Industry Overview — Banking & Financial Services
This article is the summary of the banking and financial service industry, based on business schools’ case books and my experience of doing case interview practices.
Key terms:
BB (Bulge Bracket):
The term “bulge bracket” generally refers to the largest and most prestigious investment banks on Wall Street. These banks are typically global in scope, have a strong presence in multiple financial markets, and offer a wide range of services to their clients, such as mergers and acquisitions, underwriting, sales and trading, and research.
Overdraft:
A deficit in a bank account caused by drawing more money than the account holds.
Banccasurance:
The selling of life assurance and other insurance products and services by banking institutions.
NFC (near field communication):
NFC is the technology that allows two devices — like your phone and a payments terminal — to talk to each other when they’re close together. NFC is the technology that enables contactless payments.
Keyed transaction:
A “keyed transaction” in banking refers to a type of transaction where the credit or debit card information is manually entered into the point-of-sale (POS) terminal or payment gateway instead of being swiped or tapped. This type of transaction is also known as a card-not-present transaction, as the card is not physically present during the transaction. Examples of keyed transactions include online purchases, mail or phone orders, and transactions where the card’s magnetic stripe or chip cannot be read.
Alternative financing:
Non-traditional ways of raising capital or funding that are facilitated by technology. Some examples include crowdfunding platforms, peer-to-peer (P2P) lending platforms, invoice financing, revenue-based financing, and merchant cash advances.
Neobanks/challenger banks:
Neobanks, also known as digital banks or challenger banks, are financial institutions that operate exclusively online or through mobile apps, with no physical branch locations. Neobanks are typically built on modern, cloud-based technology and offer a range of features and benefits that traditional banks may not, such as real-time account notifications, automated savings tools, and personalized financial management tools. They also tend to have lower fees and more competitive interest rates, as they have lower overhead costs than traditional banks.
Mortgage brokers:
A mortgage broker is an intermediary who brings mortgage borrowers and mortgage lenders together, but who does not use their own funds to originate mortgages. A mortgage broker helps borrowers connect with lenders and seeks out the best fit in terms of the borrower’s financial situation and interest-rate needs. The mortgage agents work by having relationships with real estate brokers. When a broker makes a sale, he refers the buyer of the home to a mortgage agent. That agent works with the home buyer to close the transaction and sell the mortgage.
Branch managers:
Branch managers are individuals who are responsible for the overall operations of a specific branch of a company or organization. They oversee the day-to-day activities of the branch, including managing employees, ensuring customer satisfaction, and meeting financial goals.
Dodd-Frank:
The Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as Dodd-Frank, is a United States law that was passed in 2010 in response to the 2008 financial crisis. aimed at regulating the financial industry and protecting consumers.
Proprietary trading:
Proprietary trading is a type of trading in which a financial institution, such as a bank or investment firm, uses its own capital to buy and sell securities, commodities, or other financial instruments for profit. In other words, proprietary trading involves the use of the institution’s own money, rather than its clients’ funds, to engage in trading activities.
“Financial supermarkets”:
A financial supermarket, also known as a financial conglomerate or a universal bank, is a type of financial institution that offers a wide range of financial products and services to its customers. In a financial supermarket, customers can access a variety of services that traditionally would be offered by separate institutions, such as banks, investment firms, insurance companies, and mortgage lenders.
Fixed-cost business:
A fixed-cost business is one in which the majority of the costs associated with producing goods or services are fixed and do not vary based on the level of output. For example, the cost of rent, salaries, insurance, and equipment may be considered fixed costs, as they do not change regardless of how many products or services the business produces or sells. In a fixed-cost business, the profitability of each unit sold increases as the level of output increases, as the fixed costs are spread out over a larger number of units.
Variable-cost business:
A variable-cost business, on the other hand, is one in which the majority of the costs associated with producing goods or services are variable and do vary based on the level of output. For example, the cost of raw materials, labor, and shipping may be considered variable costs, as they increase as the level of production or sales increases. In a variable-cost business, the profitability of each unit sold remains relatively constant, as the costs are directly tied to the level of output.
Types of banks:
- Commercial banking
- Retail banking
- Investment banking
- Mobile Banking
Where does revenue come from:
- Interest rates charged to borrowers
- Fixed and Variable fees (trading commissions, M&A fees, asset management fees)
- Premiums (from sale of insurance policies)
Where does cost come from:
- IT-related cost (including back-end processing, security, apps & websites)
- Overhead (branches, administration, compliance)
- Salaries
- Losses on investments, such as loan defaults, and bad debt expense
- Marketing
Products and services:
- Credit cards
- Mortgages
- Loans
- Payments
- Insurance
- Checking/Saving accounts *
- Private wealth management
- Underwriting for IPOs
- Retirement accounts
- Real estate loans
*The difference between checking and savings accounts:
Savings account: (the revenues and costs are from the bank’s perspective, not account owner)
- Purpose: help you save money over time, by earning interest on your deposits.
- Revenues: Interest from credit card portfolio
- Costs: Interest paid to customer, call center, fraud, marketing, statement mailing
Checking account: (the revenues and costs are from the bank’s perspective, not account owner)
Usually comes with a debit card, checks, and/or online bill pay services, and allows customers to take overdraft
- Purpose: allow you to access your money quickly and easily
- Revenues: Overdraft fee, account fees, interchange, ATM fee
- Costs: Debit card transaction processing, ACH transaction processing, ATM reimbursement (pays little to no interest on deposits)
Customers:
Segmented by income levels
- Individual customers
- High net worth customers (priority segment)
- Small/medium businesses without sufficient size for larger investment banking financing services
- Private companies going public looking for underwriting
Distribution channels:
- Increasing use of ATM services and online banking
- Mostly: face-to-face presence with bank branches, tellers, etc.
Competitive landscape:
- International and national banks compete with regional banks
- New online banks competes with traditional physical banks
- Growth of mobile banking, online banks and fintech disrupts the industry
- Industry consolidation: the industry is mature and consolidated; primary growth through acquisitions
- Trends towards “financial supermarkets”: largest players’ services extend well beyond commercial banking to investment banking, securitization, proprietary trading, etc. with services that are increasingly opaque
Other key trends:
- Regulation within the industry — after 2008 financial crisis, the Dodd-Frank Act increased capital requirements for banks
- Change in customer demographics leads to larger market for retirement products
- Offshoring of call centers, back office functions to reduce expenses
- Cyclical — credit crisis and financial meltdown threatens the solvency of industry
Sub-Sector Analysis — Insurance
Key trends:
- Credit crisis/financial meltdown threatens solvency of industry due to illiquid assets that are difficult to value
- It is important to monitor investment portfolio during credit crisis
Competitive landscape:
- Several large, integrated players operating across multiple parts of the industry (AIG, Prudential, etc) such as insurance, financial products and services
- Some niche players focus on a particular segment (sports insurance, pet insurance, equestrian insurance, etc)
Customers:
- Individual consumers seeking to manage risk at home/on the road
- Small/medium/large businesses seeking to manage risks of property damage, liability, etc.
Channels:
- Through insurance agents: sales forces to manage the front-end sales process to businesses/individuals
- Through online sales: easier with better websites and aggressive marketing
- Direct marketing to employers via in-office demonstration
Profit summary:
- Net revenue = premiums collected — claims/payments made overtime
- Operating costs: overhead (administration, compliance), salaries, sales commissions, marketing
