banking - opportunities & threats

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Banking: Opportunities anThreats

Strategic Perspectives in Banking

21 July 2014

Aravindan | Gokul | Praneesh | Rajesh | Vinayak


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Agenda

Why Financial intermediaries?

Why Banks?

What has changed?

What else will banks do?

Banks vs Finance Companies

Competition & Limits to growth

Trending opportunities

Nature of banking business

Relationship vs. transaction oribanking

Threats to the traditional relatioriented banking

Advent of securitization & its e

bank loans

Problems innate to the bankin

Transparency issues & free-ridi

Remarks


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Why FIs offer demand deposits andloans

FIs have greatermarket power

than individuals

FIs reduceuncertainty by

pooling

FIs bring econom

Reduce a firmsfunding costs

Enhancecontractualpossibilities


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Why Banks?

Both sides of Balance sheet Governments favor them as creators

Optimal institutional arrangement for private contracting

Liquidityeasy flow of credit

Re-distribution of wealth in impoverished economy

Create wealth opportunities

Govt. does NOT act as the bankitself a major borrower

Rents in deposit business: political advantage of taking a little from


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Synergies in Banking

Liquidity insurance

Avg. maturity of finance company loan50% higher than that of banks

Liquidity on demandScale

economies

FIs usually go for longer term loans

Meets unexpecrted liquidity demands

Offers liquidity on both sides of balancesheet

Co-insuran

Opaque opertaionsHigh borrowing

Building reputation will ta

considerable time

Other possibility is to invest inassets

Acts as con-insurance for liqui

LiquidIlliquid asse


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Deregulation & Technological Chan

ATM, Credit & Debit cards

Credit rating/history of a client/consumer

Reduced Transaction costs,

Provide funding on demand, not per se

Unlike Finance companies, banks lend outside their area of focu

Loan sales is a repeat sales market. -> incentive for borrowers tohonest


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Finance Companies vs Banks

Misconceptionregarding fall in the

growth of banks due tofinance companies

Short notice finance stillprovided by banks

Finance comhave much match between

income they and cost of fu

Banks offer services forcertain class of

borrowers that cannotbe obtained via capital

markets

Secondary loan salesmarket provides a

cushion effect


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Competition

Increase dueto

deregulation &

technologicalinnovations

OpportunityBanks most

valuable Asset

- CaptiveCustomer

One approachincreaseswitiching

costs

Innovation-means at

differentiation

Idetr

Re

Egcrotra


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Automation - reduces costs but high investments required

Hence done by large banks leading to consolidation

New productsModern version of traditional ones

Fingerprint replacing money, plastic card, checks

Non traditional businessunderwriting a corporate security

CapabilitiesProviding liquidity, information gathering & transactioprocessing


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Limits to growth

Personnelchahging roles,

perceived conflict

of pay equity

Perception ofLemon Problem

Effect of nbusinessebanks ave

cost of borro


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Trending Opportunities

Financialinclusion

Technologydriven

products

ImprovingCapital andBusinessefficiency

Climate RiskManagement


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Functions of a bank

Non-marketableassets(lend) funded

with liquiddeposits(borrow)

Difference in liquidityreflected in ratescharged by banks

Informasensitivity o

asse

Ability of banks toeconomize on

search/matchingcosts

Blurring boundariesbetween modern &traditional banking

Absocredit/placeQualitativ

transform


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Nature of bank loans

Capital market financing vs. Bank lending

Mitigation of information asymmetriesoptimal informat

Value of information & incentives for information acquisit

Enduring close relationships between bank & client

Nature of lending contractsflexibility & bargaining pow


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Advent of securitization: A threat totraditional lending? Primal activities of a banks lending function

OriginationScreening prospective clients & pricing contracts FundingProviding resources for the contract ServicingCollection & client monitoring Risk processingHedging, diversification, & absorption of risks

SecuritizationUnbundling of financial services

Asset-backed securities & not deposits fund bank-originated assets

Securitization removes the funding activity

Securitization quality enhanced by issuing bank through risk absorpt

Pooling benefits of securitizationextendable to commercial loans?


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Way forward for relationship bankin

Shorter nature of relationships diminishes the value of informat Weak relationships disincentivise information acquisition

Relationship puzzleborrowers also need to invest in relationsh

Relationship banking works even in cases of asymmetric informa

Relationship paradoxCompetition threatens relationships butincentivizes the need for relationships as differentiation factor


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Transparency in banking

Opaqueness due to the nature of loans and not bank policies Banks diversify into a wide range of activities

Evaluation of a banks performance becomes harder

Elevated cost of funds, thus ceding advantage to financial marke

Opaqueness leading to poor cost accounting & cross-subsidizati


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Proprietary trading & free-riding

Prop tradingBank trades with own money rather than deposito Prop trading leads to a problem of free riding

Prop trading appears more profitable than it is

Prop trading unit does not internalize risks

Relationship-oriented activities face a high cost

Internal capital allocation becomes arbitrary and flawed

Cost of capital is risk dependent & hence not same for all units

Putting idle capital to use further elevates the cost of capital


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Remarks

Relationship banking is characteristic of value-enhancing interm Relationship banking has suffered from advent of transaction ba

Financial markets have gained market share & increased competi

Diversification of bank activities & increased importance given t

Banks may mistakenly conclude relationship banking is not profi

banking - opportunities & threats

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