Forces Leading to Changes in the Banking Industry 'Literature Review' chapter

  • Length: 10 pages
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  • Subject: Economics
  • Type: 'Literature Review' chapter
  • Paper: #62670542

Excerpt from 'Literature Review' chapter :

Forces Leading to Changes in the Banking Industry

The banking sector is one of the strongest industries in the whole wide world which has been thought to be one of the industries that is incapable of feeling the adverse effects of a recession. This is not to mean that the industry does not feel any effects, rather it means that the effects felt are not as wide scale as those felt by other industries such as the airline industry and oil industry. Members of the banking industry are the financial institutions and financial intermediaries which accept deposits and then use these deposits to finance their lending activities either directly to customers or through the capital markets. Typically, this industry is one which connects the customers who have capital deficits to those who have surpluses of capital.

The banking sector is thus critical in the financial system and the economy as a whole. This is the major reason why the industry is heavily regulated in many countries of the world. The members of the banking industry are required to maintain reserves of funds deposited with the regulatory authority. This reserve is usually a fraction of the total deposits by customers of the financial institution.

This literature review attempts to analyze different pieces of literature and what they say are the forces that lead to changes in the banking industry. To do this, it is important to first trace the history of the banking industry which will give crucial information on the evolution of the industry from which the forces can be extracted. It is also important to explore the size of the banking industry in order to evaluate certain factors crucial to influencing changes in the industry. It is also essential to look at the banking regulations and laws since this is what governs how the bank relates to its customers and thus it is an important consideration in any changes in the banking industry.

History of the banking industry

The banking industry has its roots set in the time of the medieval and early Renaissance Italy although banking existed even in the year 2000 BC in Babylonia and Assyria. In Renaissance Italy it extended to the rich cities in the north of Italy such as Genoa, Florence and Venice. There were two families which ran and dominated the sector in the 14th century in the town of Florence. These families were the Peruzzi and the Bardi families. They expanded and established branches in several other parts of Europe Hoggson 14()

The banking sector saw huge growth over the centuries as the lucrative business of lending to others grew. The banks even diversified and offered more services including money changing, transferring of funds and even bank debts. However, the industry suffered a huge stroke in the year 1907 when there was a huge panic in the U.S. over banks running bankrupt. This panic spurred customers to make bank runs where they went to withdraw their deposits. This led to increase financial regulation on banks Stiroh and Strahan 802()

The 1930s great depression

During the year 1929, there was a great depression and at the time in the U.S. And the margin requirement for financial institutions was just 10%. This meant that brokerage firms were able to lend $9 for every $1 that investors had deposited with them. When the market began to fall, the brokers began to call in these loans of which there was a high default rate as most of the loans could not be paid back. Banks, as debtors, began to default on their debts and when depositors realized this, they began to withdraw, en masse, their deposits. Guarantees placed by the government and regulations put in place by the Federal Reserve were not present at the time or were ineffective. Therefore, the banks ended up losing billions in assets and the debts that were outstanding became heavier. 744 banks failed during the first 10 months of the year 1930 and three years later in the month of April of 1933, about $7 billion was frozen in banks which had failed Schweikart 608()

Future profits looked pretty dim since the debtors were unable to repay back their loans. Therefore the banks which had survived the great depression were extremely conservative in their lending. These banks accelerated the buildup of their own capital reserves and lent out fewer loans which intensified the pressure on deflation. The downward spiral was accelerated as the vicious cycle developed Braunschweiger, Geyer and Kelly 118()

All over the world, a whopping 9,000 banks failed during the 1930s great depression. This stimulated a response by the government to increase financial regulation significantly. The U.S. Securities and Exchange Commission (SEC) was established in the year 1933 after the 1930s great depression. There was also the enactment of the Glass-Steagall act which separated investment banking activities from commercial banking activities. This act was enacted in order to avoid riskier investment banking activities from causing failure of commercial banks which was the reason of the great depression of 1930s Braunschweiger, Geyer and Kelly 120()

The World Bank and the International Monetary Fund (IMF)

The World Bank and the IMF were created in the year 1944 by the Bretton Woods system during the post-World War II (WWII) period. This encouraged financial institutions to lend out money to third world governments. However, several banks became bankrupt as a result of the third world countries defaulting on their debts when the Gold Standard was abolished in the year 1971. The Gold Standard was a monetary system which used gold of a fixed weight as the standard economic unit of account. This made a number of banks to be caught out and thus they became bankrupt Schweikart 612()

Development of banking and payment technology

Technology used in the banking industry has evolved over many decades. In the year 1959, the first standard for MICR (machine readable characters) was developed and patented in the United States which was then used in checks leading to the first automated reading and sorting machines. One year later in 1960, there was the development of the first ATM (automatic teller machines) and cash machines which continued to become popular over this decade Schweikart 616()

Banks heavily invested in computer technology which served to automate the manual processes and thus the banks shifted from having many clerical staff to the use of automated systems. The first payment systems came as a result of these technological advancements which lead to the first international payment network in the year 1973, SWIFT, which was developed by the Society for Worldwide Interbank Financial Telecommunication Schweikart 618()

Deregulation and globalization

During the period of the 1980s, the banking sector in a number of countries became deregulated and as a result of this, there was huge growth and proliferation in the industry. There was the 'Big Bang' of 1986 in London which allowed banks to access the capital markets in new ways leading to significant alterations in how the banks operated and got access to capital. There was also a trend which began where retail banks began acquiring investment banks and stock brokers began creating universal banks which offered a wide range of services in the banking industry. This trend also caught up in the U.S. when the Glass-Steagull Act was repealed in the year 1980 which saw retail banks in the U.S. embarking on mergers and acquisitions and also engaging in other investment banking activities Ng 878()

Financial services continued to face huge growth through the 1990s and this was attributed to the huge demand from companies, financial institutions and governments. It was also because the conditions created in the financial market were quite buoyant and generally bullish. During the 20-year period from 1980-2000, the interest rates in the U.S. declined from 15% to about 5% for the two-year U.S. treasury notes. Financial assets grew at a rate that was approximately twice that of the economy of the world. There was also huge internationalization of the banking industry when banks began to find and invest in opportunities which presented themselves in overseas foreign markets Ng 880()

The present

By the end of 2000, the top ten banks in the world had a market share of greater than 80% which they commanded while the top five banks commanded a market share of 55%. Of the top seven banks, three were American banks and four were European banks. The remainder of the banks were large investment banks in the U.S. which had a market share of 33% shared between them.

Due to these huge and attractive figures of the banking industry, there arose other non-bank financial institutions such as insurances, mutual funds, pension funds, hedge funds, and money market funds. This growth was so large that when it came to the end of the year 2001, the market capitalization of the 15 largest financial institutions in the world included four non-bank institutions Morris 437()

Banks continued to invest largely in technology and this paid of…

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