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Environment
Sovereign Risk
Sovereign Risk essentially looks at economic
and political risk of the country in which a bank:
Has its headquarters (its home country);
Has operations (its host countries).
Requires bank analysts to work closely with
country economists within their organisation.
Complex subject:
A Process, Not Only A Set Of Formulas
Dynamic process:
Volatility and Unpredictability
Use both Quantitative and Qualitative Analysis
Increasing Focus on Financial System
Sources of Sovereign Risk
COUNTRY MARKET
FUNDAMENTALS EXPECTATIONS
More
Prudential Regulation
Medium Risk in
High Risk in
Short Term
Short & Long Term
High Risk in Long Term
Less
Less More
Competition
Bancassurance/Financial
Conglomerates
Bancassurance
Bancassurance (Allfinanz in Germany)
Combination of banking with insurance business in one financial
group.
Increasingly common in Europe.
Universal banking
Combination of banking with securities business in one financial
group.
Illegal in US from 1933 to 1999 (Glass Steagall Act)
Introduced in response to Wall Street Crash/Great Depression.
1929 Crash triggers banking failures.
FDIC established by Glass Steagall.
Commercial banks limited to earning 10% income from securities
business.
Revoked in 1999. Gramm-Leach-Bliley Act eliminated restrictions on
affiliations between commercial and investment banks.
Development of Bancassurance I
Development of Bancassurance II
Top 30 Bancassurance Groups in
the EU
Top 30 Bancassurance groups in the EU
(As of end 2001, total consolidated assets in billions)
1 Deutsche Bank Germany 917.7
2 Allianz Germany 911.9
3 BNP Paribas France 825.3
4 HSBC Holdings UK 778.6
5 ING Group Netherlands 705.1
6 ABN Amro Holding Netherlands 597.4
7 The Royal Bank of Scotland Group UK 590.0
8 Barclays UK 573.5
9 Crdit Agricole France 563.3
10 Socit Gnrale France 512.5
11 Fortis Belgium 475.4
12 AXA France 474.0
13 Santander Central Hispano Spain 355.9
14 Dexia Belgium 351.3
15 Banca Intesa Italy 313.2
16 Lloyds TSB Group UK 312.9
17 Banco Bilbao Vizcaya Argentaria Spain 305.5
18 Abbey National UK 303.3
19 Aviva UK 300.9
Source: Based on information from
20 Groupe Caisse dEpargne France 285.9 Bankscope and Isis. Assets are on a
21 Aegon Netherlands 264.1 consolidated basis if available. Formatted by
22 Almanij Belgium 259.3 European Central Bank
23 Prudential UK 255.8
24 Nordea Sweden 241.5
25 Generali Assicurazioni Italy 222.9
26 Credit Mutuel - CIC France 218.8
27 Danske Bank Denmark 209.0
28 UniCredito Italiano Italy 208.2
29 Munich Re Group Germany 190.1
30 San Paolo IMI Italy 169.3
European Bancassurance Deals I
Acquirer Sector Country Target Sector Country Year Value
Allianz Ins DE Dresdner Bank Bank DE 2001 22.3
Lloyds TSB Bank UK Scottish Widows Ins UK 2000 12.0
Group Fund & Life
Fortis Ins BE Gnrale de Bank BE 1998 10.5
Banque
Nationale Ins NL NMB Postbank Bank NL 1991 5.6
Nederlanden Groep
ING Groep Ins NL BBL Bank BE 1997 4.1
Abbey Bank UK Scottish Provident Ins UK 2001 2.9
National
Dexia Belgium Bank BE Financial Security Ins US 2000 2.7
Assurance
Irish Bank IE Irish Life Ins IE 1999 2.7
Permanent
ING Groep Ins NL BHF Bank Bank DE 1999 2.3
Lloyds TSB Bank UK Lloyds Abbey Life Ins UK 1996 2.1
Group
Wuestenrot Bank DE Wuerttembergische Ins DE 1999 2.1
Beteiligung Versicherung
SEB Bank SE Trygg-Hansa Ins SE 1997 2.0
European Bancassurance Deals II
Acquirer Sector Country Target Sector Country Year Value
Fortis NL Ins NL Banque Gnrale Bank LU 2000 1.8
du Luxembourg
Banco Bank ES Cia de Seguros Ins PT 2000 1.7
Santander Mundial
Central
Hispano
Halifax Group Bank UK Equitable Life Ins UK 2001 1.7
Sampo Ins FI Leonia Bank Bank FI 2000 1.7
Fortis Ins NL ASLK-CGER Bank BE 1999 1.5
RBS Bank UK Churchill Insurance Ins UK 2003 1.5
Caixa Geral Bank PT Cia de Seguros Ins PT 2000 1.4
de Depositos Mundial
Fortis Ins BE MeesPierson Bank NL 1997 1.3
ING Groep Ins NL BHF Bank Bank DE 1998 1.3
ING Groep Ins NL Crdit Commercial Bank FR 1999 1.2
de France
Unidanmark Bank DK Tryg-Baltica Ins DK 1999 1.2
Forsikring
Assicurazioni Ins IT Banca della Bank CH 1998 1.1
Generali Svizzera Italiana
Regulatory Issues
There is a regulatory challenge arising
from bancassurance.
Banks typically calculate capital adequacy
based on risk of assets;
Insurers typically calculate capital requirement
based on risk of liabilities;
Inconsistency of approach.
Risk of:
Double gearing on capital;
Regulatory arbitrage.
Joint Forum
Tripartite Forum composed of:
Basel Committee of Banking Supervisors;
IOSCO (International Organization of Securities Commissions);
IAIS (International Association of Insurance Supervisors).
Last set of proposals for regulatory capital issued by
Joint Forum in 1999.
EU has implemented the Financial Conglomerate
Directive.
Requires full consolidated supervision of financial
conglomerates.
Prompted the US to introduce the Consolidated Supervised
Entity for broker/dealers.
Solvency 2
EU has not yet standardised insurance company
capital regulation with that of banks and
securities firms.
Solvency 2 is a draft set of proposals:
Will introduce a three pillar approach to insurance
capital adequacy.
Parallels drawn with Basel 2.
Pillar 1 (capital requirement) will still be set
specifically for insurance companies.
Aims to enhance insurance risk management in same
way as Basel 2 has done for banks.
Bancassurance
Perceived Benefits
Cross Selling.
Insurance firms can use branch network of banks to sell
products.
Bank can use data mining techniques to target remote
advertising at its clients.
Brand Leverage.
Banks often have more customer loyalty than insurance firms,
which can trigger increased sales for the insurance company.
Surprisingly not many mergers have resulted in the introduction
of a single name across the whole group.
Internal Regulatory Arbitrage.
Although regulators try to avoid outright double gearing, it is
possible to set up a booking matrix showing which products
should be booked in which company to achieve lowest capital
charge.
Bancassurance
Potential Problems
Cultural Problems.
Bankers & Insurers tend to have quite different outlooks on
business.
Insurance often less customer focused.
Capital is more transient in insurance.
Easier to close an insurance business
Run off insurance firms are commonly found.
Technology platform quite different.
Insurance premiums can dominate business.
Bankers often view insurance premiums earned as equivalent to
fees in banking.
Recent BBC investigations accusing LloydsTSB of selling
inappropriate & expensive income protection plans in association
with personal loans.
Normal lending controls may sometimes have been subverted in
quest for insurance income.
Bancassurance
Cross Selling
Recent experience suggests that cross
selling income estimated in many
bancassurance mergers is over-estimated.
Key example is Allianz take over of Dresdner.
General view is that Allianz significantly over-
estimated potential to sell insurance through
Dresdner branches.
BUT Dresdner not primarily a retail bank. More
success might have been had selling via
Sparkassen branches.
Will A Bank Bail Out An Insurer?
Insurance firms are more likely to close their
business in times of difficulty than a bank would
be.
Life assurance in UK has faced significant problems
as equity/bond yields have fallen.
Several large life assurance firms (Britannic, Pearl,
etc) have put their main life or endowment funds into
run off now operate as closed funds.
In comparison, Abbey National recapitalised its
insurance funds, worsening financial problems at
group level and precipitating take-over by Spains
BSCH.
Ageing Population & Pension
Reform
Ageing Population
The Problem
Most of the developed world is experiencing an
ageing population.
Increased life expectancy.
Falling birth rate.
Replacement rates below 1 in many countries.
Immigration provides a route to negate underlying
demographic changes.
US helped in part by open attitude to immigration.
US population is not ageing as fast as that in Western
Europe.
Current & projected old age
dependency ratio
1995 2000 2010 2020 2050
EU15 23.0 24.1 27.0 31.7 47.2
Belgium 23.8 25.4 26.9 32.6 43.5
Denmark 22.7 22.1 24.3 30.1 37.7
Germany 22.5 23.3 29.2 31.9 46.8
Greece 22.8 25.5 29.3 32.3 48.0
Spain 22.2 24.4 26.5 29.8 56.5
France 22.9 24.3 25.5 32.6 46.4
Ireland 18.0 17.4 18.5 24.5 43.6
Italy 24.0 26.5 31.0 35.5 55.7
Luxembourg 20.6 21.5 23.5 27.9 37.8
Netherlands 19.3 20.1 22.5 29.8 40.7
Austria 22.4 22.6 25.6 28.5 44.3
Portugal 21.4 22.5 24.3 27.3 44.0
Finland 21.1 21.9 24.7 35.0 42.1
Sweden 27.4 26.8 27.9 33.4 37.9
UK 24.3 24.0 24.7 29.8 42.8
Source: Eurostat
Macro-Economic Impact
Increased healthcare costs.
Could lead to public sector rationing.
Increased pension burden.
More pensions to be paid by fewer people of
working age.
Incentive to move more pension provision to
private sector.
Biggest problem for countries with largely
unfunded pension schemes.
Impact on Financial Services
Industry
Financial Services Industry needs to re-align its
product range to new profile of customers.
In general older population spend less on large capital
items.
Less demand for unsecured lending.
Savings orientated products designed to give an
income in retirement more attractive.
Banks can expand internationally to diversify their
business across a broader population group.
Makes banks less susceptible to impact of ageing
population.
Emerging markets tend to have a younger, still
expanding population.
New Products I
Private, Funded Pensions
Huge growth area as more countries develop private
pension provision.
Pressure from governments to keep fees low.
Need for high yield could tempt individuals into higher
risk investments.
Introduces risk of mis-selling accusations (particular
problem in UK).
Equity Release
Strong in US, UK & Australia.
Enable retired people to draw an income from the
equity accumulated in their houses.
New Products II
Yield chasing investments.
Compare to Japan. When market rates are
close to zero, difficult to earn an income.
Growth of popularity of hedge funds is in part
a response to this.
Inheritance products & Products hiding
savings from government.
Will grow in popularity as governments
increasingly means test old age benefits.