An Intro to the Financial Services Industry

1. A BRIEF INTRODUCTION TO THE FINANCIAL SERVICES INDUSTRY (FSI) FOR TECH CONSULTANTS NEW TO THE SECTOR

2. The Financial Service Industry is one of the most attractive industries to target if you are a consultant.

3. To give a sense of scale, in 2014, Bank of America had over 100,000 Tech and Ops headcount and a $9B annual IT budget. http://www.informationweek.com/strategic-cio/digital-business/it-chief-of-the-year-bank-of-americas-cathy-bessant/d/d-id/1317757

4. However, when selling into, or delivering for, Financial Services Institutions (FSIs), it is useful to have some understanding of how FSI business models work, and the unique requirements that drive their IT strategies.

5. This deck is a living document(*) that hopes to act as a primer for consultants who need to support FSI clients, but who may not have prior experience in the sector. (*) If you have an idea on how to improve this deck, mail eric@savantdegrees.com

6. In this deck we’ll cover 4 topics • What are Financial Assets • What are Financial Markets • (Where Financial Assets are traded) • What are Financial Institutions • (The players that act within Financial Markets) • Special Topics: FinTech & Regulators • (Oooh…sexy) • I won’t be covering case studies. We can do a separate session on those • I also won’t go into the details of each type of product. That’s too detailed…

7. Along the way, we’ll stop to discuss ENGAGEMENT INSIGHTS which are observations that should help consultants understand how to better sell and deliver solutions that are specifically tailored to the industry.

8. PART ONE ASSETS

9. Before talking about financial institutions (FIs), it is important to first understand financial assets, because everything about how different FIs do business ultimately stems from the properties of the assets they manage.

10. An assetis any possession that has some value in an exchange.

11. Tangible assets are physical things with properties that create value. Like a cow.

12. Intangible assets represent legal claims to some future benefit. The physical form has nothing to do with the value. Seashells (or shell scripts) work just as well as dollar bills, so long as the legal structure says so.

13. When we talk about Financial Assets, we’re talking about intangible assets. And the future benefit we’re talking about, is the right to claim cash.

14. With a Financial Asset, one party, the issuer, agrees to make future payments to the owner of the financial asset, the investor. Examples of Issuers (and investors) include central governments or their agents, municipal governments, supranationals, non-financial businesses, financial businesses, and households (individuals)

15. Here are some Financial Assets: a US Government Bond Stock in Amazon.com a Home Loan a Certificate of Deposit A Corporate Bond from General Electric

16. There are generally 2 types of claims that an investor can make: fixed cash amount or a varying amount. * Some financial assets can actually be a hybrid of the 2 (such as preferred stock or convertible bonds), but let’s not worry about that for now

17. If the claim is for a fixed amount, we call that a debt * Sometimes we refer to these assets as fixed-income products

18. Debt payments can come all at once, or be spread across a period, but there is always a total, specific amount claimed. A US Treasury Bond is an example of Debt.

19. If the claim is for a variable amount, we call that equity. * Sometimes equity is referred to as a security, or a stock

20. Equity obligates the issuer to pay the investor an amount based on future value (such as earnings), usually after debt holders have been paid off first. Amazon.com stock is an example of equity. * Equity can sometimes also pay a dividend

21. Because both debt and equity represent a promise to get future cash, to figure out how much a financial asset is worth, the financial asset needs to go through a process of valuation. * Think of it this way, would you rather me give you $1000 today, or next year? Today right? See? Present money is more valuable than the promise of future money. That is why we do valuation!

22. Roughly speaking, Valuation is calculated using the timing of when you expect the future cash, the impact of inflation and prevailing interest, and, most importantly, the risk that something may happen and you don’t get the money back when it was promised

23. 1 ENGAGEMENT INSIGHT Generally speaking, timing of cash flows, inflation, and interest rates are easy to predict. That is not true with risk. Thus, calculating and managing risk becomes an absolutely central focus of all financial institutionsbecause it drives valuations and returns. So, if you sell or deliver into banks, Risk Management must be at the heart of your engagement.

24. PART TWO FINANCIAL MARKETS

25. Issuers and investors need a safe and efficient place to find each other, agree on valuation, and transact – enter Financial Markets.

26. 2 ENGAGEMENT INSIGHT FSIs need to constantly innovate to remain competitive. The areas in which you can help them innovate are tied to the scope of Financial Markets. More specifically, they are looking for 1) new ways to find market opportunities more quickly, 2) develop new products to sell, 3) transact at the best possible price and lowest cost, 4) reduce risk, and 5) improve the Customer Experience Innovation around any of those is good!

27. One way to categorize Financial markets is by asset type. For example Debt Market versus Equity Market. * Sometimes, because of hybrid assets, we merge Debt Assets and Preferred Stock into Fixed-Income Markets, and the non-preferred equity assets are grouped into a Common Stock Market.

28. Another way to categorize Financial Markets is by the maturity of claims (when you actually get your money). Short-term assets (like a certificate of deposit that matures in 3 months) are traded in a Money Market. And assets that mature over longer periods (like a 10-year bond) are traded in the Capital Markets * The cutoff between short and long-term is roughly 1 year

29. A third way to categorize is based on whether the financial assets are newly issued, which are sold in a Primary Market, or whether the financial asset was previously purchased and is now being re-sold in a Secondary Market.

30. Finally, investors can buy (or be granted) the obligation, or the choice, to buy or sell a financial asset based on various triggers. The specific terms are defined in contracts and are traded in a Derivative Market. For example, if you act within the next year, you have the option to buy a stock at $10 per share, even if the market price is $20 per share, but if the stock price drops to $8 you MUST buy it at $8.

31. There are as many derivative instruments as can be concocted by human imagination, but common ones include Options, Futures, Forwards, Swaps, and Cap and Floors. Each of these contracts is designed to help investors manage their financial risk. Unfortunately, they can also be used to double down on bad bets!

32. 3 ENGAGEMENT INSIGHT Understanding which market(s) your customer is playing is important because the business models that customers employ in each market is going to be quite different, because the needs of the customers in each market are very different. For example, a Bank’s customers in the Derivatives market are looking for risk management or high margin/high risk. Bank customers in the Debt Market are looking for low risk-low return.

33. At the end of the day, these financial markets take physical form in Exchanges (such as a stock exchange) – a marketplace where securities, commodities, derivatives and other financial instruments are traded in a fair, transparent, and orderly fashion.

34. PART THREE FINANCIAL INSTITUTIONS (FIs)

35. Issuers and Investors are not often financial experts themselves, and so Financial Markets are usually composed of FIs that serve as agents (or Intermediaries) that act on behalf of issuers and investors.

36. Oh, and Financial Market Regulators will try to poke their heads in from time to time to make sure that no one is burning down the house.

37. In addition, FSI industry service providers like credit-ratings agencies or equity research firms support specific needs of the FIs.

38. But, in short, FIs…. Take financial assets and repackage them for various financial needs Exchange assets on behalf of customers or themselves and facilitate payments Assist in the creation of financial assets Perform proprietary research and provide advice around economic forecasting, investment strategies, and capital building or preserving recommendations Manage customer portfolios to make money and/or reduce risk

39. Roughly, FIs can be segmented into: Depository Institutions Non-Depository Institutions

40. PART FOUR DEPOSITORY INSTITUTIONS

41. How do DI’s make money? Depository Institutions hold money for customers, usually charging a fee. They then take a good chunk of that money and invest it (often in the form of Loans or investment in Securities), keeping some amount in Reserve to support the day-to-day withdrawal needs of their customers. They also charge money for services, take interest on the loans they make, and charge transaction fees for just about everything.

42. DI’s are very regulated As you might imagine, DIs are the most regulated and most protected (i.e.:FDIC insurance) of the FIs because, well, that is all of our savings! A run on the banks (where depositors ask for so much of their money back that the Reserve dries up and the bank cannot support withdrawals in cash) could wipe out a national economy.

43. Depository Institutions include Commercial Banks (or simply ‘Banks’) Savings and Loan Associations Credit Unions * Commercial Banks represent the vast majority

44. Within the segment of Commercial Banks there are additional sub-segments, each with quite unique business models. The sub-segments include: Individual Banking Institutional Banking Investment (Global) Banking (quasi depository) Universal Banking

45. PART FOURDOTONE INDIVIDUAL BANKS (RETAIL BANKS & WEALTH MANAGERS)

46. CUSTOMERS OF individual banks Individual Banks provide Services to…well….individuals, like you and me. We want… a safe, transparent place to store our money the ability to use that money wherever, whenever, and through any channel we want to (in as convenient a way as possible) access to more money (for a period of time) good advice on how to protect and grow our money great and value-for-money service when providing the above

47. products of individual banks Individual Banking includes services such as managing deposits, consumer and mortgage lending, payment and withdrawal, checking and bank drafts, credit card financing, car and student loans, specialized services such as safety deposit boxes, and individual investment / advisory services.

48. How are individual banks segmented? Individual Banking roughly segments by the amount of money the typical customer deposits. There are 2 segments, Retail Banking (for you and me) and Wealth Management (for the fortunate few). * Wealth Management is sometimes called Private Banking

49. Wealth Management, in turn, breaks again into: Mass Affluent Banking (250K->2M AUM) Wealth Management Clients (2-50M AUM) High Net Worth Individuals (50-250M AUM) Ultra High Net Worth Individuals (>250M AUM) AUM = Assets Under Management

50. As you might imagine, the services offered get much more profound, complex, value additive, and expensive the more money one deposits, especially when it comes to advisory.