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History of Banking

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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 alreadyestablished 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 GrammLeach-Bliley Act. It repealed the Glass Stegall Act of 1933. Simply stated, the Gramm-LeachBliley 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 TokyoMitsubishi 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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