US Banking Structure

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Chapter 10. The Banking Industry:Structure and Competition

A Brief History

Structure

Thrifts

International Banking

The Decline of Traditional Banking


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I. A Brief History

A. dual banking systembanking at state level until Civil War

state charters, regulation banknotes as local currency

failures, fraud were common


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National Bank Act 1963

federal charters for banks

Comptroller of the Currency

federal banknotes

tax on state banknotes

state banks survived by acceptingdeposits

-- dual banking system


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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


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1863-1907

no central bank regular financial crises

panic of 1907

--bankers demanded a centralbank

Federal Reserve System (1913)


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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repealed 1994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)


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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


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Glass-Steagall Act

separated permissible activities ofcommercial, investment banks

idea: limit risk for commercial

banks weakened over time

repealed 1999


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Regulation Q

ceiling on interest rates ondeposits

no interest on checking deposits

repealed 1980


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Regulators

Comptroller of the Currency

national banks

Federal Reserve bank holding companies

state member banks

national banks (secondary)


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FDIC

nonmember state banks

state regulators

state banks (secondary)


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II. Bank StructureA. Decentralization & Consolidation

McFadden Act resulted in many smallbanks

meant to protect small banks &increase competition

-- but protected inefficient banks

-- limited economies of scale


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loopholes

-- bank holding companies

-- owned several banks

-- limited service banks

-- deposits or loans, not both-- ATMs

repealed 1994


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Consolidation

bank failures in 1980s

loopholes in McFadden

repeal of McFadden Over 14,000 banks in 1985

less than 8,000 today


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A good thing?

economies of scale

diversification

But risks with expansion?

responsive to small customers?


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B. Commercial & InvestmentBanking

separated by Glass Steagall 1933

commercial banks banned from

-- corporate underwriting

-- securities brokerage

-- real estate sales-- insurance


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why?

many believed investmentactivities led to bank failures of1930s not really true

problems

less diversification

restricting economies of scale disadvantage w/ global

competition


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Glass Steagall weakened over time

bank holding companies Federal Reserve weakened

restrictions

repealed 1999

(Gramm-Leach-Bliley)


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III. Thrift Industry

S&Ls, credit unions

dual banking systems

Savings & Loans (1,049) FDIC insured

own regulators:

-- FHLBS

-- OTS


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credit unions (10,000)

< 10% of commercial bank assets $600 billion

commercial banks $7.6 trillion

regulator: NCUA

own federal deposit insurance

nonprofit


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IV. International Banking

global economy means globalbanking

often less regulation overseas

alternative structures


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Edge Act corporations

subsidiary of U.S. bank overseas

more favorable regulation


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IBFs

international banking facilities

in the U.S.

loans and deposits to foreigncustomers

favorable regulation, tax status

keep the business in the U.S.


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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


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V. Decline of Traditional Banking

traditional bank activities

decline in profitability

decline in importance


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declining share of loans


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rising profitability..


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but due to nontraditional activities

share of incomeNOT from

interest


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why the decline?

liability side:

cost of acquiring funds has risen

asset side: income generated has declined

causes:

financial innovation since 1970s


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Money market mutual funds

substitute for checking account frominvestment companies

pay interest not insured (but low risk)

banks had to offer own version

raised the cost of funds


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Junk bond market

no market for new, low-rated debtprior to 1980

only for ratings of Baa (BBB) orbetter

improvements in credit risk

screening created market for newrisky debt


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before 1980

low-rated firms relied on banks

after 1980

low-rated firms could borrow byissuing junk bonds

junk bond markets competing with

banks for lending business


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Commercial Paper

easier to issue with improvements incredit risk screening

demanded by money market mutualfunds

replaced corporate short-term

borrowing from banks


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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 ofthe loan payments


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most often down with mortgages

2/3 of all mortgages securitized

also down with auto loans, leases,credit cards


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the implication

other financial institutions take apart of the lending process

-- originate the loan

-- service the loan

-- issue and sell security

finance companies that justspecialize in originating loans


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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


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Result of decline:

bank failures


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newer activities

fee income

credit cards commercial real estate

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