Chapter 16 Mishkin & Eakins Banking Industry: Structure and Competition.

chapter 16Mishkin & Eakins

Banking Industry: Structure and Competition

Copyright © 2001 Addison Wesley Longman TM 10- 2

Historical Development of the Banking Industry

Outcome: Multiple Regulatory Agencies1. Federal Reserve2. FDIC3. Office of the Comptroller of the Currency4. State Banking Authorities


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


Structure of the Commercial Banking Industry


Ten Largest U.S. Banks


Branching Regulations

Branching Restrictions: McFadden 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


Bank Consolidation and Number of Banks


Bank Consolidation and Nationwide Banking

Bank Consolidation: Why?1. Branching restrictions weakened2. Development of super-regional banks

Riegle-Neal Act of 19941. Overturns McFadden and Douglas - allows for

full interstate branching2. Promoted further consolidation due primarily to

economics of scale (Examples: Bank of America and Banc One)


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


Cons:1. Fear of decline of small banks and small business lending2. Fear of monopoly by public (no such fear by experts)3. Rush to consolidation may increase risk takingPros:1. Community banks have and will continue to survive2. Increased competition for banks means consumers gain

the benefits of competition among suppliers3. Increased diversification of bank loan portfolios will

lessen the likelihood of bank failures

Bank Consolidation and Nationwide Banking


Separation of Banking andSecurities Industries

Erosion of 1933 Glass-Steagall Act provisions over time


Gramm-Leach-Bliley Financial Services Act of 1999

The Repeal of Glass-Steagall1. 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


A Brief Overview - The Thrift Industry

Beyond commercial banking…• Savings and Loans Associations• Mutual Savings Banks• Credit Unions


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

1. Fewer restrictions on branching

2. Strong vestiges of “single-purpose” origin


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%)


Mutual Savings Banks

Regulators

1. FDIC

2. States

Structure

1. 400 or so and similar to S&Ls

2. Within state branching, regulations not restrictive, so there are few small MSBs

3. Located primarily in the Northeast US

4. May insure deposits with the FED: S&Ls may not

5. Not as heavily invested in home mortgages as S&Ls


Credit Unions

Regulators1. National Credit Union Administration (NCUA)2. States

Structure1. Because must have “common bond” among

depositors2. Tax exempt status linked to “common bond”3. Mostly institutions are small with deposits < $10

million


Credit Unions

Rapid growth over the last few decades…U.S. Assets in 1980 $68,974 mU.S. Assets in 1990 $221,759 mU.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


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%).


Separation – Other Countries

Separation in Other Countries1. Universal banking: Germany2. British-style universal banking3. Japanese-style separation


International Banking

• Spectacular growth over the last 40 years1. Rapid growth of international trade and multinational

corporations2. Banks abroad can pursue profitable activities that are

precluded by the regulatory environment in home country

3. Tap into Eurodollar market



U.S. Banks Overseas1. Regulators

A. Federal Reserve (Regulation K)2. Structure

A. Edge Act CorporationsB. International Banking Facilities



Foreign Banks in U.S.1. Regulators

Same as for U.S. domestic banks under the International Banking Act of 1978Foreign Bank Supervision Act of 1991

2. StructureA. 500 offices in U.S.B. 20% of total U.S. bank assets


Ten Largest Banks in the World


Financial Innovation and Declinein 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


The Decline in Banks as a Source of Finance


Bank Profitability


Share of Noninterest

Income


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


Bank Failures


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

Chapter 16 Mishkin & Eakins Banking Industry: Structure and Competition.

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