In this age of globalization, the key to survival and success for many financial institutions is to cultivate strategic partnerships that allow them to be competitive and offer diverse services to consumers. In examining the barriers to - and impact of - mergers, acquisitions and diversification in the financial services industry, it's important to consider the keys to survival in this industry:
- Understanding the individual client's needs and expectations
- Providing customer service tailored to meet customers' needs and expectations
In 2008, there were very high rates of mergers and acquisition (M&A) in the financial services sector. Let's take a look at some of the regulatory history that contributed to changes in the financial services landscape and what this means for the new landscape investors now need to traverse.
Diversification Encouraged by Deregulation
Because large, international mergers tend to impact the structure of entire domestic industries, national governments often devise and implement prevention policies aimed at reducing domestic competition among firms. Beginning in the early 1980s, the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germaine Depository Act of 1982 were passed.
By providing the Federal Reserve with greater control over non-member banks, these two acts work to allow banks to merge and thrift institutions (credit unions, savings and loans and mutual savings banks) to offer checkable deposits. These changes also became the catalysts for the dramatic transformation of the U.S. financial service markets in 2008 and the emergence of reconstituted players as well as new players and service channels. (For more on this, check out our Financial Crisis Survival Guide special feature.)
Nearly a decade later, the implementation of the Second Banking Directive in 1993 deregulated the markets of European Union countries. In 1994, European insurance markets underwent similar changes as a result of the Third Generation Insurance Directive of 1994. These two directives brought the financial services industries of the United States and Europe into fierce competitive alignment, creating a vigorous global scramble to secure customers that had been previously unreachable or untouchable.
The ability for business entities to use the internet to deliver financial services to their clientèle also impacted the product-oriented and geographic diversification in the financial services arena.
Asian markets joined the expansion movement in 1996 when "Big Bang" financial reforms brought about deregulation in Japan. Relatively far-reaching financial systems in that country became competitive in a global environment that was enlarging and changing swiftly. By 1999, nearly all remaining restrictions on foreign exchange transactions between Japan and other countries were lifted. (For background on Japan, see The Lost Decade: Lessons From Japan's Real Estate Crisis and Crashes: The Asian Crisis.)
Following the changes in the Asian financial market, the United States continued to implement several additional stages of deregulation, concluding with the Gramm-Leach-Bliley Act of 1999. This law allowed for the consolidation of major financial players, which pushed U.S.-domiciled financial service companies involved in M&A transactions to a total of $221 billion in 2000. According to a 2001 study by Joseph Teplitz, Gary Apanaschik and Elizabeth Harper Briglia in Bank Accounting & Finance, expansion of such magnitude involving trade liberalization, the privatization of banks in many emerging countries and technological advancements has become a rather common trend. (For more insight, see State-Run Economies: From Public To Private.)
The immediate effects of deregulation were increased competition, market efficiency and enhanced consumer choice. Deregulation sparked unprecedented changes that transformed customers from passive consumers to powerful and sophisticated players. Studies suggest that additional, diverse regulatory efforts further complicated the running and managing of financial institutions by increasing the layers of bureaucracy and number of regulations. (For more on this topic, see Free Markets: What's The Cost?)
Simultaneously, the technological revolution of the internet changed the nature, scope and competitive landscape of the financial services industry. Following deregulation, the new reality has each financial institution essentially operating in its own market and targeting its audience with narrower services, catering to the demands of a unique mix of customer segments. This deregulation forced financial institutions to prioritize their goals by shifting their focus from rate-setting and transaction-processing to becoming more customer-focused.
Challenges and Drawbacks of Financial Partnerships
Since 1998, the financial services industry in wealthy nations and the United States has been experiencing a rapid geographic expansion; customers previously served by local financial institutions are now targeted at a global level. Additionally, according to Alen Berger and Robert DeYoung in their article "Technological Progress and the Geographic Expansion of the Banking Industry" (Journal of Money, Credit and Banking, September 2006), between 1985 and 1998, the average distance between a main bank and its affiliates within U.S. multibank holding companies has increased by more than 50%, from 123.4 miles to 188.9 miles. This indicates that the increased ability of banks to make small business loans at greater distances enabled them to suffer fewer diseconomies of scale and boost productivity. (To learn more, check out Competitive Advantage Counts.)
Deregulation has also been the major factor behind this geographic diversification, and beginning in the early 1980s, a sequence of policy changes implemented a gradual reduction of intrastate and interstate banking restrictions.
In the European Union, a similar counterpart of policy changes enabled banking organizations and certain other financial institutions to extend their operations across the member-states.Latin America, the transitional economies of Eastern Europe and other parts of the world also began to lower or eliminate restrictions on foreign entry, thus enabling multinational financial institutions headquartered in other countries to attain considerable market shares.
Transactions without Boundaries, Borders
Recent innovations in communications and information technology have resulted in a reduction in diseconomies of scale associated with business costs faced by financial institutions contemplating geographic expansion. ATM networks and banking websites has enabled efficient long-distance interactions between institutions and their customers, and consumers have become so dependent on their newfound ability to conduct boundary-less financial transactions on a continuous basis that businesses lose all competitiveness if they are not technologically connected.
An additional driving force for financial service firms' geographic diversification has been the proliferation of corporate combination strategies such as mergers, acquisitions, strategic alliances and outsourcing. Such consolidation strategies may improve efficiency within the industry, resulting in M&As, voluntary exit, or forced withdrawal of poorly performing firms.
Consolidation strategies further empower firms to capitalize on economies of scale and focus on lowering their unit production costs. Firms often publicly declare that their mergers are motivated by a desire for revenue growth, an increase in product bases, and for increased shareholder value via staff consolidation, overhead reduction and by offering a wider array of products. However, the main reason and value of such strategy combinations is often related to internal cost reduction and increased productivity. (For further reading, check out What Are Economies of Scale?)
Unfavorable facts about the advantages and disadvantages of the major strategies used as a tool for geographic expansions within the financial services sectors were obscured in 2008 by the very high rates of M&As, such as those between Nations Bank and Bank of America (NYSE:BAC), Travelers Group and Citicorp (NYSE:C), JP Morgan Chase (NYSE:JPM) and Bank One. Their dilemma was to create a balance that maximized overall profit.
The conclusion regarding the impact, advantages and disadvantages of domestic and international geographic diversification and expansion on the financial service industry is the fact that with globalization, the survival and success of many financial service firms lies in understanding and meeting the needs, desires and expectations of their customers.
The most important and continually emerging factor for financial firms to operate successfully in extended global markets is their ability to efficiently serve discerning, highly sophisticated, better educated, more powerful consumers addicted to the ease and speed of technology. Financial firms that do not to realize the significance of being customer-oriented are wasting their resources and eventually will perish. Businesses that fail to recognize the impact of these consumer-driven transformations will struggle to survive or cease to exist in a newly forged global financial service community that has been forever changed by deregulation. (To learn more about this industry, check out The Evolution of Banking.)