Financial Services, Financial Centers

Public Policy And The Competition For Markets, Firms, And Jobs

Richard McGahey

• Publisher: Routledge
• Year: 2019
• ISBN:
  9780429714276
• Edition: 1
• Topic: Business
• Subtopic: Management
• Index: Business

This book lays out the forces that necessitate a strategy, shows how the competitive forces are affecting different financial centers and provides a policy framework for strategy development. It is essential for public officials, policy makers, legislators, scholars, and people in business.

1
The Financial Services Revolution

Many observers speak of a "revolution" in financial services in recent years, a revolution that continues today. The changes sweeping through the industry are found wherever one looks, including markets, products, the organization and strategy of firms, human resources, technology and telecommunications, and regulation and public policy.

The financial services industry has become increasingly important to the economy of the United States and to individual states. It provides not only necessary financial services to businesses and households, but jobs, tax revenues, and economic development in its own right. Direct and indirect employment from financial services have been one of the fastest-growing sources of jobs in the United States. Financial services jobs are especially attractive for economic development reasons, as they are environmentally benign, are more likely to provide full-year/full-time employment, and offer above average wages and salaries.¹ For these reasons, many locations around the country now compete aggressively to develop, attract, and retain financial services markets, firms, and jobs.

These changes reflect the sharp contrast between the financial markets of the 1950s and 1960s and the markets which have evolved since then. Stable financial markets have been replaced by volatility. Capital markets are increasingly international, rather than national, with ever-growing global pools of capital being tapped in a variety of sophisticated and complex ways. The environment in which markets operate is changing from being highly regulated to one of fewer and more liberal regulations, part of a worldwide process of deregulation. Products and services once specialized and offered only in highly discrete markets now fulfill many functions and are provided by several types of institutions.

These changes mean a more intensely competitive environment for financial services firms. Firms must be adept both at seeking out the optimal source of funds and in developing and marketing the new products required in amore volatile economic environment. This new competitive environment presents many opportunities for growth along with risks to survival.

These changes in financial services firms in turn are altering the environment for the location of financial services markets and jobs. In particular, historically strong centers of financial activity face challenges to their continued dominance and in generating new businesses, jobs, and revenue. In this new dynamic environment, no company, branch of industry, or historic financial center can count on automatic competitive advantage and future leadership.

Challenge and Opportunity

When New York's Governor Mario Cuomo appointed an Advisory Panel on Financial Services in 1988, he stated that "the financial services industry is of central importance to New York and the nation; it is a key source of jobs, economic activity, and financing." The Panel's appointment was well timed. New global and domestic forces are revolutionizing the industry, creating an uncertain future for the location of financial services jobs. This presents challenges to any state, city, or region that seeks to develop and maintain financial services firms and jobs.

New technology now makes it possible to trade stocks, bonds, currency, futures, options, and other financial instruments 24 hours a day, tying together national and global financial markets more closely than ever before. Computer-based technology, deregulation, and increasing global competition are encouraging the pace of innovation in the financial industry, making new financial instruments, markets, and products far more common. As a result, financial services markets and the jobs that they provide are being challenged by new forces. Routine jobs in financial services firms are less tied to any particular location, even to historically dominant centers of financial activity.

But these changes also present opportunities to the industry and to governments seeking to attract and retain financial services activity and employment. The increased complexity and support needs of many new financial innovations require sophisticated technology and labor, and a "critical mass" of expertise. The rise of truly national and international financial markets, together with the continued growth of huge global capital pools, are providing new opportunities for those financial centers that can offer the best combination of factors needed to attract, develop, and hold financial services markets and jobs.

The essential factors for future success span four major areas: a competitive cost environment, a well-trained labor force, advanced technology and telecommunications, and intelligent and forward-looking regulation and tax policies. All of these factors need to be combined in a coordinated strategy for job growth and business expansion in financial services.

A location that can develop and implement such a strategy has the opportunity to position itself as a regional, national, or world leader in financial services. In the future, such a strategy can help a location achieve even greater prominence as a home for financial institutions where growing capital pools are managed, and increasing volumes of transactions are processed.

States and cities can attain this goal only by creating a more competitive and dynamic environment for financial services. Historic strengths, while still formidable, cannot guarantee future leadership. But they can provide a healthy base which can lead to stability and growth when combined with forward-looking policies.

This book has two purposes. First, it explores in detail the substantial changes in markets, products, and services that have taken place in the financial services industry over the past 15 years and the impact of those changes on financial services firms. Second, it evaluates how these transformations in financial services are likely to affect economic development policies for financial centers in the United States. One main reference point is New York, the nation's historic center for financial services, but the trends and factors identified here are ones that will help determine the future economic health of any financial services center.

Main Trends: Convergence and Globalization

Two principal trends — "convergence" and "globalization" — are fostering continuing and growing global and domestic competition. These two trends are the major forces in the financial services revolution that continues to transform the industry and the global economy.

Convergence refers to the increased competition among financial institutions and financial products and the blurring of traditional boundaries among formerly discrete businesses. With convergence, institutions that were once in highly distinct markets (banks, securities firms, insurance companies) now offer similar financial products. Federal and state regulations still place limits on the extent to which institutions can converge, but firms and markets are continually pressing against these boundaries. In turn, regulators are being pressed to institute changes to accommodate these market forces. Along with the need for larger pools of capital, this competition has helped to spark mergers and acquisitions among many financial services firms.

For example, commercial banks are establishing securities subsidiaries and becoming active in international underwriting. Securities firms now provide checking and other banking-like services that were once the exclusive domain of banks. Insurance firms market an expanding array of financial products to their clients, and parent financial holding companies are creating a host of subsidiaries in all lines of business. The growth of nonfinancial companies' financing arms, in areas such as automobiles, other consumer durables, and credit cards, further intensifies the competition.

An important aspect of convergence involving new products and markets is "securitization," the increasing use of securities markets for a variety of financing and investment needs. This was first pioneered in mortgage-backed securities, but has since expanded. One rapidly growing area is the use of asset-backed securities by large corporations to finance acquisitions or expansions. Assets such as car loans, credit card receivables, and department store installment sales contracts can be packaged into high-quality securities that carry lower interest rates than traditional financing.

Asset-backed financing is only the latest expression of an existing trend away from traditional bank borrowing. This "disintermediation," the bypassing of depository institutions as a source of loanable funds, has occurred when borrowing rates or other more flexible products are more attractive in direct financial markets. For multinational firms with good credit ratings, it often has been easier and cheaper to issue bonds and commercial paper directly in international capital markets than to obtain bank loans.

In addition to convergence, the other main force transforming financial services is globalization, the continuing integration of the world's financial markets. In recent years, the internationalization of financial transactions and the emergence of 24-hour trading around the globe has been fueled by the development of new technologies, the liberalization of domestic and international capital markets regulations, and the new sophistication of corporate borrowers. Trade surpluses have created large capital pools in Japan and Europe, while America's need to import capital to finance its deficit, the availability of lower-cost capital in international markets, and volatile currency prices have all contributed to globalization.

This trend is likely to accelerate in coming years. One major implication is that financial firms must continue to have open access to funds from world markets. For this, they must have the skilled support and professional staffs needed to participate in international markets, and technologically sophisticated telecommunications and computer systems. Globalization has been made possible in large part by dramatic changes in technology. While complex transactions and transnational markets have been made possible by advances in telecommunications and computer technology, these same changes have allowed jobs to be dispersed across the nation and the world.

Firms' Responses to New Competitive Pressures

The trends of convergence and globalization mean increasing competition and complexity in financial services. Firms have responded to these new competitive pressures by seeking new markets and new ways of containing costs. Both have profound implications for employment in financial firms and for location decisions.

Entry into new markets requires that firms establish a position by expanding or relocating strategic business units where they have access to a skilled labor force. Competitive pressures increasingly have forced firms to pay strict attention to trimming all costs of doing business. Rationalization of operations, in part tied to mergers and acquisitions within the industry, has included the consolidation and relocation of back office and data processing centers to lower-cost areas, along with the introduction of new technologies and telecommunications systems to enhance productivity. Cost sensitivity also has led firms to press for changes in regulatory structures and for tax reduction.

There are four key areas that help determine how firms and financial centers will succeed in this new environment: location costs and advantages, human resources, telecommunications and technology, and regulation and taxation.

Location Costs and Advantages

The competition being shaped by convergence and globalization has profound implications for the location of financial activities and financial services firms, for firms' strategic planning, and public policy. The dispersion of financial markets has in part followed shifting patterns of economic growth and changes in regulatory structures governing capital flows. Firms seeking to establish, hold, and increase positions in emerging new markets and to work with narrowing margins in old markets, have loosened the geographic bonds which tied them to particular areas.

Two factors are critical in determining the location and relative strengths of financial centers: proximity to markets and costs of doing business. The pressure to be in key markets is driven by the need to be close to capital pools and concentrations of investors and purchasers of financial products and services, financial intermediaries, and support services. In recent years, many New York and other American banking and securities firms have established a presence in major international financial centers, such as Tokyo, London, and others.

The pressure to be near markets also has been responsible for an expansion of financial institutions within the United States. While the McFadden Act has limited banks ' ability to cross state lines, compacts among individual states have facilitated entry into regional markets, in several cases, prospects for growth in newer markets are better than in traditional markets. With the movement towards national banking in 1991, there will be greater competition among institutions and between historic and emerging national financial centers.

Similarly, securities firms, insurance companies, and other nonbank financial institutions also have enhanced their domestic networks to market stocks, insurance products, and a wide array of innovative financial products and services. In doing so, these firms, like banks, have been drawn to markets outside of traditional financial centers, establishing a presence in various locations.

The concentration of market players in major leading financial centers has reinforced the tendency for financial innovation to be concentrated there as well. Being in the more innovative centers is crucial for learning quickly about new financial instruments. And without the skilled financial staff and legal and business support services available in these locations, firms cannot provide customers with the broad range of complex services required.

While proximity to markets is perhaps the most critical element in the decision to locate strategic business units of financial firms, business costs still play a major role, especially in determining the location of back office and data processing centers. As competition intensifies and profit margins narrow in many markets, routine clerical transactions and data processing operations are being rationalized. This can entail relocation to lower-cost regions, often quite distant from the markets they support. Commercial rents, energy and telecommunications costs, taxes, and wage rates are significant factors in determining the location of these operations.

For example, New York City, especially Manhattan, remains the nation's prime location for financial services, but it is also one of the most costly places in the United States to locate or expand a business. As a result, it faces continuing and increasing pressure on its financial services employment base and challenges in capturing new jobs and business.

Apart from direct business costs, firms incur indirect costs through the problems imposed by a decline in a location's quality of life. To attract and retain the necessary professional and supporting labor force, financial centers must offer a quality of life which is both affordable and attractive or risk losing these jobs to other centers. Many older urban centers face disadvantages in quality of life issues such as transportation, housing, and public education. In addition, the problems of drugs and crime also are particularly acute. These factors play an increasingly important role in a firm's location decisions, especially as other location options multiply.

Labor Force and Human Resources

Human resources are the heart of any business. The increasing complexity and technological sophistication of financial services jobs is placing new demands on the labor force and on education and training institutions. To maintain leadership in financial services, an area must have a well-trained and sophisticated labor force, consisting of both high school- and college-educated workers who have access to continuing training opportunities throughout their careers.

The crisis in urban public schools and basic education is of special concern for the future of financial services in places like New York City, Chicago, Los Angeles, and elsewhere. The inability of urban public schools to provide new graduates with the skills and work attitudes suitable for financial services jobs is a major barrier to job growth and retention.

Slow demographic growth of new labor force entrants outside of troubled urban centers means that the most significant source of new labor market entrants for the future will be the urban, minority, underemployed, and undereducated sectors of the population. Financial services firms, with the long-term, growing need for sophisticated and educated workers, should develop cooperative strategies in urban centers, joining with schools and other broker institutions to make effective use of potential new workers.

Telecommunications and Technology

Telecommunications and technology are major factors in the changing environment for financial services. A high quality and reliable telecommunications infrastructure is vital for the competitiveness of any location seeking financial services employment.

New computer technology supports the growth of global financial markets, and is a necessary component in financial innovation. Corporate treasury functions and check clearing are almost completely automated. Stock exchanges and securities firms have become highly automated, permitting substantial market expansion; today's trading volumes would have been inconceivable just five years ago.

The largest financial services firms are investing hundreds of millions of dollars in new software, computers, and communications equipment, raising their capital expenditures to new levels. In fact, spending on data processing and teleco...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• List of Tables and Figures
• Foreword, Vincent Tese
• Acknowledgments
• About the Authors
• 1 The Financial Services Revolution
• 2 What Makes a Financial Center?
• 3 The Convergence of Products, Services, and Regulatory Regimes
• 4 Globalization of Finance
• 5 Front Office Competition Among U.S. Financial Centers
• 6 Back Offices and Data Processing: Competing on Costs
• 7 Financial Services, Financial Centers, and Public Policy
• Appendix
• Index