Integration and Globalization

1
Integration and Globalization

• Competition (both domestic and foreign), new
  technology, deregulationall about breaking down
  walls

2
Major themes

• Financial service providers
• commercial banks
• investment banks
• insurance companies
• other financial intermediaries
• Integration of financial services

3
Major themes

• Financial services consolidation and
  globalization
• Conglomerates
• bancassurance
• universal banks
• Globalization of financial services

4
Driving forces

• Demand pull
• changing buyers
• changes in awareness
• Supply push
• distributional efficiencies
• economies of scale and scope
• Political forces
• diminishing role of government

5
Regulation and public policy

• Regulation of financial institutions
• Europe
• Asia
• North America
• Public policy issues

6
Financial Intermediation A functional view

• financial functions are more stable than
  financial institutions - that is, functions
  change less over time and vary less across
  geopolitical boundaries
• competition will cause the changes in
  institutional structure to evolve toward greater
  efficiency in the performance of the financial
  system

7
Financial Intermediation A functional view

• How to design new financial systems?
• Eastern Europe
• Deregulated financial systems such as Korea
• De-re-regulated systems such as India or Mexico
  (more about that later)
• Functional perspective gives better answers on
  how to design new systems

8
What does a financial intermediary do?

• The primary function of any financial system is
  to facilitate the allocation and deployment of
  economic resources, both spatially and
  temporally, in an uncertain environment
• How?
• By getting buyers and sellers together who are
  dispersed due to information barrier

9
Six core functions of a financial system

• Function 1 A financial system provides a
  payments system for the exchange of goods and
  services.
• Function 2 A financial system provides a
  mechanism for the pooling of funds to undertake
  large-scale indivisible enterprise.

10
Six core functions of a financial system

• Function 3 A financial system provides a way to
  transfer economic resources through time and
  across geographic regions and industries.
• Function 4 A financial system provides a way to
  manage uncertainty and control risk.

11
Six core functions of a financial system

• Function 5 A financial system provides price
  information that helps coordinate decentralized
  decision-making in various sectors of the
  economy.
• Function 6 A financial system provides a way to
  deal with the asymmetric-information and
  incentive problems when one party to a financial
  transaction has information that the other party
  does not.

12
Financial Intermediaries Dynamics of
institutional change

• Ways of managing risks has changed round the
  clock trading, financial futures, junk bonds,
  ATM, LBO etc.
• Changes are due to advances in technology,
  understanding of theory which have led to
  reduction in cost of transactions
• Reduction in transactions costs lead to greater
  volume of trade in financial markets

13
Changes...

• Commodization leading opaque institutions to
  transparent institutions
• banks to money market mutual funds
• financial futures on equities indices instead of
  market wide index funds
• junk bond method of financing
• US national mortgage market rather than savings
  institutions

14
Changes...

• Securitization removes assets from financial
  intermediaries balance sheets by packaging in
  convenient form and selling the packaged
  securities in the financial markets
• Process is common in mortgage, auto loan, credit
  card, leases on consumer durable
• Process unbundles financial intermediaries

15
What do financial intermediaries do?

• Financial intermediaries bring users of funds and
  suppliers of funds together
• Traditional portfolio intermediation
• Expenses are covered by the spread
• Competition squeezes spread, institutions respond
  by cutting expenses to maintain profit levels or
  expand in areas where they did not operate before

16
Banks

• Commercial banks take in short term deposits and
  make personal/commercial loans
• Japan has most of the largest commercial banks
• Investment banks bring together issuers of
  securities (stocks and bonds) with the investors
  (here US dominates)

17
And others...

• Other intermediaries
• insurance companies borrows short and lends
  long
• mortgage banks mortgage funding and repackaging
  them
• mutual funds gather small investors to invest in
  stocks, bonds and other securities

18
What is happening...

• Financial integration Products move from one
  class of financial institution to another
• Financial service convergence one sector
  provides instruments usually associated with
  another sector
• Example securities linked life insurance products

19
Service consolidation and conglomeration

• Many countries have no restriction of bank
  holding insurance companies or vice versa
  (France, UK, Germany)
• Some have very strict rules (for example, US and
  Japan)
• Consolidation leads to new public policy issues
  and regulatory issues

20
Bancassurance or allfinanz

• Alliance between banks and insurers for the sale
  of insurance through banks
• But, insurer is responsible for manufacturing
• Banks are used as the distribution channel
• In principle, bancassurance means both way
  traffic but in reality it is mostly one way

21
Universal banks

• Fully integrated bank, securities, insurance and
  other
• Germany insurance, mortgage, other (by a banking
  and securities company)
• UK securities and insurance (by a bank)
• US banking, securities, insurance (by a holding
  company)

22
Bancassurance

• France is the leader
• Credit Agricole launched its own life insurance
  company in 1986 (Predica)
• It has sold insurance through branches since
  1970, so not surprising
• 18 months later Predica became the 2 life
  insurance company in France!

23
Examples

• In 1994, 63 of new life policies sold through
  banking channel
• Other countries Spain, Italy, the Netherlands,
  Belgium, Germany, UK
• Is that a threat to insurance companies?
• If it is a simple selling of insurance by banks,
  the answer is yes
• But, there are many other possibilities

24
Examples

• The most spectacular example of bancassurance is
  in the merger of two large companies to create a
  powerful new financial services entity such as
  ING of the Netherlands. Formed in 1990 by a
  merger of the country's largest insurance
  company, Nationale-Nederlanden NV, and the
  third-largest banking group, NMB Postbank, ING
  has become a remarkable success story.

25
Examples

• The company has experienced considerable success
  distributing insurance products through its bank
  branches. On the life insurance front, about 8
  of ING's total new domestic business comes from
  sales through the 400 branches of its
  Internationale Nederlanden Bank subsidiary,
  corresponding to the former NMB Bank network. A
  further 2 comes from sales through the Postbank
  network that serves four million households
  through 2,100 post offices

26
Lessons in bancassurance

• 1. Target the right customer.
• 2. Maximize distribution possibilities.
• 3. Integrate insurance products into the bank
  culture.
• 4. Sell the right products.
• 5. Use a knowledgeable sales representative.

27
How to target the right customer

• Banks are not waiting for people to walk into
  their branch offices for insurance
• They target people who are taking out mortgage
  loan, auto loan, etc.
• The also have a database of people with their
  income, net worth and other information
• Direct marketing and telesales

28
Integrate insurance products into the bank culture

• Two advantages
• First, bank-named products capture the trust of
  the bank customer who has come to have confidence
  in his or her bank.
• Second, bank brand names encourage staff, who are
  critical to the referral process, to make those
  referrals (they may be reluctant to do so for
  outside products)

29
Selling the right product

• The most successful products for bancassurers
  have been life insurance products of a sort,
  mostly savings investment-type products. In
  France, banks offer a product called bon de
  capitalisation, a tax-advantaged deposit account
  with a life insurance element to it. In other
  countries the life insurance products are similar.

30
In other markets

• In markets such as the United Kingdom and
  Holland, banks have developed hybrid bank
  products to supplement mortgages. A home buyer
  can buy a home through a loan at the bank and pay
  only the interest during the life of the
  loan--essentially a balloon mortgage. Meanwhile,
  the borrower takes out a cash-value life policy
  that is sufficient to cover the price of the home
  plus a little extra. At the end of the policy's
  term or in the event of death the loan is paid
  off.

31
Use a knowledgeable sales representative

• The sale of life/pension products generally
  requires skills that generalist (bank) branch
  personnel don't have.
• The traditional agent uses a one-on-one approach.
  
• Banks are utilizing branches, ATMs, direct mail,
  telephone and many other resources.
• The successful bank agent will have to rethink
  what they do against bank customer profiles and
  be flexible in terms of customer approach.

32
Emerging structures

• 1. Banking bringing in independent brokers to
  distributed through branches.
• 2. Joint ventures between banks and insurers.
• 3. Banks starting up their own insurance
  operations.
• 4. Banks buying up insurance companies and
  distributing their products through the bank.

33
Meanwhile in Mexico...

• The consequences for insurers that fail to pursue
  bank distribution channels are illustrated by
  insurers' results for 1994 in Mexico, where
  premium growth among medium-sized and small
  insurers helped the Mexican insurance market grow
  14.7 over the prior year. The largest growth
  came from small insurers (premiums of less than
  132 million pesos) with 24.4 growth and
  medium-size (premiums of less than 800 million
  pesos) with 20.2.

34
Meanwhile in Mexico...

• Aetna, the Hartford insurer announced in 1996 an
  agreement to form a bancassurance joint venture
  with Grupo Financiero Bancomer
• Aetna expects to pay 115 million for a 49
  percent stake in the venture, which will sell
  life and property insurance through Bancomer's
  848 retail bank branches.

35
Meanwhile in Mexico...

• Before 1982, banks were private
• But, they did traditional banking
• In 1982, 58 banks were nationalized
• 18 survived and sold in 1991-2
• They emerged as financial groups rather than as
  traditional banks

36
US market

• Fragmentation exists within the insurance and
  banking industries. On one side, insurers are
  encumbered by an "average acquisition expense
  estimated at 175 to 200 percent of each dollar of
  new life premium."
• Therefore, many insurers are quietly forging
  relationships with banks as well as other
  distribution channels to increase efficiencies

37
Position of intermediaries

• Insurance intermediaries (agents and brokers)
  concerned about consumer protection issues
  specifically cite the following problems
  associated with bank involvement (1) safety and
  soundness (contagion), (2) unfair competition,
  (3) coercion (tie-in sales), and (4) service
  quality.

38
Contagion

• Intermediaries argue that banks will not be
  fiscally sound due to the risk of contagion (a
  dominolike effect wherein one unit of a business
  brings down the entire parent), which could cause
  adverse micro- and macroeconomic repercussions.
  This risk presumes the bank is both the
  manufacturer and distributor of the insurance
  products

39
Unfair competition

• Intermediaries argue that banks represent unfair
  competition.
• Global evidence reveals that bank entry into
  insurance distribution stimulates free market
  competition.
• In Europe, bank-based insurance thrives by
  selling simple, commodity-like insurance policies
  to branch customers

40
Coercion

• Intermediaries argue that banks will coerce
  customers into purchasing insurance products.
  Although such a threat certainly exists, the
  infrequency of reported incidents in current
  bank/insurance activities does not indicate a
  widespread problem
• German insurance supervisory authorities
  prohibits the linkage of insurance contracts and
  loans if the face amount exceeds the total loan

41
Quality of service

• Intermediaries argue that banks will not be able
  to deliver a high quality of service or advice.
  In light of recent U.S. bank mutual fund
  problems, this is a valid concern. Successful
  European bancassurers use trained bank-based
  insurance advisers to sell standardized products
  and to service existing customers.

42
Position of banks

• Conversely, banks contend their admittance to the
  insurance playing field would have positive
  effects such as
• competition (choice),
• convenience (access), and
• efficiencies (enhancing contract value).

43
Competition

• Banks contend that their insurance services will
  have a positive effect on competition.
• Banks have enjoyed immediate success as
  distributors of insurance in Europe. Credit card
  operations, branch systems, and specialized
  financial services (e.g., trust, employee
  benefits, and personal/commercial loan
  operations) have potential efficiencies of scale
  and scope unmatched by traditional distribution
  alternatives.

44
Examples

• These competitive efficiencies have been credited
  with reducing term life insurance premiums by 14
  percent in Australia from 1990 to 1994 and 8
  percent in New Zealand from 1989 to 1993.
  Additionally, a 1994 Canadian survey ascertained
  that a Quebec consumer could enjoy up to a 35
  percent insurance discount purchasing through the
  caisses populaires

45
Convenience

• Banks contend their entrance would increase both
  customer convenience and access to insurance
  services. The issue of convenience is of special
  importance being that most customers prefer
  "one-stop shopping. Access to the financial
  services marketplace is already available to the
  lowest income levels of society through local
  bank branches

46
Efficiency

• Banks argue that their entrance would increase
  efficiencies and thereby enhance product value.
  European bancassurance results prove this to be
  true
• Banks rely on cross-selling ratios between 10 to
  15 percent to enhance profitability within their
  "core banking services. Banks have higher
  productivity than do traditional distribution
  channels-a more efficient lead generation system

47
Forces driving financial services integration and
globalization

• Demand forces
• changing buyer behavior
• more consumer awareness
• reduction in employer provision of security
• Supply forces
• Other competition (bancassurance)
• Economy of scale (larger-cheaper)
• Economy of scope (one product-another)

48
Government and political forces

• Governments are shrinking
• their role as provider of various services is
  getting smaller
• Liberalization
• Globalization

49
Globalization why?

• Rapid advances in telecommunications and
  information technology are expanding the
  boundaries of tradability in services-the
  fastest-growing component of both trade and
  foreign direct investment.
• For developing countries, promising new avenues
  for exports are opening, especially in relatively
  labor-intensive long-distance services - data
  processing, software programming, clerical and
  professional services

50
Unbundling of services

• Progress in IT is making it possible to unbundle
  the production and consumption of
  information-intensive service activities.
• Research and development (RD), computing,
  inventory management, quality control,
  accounting, personnel, secretarial, marketing,
  advertising, distribution, and legal services
• Nontradeable goods are becoming tradeable