CHAPTER-2

The Organization and

Structure of Banking
and the Financial-Services
Industry
 Introduction
• Over the years, bankers and the managers of other
financial institutions have evolved different
organizational forms to perform these various roles
and to supply the services their customers demand
• Structure, size, and types of organizations changed by-
 changing public mobility
 changing demand for financial services
 the rise of hundreds of potent competitors
 changing rules of the game
 Internal Organization of the Banking Firm

• Community Banks and Other Community-

Oriented Financial Firms
This bank is heavily committed to attracting smaller
household deposits and to making household and
small business loans.
Financial firms of this type stand in sharp contrast to
wholesale banks, like J. P. Morgan Chase and
Citibank of New York, which concentrate mainly on
serving commercial customers and making large
corporate loans all over the globe
• Close contact between top management and the
management and staff of each division is common
• community banks are usually significantly impacted
by changes in the health of the local economy
• Unlike some larger institutions, community bankers
usually know their customers well and are good at
monitoring the ever-changing fortunes of households
and small businesses.
• Banks of this size and geographic location may
represent attractive employment opportunities
 Larger Banks—Money Center,
Wholesale and Retail
• This bank is owned and controlled by a holding
company whose stockholders elect a board of
directors to oversee the bank and nonbank businesses
allied with the same holding company.
• The key problem in such an organization is often the
span of control
• Largest institutions serve many different markets with
many different services. These institutions are rarely
dependent on the economic fortunes of a single
industry or, in many cases, even a single nation.
 Trends in Organization

• Become more complex organizations over time (adds

new services and new facilities).
• Changing makeup of the skills bankers need to
function effectively
• More and more financial firms have become market
driven and sales oriented, more alert to the changing
demands of their customers and also to the challenges
competitors pose.
Unit Banking Organizations
• Unit banks, offer all of their services from one office,
although some services (such as taking deposits,
cashing checks, or paying bills) may be offered from
limited-service facilities, such as automated teller
machines (ATMs) that are linked to the bank’s
computer system.
• One reason for the comparatively large number of
unit banks is the rapid formation of new banks. Most
new banks start out as unit organizations, in part
because their capital, management, and staff are
severely limited until the bank can grow and attract
additional resources and professional staff
Branch Banking Organizations
• Branch banking organizations offer the full range of
banking services from several locations, including a
head office and one or more full-service branch
offices. Such an organization is also likely to offer
limited services through a supporting network
• Senior management of a branch banking organization
is usually located at the home office, though each
full-service branch has its own management team
with limited authority to make decisions on customer
loan applications and other facets of daily operations.
Growth of Bank Branches in Bangladesh (1901-
2000)
British period Pakistan period Bangladesh period
Year No. of Year No. of Year No. of
Branches Branches Branches
1901 25 1950 148 1975 1538
1911 45 1955 145 1980 3494
1921 149 1960 160 1985 4066
1931 359 1965 546 1990 4500
1941 565 1970 1025 1995 5500
1946 668 1972 1130 1998 5954
2000 6056
• The denationalization and privatization period is
demonstrating that the branches expanded with a
sluggish scale. During the financial linearization
period, branches expanded at rapid pace.
• In the beginning of denationalization and
privatization period the PCBs branch expansion
growth rate was very low and there were no
branches in the rural areas after permitting private
banking in the first two years
• With the passage of time the % share of PCBs in
both rural and urban areas started to increase and
within the beginning of financial liberalization
period it stood at 65: 35. And the proportion has
become wider and has stood at 74: 26 in 2004.
• The urban to rural proportion is showing the
negligible concentration in the rural areas as the
rural areas’ share of PCBs branches has decreased
gradually
Reasons behind Branching’s Growth
• The exodus of population over the past several
decades
• Healthier banks have been allowed to take over sick
ones and convert them into branch offices
• Business growth
Advantages of branch Bank
• Large Size
• Adequacy of capital
• Adequacy of Deposits
• Large Scale credit
• Adequate investment
• Efficient management
• Distribution of Risk
• Employment
• Public confidence
• More liquidity
Disadvantages of Branch Bank:
• Complex management
• More expenditure
• Delay in decision making
• Uneconomic expansion
• Local influence
• Political influence
 Electronic Branching—Web Sites and
Electronic Networks
• Electronic branches include Web sites offering
Internet banking services, automated teller
machines (ATMs) and ATM networks dispensing
cash and accepting deposits, point-of-sale (POS)
terminals in stores and shopping centers to facilitate
payment for goods and services, and personal
computers and telephone systems connecting the
customer to his or her bank
• Most electronic branches seem to operate at far lower
cost than do conventional brick and mortar branch
offices, at least for routine transactions.
• However virtual banks have to combat the fact that
customers often feel more secure if they know that
their depository institution, besides being Web
accessible, also has full-service branches where they
can go to straighten out serious problems.
 Bank Holding Company Organizations

• A bank holding company is simply a corporation

chartered for the purpose of holding the stock (equity
shares) of at least one bank.
• Under the terms of the Bank Holding Company Act,
control is assumed to exist if the holding company
acquires 25 percent or more of the outstanding equity
shares of at least one bank or can elect at least two
directors of at least one bank.
Why Holding Companies Have Grown
• Greater ease of access to capital markets in raising
funds
• Ability to use higher leverage (more debt capital
relative to equity capital) than nonaffiliated banking
firms
• Tax advantages in being able to offset profits from
one business with losses generated by other firms that
are part of the same company
• Ability to expand into businesses outside banking
One-Bank Holding Companies
• This type of holding company controlled stock in just
one bank. One-bank companies frequently owned and
operated one or more nonbank businesses as well.
• Principal advantage is diversifying sources of revenue
and profits (and, therefore, reducing risk exposure)
Multibank Holding Companies
• This type of holding company controlled stock in
more than one bank
• Banks acquired by holding companies are referred to
as affiliated banks. Banks that are not owned by
holding companies are known as independent banks
 Advantages and Disadvantages of Holding
Company Banking
• Holding company banking has been blamed for:
 reducing competition
 overcharging customers
 ignoring the credit needs of smaller towns and cities
 accepting too much risk
• Supporters of the holding company movement claim
greater efficiency, more services available to
customers, lower probability of organizational failure,
and higher and more stable profits
 Financial Holding Companies (FHCs)

• FHCs are defined as a special type of holding

company that may offer the broadest range of
financial services
• Any new service offerings appear to be “compatible”
with banking and are “financial in nature.”
• With the FHC approach each affiliated financial firm
has its own capital and management and its own
profits or losses separate from the profits or losses of
other affiliates of the FHC.
 Bank Subsidiaries

• Qualified banks produce and market their services

through a bank subsidiaries organizational structure.
• The bank in this organizational form controls one or
more subsidiary companies that can offer insurance
policies, security brokerage, and other permissible
services.
• The profits and losses of each subsidiary impact the
parent bank, however, which could increase that
bank’s risk exposure.
Mergers and Acquisitions Reshaping the
Financial Structure
• The rise of branch banking, bank holding companies,
and, most recently, financial holding companies
(FHCs) has been fueled by mergers and acquisitions
• Most of the acquired depository institutions were
converted into branch offices or into affiliates and
subsidiaries of the acquiring companies
The Changing Organization and Structure
of Banking’s Principal Competitors
• Consolidation (fewer, but much larger service
providers) is occurring at a rapid pace
• Convergence (with all financial firms coming to look
alike, especially in the menu of services offered) has
been sweeping through virtually all of banking’s
competitors
• The effects are-intensifying financial-services
competition, a widening gulf between the smallest
and the largest firms in each industry, and greater
exposure to the risks
Efficiency and Size: Do Bigger Financial
Firms Operate at Lower Cost?
• There are two possible sources of cost savings due to
growth in the size of financial firms-
• Economies of scale, mean that doubling output of any
one service or package of services will result in less
than doubling production costs because of greater
efficiencies in using the firm’s resources.
• Economies of scope imply that a financial-service
provider can save on operating costs when it expands
the mix of its output
• Fixed costs can be spread over a greater number of
service outputs.
Efficiency in Producing Financial Services
• The average cost curve in the banking industry—the
relationship between bank size (measured usually by
total assets or total deposits) and the cost of
production per unit of output—is roughly U-shaped
but appears to have a fairly flat middle portion.
• This implies that a fairly wide range of banking firms
lie close to being at maximally efficient size
• As banks are increasingly producing and delivering
services via computer, operating costs probably have
fallen substantially.
• New laws and regulations have made it possible for
financial-service companies to establish smaller
branches inside retail stores, set up more limited-
service facilities (such as ATMs and Web sites), and
branch more freely across the nation.
• Most banks, for example, do not operate at their
minimum possible cost. Rather, their degree of x-
efficiency tends to be 20 to 25 percent greater in
aggregate production costs than it should be under
conditions of maximum efficiency.
 Financial Firm Goals: Their Impact on
Operating Cost, Efficiency, and
Performance
• Goal depends on motivations of managers and
owners (stockholders).
• For example, pursuing minimum operating costs and
maximum efficiency makes some sense for financial
firms that seek maximum profitability and earnings
for their owners.
• However, for those financial firms wanting minimum
risk exposure or the biggest market share, cost control
and efficiency would appear to have a much lower
priority.
Expense-Preference Behavior
• Managers often appear to value fringe benefits, plush
offices, and ample travel budgets over the pursuit of
maximum returns for the stockholders
• Such expense-preference behavior may show up in
the form of staffs larger than required to maximize
profits or excessively rapid growth, which causes
expenses to get out of control.
Agency Theory
• It analyzes relationships between a firm’s owners
(stockholders) and its managers, who legally are
agents for the owners.
• Agency theory explores whether mechanisms exist in
a given situation to compel managers to maximize the
welfare of their firm’s owners.
• For many financial firms today, ownership is
increasingly being spread out, and the dominance of
individual stockholders in the industry appears to be
decreasing.
• One way to reduce costs from agency problems is to
develop better systems for monitoring the behavior of
managers and to put in place stronger incentives for
managers to follow the wishes of owners.
• The latter might be accomplished by tying
management salaries more closely to the firm’s
performance or giving management access to
valuable benefits (such as stock options)
• lower agency costs and better company performance
depend upon the effectiveness of corporate
governance—the relationships that exist among
managers, the board of directors, and the stockholders
and other stakeholders (such as creditors) of a
corporation.