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1、 172 CHAPTER 13 SOURCES OF FEE INCOME:INVESTMENT BANKING,SECURITY TRADING,INSURANCE,TRUST,AND OTHER REVENUE-PRODUCING SERVICES Goal of This Chapter:This chapter is designed to explore several of the most important non-deposit financial services banks have offered to the public in recent years,includ
2、ing investment banking,trust services,investments in stocks,bonds and mutual funds,insurance policies,and annuities and examine their possible benefits.To explore several of the most important nondeposit services bankers offer the public including trust services,investments in stocks,bonds and mutua
3、l funds,insurance policies and annuities and examine their possible benefits for banks.Key Topics in This Chapter The Ongoing Search for Fee Income Investment Banking Services Mutual Funds and Other Investment Products Trust Services and Insurance Products Benefits of Product-Line Diversification In
4、formation Flows and Customer Privacy Chapter Outline I.Introduction II.Sales of Investment Banking Services III.Selling Investment Products to Consumers A.Mutual Funds B.Annuities IV.Trust Services as a Source of Fee Income A.History Trust Services B.Roles of Trust Departments C.Types of Trusts V.Sa
5、les of Insurance Related Products A.Types of Insurance Products Sold by Banks and Other Financial-Service Providers in Recent Years 1.Life Insurance Policies 2.Life Insurance Underwriters 3.Property-Casualty Insurance Policies 4.Property Casualty Insurance Underwriters B.New Rules Covering Insurance
6、 sales by FDIC-Insured Depository Institutions VI.The Alleged Benefits of Financial Services Diversification A.An Example of the Product-Line Diversification Effect B.Potential Economies of Scope VII.Nondeposit Services and Information Flows within Banking or Financial Firm VIII.Summary of the Chapt
7、er 173 Concept Checks 13-1.What services are provided by investment banks(IBs)?Who are their principal clients?The primary role of investment bankers is to serve as financial advisers to corporations,governments,and other large institutions.13-2.Why were U.S.commercial banks forbidden to offer inves
8、tment banking services for several decades inside the United States?How did this affect the ability of U.S.banks to compete for underwriting business?The Glass-Steagall Act prohibited commercial banks from offering investment bank services for primary two reasons.One,the bank could force a customer
9、seeking a loan to buy the securities that they were trying to sell as a condition for getting a loan,and second,the bank would be exposed to increased risk due to the volatile and cyclical behavior of IB activity.U.S banks were not able to compete for underwriting business with foreign banking firms
10、 who in turn captured U.S.customers.13-3.What advantages do commercial banks with investment banking affiliates appear to have over competitors that do not offer investment banking services?What are the possible disadvantages?IB services complement traditional lending services allowing commercial ba
11、nking firms to offer both conventional loans and security underwriting to customers who seek to raise new funds.In addition,there are economies in information gathering about clients.On the other had,IB services are highly sensitive to fluctuations in the economy and would increase the risk exposure
12、 of the commercial bank.13-4.What are investment products?What advantages might they give to a depository institution choosing to offer these services?Investment products include stocks,bonds,mutual funds and other nondeposit services.The two most popular investment products offered include mutual f
13、unds and annuities.The potential advantages include generating considerable fee income which may be less sensitive to interest rate movements than traditional services such as loans and deposits.In addition,it is possible that it might add prestige and may help position the institution well for the
14、future as more and more individuals start planning for retirement.13-5.What risks do investment products pose for the institutions that sell them?How might these risks be minimized or controlled?There are several risks involved in the sale of these products.The value of these products is market driv
15、en and customers may blame the bank when they do not reach their earnings goals.Because of their reputation,customers may hold depository institutions to a higher standard than securities brokers.As a result,they may end up involved in costly litigation with customers who are disappointed or who cla
16、im that the risks involved were not adequately explained.In addition,174 they may have compliance problems if they do not properly register their investment products or fail to follow the rules for the sale of these products.Regulators already require these products to be sold in a separate area fro
17、m where deposits are taken and banks are required to prominently display that these products are not covered by deposit insurance.In addition,customers must be told that these products are subject to risks including potential loss of principal.Customers must sign a document stating they were informe
18、d of these risks.In addition,they must make sure that the names of these products cannot be confused with their regular products.Finally,they must demonstrate that they are regularly monitoring themselves to ensure that their sales personnel are complying with the regulatory requirements and banks a
19、re also supposed to be sure that the products they sell meet the needs of each particular customer and situation.Compliance with these regulations should help minimize the risks inherent in these products.13-6.What exactly are trust services?Trust departments manage the property of customers includi
20、ng their securities,land,buildings and other investments.This is one of the oldest services provided by banks.Trust departments should safeguard and prudently manage a customers assets to generate earnings.13-7.How do trust services generate fee income and often deposits as well for banks and other
21、financial institutions offering this service?Trust departments manage the assets of their customers.These assets include deposits and in some cases these deposits can be substantial.Trusts can be formed for individuals as well as businesses and charitable groups and they can have large deposits asso
22、ciated with them.The financial institution charges their customers a fee for providing these services.13-8.What types of insurance products do banks and a number of their competitors sell today?What advantages could these products offer banks and other depository institutions choosing to sell insura
23、nce services?Can you see any possible disadvantages?Financial institutions are starting to offer several insurance products.One product that they offer today is life insurance in which the bank promises to pay a beneficiary a specific cash payment in the event of the death of the policyholder.Anothe
24、r insurance product they are interested in is acting as a life insurance underwriter.Here,the institution would manage risks associated with paying life insurance claims.They want to profit from managing insurable risks and collect more in life insurance premiums than they pay in claims.Financial in
25、stitutions are also getting involved in selling insurance policies for protection from loss due to personal injury,property damage and other losses associated with property and casualty insurance products.In addition,they want to underwrite property-casualty insurance risks.Again,they want to collec
26、t more in premiums than they have to pay in claims on these contracts.There are two potential advantages to offering these services.One of these is the product line diversification effect which means that because these products are not highly correlated with their 175 other services that it can redu
27、ce the variability of the overall cash flows generated from the institution.In addition,there may be potential economies of scope from offering these products.Potential cost savings may exist because the same personnel can offer both traditional services as well as the newer nontraditional services
28、such as insurance products.On the other hand,selling insurance services requires financial institutions to adhere to strict consumer protection rules.13-9.What is convergence?Product-line diversification?Economies of scope?Why can they be of importance for banks and other financial service firms?Con
29、vergence is the bringing together of firms from different industries in order to create large conglomerates offering multiple services in one place.Product-line-diversification suggests that offering services that are not perfectly correlated with each other has the potential to reduce the risk(vari
30、ability)of the cash flows of the overall company.Economies of scope mean that there are potential costs savings resulting from(for example)the same employee may be able to offer both traditional and nontraditional services.These things mean that banks and other financial institutions may be more eff
31、icient and productive in delivering services to customers either resulting in higher profit margins for companies or cost savings for consumers.13-10.How can financial-service customers limit the sharing of their private data by different financial-service firms?In what way could customer informatio
32、n sharing be useful for financial institutions and for their customers?What damages does information-sharing present?Financial-services firms must inform customers of their policy regarding the sharing of information with other parties.Financial-services firms must also inform customers about how th
33、e customer can opt out of having their information shared with other parties.Generally,the customer must inform the company within 30 days of being notified that they do not want their information shared.There is some information that customers cannot protect from being shared.This information can b
34、e extremely useful to financial institutions because they can use the information to offer more than one service to the customer.They have already gathered the relevant information and can target products and services that are particularly a good fit for that customer.This can benefit them by increa
35、sing profits and cash flows and can benefit the customer by allowing them to get all of their financial services needs taken care of in one place.However,there are some real dangers that this information can be misused in some cases.For example,if there is some adverse private information about a pa
36、rticular customer(for example they have a very serious medical condition)that information might be used to deny them several financial services(such as getting a new mortgage).This customer essentially becomes blacklisted by many financial-services companies.Problems 13-1.Cotter National Bank has re
37、cently subscribed through a New York money center bank to an investment product service for its customers.Cotter will offer nonproprietary mutual funds to its customers as well as a variable annuity program for those interested in accumulating savings for retirement and to help with the costs of a c
38、ollege education for their children.The banks 176 marketing director is struggling with several important issues,however,and needs your input and advice.For example,A.is the bank likely to be better off offering a nonproprietary fund or should it attempt to help create a proprietary mutual fund serv
39、ice?A proprietary mutual fund would have the advantage of providing a more continuous stream of income to the bank as they offer investment advice to their customers and serve as a transfer agent and custodian of mutual fund shares.In addition,a proprietary fund gives the bank some added prestige an
40、d may mean a long-term relationship with that customer in the future.On the other hand,advertising the nonproprietary funds may bring added customers into the bank.B.What should Cotter do about setting up an investment products division within the bank to offer these two services?Are there any speci
41、al requirements the bank needs to be aware of in designing the location of that new division,and how it will offer these services?Cotter must offer these two new services in an area that is separate from the area where deposits are taken.Cotter also has to prominently display regulations warning cus
42、tomers that these products are not insured by the FDIC,that they are not guaranteed by the bank and that customers can suffer losses of principal.The name of the mutual fund cannot be similar to the name of the bank so there can be no confusion about the safety of the products and they must closely
43、monitor their investment products.C.What risks will the bank be confronted with when it actually begins offering these services?What kind of action plan might be designed to help minimize those risks and make Cotter Nationals program successful?Cotter faces the risk of a customer becoming angry beca
44、use the return they receive is not as good as they expected.They also face the risk these customers may feel they have been misled about these products and sue the bank.Cotter must also be careful to be in full compliance with all regulations.The bank can prevent some of this by counseling each cust
45、omer as to the risks involved in these products and have them sign a form stating that they understand the risks involved in these products.13-2.A banking company decides to expand its service menu to include underwriting of new security offerings as well as offering traditional lending and deposit
46、services.It discovers that the expected return and risk associated with these two sets of service offerings are as follows:Expected Return-Traditional Services 10%Expected Return-Security Underwriting 15%Standard Deviation-Traditional Services 3%Standard Deviation-Security Underwriting 6%Correlation
47、 of Returns Between Two Services+.25 Proportion of Revenue Traditional Services 85%Proportion of Revenue Security Underwriting 15%Please calculate the effects of the new service on the companys overall return and risk.177 10.75%.15(15%).85(10%)R W R W E(R)SSTT STST2S2S2T2T*W*W*2 *W*W S.D.TSr .06*.03*.15*.85*.0025*2 .06*.15 .03*.85 2222 =2.71%