Financial Services Financial Services and Industriesand IndustriesNeill Gilbride and Richard HagenNeill Gilbride and Richard Hagen

Presentation OutlinePresentation Outline

The structure of the financial industryThe structure of the financial industry Technological innovations and the financial industryTechnological innovations and the financial industry The role of the stateThe role of the state Corporate strategies in financial servicesCorporate strategies in financial services The Geographical structure of financial activities The Geographical structure of financial activities

Basic ConceptsBasic Concepts

Financial Services:Financial Services: mediate; abbreviate the mediate; abbreviate the exchange process within the economyexchange process within the economy

Currency is the most traded product on earthCurrency is the most traded product on earth

The growing disparity between foreign exchange and world trade

Source: based on Eatwell and Taylor, 2000: 3-4

Structure of the Financial Structure of the Financial Service IndustryService Industry

The structure functions by The structure functions by financial intermediationfinancial intermediation, , which is the pooling of financial resources by those with which is the pooling of financial resources by those with surpluses to those who choose to be in deficit, that is to surpluses to those who choose to be in deficit, that is to borrow. Projects can be financed by surpluses borrow. Projects can be financed by surpluses generated elsewhere generated elsewhere

Thus financial intermediation has constituted the basic Thus financial intermediation has constituted the basic function of banks from the very beginning. function of banks from the very beginning.

Banks have a certain sequence of development and Banks have a certain sequence of development and order of events that occur to take a bank from a local order of events that occur to take a bank from a local lender to an international competitor.lender to an international competitor.

The sequence of development of the banking system

New innovations and information technology have New innovations and information technology have made the financial industry increasingly complex. The made the financial industry increasingly complex. The result has been the development of different types of result has been the development of different types of financial institutions, each with a specific function financial institutions, each with a specific function

Certain services are concerned with the creation and Certain services are concerned with the creation and distribution of credit in various forms.distribution of credit in various forms.

Others are concerned with different forms or risk, like Others are concerned with different forms or risk, like insurance companies.insurance companies.

Certain facilities certify the accuracy of financial Certain facilities certify the accuracy of financial accounts.accounts.

Technology and innovationTechnology and innovation

Information technology and more specifically Information technology and more specifically communications technology are fundamental to the communications technology are fundamental to the financial services industry. This is because the speed of financial services industry. This is because the speed of transaction is the greatest added value to financial service transaction is the greatest added value to financial service products. products.

““It is much easier to move $41 billion from London to New It is much easier to move $41 billion from London to New York then it is to move a truck load of grape from California York then it is to move a truck load of grape from California to Nevada.”to Nevada.”

Since speed of transaction is so important, large Since speed of transaction is so important, large corporations spend a lot of money on research and corporations spend a lot of money on research and development.development.

The mid 1990’s: The top 10 USA firms spent $10 Billion on The mid 1990’s: The top 10 USA firms spent $10 Billion on IT technology.IT technology.

Three key technologiesThree key technologies: that have transformed the : that have transformed the financial services industry,financial services industry,

Computers-Computers- For hundreds of years, all payments and For hundreds of years, all payments and transfers were done by coins or credit notes. transfers were done by coins or credit notes. Progressively cheques entered the market. Since Progressively cheques entered the market. Since the 1970’s, computers have made money electronic. the 1970’s, computers have made money electronic.

Microprocessors-Microprocessors- are responsible for the socio- are responsible for the socio-economic shift known as the credit card revolution. economic shift known as the credit card revolution. Allowed for plastic cards to represent large sums of Allowed for plastic cards to represent large sums of money.money.

Satellites-Satellites- Allow for global electronic communication. Allow for global electronic communication.

Trends that have occurred as a result of these 3 Trends that have occurred as a result of these 3 technologiestechnologies

Increased productivityIncreased productivity Altered relationships from firm to firm and from firm Altered relationships from firm to firm and from firm

to clientto client Increased velocity, which has saved billions in Increased velocity, which has saved billions in

interest paymentsinterest payments Increase in loan activity internationallyIncrease in loan activity internationally Securitization: loans and borrowings may be bought Securitization: loans and borrowings may be bought

and sold on the marketand sold on the market

Technology and GlobalizationTechnology and Globalization

Globalization has produced winners and losers. The Globalization has produced winners and losers. The global integration of the financial market has created global integration of the financial market has created jobs in certain areas and eliminated jobs in others. jobs in certain areas and eliminated jobs in others.

““The increased interconnectedness and vulnerability of The increased interconnectedness and vulnerability of the world economy is tightly bound up with the world economy is tightly bound up with developments in the financial system.”developments in the financial system.”

A few pros and cons concerning globalization of the A few pros and cons concerning globalization of the financial industry:financial industry: institutes are able to instantly respond to exchange ratesinstitutes are able to instantly respond to exchange rates Shocks in one geographic market spread instantly around the Shocks in one geographic market spread instantly around the

globeglobe There is a major decline in the volume of clerical processing There is a major decline in the volume of clerical processing

workwork

The Nature of skills in the The Nature of skills in the

financial sectorfinancial sector Progressively the industry is seeing the disappearance Progressively the industry is seeing the disappearance

of low skill jobs. Employees must be able to work in an of low skill jobs. Employees must be able to work in an ill-defined and ever-changing environment. There is a ill-defined and ever-changing environment. There is a need for a better understanding of the financial system need for a better understanding of the financial system as a whole. Isolated, specialized work is transforming as a whole. Isolated, specialized work is transforming into less specialized flexible work that involves groups into less specialized flexible work that involves groups of workers. of workers.

Product InnovationsProduct Innovations There are two main types of innovations, those that There are two main types of innovations, those that

increase the speed of transfer and those that create increase the speed of transfer and those that create new methods of lending and borrowing.new methods of lending and borrowing.

Role of the StateRole of the State

Finance is the vital all encompassing network Finance is the vital all encompassing network surrounding technology and production. Investments surrounding technology and production. Investments have an enormous impact on the well being of entire have an enormous impact on the well being of entire national economies.national economies.

The role of the state has always been present. Since The role of the state has always been present. Since finance is central to sovereignty.finance is central to sovereignty.

Therefore financial services have been the most tightly Therefore financial services have been the most tightly regulated of all economic activities. regulated of all economic activities.

2 major forms of government regulation are:2 major forms of government regulation are: Governing relationships between different financial Governing relationships between different financial

activities.activities. Governing the entry of firms (foreign of domestic) Governing the entry of firms (foreign of domestic)

into the financial sector.into the financial sector.

In the 1970’s and 80’s the “walls began to crumble” In the 1970’s and 80’s the “walls began to crumble” due to TNC’s finding gaps in regulatory systems.due to TNC’s finding gaps in regulatory systems.

Along with International technology and new Along with International technology and new telecommunications technologies.telecommunications technologies.

Plus Banks and financial firms desire to operate in a Plus Banks and financial firms desire to operate in a less constrained environment- both domestically and less constrained environment- both domestically and internationally.internationally.

Therefore the globalization of finance has been largely Therefore the globalization of finance has been largely correlated to Government Deregulation world wide.correlated to Government Deregulation world wide.

Major turning pointsMajor turning points

1960’s- the creation of offshore markets.1960’s- the creation of offshore markets. 1970’s- USA made it easier for foreign banks to enter 1970’s- USA made it easier for foreign banks to enter

the domestic marketthe domestic market 1981- USA allowed international banking facilities to 1981- USA allowed international banking facilities to

infiltrate the marketinfiltrate the market ““Big Bang” The UK removed financial barriers and Big Bang” The UK removed financial barriers and

allowed foreign bank entryallowed foreign bank entry ““Little bang” France- similar to the big bang, opened up Little bang” France- similar to the big bang, opened up

their stock exchangetheir stock exchange NAFTA and the European UnionNAFTA and the European Union 1995- WTO guarantees access to banking between 30 1995- WTO guarantees access to banking between 30

countriescountries

Corporate StrategiesCorporate Strategies

The financial services industry is influenced by 3 major The financial services industry is influenced by 3 major elements.elements. The shifting patterns in demand- for financial servicesThe shifting patterns in demand- for financial services Technology innovations-affect how services are deliveredTechnology innovations-affect how services are delivered Changing regulatory frame work ie. DeregulationChanging regulatory frame work ie. Deregulation

A fourth element is the actions and strategies of A fourth element is the actions and strategies of corporationscorporations

Actions are profit motivated. A profitable environment Actions are profit motivated. A profitable environment is maintained by corporations investing their surpluses is maintained by corporations investing their surpluses and hedging against foreign currency fluctuations.and hedging against foreign currency fluctuations.

Concentration and consolidationConcentration and consolidation

trends towards concentration though trends towards concentration though mergers and acquisitionsmergers and acquisitions

1990’s saw heavy merger activity = less 1990’s saw heavy merger activity = less international firmsinternational firms

Statistically, mergers have not lead to Statistically, mergers have not lead to significant improvements in efficiency significant improvements in efficiency and thousands of jobs have been lost.and thousands of jobs have been lost.

How many created?How many created?

World’s top banks, 1989

World’s top banks, 2000

Transnationalization of Transnationalization of Banking OperationsBanking Operations There was some internationalization of banking in the There was some internationalization of banking in the

colonial period under the Dutch, British, French, and colonial period under the Dutch, British, French, and GermansGermans

And further expansions in to foreign market by US banks And further expansions in to foreign market by US banks in the early twentieth century in the early twentieth century

The true explosion of transnational banks follower the The true explosion of transnational banks follower the growth of TNCs in the 1960s and 1970sgrowth of TNCs in the 1960s and 1970s This surge was dominated by the US, due to its post-This surge was dominated by the US, due to its post-

war dominance of international financewar dominance of international finance But by the 1980s and after the European and But by the 1980s and after the European and

Japanese banks began gain a market shareJapanese banks began gain a market share

Though there may be different reasons for the Though there may be different reasons for the internationalization of banking there is a general pattern:internationalization of banking there is a general pattern:

In the post WWII period only a small number of US In the post WWII period only a small number of US overseas banks existed. With the expansion of the US overseas banks existed. With the expansion of the US TNC in the early 1960s the number of US overseas TNC in the early 1960s the number of US overseas banks exploded.banks exploded.

Growth of the number of overseas bank affiliates, 1960 to 1985

Source: Based on OECD Observer (1989) vol. 160, p.36

The second half of the 1960s featured a growth of the The second half of the 1960s featured a growth of the Eurodollar market. The result was a market developed Eurodollar market. The result was a market developed outside of US control, this allowed US banks to raise outside of US control, this allowed US banks to raise money there by re-lending overseasmoney there by re-lending overseas

As banks from non-US countries internationalized the As banks from non-US countries internationalized the process became self-reinforcing. All large banks had to process became self-reinforcing. All large banks had to operate internationally and have a presence in all leading operate internationally and have a presence in all leading marketsmarkets

In the 1970s two new movements of capital occurred: In the 1970s two new movements of capital occurred: the vast amounts of capital acquired by the OPEC the vast amounts of capital acquired by the OPEC countries and the dismantling of the exchange controls countries and the dismantling of the exchange controls of Germany, Japan, the US, and the UKof Germany, Japan, the US, and the UK

Diversification into new Diversification into new Product MarketsProduct Markets This is next logical step for global financial services This is next logical step for global financial services

following their expansion into the global market placefollowing their expansion into the global market place

To diversify financial services must offer a complete To diversify financial services must offer a complete package of related services. A number of services package of related services. A number of services provided by a leading bank would be:provided by a leading bank would be:-banking-banking -mortgages-mortgages

-corporate finance-corporate finance -travellers’ cheques-travellers’ cheques

-credit cards-credit cards -fund management-fund management

This has led to many of the leading global financial providers This has led to many of the leading global financial providers developing into “financial supermarkets”.developing into “financial supermarkets”.

Diversification into new Diversification into new Product Markets: How and Product Markets: How and Why?Why?

Though there has been some in house expansion for Though there has been some in house expansion for some financial services, the majority of the diversification some financial services, the majority of the diversification of firms has occurred through acquisition and merger.of firms has occurred through acquisition and merger.

The major encouragement for this has been deregulation The major encouragement for this has been deregulation and the advantages of economies of scale and scope:and the advantages of economies of scale and scope: The advantages of scale is the larger a company the lower costs The advantages of scale is the larger a company the lower costs

tend to be.tend to be. The advantage of scope is the bank doing business in all major The advantage of scope is the bank doing business in all major

cities will find it easier to serve clients than a regionally cities will find it easier to serve clients than a regionally concentrated bank. concentrated bank.

The argument for this diversification of financial services The argument for this diversification of financial services is that a company can now offer a “one stop shop” to is that a company can now offer a “one stop shop” to customerscustomers

This allows the company to maximize their profits from This allows the company to maximize their profits from each customer because they provide a variety of each customer because they provide a variety of servicesservices

Another advantage of the development of a large and Another advantage of the development of a large and diverse financial firm is the customer recognition which diverse financial firm is the customer recognition which can be developedcan be developed

With the reassurances on the quality of service through With the reassurances on the quality of service through advertising a financial firm can become a trusted brand advertising a financial firm can become a trusted brand namename this would result in attracting new customers due to the brand this would result in attracting new customers due to the brand

recognitionrecognition

Geography and the Nature of Geography and the Nature of Financial ProductsFinancial Products

Three types of financial products which have distinctive Three types of financial products which have distinctive geographic properties are:geographic properties are:

Transparent Products-Transparent Products- are produced where trading are produced where trading volume is large enough to make small markets volume is large enough to make small markets economical. It is based in large global centers and economical. It is based in large global centers and considered the “apex” of global trading. ie. stocksconsidered the “apex” of global trading. ie. stocks

Translucent Products-Translucent Products- rely upon economies of scale to rely upon economies of scale to assemble and maintain the information systems assemble and maintain the information systems necessary to identify, assemble, and maintain the necessary to identify, assemble, and maintain the various investments within a fund. Creates various investments within a fund. Creates opportunities for a secondary level of financial centers. opportunities for a secondary level of financial centers. ie. various fundsie. various funds

Opaque Products-Opaque Products- are those where design and are those where design and production is surrounded in some mystery to an outsider production is surrounded in some mystery to an outsider and local knowledge is needed for confident trading. The and local knowledge is needed for confident trading. The information about these products is specialized, this information about these products is specialized, this results in local markets. ie. property trustresults in local markets. ie. property trust

Financial products and their geographical characteristics

Source: Based on Clark and O’Connor, 1997: Table 4.1;99-104

The Global Network of The Global Network of Financial CentersFinancial Centers

In general financial services tend to be concentrated in In general financial services tend to be concentrated in metropolitan centers around the worldmetropolitan centers around the world

These important financial centers are connected with These important financial centers are connected with other centers across national and physical boundariesother centers across national and physical boundaries

The financial system has certain stable features, one is The financial system has certain stable features, one is the dominate tri-polar axis of Tokyo-New York-Londonthe dominate tri-polar axis of Tokyo-New York-London

• But all financial But all financial centers may centers may change their status change their status in the network in in the network in response to response to changing financial changing financial conditionsconditions

•An example is the An example is the change in the change in the status of Tokyo status of Tokyo following the following the Japanese financial Japanese financial crisiscrisis

There are four basic location determining processes for There are four basic location determining processes for financial centers:financial centers: The character of the business organization involved in The character of the business organization involved in

international financial centersinternational financial centers The diversity of markets in international financial centersThe diversity of markets in international financial centers The culture of international financial centersThe culture of international financial centers The dynamic economies of scale which arise from the sheer The dynamic economies of scale which arise from the sheer

size and concentration of financial and related service firm in size and concentration of financial and related service firm in such centerssuch centers

As a result a small number of cities control the world’s As a result a small number of cities control the world’s financial transactionsfinancial transactions ie. Tokyo, New York, and Londonie. Tokyo, New York, and London

Along with the large financial concentration, these Along with the large financial concentration, these same cities are the corporate and regional same cities are the corporate and regional headquarters of TNCsheadquarters of TNCs

With such a concentration in these cities, they be With such a concentration in these cities, they be called the called the control points of the world economycontrol points of the world economy

Offshore Financial Offshore Financial CentersCenters

““[s]cattered across the globe, a series of little places [s]cattered across the globe, a series of little places islands and micro-states- have been transformed by islands and micro-states- have been transformed by exploiting niches in the circuits of fictitious capital. exploiting niches in the circuits of fictitious capital. These places have set themselves up as offshore These places have set themselves up as offshore financial centers; as places where the circuits of financial centers; as places where the circuits of fictitious capital meet the circuits of ‘figurative money’ fictitious capital meet the circuits of ‘figurative money’ in a murky concoction of risk and opportunity. Fugitive in a murky concoction of risk and opportunity. Fugitive money is ‘hot’ money that seeks to avoid regulatory money is ‘hot’ money that seeks to avoid regulatory attention and taxes.”attention and taxes.”

-US Department of Commerce (2000: 9)-US Department of Commerce (2000: 9)

With very few exceptions these areas are set-up to With very few exceptions these areas are set-up to provide services outside the reach of national provide services outside the reach of national jurisdictionsjurisdictions

These tax havens result in the setting-up of large These tax havens result in the setting-up of large number of businesses, ie. the Virgin Islands with number of businesses, ie. the Virgin Islands with 300,000 companies300,000 companies

But the majority of these businesses are but fronts with But the majority of these businesses are but fronts with no real activity, ie. the Virgin Islands were only 9,000 of no real activity, ie. the Virgin Islands were only 9,000 of the 300,000 show signs of local activitythe 300,000 show signs of local activity

Developments in offshore Developments in offshore financial centers financial centers

There has been a recent drive to make offshore There has been a recent drive to make offshore financial centers (OFCs) more accountable financial centers (OFCs) more accountable By enforcing greater disclosure and removing preferential By enforcing greater disclosure and removing preferential

treatment for foreignerstreatment for foreigners

35 countries in these OFCs have resisted regulation35 countries in these OFCs have resisted regulation But following September 11, 2001 the US has led an But following September 11, 2001 the US has led an

effort to improve the anti-money laundering controlseffort to improve the anti-money laundering controls

Presentation EndPresentation End

Game TimeGame Time

“I pity the fool who didn’t listen caus’ now its question time”

QuestionsQuestions

1.1. CurrencyCurrency

2.2. The pooling of financial resources by those with The pooling of financial resources by those with surpluses to those who choose to be in deficit, that is surpluses to those who choose to be in deficit, that is to borrowto borrow

3.3. Computers, Microprocessors, and SatellitesComputers, Microprocessors, and Satellites

4.4. Clerical ProcessingClerical Processing

5.5. Governing relationships between different financial Governing relationships between different financial activities.activities.

Governing the entry of firms (foreign of domestic) into Governing the entry of firms (foreign of domestic) into the financial sector.the financial sector.

QuestionsQuestions

6. US, Europe, and Japan6. US, Europe, and Japan

7. Firm diversification7. Firm diversification

8. Transparent Products, Translucent Products, Opaque 8. Transparent Products, Translucent Products, Opaque ProductsProducts

9. Metropolitan areas (cities)9. Metropolitan areas (cities)

10. Offshore Financial Centers10. Offshore Financial Centers