History of Banking by leader6

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									                                            Introduction

        The financial services industry has changed significantly over the years as a result of
globalization of the economy and banking deregulation. Financial institutions have been forced
to change managerial strategies and services offered to survive in today’s competitive, technical
landscape. In this analysis, team 6 will supply a banking industry analysis by providing
information regarding the following topics: the history of banking, bank regulations and
deregulation, major effects of deregulations including consolidations and financial services,
international banking and technology.

                                        History of Banking


Early Banking
        Commercial banking started in the New World before there were even establishments
that called themselves banks. Merchants in colonial times used to act as banks by exchanging
bills of credit, trading capital, and transferring liabilities from balance sheet to balance sheet. The
first commercial bank opened in 1782 in Philadelphia, soon after the Bank of North America was
given a perpetual charter. This bank would be the first in US history to exchange paper money
for gold and silver. The bank of Philadelphia was also the first to do business with one primary
goal in mind: make profits for its owners. More banks of its kind started to appear in other states,
as they were clearly an entity that facilitated increased economic activity.


Spread of Banks
        It became clear to states without banks that those with them were prompting local funds
to cross state lines. As a result, states began competing with each other to receive banking
charters, a demand that would increase the number of banks greatly. Also, communities too
distant from their state banks started requisitioning charters, much to the dismay of the already-
established banks who were enjoying their profitable monopolies. Because many banks usually
catered to the needs of certain borrowers, such as businesses, farmers, and private individuals,
different economic sectors within states stressed their need for these economic proponents. The
Secretary of the Treasury Albert Gallatin stated in 1811 that, “The banking system is now firmly
established” (Klebaner, 1990, p. 11). Some disagreed with him, however, claiming that banks
and their money were overrunning the country. Dollar amounts issued from commercial banks




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quickly surpassed the amount of gold and silver that backed these notes, which would prove
troublesome later on.
        After the Second Bank of the United States opened in 1816, hundreds of banks began
opening and by 1860 totaled some 1,500. Clearly, the services offered by early banks have
created the framework of what would continue to be a successful industry through good times and
bad.


Surviving Industry
        The Panic of 1907 is an important event that had a major impact on the banking industry.
With Americans taking to the trend of using cash, banks having considerably more dollars in
deposits than in reserves became very vulnerable to run. After numerous banks throughout the
nation failed because of this, there emerged the need for a means of assuring depositors that their
money was secure. The panic resulted in the institution of a system that would save many banks
from failing and instill a great amount of confidence in their customers. In 1913, the National
Monetary Commission passed the Federal Reserve Act, creating a system that is one of the most
powerful influences on the financial services industry of today. Although the Fed would act as an
aid to the industry, there was nothing it could do to save it from the harsh times to come.
        Perhaps the worst blow ever dealt to the banking industry occurred during The Great
Depression. Hundreds of banks were forced to close in an industry that suffered more than in any
other developed country (Klebaner, 1990, p. 149). But banking became profitable once again in
the mid 1930's and was uplifted by the swelling economy during World War II. The industry had
managed to persevere through some of the country's toughest times and was leaning toward a
prosperous future.


Modern Banking
        Major changes to the banking industry were occurring after 1945, mostly due to the
increased strength of the US economy. One of these changes was the cost-effective trend of
branching instead of merging or acquiring other banks. They were eager to expand their market
share by branching out within their states and reaching more customers. Although many states
absolutely forbade branching, others allowed banks to open numerous branches. The adverse
impact this had on small banks was anticipated, but most of them were able to withstand the
competition.
        Another change to the banking industry was the growing number of bank holding
companies. These entities were recognized at the federal level in the late 1950's and by 1965



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there were over 500 in existence (Klebaner, 1990, p. 184). They continued to expand in number
and gained prominence in the industry by acquiring a substantial amount of total bank assets.
These non-financial companies are good examples of how big corporations began expanding their
range of services by infiltrating other industries.
        The banking industry in the latter half of the 20th century experienced a foreign-interest
trend. The overseas markets enticed domestic banks to branch out, and the lack of regulation was
an added bonus. Also, the US had increased its investments internationally, prompting banks to
follow the economic activity.
        One other change occurring in the industry over last few decades is consolidation. Due to
the continuous growth of the US economy in recent years and accompanying deregulation of the
financial services industry, it is possible for corporations to expand their market share by merging
and acquiring banks and related institutions. In the 21st century, Allen Greenspan and the Federal
Reserve are looking to slow economic growth by raising interest rates, thereby reducing excess
spending that has buried many Americans in debt (Somerville, 2000). It is not known whether or
not this will work, because the Fed has been attempting to slow growth for a number of years.


Banking: Today and Tomorrow
        With the swift advancement of technology overwhelming every arena of economic
activity, banking is taking a drastic turn in its efforts to thrive. The entire scope of expansion in
market share and customer base is now being accomplished through consolidation and electronic
facilities. Globalization of the economy is also in effect thanks to incredible advances in
communications, especially via the Internet. Financial services companies that mimic
supermarkets of financial services will be arriving on the scene, making a competitive market that
will be inhospitable to traditional banks.


Key Point
        The banking industry has proven to be enduring and prosperous throughout the course of
American history. Continuous economic growth and increased spending by consumers in the past
years have created a more profitable market for financial service organizations. In addition, the
gradual change toward deregulation and resulting consolidation gives large corporations the
opportunity to spread themselves into numerous financial service arenas. By doing this, they are
able to offer banking, mortgage, insurance, brokerage and a host of other services that will attract
customers more than a simple bank would. Combine that aspect with globalization and it




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becomes apparent that the banking industry in America is under an incredible strain to take action
or disappear amidst financial service giants. (See Appendix A for timeline)


                                 Regulations and Deregulations


What’s New in Banking Industry Reform?
        In November of 1999, Congress passed a banking reform act known as the Gramm-
Leach-Bliley Act. It repealed the Glass Stegall Act of 1933. Simply stated, the Gramm-Leach-
Bliley Act allows banks, brokerages companies, investment banks, and insurance companies to
merge. It ends 66 years of strictly regulated separation of these industries (Mann, 1999, October
26).


Glass-Stegall act of 1933
        The original idea behind the Glass-Stegall Act in 1933 was that the separation between
bankers and brokers would reduce the potential conflicts of interest that were thought to have
contributed to the speculative stock frenzy before the Depression. In addition, it would provide
safe harbor for the money of ordinary Americans by enabling them to put their money in accounts
that were protected by deposit insurance and insulated from more speculative investments like
stocks (Labaton, 1999, October 23). (See Appendix B for further information)


Resulting Change
        This change concludes decades of attempts to rewrite banking laws to catch up with a
marketplace that has already experienced broad consolidations and the rise of financial
conglomerates offering bank and brokerage accounts as well as insurance. While these
conglomerates have found ways around the old rules, those rules made it expensive and at times
impossible to expand into new lines of financial services. For instance, the nation’s largest
financial services company, Citigroup, forced its insurance operations as part their $72 billion
merger in 1998 between Citibank and Travellers Group, without legislation (Garten, 1999,
October 26).
        By allowing these mergers, it will enable financial institutions to offer corporate clients a
full range of services, from traditional loans to investment banking services, like public stock
offerings. For consumers, it paves the way for financial supermarkets, which will be able to offer
“one stop shopping” for an array of services, all under one roof. The measure is also expected to
clear a path for a new and bigger wave of corporate deal making as more companies consolidate.



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The Reaction of Consumer Groups Civil Rights Advocates
        They criticized it as being something that would benefit the nations largest financial
institutions. They said that it fails to protect the privacy interests of consumers and community
lending standards for the disadvantaged and that it will create more problems than it will solve
(Labton, 1999, November 5).


Benefits of this Legislation
        This legislation should save consumers billions of dollars. The White House estimated
that it would save consumers as much as $18 billion a year as new financial conglomerates gain
economies of scale and cut costs. Senator Schumer, Democrat of New York said, “There are
many reasons for this Bill, but first and foremost is to ensure that U.S. financial firms remain
competitive” (Labton, 1999 November 5). Jeffery E.Garten, former senior Commerce
Department official and current dean of the Yale School of Management stated, “If executives
can manage these large entities effectively, Americans – in their role as consumers, investors, and
even employees ought to benefit from these new, competitive companies, receiving more and
better goods and services at lower costs.” He also said, “The Clinton Administration inherited an
agenda for financial liberalization and we pushed for it. This push was part of a global
ideological shift in favor of free markets, as well as an increasing enthusiasm among developing
countries themselves for lifting restrictions on the flow of money” (Kristof, 1999 February 16).


Today’s Regulating Bodies
        The four governing bodies that regulate and deregulate laws are: The Federal Deposit
Insurance Corporation (FDIC), The Federal Reserve, The U.S. Securities and Exchange
Commission (SEC) and the Office of the Comptroller of the Currency. (See Appendix C, D, E
and F for further information about the above four bodies)


                                  Major Effects of Deregulation


Rise of Bank Fees
        Banks are in the business of "buying" and "selling” money. They buy from depositors
and sell to borrowers. Due to regulations, banks were never forced to compete in regards to



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prices because they were all predetermined. With deregulation came competition creating lower
prices to attract possible customers. Banks were forced to work longer hours and offer a variety
of other services. Increased competition had a definite impact because banks were forced to loan
money for lower interest rates and at the same time pay more for deposits. They took a hit from
both directions (Rakes, 2000). The introduction of bank fees occurred because banks simply
needed to replace revenues lost from the savings and loan industry. Banks argue that no "new
money" is being charged but rather there has only been a shift. It merely makes up the difference
between lower interest rates on loans and the introduction of interest paid on their checking
accounts in comparison to when bank fees were not yet implemented. Common fees in today’s
financial arena include ATM fees, overdraft charges, late payment fees, yearly credit card fees,
fees for checks, monthly service charges and penalties if proper balances are not maintained for
designated accounts.


Rise of Financial Services and Financial Institutions
        As the banking industry became less and less regulated, banks were forced to find
alternate methods of revenue. The old fashioned profit spread between loan interest revenue and
deposit interest expense was no longer substantial enough to keep banks afloat. With increased
competition came decreased profits in the savings and loan industry described above. These
deregulations put an especially tight noose around the necks of regional banks because they did
not have the resource capability or the required national exposure, as did some of the larger
banks. Therefore, in an effort to keep their doors open, regional and national banks alike were
forced to change the structure of the operation from a savings and loan atmosphere to a "financial
institution." As a financial institution, a bank might offer credit card services, capital markets
services, asset management services, mutual funds services and investment banking services.
These interrelated financial services are a prime determinant of success in today's market driven
economy.


Credit Cards and Bankruptcy
        In 1997, the banking industry was astonished by the rapid growth in consumer
bankruptcies (Standard and Poor’s Industry Analysis). This was a surprise to many due to the
bullish qualities of the current economy. Through careful analysis, many industry specialists
place the blame of rising bankruptcy on the aggressive marketing practices of creditors saying
that these credit cards push consumers into a lifestyle that they cannot afford.




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         This increase in bankruptcy has definitely had its effect on the industry as a whole.
Estimated consumer bankruptcies have cost creditors nearly $95 billion in 1998, and $154 billion
in 1999. These losses come right back to the consumer in the form of higher fees and interest
charges. Unfortunately, responsible borrowers are the people paying for others who have
managed their finances poorly. Many low-income families are also punished because of the
difficulty and expense related to having a credit card. Credit cards have undoubtedly left their
fingerprint on the banking industry (Standard and Poor’s Industry Analysis).


Other Common Financial Services
        The first topic to be discussed is the capital markets service. Capital markets include any
service where the bank acts as an intermediary (broker) between the client and the company
issuing the loan or selling a particular stock or security. The bank essentially completes the link
between the client and the companies issuing the loans or securities. Asset management is
another common service offered by financial institutions. Asset management is extremely broad
as to what it actually entails. It can range from protecting, monitoring, and tracking Information
Technology equipment to financial asset management. Financial asset management relates to the
valuation of one's assets by a professional who monitors and recommends possible ways to make
the most of their assets. This can be on a commercial or private basis. Another type of service
that is offered by financial service institutions is mutual funds. A mutual fund is essentially a
portfolio of stocks formulated with a particular objective that investors are allowed to buy into.
Investment companies that invest pooled shareholders into mutual funds also stand ready to buy
back issued shares. This is an added bonus to shareholders. The main disadvantage of mutual
funds is the fact that the investor must pay taxes on gains from year to year regardless of whether
they pull their money out or keep it in the fund. However, there are ways to circumvent these
taxes on gains by purchasing an index fund or putting the fund in the form of an IRA (Individual
Retirement Account). These examples create tax deferrals allowing profits to gain interest.
Investment banking is yet another service that is offered. This refers to an individual or an
institution that acts as an agent (capital markets) for corporations or municipalities offering
securities. Investment banks do not usually accept deposits or issue loans. They also commonly
offer advisory services to investors.


How this Relates to Regional Banking
        As stated earlier, due to deregulation, banks at all levels have been forced to enter the
financial services market in an effort to survive. These financial industries have revitalized



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banking in that they are allowing many institutions to grow and prosper. Therefore, for regional
banks to survive, they must offer these services and perform them well to compete in a fierce,
global marketplace (Higgins, 1990, p.106-126). Not only must services offered change, but
management and marketing strategies must also evolve in order to survive.


Trend of Consolidation
        Increased competition caused many local banks to find themselves in a state of financial
struggle. As a result, the consolidation among banking institutions has been accelerated. Due to
consolidations, the number of FDIC banking institutions has decreased significantly over the past
25 years with bank numbers nearly being cut in half (Appendix G). Approximately 400 healthy
bank mergers occur every year. At the end of 1998, the 9 largest U.S. banks held 52% of the
industries assets due to mergers and acquisitions. Many large banks find that acquiring these
smaller banks allows them to compete more efficiently in our less regulated banking
environment. According to Standard and Poor’s, “ The banking world must consolidate further to
improve efficiency, boost sustainable profits and build a stronger foundation to withstand heated
competition from other financial service providers.” As a result of nearly 400 successful bank
mergers per year, many power banks have emerged. The five largest banks in the U.S. ranked by
assets include Citigroup Inc., Bank America Corp., Chase Manhattan Corp., Bank One Corp., J.P.
Morgan & Co. ( See Appendix H for additional information)


Management Evolution
        In the regulated environment of the past, managers emphasized growth. When pricing
was predetermined, increased volume was the means of increasing profitability. Planning was
based on "let things happen." However, these strategies changed when competition was
introduced into the banking environment due to fee income generated from services offered. The
"Let things happen" motto was quickly replaced with "make things happen" (Higgins, 1990,
p.289-292). Goals changed from volume to profitability and planning evolved from top-down to
participatory. Without implementing the managerial changes listed above, a bank’s chance of
survival is slim to none.


Marketing Evolution
        Prior to regulation, many bankers had the attitude of "let the customers come to us rather
than we go to them" (Higgins, 1990, p.289-292). In modern banking, however, the word
customer has been replaced with client. The difference between the terms is that customers seek



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service, whereas clients are sought to be served. Products are developed and created to meet the
needs of clients. These products are tailored to meet individual needs rather than fitting
everyone's needs. Promoting full service will prove to be unsuccessful in tomorrow’s
environment if banks sacrifice quality for quantity.
                                          International Banking


What is International Banking?
        International Banking is becoming a crucial area of financing for many expanding
businesses throughout the world. International Banking is the mechanism by which one can
maintain bank accounts outside of their country of residence (International Banking Services Web
site). The globalization of banking has accelerated, driven by improved technology and the
opening of economies in Eastern Europe, Asia, Latin America, and other regions. In particular,
U.S. and other international financial institutions are forging a growing presence in lending,
trading, and underwriting in these emerging markets. Organizations such as the World Trade
Organization (WTO), functioning primarily to free international trade, have contributed to
today’s global economy (Appendix I). These efforts have created closer links among the world’s
financial markets and have improved the efficiency and availability of capital. According to
Kaye Rakes, “Over the past 20 years the banking industry has not had to conduct thorough
research to “keep up with the times.” They have generally been able to go along with the
surrounding environment due to the regulations placed on them.” In these past 20 years, banks
have been an industry that would generally take in money, then loan that money out to others.
There had been no real reason to change this system. However, as the world entered the 21st
Century, the industry had to re-adjust itself and take a step forward by entering “The Global
Revolution.” A major step in this revolution was the need for new global financial architecture.


Why Global?
        The world today works together as an interdependent economy. International businesses
are growing and developing at tremendous rates. Businesses have implemented new strategic
issues and have made the move towards expanding overseas. The marketplace is now global, and
banks must step in and help handle this globalization. Many U.S. banks have correspondent bank
relationships overseas to make this international business world operate more successfully. Fifth
Third Bank for instance has over 300 correspondent bank relationships in Europe alone (Fifth
Third Bank International Website). Businesses realize that by conducting business overseas, it
allows for higher capital gains along with international recognition. When businesses and banks



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work together globally, they are taking the first step into the heart of the competition for new
markets worldwide.


Foreign Exchange Market
        The foreign exchange market is increasing immensely. Many companies have begun
conducting business globally because they realize the advantages of expanding into the
international environment. However, the foreign exchange market is one of the most
unpredictable aspects of international business. Profit margins can quickly dissolve as currencies
freely float against one another. To protect the companies against these fluctuations, many banks
have established groups of experienced Corporate Foreign Exchange Traders (Uhlick). These
traders are offered to companies to handle the international transactions being made. The traders
reassure the company for safety and minimize risk management. One of the best things that these
traders can do for a company is make the company competitive globally. They can quote
extremely competitive pricing in all freely traded currencies. This quoting ability, combined with
their expertise in foreign currency risk management, assures that the currency risk is being
managed effectively.


Multi-Currency Accounts
        When making transactions with offshore countries, many different types of currency are
involved. As a result, many banks now offer multi-currency accounts dealing with international
currency. Offshore deposits and loans can be denominated in foreign currencies or in U.S. dollars
depending on the specific requirements of the company. By offering multi-currency accounts,
corporations can better manage cash flows and maximize profits on a global basis (PWC:
Tomorrow’s Leading Retail Bank Website). For companies active in buying and selling in
foreign currencies, the avoidance of foreign exchange conversion is a major advantage. For those
companies looking to optimize the purchase or sale of foreign currency, the account provides a
vehicle to hold currency balances pending a market move. Many financial institutions now offer
multi-currency accounts. For example, Fifth Third bank offers a very nice account for companies
looking to operate globally. They offer the “Multi-Currency Advantage Account” which gives
access to a worldwide network spanning over 90 countries and a product portfolio developed to
efficiently manage your efforts throughout the global marketplace (Fifth Third Bank International
Website).




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International Retail Services
        Not every international banking service is specifically catered towards corporations.
With many people traveling to other areas of the world, banks offer international retail services
for individual. These services are intended to make international travel easier for both business
people and tourists. Some of these services may include:
       Foreign currency
       International traveler’s checks
       Drafts denominated in foreign currency
       Domestic Wire Transfers
       International Wire Transfers


Growing Competition
        Over the past twenty years, the banking industry has become a major player in the
international environment. Due to the growing international banking environment, large banks
have been developed all over the world. The largest international bank is The Bank of Tokyo-
Mitsubishi Ltd. (Appendix J). Through deregulation and tremendous business needs to expand
overseas, the opportunity for banking globalization has risen. Financial institutions that have not
moved towards the international environment are far behind their competition. As business is
conducted in the new millennium, there is a reliance on international banking services to help
maintain financial security throughout the world.


                                            Technology


Current Technologies in the field of Banking
        As the world progresses throughout the new millennium, people in every industry are
feeling the effects of what is being touted as the Digital Age. Technology is constantly making
things easier for people. The technological advancements that have already occurred in the past
10 years are astonishing and who knows where it will all end. E-commerce already seems to be
the wave of the present, and e-banking shows great potential for the future. The financial
industry is already taking steps to streamline its e-activity to stay current to the changing needs of
the customers. Banks in the brick and mortar sense may become obsolete as less costly measures
are implemented. In order to compete and survive in the future, financial institutions must be
able to adapt and to implement the technology to make e-banking a major portion of their
operations. Some examples of this are as follows:


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WingspanBank
         Bank One’s recently released Internet-only banking product tries to see things from the
customer’s standpoint. It’s a new brand that offers a wider range of services through
partnerships. Though WingspanBank (Appendix K) is a subsidiary of Bank One, they’re giving
higher interest rates on online-checking taking business away from its parent company. “The
parent company understands that they need to do that, because if they don’t, somebody else will.
They would rather be a winner in a new environment than be a loser at both.” (ABA Banking
Website, 2000)


Intuit
         This software company has practically offered a financial supermarket on its Quicken
website. They have a full range of service-investments, trading, mortgages, brokerage, insurance,
taxes, and retirement planning. This company has become another competitor in the already
crowded financial services industry. The best part about it is that Intuit did it without buying a
bank or an insurance company, opening any storefronts, and on very little assets. They’ve done it
all with by utilizing a rather complex network of associations that they’ve brought together using
technology as an interface to make it appear perfectly uniform to the customer.


Netzee
         Another example is the recent alliance between MCI Worldcom, a leader in
communication services, and Netzee, Inc., which is to offer a full package of communications
products to the community banking industry. Netzee, as a leader in banking technology, offers the
community bank Internet banking at its finest. The Netzee package is designed for community
banks to jump into the present state of the banking industry. As a Netzee customer, the
community bank will be able to offer its customers integrated, cost-effective, secure Internet
banking, and discounted telephone services to create a comprehensive service offering. Netzee is
around to provide all the valuable services that banks will need to stay competitive in the new
millennium. The company has new technology in place that is referred to as “Banking on Main
Street,” an e-commerce service that offers products and services to the retail and business
customers of the bank. Netzee offers a full Disaster Recovery Site for their Internet banking
operations, which makes dealing with them a little less worrisome. Netzee also offers cash
management modules, comprehensive telephone services, and a complete customer-marketing
program. Companies such as Netzee will play an integral part of the banking industry in the



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future by offering traditional banks the opportunity to transform themselves into financial
services companies.


w-Bank
        Another emerging technology is that of the w-Bank, or wireless bank. The w-bank was
developed by w-Trade Technologies last year to further enable access to e-business almost
anytime, anywhere. The w-Bank has the ability to access real-time checking or savings account
balance information, transfer funds between different bank accounts, pay bills electronically, and
create Intelligent Alerts that inform them of when deposits have cleared, checks have been paid,
or when other changes have been made to their accounts. The w-Bank is based on the company’s
wireless application server, which enables the system to easily support new wireless data
networks as they are introduced. The w-Bank is ideal for all people who require constant access
to their financial information, whether it is while stopped at a red light or while waiting at a
doctor’s office. w-Trade Technologies was also the first company to introduce a wireless
handheld trading solution, appropriately called w-Trade, which is currently used by more than ten
brokerages including MyDiscountBroker.com and Firstrade Securities Inc. Currently w-Trade is
a market-leading product that is the only real-time network and device independent wireless
trading system being used by brokerages anywhere in the world (BusinessWire Website, 1999).


How Will Technology Shape the Future of the Industry?
        The future of banking focuses on the ability of the community bank to implement the
advent of e-banking. Any financial institution that cannot offer its customer total Internet
Banking capabilities will be swept under the proverbial rug faster than you can say e-commerce.
The banking customer of the future will want quick and easy access to all their account
information at the click of a mouse. The customer will want to be able to go into their electronic
stock portfolio, make some adjustments, and pay his water bill at the same time, with an
electronic check from their e-wallet. The competition from such areas as Intuit, WingspanBank,
the w-Bank, and thousands of others will keep dragging any conventionalists kicking and
screaming into the Digital Age. “The Internet is a new channel, a new medium, a new
environment for delivering services, and the sooner you understand that, the more quickly you’ll
be able to do the kind of innovative things that are going to win this game” (ABA Banking
Website, 2000). In this Digital Age, the average individual seeking financial services may be an
avid online shopper and web head who prefers to do everything mouse in hand, and any firm that
limits its opportunities to just bricks and mortar automatically loses that potential customer. The



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technology is readily available and constantly evolving and community banks need to be prepared
to use it to further their gradual progression towards becoming full service financial institutions.


                                            Conclusion

        In conclusion, the financial services industry has undergone some incredible changes

over the last few years. These changes can be attributed to deregulation and globalization forcing

banks to consolidate as a means to survive. These consolidations have given rise to bank

superpowers that offer a wide variety of financial services creating intense competition. In today's

market driven economy, the emphasis is on profit, rather than volume giving rise to an overall

change in the banking atmosphere. In an industry that by no means caters to the weak, a modern

financial institution must be technically advanced and ready to adapt to an ever-changing

environment if they want to survive.




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