Chapter Sixteen

Commercial Banking Industry: Structure and Competition

Slide 16–3

Historical Development of the Banking Industry

Figure 16-1: Time Line of the Early History of Commercial Banking in the United States

Slide 16–4

Historical Development of the Banking Industry

• Outcome: Multiple Regulatory Agencies1. Federal Reserve

2. FDIC

3. Office of the Comptroller of the Currency

4. State Banking Authorities

Slide 16–5

Structure of the Commercial Banking Industry

FDIC statistics on bankinghttp://www.fdic.gov/bank/statistical/index.html

Slide 16–6

Ten Largest U.S. Banks

World’s 100 largest bankshttp://interactive.wsj.com/public/resources/documents/wb00-100-fpublic-2000-09-25.htm

Slide 16–7

Branching Regulations

• Branching Restrictions: Very Anti-competitive• Response to Branching Restrictions

1. Bank Holding Companies• Allowed purchases of banks outside state• BHCs allowed wider scope of activities by Fed• 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

Slide 16–8

Bank Consolidation and Number of Banks

Figure 16-2: Number of Insured Commercial Banks in the United States, 1934–2001

Quarterly banking profilehttp://www2.fdic.gov/qbp/qbpSelect.asp?menuItem=QBP

Slide 16–9

Nationwide Banking and Bank Consolidation

• Bank Consolidation: Why? 1. Branching restrictions weakened

2. Development of superregional banks

• Riegle-Neal Act of 19941. Allows full interstate branching

2. Promotes further consolidation

• Future of Industry Structure– Will become more like other countries, but not quite:

• Several thousand, not several hundred

Slide 16–10

Nationwide Banking and Bank Consolidation

• Bank Consolidation: A Good Thing?– Cons

1. Fear of decline of small banks and small business lending

2. Rush to consolidation may increase risk taking

– Pros1. Community banks will survive

2. Increase competition

3. Increased diversification of bank loan portfolios: lessens likelihood of failures

Slide 16–11

Separation of Banking and Securities Industries: Glass-Steagall

• Case for Glass-Steagall1. FDIC gives unfair advantage to banks

2. Allowing banks into underwriting is dangerous because FDIC promotes too much risk taking

3. Potential conflicts of interest

• Case Against Glass-Steagall1. Decreases competition

2. Unfair to banks

3. Hinders diversification

Slide 16–12

Separation of Banking and Securities Industries: Glass-Steagall

• Will Separation Continue?– Fed, OCC, FDIC are allowing banks to engage in

underwriting activities

– Separation in Other Countries1. Universal banking: Germany

2. British-style universal banking

3. U.S./Japan separation

Slide 16–13

International Banking

• Why Rapid Growth1. Rapid growth of international trade

2. Banks abroad can pursue activities not allowed in home country

3. Tap into Eurodollar market

• U.S. Banks Overseas 1. Regulators

• Federal Reserve (Regulation K)

2. Structure• Edge Act Corporations• International Banking Facilities

Slide 16–14

International Banking

• Foreign Banks in U.S.1. Regulators

• Same as for U.S. domestic banks

2. Structure• 500 offices in U.S.

• 20% of total U.S. bank assets

Slide 16–15

Ten Largest Banks in the World

Slide 16–16

Financial Innovation and Decline in Traditional Banking

• Innovations Increasing Competition1. Money market mutual funds

• Avoids deposit rate ceilings and reserve requirements

2. Junk bonds• Result of better info in credit markets

3. Commercial paper market• Result of better info in credit markets and rise in money market

mutual funds

4. Securitization• Result of better info in credit markets and computer technology

Slide 16–17

The Decline in Banks as a Source of Finance

Figure 16-3: bank Share of Total Nonfinancial Borrowing, 1960–2001

Slide 16–18

Bank Profitability

Figure 16-4: Commercial Bank Profitability, 1970–2001

Slide 16–19

Share of Noninterest Income

Figure 16-1: Share of Noninterest Income in Total Bank Income, 1960–2001

Slide 16–20

Decline in Traditional Banking

• Loss of Cost Advantages in Acquiring Funds (Liabilities)– π i then disintermediation because

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

Slide 16–21

Decline in Traditional Banking

• 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

Slide 16–22

Figure 16-9: Bank Failures in the United States, 1934–2001

Slide 16–23

Banks' Response

• Loss of cost advantages in raising funds and income advantages in making loans causes reduction in profitability in traditional banking1. 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