Banking Sector Services: Globalization, Technology & Regulation

Introduction

The services sector comprises vast groups of industries that cater to human needs in all spheres of existence. This paper examines the banking sector, which falls under the field of services. The banking sector relates to the financial transaction requirements of individuals, nations, and international monetary systems.

Nature of Banking Services

The financial services sector comprises banks, non-banking institutions, and lending and other finance-related operations such as mutual funds and investment companies. Within the industry, banking is a vast and highly developed institution that functions on complex hierarchies and with special controls and laws. Banking serves nations, individuals, and businesses alike. The banking industry can be defined in terms of its products, markets, types of competition, and services offered. Banking can be classified as a financial intermediary service: banks accept money from depositors and lend it to applicants, and the difference in interest and service charges between the depositor and the borrower constitutes the net gain of the bank. Viewing banks as mere agents for transforming funds, while accurate on a policy and economic analysis level, is not an exact reflection of the full industry. (Duetsch, 2002, p. 174)

Banks provide necessary financial services to households, individuals, and businesses. Their operations encompass multiple services — deposits, accounts, loans, and investment services — providing customers with varied financial and commercial services at designated and regulated charges. The service is inherently regional. Banks themselves fall under the wider classification of the financial services industry, which also contains investment banks, security and share trade concerns, depositories, and many allied services. These may be coupled with core banking services or carried on individually by a single institution. Unless core banking services — that is, deposit and loan services and the transfer of negotiable instruments such as checks — are provided, an institution is classified as a non-banking financial institution. The banking service consists of a "cluster of products and services," as defined by the US Supreme Court, offering sets of services that other financial institutions cannot provide. (Duetsch, 2002, p. 174)

The types of services are based on agreements such as banking service agreements, which define the relationships among parties in the banking service. Lockbox agreements deal with the safety of deposits, valuables, and the handling of public funds. Two financial institutions may also enter into collateral agreements to regulate their internal working mechanisms and synchronize their operations with each other. Trust and escrow agreements are today important in international transfers and import or export transactions, where banks act as escrows. (Sheimo, 1993, p. 1) More recently, technological advances have introduced wire transfer, through which funds are transferred online. Banks provide this service to customers who wish to make fast payments without the usual clearing of checks. Wire transfer agreements carry inherent risks to the bank compared with traditional methods of fund transfer. (Sheimo, 1993, p. 6)

Credit is one of the most important features of the banking industry. Credit by itself functions like a currency — it is extended when needed, aiding capital formation. Checks, drafts, and other negotiable instruments are also a form of currency created and managed by banks. All of these services create the necessary cash flow in the economy. The volume of transactions in these spheres outnumbers those of actual currency dealings, which underscores the importance of this industry to the economy. Credit accounts for a large volume of transactions and forms the base of the banking sector. Any monetary problem or analysis of monetary theory therefore begins with banks. Capital is very important for any business, including banking. The larger the reserve a bank can muster, the greater the scope of its operations, and profits will be proportional. Larger capital will attract better-quality investors, thereby creating a fund and cash flow for the institution. The success of the bank is ultimately determined by the type of society it serves. (Phillips, 1920, p. 121)

The Second World War ended with a deep mistrust of monetary policies, and governments began relying more on taxation and fiscal policies. Fiscal policies also dictated that central banks ought to play a pivotal role in stabilizing the economy. Economic policies, it was perceived, could only be implemented through the central bank of a country — especially where exchange rates were concerned. When price stability became a priority in the 1990s, the role of monetary policy and the effect of banking policy on controlling prices came to be recognized. Thus, today, apart from being the lender of last resort, the central bank also plays a vital role in enforcing economic controls. (Siklos, 2002, p. 1) The unique feature of the banking industry is the reserve system and the central bank. The reserve system is an institution that has come about not only to assure depositors of the soundness of the bank, but also to keep the economy stable. Banking and trade deficits are affected by the reserve system, and central banking policy determines a country's trade deficit. The reserve system and the functioning of the central bank must therefore be treated as a special subject. (Ashdown, 2002, p. 55)

All domestic and foreign policies and activities of the economy are financed through banking institutions. Banks have also become dependent on stock markets, and that mutual dependence has to some extent caused instability. Governments therefore impose controls and checks on bank reserves and lending rates to offset market fluctuations. In all countries there exists a reserve system controlled by the country's central bank. The US Federal Reserve System was created to control the flow of credit and currency within the country and to provide stability. The central bank acts as the lender to banks, covering their deficits when required, keeping banks liquid, sustaining investor confidence, and averting major economic catastrophes. The functions performed by banks are today the basis of the world's trading system. Once gold was used as bullion to create overseas credit; the reserve system has since replaced the gold standard, and currency trade is now standard practice. Central banks still deal in gold on behalf of their countries. (Ashdown, 2002, p. 27)

The central bank has enlarged its role from lender of last resort to creator of price stability and controller of economic fluctuations. Monetary policy gained importance after industrialization took hold. However, the changing financial situation and the new financial instruments being created through technology will in due course weaken the central bank's ability to control the economy, requiring it to adapt its policies and redefine its role. (Siklos, 2002, p. 1) Though globalization and the liberalization of banking have in essence diminished the monetary policy power of the central bank, in most countries the central bank — or, in the case of Japan, the ministry of finance — controls the banking sector. Especially after the disaster of the burst bubble economy, monitoring and controlling banks has again become a serious issue, and central banks have reasserted their authority. (Osano; Tachibanaki, 2001, p. 85)

Modern banking is a new and evolving concept requiring additional controls and laws. Banks are redefining their services, and therefore regulations and laws must be expanded to suit new banking activities. Banking laws are now an integral part of the banking system and have evolved alongside changes in the nature of banking. Banking service is so complex that it must be viewed from two perspectives: the internal structure and operations of the bank, and the relationship of the bank and its legal framework with external dealings. Today banks still perform the basic functions for which they were created — lending and collecting deposits. (Cranston, 1997, p. 3)

Globalization of the Banking Sector

The core banking structure has not changed, but the method of operation has. Banks now serve customers in more ways than the traditional service — providing other financial products and creating and disseminating financial information that cannot strictly be considered part of core banking. Customers are becoming more affluent and look to banks for help with their financial decisions. Money that would have been merely deposited is now invested in mutual funds, unit trusts, pension plans, and other financial products. Banks thus play a role in distributing these products to their customers. In the international arena, banks are dealing more extensively with derivatives and foreign exchange, making their role far more important to the overall well-being of the economy. Banks are diversifying and redefining themselves as trading, banking, and service institutions — multifunctional entities known by various terms such as the "clearing bank" in the UK, "commercial banks," "investment banks," or "merchant banks." (Cranston, 1997, p. 3)

Globalization is a phenomenon that has affected all industries and human life. The changes that followed the end of the Cold War and the new social interaction between nations have affected the financial sector as well. Globalization has removed many restrictions on global operations. With available technology, the functions of any institution can now be carried out on a global scale.

There has been a significant change in the outlook on banking principles and the role of banks after globalization. At the end of the Second World War and for the decade thereafter, there was only hesitant participation in overseas banking. Banks concentrated on strengthening overseas interests, especially in neutral countries and with allies. US banks extended credit to South American countries and Europe, and American merchants benefited from the supply of credit afforded by their own banks in those countries. (Stern, 1951, p. 413) The economist Joseph A. Schumpeter theorized that new processes and policies would destroy established methods of doing business and bring in new methods and means — a process he called "creative destruction" — and predicted that such constructive changes would occur in wave-like patterns. These observations have been borne out by the sweeping changes taking place in the world today. The deregulation of international trade and transactions, coupled with changes in technology, have brought about vast changes in all sectors, especially the global financial services sector and banking institutions in particular. Some services overlap between banking and non-banking institutions — such as payments, risk-taking, and mutual funds. The methods by which these services are rendered are changing rapidly. Today the banking and financial services sector has come a long way from the times of Adam Smith; the functions and scope of operations of banks and other institutions are so wide and vast that earlier services have become almost unrecognizable. (Gup, 2003, p. 1)

The transition was not easy. Many events in the 1990s altered the structure of every nation in the globe: the formation of the European Union, the establishment of the North American Free Trade Area, and the industrialization of developing countries. Rapid changes in technology were one of the reasons why globalization could happen. The banking industry was hard hit by these global changes. Deregulation and the arrival of foreign competitors created significant disruption in the banking sector. Competition in the industry became intense and continued to gain momentum. Banking institutions were in crisis in the 1990s, with a rapid fall in margins within the European Union, and the rising cost of deposits and falling interest rates added to the pressure. (Gup, 2003, p. 12)