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1、14-1 CHAPTER 14 INVESTMENT BANKING,INSURANCE,AND OTHER SOURCES OF FEE INCOME 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,including investment banking,trust services,investments
2、in stocks,bonds and mutual funds,insurance policies,and annuities and examine their possible benefits.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 Div
3、ersification Economies of Scope and Scale Information Flows and Customer Privacy Chapter Outline I.Introduction II.Sales of Investment Banking Services A.Key Investment Banking Services B.Linkages between Commercial and Investment Banking C.Possible Advantages and Disadvantages of Linking Commercial
4、 and Investment Banking D.Key Issues for Investment Banks of the Future III.Selling Investment Products to Consumers A.Mutual Fund Investment Products B.Annuity Investment Products C.The Track Record for Sales of Investment Products D.Risks and Rules for Selling Investment Products IV.Trust Services
5、 as a Source of Fee Income A.History of Trust Services B.Roles of Trust Departments C.Types of Trusts V.Sales of Insurance-Related Products A.Types of Insurance Products Sold Today 1.Life Insurance Policies 2.Life Insurance Underwriters 3.Property/Casualty Insurance Policies 4.Property/Casualty Insu
6、rance Underwriters B.Rules Covering Insurance Sales by Federally Insured Depository Institutions VI.The Alleged Benefits of Financial-Services Diversification A.An Example of the Product-Line Diversification Effect Reducing Risk 14-2 B.Potential Economies of Scale and Scope VII.Information Flows wit
7、hin the Financial Firm VIII.Summary of the Chapter Concept Checks 14-1.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.Investment bank
8、s help underwrite a number of securities for corporations including common and preferred stock,corporate bonds,government and federal agency securities and others.In addition,they can provide a number of services including advising clients regarding acquisitions and mergers,creating and trading in d
9、erivatives,brokering loan sales,setting up special-purpose entities,stock and bond trading,currency and commodity trading,issuing credit and liquidity enhancements and developing business plans so companies can expand into new markets.14-2.Why were U.S.commercial banks forbidden to offer investment
10、banking services for several decades?How did this affect the ability of U.S.banks to compete for underwriting business?The Glass-Steagall Act in 1933 prohibited commercial banks from offering investment bank services for primary two reasons.One,the bank could force a customer seeking a loan to buy t
11、he 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 investment banking activities.Due to this,U.S banks were not able to compete for underwriting business with foreign bankin
12、g firms who in turn captured U.S.customers.14-3.What advantages do commercial banks with investment banking affiliates appear to have over competitors that do not offer investment banking services?Possible disadvantages?Investment banking services complement traditional lending services allowing com
13、mercial banking firms to offer both conventional loans and security underwriting to customers who seek to raise new funds.In addition,there are economies of scale in information gathering about clients.Though the benefits of cost and risk reduction through this new service dimension have not been pr
14、oven,the commercial banks have transformed investment banking industry by acquiring some of its largest firms and consolidating smaller investment banks into larger ones.However,investment banking services are highly sensitive to fluctuations in the economy and would increase the risk exposure of th
15、e commercial bank.14-4.What are investment products?What advantages might they bring to an institution choosing to offer these services?14-3 Investment products include stocks,bonds,mutual funds,annuities,and other nondeposit services.The most popular investment products offered by depository instit
16、utions include mutual funds.The potential advantages of offering these services to customers 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 an
17、d may help position the institution well for the future as more and more individuals start planning for retirement.14-5.What risks do investment products pose for the institutions that sell them?How might these risks be minimized?There are several risks involved in the sale of investment products.Th
18、e value of these products is market driven 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 for example.As a result,they may end up getting involved in cost
19、ly litigation with customers who are disappointed or who claim that the risks involved were not adequately explained.In addition,they may have compliance problems if they do not properly register their investment products with the Securities Exchange Commission or fail to follow the rules laid down
20、by regulatory agencies,state commissions,and other legal bodies that monitor this market for the sale of these products.Regulators already require these products to be sold in a separate area from where deposits are taken and banks are required to prominently display that these products are not insu
21、red by the Federal Deposit Insurance Corporation.The customers should also be informed that the investment products are not a deposit or other obligation of a depository institution and not guaranteed by the offering institution.In addition,customers must be told that these products are subject to r
22、isks,including potential loss of principal.Customers must sign a document stating they were informed of these risks.The institutions 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 themsel
23、ves to ensure that their sales personnel are complying with the regulatory requirements and banks are 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 produ
24、cts.14-6.What exactly are trust services?Trust departments manage the property of customers including 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 earn
25、ings.14-7.How do trust services generate fee income and often deposits as well for banks and other financial institutions offering this service?Trust departments manage the assets of their customers.The financial institution charges their customers a fee for providing these services and generates fe
26、e income.14-4 Assets managed by the trust departments include deposits and,in some cases,these deposits can be substantial.This way,trust departments often generate large deposits because they manage property for their customers.It is worth noting that deposits placed in a bank by a trust department
27、 must be fully secured.14-8.What types of insurance products do banks and a number of their competitors sell today?What advantages could these products offer depository institutions choosing to sell insurance services?Can you see any possible disadvantages?Financial institutions are starting to offe
28、r 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.Another insurance product they are interested in is life insurance underwriting.Here,the institution
29、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 institutions are also getting involved in selling insurance policies for protection from loss due to persona
30、l injury,property damage,and other losses associated with property and casualty insurance products.In addition,they also underwrite property/casualty insurance risks.Again,by doing this,they want to collect more in premiums than they have to pay in claims on these contracts.Because of the growth in
31、consolidation of the insurance industry,the financial service providers have been buying out their competitors and emerging as global players.Due to this,these companies seek lower production and marketing costs,diversification of risk exposure beyond one or two countries,and opening up greater reve
32、nue potential from what they see as“underinsured”markets(especially in Europe and Asia).On the other hand,selling insurance services requires financial institutions to adhere to strict consumer protection rules.This is practiced because the public may be misled or misinformed.For example,the custome
33、r may conclude wrongly that insurance products offered by a depository institution are covered by government-sponsored deposit insurance in case the customer suffers a loss.14-9.What is convergence?Product-line diversification?Economies of scale and scope?Why might they be of considerable importance
34、 for banks and other financial-service firms?Convergence is the bringing together 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 ot
35、her has the potential to reduce the risk(variability)of the cash flows of the overall company.Economies of scale means that there might be cost savings from being able to produce a larger number of units of the same product due to greater efficiency and the spreading of a greater volume of output ov
36、er the firms fixed c osts.Economies of scope means that there are potential costs savings resulting from producing two or more services in one firm.For example,if a single financial firm produces two services,instead of producing only one service,using the same resources,its cost of production may b
37、e lower.14-5 These things mean that banks and other financial institutions may be more efficient and productive in delivering services to customers either resulting in higher profit margins for companies or cost savings for consumers.These strategies can also result in reduced risk of failure throug
38、h greater product-line and geographic diversification.14-10.How can financial-service customers limit the sharing of their private data by different financial-service firms?In what ways could customer information sharing be useful for financial institutions and for their customers?What possible dang
39、ers does information sharing present?Financial-service firms must inform customers of their policy regarding the sharing of information with other parties.Financial-service firms must also inform customers about how the customer can opt out of having their information shared with other parties.Gener
40、ally,the customer must inform the company within 30 days of being notified that they do not want their information shared.If the customer fails to notify the service provider of his or her objections to sharing personal data,then the financial-service firm can share at least some of the customers pr
41、ivate information with others,even with outsiders.This information can be 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 p
42、articularly a good fit for that customer.This can benefit them by increasing 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 c
43、ases.For example,if there is some adverse private information about a particular customer(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 c
44、ompanies.Problems and Projects 14-1.Suppose the management of the First National Bank of New York decides that it needs to expand its fee-income-generating services.Among the services the bank is considering adding to its service menu are investment banking,the brokering of mutual funds,stocks,bonds
45、 and annuities,sales of life and casualty insurance policies,and offering personal and commercial trust services.a.Based on what you read in this chapter,list as many potential advantages as you can that might come to First National as a result of adding these services to its menu.First National may
46、 be able to supplement traditional sources of income with the new fee income that they generate and also increase the earnings stability.In addition,they may be able to reduce the risk of the overall institution by adding services that are not very correlated with the traditional services.They may f
47、ind that some of these services are less interest rate sensitive than traditional services.They may be able to generate economies of scale and scope from offering these services.Because of the economies of scale,the production cost per unit would tend to 14-6 drop as the firm would get larger.Becaus
48、e of the economies of scope,it may become cheaper to jointly produce two or more services than having to produce each service separately.b.What potential disadvantages might the bank encounter from selling these fee-generating services?There are many potential disadvantages that First National Bank
49、might encounter from selling fee-generating services.Investment banking activities tend to be much more volatile than commercial banking activities because of abrupt changes in market conditions and fierce competition.These additional services are substantially more risky than commercial banking.If
50、First National misestimates and the market price and plunges as the sale begins,it will be forced to absorb the resulting loss.Moreover,the value of some such services is market determined and their performance can turn out to be highly disappointing.This may anger the customers who may be holding t