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1. Banking in the U.S.
Bachelor Studies in Finance
Year 2, Spring 2012
•
The US financial system is often grouped with that of the
UK as a
market-based system
, indicating that the finance
of firms comes largely from the issue of securities, and
thus via markets.
BANKING
•
In fact, in some periods, the net contribution of bond and
equity issues to corporate finance has not been particularly
high and has certainly been lower than that in the UK.
Lecture 12
Banking in the U.S. and in Japan
•
Financial markets in all countries pay great attention to the
ups and downs of the Dow Jones Industrial Average index
and to the NASDAQ index.
Ewa Kania, Department of Banking
2
•
Secondly
, until recently, legislation limited the growth of US
banks and their ability to expand from their home states to
other states within the country.
•
The US banking system has a number of characteristics
that distinguish it from those of other countries.
•
The restriction on expansion within the USA was one of a
number of reasons for large banks from the financial centre,
New York, choosing to establish branches offshore, and
playing a major part in the development of the Eurocurrency
markets.
•
Firstly
, there are a very large number of banking
organizations. Although the number of banks has fallen
sharply, particularly through mergers and acquisitions,
there remained at the end of 2009 a total of 6,839
commercial banks, down from 8,315 at the end of 2000.
•
Thirdly
, there is a dual system of licensing, with banks being
chartered by both the federal government and individual
states.
•
This shows a decline in the rate of reduction of the number
of commercial banks from the height of merger activity in
the middle 1990s.
•
Fourthly
, for a significant part of the 20
th
century, other
restrictions on the operation of banks were in force, limiting
interest payments on deposits and providing for a strict
separation of investment banks from commercial banks.
•
At the end of 1984 there had been 14,496 commercial
banks.
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•
Classification of the US banking system is complicated by a
number of the system’s features. There is the classification of
depository institutions into commercial banks, thrifts (saving
institutions) and credit unions.
•
Thrifts
are subdivided into
savings and loan associations
(S&Ls) and
savings banks
. Thrifts have longer term assets
and liabilities than commercial banks.
•
Their assets principally consist of long-term bonds or house
mortgages. Their liabilities are almost exclusively savings and
time deposits.
•
Commercial banks
are deposit-accepting institutions
(depository institutions) which engage in a variety of financial
activities.
•
S&Ls are primarily involved in real estate and housing
finance. They can be traced back to the early 1830s when they
began to be set up as credit cooperatives to provide housing
finance and to act as a safe repository for small savers.
•
Under
The 1933 Banking Act
(the
Glass–Steagall Act
),
commercial banks were effectively restricted to banking
activities. The act prohibited them from originating, trading or
holding securities other than those of the federal government,
state and local governments.
•
They became the second largest type of financial institution in
the USA, behind only commercial banks, but have declined
both in number and asset size following the savings and loans
crisis of the 1980s.
•
Other securities business was restricted to investment banks,
which were non-depository institutions. The Glass–Steagall
Act was repealed in 1999, allowing commercial banks to take
on the activities of investment banks.
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•
Savings banks
were first set up in the early 19
th
century as
mutual philanthropic institutions aimed to encourage the poor
to save. They engaged in mortgage lending while also holding
large quantities of government and corporate bonds.
•
Most S&Ls were organized as
mutual associations
(owned
by their members rather than by stock-holders). In the
majority of states they were required by law to be mutual
associations.
•
Savings banks have always been safer than other depository
institutions. During the Great Depression only eight of the 598
savings banks failed and they also performed much better than
S&Ls during the 1980s crisis.
•
The collapse of house prices in the Great Depression of the
early 1930s led to the failure of nearly 2,000 S&Ls (out of a
total of just under 13,000) and to two important pieces of
legislation – the establishment of the Federal Home Loan
Bank system (1932), which provided a central credit facility
to lend to troubled institutions, and the introduction of
deposit insurance with the establishment of the Federal
Savings and Loan Insurance Corporation (FSLIC) in 1934.
•
This was partly because they responded more flexibly to the
changing economic and financial circumstances than did S&Ls
and, from the late 1960s on, began diversifying their assets
away from mortgages towards securities.
•
Recently, a number of surviving S&Ls have converted to
savings banks to escape the S&L name.
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•
All savings banks are now federally insured and many of the
larger banks have shed their mutual status, although a higher
proportion of savings banks have remained mutuals than has
been the case with S&Ls.
•
Much freer interpretations of the term ‘common bond’ have
followed, resulting in credit union mergers. Despite these
changes, the credit union sector remains small in relation to
other deposit-taking institutions.
•
Fewer than 40 per cent of thrifts have remained mutual.
•
As of 2008 in the United States there were over 9,000 credit
unions with 89 million members comprising 43.7% of the
economically active population.
•
Credit unions
deal primarily in small, fixed-term, personal
loans. Their funds come entirely from persons (and individual
deposits are very small). Credit unions too were established as
mutuals. Under the
Federal Credit Union Act
, their membership
was limited to groups having a common bond of occupation or
association. They were thus essentially local in nature.
•
The average size of the three types of depository institutions at
the end of June 2007 was:
– commercial banks
$1.42 billion
– savings institutions
$1.46 billion
•
Although they were not legally prohibited from operating across
state lines, the common bond requirement restricted the
interstate activities of credit unions to a few large institutions
serving the armed forces or large multinational corporations.
– credit unions
$90.07 million
•
That is, the asset base of the average credit union is well under
one tenth the size of that of the average commercial bank.
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•
There is the dual nature of the chartering system with financial
institutions being granted licences (charters) to operate either by
individual states (
state-chartered banks
,
state-chartered
savings institutions
) or by an agency of the federal government
(
nationally chartered banks
,
nationally chartered savings
institutions
).
•
Bank holding companies
are companies that have controlling
interests (i.e., directly controlling more than 5 per cent of voting
shares) in one or more US banks. Forming a bank holding
company provided a way around some of the restrictions
imposed on banks by legislation.
•
Up until 1956, bank holding companies could also have
controlling interests in companies engaged in activities other
than banking. This led to fears that bank assets would be used to
finance the losses of non-banking subsidiaries, increasing the
risk attached to banks.
•
This had its origin in the strong desire for local independence so
important in the development of the US governmental system.
Still today, state financial authorities continue to encourage new
banks to take out state charters and existing financial institutions
to convert to a state charter.
•
The
1956 Bank Holding Company Act
prevented multi-bank
holding companies from engaging in non-banking activities that
were not, in the judgement of the Federal Reserve, closely
related to banking.
•
They claim greater knowledge of local conditions, closer
geographical proximity to their primary regulator and hence
better communication with regulators. They might also claim
lower fees and more favourable local banking regulations.
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12
2. Banking in Japan
•
In 1999, the
Gramm–Leach–Bliley Financial Services
Modernization Act
repealed the Glass–Steagall Act of 1933
and greatly amended the Bank Holding Company Act of 1956.
•
Japan
has a bank-based financial system where banks play
a more important role than the stock market.
•
It allowed bank holding companies to become a new entity
called a
financial holding company
, which may make
minority or controlling investments in any company, including
non-bank financial companies such as securities and insurance
firms.
•
In the post-war period, Japan faced a severe shortage of
capital and weak financial infrastructure. World War II
virtually wiped out the household sector’s financial assets.
•
The priority of the US occupying force and the new
Japanese government was to increase assets, which in turn
could finance recovery of the real economy.
•
As a result of the global financial crisis of 2008, many
investment banks and finance corporations such as Goldman
Sachs, American Express, CIT Group (not to be confused with
Citigroup, another large financial services company) and
General Motors Acceptance Corporation successfully
converted to bank holding companies in order to gain access to
liquidity and funding.
•
The outcome was a highly segmented financial system,
with strong regulatory control exerted by the
Ministry of
Finance
, backed by the Bank of Japan.
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•
Following the crash of Japan’s stock market in late 1989,
Japan’s financial sector went into
severe decline
, so that by the
beginning of the 21
st
century most Japanese banks were
insolvent. In an attempt to revive the financial sector, Big Bang
was announced in 1996. The programme of reforms was
designed to fulfil two objectives:
• Domestic and foreign and short and long-term financial
transactions were kept separate, interest rates regulated, and
financial firms organised along functional lines.
• A high degree of functional segmentation fitted in with the
keiretsu
system.
•A
keiretsu
is a group of companies with cross-shareholdings
and shared directorships which normally include a bank,
trust company, insurance firm and a major industrial
concern such as steel, cars, property and construction.
•
First
, the financial sector was to be restructured, putting an end
to functional segmentation.
•
Second
, to restore financial stability, the Financial Supervisory
Agency and Financial Reconstruction Commission were
established (later merged as the Financial Services Agency).
The Bank of Japan was granted independence.
•
The bank supplies services to the other
keiretsu
members,
including loans.
•
The
Bank of Japan
was responsible for the implementation
of monetary policy, but was not independent. MoF officials
exercised strong influence through its membership on the
Bank’s policy board.
•
In place of the segmented markets is a form of
restricted
universal banking
, using the financial holding company
structure.
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The programme of reforms introduced:
•
•
Since the outbreak of the global financial crisis, Japan’s
financial system has remained stable. Increased credit costs and
losses due to impairment in stockholdings reflecting the rapid
drop in the level of economic activity and the decline in asset
prices have been easing off.
A blanket deposit insurance scheme to protect all the depositors
in the event of bank failure
•
Extended emergency liquidity assistance to troubled banks
•
Financial assistance to promote mergers among troubled
financial institutions
•
Japanese banks have taken measures such as strengthening their
capital bases through capital increase and reducing market risk
associated with stockholdings.
•
Injected capital into weak but viable banks
•
Allowed for the temporary nationalization of non-viable banks
•
Public recapitalization of various banks that amounted to
around JPY 9 trillion
•
The
loan quality
has been deteriorating.
•
Market risk
is still high. Interest rate risk is the result of
increases in long-term investment.
•
More rapid recognition of non-performing loans with tougher
loan classification
•
In this situation, banks need to make continuous efforts to
improve their risk management and strengthen their capital
bases, while properly assessing their risk-return balance.
•
Disposal of bank non-performing loans
•
Exit of a number of inefficient deposit-taking institutions
•
Establishment of various public asset management companies
that deal wit the sale of bank non-performing loans
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•
Japanese banks’ borrowers
are classified into
a) cross-shareholding firms (cross-shareholders),
b) major shareholding firms (major shareholders), and
c) other firms.
•
•
Japanese banks’
risks
relative to Tier I capital have decreased
somewhat since the beginning of 2009. Funding liquidity risk
has been restrained.
•
Banks’
capital bases
are not likely to decline substantially,
even if credit costs rise and stock prices stagnate under the
severer macroeconomic conditions. Thus, the robustness of
Japan’s financial system has been maintained on the whole.
During the 2000s, the ratio of current profits to sales and the
interest coverage ratio of the firms with strong capital ties to
banks (cross-shareholders and major shareholders) were lower
than those of the non-borrowers.
•
Nevertheless, the capital adequacy ratios stay at low levels at
banks whose profitability and capital strength are relatively
weak.
•
In particular, the profit ratios of cross-shareholders decreased
even in the recovery phase during 2005 to 2007.
•
Firms with strong capital ties to banks have tended to have
relatively low profitability through the 2000s.
•
Japanese banks face two challenges in terms of their profit
structure:
low profitability
and large fluctuations in profits.
•
One reason
why banks hold client firms’ shares
is that by
establishing long and stable relationships with clients, they can
earn returns such as interest on loans, dividends from shares,
and fees and commissions.
•
Profitability of Japanese banks remains below that of the U.S.
and European banks, mainly due to low interest margins on
loans.
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•
The Bank of Japan
is the central bank of Japan. It is a juridical
(legal) person established based on the Bank of Japan Act, and
is not a government agency or a private corporation.
• The Bank of Japan’s two missions are to maintain
price
stability
and to ensure the
stability of the financial system
,
thereby laying the foundations for sound economic
development. To fulfil these missions, the Bank of Japan
conducts the following activities:
1. Issuance and management of banknotes
2. The conduct of monetary policy
3. Providing settlement services and ensuring the stability of the
financial system
4. Treasury and government securities-related operations
5. International activities
6. Compilation of data, economic analyses and research activities
Deposit Insurance Corporation of Japan
is a semi governmental organization that
was established in 1971 with the purpose of
operating Japan’s deposit insurance system.
The logo with four blades presents the main businesses of DICJ:
1. management of the deposit insurance system
and inspection of financial institutions;
2. financial revitalization of distressed financial institutions;
3. collection of non-performing loans and pursuit of
management liabilities of failed financial institution;
4. operations related to sound financial institutions
such as capital injection.
The logo also incorporates the hope of DICJ to be a propeller to
drive forward to the stabilization of financial sector in Japan.
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Japanese banks supervised by the Financial Services Agency
(numbers as of April 2012)
The main functions of the Financial Services Agency
•
Planning and policymaking
concerning the financial system
•
city banks
– the 5 largest banks that account for over 50 per cent
of total banking assets and are mainly based in urban areas
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Inspection and supervision of
private banks, securities
companies, insurance companies
•
16
trust banks
perform investment banking services (asset
management) and also commercial banking activities
•
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regional banks
operate in various regions of the country
•
Establishment of rules for trading in securities markets
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bank holding companies
•
Establishment of business accounting standards and others
concerning corporate finance
•
16
other (licensed) banks
•
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foreign banks
•
Supervision of certified public accountants and audit firms
•
272
shinkin
banks, incl.
shinkin
central bank; these are
cooperative regional financial institutions serving small and
medium enterprises and local residents. Anyone who lives,
works, or has an office in the region served by the bank can
become a member. Companies with over 300 employees are
prohibited from membership.
•
Participation in activities of international organisations
•
Surveillance of compliance with rules governing securities
markets
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