Solution manual bank management and financial services 9th edition by rose, peter chap004

CHAPTER 4 ESTABLISHING NEW BANKS, BRANCHES, ATMS, TELEPHONE SERVICES, AND WEBSITES Goal of This Chapter: The purpose of this chapter is to learn how new banks are chartered by state an

CHAPTER 4 ESTABLISHING NEW BANKS, BRANCHES, ATMS, TELEPHONE SERVICES, AND WEBSITES

Goal of This Chapter: The purpose of this chapter is to learn how new banks are chartered by

state and federal authorities in the United States, to determine what makes a good site for a new branch office, to recognize how the role of branch offices is changing, and to explore the advantages and disadvantages of automated banking facilities

Key Topics in This Chapter

 Chartering New Financial-Service Institutions

 The Performance of New Banks

 Establishing Full-Service Branches and In-Store Branching

 Establishing Limited-Service Facilities

 ATMs and Telephone Centers

 The Internet and Online Banking

Chapter Outline

I Introduction

A The Importance of Convenience and Timely Access to Customers

B Service Options Available Today

1 Chartering New (De Novo) Financial Institutions

2 Establishing New Full-Service Branch Offices

3 Setting Up Limited-Service Facilities

II Chartering a New ( De Novo ) Financial-Service Institution

III The Bank Chartering Process in the United States

A The Chartering Authorities in the U.S

B Benefits of Applying for a Federal (National) Charter

C Benefits of Applying for a State Charter

IV Questions Regulators Usually Ask the Organizers of a New (De Novo) Bank

V Factors Weighing on the Decision to Seek a New Charter

A External Factors

1 Level & Growth of Economic Activity

2 The Need for a new financial firm.

3 The Strength and Character of Competition in Supplying Financial

Services

B Internal Factors

1 Qualifications and Contacts of the Organizers

2 Management Quality

3 Pledging of Capital to Cover the Cost of Filing a Charter Application and

Getting Underway

VI Volume and Characteristics of New Charters

VII How Well Do New Charters Perform?

Research Findings on New Bank Performance VIII Establishing Full-Service Branch Offices: Choosing Locations and Designing New

Branches

A Advantages of Full-Service Branches

B Trends in the Design of New Branches

C Desirable Sites for New Branches

1 Expected Rate of Return

2 Geographic Diversification

D Branch Regulation

E The Changing Role of Financial-Service Branch Offices

F In-Store Branching

IX Establishing and Monitoring Automated Limited-Service Facilities (“Branchless

Banking”)

A Point-of-Sale Terminals

B Automated Tellers (ATMs)

1 History of ATMs

2 ATM Services

3 Advantages and Disadvantages of ATMs

4 The Decision to Install a New ATM

5 Example of the ATM Capital-Budgeting Decision

X Banking in Homes, Offices, Stores, and on the Street

A Telephone Banking and Call Centers

B Internet Banking

1 Services Provided through the Internet

2 Challenges in Providing Internet Services

3 The Net and Customer Privacy and Security

XI Financial-Service Facilities of the Future

XII Summary of the Chapter

Concept Checks

4-1 Why is the physical presence of a bank still important to many customers despite recent

advances in long-distance communications technology?

Many customers still prefer the personal attention and personal service that contact with bank employees provides Moreover, for those services where problems can arise that require detailed information and explanation For example, when a customer discovers that his or her account is overdrawn, or if he or she suspects an account is being victimized by identity theft, or when the customer’s estimate of an account balance does not agree with the institution that holds that account, and checks or charges begin to bounce, the presence of a nearby service facility may become important

4-2 Why is the creation (chartering) of new banks closely regulated? What about nonbank financial firms?

The creation of new banks is regulated to ensure the safety and soundness of banking system and

to avoid excessive numbers of bank failures The same arguments are usually made for nonbank financial firms Financial-service firms that hold the public’s savings are at the heart of the payment process to support trade and commerce These firms often create money The failure of these firms could disrupt the economy and chartering too many might result in excessive growth

in the money supply and inflation

4-3 What do you see as the principal benefits and costs of government regulation on the number of financial-service charters issued?

While control over the entry of new banks may reduce the number of failures, it also limits competition, so the public may receive a smaller volume or lower quality of services at excessive prices

4-4 Who charters new banks in the United States?

New banks are chartered by the banking commissions of the individual states or, at the federal level, by the Office of the Comptroller of the Currency (OCC)–a division of the Treasury

Department Thrift institutions are chartered by the states or at the federal level by the Office of Thrift Supervision

4-5 What key role does the FDIC play in the chartering process?

The FDIC exercises some control over state bank charter activity as well as federal charters because most states insist that their new banks qualify for federal deposit insurance before they can open for business The FDIC requires new insured banks to maintain a certain ratio of Tier 1 (permanent equity) capital to assets to provide an extra cushion against failure The Federal Deposit Insurance Corporation Improvement Act of 1991 requires all depository institutions— including both new federally chartered and new state-chartered banks—to apply to the FDIC for insurance coverage

4-6 What are the advantages of having a national bank charter? A state bank charter?

The benefits of a national charter are:

a) It brings added prestige due to stricter regulatory standards that may help attract

deposits

b) In times of trouble the technical assistance supplied to a struggling institution by

national authorities may be of better quality, giving the troubled bank a better chance to survive

c) Federal rules can pre-empt state laws

The benefits of a state charter are:

a) It is generally easier and less costly to secure a state charter and supervisory fees

are usually lower

b) The bank does not have to join the Federal Reserve and therefore avoids buying

and holding low yield stock of the Federal Reserve

c) Some states allow a bank to lend a higher percentage of its capital to a single

borrower

d) State-chartered banks may be able to offer certain services that national banks

may not be able to offer

4-7 What kinds of information must the organizers of new national banks provide the

Comptroller of the Currency in order to get a charter? Why might this required information be important?

The applicants for a national bank charter are required to submit a detailed business plan, which contains a description of the proposed bank and its marketing, management, and financial plans The Comptroller of the Currency asks for information on the number of competing banks and bank-like institutions in the service area of the proposed bank More competitive market

situations limit the profit potential and perhaps the growth potential of a new bank Also

requested is the information about shopping centers, retail and wholesale business activity, recent population growth, traffic counts, and personal income levels–all viewed as indicators of

potential demand for banking services in the service area of the proposed new bank Applicants must also provide background information on the organizers and proposed management of a new bank so the Comptroller can decide if these people are qualified, law-abiding, and trustworthy to manage the public's funds as well as their own

4-8 Why do you think the organizers of a new financial firm are usually expected to put

together a detailed business plan, including marketing, management, and financial components?

A detailed business plan demonstrates to regulators that the organizers of the bank have the expertise, experience, and skills necessary to be successful in managing the new bank If the organizers of a bank do not know where they are going, they are unlikely to be successful In addition, it demonstrates whether the organizers of the new bank have a realistic picture of the community they are planning on serving and whether the organizers have a realistic view of the profit potential in the new bank

4-9 What are the key factors the organizers of a new financial firm should consider before deciding to seek a charter?

While a variety of factors are examined by different business people interested in establishing a new bank, most look at some or all of the following factors

1 External Factors

a The level and growth of economic activity

b The need for a new financial firm

c The strength and character of competition in supplying financial services

2 Internal Factors

a Qualifications and contacts of the organizers

b Management quality

c Pledging of capital to cover the cost of filing a charter application and

begin operations 4-10 Where are most new banks chartered in the United States?

New charters tend to be concentrated in large urban areas where expected rates of return on the organizers investments are likely to be the highest As the population increases relative to the number of financial firms, the number of new charters increases The success of local banks already in the area can suggest how successful the new financial firms will be Although, places with a higher concentration ratio of new banks tend to chartering activities

4-11 How well do most new banks perform for the public and for their owners?

Most new banks succeed, especially those whose organizers can bring in new deposits and loan accounts during the first year of the bank's operation Most are profitable within two to three years of opening There is some evidence that newly charted banks are “financially fragile” and more prone to failure than established banks They appear to be more vulnerable to real estate crises than established banks because their portfolios are often heavily invested in riskier real estate loans New banks tend to underperform their competitors until they have been around for a while and new banks are more closely supervised by the government regulators than established banks

4-12 Why is the establishment of new branch offices usually favored over the chartering of new financial firms as a vehicle for delivering financial services?

The chartering of a new financing corporation is normally a lengthy and expensive process, requiring the completion of elaborate federal or state application forms, while the branch

application process is normally far simpler and less costly Moreover, with the increase in the number of failures in recent years, regulatory-imposed capital requirements for new charters have increased substantially New branch offices usually carry significantly lower capital

requirements Also, branch offices themselves are often much less elaborate and costly to build

and maintain than are the headquarters' facility of a new institution where some duplicate

facilities can be eliminated (for example, checking processing, credit analysis, and records departments)

4-13 What factors are often considered in evaluating possible sites for new branch offices? Bankers first need to decide the goals and objectives of a new facility Often this means assessing whether the proposed new branch is aimed at selling one or more particular services, such as deposits or loans, and also deciding how closely correlated cash flows and returns from the new branch office may be with cash flows and returns from the other facilities operated by the bank

If returns or cash flows through the proposed new institution are negatively correlated or display low positive correlation with the institution's other facilities, they may be able to lower the variance of its returns or cash flows by proceeding to establish the new office

Other considerations revolve around the economic strength of the proposed branch office site– whether there is adequate traffic volume, large numbers of stores and shops, older or younger age populations who often require slightly different menus of services, recent area population

growth, density and income, the occupational and residential makeup of the proposed new branch area, a large enough population to generate enough customers to breakeven, and the number and size of facilities operated by competitors Generally, for branches designed to attract and hold deposits, key factors to consider usually revolve around individual and family incomes, concentrations of retail stores and shops, older-than-average residents, and homeowners rather than renters For branch facilities emphasizing credit services residential areas with substantial new construction activity, heavy traffic flow, and high concentrations of stores and shopping centers are typically desirable for consumer and retail loan demand, while central city office locations are often chosen as locations for commercial loan facilities

4-14 What changes are occurring in the design of, and the roles played by, branch offices? Please explain why these changes are occurring

Bank branches are increasingly becoming selling platforms in which more and more fee-based services are attractively and prominently advertised in order to maximize the fee-income

generating potential of each branch Moreover, branches are becoming increasingly automated to reduce personnel and other operating costs and improve speed, efficiency, and accuracy in handling a growing service volume Branch design has come to reflect these trends with

automated facilities placed at easy access points, along with information booths to speedily direct customers to the service areas they need Human tellers may be placed deeper inside branch facilities so that customers must pass by other service departments and conspicuous advertising

in order to encourage customers to become aware of and avail themselves of other bank services

4-15 What laws and regulations affect the creation of new bank and thrift branches and the closing of existing branches? What advantages and what problems can the closing of a branch office create?

The opening of new branch offices must be approved by a bank's or thrift’s principal federal or state supervisor According to the FDIC and other regulatory agencies, no new bank can enter

the industry without government approval, in the form of a charter, to operate The types of deposits and other financial instruments sold to the public to raise funds must be sanctioned by each institution’s principal regulatory agency The quality of loans and investments and the adequacy of capital are carefully reviewed by government examiners The principal regulatory agencies who issue charters for new national banks and depository institutions include the Comptroller of the Currency and the State Boards or Commissions

Closing a branch office has become much more complicated in recent years as the result of several new laws and regulations For example, the FDIC Improvement Act requires 90 days advance notice of branch closings to both customers and the principal supervisory agency and a posting on the branch site at least 30 days prior to closing Banks and thrifts must also make an

"affirmative effort" to reach all segments of their communities without discrimination under the terms of the Community Reinvestment Act which raises the danger of customer protests against closings if it appears the bank is under-serving certain groups of customers Finally, the

Community Reinvestment Act can be used as a vehicle to prevent U.S banks and thrifts from branching expansion when they have a poor record of serving all segments of their communities

Closing selected branch offices can reduce operating costs and divert resources from less

profitable to more profitable uses However, they risk alienating good customer relationships unless it can serve those same customers with its remaining facilities

4-16 What new and innovative sites have been selected for new branch offices in recent years? Why have these sites been chosen by some financial firms? Do you have any ideas about other sites that you believe should be considered?

Rapid increases in new branches located in grocery stores, shopping centers, and inside other businesses and facilities where the public frequently gathers have helped to reduce branch construction costs and promote cross-selling of goods and financial services Other branches have been opened in apartment complexes, senior citizen centers, and other customer-convenient locations as bankers come to realize they must adjust their service locations and service hours to conform to customer needs in an intensely competitive financial-services environment

4-17 What are POS terminals, and where are they usually located?

Point-of-sale terminals are set up to accommodate customer purchases of goods and services These computer terminals normally are located in supermarkets, gasoline stations, and similar places with a link to the banks’ own computer records When a customer of the bank makes a purchase, the amount of the transaction is deducted from the customer's deposit account and added to the store's account Because the customer immediately loses funds, many bank

customers have been hesitant to use the service as opposed to paying by check or credit card where payment is delayed for a few days However, this depends on whether the POS terminal is

an offline or online terminal An offline terminal accumulates all transactions until the end of the day when all transactions are subtracted from a customer’s account This type of terminal is less costly for the bank to operate An online terminal subtracts the transactions immediately from the customer’s account and reduces the chance of an overdraft occurring but is more expensive for

the bank to operate Consumer reluctance to use POS terminals appears to be fading and as fees for other services rise, this reluctance will continue to disappear

4-18 What services do ATMs provide? What are the principal limitations of ATMs as a service provider? Should ATM carry fees? Why?

The earliest ATMs provided a convenient mechanism for cashing checks, making deposits, and verifying checking account balances, often at hours when the full-service branch offices were closed Today, ATMs frequently provide a wide menu of old and new services, including bill paying, transfer of funds between accounts, and the purchase of tickets for travel and

entertainment Most authorities expect ATM usage to grow rapidly as these machines offer more services and as bankers increasingly move to restrict customer access to more costly human tellers and other bank personnel, often by charging extra fees for personal service

ATMs do have some significant limitations that bankers will have to work to overcome They break down and need to be replaced, sometimes quite frequently and annoyingly for customers, and as technology changes often become quickly outdated Customer activity around ATMs, particularly at night, has invited criminals to steal money and injure customers, sometimes creating liability for banks Moreover, not all customers make use of these facilities due to a preference for personalized service, fear of crime, or unfamiliarity with how the machines work Customer education and better service pricing are two important tools that could help with these problem areas in the future In addition, ATMs do not rank high in their ability to sell peripheral services Some banks have found that there has been a sharp decline in their ability to sell other services Finally, ATMs are not necessarily profitable for all banks Because they are available 24 hours, some customers may make more frequent and smaller withdrawals from the machine than they would with a human teller, driving up the costs In addition, these same customers will often still demand a human teller to deposit their pay check, making the bank keep both tellers and ATM machines

Whether ATM should carry a fee is rather controversial Recently, some of the largest ATM networks have decided to let owners of ATMs charge non-customers a surcharge Several

regional banks have begun to charge fees as well These fees reflect the usage of ATMs About 80% of all ATM transactions consist of cash withdrawals and only about 10 percent represent incoming deposits In addition, in many places, ATM usage has declined as customers pass over ATMs in favor of credit and debit cards, onsite terminals and the Internet

4-19 What are self-service terminals and what advantages do they have for financial

institutions and their customers?

Self-service terminals include ATMs and other computer-based limited-service facilities that permit a customer to call up information about his or her account and recent transactions with the institution or information about different services that the customer might be interested in

purchasing Customer can also get copies of forms and legal documents and even schedule appointments with staff Many are accessible 24 hours a day or are easier to get to rather than wait for the help of personnel They can save on resources by saving on staff time Many

institutions are adding telephones and video screens so that customers with problems can dial up

an employee day or night with problems This is also saving money because they can avoid duplication of staff at each branch

4-20 Why do many experts regard the telephone as a key instrument in the delivery of

financial services in the future? What advantages does the telephone have over other service-delivery vehicles?

Many different services can be marketed, delivered, and verified at low cost via the phone It is among the most popular channels for putting customers in touch with financial-service providers today Thus many experts regard the telephone to be the key financial-service delivery device into the future Increased call centers to assist customers in obtaining account information and in carrying out transactions, leads to avoiding walking or driving to a branch office or ATM The key feature of today’s telephone is mobility The biggest advantage of the cell phone is that it is easily transportable and not tied to any particular location Phone has revolutionized

communications and delivery of services, lowering dramatically the cost of both The recent development of bigger and cleaner screens on mobile phones and the recent implementation of tighter security procedures in accessing accounts have made cell phones increasingly comparable

to personal computers and even more convenient than PCs when traveling

4-21 What financial services are currently available on the Internet? What problems have been encountered in trying to offer Internet-delivered services?

Customers can make payments, check on account balances, confirm that deposited funds have been received, checks have been cleared They can move funds between accounts and get

applications for loans, deposits and other services In addition banks can advertise on the web Some of the problems include protecting customers’ privacy and heading off crime In addition, the web does not make it easy for a bank to get to know their customers personally The cost may also be prohibitive to some customers

4-22 How can financial firms better promote Internet service options?

They need to emphasize the safety of their Internet services They need to promote their home page at every opportunity and update it frequently to keep customers’ interest They need to do a customer survey about their satisfaction with the services and encourage dialogue via e-mail to resolve problems They can also provide programs to download to act as screen savers (and advertisements) and also information about the institution and the services it provides

Problems

4-1 A group of businesspeople from Scott Island are considering filing an application with the state banking commission to charter a new bank Due to a lack of current banking facilities within a 10-mile radius of the community, the organizing group estimates that the initial banking facility would cost about $3.3 million to build along with another $500,000 in other organizing expenses and would last for about 25 years Total revenues are projected to be $400,000 the first year, while total operating expenses are projected to reach $160,000 in year 1 Revenues are expected to increase 4 percent annually after the first year, while expenses will grow an

estimated 2 percent annually after year 1 If the organizers require a minimum of a 10 percent annual rate of return on their investment of capital in the proposed new bank, are they likely to proceed with their charter application given the above estimates?

Year Revenues Op Expense Net Profit

1 $400,000 $160,000 $240,000

2 $416,000 $163,200 $252,800

3 $432,640 $166,464 $266,176

4 $449,946 $169,793 $280,152

5 $467,943 $173,189 $294,754

6 $486,661 $176,653 $310,008

7 $506,128 $180,186 $325,942

8 $526,373 $183,790 $342,583

9 $547,428 $187,466 $359,962

10 $569,325 $191,215 $378,110

11 $592,098 $195,039 $397,059

12 $615,782 $198,940 $416,842

13 $640,413 $202,919 $437,494

14 $666,029 $206,977 $459,052

15 $692,671 $211,117 $481,554

16 $720,377 $215,339 $505,038

17 $749,192 $219,646 $529,547

18 $779,160 $224,039 $555,122

19 $810,327 $228,519 $581,807

20 $842,740 $233,090 $609,650

21 $876,449 $237,752 $638,698

22 $911,507 $242,507 $669,001

23 $947,968 $247,357 $700,611

24 $985,886 $252,304 $733,582

25 $1,025,322 $257,350 $767,972

Required

Rate of

Present value of future

cash flows @ 10% $3,329,203

Initial investment $3,800,000

Net Present Value of

Given the above information, the organizers are not likely to proceed given that the net present value of this investment is negative The return they are going to earn is less than the 10% they need to earn