Chapter 10.

The Banking Industry: Structure and Competition

A Brief History Structure Thrifts International Banking The Decline of Traditional Banking

I. A Brief History A. dual banking system

banking at state level until Civil War state charters, regulation banknotes as local currency failures, fraud were common

 National Bank Act 1963

federal charters for banks Comptroller of the Currency federal banknotes tax on state banknotes state banks survived by accepting deposits -- dual banking system

B. A central bank

U.S. had two prior central banks

the Bank of the U.S. (1791-1811)) the Second Bank of the U.S. (1816-63) U.S. central banks not popular w/ ranchers & farmers states rights

 1863-1907
no central bank regular financial crises panic of 1907 --bankers demanded a central bank Federal Reserve System (1913)

C. Branching Restrictions

McFadden Act

1927 restricted intra and interstate branching of national banks meant to protect small banks & increase competition repealed 1994 (Riegle-Neal)

D. Great Depression

1930-33, 1/3 of all U.S. banks failed Congress responded w/ legislation FDIC
federal insurance for bank deposits banks pay premiums

 Glass-Steagall Act
separated permissible activities of commercial, investment banks idea: limit risk for commercial banks weakened over time repealed 1999

 Regulation Q
ceiling on interest rates on deposits no interest on checking deposits repealed 1980

Regulators

Comptroller of the Currency

national banks Federal Reserve bank holding companies state member banks national banks (secondary)

 FDIC

nonmember state banks state regulators state banks (secondary)

II. Bank Structure A. Decentralization & Consolidation

McFadden Act resulted in many small banks meant to protect small banks & increase competition -- but protected inefficient banks -- limited economies of scale

 loopholes -- bank holding companies -- owned several banks -- limited service banks -- deposits or loans, not both -- ATMs repealed 1994

Consolidation

bank failures in 1980s loopholes in McFadden repeal of McFadden Over 14,000 banks in 1985
less than 8,000 today

A good thing?

economies of scale diversification But

risks with expansion? responsive to small customers?

B. Commercial & Investment Banking

separated by Glass Steagall 1933

commercial banks banned from -- corporate underwriting -- securities brokerage -- real estate sales -- insurance

 why?
many believed investment activities led to bank failures of 1930s
not really true

problems
less diversification restricting economies of scale disadvantage w/ global competition

 Glass Steagall weakened over time

bank holding companies Federal Reserve weakened restrictions repealed 1999 (Gramm-Leach-Bliley)

III. Thrift Industry

S&Ls, credit unions dual banking systems Savings & Loans (1,049)
FDIC insured own regulators: -- FHLBS -- OTS

 credit unions (10,000)

< 10% of commercial bank assets
$600 billion commercial banks $7.6 trillion

regulator: NCUA own federal deposit insurance nonprofit

IV. International Banking

global economy means global

banking often less regulation overseas alternative structures

Edge Act corporations

subsidiary of U.S. bank overseas more favorable regulation

IBFs

international banking facilities in the U.S. loans and deposits to foreign

customers favorable regulation, tax status keep the business in the U.S.

Foreign banks in the U.S.

Agency office

not full service but less regulated Full service branch U.S. regulations U.S. subsidiary U.S. regulations

V. Decline of Traditional Banking

traditional bank activities

decline in profitability decline in importance

declining share of loans

rising profitability..

but due to nontraditional activities

share of income NOT from interest

why the decline?

liability side:
cost of acquiring funds has risen asset side: income generated has declined causes: financial innovation since 1970s

Money market mutual funds

substitute for checking account from

investment companies pay interest not insured (but low risk) banks had to offer own version raised the cost of funds

Junk bond market

no market for new, low-rated debt

prior to 1980 only for ratings of Baa (BBB) or better improvements in credit risk screening created market for new risky debt

 before 1980
low-rated firms relied on banks after 1980 low-rated firms could borrow by issuing junk bonds junk bond markets competing with banks for lending business

Commercial Paper

easier to issue with improvements in

credit risk screening demanded by money market mutual funds replaced corporate short-term borrowing from banks

Securitization

transform illiquid loans

into liquid debt securities individual loans bundled together debt securities issued, backed by pool of loans owners of security get a share of the loan payments

 most often down with mortgages

2/3 of all mortgages securitized also down with auto loans, leases, credit cards

 the implication
other financial institutions take a part of the lending process -- originate the loan -- service the loan -- issue and sell security finance companies that just specialize in originating loans

in total

higher cost of obtaining funds

due to competition from money market lower income from loans due to competition from -- junk bond market -- commercial paper market -- financial companies

Result of decline:

bank failures

 newer activities
fee income credit cards commercial real estate