Chapter 10. The Banking Industry: Structure and Competition

1. Chapter 10. The Banking Industry:Structure and Competition • A Brief History • Structure • Thrifts • International Banking • The Decline of Traditional Banking

2. I. A Brief HistoryA. dual banking system banking at state level until Civil War • state charters, regulation • banknotes as local currency • failures, fraud were common

3. 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

4. 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

5. 1863-1907 • no central bank • regular financial crises • panic of 1907 --bankers demanded a central bank • Federal Reserve System (1913)

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• restricted intra and interstate branching of national banks • meant to protect small banks & increase competition • repealed 1994 (Riegle-Neal)

7. 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

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permissible activities of commercial, investment banks • idea: limit risk for commercial banks • weakened over time • repealed 1999

9. Regulation Q • ceiling on interest rates on deposits • no interest on checking deposits • repealed 1980

10. Regulators • Comptroller of the Currency • national banks • Federal Reserve • bank holding companies • state member banks • national banks (secondary)

11. FDIC • nonmember state banks • state regulators • state banks (secondary)

12. II. Bank StructureA. Decentralization & Consolidation McFadden Act resulted in many small banks • meant to protect small banks & increase competition -- but protected inefficient banks -- limited economies of scale

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-- bank holding companies -- owned several banks -- limited service banks -- deposits or loans, not both -- ATMs • repealed 1994

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

16. A good thing? • economies of scale • diversification • But • risks with expansion? • responsive to small customers?

17. B. Commercial & Investment Banking • separated by Glass Steagall 1933 • commercial banks banned from -- corporate underwriting -- securities brokerage -- real estate sales -- insurance

18. 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

19. Glass Steagall weakened over time • bank holding companies • Federal Reserve weakened restrictions • repealed 1999 (Gramm-Leach-Bliley)

20. III. Thrift Industry • S&Ls, credit unions • dual banking systems • Savings & Loans (1,049) • FDIC insured • own regulators: -- FHLBS -- OTS

21. credit unions (10,000) • < 10% of commercial bank assets • $600 billion • commercial banks $7.6 trillion • regulator: NCUA • own federal deposit insurance • nonprofit

22. IV. International Banking • global economy means global banking • often less regulation overseas • alternative structures

23. Edge Act corporations • subsidiary of U.S. bank overseas • more favorable regulation

24. 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.

25. 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

26. V. Decline of Traditional Banking • traditional bank activities • decline in profitability • decline in importance

27. declining share of loans

28. rising profitability…..

29. but due to nontraditional activities share of income NOT from interest

30. why the decline? • liability side: • cost of acquiring funds has risen • asset side: • income generated has declined • causes: • financial innovation since 1970s

31. 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

32. 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

33. 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

34. Commercial Paper • easier to issue with improvements in credit risk screening • demanded by money market mutual funds • replaced corporate short-term borrowing from banks

35. 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

36. most often down with mortgages • 2/3 of all mortgages securitized • also down with auto loans, leases, credit cards

37. 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

38. 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

39. Result of decline: • bank failures

40. newer activities • fee income • credit cards • commercial real estate