Download The Meanings of Financial Services Integration

Fall 2008 Version
Professor Dan C. Jones
FINA 4355
Will address time permitting
Risk Management and Insurance: Perspectives in a Global Economy
25. Financial Services Integration
Professor Dan C. Jones
FINA 4355
Will address time permitting
Study Points
Meanings and forms of integration
The economics of integration
Management issues in integration
Public policy concerns in integration
The future of financial services integration
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Meanings and Forms of Integration
The Meanings of Financial Services Integration
Meaning
It occurs when a financial service traditionally associated with one of
the three main financial sectors is produced or distributed by
companies in another financial sector.
It occurs at one of three levels: (1) supplier, (2) product or (3) advice.
Various terms
Bancassurance
Allfinanz
Universal bank
Financial conglomerate – de facto or mixed
Advisory integration
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Structures for Delivery
Full integration
Universal bank (German variations)
Bank (or insurer) patent
Holding company arrangement
Joint venture (or other similar arrangements)
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Full Financial Services Integration (Figure 25.1)
Banking
Securities
Insurance
Other Financial
Activities
Activities
Activities
Activities
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Universal Bank – German Variant (Figure 25.2)
Commercial Banking
Investment Banking
Activities
Activities
Insurance
Activities
Securities
Activities
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Bank Ownership (Figure 25.3)
Commercial Banking
Activities
Securities
Activities
Insurance
Activities
Other Financial
Activities
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Holding Company (Figure 25.4)
Financial Services
Holding Company
Banking
Activities
Securities
Activities
Insurance
Activities
Other Financial
Activities
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The Economics of Integration
The Economics of Integration
Cost effects
Revenue effects
Profit efficiency
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The Economics – Cost Effect Analysis
Economies of scale
Economies of scope in production resulting from
Investment operations
Information technology
Distribution
Reputation
Operational efficiencies
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The Economics – Revenue Effect Analysis
Economies of scope in consumption
Market power
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The Economics – Profit Efficiency Analysis
A conglomerate could incur greater costs (resulting in cost
inefficiency) yet realize greater revenues (from revenue
efficiency) such that net profits increased.
The reverse is also possible.
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Management Issues in Integration
Issues in Integration (Figure 25.5)
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Group Structure
De jure (law-based) structure
De facto (fact-based) structure
Group structure decisions also relate to whether the
necessary manufacturing platforms will be acquired or
created de novo.
Organic growth has been more successful than growth through
acquisition.
Organic growth requires more time (investment).
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Operational Complexity
Especially relevant when integration is accomplished via
merger or acquisition
The problem of complexity seems largely to be ignored at
present.
“It is, to say the least, surprising that there should be such widespread
and critical [sic] acceptance of this need, with no precise distinction
between types of business and without meticulous analysis of the
many drawbacks that these processes may involve and of the
problematic nature of their purported advantages.”
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Corporate Culture
Corporate cultures varying across firms/industries
Challenges for management of financial conglomerates, especially
those resulting from merger and acquisition.
National differences in management dedication to
shareholder value – a principal-agent agency problem
Focused banks
Operate within a culture of shareholder value, use internationally
accepted accounting principles and have a sharper focus on retail
banking operations
Universal banks
Operate within a managerial culture, follow inferior accounting
practices and believe in universal banking as a concept
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Inexperience and Lack of Expertise
Pose vexing problems at the early stage of integration
Particularly relevant in markets where financial services integration
was unprecedented
Joint ventures and strategic alliances between domestic and
experienced foreign companies may prove most appealing to
both domestic and foreign entrants.
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Marketing and Distribution
Distribution among the most challenging for management of
integrated financial institutions
Especially those groups created via merger and acquisition
Insight 25.1
Channel conflict less of a management challenge for de novo
operations
Marketing issues associated largely with demand-side
economies of scope
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Target Market Clarity
Management must be clear about the group’s target market.
Management must determine
The classes of products to be offered
Asset accumulation
Debt management and asset protection products
Distribution channels
To date, most success in financial services integration has
been in the retail market.
Some financial products may carry the potential of creating
diseconomies of scope
Nonlife insurance is perhaps the most commonly discussed product
line.
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Financial Management Issues
Enterprise risk management
Understanding the risk profile of the group as a whole
Performance appraisal
Banks historically have focused on interest spread, with return on
equity of more recent importance.
Life insurers increasingly use embedded value analysis.
Nonlife insurers use combined and operating ratios and return on
equity.
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Conflict of Interest
Conflicts
Salesperson’s stake
Stuffing fiduciary accounts
Bankruptcy risk transfer
Tie-in sales
Internal information transfer
Incentive conflicts can be managed through regulation or by
finding a market solution
Management of reputational risk is an increasing concern.
Franchise
Goodwill
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Public Policy Concerns
Public Policy Concerns
Financial services regulators are concerned primarily with
three broad categories of market imperfections:
Information problems
Market power
Negative externalities
Regulatory interventions
Prudential
Market conduct
Competition policy
Refer to Figure
25.5
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Public Policy Concerns – Information Problems
Six issues in prudential regulation
Transparency
Contagion
Double and multiple gearing
Unregulated group entities
Fit and proper requirements
Regulatory arbitrage
“Issues in prudential
regulation”
discussed in pages
669-673.
Issues in market conduct regulation
Conflict of interest
“Issues in market
conduct regulation”
discussed in page
673.
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Information Problems – Transparency
Group transparency
Disclosure (to external parties)
Large international financial conglomerates can be
particularly complex
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Information Problems – Contagion
The risk
Financial distress encountered by one unit in a financial conglomerate
could have adverse effects on the financial stability of the group or on
the entire market (i.e., negative externalities)
Two types of contagion
Psychological
Inter-group exposures such as:
Credit extensions or lines of credit between affiliates
Cross-shareholdings
Intra-group trading in securities
Insurance or other risk management services provided by one unit
for another
Intra-group guarantees and commitments
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Information Problems – Gearing
Types
Double gearing
Multiple gearing
The issue is more on the proper assessment of a financial
conglomerate’s consolidated capital
That is, less on the ownership structure flowing from it
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Information Problems – Unregulated Entities
Excessive leveraging
An intra-group exposure
An unregulated parent issues debt or other instruments not
acceptable as regulatory capital in a downstream entity and
downstreams the proceeds to a subsidiary firm in the form of equity or
other regulatory capital
May also occur when the unregulated entity is an intermediate holding
company
With an unregulated holding company, an assessment of
group-wide capital adequacy should encompass the effect of
the holding company’s structure.
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Information Problems – Fit and Proper Requirements
The probity and competence of the top management
For regional and international financial conglomerates,
issues of supervisory jurisdiction arise.
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Information Problems – Regulatory Arbitrage
To the extent that industry-specific regulations and taxation
differ, arbitrage possibilities are created.
Arbitrage possibilities influence decisions about the structure
of the group.
A move toward consolidated financial regulation suggested
as a solution
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Public Policy Concerns – Market Power
Market power could:
Arise from size alone if barriers to entry are great
Evolve through predatory pricing
The predatory pricing option seems remote, provided there
are not substantial barriers to entry.
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Public Policy Concerns – Negative Externalities
Systemic risk, most commonly associated with commercial
banking
Are financial conglomerates riskier?
A “too-big-to-fail” (TBTF) position?
Does financial service integration pose additional burdens on
the safety net?
Safety nets such as deposit insurance, guaranty funds, the discount
window and payment system guarantees
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Regulatory Structure
Single regulator?
Could minimize the problems of information sharing and coordination
associated with sector-specific supervision
Permit a less complex approach for addressing issues discussed
above
Facilitate needed harmonization of accounting and capital adequacy
requirements across financial intermediaries
Lessen opportunities for regulatory arbitrage
Is creating a single regulator feasible in the local market?
No international consensus has yet emerged on this issue.
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Regulatory Structure
Consolidated regulation suitable in a market where:
Similar products/services are offered by different types of
intermediaries in the same market segments.
Institutions in competing sectors have similar strategies for growth
and development in the domestic and/or the international market.
Institutions in one sector create systemic risk exposure for another
industry.
Competing sectors are at a similar and advanced stage of
development.
Institutions are combining in ways that make it difficult to distinguish a
bank from an insurance firm.
The financial services industry is pushing for reform to meet
competitive pressures.
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The Future
The present pressures for integration seem strong.
The globalization of business in particular and financial services
specifically fosters integration.
Financial services innovation and production efficiency are
essential to economic development.
How integrated financial services fit into this evolution?
Whether it poses unacceptable risk to consumers and the financial
system?
The market will determine whether financial conglomeration
makes good business sense and, if so, the optimum
operational structure.
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The Future
Regulatory convergence in two dimensions
Those aspects of national regulation and taxation that are specific to
one financial services industry or its products can be expected to
cause increasing distortion.
International differences in regulation and taxation of financial
institutions and products increasingly will afford opportunities for
international regulatory and tax arbitrage.
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Discussion Questions
Discussion Question 1
If bancassurance becomes a globally accepted method of
insurance distribution, are consumers more likely to be
helped or harmed? How would your answer differ if the same
question were asked about a perfectly competitive market
compared with an oligopolistic market?
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Discussion Question 2
From a strictly marketing perspective, what role might culture
play in the process of financial services integration? As the
executive vice president of marketing for a global
conglomerate, how might your overcome these challenges?
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Discussion Question 3
Speculate about the degree to which each of the following
market segments would be affected (either positively or
negatively) if financial services competition were dominated
by financial services conglomerates: low, middle and upper
income?
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Discussion Question 4
What are some of the political ramifications of financial
services integration? As the financial services regulation czar
for the E.U., list the three most pressing challenges you
would have to overcome. How would you accomplish each?
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Discussion Question 5
Choose any two public policy issues. Argue either for
integration, citing potential solutions, or against integration,
citing reasons why the issue cannot be overcome?
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Discussion Question 6
If full integration were permitted tomorrow in your country,
how would the financial landscape look 1, 10 and 25 years
from now? What would be the impact on (a) the national
economy and (b) consumers?
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