TIPS ON CHOOSING YOUR BANK - WHAT TO LOOK FOR IN A BANK

Evaluating a bank: What to look for

When looking for a bank that fits your needs, put on your detective hat and get ready to search for the best deals. You don’t want to pick a bank just because that’s where your parents or co-worker banked.

So what do you look for? You first want to look for a bank that participates in the U.S. government–operated Federal Deposit Insurance Corporation (FDIC) program. Otherwise, if the bank fails, your money isn’t protected.

The FDIC covers your deposits at each bank up to a cool quarter million dollars. Some online banks are able to offer higher interest rates because they’re based overseas and, therefore, don’t participate in the FDIC program. (Banks must pay insurance premiums into the FDIC fund, which, of course, adds to a bank’s costs.)

Another risk for you is noncovered banks that take excessive risks with their business to be able to pay depositors higher interest rates.

When considering doing business with an online bank or a smaller bank you haven’t heard of, you should be especially careful to ensure that the bank is covered under the FDIC. And don’t simply accept the bank’s word for it or the bank’s display of the FDIC logo in its offices or on its Web site.

Check the FDIC’s Web site database of FDIC-insured institutions to see whether the bank you’re considering doing business with is covered. Search by going to the FDIC’s “Bank Find” page (www2.fdic.gov/idasp/main_bankfind.asp). You can search by bank name, city, state, or zip code of the bank.

For insured banks, you can see the date it became insured, its insurance certificate number, the main office location for the bank (and branches), its primary government regulator, and other links to detailed information about the bank. In the event that your bank doesn’t appear on the FDIC list yet the bank claims FDIC coverage, contact the FDIC at 877-275-3342.

In addition to ensuring that a bank is covered by the FDIC, also seek answers to these questions:

✓ What’s the bank’s reputation for its services? This may not be easy to discern, but at a minimum, you should conduct an Internet search of the bank’s name along with the word “complaints” or “problems” and examine the results.

✓ How accessible and knowledgeable are customer service people at the bank? You want to be able to talk to a live, helpful person when you need help. Look for a phone number on the bank’s Web site and call it to see how difficult reaching a live person is. Ask the customer service representatives questions to determine how knowledgeable and service oriented they are.

✓ What’s the process and options for withdrawing your money? This issue is important to discuss with the bank’s customer service people because you want convenient, low-cost access to your money. For example, if a bank lacks ATMs, what do they charge you for using other ATMs?

✓ What are the fees for particular services? You can probably find this information on the bank’s Web site in a section called “accounts terms” or “disclosures.” Also, look for the Truth in Savings Disclosure, which answers relevant account questions in a standardized format.

BANK EQUITY PRODUCTS CAPITAL VENTURES BASIC INFORMATION AND TUTORIALS

The main clearing banks, which also promote reputable ‘business angels’, have designed and offer a range of equity products for smaller companies.

Prominent among the funds on offer from the clearing banks are the nine HSBC Enterprise Funds, operated by HSBC, which provide investments from £5,000 to £250,000 specifically orientated to start-ups and small businesses.

HSBC has committed £18.75 million to these funds since 1992. HSBC has also leveraged in money from other sources (including the European Investment Bank (EIB)), which have committed over £45 million to the Enterprise funds and a separate fund for technology-based companies, of which some £27 million has already been invested in 203 companies.

The average investment value is just £133,000. In addition, HSBC Ventures, the bank’s venture capital arm, specialises in investing equity sums of between £250,000 and £2 million.

Separately, the Bank of Scotland contributes to a number of Scottish-orientated funds, such as the Dumbartonshire Fund and the West Lothian Venture Fund; the Bank also participates with other clearers as an investor in the Scottish Equity Partnership.

Barclays, HSBC, Lloyds TSB, and RBS-NatWest together support the National Business Angel Network (NBAN), which relies on a regional presence to match business angels with appropriate investment opportunities.

Valuation Framework for Banks Basic Information and Tutorials

The approach that is typically applied to decide whether a firm creates value is a variant of the traditional discounted cash flow (DCF) analysis of financial theory, with which the value of any asset can be determined.

This (shareholder value) approach estimates the value of the entire firm (therefore, it is also called “entity” approach) using a multi period framework.

It estimates a firm’s (free) cash flows, which are available for distribution to both shareholders and debt holders, and discounts them at the appropriate rate, which is the so-called weighted average costs of capital (WACC) and reflects both the riskiness and timing of the cash flows and the firm’s leverage.

The (market) value of the firm’s equity is then determined by subtracting the (market) value of the firm’s liabilities from the determined entity value.

As an exception to the rule, a different approach is often chosen for banks—even though the results are mathematically equivalent. This so-called “equity” approach estimates the bank’s (free) cash flows to its shareholders and then discounts these at the cost of equity capital39 to derive the value of the bank’s equity directly. Besides being easier to apply, this approach also has the following practical and conceptual advantages in the financial industry:

■ Determining the equity value by first determining the entity’s value and then subtracting the value of the liabilities is much more difficult for banks than for industrial companies, because a bank’s debt is, to a large extent, not traded in the capital markets. For instance, savings and current account deposits have either no interest rate or an interest rate far below their fair market return—and an unknown maturity.

Hence, it is very difficult to determine the fair overall market value of debt because of the simple practical inability to determine the appropriate cost of capital for these liabilities.

■ Additionally, the fact that taking in deposits may allow the bank to generate value (because it pays interest rates below their market opportunity costs) makes liability management a part of the bank’s business operations and not just a pure financing function.

This potential for value creation needs to be adequately reflected in the applied valuation methodology, which is not the case in the entity approach.

■ Given the narrow margins of the banking business, small errors in the estimation of the appropriate interest rates can lead to huge swings in the value of the equity when applying the entity approach.

Even though we will not discuss the details of the determination of (free) cash flows and the application of this framework at the business unit or even the transaction level  here, some authors43 and—by anecdotal evidence—many bank analysts point out that this valuation framework is notoriously difficult and cumbersome to apply to banks.

This observation is true for bank insiders, but especially for bank outsiders and is mostly due to the fact that banks are opaque institutions.  However, these informational problems may be only one reason for the scarce application of the valuation approach in banks. We will discuss potential other problems in the following section.

REGIONAL DEVELOPMENT BANKS BASIC INFORMATION

Regional development banks are organized with goals similar to the World Bank, such as poverty reduction and promotion of economic growth. Rather than a global focus, however, these banks instead focus on a particular geographic region. They are owned and funded by the governments of the region and industrialized nations. These include:

■ African Development Bank The African Development Bank (AfDB), which began operations in 1963, is a major source of public financing in Africa. The member countries include 51 African states and 25 other countries, most of which are industrialized nations.

■ Arab Fund for Economic and Social Development Established in 1972, the Arab Fund for Economic and Social Development assists development in the member countries of the Arab League. The fund assists in financing of development projects.

■ Asian Development Bank The Asian Development Bank is a multilateral development finance institution that engages in mostly public sector lending for development purposes in its developing member countries in Asia and the Pacific. It pursues this goal by providing loans and technical assistance for a broad range of development activities.

ADB raises funds through bond issues on the world’s capital markets but also relies on members’ contributions. The ADB was established in 1966 and has its headquarters in Manila, Philippines. As of September of 2003, the ADB had 58 member countries. Although ADB historically focused on government level public agency lending with a governmental guarantee, the significant increase in privatizations in member countries has resulted in a private-sector mandate.


■ European Bank for Reconstruction and Development The European Bank for Reconstruction and Development (EBRD) began operations in 1991. It was organized to provide assistance to the nations of Central and Eastern Europe for transition to market based economies. There are over 50 member countries. The EBRD raises funds from member countries as well as the capital markets.

■ European Union The European Union, organized in 1993, is an organization of 25 industrialized European nations. It provides grant  to developing countries throughout the world, including Africa, Asia, the Caribbean, central and eastern Europe, Latin America and the former Soviet Union.

■ European Investment Bank Organized in 1958, the European Investment Bank (EIB) provides financial support for development. The members of the EIB are the members states of the European Union. Funds are raised by the EIB from member countries and also from the capital markets. Loans are generally made within the European Union, but are also made outside of the union.

■ Inter-American Development Bank The Inter-American Development Bank (IDB) was organized in 1959, and is a major lender to Latin American and Caribbean member countries. It is currently the principal source of external finance for most Latin American countries.

The 46 member countries include Latin American countries, the United States and other industrialized nations. Funds for loans are raised by the IDB from member countries as well as from the capital markets.

Loans are generally made to public agencies of member countries to finance specific projects. A government guarantee is required. Direct support to the private sector is made available by the bank through its affiliate, the Inter-American Investment Corporation (IIC).


■ Islamic Development Bank The Islamic Development Bank (IsDB), established in 1974, is a multilateral organization of 45 countries. Its purpose is to promote economic development in member countries and in Muslim communities in non-member countries.

The bank, operating within the principles of the Koran, provides interest-free loans for development projects, and also finances lease transactions and instalment sales, and makes equity investments.

■ Nordic Investment Bank The Nordic Investment Bank (NIB) was formed in 1975 by Denmark, Finland, Iceland, Norway and Sweden. Its purpose is to finance investments in which its member nations are interested, both within the Nordic countries and internationally.

■ Nordic Development Fund Since l989, the Nordic Development Fund (NDF) has provided credits to developing countries on concessional terms, primarily in Africa and Asia. It participates in co-financing arrangements with other multilateral agencies and regional banks.

■ OPEC Fund for International Development The OPEC Fund for International Development, established in 1976, provides financial assistance to developing countries. Its members are the countries that are members of the Organization of Petroleum Exporting Countries.

WHAT IS E-BANKING (ELECTRONIC BANKING)?

E-BANKING: IMPORTANCE, RELEVANCE, AND EVOLUTION

Electronic Banking (E-Banking) is a reality. In its very basic form, e-banking can mean the provision of information about a bank and its services via a home page on the World Wide Web (WWW). More sophisticated e-banking services provide customer access to accounts, the ability to move their money between different accounts, and making payments or applying for loans via e-Channels.

The term e-banking will be used in this book to describe the latter type of provision of services by an organization to its customers. Such customers may be either an individual or another business.

To understand the electronic distribution of goods and services, the work of Rayport and Sviokla (1994; 1995) is a good starting point. They highlight the differences between the physical market place and the virtual market place, which they describe as an information-defined arena.

In the context of e-banking, electronic delivery of services means a customer conducting transactions using online electronic channels such as the Internet.

Many banks and other organizations are eager to use this channel to deliver their services because of its relatively lower delivery cost, higher sales and potential for offering greater convenience for customers. But this medium offers many more benefits, which will be discussed in the next section.

A large number of organizations from within and outside the financial sector are currently offering e-banking which include delivering services using Wireless Application Protocol (WAP) phones and Interactive Television (iTV).

Many people see the development of e-Banking as a revolutionary development, but, broadly speaking, e banking could be seen as another step in banking evolution. Just like ATMs, it gives consumers another medium for conducting their banking.

The fears that this channel will completely replace existing channels may not be realistic, and experience so far shows that the future is a mixture of “clicks (e-banking) and mortar (branches)”. Although start up costs for an internet banking channel can be high, it can quickly become profitable once a critical mass is achieved.


There have been significant developments in the e-financial services sector in the past 30 years. According to Devlin (1995), until the early 1970s functional demarcation was predominant with many regulatory restrictions imposed.

One main consequence of this was limited competition both domestically and internationally. As a result there was heavy reliance on traditional branch based delivery of financial services and little pressure for change. This changed gradually with deregulation of the industry during 1980s and 1990s, whilst during this time, the increasingly important role of information and communication technologies brought stiffer competition and pressure for a faster pace of change.

The Internet is a relatively new channel for delivering banking services. Its early form ‘online banking services’, requiring a PC, modem and software provided by the financial services vendors, were first introduced in the early 1980s. However, it failed to get widespread acceptance and most initiatives of this kind were discontinued.

With the rapid growth of other types of electronic services since mid 1990s, banks renewed their interest in electronic modes of delivery using the Internet. The bursting of the Internet bubble in early 2001 caused speculation that the opportunities for Internet services firms had vanished.

The “dot.com” companies and Internet players struggled for survival during that time but e-commerce recovered from that shock quickly and most of its branches including e-banking have been steadily, and in some cases dramatically, growing in most parts of the world.

One survey conducted by the TechWeb News in 2005 (TechWeb News, 2005) found e-banking to be the fastest growing commercial activity on the Internet. In its survey of Internet users, it found that 13 million Americans carry out some banking activity online on a typical day, a 58 percent jump from late 2002.

The spread of online banking has coincided with the spread of high-speed broadband connections and the increasing maturation of the Internet user population. Another factor in e-banking growth is that banks have discovered the benefits of e-banking and have become keener to offer it as an option to customers.

COMMERCIAL BANKS, INVESTMENT BANKS, AND THE SHADOW BANKING SYSTEM

WHAT ARE COMMERCIAL BANKS, INVESTMENT BANKS, AND THE SHADOW BANKING SYSTEM?


Commercial banks are among the most important financial institutions in the economy because they provide savers with a secure place to invest funds and they offer both individuals and companies loans to finance investments, such as the purchase of a new home or the expansion of a business.

Investment banks are institutions that (1) assist companies in raising capital, (2) advise firms on major transactions such as mergers or financial restructurings, and (3) engage in trading and market making activities.

The traditional business model of a commercial bank—taking in and paying interest on deposits and investing or lending those funds back out at higher interest rates—works to the extent that depositors believe that their investments are secure.

Since the 1930s, the U.S. government has given some assurance to depositors that their money is safe by providing deposit insurance (currently up to $250,000 per depositor). Deposit insurance was put in place in response to the banking runs or panics that were part of the Great Depression.

The same act of Congress that introduced deposit insurance, the Glass-Steagall Act, also created a separation between commercial banks and investment banks, meaning that an institution engaged in taking in deposits could not also engage in the somewhat riskier activities of securities underwriting and trading.

Commercial and investment banks remained essentially separate for more than 50 years, but in the late 1990s Glass-Steagall was repealed. Companies that had formerly engaged only in the traditional activities of a commercial bank began competing with investment banks for underwriting and other services.

In addition, the 1990s witnessed tremendous growth in what has come to be known as the shadow banking system. The shadow banking system describes a group of institutions that engage in lending activities, much like traditional banks, but these institutions do not accept deposits and are therefore not subject to the same regulations as traditional banks.

For example, an institution such as a pension fund might have excess cash to invest, and a large corporation might need short-term financing to cover seasonal cash flow needs. A business like Lehman Brothers acted as an intermediary between these two parties, helping to facilitate a loan, and thereby became part of the shadow banking system.

In March 2010, Treasury Secretary Timothy Geithner noted that at its peak the shadow banking system financed roughly $8 trillion in assets and was roughly as large as the traditional banking system.