• Loan commitments. Banks receive a flat fee for extending a loan commitment of a certain amount of funds for a period of time, regardless of whether the full amount is drawn down by the borrower. When the borrower uses the loan commitment, either in full or in part, the used portion of the commitment is recorded on the bank's balance sheet. The unused portion remains off its balance sheet.
• Letters of credit. When a bank provides a letter of credit, it guarantees a payment (up to the amount specified in the letter of credit) on behalf of its customer and receives a fee for providing this guarantee.
• Insurance services. Many banks, particularly those outside the United States, offer insurance products to broaden their customer base. Insurance services are a logical progression for banks since insurance products have financial intermediation and asset transformation features similar to traditional bank products. Life insurance policies, for instance, are often similar to many of the long-term deposit products that banks offer: all are savings tools, but they deliver their savings benefits differently.
• Trust services. Some bank customers, particularly wealthy individuals, corporate pension plans, and estates, prefer to have professionals manage their assets. Therefore, many banks offer trust services that professionally manage a customer's assets for a fee. These assets under management do not show up on the balance sheet of the bank.
• Risk management services. As banks have expanded into more complex businesses, they have had to confront more complicated and composite risks such as interest rate, exchange rate, and price risks. Banks have developed sophisticated skills and complicated tools to manage these complex risks. For a fee, banks now offer the same risk management skills and tools to their customers.
This section illustrates different types of banks by focusing on the types of customers served and the range of services offered. Variations of the types of banks described here exist in different parts of the world.
1.2.1 Retail Banks
Retail banks' primary customers are individuals, or “consumers.” Many retail banks also offer services to small and medium enterprises (SMEs).Retail banks may have different specializations:
• Retail and consumer banks, savings and loans companies (thrifts, building societies), cooperatives, and credit unions. These offer loans primarily to individuals to finance house, car, or other purchases (e.g., Woodlands Bank in the United States, TSB Bank in the United Kingdom, or OTP Bank in Hungary). The particular features of cooperatives and credit unions are addressed below.
• Private banking firms. These provide wealth management services, including tax and investment advice, typically to rich individuals (e.g., Coutts & Co. in the United Kingdom and Bank Julius Baer in Switzerland).
• Postal banks. These offer banking services to customers in post offices. This structure, where the postal service owns or collaborates with a bank, is widely used throughout the world (e.g., Postbank A.G. in Germany, Japan Post Bank in Japan).
Although retail banks can come in many forms, most have a network of local branches that enable them to focus on retail consumers in one specific geographic area such as a city or a region of a country. However, there are a number of very large retail banks that have extensive branch networks that cover entire countries or portions of countries (e.g., HSBC and Industrial and Commercial Bank of China) and link to retail branches in networks owned through their affiliated entities in other parts of the world (e.g., Citigroup and Santander).
1.2.2 Wholesale Banks
Wholesale banks' customers are primarily corporate and noncorporate businesses. Although the range of business customers varies, it usually includes larger domestic and international companies. Wholesale banks also offer advisory services tailored to the specific needs of large businesses. Types of wholesale banks include:
• Commercial banks. These offer a wide range of highly specialized loans to large businesses, act as intermediaries in raising funds, and provide specialized financial services, such as payment and risk management services.
• Correspondent banks. These offer banking services to other banks, often in another country, including loans and various investment alternatives.
• Investment (sometimes called “merchant banks”). These offer professional advice to corporations and governments about raising funds in the capital markets such as the stock, bond, or credit markets. In the case of companies, they also provide advice on buying or selling companies as a whole or in part. In the case of governments, they will advise on privatizing public assets. They may also serve as underwriters and investors in these activities.
BANKING IN FOCUS
The number of investment or merchant banks has diminished since 2008 due to the effects of the global financial crisis that started in 2007.
In 2008, in the wake of the collapse of the subprime mortgage market, investment banks Bear Stearns and Lehman Brothers went out of business. Bear Stearns was sold to JPMorgan Chase, and
Lehman Brothers declared bankruptcy. Merrill Lynch, the third largest investment bank in the United States, merged with Bank of America. Two of the remaining major U.S. investment banks, Goldman Sachs and Morgan Stanley, legally converted their operations to those of bank holding companies. This move allowed them to accept deposits and thereby raise funds through customer deposits to support their ongoing operations. It also gave them access to emergency funding from their central bank, which was perhaps more important than their new ability to collect deposits.
This was a monumental change to banking because the investment banking model – which relies on accessing the credit markets daily for financing while being exposed to financial market risks – has been called into question.
In Europe, some large banks, such as Barclays, reduced their investment banking activity, although because they had significant businesses in other areas (such as retail banking) they were better able to survive than those banks that were wholly reliant on investment banking business.
Although the large investment banks in the United States have either converted to banks or collapsed, there are still investment banks remaining in the United States. Many of them are smaller, highly specialized investment banks. They are not as reliant on wholesale funding, and typically focus on providing advice to corporate customers about raising money in the financial markets (e.g., Keefe, Bruyette & Woods).
Many wholesale banks finance international trade and often operate in several countries through representative offices or smaller branches. These banks are known as international, multinational, or global banks. Banks that offer financial services, including insurance, along with the core banking functions are called universal banks. Citibank, Deutsche Bank, HSBC, and BNP Paribas are examples of large universal banks.
1.2.3 Bank Holding Companies
Bank holding companies are companies that own one or more banks but do not conduct banking business themselves. Bank holding companies are primarily a feature of the U.S. banking system where regulators were concerned to limit the ability of banks to engage in nonbanking activity. Bank holding companies could own subsidiaries that, between them, covered the full range of financial service activities, but each individual operating institution engaged in only a limited sector of the financial markets.
When analyzing U.S. banks, it is important to differentiate between the holding company or the operating company. For example, Wells Fargo & Company is a holding company that owns Wells Fargo Bank. It is Wells