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Financial Innovation
Innovation is result of search for profits
Response to Changes in Demand
Major change is huge increase in interest-rate risk starting in 1960s
Example: Adjustable-rate mortgages
Financial Derivatives
Response to Change in Supply
Major change is improvement in computer technology
1. Increases ability to collect information
• Schedule II banks are some domestic banks and the Canadian subsidiaries of foreign banks. As of October 2002, there were 31 Schedule II banks in Canada
Chapter 10
Banking Industry: Structure and Competition
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Historical Development of the Banking Industry
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them to raise funds
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Banks’ Response
Loss of cost advantages in raising funds and income advantages in making loans causes reduction in profitability in traditional banking 1. Expand lending into riskier areas: e.g., real estate 2. Expand into off-balance sheet activities 3. Creates problems for regulatory system Similar problems for banking industry in other countries
2. Lowers transaction costs
Examples:
1. Bank credit and debit cards
2. Electronic banking facilities
3. Junk bonds
4. Commercial paper market
5. Seห้องสมุดไป่ตู้uritization
10-4
Decline in Traditional Banking
Loss of Cost Advantages in Acquiring Funds (Liabilities)
i then disintermediation because
1. Deposit rate ceilings
2. Money market mutual funds
3. Foreign banks have cheaper source of funds: Japanese banks can tap large savings pool
Loss of Income Advantages on Uses of Funds (Assets)
As i , loophole mine to escape reserve requirement tax and deposit-rate ceilings Examples 1. Money market mutual funds 2. Sweep accounts
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• A Schedule III bank is a foreign bank allowed (under certain restrictions) to branch directly into Canada. As of October 2002, there were 21 Schedule III banks in Canada
1. Easier to use securities markets to raise funds: commercial paper, junk bonds, securitization
2. Finance companies more important because easier for
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10-7
Canadian Chartered Banks
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10-3
Avoidance of Existing Regulations
Regulations Behind Financial Innovation 1. Reserve requirements
Tax on deposits = i r 2. Deposit-rate ceilings
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Schedule I, Schedule II, and Schedule III Banks
• The Big Six, together with the Laurentian Bank of Canada, the Canadian Western Bank, and another 8 domestic banks are Canada’s Schedule I banks