In addition to the commercial banking institutions, the following are also part of the United States financial system (Rose, 2008): Representative Offices Representative offices of U.S. commercial banks help to market each U.S. commercial bank service to customers outside the United States. Representative offices are unable to take deposits and book loans. Joint Ventures U.S. commercial banks establish joint ventures with foreign banks and sharing expenses to gain access to the expertise and customer contacts already made by foreign banks. Subsidiaries of U.S. Commercial Banks U.S. commercial banks sometimes find it less expensive to acquire an existing bank outside the United States with an established clientele than to set up their own branch offices. The acquired bank becomes a subsidiary of the U.S. commercial bank, retaining its own charter and capital stock. Branch Banks The majority of U.S. commercial banks are branch bank organizations. Commercial banks follow their customers from rural areas to cities and suburbs nationwide and outside the United States to protect their sources of funds and earnings, particularly from such nonbank financial institutions as credit unions, mutual funds, and pension funds. The passage of the Riegel-Neal Interstate Banking bill by the United States Congress in 1994 allowed nationwide banking. Branch offices of U.S. commercial banks offer all or most of the services outside the United States that U.S. commercial banks offer to their customers. Bank Holding Companies A bank holding company (BHC) is a corporation organized to acquire and hold stock of one or more banks. The company may also hold stock in nonbank business ventures. In the United States, BHCs offer services that banks themselves are unable to offer. In recent years, in an effort to cut costs and raise capital, several large holding companies have sold off some of their nonbank business ventures. These BHCs found they were unable to effectively 1
manage such a highly diverse set of nonbank businesses. In international markets, BHCs have become the predominant bank organization because they offer advantages in raising capital. They can spread out their risk exposure by diversifying banking operations and allowing entry into new business opportunities to gain access to a broader market such as insurance agencies, finance companies, mortgage companies, and consulting firms. Financial Holding Companies The passage of the Gramm-Leach-Bliley Act (GLB) in 1999 has spurred the creation of financial holding companies (FHCs). While the number of FHCs represent less than 10% of all BHCs registered in the United States, the banking affiliates of FHCs account for more than 90% of the total assets of the U.S. banking industry. Provided FHCs hold strong capital positions and possess sound management, they are permitted to bring together under the same corporate umbrella, commercial banks, investment banks, insurance companies, and other affiliated financial companies synergistic with banking. U.S. FHCs mirror the organizational structures and offer services similar to those of leading European banks. Nonbank Financial Institutions Nonbank financial institutions play a vital role in the flow of money and credit within the U.S. financial system, particularly in the home mortgage market and market for personal savings. Nonbank financial institutions include savings and loans, credit unions, savings banks, money market funds, pension funds, insurance companies, finance companies, and mutual funds. Savings and Loans Among the largest of all thrift institutions, savings and loans (S&Ls) accept deposits and extend loans and other services primarily to household customers. S&Ls emphasize longer term loans to individuals and families in contrast to the shorter term lending focus of other types of depository institutions. In the United States, S&Ls provide the majority of mortgage loans to finance the purchase of single-family homes and multifamily dwellings (such as apartments and duplexes). Savings Banks Relatively few in number, customer-owned institutions called savings banks (SBs) focus on mortgage loans and mortgage-related instruments, which 2
account for the majority of the SB industry s assets. Direct mortgage loans to build single-family homes, apartments, shopping centers, and other commercial and residential structures dominate the remainder of mortgage assets devoted to mortgage-backed securities. A distant second in SB assets involves consumer installment credit to finance purchases of furniture and appliances; automobiles; educational and medical services; and other household cash needs, corporate bonds, corporate stock, and government bonds. Deposits with no maturity and time deposits furnish the principal source of funds for SBs. With larger SBs offering extensive branch systems, SBs operate throughout the United States with operations concentrated first in Massachusetts, followed by New York, and then California, Connecticut, Maine, New Hampshire, New Jersey, Pennsylvania, Texas, and Wisconsin. Credit Unions Among the most numerous of thrift institutions, credit unions (CUs) offer deposit and credit services to only their members. CUs are the third largest institutional supplier of nonmortgage installment credit to individuals and families, trailing only commercial banks and finance companies and outstripping installment credit extended by S&Ls and SBs on a ration of more than 2:1. The CU sector accounts for about 10% of all consumer savings and 10% of all consumer installment loans in the United States Because the operating cost of CUs is lowest among all financial service firms, they accept smaller spreads between their loan and deposit interest rates. Frequently, the sponsoring employer or association provides free office facilities, and officers and directors frequently serve with no compensation. Members elect officers and directors, each member having one vote regardless of the size of his or her account. Investment Companies Investment companies provide an outlet for the savings of individual investors, directing their funds into bonds, stocks, and money market securities. Especially attractive to small investors, investment companies offer continuous management services for large and varied security portfolios. By purchasing highly liquid shares offered by investment companies, small savers gain greater diversification, risk sharing, lower transactions costs, opportunities for capital gains, and indirect access to higher yielding securities that can be purchased only in large blocks. Investment companies can repurchase their outstanding shares at current market prices at any time. Close to half of all American households (individual and families, rather than institutional 3
investors) hold the majority of investment company stock. Open-end investment companies, often called mutual funds, buy back (redeem) their shares any time a customer wishes and sell shares in any quantity demanded. Open-end investment companies rely almost entirely on the sale of equity shares to the public to raise the funds they need. Closed-end investment companies sell only a specific number of ownership shares, which usually trade on an exchange. An investor wanting to acquire closed-end shares must find another investor who wishes to sell the investment company itself takes no part in the transaction. Closed-end funds issue a variety of securities to raise funds including preferred stock, regular and convertible bonds, and stock warrants. Life Insurance Companies The majority of the approximately 1,500 U.S. life insurance companies are corporations owned by their stockholders. The rest are mutuals, which issue ownership shares to their policyholders. On average, mutuals are bigger and were established earlier than stockholder-owned life insurance companies. Property and Casualty Insurance Companies Property and casualty insurance companies (P/Cs) offer protection against a broad range of risks including fire, theft, bad weather, negligence, and other acts and events that result in injury to persons or property. Traditional insurance lines include automobile, fire, marine, personal liability, and property coverage. As of the 20th century, stockholder-owned companies dominated the market, holding about three-fourths of the industry s total resources, with the remaining quarter held by policyholder-owned P/Cs. Agency P/Cs sell policies primarily through local agents who earn commissions on their sales from many different insurance companies. Direct writers sell directly to the public (often via the telephone, the Web, or television) or have their own dedicated agents to promote their products. Among the eight leading P/Cs in the world, half are based in the United States. Finance Companies Finance companies grant credit to businesses and consumers for a wide variety of purposes including the purchase of business equipment, automobiles, vacations, and home appliances. Consumer finance companies make personal cash loans to individuals the majority for homes, automobiles, recreational 4
vehicles, home appliances, and mobile homes and issue consumer cards and credit to cover medical and hospital expenses, educational costs, and travel. Because these loans are riskier than loans made by banks and credit unions, they carry steeper finance charges. Sales finance companies make indirect loans to consumers by purchasing installment paper from dealers selling automobiles and other consumer durables. Many of these finance companies are controlled by dealers and manufacturers that principally promote sales of the sponsoring firm s products. Generally, sales finance companies specify in advance to retail dealers the terms of installment contracts they are willing to accept. Frequently, they will give a retail dealer sample contract forms, which the dealer completes when a sale is made. The contract is then sold to the finance company. Commercial finance companies focus principally on extending credit to businesses. Most of these companies provide accounts receivable financing or factoring services to small- or medium-sized manufacturers and wholesalers. In factoring arrangements, the finance company acquires the borrowing firm s credit accounts at an appropriate discount rate to cover the risk of loss. Commercial finance companies also extend loans secured by business inventories and fixed assets, lease financing for the purchase of capital equipment and rolling stock (such as airplanes and railroad cars), and give short-term unsecured cash loans. Investment Banks Investment banks, one of the most important and one of the riskiest institutions in the U.S. financial system, raise funds for and provide financial advice to corporations and government agencies. Marketing large volumes of new stock, bonds, and other financial instruments issued by their corporate and government customers is their principal function to raise new money and act as wholesalers in attracting and distributing capital. In underwriting, investment banks purchase new offerings of financial instruments from original issuers, placing them in the hands of buyers at higher prices that paid issuers. Security underwriting places investment banks at substantial risk because the market value of the securities being underwritten may fall, presenting underwriters with substantial losses on resale. Often, to mitigate these risks, several investment banks band together to form a syndicate to bid for and market new security issues, thereby spreading risk exposure among multiple underwriters. 5
Security Brokers and Dealers Security brokers and dealers provide a conduit for buyers and sellers of stocks, bonds, and other marketable financial instruments to adjust their holdings of these assets. Security dealers stand ready to buy private and government securities from their clients and sell those same instruments to other clients who need to make adjustments in their investment portfolios. By standing ready to buy and sell particular assets, dealers make markets for the assets they trade. Security brokers take no position of risk; rather, they bring buyers and sellers together to facilitate the exchange of assets. Brokers and dealers reduce information costs for buyers and sellers of financial instruments and help increase the liquidity of the instruments they trade. Brokerage commissions and dealer fees compensate these financial firms for the services they provide. Venture Capital Firms Venture capital firms gather funds from private investors and other sources and then look for promising new businesses and rapidly emerging companies in which to invest. Many large banks and insurance companies have set up affiliated venture capital companies to make these risky investments and hold the high-risk stocks and bonds of new and rapidly growing businesses. Mortgage Banks Mortgage banks commit to taking on new mortgage loans used to fund the construction of homes, office buildings, and other structures. They carry these loans for a short time until the mortgages can be sold to a long-term (permanent) lender such as an insurance company. Mortgage banks are exposed to substantial financial risks. For example, increases in interest rates can sharply reduce the market values of existing fixed-rate mortgage loans, presenting mortgage banks with losses when they sell loans out of their portfolios. Financial risks encourage mortgage banks to turn over their portfolios rapidly and arrange lines of credit from lending institutions to backstop their operations. These firms also service mortgage loans they sell to other lenders, collecting loan payment and inspecting mortgaged property. Government-Sponsored Enterprises Government-sponsored enterprises (GSEs) are responsible for more than three-quarters of the residential mortgage loans in the United States. Leading GSEs include the Federal National Mortgage Association (FNMA), the Federal 6
Home Loan Mortgage Corporation (FHLMC), and the Federal Home Loan Banks (FHLBs). Leasing Companies Leasing companies provide customers with access to productive assets such as airplanes, automobiles, and equipment through the writing of leases. These leases allow businesses and households to rent assets, often at a lower cost than borrowing money and owing those same assets. Leasing companies benefit from the stream of lease payments and gain substantial tax benefits from depreciating the leased assets. Reference Rose, P. S. (2008). Money and capital markets: Financial institutions and instruments in a global marketplace (10th ed.). New York: McGraw- Hill/Irwin. 7