Chapter ThreeThe Organization and Structure of Banking and the Financial-Services Industry

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Key Topics

• The Organization and Structure of the Commercial Banking Industry • The Array of Organizational Structures in Banking• Interstate Banking and the Riegle-Neal Act • The Financial Holding Company• Mergers and Acquisition • Banking Structure and Organization in Europe and Asia• The Changing Organization and Structure of Banking’s Principal Competitors • Economies of Scale and Scope

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Assets Held by U.S. FDIC-Insured Commercial Banks, 2007

87%

11%

2%

Assets Held By Large BanksAssets Held By Medium BanksAssets Held By Small Banks

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Number of U.S. FDIC-insured Commercial Banks, 2007

43%

50%

7%

Small ≤ $100 Million

Medium $100 Million -$1 Billion

Large > $1 Billion

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Community Banks or Retail Banks

• ‘Typical’ Size is $300 Million•Organizational Chart is Not Complicated•Significantly Affected by Health of Local

Economy•Generally Know their Customers Well –

Relationship Lending

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Money Center or Wholesale Banks

•Generally Multi-Billion Dollar Company•Organizational Chart is Much More

Complex•Serve Many Different Markets with Many

Different Services so are Better Diversified Geographically and by Product

•Able to Raise Large Amounts of Capital at Relatively Low Costs

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Quick Quiz

•What are the general trends in the size distribution and asset concentration of American banking industry?

•Describe differences between a typical organizational structure of smaller community bank and a larger money-center bank.

•What trends are affecting the way banks and their competitors are organized today?

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Common Classifications of U.S. Banks

2%

98%

0% 20% 40% 60% 80% 100% 120%

Not FDIC Insured

FDIC Insured Banks

75%

25%

0% 10% 20% 30% 40% 50% 60% 70% 80%

State Banks

National Banks

64%

36%

0% 10% 20% 30% 40% 50% 60% 70%

Non Member Banks

Member Banks

Source: FRB and FDIC, 2005

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Deposits Held By Banks

23%

77%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Deposits of Non Member Banks

Deposits of Member Banks

45%

55%

0% 10% 20% 30% 40% 50% 60%

Deposits of State Banks

Deposits of National Banks

Source: FRB and FDIC, 2005

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Unit Banks

•Offer All Services From One Office•One of the Oldest Kinds of Banks•New Banks are Generally Unit Banks Until

Can Grow and Attract More Resources

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Branch Banks

•Offer Full Range of Services from Several Locations

•Senior Management at the Home Office•Each Branch has its Own Management

Team with Limited Decision Making Ability•Some Functions are Highly Centralized,

While Others are Decentralized

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Reasons for Growth of Branching

•Exodus of Population to Suburban Communities

• Increased Bank Failures in Recent Years•Business Growth

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What Trend in Branch Banking Has Been Prominent in the U.S. in Recent Years?

Year # of Bank Main Offices

# of Branch Offices

Total of U.S. Bank Offices

Ave # of Branches/U.S. Bank

1934 14,146 2,985 17,131 0.21

1970 13,511 21,810 35,321 1.61

1982 14,451 39,784 54,235 1.75

2007 7,241 77,947 85,188 10.76

From Table 3-2; Source: FDIC

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Electronic Branches

• Internet Banking Services•Automated Teller Machines (ATMs)•Point of Sale (POS) Terminals

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Virtual Banks

•Provide their Services Exclusively Through the Web

•Can Generate Cost Savings Over Traditional Brick-and-Mortar Banks

•Have Not Yet Demonstrated They Can Be Consistently Profitable

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Bank Holding Companies (BHC)

•A Corporation Chartered for the Purpose of Holding the Stock of One or More Banks

•Control of a bank is Assumed When 25% or More of the Stock is Owned

•Must Get Approval from Federal Reserve Board to Control a Bank

•One-Bank Holding Companies vs. Multibank Holding Companies

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Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries

Bank Branches

Each subsidiary has apresident and line officers

The bottom four levels have the same organizational form as the independent bank.

Single Bank Holding Company

Multibank Holding Company

Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries Bank Subsidiary

Bank Branches Bank Branches

Organizational Structure of a BHC

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Nonbank Businesses of BHCs• Finance Companies•Mortgage Companies•Data Processing

Companies• Factoring Companies• Security Brokerage

Firms• Financial Advising• Credit Insurance

Underwriters•Merchant Banking

• Investment Banking Firms

• Trust Companies• Credit Card

Companies• Leasing Companies• Insurance Companies

and Agencies• Real Estate Services• Savings Associations

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Reasons for the Growth of BHCs

•Geographic Diversification•Product Line Diversification•Tax Sheltering•Double Leveraging•Source of Strength•A Way Around Regulatory Restrictions

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Reasons for Full-Service Interstate Banking•Need to Bring New Capital to Revive

Struggling Local Economies•The Expansion by Non Bank Financial

Institutions with Fewer Restrictions •A Strong Desire by Large Banks to Expand

Geographically•Belief Among Regulators that Large Banks

are More Efficient and Less Prone to Failure•Advances in Technology

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Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994•Allows BHCs to Acquire Banks Anywhere in

the U.S.•Allows BHCs to Convert Banks to Branches

– June 1997•States Can ‘Opt Out’ and Not Allow BHCs

to Convert to Branches•States Can ‘Opt In’ Early•Limits Deposits of One BHC to 10%

Nationwide and 30% Within One State

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Proponents and Opponents of Interstate Banking

Proponents• Efficient Use of Scarce

Resources• Lower Prices for Services• Geographic Diversification• Efficient Flow of Credit in

the System

Opponents• Increased Bank

Concentration• Less Competition• Higher Prices for Services• Drain Resources from

Community

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Financial Holding Companies: GLB Act of 1999

• Special Type of Holding Company•Offers the Broadest Range of Services•List of Activities Offered May Expand as

Regulators Decide What Services are ‘Compatible’ with Banking

•Each Affiliated Financial Firm has its Own Capital and Management and its Own Profit or Loss

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Bank

Holding

Company

SecuritiesSubsidiaries Insurance

Subsidiary

Thrift HoldingCompany

Real

Estate

Subsidiary

Financial HoldingCompany

Subsidiariesand ServiceCompanies

Thrift CompanyNonbankSubsidiaries

Commercial Banking Company

Sample Organizational Structure of FHC

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Bank Subsidiaries

•Bank Controls One or More Subsidiaries•Subsidiaries Offer Other Services Such as

Insurance and Security Brokerage Services•Profits and Losses of Each Subsidiary

Impact Parent Bank

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The Changing Organization and Structure

•Rise in Branching, BHCs, and FHCs•Consolidation among Banks and Nonbanks•Convergence •Other forces of change:▫Deregulation/Reregulation▫Financial Innovation▫Securitization▫Globalization▫Advances in Technology

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Do Bigger Firms Operate at Lower Cost?•Economies of Scale•Exhibit 3-10

•Economies of Scope•Banking and Financial Firm Goals and

Motivations•Expense-Preference Behavior•Agency Theory•Corporate Governance

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Structure and Organization of Banks in Europe•Germany – Largest European Banking

Industry▫Private Sector Banks▫Public Sector Banks

•France – Second in Number of Banks•Belgium – Dominated by Five Large Banks•Great Britain – Dominated by a Half Dozen

Banking Firms•Switzerland – Credit Suisse and UBS and

Many Smaller Firms• Italy Privatized Banking in the 1990’s

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Structure and Organization of Banks in Asia•China – Large Dominating Government

Sector, Although Private Banks are Expanding

• Japan – Dominated by the Big Four Financial Group with More than One Hundred Smaller Domestic Banks and Seventy Foreign Banks

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Quick Quiz•Which type of corporations chartered for the

simple purpose of holding the stock of at least one bank?

•What were the reasons for the Riegle Neal Act of1994?

•When the banking industry moves toward larger but fewer organizations, what is it known as?

•What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered?

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