Chapter Three

The Organization and Structure of

Banking and the Financial-Services
Industry
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 Key Topics
• The Organization and Structure of Banks and the Banking
Industry
• The Array of Organizational Structures in Banking: Unit,
Branch, Holding Company, and Electronic Services
• Interstate Banking and the Riegle-Neal Act
• The Financial Holding Company (FHC)
• Mergers and Acquisitions
• Banking Structure and Organization in Europe and Asia
• The Changing Organization and Structure of Banking’s
Principal Competitors
• Economies of Scale and Scope and Expense Preference
Behavior
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 Introduction
• Chapter 1 explored many of the roles and services of the
modern bank and competitors of banks
• Over the years, bankers and the managers of competing
financial institutions have evolved into different
organizational forms
• A financial institution’s role and size are not the only
determinants of how it is organized or how well it
performs
• In this chapter, we will discuss the causes that have
dramatically changed the structure, size, and types of
organizations dominating the financial-services industry
today
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 The Organization and Structure of the
Commercial Banking Industry
• Advancing Size and Concentration of Assets
▫ Commercial banking is the dominant supplier of credit and
payments services to businesses and households
▫ Many banks in the United States are small by global
standards
▫ These smallest financial institutions, numerous as they are, held
little more than one percent of total industry assets
▫ In contrast, the American banking industry also contains
some of the largest financial service organizations on the
planet
▫ Citigroup, JP Morgan Chase, and the Bank of America hold
about 6 trillion dollars combined
▫ Thus, banking continues to be increasingly concentrated not
only in the smallest, but also in the very largest of all
financial firms
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 EXHIBIT 3–1 The Structure of the U.S. Commercial
Banking Industry, December 31, 2009

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 EXHIBIT 3–1 The Structure of the U.S. Commercial
Banking Industry, December 31, 2009

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 Internal Organization of the Banking Firm
• The great differences in size across the
industry that have appeared in recent years
have led to marked differences in the way
banks and other service providers are
organized internally and in the variety of
financial services each institution sells in the
markets it chooses to serve

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 EXHIBIT 3–2 Small and Medium-Size U.S. Banks Lose
Market Share to the Largest Banking Institutions

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 Internal Organization of the Banking Firm
(continued)
• Community Banks and Other Community-Oriented
Financial Firms
▫ Devoted principally to the markets for smaller, locally based
deposits and loans and are often referred to as a retail bank
▫ Financial firms of this type stand in sharp contrast to wholesale
banks
▫ Close contact between top management and management and staff
of each division is common
▫ Community banks are usually significantly impacted by changes in
the health of the local economy and keeping up with new
regulations
▫ These institutions have been losing ground, both in numbers of
institutions and in industry shares
▫ Around 14,000 community banks in 1985 and about 6,000 in 2010
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 EXHIBIT 3–3 Organization Chart for a Smaller Community
Bank

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 Internal Organization of the Banking Firm
(continued)
• Larger Banks – Money Center, Wholesale and Retail
▫ A large money center bank is usually located in a large city
and has a focus towards wholesale or wholesale plus retail
▫ Some of the largest banks have moved toward the profit-
centered or performance approach
▫ Each major department strives to maximize its contribution to
profitability or to some other performance indicator
▫ The largest money-center banks possess some important
advantages over community oriented institutions
▫ Better diversified – both geographically and by product line
▫ Can better withstand the risks of a fluctuating economy
▫ Able to raise huge amounts of financial capital at relatively low cost
▫ Can attract top managerial talent
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 EXHIBIT 3–4 Organization Chart for a Money Center or
Wholesale Bank Serving Domestic and International Markets

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 Internal Organization of the Banking Firm
(continued)
• Trends in Organization
▫ The tendency in recent years has been for most financial
institutions to become more complex organizations over time
▫ When a financial firm begins to grow, it usually adds new services
and new facilities
▫ Another significant factor influencing financial organizations today
is the changing makeup of the skills financial-service providers
need to function effectively
▫ Financial firms have needed growing numbers of people with
computer skills
▫ Call centers have grown in the industry to sell profitable services
and respond to customer problems
▫ Automated bookkeeping has reduced the time managers spend in
routine operations
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 The Array of Organizational Structures and
Types in the Banking Industry
• There are so many different types of financial
institutions today that the distinctions between these
different types of organizations often get very
confusing
▫ Insured banks
▫ State chartered banks
▫ National banks
▫ Member banks

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 EXHIBIT 3–5 U.S. Commercial Banks with Federal versus State
Charters, Membership in the Federal Reserve System, and Deposit
Insurance from the Federal Government (as of December 31, 2009)

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Unit Banking Organizations
▫ Unit banks, one of the oldest kinds, offer all of their
services from one office
▫ Some services (such as taking deposits, cashing checks, or
paying bills) may be offered from limited-service facilities,
such as drive-up windows and automated teller machines
(ATMs)
▫ These organizations are still common today
▫ One reason for the large numbers of unit banks is the
continuing formation of new banks
▫ Many customers still seem to prefer smaller banks, which
often seem to know their customers better than larger banks
▫ Many new banks start out as unit organizations
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 TABLE 3–1 Entry and Exit in U.S. Banking

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Branching Organizations
▫ As a unit financial firm grows larger in size it usually decides at
some point to establish a branching organization
▫ They offer the full range of services from several locations,
including a head office and one or more full-service branch offices
▫ Likely to offer limited services through a supporting network of
drive-in windows, ATMs, computers networked with the bank’s
computers, point-of-sale terminals in stores and shopping centers,
the Internet, and other advanced communications systems
▫ Senior management of a branching organization is usually located
at the home office, though each full-service branch has its own
management team with limited authority to make decisions

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 EXHIBIT 3–6 The Branch Banking Organization

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Branching’s Expansion
▫ During the Great Depression of the 1930s, only one in five
American banks operated a full-service branch office
▫ By the beginning of the 21st century, the average U.S. bank
operated close to 12 full-service branch offices
▫ One contributing factor has been the exodus of population
from cities to suburban communities
▫ The passage of the Riegle-Neal Interstate Banking and
Branching Efficiency Act in 1994 provided the basis for
expansion
▫ However, in recent years new bank branch office expansion
appears to have slowed somewhat
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 TABLE 3–2 Growth of Commercial Bank Branch Offices in
the United States

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Electronic Branching – Websites and Electronic
Networks: An Alternative or a Supplement to
Traditional Bank Branch Offices?
▫ Electronic branches
▫ Internet banking services
▫ Automated teller machines (ATMs)
▫ Point-of-sale (POS) terminals
▫ Personal computers
▫ Call-center systems
▫ Virtual banks

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 EXHIBIT 3–7 Electronic Banking Systems, Computer Networks,
and Web Banking: An Effective Alternative to Full-Service
Branches?

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Holding Company Organizations
▫ A bank holding company is simply a corporation
chartered for the purpose of holding the stock of at
least one bank, often along with other businesses
▫ The growth of holding companies has been rapid in
recent decades
▫ The principal reasons for this rapid upsurge:
▫ Access to capital markets in raising funds
▫ Ability to use higher leverage
▫ Tax advantages
▫ Ability to expand into businesses outside banking
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 TABLE 3–3 The 10 Largest Bank Holding Companies
Operating in the United States (Total Assets as Reported on
June 30, 2010)

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Most registered bank holding companies in the United States are one-
bank companies
▫ However, these one-bank companies frequently control one or more
nonbank businesses as well
• The principal advantage for holding companies entering nonbank
lines of business is the prospect of diversifying sources of revenue and
profits and reducing risk exposure
• A minority of bank holding company organizations are multibank
holding companies
▫ Multibank companies control more than 70 percent of the total
assets of all U.S. banking organizations
• One dramatic effect of holding company expansion has been a sharp
decline in the number of independently owned banking organizations
• Banks acquired by holding companies are referred to as affiliated
banks
• Banks not owned by holding companies are known as independent
banks
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 TABLE 3–4 The Most Important Nonbank Financially
Related Businesses That Registered Holding Companies
Can Acquire under U.S. Banking Regulations

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 EXHIBIT 3–8 The Multibank Holding Company

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 The Array of Organizational Structures and
Types in the Banking Industry (continued)
• Holding company banking has been blamed for reducing
competition by critics
• Supporters of the holding company movement claim
greater efficiency, more services, lower probability of
organizational failure, and higher and more stable profits
▫ The holding company as a whole tends to be more profitable
than banking organizations that do not form holding companies
• Moreover, the failure rate for holding company banks
appears to be below that of comparable-size independent
banks
• However, there is anecdotal evidence that multibank
holding companies may drain scarce capital from some
communities and weaken smaller towns and rural areas
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 Interstate Banking Organizations and the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994
• Riegle-Neal allows holding companies to acquire banks throughout the
United States without needing any state’s permission to do so and to
establish branch offices across state lines
• Why did the federal government eventually enact and the states
support interstate banking laws?
▫ The need to bring in new capital to revive struggling local economies
▫ The expansion of financial-service offerings by nonbank financial
institutions that faced few restrictions on their ability to expand nationwide
▫ A strong desire on the part of the largest financial firms to geographically
diversify their operations and open up new marketing opportunities
▫ The belief among regulators that larger financial firms may be more
efficient and less prone to failure
▫ Advances in the technology of financial-services delivery, permitting service
to customers over broader geographic areas

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 An Alternative Type of Banking Organization Available
as the 21st Century Opened: Financial Holding
Companies (FHCs)
• Under the terms of the Gramm-Leach-Bliley (GLB) Act,
financial holding companies (FHCs) are defined as a special
type of holding company that may offer the broadest range of
financial services, including dealing in and underwriting
securities and selling and underwriting insurance
• With the FHCs, each affiliated financial firm has its own
▫ Capital
▫ Management
▫ Profits or losses separate from the profits or losses of other affiliates
of the FHC
▫ Some protection against companywide losses
• Led to consolidation and convergence within the industry

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 EXHIBIT 3–9 The Financial Holding Company (FHC)

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 TABLE 3–5 Leading Financial Holding Companies (FHCs)
Registered with the Federal Reserve Board

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 Mergers and Acquisitions Reshaping the Structure and
Organization of the Financial-Services Sector
• The rise of branching, bank holding companies, and
financial holding companies has been fueled by multiple
factors
• Another powerful factor spurring these organizational
types forward is their ability to carry out mergers and
acquisitions
• Bigger companies have pursued smaller financial-service
providers and purchased their assets in great numbers
▫ Since 1980 more than 12,000 bank mergers have occurred in
the United States

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 The Changing Organization and Structure of
Banking’s Principal Competitors
• Banking’s principal competitors – credit unions, savings
associations, finance companies, insurance firms, security
dealers, hedge funds, and other financial firms
• All are affected by powerful forces such as rising operating
costs and rapidly changing technology
• A notable exception until very recently has been hedge
funds
• All financial firms are starting to look alike, especially in the
menu of services offered
▫ Convergence
• Great structural and organizational changes have “spilled
over” into one financial-service industry after another
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 Efficiency and Size: Do Bigger Financial
Firms Operate at Lower Cost?
• If not, then why have some financial institutions become
some of the largest businesses on the planet?
• Two possible sources of cost savings
▫ Economies of scale
▫ Economies of scope
• For financial firms, there is evidence for at least
moderate economies of scale in banking, though most
studies find only weak evidence or none at all for
economies of scope
▫ Studies of selected nonbank financial firms often reach
conclusions that roughly parallel the results for banking firms

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 EXHIBIT 3–10 The Most Efficient Sizes for Banks and
Selected Other Financial Firms

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 Financial Firm Goals: Their Impact on
Operating Cost, Efficiency, and Performance
• Expense-Preference Behavior
▫ When the management of a financial firm decides that benefits for
managers (and not the stockholders or the public) should be the
primary objective of the company
▫ Opposite of cost control and efficiency
• Agency Theory
▫ Analyzes relationships between a firm’s owners (stockholders) and
its managers, who legally are agents for the owners
▫ Explores whether mechanisms exist in a given situation to compel
managers to maximize the welfare of their firm’s owners
• Lower agency costs and better company performance depend
upon the effectiveness of corporate governance

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 Quick Quiz
• What trends are affecting the way banks and their competitors
are organized today?
• What trend in branch banking has been prominent in the
United States in recent years?
• What is a bank holding company?
• Are there any significant advantages or disadvantages for
holding companies or the public if these companies acquire
banks or nonbank business ventures?
• Can you see any advantages to allowing interstate banking?
What about potential disadvantages?
• What relationship appears to exist between bank size, efficiency,
and operating costs per unit of service produced and delivered?

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