16 - Chapter Fourteen Technology and Other Operational Risk...

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Chapter Fourteen Technology and Other Operational Risk Chapter Outline Introduction What Are the Sources of Operational Risk? Technological Innovation and Profitability The Impact of Technology on Wholesale and Retail Financial Services Production Wholesale Financial Services Retail Financial Services The Effect of Technology on Revenues and Costs Technology and Revenues Technology and Costs Testing for Economies of Scale and Economies of Scope The Production Approach The Intermediation Approach Empirical Findings on Cost Economies of Scale and Scope and Implications for Technology Expenditures Economies of Scale and Scope and X-Inefficiencies Technology and the Evolution of the Payments System Risks that Arise in an Electronic Transfer Payment System Other Operational Risks Regulatory Issues and Technology and Operational Risks Summary 167
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Solutions for End-of-Chapter Questions and Problems: Chapter Fourteen 1. Explain how technological improvements can increase an FI’s interest and noninterest income and reduce interest and noninterest expenses. Use some specific examples. Technological improvements in the services provided by financial intermediaries help increase income and reduce costs in several ways: (a) Interest income: By making it easier to draw down on loans directly via computers, as well as by processing loan applications faster. (b) Interest expense: By enabling banks to access lower cost funds that are available directly from brokers and dealers through computers and screen-based trading. (c) Noninterest income: By making more nonloan products available to customers through the computers to customers such as letters of credit and commercial paper and derivatives. (d) Noninterest expense: By reducing processing and settlement fees, an area that has changed drastically for most FIs, especially in trading activities and in the use of automated teller machines (ATMs). 2. Table 14-1 shows data on earnings, expenses, and assets for all insured banks. Calculate the annual growth rates in the various income, expense, earnings and asset categories from 1991 to 2003. If part of the growth rates in assets, earnings, and expenses can be attributed to technological change, in what areas of operating performance has technological change appeared to have the greatest impact? What growth rates are more likely caused by economy-wide economic activity? Growth rates through the end of 2003: Category Nine-Year Interest income -1.14% Interest expense -6.62% Net interest income 3.23% Provision for Loan Loss -2.17% Noninterest income 7.24% Noninterest expenses 3.22% Net earnings 12.74% Average total assets 6.50% The high growth rate in noninterest income reflects in part, the additional fees for technology oriented products such as ATMs and other services. The growth in noninterest expense reflects a lower growth in personnel expenses that further supports the transition toward more technology. The negative growth rates in interest income and interest expense reflect the low interest rate
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This note was uploaded on 10/25/2010 for the course FIN 398 taught by Professor Ray,jackson during the Spring '10 term at UMass Dartmouth.

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16 - Chapter Fourteen Technology and Other Operational Risk...

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