Survival skils in financial services

Providers: Professionals Who Sell to the Industry Financial institutions buy a wide range of products and services from side vendors.. he goal of Survival Skills in Financial Services is

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SURVIVAL SKILLS IN FINANCIAL SERVICES

Strategies for Turbulent Times

Julian Lowenthal

John Wiley & Sons, Inc

whose courage, insight and support inspire me

every day and for Steven, a joy today and a vision

of the wonderful things yet to come.

Copyright ©2002 by Julian Lowenthal All rights reserved.

Published by John Wiley & Sons, Inc., New York.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system or transmitted

in any form or by any means, electronic, mechanical, photocopying, recording, scanning

or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authoriza- tion through payment of the appropriate per-copy fee to the Copyright Clearance Center,

222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4744 Requests to the Publisher for permission should be addressed to the Permissions

Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-6008, E-Mail: PERMREQ@WILEY.COM.

This publication is designed to provide accurate and authoritative information in regard

to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering professional services If professional advice or other expert assis- tance is required, the services of a competent professional person should be sought Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products visit our Web site at www.wiley.com.

ISBN: 0-471-21880-4

Printed in the United States of America.

10 9 8 7 6 5 4 3 2 1

This book would not have been possible without the help of a wide work of colleagues, family and friends Many thanks to the industry pro-fessionals who gave their time for interviews and who selflessly sharedtheir insights Their words, both on and off “the record” form the heartand soul of the book

net-A special thanks to Keith Darcy, a long-time friend and mentor whowas the original instigator of this project Thank you to Susan Davis, whoreviewed and edited drafts of the manuscripts and provided guidance onthe importance of being pithy I also want to thank Arline Lowenthal fortaking on the tedious job of transcribing the bulk of the interviews.Finally, thanks to David Pugh at John Wiley and Sons, Inc for putting

up with me, Hy Turner, my role model for perseverance in the literaryworld, and Jacqueline Philpotts for pointing me in the right directionearly on in the project

V

The camera, the tape recorder misused, well-used There are the

paparazzi; and there is Walker Evans The portable tape recorder, too, is

for better or for worse It can be, tiny and well-concealed, a means ofblackmail, an instrument of the police state or, as most often is the case,

a transmitter of the banal Yet a tape recorder, with microphone in hand,

on the table or the arm of the chair or on the grass, can transform boththe visitor and the host On one occasion, during the play-back, my com-panion murmured in wonder, “I never realized I felt that way.” And I wasfilled with wonder, too

Studs Terkel

Working

1972

Introduction: Setting the Stage xi

CHAPTER 1 I Don’t Think We’re on Wall Street Anymore 3

CHAPTER 10 “The Biggest Thing Is That People Aren’t Stupid Anymore” 157 CHAPTER 11 Sometimes You Just Have to Say, What the ? 169

CHAPTER 13 There Is No Need to Change—Survival Is Not Mandatory 191

Contents

IX

Setting the Stage

Why Now?

hange It is spinning all around us You read about “changingtimes” in the press, you hear about “changing technology” on theradio All economic, social, political, and technological systems areundergoing unprecedented periods of change How many times have youheard the saying “The only constant is change”?

The financial services industry (FSI) is no exception In fact, you couldmake the case that the FSI is one of the most rapidly changing sectors intoday’s global marketplace Every day, it seems, there is another breakingstory:

conglomerate

As a consultant to financial services institutions, I have followed these ries with great interest I had to—these are my clients But as I studied theseevents and incorporated these developments into my work, I realized thatthere was something missing Where were the people? Nobody was talkingabout the people This struck me as odd because “institutions” don’t gener-ate new business, meet customer needs, design and implement systems,

sto-Introduction

XI

C

manage a professional staff, or provide essential support functions—people

do People are the foundation of this business But when I realized thatnobody was talking about the impact of these change forces on the profes-

sionals at work, I knew I had a mission—and Survival Skills in Financial

Services was born

What Is Survival Skills in Financial Services?

Let me start out by explaining what the book is not It’s not:

offers)—it is critical information you can use to be SUCCESSFUL

a recession or a recovery—it’s about CHANGE

When I began the book, I set out to answer the following questions:

1 What are the key change forces affecting the financial servicesindustry?

2 What are the effects, or what I like to call the pressure points, ofthese forces on professionals working in the industry?

3 What are the key knowledge areas, skills, and abilities that cial professionals at all levels need to succeed in this dynamicindustry?

finan-The answer to the first question was not that hard Anyone who was nothibernating over the last decade could pick out the key change forces Forquestions 2 and 3, I had some answers but not enough I wanted to talk

to people in the industry to get their views and insights on these criticaltopics The result of my investigation is the book you are holding in yourhands (or paging through on your computer or listening to in your car or

you get the idea) Survival Skills in Financial Services focuses on:

and sophisticated customer, and new developments in the risk andregulatory environment are impacting people who work in financialcompanies

■ The knowledge, skills, and abilities that professionals need to acquireand develop to succeed in these turbulent times.

serv-ices to the financial servserv-ices industry can use to effectively sell theirofferings in a chaotic industry

But the word Survival in the title of the book (you know that’s why

you’re reading this)—is the situation truly that serious? Throughout theproject, I have received a number of reactions to the title, including this:

That word, survival I’m sure you were very careful in selecting that In and of itself, it’s the hook Using that word—laying that against each of those [change forces]—we can talk for hours about it [Dennis

Buchert]

And I did talk for hours with many industry professionals who were erous enough to devote their time and efforts to help you succeed

gen-Who Should Read This Book?

Everyone Really I feel that everyone would benefit by reading this book.However, the book is targeted at three main groups of people, whom I

label Insiders, Providers, and Observers.

Insiders: Professionals Who Work in the FSI

If you are an Insider—someone who works in a large, medium-sized, orsmall financial services firm, or even in a one-person shop—you will ben-efit from this book It will give you insights into the changes affecting theindustry and guide you through the steps you should take to be success-ful in these turbulent times And an added benefit to you is that thisinformation is not coming solely from some so-called expert who got abook deal You will be hearing it straight from experienced, successfulindustry leaders

Providers: Professionals Who Sell to the Industry

Financial institutions buy a wide range of products and services from side vendors Sales professionals, however, do not sell to institutions—

out-INTRODUCTION XIII

they sell to people If you are a Provider, Survival Skills in Financial

Services will give you valuable insights into the issues that are affecting

your customers on a day-to-day basis It also includes specific tips on how

to position your products and services as they relate to the change forces

at play in the market You can use these tools to create focused valuepropositions that will improve your sales efforts to the industry

Observers: On the Outside Looking In

This book will also be useful to people who want an inside look at the rent state of the industry Students, journalists, social critics, talk showhosts, politicians, performance artists, and other interested parties will allbenefit from this analysis on the impact of change on FSI professionals

cur-Using Survival Skills in Financial Services

The book is divided into three parts In Part One: The Situation Room,you will learn about the current state of the industry and how we gothere You will read about the five major change forces impacting theindustry:

■ Tech Effects—advances in technology and their impact on financial

services

■ Global Mobilization—the globalization of world financial markets.

■ Cognizant Customers—the proliferation of sophisticated and

knowl-edgeable institutional and retail customers

■ Shifting Risks—a dynamic risk environment that challenges traditional

assumptions and priorities

■ Rewriting the Rules—changes in industry regulations and their impact

on market structure

also discusses the particular challenges faced by all levels of industry fessionals, including:

pro-■ Leaders—executive-level professionals with strategic and leadership

responsibilities who are accountable to all institutional stakeholders

■ Managers—midlevel professionals who implement business objectives

through other people

■ Builders—professionals who are responsible for growing the business in

line with the institution’s strategic vision

■ Producers—frontline professionals who implement the firm’s products

and services, and generate revenues

■ Supporters—employees who support all levels of the institution and

serve as resource centers

In Part Two: Survival Manual, you will find a framework for analyzingthe change forces and the impact on industry professionals, the top fiveindividual survival skills, a guide to the basic knowledge requirements forpeople working in or selling to the industry as well as specific skill require-ments for Leaders, Managers, Builders, Producers, and Supporters Eachchapter focuses on the impact a particular change forces on professionals

at work Each chapter follows a standard format:

particu-lar change force

Global Mobilization, Cognizant Customers you get the idea

make it through this mess

Part Three: Pressure Points, looks at the effects created by each of thechange forces and the knowledge, skills, and abilities required to succeed

in the face of these challenges Throughout the book, Providers will findstrategies and sales techniques as they relate to the topics being considered There are many ways to use this book

their people

needs to succeed in turbulent times

next move

INTRODUCTION XV

Is This Just Another “Success” Book?

As I was putting this book together, I thought a lot about the idea of cess and what it means to be successful As part of my research I went tothe Internet (where else?) and did a keyword search on the term success

suc-at one of those huge online booksellers I received 11,236 hits

You, the reader, have quite a selection available to you You can get

Inside the Magic Kingdom and read about the Seven Keys to Disney’s Success.

You can discover the link between The Creative Mind and Success You can achieve Success with Words You can learn how to Dress for Success or dis- cover that Success Is a Choice and that The Road to Success Is Paved with

Failure You can identify the The Seven Habits of Highly Effective Teens in The Ultimate Teenage Success Guide (What is it about the number seven?)

You could be Succeeding in the Digital Culture of Tomorrow or learn 24

Lessons for Investment Success You can find out What Men Know about Success That Women Need to Learn and learn about The Seven Spiritual Laws for Success (there’s that number again) You can even discover The Secret to Success By Achieving More with Less.

And that was just the first page

The real point is—success is a personal value and my objective is not

to try to define it for you However, this book can, I hope, help youachieve your professional goals—it can help you reach a position in whichyou can choose where you want to go and what you want to be doing

So Are You with Me?

If you do not want to spend the time to read the whole book, I will nowprovide you with the executive summary The following comment wasoffered up by a longtime colleague who has a gift for her ability to get

to the heart of an issue I selected this quote for its brevity and clarity,and for the way it captures the essence of today’s wild world of financialservices:

Oh, God, I tell you it’s not easy in this day and age.

Any questions?

he goal of Survival Skills in Financial Services is to provide you not

only with my view of the world but also with the insight and advice

of key industry players who are living the reality of today’s

dynam-ic financial servdynam-ices industry To meet this objective, I assembled an sory team of senior executives, consultants, and industry analysts andasked them to share their experiences and provide guidance to my read-ers Their words make these vital issues come alive

advi-The professionals listed below went “on the record”—you will be ing their words throughout the book I have attempted to represent theirviews in the proper context, and I take full responsibility for the presen-tation and interpretation of their comments I also had the benefit ofspeaking with a number of professionals who were unable to provideattributable quotes—their input is included as well I also omitted attri-butions when I felt that printing names would breach confidentiality Interviews for the book were conducted from February throughNovember 2001 I have included a brief biography of the members of theteam to provide a context for their comments Biographical informationwas collected in December 2001

read-■ Doug Adamson is Executive Director of the Professional Development

Group for the American Bankers Association (ABA) In this capacity

he is responsible for ABA’s professional development programs Prior

to holding this position, he was Executive Vice President of the BankMarketing Association (BMA) Before joining the BMA in 1987 inChicago, Mr Adamson was Senior Vice President and head ofConsumer Banking for Bank One

■ Thomas Bailer is Vice President, Organizational Development and

Corporate Education, The Hartford Financial Services Group, Inc.Previous positions Tom has held at The Hartford include Director,Continuous Improvement; Director, Corporate Productivity Services;and Director, Planning, Monitoring and Control He also served in a

Cast of Characters

XVII

T

number of Underwriting and Office Administration managementpositions with Crum and Foster and The Hartford.

■ Dennis Buchert is President and Chief Executive Officer of IBJ

Whitehall Financial Group He also served as President and ChiefExecutive Officer of IBJ Schroder Bank and Trust Company (IBJWhitehall’s predecessor company) Mr Buchert came to IBJ fromSwiss Bank Corporation, where he was Executive Director, MerchantBanking He has also been with Marine Midland Bank in a variety ofmanagement posts

■ Lee Carlson is Vice President, Employee Relations and Resourcing,

HSBC Bank USA in Buffalo, New York He has over thirty six years’banking experience, gained through management positions in branch-

es, commercial finance, and human resources His human resourcesexperience includes human resource management, training, andemployee relations

■ Keith Darcy is Executive Vice President, Director of Professional

Services, and a member of the Executive Office of IBJ Whitehall Bank

& Trust Company, a subsidiary of the Industrial Bank of Japan He isresponsible for leading the bank’s professional services Mr Darcy hascombined a career in the financial services industry with his profession

as an educator and his long-term involvement in promoting ethics andleadership

■ Robert Davis is President and Chief Executive Officer of Republic First

Bank Prior to holding this position, Mr Davis was Regional President

of Mellon Bank, where he managed the Mellon PSFS retail office work, business banking, private banking, and community investmentareas in the Philadelphia and southern New Jersey region Before that,

net-he served as Chairman, President, and Chief Executive Officer atMellon Bank, N.A., Northern Region

■ Micah Green is President of the Bond Market Association He has

over-all responsibility for the management and activities of the organization,reporting to the executive committee and the board of directors Prior

to taking his current position, Micah was Chief Operating Officer ofthe Bond Market Association, directing staff operations and managingboth the New York and Washington offices

■ Patricia Guinn serves on Towers Perrin’s executive council as Managing

Director of Tillinghast–Towers Perrin and Towers Perrin Reinsurance.Patricia’s consulting expertise includes mergers and acquisitions, finan-cial projections, and performance measurement for life insurers

■ Rodgers Harper is Managing Director, The Harper Company LLC.

Rodgers has business experience in consulting and has held generalmanagement positions in finance and manufacturing His consultingclients include money center banks, regional banks, and investmentbanks His principal consulting expertise is in the areas of strategy,marketing, business process effectiveness, and organization

■ Robert Iati is the Director of Securities and Capital Markets at

TowerGroup, focusing on technologies used by broker/dealers Prior tojoining TowerGroup, Bob held officer-level positions at LehmanBrothers and at Deutsche Bank Securities, where he participated in abroad range of systems development projects

■ Thornton Jenness II is Director, Human Resources at SG/SG Cowen,

New York He is the Senior Generalist covering major business sectorsand product lines for the Americas Branch and regional InvestmentBanking platform of this Global bank based in France Thorn hasserved as a Vice President/Training Director at both Prudential-BacheCapital Funding and Citibank/Citicorp

■ Bruce Kasman is Managing Director and Director of Global Economic

Coordination and U.S Economic Forecasting at JP Morgan Chase He

is the editor of Global Data Watch Prior to his arrival at JP Morgan,

Bruce was Senior International Economist at Morgan Stanley & Co

He started his career at the Federal Reserve Bank of New York, where

he was a Research Officer in the International Research Department

■ Thomas Kohlmann is President, Chief Executive Officer, and Director

of Suffolk Bancorp and its banking subsidiary, the Suffolk CountyNational Bank (SCNB) Before assuming this position, Mr Kohlmannwas Executive Vice President and Chief Lending Officer at SCNB.Prior to joining Suffolk Bancorp, he served as president of the LongIsland division of Marine Midland Bank

■ Barry Kroeger is Ernst & Young’s Director of Banking for the Americas.

He is responsible for leading the development and execution of thefirm’s strategy and related initiatives to serve the banking industry.Barry is a Senior Partner with over 25 years of experience and hasserved numerous banking and other complex financial institutions

■ Marc Lackritz is President of the Securities Industry Association (SIA).

He has a background in law, economics, and public policy, and joinedthe SIA as Executive Vice President and head of the Washington office

CAST OF CHARACTERS XIX

Prior to joining SIA, Marc was the Executive Vice President and head

of the Washington office of the Public Securities Association He hashad extensive experience in the U.S Congress and was a partner of theformer Washington-based law firm of Wald, Harkrader and Ross

■ Kathleen O’Hare serves as a Principal in Deloitte & Touche’s Enterprise

Risk Services (ERS) practice She is responsible for the Internal AuditServices for Financial Services of Enterprise Risk Services in the NewYork area region and quality and risk management review for thenortheast ERS practice Prior to joining Deloitte & Touche, she was aSenior Vice President at The Bank of New York, with responsibilitiesfor deployment of global technology and large business applicationsdevelopment groups

■ Sue Perrotty is Executive Vice President and Director of Operations for

First Union National Bank She provides executive leadership to alltransaction processing and support functions Prior to taking this posi-tion, Sue led the General Banking Group’s Pennsylvania/Delawareregion Sue joined First Union through the acquisition of CoreStatesFinancial Corporation, where she was the Executive Vice President andChief Information Technology Officer

■ Anita Reid is Director, Global Human Resources, Equity Division at

Credit Suisse First Boston Anita has a wide range of HR expertise with

a focus on organization development, training and leadership Prior tojoining CSFB, she held senior HR positions at Citibank, Instinet andReuters

■ Walter J Ridlon III is a Vice President of New York Life and Chief

Executive Officer of the Nautilus Group Prior to joining New YorkLife, he worked as a General Manager for the Principal FinancialGroup He has also worked as a Senior Vice President and ChiefMarketing Officer for Pacific Mutual Prior to that, Mr Ridlon spentnineteen years with MetLife

■ Robert Stuchiner is Senior Vice President and Chief Marketing Officer

for US Life, with overall responsibility for product development, keting strategy, communications, and sales support Prior to taking thisposition, he was with TowerMark, a joint venture with the TravelersLife Insurance Company, as Director of Marketing Before that, Mr.Stuchiner held positions at Wolper Ross & Company and Davis, Polk

mar-& Wardwell

■ Larry Sweet is Vice President in the Emerging Markets and

International Affairs group at the Federal Reserve Bank of New York

He is the principal contact for the bank on international paymentissues Larry is currently the bank’s principal representative to theGroup of Ten central banks’ Committee on Payment and SettlementSystems (CPSS) and Chairman of the CPSS Sub-Group on ForeignExchange Settlement Risk

■ John Vaccaro is Founder and President of Westport Resources, a

full-service financial planning and investment management firm Prior tofounding the firm, he was affiliated with several investment firms.Notably, he held the position of Capital Partner with the investmentbanking firm Colin, Hochstin Before that, John helped found andacted as Securities Principal and minority owner of Sperber Adams, adiscount brokerage firm

■ Richard Wecker is President and Chief Executive Officer of LIMRA

International Prior to this position, Rich headed the marketing ations of New York Life He joined New York Life as an agent in 1971

oper-He subsequently served as general manager, regional vice president,vice president, and senior vice president in charge of the agency depart-ment He was elected to the board of directors of NYLIFE of Arizona,

a subsidiary of New York Life, and subsequently was named SeniorVice President in charge of the marketing department

CAST OF CHARACTERS XXI

The Situation Room

The Seven Enemies of Survival

Fear and anxiety Cold and heat Thirst Boredom and loneliness Fatigue Hunger Pain and injury

Nature Knowledgewww.youwillsurvive.comPart One

I Don’t Think We’re

on Wall Street Anymore

The Wide World of Financial Services

s you have seen already and as you will hear about again and againand again, change is an enduring feature of the financial servicesindustry (FSI) If you are working in the industry, you have beenliving it If you have been selling to the industry, you have encountered

it If you have been observing the industry, you have certainly noticed it.And if you are a rookie in the industry—get ready for it

Change is nothing new to financial services For several years a parade

of new products; new customers; and changes in technology, regulations,and economic factors have all shaken the industry in various ways But in

my talks with industry professionals, many expressed the feeling that thepace of change is accelerating

There’s no question about it Change was very manageable and dictable thirty years ago in a nice regulated industry This is a stark dif- ference in today’s reality People need to adapt to change not only daily but hourly [Robert Davis]

pre-1

C H A P T E R

3

A

Today we are in a new era of change All of the change forces that weare considering are occurring amid an unprecedented wave of deregula-tion—financial services companies have been liberated from Depression-era regulations restricting the businesses in which they can participate.Deregulation is serving as a catalyst—unleashing tremendous change andenhancing the impact on professionals at work The genie is out of thebottle.

I had many memorable encounters as I talked to people in the try One of the images that stays with me is that of a journey Aspokesman for a large insurance company said of her company: “We are

indus-at the beginning of a wonderful journey ” Hartford Financial Service’s

2000 annual report spoke of the company’s desire to become “the officialsupplier of America’s financial journey.” It’s a journey, all right But it’sone fraught with peril and uncertainty

The challenge facing financial services institutions reminds me of the

film The Candidate, in which Robert Redford plays the son of a

California governor The son is persuaded to run for the U.S Senate andwins in an upset, but he is seen as having sold out for the victory, talking

in meaningless sound bites to appeal to the masses His appreciative fathercomes up to him and offers him a left-handed compliment: “Son, you’re

a politician.” Amid the hysteria of the victory celebration of the partyfaithful, the newly elected senator, with a confused expression on his face,asks his father, “What do we do now?” That is the same question thatmany financial services industry leaders are asking themselves today.Many of these institutions got what they wanted; now they face an evenbigger challenge of deciding what to do in this wide-open playing field

As you begin your journey into the wide world of financial services, it

is important to establish some definitions What types of firms are wetalking about?

■ Banks You know (or you think you know) what a bank does

■ Securities firms These include brokers, dealers, broker/dealers, and

investment banks

■ Insurance companies Do you own a car? A house? A life? Enough said

Actually, not nearly enough said Later in the chapter, I will provide youwith the fundamentals of each of these sectors—more than enoughinformation to get you through the book

Was That the Sound of Breaking Glass?

As you have heard a thousand times before, change is not unique to anyindustry, so what is the big buzz about changes in the FSI? I guess all peo-ple like to think they are unique, but the question for us is, What’s so spe-cial about the FSI? Here are a few reasons why things are a bit different

in financial services:

■ Everyone is a stakeholder Every individual, public and private

institu-tion, has a stake in what happens in the industry As a result, everyone

is affected by changes resulting in increased scrutiny

■ The FSI is an important economic engine The FSI plays an important

role in the global economy by lending money to individuals and nesses, helping institutions and governments raise capital, ensuring thesmooth functioning of capital markets, and providing safeguards andprotection to help manage and transfer risk

busi-■ The FSI is highly leveraged Banks and securities firms rely heavily on

the use of borrowed funds to provide their services As a result, there

is little margin for error The CEO of a midsize commercial bankshared his thoughts on the tenuous nature of running a financial insti-tution:

On average, you can get away with one out of ten bad loans As soon as your average starts approaching two out of ten, you’re out of the ball game You must keep a sharp eye on that batting average [Dennis

Buchert]

■ The public’s money is at risk A large portion of the FSI’s borrowed funds

are retail and business banking deposits It is in the public’s best est to ensure the safety and solvency of financial institutions

inter-■ Financial institutions are literally “made of money.” The inputs and

out-puts of the FSI are highly liquid assets that are less and less often

actu-al currency and physicactu-al securities and more and more often bits andbytes of information In a world of technology gone mad, the velocity

of money—the speed at which it travels through the economy—hasaccelerated (You’ll hear more about this later.) The result is that anychanges or problems spread through the system instantaneously

■ The FSI is highly regulated For the reasons listed above and in the

name of other public policy concerns, the industry has been highly

I DON'T THINK WE'RE ON WALL STREET ANYMORE 5

regulated regarding in which businesses firms can participate and howthey conduct their day-to-day operations

Since I’ve been talking a lot about regulation, here are two laws youshould know about:

■ Glass Steagall Act of 1933 This was the legislation that, among other

things, separated the various financial services sectors into the threedistinct arenas of banking, securities, and insurance

■ Financial Modernization Act of 1999 In Washington they call it

Graham Leach Bliley This legislation effectively eliminated the tions set up by Glass Steagall

restric-This will be on the final exam

Defining Today’s FSI

OK, so where are we? Let’s take a look at the industry today (or, morerealistically, as I am writing this book) You can think of the FSI as athree-legged stool; the legs being banking, securities, and insurance.Although each leg is unique, they share some common characteristics:

If you look at their balance sheets, all you see is money In fact, cial statements for FSI firms are often referred to as sources and usesstatements—sources of funds and uses of funds

the money in at a cost and doing something with it to earn a return.Their profit is the difference or the spread between the cost of fundsand the return on their money

the risks that they incur when in their day-to-day business

The following pages will give you a broad overview of each of these nesses One caveat: This is real broad stuff, but it will help to define termsand, I hope, round out your perspective on the financial services market-place For each type of business, I have included information on the scope

busi-of services, key risks, and prbusi-ofit dynamics

busi-Securities and Foreign Exchange (FX)

Banks also hold securities Due to Glass Steagall restrictions, the

majori-ty of these securities have been U.S government securities (Treasury bills,notes, and bonds) and municipal bonds issued by states, counties, town-ships, etc Since the late 1990s, banks have been allowed to hold corpo-rate securities Banks hold these securities to earn interest and dividendsand to reap capital gains if they can Many banks are also major players

in the foreign exchange (FX) markets Playing in these markets involvesbuying and selling foreign currencies for customers and for the bank’sown account

Fee-Based Services

Banks also provide fee-based services that do not directly require capital

to deliver These services include advisory, trust, custodial, and writing (helping companies and governments raise funds in the capitalmarkets)

under-Key Risks

If you consider the scope of services that banks provide, you can get to therisks pretty easily With regard to loans, banks face the risk that borrow-ers will not pay back the money There is also the risk that the cost offunding loans will increase faster than the interest rate the banks earn bylending money Such an increase will reduce the spread (the differencebetween the interest earned on the loan and the cost of funding the loan).For securities holdings, there is the risk that equity issuers reduce oreliminate the dividends they were paying on stock For both securities and

FX, there is the risk that the bank buys low and sells lower In addition,

I DON'T THINK WE'RE ON WALL STREET ANYMORE 7

banks as bondholders face a risk that the issuer will default on periodicinterest payments and repayment of principal as scheduled.

Banks face risks, too, in their day-to-day operations You will hear a lotabout these risks throughout the book

Profit Dynamics

Bankers’ profits come from two distinct worlds: interest and non-interestincome and expense

■ Interest income—income from loans and securities they hold.

■ Interest expense—the cost of raising funds (interest paid on deposits and

other borrowings)

■ Non-interest income—money earned from fee-based services and

prof-its from buying and selling securities and FX

■ Non-interest expense—money spent on people, systems, buildings,

office equipment, and so on It is interesting to note that, in the past

at least, the largest non-interest expense item for financial servicesfirms has been people Are you surprised?

securi-Dealer Services

When a firm acts as a dealer, it is buying and selling securities for its ownaccount This is known as principal or proprietary trading All profits andlosses accrue directly to the firm

Fee-Based Services

Securities firms offer a host of fee-based services including underwritingand other investment banking services Examples of these services are cor-porate finance advisory services, merger and acquisition advisory, assetmanagement, and risk management

Investment Management

Under the heading of Securities Firms, I am also including investmentmanagement companies that provide investment vehicles for both indi-viduals and institutions This category includes:

be a result of either errors made by the firm, systems failures, problemswith customer accounts or with the securities themselves

With dealer services, the risks are identical to those in banks’ securitiesoperations: the value of the securities held may go down, and issuers maydefault on payments related to debt instruments Dealers also face fund-ing risks from borrowed money (the cost of funds may rise) and the riskthat money lent to margin customers will not be repaid

Profit Dynamics

The following are the key revenue and expense components for the rities sector

secu-Revenues

■ Commission income When a broker/dealer buys and sells securities on

behalf of its customers, it earns commissions Customers are chargedfor both a purchase and a sale This often represents the largest source

of revenue for a broker/dealer

■ Trading gains and losses These are profits and losses from principal

trad-ing activity—buytrad-ing and selltrad-ing securities that the firm owns These are

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realized gains and losses (the transactions have taken place) as opposed

to unrealized gains and losses that are reported periodically.

■ Investment banking income This includes fees gained from the

fee-based businesses described above

■ Interest and dividend income A brokerage firm earns interest and

divi-dends from the securities it owns

■ Other sources of interest income Brokerage firms earn interest from

secu-rities lending activities and margin transactions, among other activities

Expenses

Key expense categories in this area include:

■ Employee compensation and benefits This represents a significant

expense due to the labor intensity of the securities business

■ Commissions and floor brokerage expense If a broker/dealer needs to

trade on an exchange where it is not a member, it must pay fees to amember broker This is known as a floor brokerage expense.Commissions are incurred if the broker/dealer utilizes another brokerfor trade execution or clearance services

■ Communication and systems expense This is another significant expense.

We will be talking a lot about these costs throughout the book

■ Interest expense Securities firms incur interest expense through the

fol-lowing types of transactions: money borrowed by the broker/dealer tofinance payment for securities purchased; money received as collateralfor securities loaned/repurchased transactions; interest on debt (bor-rowed money); and interest on customer credit balances

Insurance Companies

Banking and securities firms are close relatives in the financial servicesfamily For one thing, they both provide transaction, savings, and invest-ment accounts But there are deeper ties that bind:

stock companies and as such have operated in an environmentdemanding short-term results, transparency, and accountability toboth shareholders and Wall Street The exception to this was that manysecurities firms were originally organized as partnerships Althoughstock ownership puts a large burden on the firm, the key benefit of thisstructure is the ability to grow by raising funds in the capital markets

■ Banks and securities firms have historically been regulated on anational level with the SEC as the primary regulator of the securitiesindustry and a variety of federal organizations governing bankinginstitutions These firms have lived in an environment of nationaloversight and accountability

form of a combination of physical branches and electronic cation channels for retail customers and the relationship managermodel for institutional customers

communi-Insurance companies, in contrast, have grown up in a somewhat differentworld

are owned by their policyholders The benefit of this organization hasbeen the ability to develop long-term planning cycles and business rela-tionships These firms didn’t have Wall Street analysts and demandingshareholders breathing down their neck, insisting that tomorrow must

be better than today The downside of this structure however, has been

a limited ability to increase the size of the firm The way to grow amutual company is to write more policies

cre-ates a large internal bureaucracy and at times a limited, regional focus

in-house and third-party agents As you will see, this system ates key issues facing the industry such as teamwork, partnerships, andrelationships

accentu-As the new financial marketplace continues to evolve, insurance sionals will be facing huge businesses and cultural challenges Their jour-ney may be the toughest one of all

profes-Scope of Services

The insurance industry includes two major sectors: life insurance, andproperty and casualty insurance Life insurance services include investmentand retirement products such as variable and fixed annuities, mutualfunds, and retirement plans Insurers provide both individual and corpo-rate-owned life insurance as well as individual and group disability plans

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The life insurance business is undergoing a major transformation.According to a senior insurance executive, the industry is being pulled intwo different directions:

The first direction is the commodization of the risk element of life ance, which is term insurance Life insurance heretofore has been term insurance and this other product called whole life, which is essentially term insurance with a side fund that has tax advantages designed to dis- charge the cost of term insurance [Robert Stuchiner]

insur-The result has been the proliferation of low-cost life insurance for themasses Insurers are able to provide this by reducing the cost of distribu-tion and utilizing market mechanisms to reduce overall risk

The second direction in which the industry is being pulled is towardthe asset management business Stuchiner continues:

The other direction the market is taking us is the whole asset-gathering business We have the risk side and the asset-gathering side And we want to compete with the banks and the brokers In order to do that,

we have to break out of the traditional life insurance mode [Robert

Stuchiner]

The second insurance sector, property and casualty insurance, includesitems such as workers’ compensation and property, auto, liability, marine,and agricultural insurance It also includes business and fire insurance.This sector has been rocked by a changing political environment, duemost notably to the events of September 11, 2001

Many firms also provide reinsurance products and services In thismarket, insurance companies purchase and assume obligations originated

by other institutions This is increasingly becoming a global market asfavorable accounting treatments outside the United States push this mar-ket overseas

Key Risks

As I stated earlier—this is a risk business Insurance is no exception

The insurance industry is all about risk Another way of saying this is,

“It is all about guarantees.” It’s about protecting people from risk You pay me a premium, and I’ll pay you if a specific event occurs A lot of the products that have savings elements say, “You pay me money, and I’ll guarantee you such and such a return And I have the risk to make

money on that promise.” One of the industry’s challenges is to stand the cost of the guarantee that is embedded in its products And to get adequately compensated for that cost [Patricia Guinn]

under-Insurance companies face a number of specific risks They take money

in from premiums and invest those funds to cover expenses As investors,they face the same risks as banks and securities firms in their proprietarytrading activities Unlike those for banking and securities firms, however,investment goals for insurance companies are tied to the expected payoutsfor future claims Life insurers face the risk that actual mortality rates willdiffer from projected rates so as to create a shortfall of funds to pay ben-efits Property and casualty insurers face risks related to the constructionand use of property and to the exposure and degree of liability claimsagainst policyholders

Profit Dynamics

There are three primary revenue components for insurers:

policies, and mutual funds

Primary costs for insurance firms include:

part

Other Players

There are dozens of other organizations that play important roles in theFSI You should get to know these firms too The following is a partiallist:

■ Finance companies and depository institutions These firms lend money

by raising funds in money and capital markets Other institutionsaccept consumer deposits and often pay higher-than-market rates ofreturn This category also includes subsidiaries on nonfinancial com-panies such as GMAC, GECC, and Ford Motor Credit

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■ Regulators Banking, securities, and insurance regulators establish and

enforce the rules of the market Hold on to your hat as the market tinues to sort itself out

con-■ Credit rating agencies These agencies evaluate the creditworthiness of

companies and debt issuances They provide valuable risk informationthat is used by key players in the financial marketplace

■ Clearing corporations These organizations facilitate securities trading

by netting out broker/dealer positions to guarantee that buyers gettheir securities and sellers get their money

■ Funds transfer systems These are systems that move money around the

world; they include the so-called electronic funds transfer (EFT) tems such as Fedwire, CHIPS, ACH, and SWIFT

sys-■ Trading execution venues These include exchanges, over-the-counter

markets, electric communication networks (ECNs), and trading portals

■ Credit card associations These organizations, such as Visa and

MasterCard, facilitate credit card transactions around the world

In today’s dynamic environment it is hard to tell the players—even with

a scorecard

Dangerous Curves Ahead

As banks, securities firms, and insurance companies branch out into anew product and service arenas, the key question becomes “How is thisall going to shake out?” Nobody knows

The rules that were inhibitions—the players competing with each other—those rules are changing I think how those rules are applied and how they are implemented in the marketplace, not just by regulators, has yet to be seen What is the financial supermarket? Is it the Citi model? Is it the Chase model? Is it the DeutscheBank model? Is it the UBS model? Or is the Merrill mode going to continue? The changing laws are setting for the stage for the market to figure out which way to

go Is there a right answer? My guess is, there is no right answer.

[Micah Green]

Calling All Providers

In the Introduction, I noted that this book was targeted at Insiders,Providers, and Observers I hope all of you have learned something up tothis point This section of the chapter is the first in a series of segments inthe book directed at Providers—those folks who sell to the industry.Although anyone is allowed to read anything they want, this information

is intended to help Providers be more effective in changing times Providers may want to move to the chapter review (p 17)

Non-The key message for you Providers out there is that this industry is

diverse, dynamic, developing, and any other d word you can think of.

And it is always changing So here are some suggestions

Know Your Customer!

I know that in Selling 101 they taught you to know your customer, but

in this industry it really matters Even basic things like names can bedeceiving Although your client may call itself a bank, that doesn’t meanthat it does only what a traditional bank has always done Chapter 6 willprovide you with a framework for understanding the industry, the insti-tutions, and the individuals with whom you are working

Throw Out Your Assumptions

Because you already have some relationship with a bank or a securitiesfirm or an insurance company, you probably think you know somethingabout these institutions Fagettaboutit! Financial institutions are incredi-bly complex and fungible Those nice brochures you pick up in yourbank’s branch or the disclaimers on your brokerage account statements donot provide you with a clue about what is really going on down in thebowels of these institutions

Everything in This Book Is a Lie

Well, not really The heading above is a lie (Think about it.) The fact thateverything in this industry moves so fast (Have I mentioned that?) meansthat the shelf life of anything you know or think you know is becomingincreasingly short

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The following table should be used as a guide:

The moral of the story is: You must stay current! Keep up with what isgoing on in the industry This means more than watching a few minutes

of your local financial television network each morning It also meansmore than reading the business section of the newspaper It involveskeeping your head in the game Talk to people at work Talk to your cus-tomers Build a network of people inside and outside your firm to get thelatest information

In Review

The financial services industry is on a journey, a journey of change.Change is nothing new to financial services; however, today the industryfinds itself in a new era of unprecedented upheaval

The following is a quick review of the traditional sectors of the industry

Banks

■ Products/services: Banks provide loans; investments in government,

municipal, and (most recently) corporate securities; foreign exchangetrading; and a variety of fee-based services

■ Risks: Banks face credit risks on loans, and investment risks in the

secu-rities and foreign exchange (FX) businesses

■ Profits: Banks’ profits come from interest income versus interest

expense and non-interest income versus non-interest expense

Securities Firms

■ Products/services: Securities firms provide brokerage services, dealer

services, and a variety of fee-based offerings Also included in this egory are investment management companies and other private invest-ment firms

cat-■ Risks: Securities firms must worry about successful completion of

transactions for brokerage customers and trading risks for their dealerbusiness

■ Profits: Revenue sources include commission income, trading gains,

investment banking income, and interest and dividend income fromsecurities held Expenses include employee compensation and benefits,commissions and floor brokerage expenses, communication and sys-tems expenses, and interest expense

Insurance Companies

■ Products/services: Life insurance firms provide individual and business

life insurance, investment, and retirement products Property andcasualty insurers provide a wide range of guarantees based on theoccurrence of future events

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