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Financial Holding Companies: A Global Perspective

S. Ghon Rhee, K. J. Luke Distinguished Professor S. Ghon Rhee, K. J. Luke Distinguished Professor of International Finance and Bankingof International Finance and Banking

University of Hawai’iUniversity of Hawai’i

The 7The 7thth International Financial Forum International Financial Forum April 26-27, 2006, Seoul, KoreaApril 26-27, 2006, Seoul, Korea

Asia-Pacific Financial Markets Research Center, University of Hawaii

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A Historical Overview of Financial Services Industry: Continental Europe

1.1. Universal Banking PrincipleUniversal Banking Principle

a.a. Banks conduct a full range of securities businessBanks conduct a full range of securities businessb.b. Cross shareholding and strategic alliance between Cross shareholding and strategic alliance between banks banks and insurers are common practiceand insurers are common practice

2.2. Bank-based rather than capital market-based Bank-based rather than capital market-based financial systemfinancial system

3.3. High level of government involvement in financial High level of government involvement in financial services industryservices industry

4.4. Limited role of institutional investorsLimited role of institutional investors

Asia-Pacific Financial Markets Research Center, University of Hawaii

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A Historical Overview of Financial Services Industry: United States

1.1. Segmentation among banking, insurance, and securities Segmentation among banking, insurance, and securities businesses:businesses:

Glass-Steagall Act of 1932 Glass-Steagall Act of 1932 Bank Holding Company Act of 1956Bank Holding Company Act of 1956

2.2. The Gramm-Leach-Bliley (GLB) Act of 1999 The Gramm-Leach-Bliley (GLB) Act of 1999

RRepealed Glass-Steagall Act and some provisions of Bank Holding epealed Glass-Steagall Act and some provisions of Bank Holding Company ActCompany Act

Allowed financial holding company (FHC) structureAllowed financial holding company (FHC) structure

A two-way street permitting banks, securities A two-way street permitting banks, securities firms, and insurers to affiliate with each other firms, and insurers to affiliate with each other

Asia-Pacific Financial Markets Research Center, University of Hawaii

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A Historical Overview of Financial Services Industry: United Kingdom UK financial sectorUK financial sector: : In 1980s, dominated by In 1980s, dominated by

a.a. small number of large banks small number of large banks b.b. large number of building societies, insurers, large number of building societies, insurers, credit credit

unions and friendly societies in 1980unions and friendly societies in 1980 Segmentation among banks, insurers, and securities firmsSegmentation among banks, insurers, and securities firms Gradual regulatory reforms in 1980s and 1990s removed Gradual regulatory reforms in 1980s and 1990s removed

segmentationsegmentationUniversal banking structureUniversal banking structure

1986 Big Bang1986 Big Bang: : Globalization of local, provincial financial sectorGlobalization of local, provincial financial sector

Asia-Pacific Financial Markets Research Center, University of Hawaii

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A Historical Overview of Financial Services Industry: Japan Segmented financial services industrySegmented financial services industry Industry consolidation: Industry consolidation:

Largely driven by bank balance sheet Largely driven by bank balance sheet deterioration rather than economies of scaledeterioration rather than economies of scale

Financial conglomerates: Financial conglomerates: a.a. Under study by the Financial System Under study by the Financial System Council in Council in Financial Services Agency Financial Services Agencyb. No tangible reforms yetb. No tangible reforms yet

Asia-Pacific Financial Markets Research Center, University of Hawaii

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A Historical Overview of Financial Services Industry: Australia Segmented financial services industry by Segmented financial services industry by

historical development rather than regulation until historical development rather than regulation until 1980s1980s

Four Pillars Policy: Four Pillars Policy: Government policy ruled out mergers among four Government policy ruled out mergers among four

major major banks (banks (Commonwealth Bank, ANZ, Westpac and Commonwealth Bank, ANZ, Westpac and National National Australia BankAustralia Bank))

Financial deregulation and the opening of the Financial deregulation and the opening of the banking industry to foreign competition in 1992 banking industry to foreign competition in 1992 expanded the financial sectorexpanded the financial sector

Financial Services Reform Act of 2002: Financial Services Reform Act of 2002: the Australian version of the US GLB Act of 1999.the Australian version of the US GLB Act of 1999.

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Changing Financial Sector Landscape in the 1990s: Financial Consolidation

Increasing M&A activities among Increasing M&A activities among financial institutions in the 1990s financial institutions in the 1990s

Increasing Joint ventures and Increasing Joint ventures and strategic alliances among strategic alliances among financial institutionsfinancial institutions

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Total Value of M&A Activities in G10 + Spain & Australia in 1990s

Asia-Pacific Financial Markets Research Center, University of Hawaii

$38 $38 $38$65 $53

$152

$97

$293

$495

$353

$0

$100

$200

$300

$400

$500

$600

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

US$ BillionUS$ Billion

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Total Value of M&As by Industry (1990-1999)

Securities Firms

$182 billion11%

Insurers$275 billion

17%

Banks$1,166 billion

72%Total: US$1,623 billionTotal: US$1,623 billion

100%100%

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Total Value of M&As by Region (1990-1999)

North American

$977 billion60%

Pacific Rim$142 billion

9%

European$504 billion

31% Total: US$1,623 billionTotal: US$1,623 billion100%100%

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Total Value of M&As Intra- and Inter-Industry (1990-1999)

Intra-Industry $1,370 billion

84%

Inter-Industry

$253 billion16%

Total: US$1,623 billionTotal: US$1,623 billion100%100%

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Total Value of M&As in Banking Industry (1990-1999)

Asia-Pacific Financial Markets Research Center, University of Hawaii

0

50

100

150

200

250

300

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Within border/within industry Within border/cross industry

Crossborder/within industry Crossborder/cross industry

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Total Value of M&As in Securities Industry (1990-1999)

Asia-Pacific Financial Markets Research Center, University of Hawaii

0

5

10

15

20

25

30

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Within border/within industry Within border/cross industry

Crossborder/within industry Crossborder/cross industry

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Total Value of M&As in Insurance Industry (1990-1999)

Asia-Pacific Financial Markets Research Center, University of Hawaii

0

10

20

30

40

50

60

70

80

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Within border/within industry Within border/cross industry

Crossborder/within industry Crossborder/cross industry

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Total Value of M&As by Industry (1990-1999): United States

Asia-Pacific Financial Markets Research Center, University of Hawaii

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Banking insurance Securities/others US$ BillionUS$ Billion

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Total Value of M&As by Industry (1990-1999): United Kingdom

Asia-Pacific Financial Markets Research Center, University of Hawaii

$0

$20

$40

$60

$80

$100

$120

$140

$160

Banking insurance Securities/others

US BillionUS Billion

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Total Value of M&As by Industry (1990-1999): Japan

Asia-Pacific Financial Markets Research Center, University of Hawaii

0

10

20

30

40

50

60

70

80

90

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Banking insurance Securities/others

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Total Value of M&As by Industry (1990-1999): Germany

Asia-Pacific Financial Markets Research Center, University of Hawaii

0

2

4

6

8

10

12

14

16

18

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Banking insurance Securities/others

US$ billionUS$ billion

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Underlying Causes of Global Financial Consolidation Cost Savings and Revenue EnhancementsCost Savings and Revenue Enhancements Financial Deregulation and Financial Deregulation and GlobalizationGlobalization

Banks are no longer lenders and deposit-takersBanks are no longer lenders and deposit-takers Technological and financial innovationTechnological and financial innovation

Changing Consumer Demand Changing Consumer Demand New products: mutual funds, annuities, pension productsNew products: mutual funds, annuities, pension products

Corporate and institutional demandCorporate and institutional demand increasing demand for customized OTC derivativesincreasing demand for customized OTC derivatives

Shareholder Pressure on Financial Shareholder Pressure on Financial PerformancePerformance

Asia-Pacific Financial Markets Research Center, University of Hawaii

Sources: G-10 Report (2001) and Olson (2003)Sources: G-10 Report (2001) and Olson (2003)

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U.S. Financial Holding Companies (FHCs) (I) GLB Act allows FHCs to engage in:GLB Act allows FHCs to engage in: securities underwriting and dealingsecurities underwriting and dealing insurance underwriting insurance underwriting insurance agency activitiesinsurance agency activities merchant bankingmerchant banking

Bank Holding Companies (BHCs) may elect to become FHCsBank Holding Companies (BHCs) may elect to become FHCs

Asia-Pacific Financial Markets Research Center, University of Hawaii

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U.S. Financial Holding Companies (FHCs) (II)

Asia-Pacific Financial Markets Research Center, University of Hawaii

Source: Federal Reserve System and US Department of Treasury Source: Federal Reserve System and US Department of Treasury

Number Assets ($Bn)

Domestic BHCs 5,093 $7,673

Foreign BHCs 191 2,942

Total 5,284 10,615

Domestic FHCs 600 6,083

Foreign FHCs 30 2,240

Total 630 8,323

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The Impact of FHCs on Market Concentration (I)

Asia-Pacific Financial Markets Research Center, University of Hawaii

A. A. Market Share of Largest Market Share of Largest Domestic Domestic FHCs in FHCs in Securities Underwriting and Dealing Securities Underwriting and Dealing

Source: Federal Reserve System and US Department of Treasury Source: Federal Reserve System and US Department of Treasury

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The Impact of FHCs on Market Concentration (II)

Asia-Pacific Financial Markets Research Center, University of Hawaii

B. B. Market Share of Largest Market Share of Largest ForeignForeign FHCs in FHCs in Securities Underwriting and Dealing Securities Underwriting and Dealing

Source: Federal Reserve System and US Department of Treasury Source: Federal Reserve System and US Department of Treasury

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The Impact of FHCs on Market Concentration (III)

Asia-Pacific Financial Markets Research Center, University of Hawaii

C. C. Concentration Indexes for Property-Concentration Indexes for Property-Casualty InsuranceCasualty Insurance

Source: Federal Reserve System and US Department of Treasury Source: Federal Reserve System and US Department of Treasury

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The Impact of FHCs on Market Concentration (IV)

Asia-Pacific Financial Markets Research Center, University of Hawaii

D. D. Concentration Indexes for Life and Health Concentration Indexes for Life and Health InsuranceInsurance

Source: Federal Reserve System and US Department of Treasury Source: Federal Reserve System and US Department of Treasury

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Some Thoughts on Implications for Korea

Asia-Pacific Financial Markets Research Center, University of Hawaii

1.1. Supervisory and Regulatory StructureSupervisory and Regulatory Structure

Korea’s centralized regulatory structure is a big Korea’s centralized regulatory structure is a big

advantageadvantage

2.2. Risks Posed by Commercial Activities of Risks Posed by Commercial Activities of FHCsFHCs

a. a. Korea faces a high risk due to chaebols’ direct Korea faces a high risk due to chaebols’ direct ownership over insurers and securities ownership over insurers and securities

companiescompanies

b. The GLB Act maintains separation of financial and b. The GLB Act maintains separation of financial and commercial activitiescommercial activities

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Mahalo for You Attention!