions throughout the world. The globalisation phenomenon refers to the emergence of a broadly integrated, international but practically single market in finance: in short, the socalled 'global village' concept.

Globalisation and internationalisation are highly interrelated. This is because globalisation is changing the world economy as a result of increased international trade and cultural exchange. Hence in our context, internationalisation generally refers to the rapid growth in international business of banks (e.g., growth in multinational banking, see Section 4.7 on the increasing role of foreign banks in domestic banking systems) and can be considered as an essential condition for globalisation.

Therefore we can define 'global banks' as the institutions with the widest reach, that is, either though subsidiaries or branches they provide services in several world countries and have a presence in all continents. 'International banks' are institutions that provide cross-border services, but operate in too few countries, or are relatively too small, to be defined as global. Such banks are also referred to as 'regional banks' (Berger et al, 2003). Finally, a 'local bank' is an institution providing services only in the country where it is headquartered.

2.6.4 Other responses to the forces of change

Other important responses to the forces of change described above are: disintermediation, growth in OBS activities and securitisation.

Disintermediation is the process whereby economic units bypass banks and other financial institutions in order to invest their funds directly in the financial markets. Disintermediation is often associated with relatively good market transparency and is mostly present in strongly market-oriented systems such as those found in the United States and Britain. Another important response to the forces of change is the growth in off-balance sheet (OBS) activities and particularly derivative products. Modern banks do a considerable amount of OBS business; typically these activities refer to promises or commitments of the bank to undertake certain types of business in the future; one simple example of OBS activity is overdrafts facilities. Other

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common OBS items include derivatives transactions (e.g., futures, options and swaps), underwriting business and various other commitments and guarantees. Finally, securitisation refers to the process whereby loans and other financial assets (e.g., mortgages) are pooled together for sale as securities to investors.

Box 2.4 Focus on globalisation

The banking industry still appears far from being globally integrated. A recent study by Berger et a/. (2003) finds that in industrialised countries the foreign share of bank assets remains at or below 10 per cent. In a frictionless banking market with no barriers to integration, commercial customers will select the bank that provides the price, quality and mix of services that will best facilitate their business operations. Berger et a/. (2003) define two potentially important criteria for a foreign affiliate's choice of bank: the bank's nationality and reach. Bank nationality refers to the country in which the bank is headquartered. Some companies might value banking services that require a detailed knowledge of the country in which they operate (host-based expertise). Banks headquartered in the nation that hosts the affiliate will likely have an advantage in offering these services. Other companies might value a bank that offers 'home-based expertise' - that is, an understanding of the home market of the affiliate's parent. Banks from third countries (that is, from neither the host nor the home country) may not have hostbased or home-based expertise, but they might still competitively offer services in other dimensions valued by company. Bank reach refers to the size and geographic scope of the bank. Some companies may value a large, global bank that can offer a broad range of financial services, expertise within many foreign markets, superior risk diversification and the ability to facilitate large deals. Other companies may prefer the advantages of a smaller bank that offers services in only a local area because such a bank is more likely to establish a close relationship with the customer and provide customised services. In the absence of barriers, the extent of integration in the banking industry will depend on how customers value different banking services and the extent to which banks of a given nationality and reach can provide those services. Essentially, if customers place a high value on global services and have little value for host-based or home-based expertise, then we might expect to see an integrated banking industry, perhaps with a few global banks dominating markets around the world. Conversely, if customers value host-based expertise and place less value on global services, then we should observe limited banking industry integration. Thus, depending on the services valued by bank customers, we could

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have a world with extensive integration or one with little integration. Berger et a/. (2003) argue that foreign banking organisations may be at significant competitive disadvantages in providing the price, quality and mix of services that best suit bank customers, and that such disadvantages may limit the integration of the banking industry. Overall, the findings suggest that domestic banks possess some competitive advantages that may significantly limit the global integration of the banking industry.

REVISION QUESTIONS

1.What is a deposit-taking institution?

2.Define a payment system.

3.What are the main characteristics of a plastic card?

4.What is e-banking?

5.What are the main forces that generate trends in the banking sector?

6.Outline the differences between deregulation and re-regulation in the banking sector.

7.What are the most common motives for M&As?

8.Define the disintermediation process.

CHAPTER 3

Types of Banking

VOCABULARY STUDY

1).Study the words below and explain their meaning within the text 2). Suggest Russian equivalents of these words

3.1. Introduction

This chapter outlines the main types of firms that undertake banking business and describes the main features of commercial and investment banking. The first part of the chapter describes the recent trend towards the development of financial service conglomerates and the widespread acceptance of the universal banking model. We then go on to outline the main types of banks engaged in commercial banking activity and also focus on the products and services offered to personal (including private banking) and corporate banking customers. Discussion on corporate banking services is split between services offered to small companies and corporate and investment banking products offered to mid-sized and large companies. Finally, we briefly highlight the main aspects of investment banking business. A major theme throughout the chapter is the increasing blurring of distinctions between particular areas of banking and financial services provision, and the focus on customer relationships and meeting the increasingly complex and diverse needs of clients.

3.2 Traditional versus modern banking

Banking business has experienced substantial change over the last 30 years or so as banks have transformed their operations from relatively narrow activities to full service financial firms. Traditionally, banks' main business consisted of taking deposits and making loans and the majority of their income was derived from lending business. Net interest margins (the difference between interest revenues from lending minus the interest cost on deposits) was the main driver of bank profitability. In such an environment banks sought to maximise interest margins and control operating costs (staff and other costs) in order to boost profits. Banks strategically focused on lending and deposit gathering as their main objectives.

Up until the 1990s many banking markets were highly regulated and competition was restricted. In Britain banks were restricted from doing various securities and investment banking business up until 1986 when various reforms allowed commercial banks to acquire stockbroking firms. In continental Europe, branching restrictions were in place in Spain and Italy until 1992 and banks were also limited in

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terms of the types of business they could conduct. The implementation of the EU's 1988 Second Banking Directive in 1992 established a formal definition of what constituted banking business throughout Europe and this introduced the so-called universal banking model. Under the universal banking model, banking business is broadly defined to include all aspects of financial service activity -including securities operations, insurance, pensions, leasing and so on. This meant that from 1992 onwards banks throughout the European Union could undertake a broad range of financial services activity.

A similar trend has also occurred in the United States. For example, there were nationwide branching restrictions in place until the passing of the Riegle-Neal Interstate Banking and Branching Efficiency Act in 1994 which allowed national banks to operate branches across state lines after 1 June 1997. Also the Gramm- Leach-Bliley Act in November 1999 allowed commercial banks to undertake securities and insurance business thus establishing the possibility of universal banking activity for US banks. Similar legislation was also enacted in Japan in 1999.

The type of business banks can undertake, therefore, has expanded dramatically. As detailed in Chapter 2, in addition to deregulation various other factors have also had an impact on banking business globally. Capital restrictions that limited the free flow of funds across national boundaries gradually disappeared throughout the 1980s facilitating the growth of international operations. The role of state-owned banks in Europe and elsewhere has declined as a result of privatisation and various balance sheet restrictions (known as portfolio restrictions) have also been lowered or abolished allowing banks greater freedom in the financial management of their activities. These global trends have also been complemented by advances in technology that have revolutionised back-office processing and front-office delivery of financial services to customers. The general improvements in communication technology and the subsequent decline in costs allow dissemination of information throughout a widespread organisation, making it practical to operate in geographically diversified markets. Lower communication costs also increase the role of competitive forces, as physically distant financial service providers become increasingly relevant as competitors.

Technology has also continued to blur the lines of specialisation among financial intermediaries. The development of the internet and other computing technology, for example, has enabled insurance companies to offer banking

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services online (such as the online bank Egg owned by Prudential in Britain) and has also promoted asset securitisation particularly in the United States (where standardised packages of loans are moved off banks' balance sheets and sold to investors, resulting in intermediation of similar assets across different types of intermediaries). Advances in computing power also allow investment banks and other financial service firms to offer accounts with characteristics similar to bank accounts. Technological developments, therefore, have generally facilitated growth in the range of financial services available and heightened the competitive environment.

It can be seen that banking business has changed dramatically from an activity characterised by limited competition and a relatively restricted product offering to a much more competitive and diverse activity. These differences are highlighted in Table 3.1.

Table 3.1 shows that the nature of banking business has changed from being relatively restricted and uncompetitive to a much more dynamic activity. Banks are now regarded as full service financial firms - and many banks have even dropped the word 'bank' from their name in their promotional material, such as 'Barclays' in Britain and JP Morgan Chase in the United States. The transformation of banks into full service financial institutions has been motivated by the strategic objective of banks to be able to meet as broad a range of customer financial service demands as possible. The increase in products and services that can be sold to customers helps strengthen client relationships and (so long as customers value the services being provided) should boost returns to the bank over the longer term.

In an increasingly competitive environment banks have sought to diversify their earnings - complementing interest revenues from lending activity with fee and commission income from selling non-traditional banking products such as insurance. The greater emphasis on building client relationships means that banks have had to become much more demand-oriented, focusing on meeting the needs of a more diverse and financially sophisticated client base.