Strategies of banks and other financial institutions : theories and cases

535 Pages·2014·3.885 MB·English

by  Rajesh Kumar

Strategies of Banks
and Other Financial
Institutions
Strategies of Banks
and Other Financial
Institutions
Theories and Cases
Rajesh Kumar
AMSTERDAM (cid:127) BOSTON (cid:127) HEIDELBERG (cid:127) LONDON
NEW YORK (cid:127) OXFORD (cid:127) PARIS (cid:127) SAN DIEGO
SAN FRANCISCO (cid:127) SINGAPORE (cid:127) SYDNEY (cid:127) TOKYO
Academic Press is an imprint of Elsevier
Academic Press is an imprint of Elsevier
525 B Street, Suite 1800, San Diego, CA 92101, USA
225 Wyman Street, Waltham, MA 02451, USA
The Boulevard, Langford Lane, Kidlington, Oxford, OX5 1GB, UK
Copyright © 2014 Elsevier Inc. All rights reserved
No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form
or by any means electronic, mechanical, photocopying, recording or otherwise without the prior written
permission of the publisher.
Permissions may be sought directly from Elsevier's Science & Technology Rights Department in Oxford,
UK: phone (+44) (0) 1865 843830; fax (+44) (0) 1865 853333; email: [email protected].
Alternatively you can submit your request online by visiting the Elsevier web site at http://elsevier.com/
locate/permissions, and selecting Obtaining permission to use Elsevier material.
Notice
No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a
matter of products liability, negligence or otherwise, or from any use or operation of any methods, products,
instructions or ideas contained in the material herein. Because of rapid advances in the medical sciences, in
particular, independent verification of diagnoses and drug dosages should be made.
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
A catalog record for this book is available from the Library of Congress
978-0-12-416997-5
For information on all Academic Press publications
visit our website at books.elsevier.com
Printed and bound in the United States
14 15 16 17 10 9 8 7 6 5 4 3 2 1
Preface
STRATEGIES OF BANKS AND OTHER FINANCIAL INSTITUTIONS: THEORIES
AND CASES
Rapid changes in the technological, economic, social, demographic, and regulatory environments have
led financial institutions to evolve their strategies for gaining competitive advantage. The growth of the
financial sector around the world depends on critical factors such as globalization, regulatory compli-
ance, risk management, technological innovation, and demographics. The changing landscape of finan-
cial institutions in the context of competition, diversification, new products, and new geographic markets
has dramatically changed the risk profile of financial institutions. Increasing regulation due to Basel III
stipulations has become a critical driver of post-crisis bank profitability in developed countries. Banks in
emerging markets are becoming the major growth drivers of the global banking industry.
In the context of technological advances banks face new challenges with shifting digital consumer
behavior. Global technology trends indicate increased focus on next-generation remote banking solu-
tions, business intelligence, and analytics in transaction monitoring. This changing demographic pro-
file has compelled banks to develop specialized products and services for serving older generations.
The concept of universal banking has also become an established trend. Investment banking, private
banking, and bancassurance are among the most profitable and fastest growing segments of the finan-
cial service industry. Mergers, acquisitions, and alliances are also key strategies adopted by financial
institutions. Consolidation is happening due to disintermediation in the banking sector. A new wave
of regulations in banking is being shaped following global financial crises such as Basel III changes,
legislation such as Dodd–Frank in the United States, and more concrete actions by G-20.
Strategies of Banks and Other Financial Institutions: Theories and Cases consists of two parts. The
first part proposes a useful theoretical framework on strategic perspectives concerning risk, regula-
tion, markets, and challenges driving the financial sectors. The second part presents case studies about
the world’s largest commercial banks, mortgage institutions, investment banks, investment companies,
insurance company pension funds, Islamic banks, hedge funds, private equity firms, and sovereign
wealth funds.
The introductory chapter analyzes the strategic trends in the banking industry and the impact of the
financial crisis on the global banking system. The chapter highlights the key strategic reform policy
and technological trends shaping financial institutions. This chapter also discusses the different types of
financial institutions and the concept of the shadow banking system. Chapter 2 focuses on the regula-
tory environment of financial institutions. This chapter deals with the functions of regulatory agencies,
the history of regulatory reforms, and the regulation of banking and nonbanking financial institutions.
The major emphasis is on Basel reforms. Chapter 3 explores the risk inherent in financial institutions.
The chapter highlights the different types of risk in financial institutions. The major focus is on the risk
management framework in banks and the risk mitigation strategies adopted by financial institutions.
The following two chapters highlight the different types of financial markets and financial institu-
tions. Chapter 4 focuses on the money markets, bond markets, and mortgage markets. The chapter
covers different types of money market and capital market instruments. Chapter 5 focuses on stock
markets, derivatives markets, and foreign exchange markets. Chapter 6 explains the strategies of de-
pository institutions such as commercial banks and thrift institutions comprising mutual savings banks,
xvii
xviii Preface
savings and loan associations, and credit unions. Chapter 7 discusses the strategies of nondepository
institutions such as investment banks and finance companies. Chapter 8 covers the strategies of other
nondepository institutions such as mutual funds and insurance and pension funds. Chapter 9 deals with
the strategic aspects of private equity and hedge funds. Chapter 10 introduces the principles of Islamic
finance and various instruments of Islamic finance. The final chapter highlights the trends of consolida-
tion in financial markets and institutions.
Cases are discussed along a framework consisting of structure, strategy, regulatory environment,
and risk management of financial institutions. In universal banking, the cases of Bank of America,
JPMorgan Chase, Citigroup, Barclays, BNP Paribas, Credit Agricole Group, HSBC, Industrial and
Commercial Bank of China, and Deutsche Bank are discussed. The Mortgage institution-related cases
discussed include Fannie Mae, Freddie Mac, and Ginnie Mae. Cases on credit unions such as the Navy
Federal Credit Union, State Employees’ Credit Union, and Pentagon Federal Credit Union are discussed
under the category of thrift institutions. Major investment bank cases such as Credit Suisse, Goldman
Sachs Group, Morgan Stanley, and UBS Group are also included. The investment management compa-
nies highlighted include Vanguard, American Funds, Fidelity Funds, T. Rowe Price, PIMCO, Franklin
Templeton, and BlackRock.
The insurance sector chapter covers case studies on insurance companies such as Japan Post
Insurance Co., Berkshire Hathaway, AXA Group, Allianz, Generali Group, Nippon Life Insurance,
Munich Reinsurance, AIG, and MetLife. The case studies on pension funds consist of sovereign and
corporate pension funds. The private equity firms in the chapter include Kohlberg Kravis and Robert
(KKR), Blackstone Group, Bain Capital, Carlyle Group, and TPG Capital. The hedge fund cases in-
clude Bridgewater Associates, Adage Capital Management, York Capital Management, Graham Capital
Management, Brevan Howard Asset Management, etc.
The case studies on Islamic banks include Saudi Al Rajhi Bank, Kuwait Finance House, Dubai
Islamic Bank, Abu Dhabi Islamic Bank, Al Baraka Islamic Bank, and Qatar Islamic Bank. The fi-
nal chapter deals with sovereign wealth funds and includes cases on Norway Sovereign Wealth
Fund, SAMA Foreign Holdings, Saudi Arabia, Abu Dhabi Investment Authority, China Investment
Corporation, SAFE Investment China, Kuwait Investment Authority, Hong Kong Monetary Authority,
Government of Singapore Investment Corporation, Temasek Holding, and Qatar Investment Authority.
Acknowledgments
I would like to thank the production and editorial staff at Elsevier who guided this book through the
publishing process. I wish to acknowledge the valuable guidance and support of Scott Bentley, Senior
Acquisition Editor at Elsevier. My thanks also to Melissa Murray, Editorial Project Manager, and
her team for all the cooperation and support in the publication of this book. I thank Jason Mitchell,
Publishing Services Manager, and his team for all the support. I also acknowledge the content of the
various websites and sources of information to which I referred. I acknowledge the permissions granted
by McKinsey & Company, Investment Company Institute, The Banker Database of Financial Times,
World Council of Credit Unions, World Federation of Exchanges, and Insurance Market Research at
Conning to use their data in my book. I also thank my family for all their support. Special gratitude to
my wife, Sreelatha, for her understanding and support.
xix
Dedication
To my beloved brother, Suresh, and sister, Rajasree
xxi
CHAPTER
1
STRATEGIES AND
STRUCTURES OF
FINANCIAL INSTITUTIONS
1.1 INTRODUCTION
Financial institutions basically serve as financial intermediaries between primary saving and bor-
rowing sectors. In the current environment it has become critical for financial institutions to evolve
strategies for competitiveness in the context of rapid changes within technological, economic, social,
demographic, and regulatory environments. The financial sector encompasses a set of institutions, in-
struments, and markets as well as the legal and regulatory framework. Globalization, regulatory com-
pliance, risk management, technological innovation, and demographics are the major transformative
issues that will determine the growth of the global financial sector. Consolidation and cross-border
mergers and acquisitions (M&A) in the context of easing cross-border investment regulations are also
visible trends observed in the global financial sector. Technology has transformed products offered by
financial institutions into commodities. Technology has transformed the internal operating environ-
ment as well as the external market environment. Information technology (IT) is the primary force that
keeps the financial industry dynamic.
The biggest banking markets by assets are the United States, the United Kingdom, Japan, China,
and France. Of these countries, the United States has the largest number of banking institutions in the
world. In 2011, there were 6291 commercial banking institutions with 83,209 branches in the United
States. In the 1990s, the number of US banking institutions was approximately 12,000. In 2011, the
number of savings institutions was 1067.1
US, German, and Japanese banks are dominant both in terms of assets and number of institutions.
There are 20 US banks, 16 German banks, and 11 Japanese banks among the top 100 banks.2
1.2 BANKING PERFORMANCE TRENDS
A McKinsey Global Institute report indicates that during the next 10 years, the growth rate of the global
banking industry will exceed that of the gross domestic product (GDP). Experts estimate that the bank-
ing industry is likely to more than double its revenues and profits over this period. The shadow bank-
ing system around the world had grown to a $67 trillion market by 2011, according to the Financial
Stability Board (FSB) Monitoring Report of 2012.
1 Federal Deposit Insurance Corporation Report.
2 Eugenio Cerutti, Giovanni Dell’Ariccia, Maria Soledad Martınez Perı´a (2007), How banks go abroad: Branches or subsid-
iaries. Journal of Banking and Finance, 31, 1669-1692.
Strategies of Banks and Other Financial Institutions 3
Copyright © 2014 Elsevier Inc. All rights reserved.
4 CHAPTER 1 STRATEGIES AND STRUCTURES OF FINANCIAL INSTITUTIONS
According to the FSB report, the global banks sector is forecast to have a value of $136,946.8
billion by 2015, which represents an increase of approximately 34% from 2010. Bank credit is the
largest segment of global banking, accounting for 59.7% of the total sector value. Europe accounts
for 53% of the global banks’ sector value. In 2010, the global banks industry group had total assets
of $101,880.2 billion, representing a compounded annual growth rate (CAGR) of 7.6% during the
period 2006-2010.
The United States accounts for 11.5% of the global banks sector value. By 2015, the US banks
sector is forecasted to have a value of $15.617 billion dollars.3 The Asia Pacific bank sector is fore-
casted to have a value of $40,669 billion. Currently, China accounts for 47.9% of the Asia Pacific bank
sector value,4 and Japan accounts for a further 31.3% of the Asia Pacific sector. In the year 2011, the
biggest banks in terms of market capitalization were the Industrial and Commercial Bank of China,
China Construction Bank Corporation, HSBC Holdings, and JPMorgan.
The industry growth rate of assets of the top 1000 banks was 2.7% in the post-crisis period of 2008-
2010, as compared to the double-digit growth witnessed by the sector during the period 2006-2007.5
At the same time, the capital adequacy ratio of the banks registered a growth rate of 3.8% during the
period 2007-2010. In the period between 2007 and 2008, the profit before tax of the top 1000 global
banks declined by $667 billion.6
The highest growth was registered by Latin American banks whose assets grew at a CAGR of
28.1% during 2007-2010. During the same period, the assets of the banking sectors in Asia Pacific
and North America grew at rates of 16.3% and 6.9%, respectively, while the assets of European banks
declined at a rate of 3.3%.7
In the post-crisis period, the cost-to-income ratio showed impressive improvement in North
America, Europe, and Latin America. This improvement was primarily because of the reduction of
operational costs owing to the adoption of the Basel recommendations.
According to a McKinsey Quarterly report in 2011, “The state of global banking—in search of a
sustainable model,” despite a strong global profit performance in 2010 and the first half of 2011, the
return on equity (ROE) of banks in Europe and the United States has still not recovered, particularly
in the context of gaps that arise from the new regulatory requirements. The global banking revenues
reached a record $3.8 trillion in 2010 compared to $3.5 trillion in 2009. Global banking profits after
tax grew to $712 billion in 2010, up from $400 billion in 2009. But 90% of the profit increase was at-
tributable to a decline in provisions for loan losses. In 2010, US and European banking industries had
an ROE of just 7% and 7.9%, respectively. Bank revenues in such developing countries as India, Brazil,
and China grew by approximately 19.8%, 17.6%, and 13.7%, respectively, during 2010.8 In spite of the
economic crisis of 2008, total banking assets are predicted to reach an estimated $163,058 billion in
2017 with a CAGR of 8% over the next five years.9 Table 1.1 highlights the global banking performance
trends in terms of profits. Table 1.2 shows the financial position of the global banking industry in terms
of loans and deposits, total assets and liabilities during the period 2009-2011.
3 Data monitor (June 2011), Banks in the United States, Reference Code: 0072-2013.
4 Data monitor (June 2011), Banks in the Asia Pacific, Reference Code: 0200-2013.
5 Capgemini Report (2011), Trends in the global banking industry.
6 The Banker Database (September 2011), http://www.thebankerdatabase.com.
7 The Banker Database (September 2011), http://www.thebankerdatabase.com.
8 McKinsey Quarterly Report (2011), The state of global banking—in search of a sustainable model.
9 Lucintel Report (2011), Global banking industry analysis 2012-2017: industry trend, profit, and forecast analysis.
1.3 STRATEGIC TRENDS 5
Table 1.1 Global Banking After-Tax Profits (Billions of US Dollars)
Year Profits
2000 366
2005 681
2006 802
2007 952
2008 852
2009 549
2010 730
Source: McKinsey Global Banking Pools.
The estimated profits realized by banks and nonbanking financial institutions from the provision of banking services to clients.
Nonclient driven banking activities such as asset liability management, market making, proprietary trading (the latter two with the
exception of Asia Pacific) and banks’ nonbanking activities are excluded.
Table 1.2 Global Banking Amounts Outstanding (Billions of US Dollars)
Positions December 2009 December 2010 September 2011
Total assets 33,841.4 33,989.1 35,878.1
Loans and deposits 21,664.1 22,083.7 23,303.2
Total liabilities 32,338.9 32,801.6 34,878.7
Source: BIS Quarterly Review, March 2012.
1.3 STRATEGIC TRENDS
The gap for bank revenue growth is expected to widen between growing markets in emerging markets
and saturated developed markets. Banks from the emerging markets will become the growth drivers of
the global banking industry. Geographically the regions of biggest potential are China, India, Brazil,
and Russia. The most populous nation in the world, China has one of the largest savings rates at 40% of
the GDP. Financial institutions have spent billions to acquire stakes in Chinese banks. Chinese markets
are characterized by a large savings rate and a dearth of health care and pension funds.
With the imposition of more stringent capital adequacy and risk management standards, banks face
strains on their traditional business models and operating margins. The financial crisis highlighted the dif-
ferences that exist between the performances of the banking sectors of emerging and developed markets.
The banking industry in the emerging markets of Asia Pacific and Latin America remained resilient during
the crisis in contrast to the developed markets of Europe and the United States, which registered heavy
losses. China, India, and Brazil account for a growing share of the world’s economic activity and provide
challenges for banking. China, Russia, and India provide an abundance of retail and wholesale customers.
Two thirds of the world’s economic growth will come from emerging markets through 2015. It is
estimated that the share of global GDPs generated by emerging markets will rise from 31% to 41%.
The BRIC countries (Brazil, Russia, India, and China) are established growth markets where banks are
expected to continue to invest. But regions such as China, although an ideal target for global banks,