AMERICAN COLLEGE

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• AMERICAN COLLEGE
• S K O P J E
•   PRINCIPLES OF BANKING
• Chapter 5
•  Instructror Tome Nenovski, Ph. D.
•  

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5. BANK INDUSTRY INNOVATIONS

• - Bank innovation factor for keeping or even,
  increasing bank wealth
• - Because of many reasons, traditional banking
  is not as profitable as it used to be
• - Some traditional bank products have stopped
  being sold
• - Fund resources have become narrow
• - Strong bank regulation Liabilities interest
  rates limitation
• - Needs for new profitable bank products

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•  5. BANK INDUSTRY INNOVATIONS
• - Developing new balance and off balance
  products
• - Appearance of bank innovations
• - Innovations Systemic bank changes process

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5. BANK INDUSTRY INNOVATIONS

• Innovation forms
• - new products and services
• - new organizational forms
• - new systems for realizing bank clients
• orders
• - finding new markets for securing
• liquidity
• - changes in financial instruments etc.

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•   5. BANK INNOVATIONS
• - Computer and information technology as
  innovation source
• - Introducing and developing financial
  engineering inbounding some financial
  instruments to their consisted parts and their
  rebounding (new packing) in new instruments
• - Introducing financial derivatives (futures,
  options, swaps)
• - New possibilities for transfer risk to other
  subjects
• - Final result of introducing innovations Bank
  profitability increase.

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• 5.1. Factors that create innovations
• - Instigators of huge banking changes in
  particular country are
• Tax laws changes technology progress
  inflation rate changes interest rates changes
  foreign exchange rate changes economic activity
  changes regulation framework changes etc.

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• 5.1. Factors that create innovations
• - On global level there are couple of factors
  that induced innovations which are spread to the
  banks all round the world
• a) deregulation
• b) information technology
• c) globalization
• d) economy of scale
• e) economy of scope (diversification).

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• 5.1.1. Deregulation
• - Banks are most regulated institutions within
  the economy
• - Bank regulator determines what products and
  services bank can sell, who can govern bank, on
  which market bank can act etc.
• - Big alternation Bank deregulation No limits
  for interest rates, directing bank credits and
  narrow bank specialization possibility for usage
  new flexible financial instruments (financial
  derivatives, new off-balance sheet products
  etc.)
• Notice Deregulation is not same as
  reregulation!

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• 5.1.2. Competition
• - Deregulation derived bigger bank (and
  financial
• market) competition and rivality
• - Two types of competition
• a) Price (interest rates) competititon
• b) Product competition.

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• 5.1.3. Information technology
• - Info-technological revolution
• - Transfering money and data at the same moment
• - Need for changing classic bank organization
  (narrowing the number of branches)
• - Internet development (banking on line)
• - Virtual bank appearance.

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• 5.1.4. Globalization
• - Internationalization and globalization of bank
  activities
• - Global or planet banks
• - Big banks buy majority of shares of a certain
  bank they are interested in
• - Universal banks are mostly represented in this
  process.

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• 5.1.5. Economies of scale
• - Bank deregulation smaller bank profits
  margins
• - Creating new bank products for compensating
  profit decrease
• - Developing cost-benefit and trade-off bank
  functions and activities
• - Two ways for introducing and developing
  economies of scale
• a) Internal (bank own total development)
• b) External (bank merger and acquisition).
• - Goal Decreasing bank costs.

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• 5.1.6. Economies of scope
• - Bank activities diversification
• - Broadening bank activities in insurance,
  brokerage, investment funds
• - Additional bank activities, lower costs and
  higher bank income
• - Cross-selling services
• - One-stop- banking
• - Banks as financial supermarkets.

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• 5.2. More important bank innovation
• - Banks use new instruments for financing their
  activities, lowering costs and reducing risks
• - Most important instruments are
• a) Financial derivatives
• b) Securitization
• c) Selling credits
• d) Stand by guarantees
• e) Credit derivatives
• f) Electronic banking
• g) Bank innovations in dealing with securities.
  

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• 5.2.1. Financial derivatives
• - Instruments for hedging bank risks
• - Appeared in 80s and 90s of XX century
• - Types forwards, futures, options and swaps
• - More elaboration about these bank innovation
  in
• Chapter 7.

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• 5.2.2. Securitization
• - Definition Conversion of part of the bank
  assets with lowered market value in securities
  that are acceptable for investors on secondary
  market
• - Transforming part of bank credits into
  securities, usually bonds Asset backed
  securities
• - Goals Regulating bank liquidity, hedging
  interest rate risk, finding income resource,
  accomplishing capital adequacy obligation etc.
• - Securitization process (to be explained)

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• 5.2.2. Securitization/2
• Participants in securitization process

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• 5.2.2. Securitization/3
• - Bank benefits from securitization
• a) Securing liquidity
• b) Hedging interest risk
• c) Decreasing credit risk
• d) Increasing bank profit
• e) Accomplishing capital adequacy

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• 5.2.2. Securitization/3
• - Usage of securitization for collecting funds
  on lower price rather than costs for collecting
  deposits
• - Bonds are part of the bank balance sheet
• - Bonds obligation are paid by the bank
• - Bonds price is lower than deposit price
• - The term of bond maturity, usually, is
  longer than
• deposit term of
  maturity The average Liabilities
• term of maturity
  becomes longer
• - Weaknesses of that kind of securitization
• -Need for additional increase the capital
  amount
• (Problem with
  accomplishing capital adequacy level) -
  Reserve requirement accomplishing problems.

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• 5.2.3. Selling credits
• - Banks sell new credits or credits with term to
  maturity
• up to 3 months
• - Reasons why banks sell credits
• - changing lower yield with higher yield
  credits
• - lowering credit and interest rate risk
• - lowering credit exposure
• - getting liquid funds needed for investing in
  higher
• yield projects etc.

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• 5.2.3. Selling credits/2
• - Credits buyers are other banks, insurance
  companies, pension funds, mutual funds, big
  investment banks etc.
• - Usually bank-credit seller keeps the right to
  take care for that credit on behalf of the
  credit-buyer
• - Types of selling credits
• - Participative credits
• - Reproaching (transfering) credit to its
  buyer
• - Selling credits on parts.
• - Selling credits weaknesses.

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• 5.2.4. Stand by guarantee
• - Definition Financial instrument through which
  the bank guarantees that a particular client will
  fulfill his credit, securities or project
  obligation
• - Stand by guarantee could be
• a) Performance guarantee
• b) Repayment guarantee.
• - Stand by guarantee is bank potential
  obligation
• - Advantages low issuing costs low risk
  profitability big help for bank client
• - Weaknesses liquidity risk and interest rate
  risk.

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• 5.2.5. Credit derivatives
• - Bank security in a case of inability of a
  credit pay off
• - Credit swaps Two banks agree to change repaid
  parts of credits they have extended to their
  clients
• - Advantages of credit swap
• - Each bank can disperse its credit portfolio
  risk
• - Spreading bank presence on other markets.

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• 5.2.5. Credit derivatives/2
• - Full return swap
• - Credit options
• - Bank protection from extended credit value
  loss
• - Setting off higher borrowing costs because of
  bank credit rating changes.

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• 5.2.6. Electronic banking
• - Modern technology revolution
• - Electronic funds transfer
• - Automatic teller machines ATM introduction
• - Point of sale POS or Electronic funds
  transfer at the
• point of sale EFTPOS
• - Home banking
• - Internet
• - Intranet

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• 5.2.6. Electronic banking/2
• - Virtual banks
• - Advantages for banks that have accepted new
  information technology
• 1) Bank competition increase
• 2) Economies of scale and economies of scope
  development (Bank productivity increase and bank
  costs decrease)
• 3) Bank organization changes (merger and
  acquisition)
• 4) Bank credit rating increases.

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• 5.2.7. Bank innovations in dealing with
  securities
• a) Mutual funds (A way for deposit
  disintermediation protection)
• b) Note Issuance Facilities NIF
• - Revolving underwriting facility
• c) Trade banking (temporarily companys
  shareholder)
• d) Securities consulting.

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• KEY WORDS/TERMS
• Bank innovation
• Financial derivatives
• Forwards
• Futures
• Options
• Swaps
• Deregulation
• Information technology
• Globalization
• Economies of scale
• Economies of scope
• Competition

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• KEY WORDS/TERMS/2
• Cross-selling services
• One-stop banking
• Securitization
• Selling credits
• Participative credits
• Reproach credits
• Stand by guarantee
• Performance guarantee
• Repayment guarantee
• Credit derivatives
• Electronic banking
• Risk hedging
• Automate teller machine
• Post of sale POS

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• KEY WORDS/TERMS/3
• Electronic funds transfer at the point of sale
  EFTPOS
• Home banking
• Mutual funds
• Note issuance facilities NIF
• Trade banking

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• CHECKING QUESTIONS
• What are the main reasons for bank innovation
  appearence?
• In which forms do innovations appear?
• What is the final result of introducing bank
  innovations?
• What are the main factors that create
  innovations?
• What does deregulation consist of?
• Explain price and product competition.
• What is hideen behind information technology?
• Define bank globalization.
• Define economies of scale.
• Explain what cross-selling services means.

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CHECKING QUESTIONS/2

• 11. Define securitization.
• 12. What are bank benefits from securitization?
• 13. Why banks sell credits?
• 14. Enumerate types of selling credits.
• 15. Explain the meaning of performance and
  repayment guarantee.
• 16. How does credit swap function?
• 17. How does credit option function?
• 18. What are the main characteristics of
  electronic banking?
• 19. What are mutual funds?