Banking and Financial Services

SECTION 1: INDUSTRY OVERVIEW

BUSINESS SENSE ABSTRACT

The banking and financial services industry is one of the largest and most influential industries, facilitating the flow of capital and providing credit globally. The banking sector in the US alone employs 2.02 million people, with the revenue from banking, financial services, and insurance in the US in 2022 being $4.962 trillion. The sector is constantly in flux, especially currently with plenty of regulatory changes after the 2008 financial crisis. Other factors increasingly affecting the industry are digital transformation, increased globalization, and the rise of cryptocurrencies. Banks work in the most basic sense by accepting deposits and using this money to lend out to other customers, but this is only an extremely basic overview of the industry.

SIGNIFICANCE

The relatability of the industry is quite easy to see - almost everyone reading this document will have an account with a bank that they regularly use to receive, send, or store money. The huge global impact of the 2008 financial crisis, caused by banks’ risky lending practices, also demonstrated the impact that the banking industry has on the global economy.

CASE STUDY TOPICS

Interesting case study topics on this industry may include how commercial banks set interest rates, the profit strategy of investment banks, the trading strategies for securities by banks, or how minimum reserve requirements set by central banks affect the economy.

KEY TRENDS AND EVENTS

2008 financial crisis: The 2008 global financial crisis was triggered by a housing market bubble and high-risk lending practices by banks that resulted in many of the world's largest economies entering recession.

Russia’s invasion of Ukraine: Sanctions imposed on Russia by many Western economies meant many banks had to cut ties with Russian clients, causing much turmoil in the industry. The banking sector is also heavily intertwined with the oil industry, and with Russia being one of the world’s largest oil providers, this further complicates things.

COVID-19: COVID-19 plunged many of the world’s economies into recession and caused huge fluctuations in interest rates, both of which hugely impact banking practices worldwide.

2023 collapse of SVB: This showed that despite the increased regulation since 2008, risky behavior is still a large issue within the industry to date. Although, the fallout of this incident was significantly smaller than the 2008 crisis.

INFLUENCES AND HEADWINDS

Rise of fintech and digitalization: as discussed below in ‘case examples’, the rise of digitalization in banking and the way money is sent or received has led lots of banks to prioritize their digital transformations.

Fluctuating interest rates: The base interest rates set by central banks have a huge impact on banking revenues as this influences the rates they can charge, especially with rates changing so rapidly in the modern-day economy.

Changing regulation: The financial crisis triggered a myriad of regulatory changes to the industry to prevent a repeat, such as stricter liquidity requirements, more transparency in the derivative markets, and the creation and expansion of more regulatory agencies.

CASE EXAMPLES

2008 global financial crisis: There is no better example in recent history of the influence of the banking sector than the Global Financial Crisis. Many of the world’s largest banks were lending large sums of money to ‘subprime’ customers to allow them to buy homes they could not actually afford. This led to a housing market bubble that eventually crashed, with the peak of the crisis commonly known as the collapse of US bank Lehman Brothers - the largest bankruptcy in US history to date. This crisis sent several of the largest economies of the world into recession, costing people their jobs and homes, showing the influence of the banking industry globally.

Digital transformation and the rise of fintech services: Companies/services such as PayPal, Alipay, Zelle, etc. have transformed the way money can be sent and received around the globe. These are more user-friendly alternatives to traditional banking services and have encouraged many banks to increase their digital presence and offerings to keep up with these global trends.

SECTION 2: BANKING & FINANCIAL SERVICES FINANCIALS AND METRICS

REVENUE DRIVERS

Interest income and lending services: When lending loans to borrowers, banks charge an interest rate. Banks also pay an interest rate to depositors. If a bank charges a 5% interest rate on a loan but only pays a 2% interest rate to a depositor, the remaining 3% is revenue for the bank. This concept also applies to different types of loans, such as mortgages.

Asset management and investment services for clients: Banks may charge a fee to clients who want their assets managed for them. Many banks also offer brokerage services, allowing clients to trade securities through them, for which they will charge a commission.

Trading income: Banks themselves also make profits from trading in forex, equity, and bond markets.

Insurance premiums: Banks often generate revenue by collaborating with insurance companies. While insurance companies write the policies, banks often act as an intermediary between these companies and the consumer.

General fees and commissions: Banks charge general fees and commissions for other activities, which sometimes include sending and receiving money, overdraft fees, etc.

COST DRIVERS

Employee expenses: Many banks try to hire some of the most competitive talent in the world. This, balanced with the often stressful job and poor work-life balance, means their employees often demand extremely high salaries.

Technology infrastructure: With the increasingly digital world, the vast majority of banking and financial services involve some form of technology. From high-frequency trading to simply sending and receiving money, the level of technology infrastructure in the industry is huge, which comes with a massive capital cost.

Compliance with regulations: Especially after the 2008 financial crisis, regulation in the industry has increased massively. Banks have had to make many changes to their day-to-day operations, which has incurred a large cost.

Risk management: Similar to the last point, since banks handle such large sums of money, they have to invest significantly in their risk management departments to ensure the correct level of risk is being taken.

Professional services: Often banks reach out to consultants and lawyers for help, as well as other professional services, which come at a high cost.

KEY METRICS

Annual Percentage Rate (APR): expresses the annual rate charged for borrowing or the annual rate earned as a percentage.

Assets Under Management (AUM): the total value of financial assets that a financial institution has under management on behalf of its clients.

Credit Score: a number representing the ‘trustworthiness’ of an individual to repay any credit given to them, based mostly on their credit history. It is used to determine the risk of giving a loan and/or its associated interest rate.

Net Interest Margin (NIM) is a profit metric for banks representing the difference between interest income generated from loans and investments, and the interest paid to depositors or other liabilities.

Return on Assets (ROA) is another profit metric that shows how efficiently a company profits from its total assets.