chapter 16 Mishkin Eakins Banking Industry Structure and

chapter 16 Mishkin & Eakins Banking Industry: Structure and Competition

Historical Development of the Banking Industry Outcome: Multiple Regulatory Agencies 1. Federal Reserve 2. FDIC 3. Office of the Comptroller of the Currency 4. State Banking Authorities Copyright © 2001 Addison Wesley Longman TM 10 - 2

Federal Regulation • 1913 - Federal Reserve System created • The economic collapse of the banking system during the Great Depression ushered in additional regulation. – 1933 - Federal Deposit Insurance Corporation (FCIC) formed – 1933 - Glass-Steagall Act of 1933 separating out commercial banking from investment banking Copyright © 2001 Addison Wesley Longman TM 10 - 3

Structure of the Commercial Banking Industry Copyright © 2001 Addison Wesley Longman TM 10

Ten Largest U. S. Banks Copyright © 2001 Addison Wesley Longman TM 10 -

Branching Regulations Branching Restrictions: Mc. Fadden Act (1927) and Douglas Amendments (1956) Very anti-competitive results Response to Branching Restrictions 1. Bank Holding Companies (BHCs) A. Allowed purchases of banks outside state B. BHCs allowed wider scope of activities by Fed C. BHCs dominant form of corporate structure for banks 2. Nonbank Banks Not subject to branching regulations, but loophole closed in 1987 3. Automated Teller Machines Not considered to be branch of bank, so networks allowed Copyright © 2001 Addison Wesley Longman TM 10 - 6

Bank Consolidation and Number of Banks Copyright © 2001 Addison Wesley Longman TM 10

Bank Consolidation and Nationwide Banking Bank Consolidation: Why? 1. Branching restrictions weakened 2. Development of super-regional banks Riegle-Neal Act of 1994 1. Overturns Mc. Fadden and Douglas - allows for full interstate branching 2. Promoted further consolidation due primarily to economics of scale (Examples: Bank of America and Banc One) Copyright © 2001 Addison Wesley Longman TM 10 - 8

Future of Industry Structure in the United States • Fewer and larger commercial banks • We will become more like other countries, but not exactly similar due the effects of historical realities • Research work expects several thousand institutions in the U. S. rather than the more typical several hundred Copyright © 2001 Addison Wesley Longman TM 10 - 9

Bank Consolidation and Nationwide Banking Cons: 1. Fear of decline of small banks and small business lending 2. Fear of monopoly by public (no such fear by experts) 3. Rush to consolidation may increase risk taking Pros: 1. Community banks have and will continue to survive 2. Increased competition for banks means consumers gain the benefits of competition among suppliers 3. Increased diversification of bank loan portfolios will lessen the likelihood of bank failures Copyright © 2001 Addison Wesley Longman TM 10 - 10

Separation of Banking and Securities Industries Erosion of 1933 Glass-Steagall Act provisions over time

Gramm-Leach-Bliley Financial Services Act of 1999 The Repeal of Glass-Steagall 1. Allows securities firms and insurance companies to purchase banks 2. Banks allowed to underwrite insurance and engage in real estate activities 3. OCC regulates bank subsidiaries engaged in securities underwriting 4. Fed oversee bank holding companies under which all real estate, insurance and large securities operations are housed 5. Banking institutions become larger and more complex Copyright © 2001 Addison Wesley Longman TM 10 - 12

A Brief Overview - The Thrift Industry Beyond commercial banking… • Savings and Loans

Savings and Loans Regulators 1. Office of Thrift Supervision 2. Federal Home Loan Bank System (FHLBS) 3. FDIC’s Saving Association Insurance Fund (SAIF) 4. State banking authorities Structure • Fewer restrictions on branching • Strong vestiges of “single-purpose” origin Copyright © 2001 Addison Wesley Longman TM 10 - 14

S&Ls - Assets and Liabilities • Primary Assets for S&Ls – – – Mortgages (60. 1%) US Govt and Federal Agency Securities (15. 5%) State and Local Bonds (6. 2%) Consumer credit (4. 6%) Loans to business are only 1. 9%. • Primary liabilities for S&Ls – Small time and savings deposits (41. 4%) – Checkable deposits (16. 4%) – Borrowings from the Federal Home Loan banks and other banks (14. 2%) – Large time deposits of over $100, 000 (10. 2%) Copyright © 2001 Addison Wesley Longman TM 10 - 15

Mutual Savings Banks Regulators 1. FDIC 2. States Structure 1. 400 or so and similar to S&Ls • Within state branching, regulations not restrictive, so there are few small MSBs • Located primarily in the Northeast US • May insure deposits with the FED: S&Ls may not • Not as heavily invested in home mortgages as S&Ls Copyright © 2001 Addison Wesley Longman TM 10 - 16

Credit Unions Regulators 1. National Credit Union Administration (NCUA) 2. States Structure 1. Because must have “common bond” among depositors 2. Tax exempt status linked to “common bond” 3. Mostly institutions are small with deposits < $10 million Copyright © 2001 Addison Wesley Longman TM 10 - 17

Credit Unions Rapid growth over the last few decades… U. S. Assets in 1980 $68, 974 m U. S. Assets in 1990 $221, 759 m U. S. Assets in 1996 $336, 452 m Worldwide in 1996 • 36, 244 Credit Unions • 89, 658, 210 Members • $379. 3 billion (U. S) in Assets Copyright © 2001 Addison Wesley Longman TM 10 - 18

Credit Unions • Primary Assets for Credit Unions – – Consumer Installment Loads (39. 6%) Home mortgage and equity loans (25. 3%) US Govt and Federal Agency Securities (18. 9%) Time and Savings Deposits (4. 9%) • Primary liabilities for Credit Unions – Small time and savings deposits (82. 1%) – Checkable deposits (11. 34%) – Large time deposits of over $100, 000 (4. 8%). Copyright © 2001 Addison Wesley Longman TM 10 - 19

Separation – Other Countries Separation in Other Countries 1. Universal banking: Germany 2. British-style universal banking 3. Japanese-style separation Copyright © 2001 Addison Wesley Longman TM 10 - 20

International Banking • Spectacular growth over the last 40 years 1. Rapid growth of international trade and multinational corporations 2. Banks abroad can pursue profitable activities that are precluded by the regulatory environment in home country 3. Tap into Eurodollar market Copyright © 2001 Addison Wesley Longman TM 10 - 21

International Banking U. S. Banks Overseas 1. Regulators A. Federal Reserve (Regulation K) 2. Structure A. Edge Act Corporations B. International Banking Facilities Copyright © 2001 Addison Wesley Longman TM 10 - 22

International Banking Foreign Banks in U. S. 1. Regulators Same as for U. S. domestic banks under the International Banking Act of 1978 Foreign Bank Supervision Act of 1991 2. Structure A. 500 offices in U. S. B. 20% of total U. S. bank assets Copyright © 2001 Addison Wesley Longman TM 10 - 23

Ten Largest Banks in the World Copyright © 2001 Addison Wesley Longman TM 10

Financial Innovation and Decline in Traditional Banking Innovations Increasing Competition 1. Money market mutual funds Avoids deposit rate ceilings and reserve requirements 2. Junk bonds Result of better information in credit markets 3. Commercial paper market Result of better information in credit markets and rise in money market mutual funds 4. Securitization Result of better information in credit markets and computer technology Copyright © 2001 Addison Wesley Longman TM 10 - 25

The Decline in Banks as a Source of Finance Copyright © 2001 Addison Wesley

Bank Profitability Copyright © 2001 Addison Wesley Longman TM 10 - 27

Share of Noninterest Income Copyright © 2001 Addison Wesley Longman TM 10 - 28

Disintermediation – the decline of Traditional Banking Loss of Cost Advantages in Acquiring Funds (Liabilities) Disintermediation occurred due to 1. Deposit Rate Ceilings and Regulation Q 2. Money Market Mutual Funds 3. Foreign banks have cheaper source of funds: Japanese banks can tap large savings pool Loss of Income Advantages on Uses of Funds (Assets) 1. Easier to use securities markets to raise funds: commercial paper, junk bonds, securitization 2. Finance companies more important because easier for them to raise funds Copyright © 2001 Addison Wesley Longman TM 10 - 29

Bank Failures Copyright © 2001 Addison Wesley Longman TM 10 - 30

Banks’ Response Loss of cost advantages in raising funds and income advantages in making loans causes reduction in profitability in traditional banking 1. Expand lending into riskier areas: e. g. , real estate 2. Expand into off-balance sheet activities 3. Creates problems for U. S. regulatory system Similar problems for banking industry in other countries Copyright © 2001 Addison Wesley Longman TM 10 - 31