MFI Textbook.pdf

Bank Management & Financial Services The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate Stephen A. Ross Franco Modigliani Professor of Finance and Economics Sloan School of Management Massachusetts Institute of Technology Consulting Editor FINANCIAL MANAGEMENT Ross, Westerfield,...

Bank Management & Financial Services The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate Stephen A. Ross Franco Modigliani Professor of Finance and Economics Sloan School of Management Massachusetts Institute of Technology Consulting Editor FINANCIAL MANAGEMENT Ross, Westerfield, and Jaffe Corporate Finance Ninth Edition Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Second Edition Adair Excel Applications for Corporate Finance First Edition Ross, Westerfield, and Jordan Essentials of Corporate Finance Sixth Edition Block, Hirt, and Danielsen Foundations of Financial Management Thirteenth Edition Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Ninth Edition Brealey, Myers, and Allen Principles of Corporate Finance Ninth Edition Brealey, Myers, and Allen Principles of Corporate Finance, Concise First Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Sixth Edition Brooks FinGame Online 5.0 Bruner Case Studies in Finance: Managing for Corporate Value Creation Sixth Edition Chew The New Corporate Finance: Where Theory Meets Practice Third Edition Cornett, Adair, and Nofsinger Finance: Applications and Theory First Edition DeMello Cases in Finance Second Edition Grinblatt (editor) Stephen A. Ross, Mentor: Influence through Generations Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition Higgins Analysis for Financial Management Ninth Edition Kellison Theory of Interest Third Edition Kester, Ruback, and Tufano Case Problems in Finance Twelfth Edition Shefrin Behavioral Corporate Finance: Decisions That Create Value First Edition White Financial Analysis with an Electronic Calculator Sixth Edition INVESTMENTS Bodie, Kane, and Marcus Essentials of Investments Eighth Edition Bodie, Kane, and Marcus Investments Eighth Edition Hirt and Block Fundamentals of Investment Management Ninth Edition Hirschey and Nofsinger Investments: Analysis and Behavior Second Edition Saunders and Cornett Financial Markets and Institutions Fourth Edition INTERNATIONAL FINANCE Eun and Resnick International Financial Management Fifth Edition Kuemmerle Case Studies in International Entrepreneurship: Managing and Financing Ventures in the Global Economy First Edition REAL ESTATE Brueggeman and Fisher Real Estate Finance and Investments Thirteenth Edition Ling and Archer Real Estate Principles: A Value Approach Third Edition FINANCIAL PLANNING AND INSURANCE Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches Tenth Edition Altfest Personal Financial Planning First Edition Harrington and Niehaus Risk Management and Insurance Second Edition Jordan and Miller Fundamentals of Investments: Valuation and Management Fifth Edition Kapoor, Dlabay, and Hughes Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills Third Edition FINANCIAL INSTITUTIONS AND MARKETS Kapoor, Dlabay, and Hughes Personal Finance Ninth Edition Rose and Hudgins Bank Management and Financial Services Eighth Edition Rose and Marquis Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace Tenth Edition Saunders and Cornett Financial Institutions Management: A Risk Management Approach Seventh Edition Bank Management & Financial Services Eighth Edition Peter S. Rose Texas A & M University Sylvia C. Hudgins Old Dominion University Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto BANK MANAGEMENT & FINANCIAL SERVICES Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2010, 2008, 2005, 2002, 1999, 1996, 1993, 1991 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 QPD/QPD 0 9 ISBN: 978-0-07-338243-2 MHID: 0-07-338243-4 Vice president and editor-in-chief: Brent Gordon Publisher: Douglas Reiner Executive editor: Michele Janicek Editorial assistant: Meg Maloney Marketing manager: Ashley Smith Senior project manager: Harvey Yep Full service project manager: Michelle Gardner, Pine Tree Composition, Inc. Lead production supervisor: Michael R. McCormick Designer: Matt Diamond Media project manager: Balaji Sundararaman, Hurix Systems Pvt. Ltd. Cover design: Matt Diamond Cover image: © Corbis Interior design: Matt Diamond Typeface: 10/12 Goudy Compositor: Laserwords Private Limited Printer: Quebecor World Dubuque Inc. Library of Congress Cataloging-in-Publication Data Rose, Peter S. Bank management & financial services / Peter S. Rose, Sylvia C. Hudgins.—8th ed. p. cm.—(The McGraw-Hill/Irwin series in finance, insurance and real estate) Includes index. ISBN-13: 978-0-07-338243-2 (alk. paper) ISBN-10: 0-07-338243-4 (alk. paper) 1. Financial institutions—United States. 2. Bank management—United States. 3. Financial services industry—United States. 4. Banks and banking, International. I. Hudgins, Sylvia Conway, 1956- II. Title. HG181.R65 2010 332.1068—dc22 2009000140 www.mhhe.com To my family. —Peter S. Rose To my friend and co-author, Lawrence G. Goldberg (1944–2005). —Sylvia C. Hudgins About the Authors Peter S. Rose Peter S. Rose is Professor Emeritus in Finance from Texas A&M University where he taught and conducted research for approximately 30 years and held the Blocker Chair of Business Administration until his recent retirement. Before his career at A&M he served as a financial economist with the Federal Reserve System. Rose has served as author and consultant to a variety of financial institutions. He has published more than 200 articles in journals and proceedings in the United States, Canada, Great Britain, France, Brazil, India, Mexico, and other nations. He has been an author, coauthor, or editor for numerous books, including Bank Management and Financial Services (McGraw-Hill/Irwin), coauthored with Sylvia C. Hudgins and now entering its eighth edition; Money and Capital Markets (McGraw-Hill/Irwin), coauthored with Milton H. Marquis and now in its tenth edition; Financial Institutions, a coauthored text published by Richard D. Irwin, which passed through five editions; Banking across State Lines (published by Quorum Books); The Changing Structure of American Banking (published by Columbia University Press); and Japanese Banking and Investment in the United States (also from Quorum Books). Several of these books have been translated into Chinese, Russian, Polish, and other languages and are used in classrooms around the globe. Rose’s principal outside interests include classical music and training golden retrievers. Sylvia C. Hudgins Sylvia C. Hudgins is a Professor of Finance at Old Dominion University in Norfolk, Virginia, where she teaches classes in banking, financial institutions, and corporate finance. She serves as the director of the Ph.D. Program in the College of Business and Public Administration. Her own doctorate is from Virginia Tech. Yes, she is Virginian-born and raised in the Commonwealth. Much of her research focuses on the empirical analysis of commercial banks and thrifts. She examines questions concerning management, regulation, and legislation of financial institutions. The journals publishing her research include Journal of Money, Credit, and Banking; Financial Management; Journal of Financial Economics; and Economic Inquiry. Professionally she has served as director of both the Eastern Finance Association and the Southern Finance Association and as a member on the Board of Editors for the Financial Management Association’s Survey and Synthesis Series. In the community, she is treasurer and a member of the Board of Directors of the Old Dominion University Credit Union, where she sees the “real-world” side of the management of financial institutions. vi Brief Contents Preface xviii 9 PART ONE Introduction to Banking and Financial Services 1 Risk Management: Asset-Backed Securities, Loan Sales, Credit Standbys, and Credit Derivatives 285 PART FOUR 1 An Overview of the Changing Financial-Services Sector 1 Managing Investment Portfolios and Liquidity Positions for Financial Firms 313 2 The Impact of Government Policy and Regulation on the Financial-Services Industry 29 10 The Investment Function in FinancialServices Management 313 11 Liquidity and Reserves Management: Strategies and Policies 351 3 4 The Organization and Structure of Banking and the Financial-Services Industry 65 Establishing New Banks, Branches, ATMs, Telephone Services, and Web Sites 99 PART FIVE Managing Sources of Funds for a Financial Firm 389 12 Managing and Pricing Deposit Services 389 PART TWO 13 Managing Nondeposit Liabilities Financial Statements and Financial-Firm Performance 129 14 Investment Banking, Insurance, and Other Sources of Fee Income 451 The Management of Capital 5 The Financial Statements of Banks and Their Principal Competitors 129 15 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 167 PART SIX PART THREE Tools for Managing and Hedging Against Risk 209 7 Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques 209 8 Risk Management: Financial Futures, Options, Swaps, and Other Hedging Tools 247 419 479 Providing Loans to Businesses and Consumers 515 16 Lending Policies and Procedures: Managing Credit Risk 515 17 Lending to Business Firms and Pricing Business Loans 547 18 Consumer Loans, Credit Cards, and Real Estate Lending 589 vii viii Brief Contents PART SEVEN Managing the Future in a Global Marketplace 629 19 Acquisitions and Mergers in FinancialServices Management 629 20 International Banking and the Future of Banking and Financial Services 659 Dictionary of Banking and Financial-Service Terms 693 Index 711 Contents Preface xviii PART ONE INTRODUCTION TO BANKING AND FINANCIAL SERVICES 1 Chapter 1 An Overview of the Changing FinancialServices Sector 1 Key Topics in This Chapter 1 1–1 Introduction 1 1–2 What Is a Bank? 2 1–3 The Financial System and Competing FinancialService Institutions 5 Roles of the Financial System 5 The Competitive Challenge for Banks Leading Competitors with Banks 6 5 1–4 Services Banks and Many of Their Closest Competitors Offer the Public 8 Services Banks Have Offered for Centuries 8 Services Banks and Many of Their Financial-Service Competitors Began Offering in the Past Century 11 Convenience: The Sum Total of All Banking and Financial Services 15 1–5 Key Trends Affecting All Financial-Service Firms 16 1–6 The Plan of This Book 18 Summary 20 Key Terms 21 Problems and Projects 21 Internet Exercises 22 S&P Market Insight Challenge 23 Real Numbers for Real Banks: The Very First Case Assignment 24 Selected References 25 Appendix: Career Opportunities in Financial Services 25 Chapter 2 The Impact of Government Policy and Regulation on the Financial-Services Industry 29 Key Topics in This Chapter 29 2–1 Introduction 29 2–2 Banking Regulation 30 Pros and Cons of Strict Rules 30 The Impact of Regulation—The Arguments for Strict Rules versus Lenient Rules 33 2–3 Major Banking Laws—Where and When the Rules Originated 33 Meet the “Parents”: The Legislation That Created Today’s Bank Regulators 33 Instilling Social Graces and Morals—Social Responsibility Laws 37 Legislation Aimed at Allowing Interstate Banking: Where Can the “Kids” Play? 39 The Gramm-Leach-Bliley Act (1999): What Are Acceptable Activities for Playtime? 40 The USA Patriot and Bank Secrecy Acts: Fighting Terrorism and Money Laundering 41 Telling the Truth and Not Stretching It—The SarbanesOxley Accounting Standards Act (2002) 42 2–4 The 21st Century Ushers In an Array of New Laws, Regulations, and Regulatory Strategies 43 2–5 The Regulation of Nonbank Financial-Service Firms Competing with Banks 49 Regulating the Thrift (Savings) Industry 49 Regulating Other Nonbank Financial Firms 50 Are Regulations Really Necessary in the Financial-Services Sector? 51 2–6 The Central Banking System: Its Impact on the Decisions and Policies of Financial Institutions 52 Organizational Structure of the Federal Reserve System 52 The Central Bank’s Principal Task: Making and Implementing Monetary Policy 54 ix x Contents Summary 58 Key Terms 59 Problems and Projects 59 Internet Exercises 60 S&P Market Insight Challenge 60 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 2 61 Selected References 62 Summary 92 Key Terms 93 Problems and Projects 93 Internet Exercises 94 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 3 95 S&P Market Insight Challenge 96 Selected References 96 Chapter 3 The Organization and Structure of Banking and the Financial-Services Industry 65 Chapter 4 Establishing New Banks, Branches, ATMs, Telephone Services, and Web Sites 99 Key Topics in This Chapter 65 3–1 Introduction 65 3–2 The Organization and Structure of the Commercial Banking Industry 66 Key Topics in This Chapter 99 4–1 Introduction 99 4–2 Chartering a New (De Novo) Financial-Service Institution 100 4–3 The Bank Chartering Process in the United States 101 4–4 Questions Regulators Usually Ask the Organizers of a New (De Novo) Bank 102 4–5 Factors Weighing on the Decision to Seek a New Charter 103 4–6 Volume and Characteristics of New Charters 104 4–7 How Well Do New Charters Perform? 104 4–8 Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches 106 Advancing Size and Concentration of Assets 66 Is a Countertrend Now under Way? 66 3–3 Internal Organization of the Banking Firm 68 Community Banks and Other Community-Oriented Financial Firms 68 Larger Banks—Money Center, Wholesale and Retail Trends in Organization 70 69 3–4 The Array of Organizational Structures and Types in the Banking Industry 71 Unit Banking Organizations 72 Branching Organizations 73 Electronic Branching—Web Sites and Electronic Networks: An Alternative or a Supplement to Traditional Bank Branch Offices? 76 Holding Company Organizations 77 3–5 Interstate Banking Organizations and the RiegleNeal Interstate Banking and Branching Efficiency Act of 1994 81 Research on Interstate Banking 82 3–6 An Alternative Type of Banking Organization Available as the 21st Century Opened: Financial Holding Companies (FHCs) 83 3–7 Mergers and Acquisitions Reshaping the Structure and Organization of the Financial-Services Sector 85 3–8 The Changing Organization and Structure of Banking’s Principal Competitors 85 3–9 Efficiency and Size: Do Bigger Financial Firms Operate at Lower Cost? 87 Efficiency in Producing Financial Services 87 3–10 Financial Firm Goals: Their Impact on Operating Cost, Efficiency, and Performance 89 Desirable Sites for New Branches 108 Branch Regulation 111 The Changing Role of Financial-Service Branch Offices 111 In-Store Branching 112 4–9 Establishing and Monitoring Automated Limited-Service Facilities 113 Point-of-Sale Terminals 113 Automated Teller Machines (ATMs) 4–10 Home and Office Banking 114 117 Telephone Banking and Call Centers 117 Internet Banking 118 4–11 Financial-Service Facilities of the Future 120 Summary 123 Key Terms 123 Problems and Projects 124 Internet Exercises 125 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 4 126 S&P Market Insight Challenge 126 Selected References 127 Contents PART TWO FINANCIAL STATEMENTS AND FINANCIAL-FIRM PERFORMANCE 129 Chapter 5 The Financial Statements of Banks and Their Principal Competitors 129 Key Topics in This Chapter 129 5–1 Introduction 129 5–2 An Overview of Balance Sheets and Income Statements 130 5–3 The Balance Sheet (Report of Condition) 131 The Principal Types of Accounts 131 Recent Expansion of Off-Balance-Sheet Items in Banking 140 The Problem of Book-Value Accounting 142 Auditing: Assuring Reliability of Financial Statements 144 5–4 Components of the Income Statement (Report of Income) 145 Financial Flows and Stocks 146 Comparative Income Statement Ratios for Different-Size Financial Firms 151 5–5 The Financial Statements of Leading Nonbank Financial Firms: A Comparison to Bank Statements 151 5–6 An Overview of Key Features of Financial Statements and Their Consequences 153 Summary 154 Key Terms 155 Problems and Projects 155 Internet Exercises 160 S&P Market Insight Challenge 161 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 5 162 Selected References 164 Appendix: Sources of Information on the FinancialServices Industry 164 Chapter 6 Measuring and Evaluating the Performance of Banks and Their Principal Competitors 167 Key Topics in This Chapter 167 6–1 Introduction 167 6–2 Evaluating Performance 168 Determining Long-Range Objectives 168 Maximizing the Value of the Firm: A Key Objective for Nearly All Financial-Service Institutions 169 xi Profitability Ratios: A Surrogate for Stock Values 171 Useful Profitability Formulas for Banks and Other Financial-Service Companies 173 Return on Equity and Its Principal Components 174 The Return on Assets and Its Principal Components 178 What a Breakdown of Profitability Measures Can Tell Us 180 Measuring Risk in Banking and Financial Services 181 Other Goals in Banking and Financial-Services Management 188 6–3 Performance Indicators among Banking’s Key Competitors 189 6–4 The Impact of Size on Performance 189 Size, Location, and Regulatory Bias in Analyzing the Performance of Banks and Competing Financial Institutions 191 Summary 192 Key Terms 193 Problems and Projects 193 Internet Exercises 197 S&P Market Insight Challenge 198 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 6 198 Selected References 200 Appendix: Using Financial Ratios and Other Analytical Tools to Track Financial-Firm Performance—The UBPR and BHCPR 201 PART THREE TOOLS FOR MANAGING AND HEDGING AGAINST RISK 209 Chapter 7 Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques 209 Key Topics in This Chapter 209 7–1 Introduction 209 7–2 Asset-Liability Management Strategies Asset Management Strategy 210 Liability Management Strategy 210 Funds Management Strategy 211 7–3 Interest Rate Risk: One of the Greatest Management Challenges 211 Forces Determining Interest Rates 212 The Measurement of Interest Rates 213 The Components of Interest Rates 214 Responses to Interest Rate Risk 217 210 xii Contents 7–4 One of the Goals of Interest Rate Hedging: Protect the Net Interest Margin 218 Interest-Sensitive Gap Management as a RiskManagement Tool 219 Problems with Interest-Sensitive GAP Management Real Numbers for Real Banks: Continuing Case Assignment for Chapter 8 282 S&P Market Insight Challenge 283 Selected References 283 226 7–5 The Concept of Duration as a RiskManagement Tool 228 What Is Duration? 229 Price Sensitivity to Changes in Interest Rates and Duration 230 Convexity and Duration 231 7–6 Using Duration to Hedge against Interest Rate Risk 231 7–7 The Limitations of Duration Gap Management 238 Summary 239 Key Terms 240 Problems and Projects 240 Internet Exercises 243 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 7 244 S&P Market Insight Challenge 245 Selected References 246 Chapter 8 Risk Management: Financial Futures, Options, Swaps, and Other Hedging Tools 247 Key Topics in This Chapter 247 8–1 Introduction 247 8–2 Uses of Derivative Contracts 248 8–3 Financial Futures Contracts: Promises of Future Security Trades at a Set Price 250 The Short Hedge in Futures 255 The Long Hedge in Futures 255 8–4 Interest-Rate Options 262 8–5 Regulations and Accounting Rules for Bank Futures and Options Trading 268 8–6 Interest-Rate Swaps 269 8–7 Caps, Floors, and Collars 275 Interest-Rate Caps 275 Interest-Rate Floors 276 Interest-Rate Collars 276 Summary 277 Key Terms 278 Problems and Projects 278 Internet Exercises 281 Chapter 9 Risk Management: Asset-Backed Securities, Loan Sales, Credit Standbys, and Credit Derivatives 285 Key Topics in This Chapter 285 9–1 Introduction 285 9–2 Securitizing Loans and Other Assets 286 The Beginnings of Securitization—The Home Mortgage Market 289 Examples of Other Assets That Have Been Securitized 291 The Impact of Securitization upon Lending Institutions 293 Regulators’ Concerns about Securitization 294 9–3 Sales of Loans to Raise Funds and Reduce Risk 295 Reasons behind Loan Sales 296 The Risks in Loan Sales 297 9–4 Standby Credit Letters to Reduce the Risk of Nonpayment or Nonperformance 297 The Structure of SLCs 298 The Value and Pricing of Standby Letters 298 Sources of Risk with Standbys 299 Regulatory Concerns about SLCs 300 Research Studies on Standbys, Loan Sales, and Securitizations 300 9–5 Credit Derivatives: Contracts for Reducing Credit Risk Exposure on the Balance Sheet 301 Credit Swaps 301 Credit Options 302 Credit Default Swaps (CDSs) 303 Credit-Linked Notes 305 Collateralized Debt Obligations (CDOs) 305 Risks Associated with Credit Derivatives 306 Summary 307 Key Terms 307 Problems and Projects 307 Internet Exercises 309 S&P Market Insight Challenge 310 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 9 310 Selected References 311 Contents PART FOUR MANAGING INVESTMENT PORTFOLIOS AND LIQUIDITY POSITIONS FOR FINANCIAL FIRMS 313 Chapter 10 The Investment Function in FinancialServices Management 313 Key Topics in This Chapter 313 10–1 Introduction 313 10–2 Investment Instruments Available to Financial Firms 314 10–3 Popular Money Market Investment Instruments 315 Treasury Bills 315 Short-Term Treasury Notes and Bonds 317 Federal Agency Securities 317 Certificates of Deposit 317 International Eurocurrency Deposits 317 Bankers’ Acceptances 318 Commercial Paper 318 Short-Term Municipal Obligations 318 10–4 Popular Capital Market Investment Instruments 319 Treasury Notes and Bonds 319 Municipal Notes and Bonds 319 Corporate Notes and Bonds 319 10–5 Investment Instruments Developed More Recently 320 Structured Notes 320 Securitized Assets 320 10–6 Investment Securities Held by Banks 322 10–7 Factors Affecting Choice of Investment Securities 324 Expected Rate of Return 324 Tax Exposure 325 Interest Rate Risk 329 Credit or Default Risk 330 Business Risk 331 Liquidity Risk 332 Call Risk 332 Prepayment Risk 332 Inflation Risk 334 Pledging Requirements 334 xiii 10–8 Investment Maturity Strategies 335 10–9 Maturity Management Tools 338 The Yield Curve Duration 340 338 Summary 342 Key Terms 343 Problems and Projects 343 Internet Exercises 345 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 10 346 S&P Market Insight Challenge 346 Selected References 349 Chapter 11 Liquidity and Reserves Management: Strategies and Policies 351 Key Topics in This Chapter 351 11–1 Introduction 351 11–2 The Demand for and Supply of Liquidity 352 11–3 Why Financial Firms Often Face Significant Liquidity Problems 354 11–4 Strategies for Liquidity Managers 355 Asset Liquidity Management (or Asset Conversion) Strategies 355 Borrowed Liquidity (Liability) Management Strategies 356 Balanced Liquidity Management Strategies 357 Guidelines for Liquidity Managers 358 11–5 Estimating Liquidity Needs 358 The Sources and Uses of Funds Approach 359 The Structure of Funds Approach 362 Liquidity Indicator Approach 366 The Ultimate Standard for Assessing Liquidity Needs: Signals from the Marketplace 368 11–6 Legal Reserves and Money Position Management 370 Regulations on Calculating Legal Reserve Requirements 370 Factors Influencing the Money Position 374 11–7 Factors in Choosing among the Different Sources of Reserves 378 11–8 Central Bank Reserve Requirements around the Globe 380 Summary 380 Key Terms 381 Problems and Projects 381 Internet Exercises 385 xiv Contents Real Numbers for Real Banks: Continuing Case Assignment for Chapter 11 386 S&P Market Insight Challenge 387 Selected References 387 PART FIVE MANAGING SOURCES OF FUNDS FOR A FINANCIAL FIRM 389 Chapter 12 Managing and Pricing Deposit Services 389 Key Topics in This Chapter 389 12–1 Introduction 389 12–2 Types of Deposits Offered by Banks and Other Depository Institutions 390 Transaction (Payments or Demand) Deposits 390 Nontransaction (Savings or Thrift) Deposits 391 Retirement Savings Deposits 392 12–3 Interest Rates Offered on Different Types of Deposits 393 The Composition of Deposits 393 The Ownership of Deposits 394 The Cost of Different Deposit Accounts 396 12–4 Pricing Deposit-Related Services 398 12–5 Pricing Deposits at Cost Plus Profit Margin 398 12–6 Using Marginal Cost to Set Interest Rates on Deposits 400 Conditional Pricing 402 12–7 Pricing Based on the Total Customer Relationship and Choosing a Depository 406 The Role That Pricing and Other Factors Play When Customers Choose a Depository Institution to Hold Their Accounts 406 12–8 Basic (Lifeline) Banking: Key Services for Low-Income Customers 408 Summary 410 Key Terms 411 Problems and Projects 411 Internet Exercises 413 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 12 414 S&P Market Insight Challenge 417 Selected References 417 Chapter 13 Managing Nondeposit Liabilities 419 Key Topics in This Chapter 419 13–1 Introduction 419 13–2 Liability Management and the Customer Relationship Doctrine 419 13–3 Alternative Nondeposit Sources of Funds 422 Federal Funds Market (“Fed Funds”) 422 Repurchase Agreements as a Source of Funds 425 Borrowing from Federal Reserve Banks 428 Advances from Federal Home Loan Banks 429 Development and Sale of Large Negotiable CDs 430 The Eurocurrency Deposit Market 432 Commercial Paper Market 433 Long-Term Nondeposit Funds Sources 434 13–4 Choosing among Alternative Nondeposit Sources 435 Measuring a Financial Firm’s Total Need for Nondeposit Funds: The Available Funds Gap 435 Nondeposit Funding Sources: Factors to Consider 436 Summary 443 Key Terms 444 Problems and Projects 444 Internet Exercises 446 S&P Market Insight Challenge 447 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 13 448 Selected References 449 Chapter 14 Investment Banking, Insurance, and Other Sources of Fee Income 451 Key Topics in This Chapter 451 14–1 Introduction 451 14–2 Sales of Investment Banking Services 452 Key Investment Banking Services 453 Linkages between Commercial and Investment Banking 455 Possible Advantages and Disadvantages of Linking Commercial and Investment Banking 456 Key Issues for Investment Banks of the Future 456 14–3 Selling Investment Products to Consumers 458 Mutual Fund Investment Products 458 Annuity Investment Products 460 The Track Record for Sales of Investment Products 460 Risks and Rules for Selling Investment Products 461 14–4 Trust Services as a Source of Fee Income 462 14–5 Sales of Insurance-Related Products 464 Types of Insurance Products Sold Today 465 Rules Covering Insurance Sales by Federally Insured Depository Institutions 466 Contents 14–6 The Alleged Benefits of Financial-Services Diversification 467 PART SIX PROVIDING LOANS TO BUSINESSES AND CONSUMERS 515 An Example of the Product-Line Diversification Effect Reducing Risk 467 Potential Economies of Scale and Scope 470 Chapter 16 Lending Policies and Procedures: Managing Credit Risk 515 14–7 Information Flows within the Financial Firm 470 Summary 472 Key Terms 473 Problems and Projects 473 Internet Exercises 474 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 14 475 S&P Market Insight Challenge 476 Selected References 477 Key Topics in This Chapter 16–1 Introduction 515 16–2 Types of Loans 516 Factors Determining the Growth and Mix of Loans 516 Establishing a Good Written Loan Policy 1. Is the Borrower Creditworthy? The Cs of Credit 524 2. Can the Loan Agreement Be Properly Structured and Documented? 527 3. Can the Lender Perfect Its Claim against the Borrower’s Earnings and Any Assets That May Be Pledged as Collateral? 528 Key Risks in Banking and Financial Institutions’ Management 481 Defenses against Risk 482 15–4 Types of Capital in Use 483 484 486 Regulatory Approach to Evaluating Capital Needs 486 15–6 The Basel Agreement on International Capital Standards: A Historic Contract among Leading Nations 488 Basel I 488 Capital Requirements Attached to Derivatives 491 Basel II: A New Capital Accord Unfolding 496 15–7 Changing Capital Standards Inside the United States 500 15–8 Planning to Meet Capital Needs 502 Raising Capital Internally 502 Raising Capital Externally 504 Summary 507 Key Terms 508 Problems and Projects 508 Internet Exercises 511 S&P Market Insight Challenge 511 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 15 512 Selected References 512 521 16–4 Steps in the Lending Process 522 16–5 Credit Analysis: What Makes a Good Loan? 524 Key Topics in This Chapter 479 15–1 Introduction 479 15–2 The Many Tasks Capital Performs 480 15–3 Capital and Risk 481 Relative Importance of Different Sources of Capital 515 16–3 Regulation of Lending 519 Chapter 15 The Management of Capital 479 15–5 One of the Great Issues in the History of Banking: How Much Capital Is Really Needed? xv 16–6 Sources of Information about Loan Customers 531 16–7 Parts of a Typical Loan Agreement 533 16–8 Loan Review 536 16–9 Loan Workouts 537 Summary 539 Key Terms 539 Problems and Projects 540 Internet Exercises 542 S&P Market Insight Challenge 542 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 16 543 Selected References 544 Chapter 17 Lending to Business Firms and Pricing Business Loans 547 Key Topics in This Chapter 547 17–1 Introduction 547 17–2 Brief History of Business Lending 548 17–3 Types of Business Loans 548 17–4 Short-Term Loans to Business Firms 548 Self-Liquidating Inventory Loans 548 Working Capital Loans 549 Interim Construction Financing 549 Security Dealer Financing 550 Retailer and Equipment Financing 550 xvi Contents Asset-Based Financing 551 Syndicated Loans (SNCs) 551 17–5 Long-Term Loans to Business Firms 552 Term Business Loans 552 Revolving Credit Financing 552 Long-Term Project Loans 553 Loans to Support the Acquisition of Other Business Firms—Leveraged Buyouts 554 17–6 Analyzing Business Loan Applications 554 Analysis of a Business Borrower’s Financial Statements 555 17–7 Financial Ratio Analysis of a Customer’s Financial Statements 556 The Business Customer’s Control over Expenses 558 Operating Efficiency: Measure of a Business Firm’s Performance Effectiveness 558 Marketability of the Customer’s Product or Service 559 Coverage Ratios: Measuring the Adequacy of Earnings 560 Liquidity Indicators for Business Customers 561 Profitability Indicators 562 The Financial Leverage Factor as a Barometer of a Business Firm’s Capital Structure 563 17–8 Comparing a Business Customer’s Performance to the Performance of Its Industry 563 Contingent Liabilities 565 17–9 Preparing Statements of Cash Flows from Business Financial Statements 566 Pro Forma Statements of Cash Flows and Balance Sheets 569 The Loan Officer’s Responsibility to the Lending Institution and the Customer 571 17–10 Pricing Business Loans 573 The Cost-Plus Loan Pricing Method 573 The Price Leadership Model 574 Below-Prime Market Pricing 576 Customer Profitability Analysis (CPA) 576 Summary 580 Key Terms 581 Problems and Projects 581 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 17 585 Internet Exercises 585 S&P Market Insight Challenge 586 Selected References 586 Chapter 18 Consumer Loans, Credit Cards, and Real Estate Lending 589 Key Topics in This Chapter 589 18–1 Introduction 589 18–2 Types of Loans Granted to Individuals and Families 590 Residential Loans 590 Nonresidential Loans 591 Credit Card Loans and Revolving Credit 591 New Credit Card Regulations 592 Debit Cards: A Partial Substitute for Credit Cards? 593 Rapid Consumer Loan Growth: Rising Debt-to-Income Ratios 593 18–3 Characteristics of Consumer Loans 593 18–4 Evaluating a Consumer Loan Application 594 18–5 Example of a Consumer Loan Application 596 18–6 Credit Scoring Consumer Loan Applications 599 The FICO Scoring System 602 18–7 Laws and Regulations Applying to Consumer Loans 603 Customer Disclosure Requirements 604 Outlawing Credit Discrimination 604 Predatory Lending and Subprime Loans 606 18–8 Real Estate Loans 607 Differences between Real Estate Loans and Other Loans 608 Factors in Evaluating Applications for Real Estate Loans 608 Home Equity Lending 610 The Most Controversial of Home Mortgage Loans: Interest-Only and Adjustable Mortgages and the Recent Mortgage Crisis 611 18–9 A New Federal Bankruptcy Code as Bankruptcy Filings Soar 613 18–10 Pricing Consumer and Real Estate Loans: Determining the Rate of Interest and Other Loan Terms 614 The Interest Rate Attached to Nonresidential Consumer Loans 615 Interest Rates on Home Mortgage Loans 618 Summary 621 Key Terms 621 Problems and Projects 622 Internet Exercises 625 S&P Market Insight Challenge 625 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 18 626 Selected References 626 PART SEVEN MANAGING THE FUTURE IN A GLOBAL MARKETPLACE 629 Chapter 19 Acquisitions and Mergers in FinancialServices Management 629 Key Topics in This Chapter 629 19–1 Introduction 629 19–2 Mergers on the Rise 630 Contents 19–3 The Motives behind the Rapid Growth of Financial-Service Mergers 632 19–4 Selecting a Suitable Merger Partner 636 19–5 The Merger and Acquisition Route to Growth 639 19–6 Methods of Consummating Merger Transactions 640 19–7 Regulatory Rules for Bank Mergers in the United States 641 Justice Department Guidelines 642 The Merger Decision-Making Process by U.S. Federal Regulators 645 19–8 Merger Rules in Europe and Asia 645 19–9 Making a Success of a Merger 646 19–10 Research Findings on the Impact of FinancialService Mergers 648 The Financial and Economic Impact of Acquisitions and Mergers 648 Public Benefits from Mergers and Acquisitions 650 Summary 651 Key Terms 652 Problems and Projects 652 Internet Exercises 654 S&P Market Insight Challenge 654 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 19 655 Selected References 655 Chapter 20 International Banking and the Future of Banking and Financial Services 659 Key Topics in This Chapter 659 20–1 Introduction 659 20–2 Types of International Banking Organizations 660 20–3 Regulation of International Banking 663 Goals of International Banking Regulation 663 U.S. Banks’ Activities Abroad 663 Expansion and Regulation of Foreign Bank Activity in the United States 664 xvii New Capital Regulations for Major Banks Worldwide 665 20–4 Services Supplied by Banks in International Markets 666 Making Foreign Currencies Available to Customers 666 Hedging against Foreign Currency Risk Exposure 667 Other Tools for Reducing Currency Risk 670 Supplying Customers with Short- and Long-Term Credit or Credit Guarantees 671 Supplying Payments and Thrift (Savings) Instruments to International Customers 672 Underwriting Customer Note and Bond Issues in the Eurobond Market 674 Protecting Customers against Interest Rate Risk 674 Helping Customers Market Their Products through Export Trading Companies 675 20–5 Challenges for International Banks in Foreign Markets 676 Growing Customer Use of Securities Markets to Raise Funds in a More Volatile and Risky World 676 Developing Better Methods for Assessing Risk in International Lending 677 Adjusting to New Market Opportunities Created by Deregulation and New International Agreements 680 20–6 The Future of Banking and Financial Services 682 Summary 686 Key Terms 687 Problems and Projects 688 Real Numbers for Real Banks: Continuing Case Assignment for Chapter 20 689 Internet Exercises 690 S&P Market Insight Challenge 690 Selected References 690 Dictionary of Banking and Financial-Service Terms 693 Index 711 Preface As this book enters its eighth edition, the world that we know is changing rapidly and, in some cases, ominously. Financial firms and the services they offer are becoming increasingly internationalized and most financial-service providers are growing in size and complexity. Risk management has come to be the dominant subject that most financial managers are concerned with as the risks faced by financial institutions seem to grow almost daily. Indeed, the whole financial sector is threatened by significant risks at home and abroad, inside and outside the individual financial firm, and more and more financialservice providers are failing. External risks to financial firms include wars, crime, poverty, environmental destruction, global warming, political revolution and strife, falling currency values, volatile equity markets, weakening economies, declining sales in key industries, inflation, increasing energy shortages, and a troubled home mortgage market. All of these external risks have had (and will continue to have) a profound effect on the services financial firms can offer and the profits and future growth they may hope for. Moreover, many financialservice providers today are caught in the middle of a geopolitical struggle as important countries like China, India, Korea, Japan, and Russia are knocking on the door of global leadership and demanding a growing economic and political role. If the foregoing external risks were not enough, numerous internal risks (some of them old and some relatively new) have surfaced inside many financial firms. These include exposures to loss from such risk dimensions as credit risk, liquidity risk, market and price risk, interest rate risk, sovereign risk, operational risk, currency risk, off-balance-sheet risk, legal and compliance risks, strategic risk, reputation risk, and capital risk. Each of these types of risk is a major focus of attention in the pages of this book. The successful manager of a financial-service institution today must understand the foregoing external and internal challenges and the strategies developed to deal with all of these threats. That is our purpose here—to examine the different risk exposures that confront financial-service providers today and to discover ways to deal with these challenges efficiently and effectively. In addition to combating losses from risk exposure we must understand clearly the importance and key roles that financial institutions play in our lives and careers. These institutions are the principal means that we all draw upon to make payments for the goods and services we wish to buy. They are the vehicles through which we raise liquidity when emergency needs for cash arise. They are the principal repositories for our savings as we prepare for future spending and future financial challenges. They are the primary suppliers of credit which fuels spending and results in the creation of more jobs. These financial firms we will be studying are the principal sources for insurance protection and the purveyor of hedges to help us protect the value of the assets we hold and the income we receive. Finally, the financial-service providers we target in this book are major vehicles through which government economic policy (including monetary policy carried out by central banks) struggles in an attempt to stabilize the economy, avoid serious inflation, and reduce unemployment. xviii Preface xix To be successful in our study we must learn about the key differences between one type of financial-service provider and another, and about the management principles and practices that can be used to help strengthen these firms, offering better service to the public. No longer is our world populated by one type of financial institution. There are thousands of these firms, some of which we still call banks, insurance companies, security dealers and brokers, mutual funds, and so on. But with increasing frequency these institutions have invaded each other’s territory and taken on characteristics of their competitors. This so-called convergence trend leads to overlapping of services and confusion about what is actually happening in the financial sector. Today larger banks control insurance and security affiliates. Many insurers own banks and serve as security brokers and dealers. Major security dealers have chartered banks and, in some cases, created insurance affiliates or departments. These convergences among different financial-service institutions make our study somewhat harder and raise questions about what is the appropriate business model in the financial sector today and for the future. Can all these financial-service providers succeed or are an increasing number doomed to disappointment and failure? In addition to today’s confusion over which financial firm does what, we will also discover the great size and performance differences among different financial firms, which have aroused major questions and issues. A key question in this field today centers on the future of the thousands of smaller financial institutions that exist in almost every country. Can these so-called small-fry institutions really survive in a land of giants (Citigroup, Bank of America, J. P. Morgan Chase, Barclays PLC, Prudential, HSBC Holdings, etc.)? Can smaller financial institutions successfully face off against trillion-dollar financial-service companies? What is the optimal size and product mix for a financial firm, and how is that changing? With all the sweeping changes that have dominated the financial world lately one must wonder at times: Why would anyone write a book about this daunting subject today? We must convey what we believe are the principles of sound financial management and what we think are the best practices for today’s financial firms and financial-service industries. We must offer analysis and advice for a wide range of financial institutions, whether they be among the giants or among the smallest service providers. We admit that writing a book about bank and nonbank financial firms and financial services is a hard job. However difficult, though, we must reveal that it is also an exciting adventure. We have come to realize that to ignore this sector of the economy places us at something of a personal and professional peril. We must discover everything we can about these institutions because all of us, whether we become banking and financial-service managers or not, must rely on the services financial firms provide. We ignore this sector of our system at considerable risk. We should also remind ourselves that, had we never thought about it before, the financial-services sector represents a possible significant career opportunity down the road as the current credit crisis ebbs. Financial services is becoming one of the more creative industries, less routine now that computer systems are available to handle most routine tasks. There is also a strong emphasis on sales promotion and serving the customers as fully as possible. A job in this dynamic, information-oriented sector poses a challenging and fascinating career possibility. The authors sincerely hope that the pages of this book will help you determine whether financial services just might be the exciting career opportunity you are searching for in the years ahead. xx Preface Key Trends Unfolding in the Financial-Services Sector: Which Ones Does This Book Focus On? This book unlocks the door to many of the major changes and events that are remaking the banking and financial services fields today. Among the key events and unfolding trends covered in this text are the following: • An expanded look at ethics in the financial sector with more examples of recent ethical dilemmas. (See Chapters 2, 3, 14, and 20.) • A close look at the U.S. central bank, the Federal Reserve System, and how it dealt successfully with the 9/11 terrorist crisis and more recently has worked to battle against the troubled residential mortgage market amid a weakening economy. (See Chapters 2 and 11.) • A look at the mortgage market crisis and its impact on financial-market conditions and the economy. (See Chapter 18.) • An exploration of the rise of China, India, Korea, Japan, and other leading nations inside the global financial system to positions of increasing prominence and influence, offering competition to American and European bank and nonbank financial firms and an opportunity for international financial firms to enter vast new national markets. (See Chapters 2 and 20.) • An analysis of investment banking houses, such as Bear Stearns, Lehman Brothers, and other firms (such as Countrywide Mortgage) that became victims of the most recent credit crisis and demonstrated once again that even the largest financial institutions are vulnerable to mistakes, in this case through dealing heavily in the subprime residential mortgage market. (See Chapters 1 and 18.) • A more detailed look at leading financial firms, led by commercial and investment banks, security brokers and dealers, mutual funds, hedge funds, finance companies, mortgage banks, and several others. Investment banking is a particular target of our study because it is often among the most powerful financial industry members because of the higher returns these companies may achieve and the vital services they provide. (See Chapters 1, 2, 3, and 14.) • Coverage of the ongoing battle between industrial and retailing firms trying to get into the financial sector and existing financial-service providers. A key discussion point concerns “walls”— regulatory barriers between financial services and other industries that the United States and other leading countries have put in place, presumably to protect the safety of the public’s funds. (See Chapters 1, 2, and 20.) • A closer look at financial-service delivery vehicles, especially the dynamic growth in Web activities and the growing use of cell phones, call centers, and other devices. (See Chapter 4.) • A look at the strengths and the weaknesses of the securitization process and an examination of the use of interest-rate and currency hedging instruments, including the risks these instruments and techniques create for themselves and for the financial system as a whole. (See Chapters 7, 8, 9, and 20.) • A continuing discussion of the controversial Bank Secrecy and Patriot acts which have appeared in one form or another in several nations, particularly following the terrorist attack of 9/11, and the widening use of monetary penalties for banks that have had problems in trying to trace the financial activities of some of their customers. (See Chapter 2.) Preface xxi • An exploration of new international capital rules created at Basel, Switzerland, which currently apply mainly to leading international banks around the globe, but have also provided a risk-analysis framework for smaller banks inside the United States and several other countries. (See Chapters 2, 15, and 20.) • A look at the Grameen Bank and other microlenders emerging around the globe—what they do and what impact they have had. (See Chapter 20.) • An increased recognition of the many (and expanding) types of risk that surround and threaten financial firms and an explanation of how risk can be measured and managed. (See Chapters 6, 7, 8, 9, and 15.) • An exploration of recently new financial instruments and their impact, including option mortgages, trust preferred securities, exchange traded funds, and range notes. (See Chapters 10, 14, 15, and 18.) Teaching and Learning Tools surrounding the Eighth Edition The new eighth edition offers several tools to promote learning and understanding and make this book an effective resource for the teacher. Among the most useful are likely to be: • New and newly revised problems to solve (including problems suitable for Excel) along with an extensive battery of challenging, quality problems from earlier editions. • A continuing case problem that runs through most of the chapters and encourages the development of analytical techniques while acting as a useful exercise for those who like to assign term papers or semester projects. • More URLs in the margins that point the reader toward new information and new ideas on the Web. • Factoids and filmtoids supplementing the URLs and presenting interesting facts to stimulate reader interest. • Video clips in a variety of chapters that visually bring the reader up to date about new developments in the financial-services marketplace (such as Toyota recently opening a bank in Russia), provide tutorials on various financial topics (such as construction of the yield curve and calculations of yields to maturity using Excel and financial calculators), offer explanations of how financial services are delivered (such as through ATMs), and broadcast an exploration of the history of financial institutions (such as the recent rapid expansion of credit unions and fringe banks). • As in previous editions, a series of topics boxes devoted to E-Banking and E-Commerce, Real Banks Real Decisions, Insights and Issues, and Ethics in Banking and Financial Services. Following the lead offered by previous editions of Bank Management and Financial Services, several learning tools show up in the structure of materials inside each chapter. Specifically: • Chapter Introductions that set the tone and list the most critical material about to be presented in each chapter. • Key URLs that appear in every chapter and offer to carry the reader into supplemental material that could be useful for class presentations and to help those who want to dig deeper and master the subject. • Factoids that offer pertinent and interesting facts and ideas that supplement what the text is saying and excite readers. xxii Preface • Filmtoids, mention movies of the recent past that provide unique insights about the development of the banking and financial-services sectors of the economy. • Key Video Links, a new feature referenced in the margins, that offer the reader video/ audio presentations on recent financial-service developments and provide tutorials on key topics to supplement text material. • Boxed features that sharpen the focus surrounding controversies in the financial institutions field, explore the most recent developments, analyze management decisions, and discuss ethical issues in the field. • Concept Checks that pose questions and brief problems to allow the reader to see if he or she understood what they have just read in each part of a chapter. • Chapter Summaries that present an outline of what the chapter has discussed, summarize the key points presented, and offer an avenue of review to help prepare the reader for an exam. • Key Terms that are listed at the conclusion of each chapter’s narrative along with the page numbers indicating where these terms appear and are defined. • Problems and Projects that offer a challenge to the reader and explore the reader’s depth of understanding, giving him or her an opportunity to solve problems and make numerical calculations. • Internet Exercises that request the reader to dig into the vast reservoir of the Worldwide Web to discover information sources pertinent to the most important aspects of each chapter. • Real Numbers for Real Banks, which offers the reader (including both students and teachers) the opportunity to dig into the data resources available in banking and financial services (including the financial statements of financial-service providers) and use the information found to make management and public policy decisions. • S&P Market Insight Challenge that presents questions that can be resolved with the use of a very large database consisting of financial and other pertinent facts for hundreds of corporations (including both financial and nonfinancial institutions) assembled by Standard & Poor’s. • Selected References that are arranged by topic and appear at the conclusion of each chapter, helping the reader decide where to inquire further on any major topic presented in the foregoing chapter. • A Dictionary of Banking and Financial-Service Terms appearing at the back of the book following the last chapter in which the key terms that appeared in each chapter are defined. These definitions help the reader more clearly understand the language of the banking and financial-services sector. Supplementary Tools to Promote Learning and Understanding A number of supplementary learning and information tools accompany this text. The most significant of these educational materials are: • Instructor’s Manual and Testbank, which supplies a topic outline of each chapter, makes available hundreds of questions to answer for study and for the construction of lectures and exams, and presents problems to work out. • PowerPoint Presentation System, which aids teachers in putting together classroom presentations facilitating discussion in class and over the Internet, and grants readers study notes helpful in completing assignments and preparing for tests. The PowerPoint slides contain lecture outlines, charts, graphs, numerical examples, outlines of Preface xxiii key topics, and repetition of key points addressed in the text. Teachers and other presenters electing to use these slides can rearrange and edit these PowerPoint materials to more sufficiently satisfy their instructional and presentation needs. • Text Web Site, www.mhhe.com/rosehudgins8e, which can be accessed by class members, teachers, and other users of the text. Periodically the authors develop updated material for insert into the Web site in an effort to keep the text up-to-date. • S&P Market Insight, Educational Version, www.mhhe.com/edumarketinsight, provides an extensive collection of files on individual corporations (including financial-service providers). This large database is fertile ground for constructing class assignments and projects and encouraging readers to carry out financial and operating analyses of individual financial institutions. It’s also a good resource to use for comparing the financial and operating position of financial firms versus nonfinancial firms. There is evidence in recent years that sources like S&P Market Insights have been useful for students seeking employment who need to know as much as possible about the companies they will be interviewing with. Acknowledging the Important Contributions of Reviewers and Commentors The authors wish to express their gratitude to the many readers, teachers, financial managers, professional editors, and other talented reviewers who have criticized the text in an effort to improve it and have suggested new features that might aid those who plan to read and study from this text. As the book passes into its eighth edition, the list of significant contributors has grown beyond the capability of the authors to successfully acknowledge all of these valuable contributions. However, among the talented and well-informed teachers who have helped significantly are the following professionals in the field: Faud Abdullah University of Nebraska–Omaha Jack Griggs Abilene Christian University Lyle L. Bowlin University of Northern Iowa Scott Hein Texas Tech University Emile J. Brinkmann University of Houston James B. Kehr Miami University Samuel Bulmash Stockton College Marcus A. Kerbel Florida International University Tony Cherin San Diego State University George W. Kutner Marquette University Ronnie Clayton Jacksonville State University Young Kwak Delaware State University Edwin Cox Boston University Nelson J. Lacey University of Massachusetts–Amherst David R. Durst University of Akron Edward C. Lawrence The University of Missouri–St. Louis David T. Flynn University of North Dakota–Grand Forks William H. Lepley University of Wisconsin–Green Bay xxiv Preface David G. Martin Bloomsberg University James E. McNulty Florida Atlantic University Iqbal Memon Fort Lewis College Walt A. Nelson Southwest Missouri State University Therese E. Pactwa St. John’s University Armand Picou University of Central Arkansas David Rand Northwest Tech College in Ohio William Sackley University of North Carolina at Wilmington Sudhir Singh Frostberg State University David Stewart Winston-Salem University Cevder Uruk University of Memphis Oliver G. Wood Jr. University of South Carolina Robert Wyatt University of Northern Iowa With the emergence of this newest edition the authors also express their gratitude to the professionals who made numerous comments and suggestions as the eighth edition was being prepared. These teachers and researchers with exceptional knowledge in the financial-services field included: Sindy Abadie Southwest Tennessee Community College/Macon Campus John Lajaunie Nicholls State University Emily Breit Fort Hays State University James McNulty Florida Atlantic University–Boca Raton Victoria Geyfman Bloomsburg University of Pennsylvania Hamid Moini University of Wisconsin–Whitewater Jeff Guernsey Cedarville University Walt Nelson Missouri State University Curt Hoff Iowa State University Michael Tanaka University of Hawaii–Manoa Pankaj Jain University of Memphis Robert Wolf University of Wisconsin–La Crosse Deniz Kebabci San Francisco State University We acknowledge the contribution of The Canadian Banker, the widely circulated publication of the Canadian Bankers’ Association, for permission to use portions of earlier articles prepared by one of this text’s authors. Finally, no text of this size and complexity could possibly be completed without the quality workmanship and professional advice supplied by the talented editors and staff of McGraw-Hill Higher Education. We are especially grateful to Douglas Reiner, Michele Janicek, Meg Maloney, Balaji Sundararaman, Harvey Yep, Michael McCormick, and Preface xxv Matt Diamond. Their dedication to this project, over a period spanning many months, was truly remarkable. The deficiencies that remain, though, are the responsibility of the authors of this book. A Special Note Addressed to the Readers of Bank Management and Financial Services Beginning a new term or semester of an educational program is always challenging and suffused with an air of uncertainty. Did we take the right course or choose the most talented and effective teacher? Do we have the background needed to learn everything that’s written and discussed in this class? Is there content in this course that may change our lives for the better? Or is all of this just a big waste of time? Unfortunately, answers to these important questions usually do not arrive until the formal educational experience is coming to an end. Sometimes we still do not know how valuable a particular course was even years later as we work our way into the middle of a career. At the start of this venture most of us simply have to take a “leap of faith” that our educational journey will ultimately turn out to be worthwhile. But the opening of this particular bo