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The purpose of this chapter is to learn how new banks are chartered by state and federal authorities in the United States, to determine what makes a good site for a new branch office, to recognize how the role of branch offices is changing, and to explore the advantages and disadvantages of automated banking facilities. Key Topics in This Chapter Chartering New Financial Service Institutions Performance of New Banks Establishing Full Service Branches In-Store Branching Establishing Limited Service Facilities ATMs and Telephone Centers The Internet and Online Banking Chapter Outline I. Introduction A. The Importance of Convenience and Timely Access to Customers B. Service Options Available Today 1. Chartering New (De Novo) Financial Institutions 2. Establishing New Full-Service Branches 3. Setting Up Limited-Service Facilities Chartering a New Bank or Other Financial Service Institutions The Bank Chartering Process in the United States A. The Chartering Authorities in the U.S. B. Benefits of Applying for a National Charter C. Benefits of Applying for a State Charter Questions Regulators Usually Ask the Organizers of a New Bank Factors Weighing on the Decision to Seek a New Bank Charter A. External Factors 1. Level of Economic Activity 2. Growth of Local Economic Activity 3. The Need for a New Bank 4. Strength and Character of Local Competition in Supplying Financial Services


IV. V.


Internal Factors 1. Qualifications and Contacts of the Organizers 2. Management Quality 3. Pledging of Capital and Funds to Cover the Cost of Filing a Charter Application and Getting Underway VI. Volume and Characteristics of New Bank Charters A. Numbers of New Charters B. Characteristics of New Charter Markets VII. How Well Do New Banks Perform? A. New Bank Financial Performance B. Pro-Competitive Effects on Service Offerings and Service Pricing VIII. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches A. Advantages of Full-Service Branches B. Trends in the Design of New Branches C. Desirable Sites for New Branches D. Expected Rate of Return E. Geographic Diversification F. Branch Regulation G. The Changing Role of Branches H. In-Store Branching IX. Establishing and Monitoring Automated Limited-Service Facilities X. Point-of-Sale Terminals XI. Automated Tellers (ATMs) A. History of ATMs B. ATM Services C. Fee Structures for ATM Usage D. Customer Service Limitations of ATMs E. Example of the ATM Capital-Budgeting Decision XII. Home and Office Online Banking A. Telephone Banking and Call Centers B. Internet Banking 1. Services Provided Through the Internet 2. Challenges in Providing Internet Services 3. The Net and Customer Privacy and Security XIII. Financial Service Facilities of the Future XIV. Summary of the Chapter Concept Checks 4-1. Why is the physical presence of a bank still important to many bank customers despite recent advances in long-distance communications technology?



Many customers still prefer the personal attention and personal service that contact with bank employees provides. Moreover, for those services where problems can arise that require detailed information and explanation-for example, when a checking account is overdrawn and checks begin to bounce-the customer needs quick access and, often, the personal attention to his or her problem on the part of one or more employees. 4-2. Why is the creation (chartering) of new banks closely regulated? What about nonblank financial firms? The creation of new banks is regulated to insure the safety and soundness of existing banks and to avoid excessive numbers of bank failures. The same arguments are usually made for nonbank financial firms. Financial-Service firms hold the publics savings, are the heart of the payment system and create money. The failure of these firms could disrupt the economy and too many could mean in excessive growth in the money supply and inflation. 4-3. What do you see as the principal benefits and costs of government regulation of the number of financial service charters issued? While control over the entry of new banks may reduce the number of failures, it also limits competition, so that the public may receive a smaller volume or lower quality of services at excessive prices. 4-4. Who charters new banks in the United States? New thrift institutions?

New banks are chartered by the banking commissions of the individual states or, at the federal level, by the Comptroller of the Currency. Thrift institutions are chartered by the states or at the federal level by the Office of Thrift Supervision. 4-5. What key role does the FDIC play in the chartering process?

The FDIC exercises some control over state bank charter activity as well as federal charters because most states insist that their new banks qualify for federal deposit insurance before they can open for business. 4-6. What are the advantages of having a national bank charter? A state bank charter?

The benefits of a national charter are: a.) It brings prestige due to stricter regulations and may help attract more customers b.) In times of trouble the technical assistance given may be better ensuring a better chance of long run survival


The benefits of a state charter are: a.) It may be easier and less costly to get a state charter b.) The bank does not have to join the Federal Reserve and therefore avoids buying and holding low yield stock of the Federal Reserve c.) Many states let a bank lend more to one borrower d.) State chartered banks may be able to make types of loans that a nationally chartered bank cannot 4-7. What kinds of information must the organizers of new national banks provide the Comptroller of the Currency in order to get a charter? Why might this required information be important? The Comptroller of the Currency asks for information on the number of competing banks and bank-like institutions in the service area of the proposed bank. More competitive market situations limit the profit potential and perhaps the growth potential of a new bank. Also requested is information about shopping centers, retail and wholesale business activity, recent population growth, traffic counts, and personal income levels - all viewed as indicators of potential demand for banking services in the service area of the proposed new bank. Applicants must also provide background information on the organizers and proposed management of a new bank so the Comptroller can decide if these people are qualified, law-abiding, and trustworthy to manage the public's funds as well as their own. 4-8. Why do you think the organizers of a new financial firm are usually expected to put together and submit to the chartering authority a detailed business plan, including marketing, management, and financial components? This demonstrates to regulators that the organizers of the bank have the expertise, experience and skills necessary to be successful in managing the new bank. If the organizers of a bank do not know where they are going, they are unlikely to be successful. In addition, it demonstrates whether the organizers of the new bank have a realistic picture of the community they are planning on serving and whether the organizers have a realistic view of the profit potential in the new bank. 4-9. What are the key factors the organizers of a new financial firm should consider before deciding to seek a charter? While a variety of factors are examined by different business people interested in establishing a new bank, most look at some or all of the following factors. 1. External Factors a. b. c. d. The level of local economic activity. Growth of local economic activity. The need for a new bank. The strength and character of local competition in supplying financial services.



Internal Factors a. b. c. Qualifications and contacts of the new bank's organizers. Management quality. Pledging of capital and funds to cover the cost of filing a charter application and begin operations.

4-10. Where are most new banks chartered in the United States? New charters tend to be concentrated in large urban areas where expected rates of return on the organizers investments are likely to be the highest. As the population increases relative to the number of financial firms, the number of new charters increases. The success of local banks already in the area suggests that new financial firms would also be successful. Places where the concentration ratio for new banks has increased tend to have fewer new bank charters. 4-11. How well do most new banks perform for the public and for their owners? Most new banks succeed, especially those whose organizers can bring in new deposits and loan accounts during the first year of the bank's operation. Most are profitable within two to three years of opening. There is some evidence that newly charted banks are financially fragile and more prone to failure than existing banks. They appear to be more vulnerable to real estate crises than established banks. New banks tend to under perform their competitors until they have been around for a while and new banks are more closely supervised than established banks. 4-12. Why is the establishment of new branch offices usually favored over the chartering of new financial firms as a vehicle for delivering financial services? The chartering of a new financing corporation is normally a lengthy and expensive process, requiring the completion of elaborate federal or state application forms, while the branch application process is normally far simpler and less costly. Moreover, with the increase in the number of failures in recent years regulatory-imposed capital requirements for new charters have increased substantially, while new branch offices usually carry significantly lower capital requirements. Moreover, branch offices themselves are often much less elaborate and costly to build and maintain than are the headquarters' facility of a new institution where some duplicate facilities can be eliminated (for example, checking processing, credit analysis, and records departments).


4-13. What factors are often considered in evaluating possible sites for new branch offices? Bankers first need to decide the goals and objectives of a new facility. Often this means assessing whether the proposed new branch is aimed at selling one or more particular services, such as deposits or loans, and also deciding how closely correlated cash flows and returns from the new branch office may be with cash flows and returns from the other facilities operated by the bank. If returns or cash flows through the proposed new institution are negatively correlated or display low positive correlation with the institution's other facilities, they may be able to lower the variance of its returns or cash flows by proceeding to establish the new office. Other considerations revolve around the economic strength of the proposed branch office sitewhether there is adequate traffic volume, large numbers of stores and shops, older or younger age populations who often require slightly different menus of services, recent area population growth, density and income, the occupational and residential makeup of the proposed new branch area, a large enough population to generate enough customers to breakeven and the number and size of facilities operated by competitors. Generally, for branches designed to attract and hold deposits key factors to consider usually revolve around individual and family incomes, concentrations of retail stores and shops, older-than-average residents, and homeowners rather than renters. For branch facilities emphasizing credit services residential areas with substantial new construction activity, heavy traffic flow, and high concentrations of stores and shopping centers are typically desirable for consumer and retail loan demand, while central city office locations are often chosen as locations for commercial loan facilities. 4-14. What changes are occurring in the design of, and the roles played by, branch offices? Please explain why these changes are occurring. Bank branches are increasingly becoming selling platforms in which more and more fee-based services are attractively and prominently advertised in order to maximize the fee-income generating potential of each branch. Moreover, branches are becoming increasingly automated to reduce personnel and other operating costs and improve speed, efficiency, and accuracy in handling a growing service volume. Branch design has come to reflect these trends with automated facilities placed at easy access points, along with information booths to speedily direct customers to the service areas they need. Human tellers may be placed deeper inside branch facilities so that customers must pass by other service departments and conspicuous advertising in order to encourage customers to become aware of and avail themselves of other bank services. 4-15. What laws and regulations affect the creation of new bank and thrift branches and the closing of existing branches? What advantages and what problems can the closing of a branch office create?


The opening of new branch offices must be approved by a bank's or thrifts principal federal or state supervisor. Closing a branch office has become much more complicated in recent years as the result of several new laws and regulations. For example, the FDIC Improvement Act requires 90 days advance notice of branch closings to both customers and the principal supervisory agency and a posting on the branch site at least 30 days prior to closing. Banks and thrifts must also make an "affirmative effort" to reach all segments of their communities without discrimination under the terms of the Community Reinvestment Act which raises the danger of customer protests against closings if it appears the bank is under-serving certain groups of customers. Finally, the Community Reinvestment Act can be used as a vehicle to prevent U.S. banks and thrifts from branching expansion when they have a poor record of serving all segments of their communities. Closing selected branch offices can reduce operating costs and divert resources from less profitable to more profitable uses. However, they risk alienating good customer relationships unless it can serve those same customers with its remaining facilities. 4-16. What new and innovative sites have been selected for new branch offices in recent years? Why have these sites been chosen by financial firms? Do you have any ideas about other sites that you believe should be considered? Rapid increases in new branches located in grocery stores, shopping centers, and inside other businesses and facilities where the public frequently gathers have helped to reduce branch construction costs and promote cross-selling of goods and financial services. Other branches have been opened in apartment complexes, senior citizen centers, and other customer-convenient locations as bankers come to realize they must adjust their service locations and service hours to conform to customer needs in an intensely competitive financial-services environment. 4-17. What are POS terminals and where are they usually located? Point-of-sale terminals are set up to accommodate customer purchases of goods and services. These computer terminals normally are located in retail stores, gasoline stations, and similar places with a link to the banks own computer records. When a customer of the bank makes a purchase, the amount of the transaction is deducted from the customer's deposit account and added to the store's account. Because the customer immediately loses funds many bank customers have been hesitant to use the service as opposed to paying by check or credit card where payment is delayed for a few days. However, this depends on whether the POS terminal is an offline or online terminal. An offline terminal accumulates all transactions until the end of the day when all transactions are subtracted from a customers account. This type of terminal is less costly for the bank to operate. An online terminal subtracts the transactions immediately from the customers account and reduces the chance of an overdraft occurring but is more expensive for the bank to operate. Consumer reluctance to use POS terminals appears to be fading and as fees for other services rise this reluctance will continue to disappear. 4-18. What services do ATMs provide? What are the principal limitations of ATMs as a service provider? Should ATM carry fees? Why?


The earliest ATMs provided a convenient mechanism for cashing checks, making deposits, and verifying checking account balances, often at hours when the full-service branch offices were closed. Today, ATMs frequently provide a wide menu of old and new services, including bill paying, transfer of funds between accounts, and the purchase of tickets for travel and entertainment. Most authorities expect ATM usage to grow rapidly as these machines offer more services and as bankers increasingly move to restrict customer access to more costly human tellers and other bank personnel, often by charging extra fees for personal service. ATMs do have some significant limitations that bankers will have to work to overcome. They break down and need to be replaced, sometimes quite frequently and annoyingly for customers, and as technology changes often become quickly outdated. Customer activity around ATMs, particularly at night, has invited criminals to steal money and injure customers, sometimes creating liability for banks. Moreover, not all customers make use of these facilities due to a preference for personalized service, fear of crime, or unfamiliarity with how the machines work. Customer education and better service pricing are two important tools that could help with these problem areas in the future. In addition, ATMs do not rank high in their ability to sell peripheral services. Some banks have found that there has been a sharp decline in their ability to sell other services. Finally, ATMs are not necessarily profitable for all banks. Because they are available 24 hours, some customers may make more frequent and smaller withdrawals from the machine than they would with a human teller, driving up the costs. In addition, these same customers will often still demand a human teller to deposit their pay check, making the bank keep both tellers and ATM machines. Whether ATM should carry a fee is rather controversial. Recently, two of the largest ATM networks have decided to let owners of ATMs charge non-customers a surcharge. Several regional have begun to charge fees as well. These fees reflect the usage of ATMs. About 85% of all ATM transactions consist of cash withdrawals and only about 10 percent represent incoming deposits. In addition, in many places, ATM usage has declined as customers pass over ATMs in favor of credit and debit cards, onsite terminals and the internet. 4-19. What are self-service terminals and what advantages do they have for financial institutions and their customers? Self-service terminals include ATMs and other computer-based limited-service facilities that permit a customer to call up information about his or her account and recent transactions with the institution or information about different services that the customer might be interested in purchasing. Many are accessible 24 hours a day or are easier to get to rather than wait for the help of personnel. They can save on resources by saving on staff time. Many institutions are adding telephones and video screens so that customers with problems can dial up an employee day or night with problems. This is also saving money because they can avoid duplication of staff at each branch. 4-20. What financial services are currently available from banks on the internet? What problems have been encountered in trying to offer internet services?


Customers can make payments, check on account balances, move funds between accounts and get applications for loans, deposits and other services. In addition banks can advertise on the web. Some of the problems include protecting customers privacy and heading off crime. In addition, the web does not make it easy for a bank to get to know their customers personally. The cost may also be prohibitive to some customers. 4-21. How can financial firms better promote internet services? They need to emphasize the safety of their internet services. They need to promote their home page at every opportunity and update it frequently to keep customers interest. They need to survey customers about their satisfaction with the services and encourage dialogue via e-mail to resolve problems. They can also provide programs to download to act as screen savers (and advertisements) and also information about the institution and the services it provides. Problems 4-1. A group of businessmen and women from the town of Mathews are considering filing an application with the state banking commission to charter a new bank. Due to a lack of current banking facilities within a 10-mile radius of the community, the organizing group estimates that the initial banking facility would cost about $3.2 million to build along with another $700,000 in other organizing expenses and would last for about 20 years. Total revenues are projected to be $510,000 the first year, while total operating expenses are projected to reach $180,000 in year 1. Revenues are expected to increase 6 percent annually after the first year, while expenses will grow an estimated 5 percent annually after year 1. If the organizers require a minimum of a 10 percent annual rate of return on their investment of capital in the proposed new bank, are they likely to proceed with their charter application given the above estimates?


Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Revenues $510,000 $540,600 $573,036 $607,418 $643,863 $682,495 $723,445 $766,851 $812,863 $861,634 $913,332 $968,132 $1,026,220 $1,087,793 $1,153,061 $1,222,245 $1,295,579 $1,373,314 $1,455,713 $1,543,056

Op Expense $180,000 $189,000 $198,450 $208,373 $218,791 $229,731 $241,217 $253,278 $265,942 $279,239 $293,201 $307,861 $323,254 $339,417 $356,388 $374,207 $392,917 $412,563 $433,191 $454,851

Net Profits $330,000 $351,600 $374,586 $399,046 $425,072 $452,764 $482,228 $513,573 $546,921 $582,395 $620,131 $660,271 $702,966 $748,377 $796,673 $848,038 $902,662 $960,751 $1,022,522 $1,088,205

Initial Investment Required Rate of Return Present Value of Future Cash Flows Net Present Value of Investment

$3,900,000 0.10 $4,491,642 $591,642

Given the above information, the organizers are likely to proceed given that the net present value of this investment is positive. The return they are going to earn is greater than the 10% they need to earn. 4-2. Andover Savings Bank is considering the establishment of a new branch office at the corner of Lafayette and Connecticut Avenues. The savings associations Economics Department projects annual operating revenues of $1.75 million from services sold to generate fee income and annual branching operating expenses of $880,000. The cost of procuring the property is $2.5 million and branch construction will total an estimated $2.32 million; the facility is expected to last 16 years. If the savings bank has a minimum acceptable rate of return on its invested capital of 12 percent, will Andover likely proceed with this branch office project?


Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Revenues $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000 $1,750,000

Op Expenses $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000 $880,000

Net Profits $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $870,000 $4,820,000 0.12 $6,067,368 $1,247,368

Initial Investment Required Rate of Return Present Value of Future Cash Flows Net Present Value of Investment

Andover is likely to proceed with this project because the net present value is positive. This means that the interest rate that Andover will earn on this project is higher than the 12% they need to earn. 4-3. Jackson Bank of Commerce estimates that building a new branch office in the newly developed Guidar residential township will yield an annual expected return of 13 percent with an estimated standard deviation of 5 percent. The banks marketing department estimates that cash flows from the proposed Guidar branch will be mildly correlated (with a correlation coefficient of +0.3) with the banks other sources of cash flow. The expected annual return from the bank's existing facilities and other assets is 10 percent with a standard deviation of 3 percent. The branch will represent just 10 percent of Jacksons total assets. Will the proposed branch increase Sullivan's overall rate of return? Its overall risk? The estimated total rate of return would be: E (R) = 0.10 (13%) + 0.90 (10%) = 10.3% The risk attached to this overall return rate would be:

2 = (.1) 2 (.05) 2 + (.9) 2 (.03) 2 + 2(.1)(.9)(.3)(.05)(.03) 2 = .000835 = .000835 = .0289 or 2.89%


Thus 2.89% and the branch will slightly increase the bank's expected return but slightly decrease its overall risk. The bank should proceed with this project. 4-4. The following statistics and estimates were compiled by First Savings Bank of Talbot regarding a proposed new branch office and the bank itself: Branch Office Expected Return Standard Deviation of Return Banks overall expected return Standard deviation of banks return Branch Asset Value as a Percent of Total Bank Assets Correlation of Cash Flows = = = = = 16% 7% 10% 3% 15% + 0.27

What will happen to the Talbots total expected return and overall risk if the proposed new branch is adopted? The bank's total expected return is: E (R) = 0.15 (16%) + 0.85 (10%) The bank's risk exposure is: = 10.9%

2 = (.15) 2 (.07) 2 + (.85) 2 (.03) 2 + 2(.15)(.85)(.27)(.07)(.03) 2 = .0009051 And thus = .0301 or 3.01%
The proposed project raises the savings banks expected return slightly and does not affect the risk of the bank. This is a good project. 4-5. First National Bank of Yukon is considering installing 3 ATMs in its westside branch. The new machines are expected to cost $48,000 apiece. Installation costs will amount to about $16,000 per machine. Each machine has a projected useful life of 10 years. Due to rapid growth in the westside district these three machines are expected to handle 180,000 transactions per year. On average, each cash transaction is expected to save $0.32 per transaction in check processing costs. If First National has a 12% cost of capital, should the bank proceed with this investment project?


Year 1 2 3 4 5 6 7 8 9 10

Savings $57,600 $57,600 $57,600 $57,600 $57,600 $57,600 $57,600 $57,600 $57,600 $57,600 (.32*180,000)

Initial Investment Required Rate of Return Present Value of Future Cash Flows Net Present Value

192000 0.12 $325,452.85 $133,452.85


The net present value of this project is positive. First National Bank of Yukon should add the ATM machines to the Westside. 4-6. First State Security Bank is planning to set up its own web page to advertise its location and services on the Internet and to offer customers selected service options, such as paying recurring household bills, verification of account balances, and dispensing deposit account and loan application forms. What factors should First State take into account as it plans its own web page and Internet service menu? How can the bank effectively differentiate itself from other banks currently present on the Internet? How might the bank be able to involve its own customers in designing its web site and pricing its Internet service package? The bank should remember that while the internet is a relatively low cost way of expanding and allows customers to find the bank rather than the bank having to find customers, there are serious concerns about privacy. In addition, the Internet is not limited by geography and while there are thousands of potential customers, there are also many financial institutions around the world competing for customer deposits and loans. The bank needs to be aware that there are many bank web pages out there and that they will need to invest in employees with the technical expertise to manage the new web site well. One of the first things the bank needs to do is to take steps to protect its customers and let its customers know what its privacy and security policies are. Another step the bank can take is to start with a customer survey to find out what its customers want and need from the banks Internet services. They can run this as a contest and give away some small items to the customer with the best ideas for the web page and Internet service. This should help get customers involved in the design and implementation of the web page and may help the bank start building an online customer base.