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In the 21st Century Banks remain an integral component of the well developed
financial markets. Banking has developed into :
Niche or specialist banks.

Generalist banks offering banking and a wide range of financial products and
services
Typical examples are HSBC, ING, UniCredit and SocGen.

The financial crises has caused banks to focus more on their core business and sell
off unrelated ones. For instance RBS sold off most of its non-core business to focus
on the UK retail market. HSBC has sold of its US card business.

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Typical examples of specialist banks are
Euroclear (Clearing and Settlement Agents),
Deutsche Bank (Cash Management and Cross
Border Payments), Bank of New York Mellon
(BoNY)Global Custody and Asset
Management, JPMorgan Chase ( Asset
Management, Global Custody Securities
Lending). Visa and Master Card are specialist
banks specifically geared to electronic transfer
of money.

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The emphasis of these models is to create a unique
customer experience which is reflected in the
delivery channel chosen.
If it is mobile or internet banking, the model is built in
such a way as to offer ease of use and secure
banking.
If the chosen delivery channel is through relationship
management then managers function as concierges
offering extraordinary levels of service in support of
phone and online channels.
All of these elements of this niche model reflect and
align with how these customer segments want to do
business, whether it relates to banking, making

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travel arrangements or pursuing other interests.

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Limiting the number of supporting strategic
initiatives to a vital few
As a result these can be more easily
articulated, defined in terms of success
metrics and demonstrably aligned with the
banks vision and strategy.
E.g such banks built there models on serving
top net worth customers different to the
service model of commercial or conventional
retail banking model
Targeting Investments with higher ROIs
E.g. Enhanced CRM system which provides

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 feedback to test how well the bank is meeting
customers expectations.

model

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Typical examples are :
Euroclear, Clearstream and Cedel

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In our first lecture we discussed how banks
especially in Europe offer universal banking which
apart from traditional banking products also offer
non-banking products like stockbroking, fund
management and custody.

If we take a look at our own banks in Malta and

Gozo, we can identify a number of services which
fall into the above category.

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Most banks engage in Off balance sheet activity to earn non-
interest income in the form of fees and commissions from
trade finance. Typical products offered are Letters of Credit
and Guarantees which we will examine more in detail in
Lecture 7. Because these instruments create a contingent
liability for the Bank, this is not normally recorded on balance
sheet but adequate provisions are still maintained out of
normal profits.
Letter of Credit
An undertaking by the bank that it will meet the obligations of
the agent carrying the letter of credit should that agent fail to
pay for goods and services etc.
Derivatives are also another form of off balance sheet activity.
Typical derivatives are options , interest swaps and forward
rate agreements.
A derivative is a contract which gives one party a contingent
claim on an underlying asset (e.g. bond equity or commodity)
or the cash value of that asset at some future date. The other
party is bound to meet the corresponding liability. The key
derivatives are futures, forwards, options, and swaps. Some of
these derivatives are traded on organised exchanges, (LIFFE,
CBT). However today the larger volume of derivatives are

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traded OTC (Over the Counter) . The predominant OTC
contract are swaps options and forward rate agreements.
These are regulated by the ISDA Agreement.

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With all this turmoil, it is only natural to ask what banks will
survive. With the collapse of Lehman Brothers Holdings Inc for
many years considered an icon in American banking history-and
its numerous affiliates across the globe, it is no wonder that
nothing in banking has remained sacred.
Numerous surveys have been carried out on excellent banks.
One thing in common is that : these banks tend to get their
strategic direction and focus right.
Banking in the late 20th and beginning of the 21st Century was
best described by Walter Wriston ex CEO of Citibank.
He remarked that bankers were in the business of managing
risk, pure and simple that is the business of banking.
Many times, banks do tend to take wrong strategic directions,
take for example the UK bank RBS with its acquisition of ABN
Amro and the ill-timed acquisition of HBOS by Lloyds bank. The
two icons of UK banking had to be bailed out by the British
taxpayers and are now both government owned.
Most of the financial crises which will be examined in other
lecture, can be traced to strategic misdirection and lack of focus,
where the above tenets of managing risks were overlooked by
the lure of huge profit-taking in speculative dealings.

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Davis (1989) carried out a survey on excellent banks and his findings
highlighted:
The importance of the niche market :
this creates competitive advantage take for instance VISA, MasterCard,
Euroclear, BoNY
Low cost production:
Large economies of scale and scope for e.g. Deutsche Bank is the
largest Eur clearer in Europe and is the number 1 processor of SEPA
cross border payments.
SWOT and Acting upon it:
Being capable of analysing the internal capabilities (Strengths and
weaknesses) and identifying Opportunities andthreats
Thinking change: Banks must be able to anticipate change and mange
it well. Many banks fail not in the planning but in the implementation or
business transformation.
Staying ahead of the game:
Being first in the market, enjoying technological superiority over rivals,
offering innovative products which make customers lives easier
Focus on quality:
Quality helps mainatins customer loyalty, but it can come at a high price.
Continuous investment in staff training, upgrading of hard and software,
brand standards must be maintained not only in the physical
environment of branch outlets but in offices and advertising, marketing
and promotion of the bank. This forms part of the bank identity, i.e. the
way it is perceived by the external stakeholders.
Entrepreneurial drive:
Stiff market competition means that banks have to strive hard for their
market share. Branches have to create their own marketing according to
the local environment in which they operate, e.g. rural areas.
Sometimes bank personnel have to reach out to different customer

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segments in different ways since banking after all is no different than
other businesses.

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Kay (1993) argued that the strategy of a firm is the match between its
internal capabilities and its external relationships.
This means that there has to be a perfect balance between what a bank is
actually capable of achieving with its finite resources and the management of its
relationships with its many stakeholders. For instance, in order to maintain its
brand promise, its international organisation must also be able to deliver. The
service chain is as strong as the weakest link. There needs to be what is referred
to as E-V-R congruency.
E-V-R shows how the environment is a source of opportunities and threats -
external key success factors; and that resources constitute strengths and
weaknesses, strategic competencies which either match, or fail to match,
environmental needs. Sustaining and changing this strategic fit is dependent on
leadership, culture and values. The EVR model goes on to show that
entrepreneurship is a process which is essential for establishing winning strategic
positions and, as such, is relevant and vital for all types and size of organisation.
He described how a firm responds to its suppliers, customers, competitors, and
the social and economic environment in which it operates.
All key stakeholders are important for the Bank to be successful. If the Bank
ignores its employees, then demotivation sets in, which leads to poor customer
service, which results in loss of repeat business and decline in profits, deposits
etc.
Likewise if shareholders are neglected, like for instance having a poor dividend
policy, they will sell off their shares and invest elsewhere. This might lead to a
bearish run on shares and loss of market capitilisation. This will also make it
difficult for the Bank to raise additional capital if beed be. Likewise it must have
good relationships with its correspondent network of banks, suppliers of IT
hardware and software, unions and regulators, but most importantly its
customers, depositors and borrowers alike.
Success of a firm may relate to size and market share; or profitability and
shareholder value. Attention to the above stakeholders in the context of a CSR
framework (Corporate Social Responsibility) hepls the Bank and any other firm
for that matter to increase market share, profitability and hence shareholder
value.
A firms Competitive Advantage will depend upon its Distinctive Capabilities,
Strategic Assets and Market structure.
For any firm to compete well in the market, it needs to have a distinctive edge
over its competitors. This competitive advantage will depend on its capabilities,
strategic assets and market structure.

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PTO

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1. Architecture:

This relates to the establishment of long-term relationships

between the bank and its customers and the bank and its
officers. Today , as we have seen a couple of slides ago we
now speak of the importance of building a strong and good
relationship with all stakeholders, including shareholders,
employees, unions and authorities etc.
In Germany and Japan, banks hold cross-ownership in non-
financial firms. Banks in Europe and the US tend to focus on
transactional (arms-length) and classical contracts, making
lending decisions on the basis of security (collateral) of assets
and project feasibility.

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2. Reputation:
This is the second distinctive capability which relates to the
markets method of dealing with the attributes of goods and
services where it is difficult for customers to obtain
independent information.
Depositor confidence is essential since Banks main funding
may come from deposit-taking not wholesale borrowing from
the interbank market, although reputation is also key here as
witnessed in the 2008 financial crises triggered by the collapse
of Lehman Brothers. More of this later on in the course.
Borrowers also need to be assured that their loans will not be
called in. Business projects are long-term in nature and
therefore funding arrangements must match the projects
estimated time-line for payback. If a loan is called prior to the
project starting to provide a return on investment, then this
would lead to instability.
Investors seeking the financial services of banks also need to
deal with an institution of high repute. Their investment would
probably be of a long term nature and therefore they need the
assurance that their holdings are in safe hands
Banks also need to maintain their reputation and integrity in
their dealings with regulators, unions, and all economic and
social operators .

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Sustain the high cost of innovation
Innovation comes at a huge expense and capital outlay. The Bank must
have sufficient financial resources to acquire and maintain and develop
new technology. Apart from the actual cost of hardware and software,
there are additional expenses which need to be taken into consideration
such as recruitment of qualified personnel, training of existing staff and
maintenance costs which increase with the ageing of the system.
Also , the Bank must have enough financial resilience to withstand the
failure of the innovation. The example below refers.
Manage the process of innovation well
Typical failures of innovation are Midland Banks attempt to enter the US
retail bank market in the 1990s. The bank had hoped to employ new
technology to overcome brancjing costs and offer new products, but it
was unable to do so because of managerial deficiencies and weak
competitive positioning.
On the other hand, First Direct, a telephone banking subsidiary of
Midland, is a good example of how most aspects of branch banking can
be successively replaced through the application of new technology in the
retail sector.
Its innovation must be unique (inimitable) and not easily copied
(appropriable)
Like in many other projects, there advantages and disadvantages of
being first in the market. The harder it is copy or imitate a service, the
more profitable it would be for a bank to enter the market first and recoup
initial investment. As the competitor finally catches up, the incumbent
would have gained significant market share which would make it more
difficult on the new entrant to obtain new business.
In wholesale and Investment Banking it is difficult to plan a strategy of
innovation to gain competitive advantage, because innovations are easily
copied.

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Strategic Assets :

In addition to Distinctive Capabilities, Kays argued that some

firms (banks) may dominate the market because they possess
strategic assets, which arise for a number of reasons e.g.
natural monopoly, relatively high sunk costs, infrastructure.
For instance a bank with a large branch network would have the
capability to reach a wider geographical spread of customers
than a bank with a few outlets.
Also a large loyal customer base makes direct marketing easier
and less costly because the bank would already be known to the
customer. Also building longer term relationships would also be
easier for the bank since it would have built trust over time. Of
course the important caveat here is that the level of customer
service is maintained at excellent levels.

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We will discuss whether the rapid rise of technology has given rise
to a threat to banks intermediation role especially in the payments
area.
Banks have to continually adapt to the changing nature of
intermediation , and compete with new technology which narrows
information asymmetries (therefore reducing the need for
intermediaries).
Typical examples of new technology challeging banks intermediary
role are the following:
E-cash: prepaid cards e.g. BOVs mastercard pre-paid cards
E-Wallet: Visa Electron , or Cashlink Visa are debit cards which can
be top-upped via 24x7 internet banking. BOV is about to launch its
mobile banking which will dominate e-payments in the very near
future and will make the use of cards obsolete.
PayPal is a California based company that offers business and
personal customers a secure means of sending and receiving
payments via email. Customers use PayPal if they are reluctant to
provide credit card details to unknown internet merchants. Also for
tiny internet firms that cannot afford the cost of offering credit or
debit card facilities, PayPal credits them for any purchases made via
PayPal. PayPal acts as an Exchange, where the credit card details
are not divulged to other party.

The exponential growth of internet has led to change the way the
bond market functions. In 2000 World Bank employed two
investment banks to issue new bonds direct to investors via the
internet. Facebook have only recently made their first IPO on the
internet. This innovation also reduces the dominance of institutional
investors, since World Bank e-bonds for instance attracted investors
having between US$1000 to 250 million worth of bonds.

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There has been much discussion on the threat posed to traditional
banks by the growth of non-banks.
Non-Banks are firms that do not offer a complete core banking service
but are very similar to banks.
For example personal loan and mortgage corporations specialise in
loans and mortgages that are funded through bond issues and or by
turning a bundle of assets into asset backed pr mortgage backed
securities and selling them to raise liquidity. Though they are offering
a loan/mortgage they are still not banks because they are not funded
by deposits.
E.G GE Capital is the financial services subsidiary of General Electric
issues the largest amount of commercial paper in the USA , supplies
credit card facilities to department stores , is the largest insurer of
private homes . Other examples are marks and Spencer in the UK,
Virgin, Tesco and Sainsbury.
Most offer core banking services e.g. credit via existing banks. For
example Tesco, Sainsbury and Virgin have their banking products
supplied to them by RBS, HBOS (now Lloyds).
Another important trend in banking has been the increased
consolidation of banks. Take the UK for e.g. Lloyds Bank acquired
HBOS , while RBS acquired Nat West some years ago. HSBC
acquired Midland Bank , so that together with Barclays there are only
4 remaining big UK banks , two of them government owned.

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The debate sometimes revolves around a simple question:

Is financial innovation good or bad? But quantifying the benefits of

innovation is almost impossible, and like most things it depends.
It is its tendency to excess that must be curbed.
For example: Are credit cards bad? Or mortgages?

It is true that some instruments like highly leveraged ones, are

inherently more dangerous than others. We will later on in the course
look at Collateralised Debt Obligations which were backed by sub-prime
mortgages and CDSs which are precisely these types of instruments
which played a great part in the financial crises in 2008/2009. The ideas
behind these two financial innovations are sound e.g. the use of
securitisation and CDSs in India is freeing up capital which can be used
by the government for further investment.

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