interstate banking and georgia based banks interstate banking and georgia-based banks

INTERSTATE BANKING AND GEORGIA BASED BANKS Dileep R. Mehta

FRP Report No. 58 May 2001

Interstate Banking and Georgia-Based Banks

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“WITHIN ten minutes of the Supreme Court's 1985 decision to allow interstate banking, Edward Crutchfield, chief executive of First Union bank in North Carolina, launched merger talks with Atlantic Bancorporation in Florida. Since then, there has been no stopping “Fast Eddie.” A constant flow of deals has increased First Union's assets from $8 billion to $155 billion [by the middle of 1997].” The Economist, “Bank Mergers in America. How much bigger?” November 22, 1997

Introduction

One unique characteristic of the U.S. banking system has been the large

number of banks across the land. Prohibition of interstate banking (often hand-in-

hand with prohibition of in-state branches) was the driving force responsible for the

large number of banks. Historically, the need for this prohibition on interstate

banking came about when states had to surrender to the federal government the right

to issue money. As a result, states started to charter banks that could conduct business

in the state, and collect fees, which were not insubstantial portion of states revenues.1

Revenue collection motive also led states to prohibit banks chartered in other states

from doing business in the state. Further, there was also the motivation to protect

people in the state from the inconvenience (or at worst the scam) of converting notes

issued by out-of-state-banks into precious metals.2

This prohibition on interstate banking created an ambiguity. Could (or

should) the ban on state-chartered banks be extended to banks that were federally

chartered?36 (originally the ban was imposed to help fund the Civil War, as the

federally chartered banks had to have reserves of the federal government bonds to

back any issuance of notes). The ambiguity was only resolved in 1927, with the

passage of the McFadden Act, which subjected federally chartered banks to the

regulations of the state in which they were operating, and in any state they wanted to

operate in beyond where they were domiciled. This latter provision effectively

1 Sylla, Legler and Wallis [1987] 2 This problem was generally not significant with respect to notes issued by the in-state banks, as the branch network was also not prevalent and most banks had only one operational location.

3 In 1816, the U.S. Congress chartered the Second Bank of the United States [the First Bank's charter granted in 1791 was allowed to lapse by the Congress in 1811]. The Supreme Court in 1819 thwarted the attempt by several states to tax it. The Second Bank’s charter lapsed in 1832.


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strengthened the states’ hand in preventing banks from other states from undertaking

banking activities in the state.

Although the McFadden Act [1927,1933] essentially left it up to the state

whether to permit an out-of-state bank to acquire an in-state bank, the format of a

bank holding company (BHC) allowed a bank to circumvent any state restriction

placed on acquisition of an in-state bank by an out-of-state bank. However, the 1956

Douglas amendment of the BHC Act took care of such practice by prohibiting an out-

of-state BHC from undertaking a bank acquisition unless it obtained explicit

permission from the target state.

Since the mid-1970s, states have gradually eased restrictions on out-of-state

banking institutions from acquiring in-state banks. A popular format was the regional

compact, which extended to banks from contiguous states in a region the privilege of

buying in-state banks. This trend toward deregulation was further expedited by the

implementation of the Interstate Banking and Bank Branching Efficiency Act

(IBBEA) in June 1997. It effectively repealed the Douglas Amendment by permitting

banks to branch interstate through an in-state bank. It also allows BHCs to integrate

their branch network by consolidating subsidiaries in various states.4 Even prior to

the enactment of IBBEA, 49 states, by 1995, permitted out-of-state banks to acquire

banks in their own states. These developments led to a dramatic decline in the

number of banks over the period 1980-1995, as Table 1 shows.

4 States were allowed to “opt-out” from this Act by legislating specific restrictions prior to the middle of 1997.


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TABLE 1. BANKS AND BRANCHES, 1980-1994

Year Banks Banks+BHCs Branches Population per Branch

1980 14407 12335 52710 4307

1985 14268 11019 57417 4145

1990 12195 9224 63393 3928

1994 10362 7901 65100 3994

Source: adapted from Rose [1997, table 1.1, P.3]

This was not just the case of reduction in numbers. As Rose [1997] has noted,

51 BHCs in 1987 controlled at least one bank across state lines and managed 6

percent of total banking assets in the U.S. By June 1993, the corresponding number

was 178 BHCs holding over 21 percent of banking assets and 23 percent of deposits.

At the same time, the number of branches increased; hence the average population

served by a branch decreased. These results, when combined, suggest a strong trend

toward consolidation in the banking industry, a tendency not necessarily stemming

from a defensive posture aimed at reducing losses by closing down marginally

profitable branches.

Is interstate branching a good thing? And, good from whose viewpoint?

There are several stakeholders affected by the ongoing, interstate-banking-induced

consolidation in the banking industry: state and federal governments, businesses,

individual consumers, employees, managers, and stockholders. Although some of

these parties have overlapping interests, they also have conflicting perspectives.

Managers and employees alike have, for instance, a stake in the survival of a bank.

However, an incentive scheme that ties compensation of the manager to the “bottom

line” (profits) may lead the manger to assign a low priority to the welfare of his/her

subordinates if such a move is expected to reduce profits.

For the state of Georgia, the dramatic change in the nature of the banking

industry has followed the state's entry in the compact of other southeastern states in

1983. Two major developments ensued.


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• Some of the largest banks from Georgia in 1975 (C&S, First Atlanta, First

Georgia, National Bank of Georgia, and Bank South) were acquired by

out-of-state banks by 1995.

• Several new, small banks were chartered, especially in the Atlanta

metropolitan area.

Economic growth of Georgia has been remarkable over the last twenty-five

years. Has this growth been helped or hindered by these two developments? Are the

stakeholders in the state favorably or adversely affected by these developments?

Would they have remained unaffected if interstate banking had not been allowed in

the first place? Below we examine some of these issues, first, in light of forces that

led to the relaxation of the ban on interstate banking. Then we investigate

implications of the change for various stakeholders, and examine empirical evidence

for both the U.S. in general and the state of Georgia in particular to shed light on the

purported benefits and harm of interstate banking. Finally, we will consider some

emerging trends in the financial services industry and their future implications for the

banking industry in Georgia as well as for various stakeholders in the state.


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Factors Responsible for Deregulation of Interstate Banking

Several forces have been responsible for deregulation of interstate banking.

From a global perspective, increasing integration of financial markets has highlighted

the connection between banks’ survival (and prosperity) and such deregulation,

which would fortify their ability to benefit from cheaper global sources of funds as

well as more profitable worldwide investment opportunities. A European banker

based in Atlanta during 1980s underscored his bank’s ability to access Eurocurrency

markets that allowed him to offer loans to midsize Georgia businesses loans at

interest rates 50 to 75 basis points (1/2 to 3/4 percent) lower than the local banks.

Advances in information technology have significantly aided this access to

the global market and the resultant trend toward global market integration. The cost

of information acquisition and telecommunications has been declining at a rapid rate.

So is the cost of hardware and software for processing the acquired data into useful

information that can be stored as well as disseminated to appropriate parties. Even

before the advent of the Internet, a treasurer of a company in Augusta could obtain

information on the LIBOR (London InterBank Offer Rate) on deposits in Singapore

or Panama and transfer deposits offering highest interest rates in matters of minutes

with the telephone, telexes, or faxes. Similarly, the development of Automatic Teller

Machines (ATMs) has allowed a customer of a Columbus-based bank to withdraw

funds from her U.S. account in French francs, transfer money from one account to

another, or pay credit card bills, while visiting Paris. For the banking industry, ATMs

have become virtual branches enabling them to overcome the state as well as national

barriers for servicing customers.

Both market integration and technological advances put pressures on the

government to modify regulation of financial intermediaries. However, regulatory

authorities have not acted with equal swiftness across the board. Banks, whose sphere

of activities was severely constrained by various laws and regulations (e.g., ban on

interstate banking and prohibition on entering investment banking business), saw

progress moving at a snail’s pace—and perhaps for a good reason. Banks, whose

major function as financial intermediaries revolves around gathering, processing and

disseminating information (e.g., search for depositors and credit evaluation of

borrowers), are unique among financial intermediaries in one major respect: only they


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forge a critical link in implementing changes in the government’s monetary policy.

When, for instance, the Federal Reserve (Fed) wants to curb inflationary forces

through tightening the money supply, it sells U.S. Treasury securities. Such a

transaction immediately siphons off bank deposits and leads banks to raise their

lending rates and/or ration funds to business customers. In either case, businesses are

forced to curb expansion by cutting back on investments. The revised investment

plans ease pressures on price to rise, i.e., inflation. To the extent that banks can

replace lost deposits by raising cheaper funds outside the U.S., they would not have

to raise their lending rates or ration funds. In that case, the Fed’s efforts to maintain

price stability through open market operations would be frustrated. Given the pivotal

role played by banks in implementing monetary policy changes, naturally there

would be reluctance on the government’s part to loosen regulatory control over

banks. It is then not surprising to find that the speed for regulatory changes during the

initial phase of deregulation (around 1975-1985) was slower for the banking industry

than for other financial intermediaries. For instance,

• brokerage houses were allowed to offer money market accounts carrying

higher interest rates than closely comparable demand or time deposits

with the banks. At the same time, no restrictions were ever placed on

brokerage houses for operating multi-state facilities,5 and

• savings and loan associations (S&Ls) were permitted to enter the

commercial real estate field, although previous demarcation between

banks and S&Ls required S&Ls to confine their financing to residential

real estate.

A similar situation also existed for the U.S. banks vis-a-vis foreign banks

operating banking facilities in the U.S. For instance, stringent capital adequacy

requirements were imposed on the U.S. banks earlier than on their counterparts

elsewhere. As a result, foreign bank facilities had an unfair advantage in the U.S. over

5 One rationale justifying this discriminatory practice was that the brokerage accounts could not obtain insurance protection that the Federal Deposit Insurance Corporation (FDIC), a U.S. Government-chartered body, routinely offers to bank deposits below $100,000.


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the U.S. banks.6 Thus, competition from both other financial intermediaries and

foreign banks intensified for U.S. banking firms.

Banks, however, were not completely left in the lurch. The Fed helped banks

by allowing them to:

• offer nationwide money market accounts without interest ceilings

applicable to demand deposits; and

• open loan production offices as well as limited-scope financial activity

centers (such as leasing offices), without seeking approval of state or

federal authorities.

These measures allowed banks to fight back the intensified competition.7

Further, the Fed policy in the 1980s that a bank is a bank only when it accepts

deposits and makes loans meant that cross-border business was possible by an out-of-

state bank when it separated these two operations. As a matter of fact, for large banks,

it was advantageous to centralize the funds raising activity while decentralizing the

lending function. The net result was that the national boundaries (and pari passu state

borders) became fuzzy and became a less severe constraint for banks in conducting

cross-border business than in the past. Still, bank market share vis-à-vis other

financial intermediaries dropped from 56 percent in 1948 to 25 percent in1993.8

Increased competition for market share among financial intermediaries

reduced profit margins on the conventional services offered by banks. Further, large

corporate customers learned to access financial markets directly, thus bypassing

banks to satisfy their seasonal, short- or medium-term needs.9 Sustaining profitable

6 Adoption of the Basle Accord in the late 1980s and subsequent modifications have gone a long way in removing disparity in capital adequacy requirements in major industrialized nations. 7 In the early 1980s the Fed also allowed banks to open International Banking Facilities (IBFs) that were not subject to requirements of reserves or deposit insurance on accounts held by nonresident entities. IBFs permitted banks to create Eurocurrencies market on the U.S. soil.

8 A qualification is necessary here. The market share is exclusively measured in terms of assets on the balance sheet. Off-balance-sheet activities, however, have substantially increased in the last twenty years, especially for large banks: these activities encompass, for instance, derivatives such as swaps and custom-made options provided by banks to their customers for risk management. 9 In many instances, banks facilitated this access; for instance, they started providing standby letters of credit to the corporations for raising funds through commercial papers, and placing medium-term floating rate notes issued by the corporations.


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operations forced banks to find new customers and offer new products or services

that were often not lucrative individually. Banks started to seek larger scale of

operations to offset lower profit margins.10 Interstate foray was a logical way to meet

this need.

Changing circumstances transformed the attitude of states: instead of keeping

out the out-of-state banks, they started to pursue them aggressively. Indeed, attracting

foreign bank operations whether they be the representative offices (loan production

offices), agencies (banks for all practical purposes except one, i.e., they cannot accept

deposits), branches, etc. became a badge of honor for some states.

In brief, the interrelated forces of technological advances, increased financial

market integration, uneven pace of deregulation, and intensified competition in

financial service industry paved the ground for lifting the ban on interstate banking.

10 Cooperative efforts, such as Mastercard and Visa, reduced the pressures on banks for enlarging the scale of operations.


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Benefits and Cost of Interstate Banking

It is obvious from the above description that as the U.S. economy underwent

change in the post World War II period, banks lost their market share vis-a-vis

foreign banks and other financial intermediaries. To the extent that the interstate-

banking ban prevented banks from retaining their competitive edge, a removal of

such ban should also eliminate the handicap for banks. In turn, the restored

profitability should help various stakeholders depositors, borrowers, employees,

stockholders, and federal as well as local governments to benefit from cheaper, more

efficient services, stable employment, higher returns at lower risk, and enhanced tax

bases.

Calomiris [1993] states:

“Previous research has suggested that geographic restrictions destabilized the banking system by creating small, poorly diversified banks that were vulnerable to bank runs and portfolio shocks.”

Similarly, Jayratne and Strahan [1995] write:

“... bank efficiency improved greatly once [intra-state] branching restrictions were lifted. Loan losses and operating costs fell sharply, and the reduction in banks’ cost was largely passed along to bank borrowers in the form of lower loan rates. The relaxation of state limits on interstate banking was also followed by improvements in bank performance, but the gains were smaller and the evidence of a causal relationship less robust.”

Still, these benefits have not been unalloyed. The potentially negative impact

from permitting interstate banking stems from:

• fewer, larger banks diminishing the competition in the industry;

• banks rendering barely acceptable services to customers because of

bureaucracy necessitated by the large size;

• banks displaying inflexible and unresponsive attitude toward catering to

local needs;

• intensified agency problems between stockholders and management; and


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• banks exercising undue influence on legislators to get laws enacted and

regulations established that may not be in the best interest of the

community, state, or even the nation.

States also incurred a loss of fees from granting fewer bank charters [Sylla,

Legler, and Wallis 1987]. Finally, Rose[1996] found that diversification across state

lines was frequently risk increasing until certain threshold levels were reached.

(These thresholds were defined by a bank's operations in (a) the number of states and

(b) more than one geographically distinct regions). Hence, a superior risk-adjusted

return was not necessarily a forgone conclusion.

Table 2 summarizes these benefits and costs. Table 2 is indicative rather than

comprehensive. The purported advantages stem from economies of scale and scope;

the disadvantages are suppose to arise from failure of competition.

TABLE 2. SUPPOSED ADVANTAGES AND DRAWBACKS OF PERMITTING INTERSTATE BANKING

Advantages Drawbacks

Greater service convenience to traveling customers Higher service charges

Improved cash management for firms conducting interstate businesses

Lower returns on deposits

Larger service menu Greater credit rationing to small businesses

Increased innovation More effective maneuvering to avoid taxes

Stable tax base Employee layoffs

Reduced risk of system failure Bloated bureaucracy

Increased efficiency leading to lower prices Increased inflexibility in responding to environment changes

Improved regulatory efficiency Increased customer inconvenience due to branch closings

Stable employment Tax revenue loss for states

Higher or safer returns to stockholders Excessive payments for acquisitions that reduce the returns to existing stockholder


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Empirical Evidence in Historical Perspective

A major problem with empirical studies that have examined the impact of

deregulating interstate banking has been that they have not controlled for the impact

of other potentially influential variables. Here we consider three such factors. First,

acquisition of banks across state lines occurred in the early and mid 1980s because of

the FDIC (Federal Deposit Insurance Corporation) policy to liquidate failed banks’

property at give-away prices. The resultant windfall gain generated a favorable

impact on the acquiring bank’s share price. Further, this windfall gain allowed the

acquiring bank to display the attitude of benevolent neglect toward inefficiencies in

the target bank.

Recent interstate acquisitions, in contrast, have necessitated more than 25

percent premiums over the market value of the target bank. Consequently acquisitions

have been accompanied with swift actions rooting out inefficiencies and most

conspicuously followed by the downsizing of the work force. Studies confined to the

1980s are thus likely to show benefits for the stockholders of the acquiring bank and

a lack of adverse impact on the employees of the target bank, thanks to the FDIC

policy measures of the time.

Second, sovereign loans enjoyed immense popularity with banks in the late

1970s and early 1980s. When these loans went sour during 1982-85, banks shifted

gears and started focusing on domestic loans. The coincidence of this change in bank

behavior with increased popularity of interstate banking (especially in light of the

FDIC policy for disposing of failed bank assets11 and softening stance of states

toward out-of-state banks) raises doubts on the inference that interstate banking was

responsible for increased loan activity. Jayratne and Strahan(1995) thus carefully

considered factors such as the health of the state’s economy that might influence cost

efficiency, but failed to consider the potential impact of this shift in bank behavior as

a result of country loan defaults.

11 Different estimates were provided by different published sources at different times, but the number $150 billion of assets of failed banks on the FDIC’s hand is widely accepted as reasonable.


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TABLE 3. INTERSTATE INVOLVEMENT OF MAJOR GEORGIA BANKS

Bank Name Surviving Organization Headquarters Date of Merger

Trust Company SunTrust Atlanta June 1985

First Atlanta Wachovia North Carolina December 1985

First Railroad First Union North Carolina August 1986

C&S C&S/Sovran Atlanta September 1990

C&S/Sovran NationsBank* North Carolina July 1991

BankSouth NationsBank* North Carolina September 1995

Third, the earlier implementation by the Fed of the Basle Agreement

superimposed higher capital adequacy on U.S. banks. Unlike its German or Japanese

counterpart, the Fed was also unwilling to consider the market value (in place of

historical value) for assets such as real estate owned by banks in determining capital

base. This stance virtually forced U.S. banks in the mid 1980s to undertake sale and

leaseback of their real estate properties occupied by branches and/or headquarters and

realize the capital gains that would enhance the equity cushion. This practice of sale-

and-leaseback of properties had an interesting side effect. It led to an increase in their

non-interest expense (due to lease or rental charges). A constant proportion of non-

interest expense coupled with larger lease charges then would suggest smaller

proportion of other non-lease charges, such as loan write-offs. Thus, the inference by

Jayratne and Strahan that the observed constant proportion of non-interest expense

implied stable output mix (i.e., absence of credit rationing in the wake of

deregulation) is questionable.

Incidentally, advocates of deregulation advance the adverse selection

hypothesis for explaining inefficient bank performance. Under regulatory protection,

stronger banks’ performance would be no better than the weaker banks. The

reasoning is as follows. Additional profitability generated by efficient management in

stronger banks would prompt regulators to extend leniency to weaker, and possibly

less efficient, banks. This action would remove the edge gained by stronger banks


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over weaker banks. But, at the same time, it discourages stronger banks from

improving their performance. When, however, this protection is removed, efficient

banks break loose from the pack.

A dramatic improvement in large bank performance is explained along this

line of reasoning to suggest that deregulation of interstate banking provided a strong

impetus for performance improvement to large banks. It is, however, possible that

larger banks, which had greater participation in sovereign and foreign loans in early

1980s, also racked up proportionately heavier losses; and when they shifted gears,

shunned country loans in the third world, and focused attention on domestic loans –

especially loans for LBOs (leveraged buyouts) that remained popular among these

banks until the end of the 1980s, they managed to earn high interest income, in

contrast to nonperforming country loans of the early 1980s. This would explain, at

least partially, why the domestic loan business improved (see Table 4) and why larger

banks had superior profit performance coincidentally when deregulation of interstate

banking gathered momentum.


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TABLE 4. COMMERCIAL AND INDUSTRIAL LOANS AT ALL COMMERCIAL BANKS

Seasonally Adjusted; Billions of Dollars: As of December

Year BusLoans Growth Rate

1973 $167.3 -- 1974 198.7 18.8% 1975 188.9 -4.9% 1976 191.5 1.4% 1977 211.3 10.3% 1978 246.2 16.5% 1979 285.6 16.0% 1980 317.1 11.0% 1981 356.0 12.3% 1982 397.5 11.7% 1983 419.7 5.6% 1984 480.1 14.4% 1985 505.7 5.3% 1986 541.9 7.2% 1987 570.5 5.3% 1988 607.0 6.4% 1989 638.8 5.2% 1990 641.2 0.4% 1991 619.8 -3.3% 1992 596.2 -3.8% 1993 586.4 -1.6% 1994 645.5 10.1% 1995 717.4 11.1% 1996 783.9 9.3% 1997 815.6 4.0%


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Conceptual Aspects for Empirical Tests Casual observations on previous studies mentioned above suggest the hazards

of inferences from limited-scope empirical investigations. Further, arguments both

for and against interstate banking rest on economic premises whose justification

cannot be taken for granted.

A. Economic Efficiency

A rationale for Interstate expansion of banking business rests on the premise

of economic efficiency. Economic efficiency, in turn, stems from economies of scale,

scope, or both.

• Economies of scale arise when the average cost per unit of output falls

with an increase in the output of a given product line. When the overhead

or fixed cost component is significant and excess capacity exists, total

cost related to additional output increases less fast than the output

quantity, and the average cost per output unit decreases.

• Economies of scope arise when the average cost per unit of output falls as

the firm broadens the range of its activities. In this case, existing fixed

overhead (assuming excess capacity) allows the firm to undertake

additional activities without incurring costs necessitated in absence of

existing activities.

In the case of interstate banking, the central issue is thus economic efficiency.

If greater efficiency is achieved, the distribution of the resultant gains among various

stakeholders is important but still a secondary issue. If greater economic efficiency is

not achieved, there will not be any gains, and any net increase in gains for one

stakeholder has to come from a commensurate loss for some other stakeholders, i.e.,

it’s a zero-sum game.

Essentially, scale and scope economies, as described above, are connected

with fixed cost as a proportion of the total cost incurred by the enterprise. The fixed

cost component has two dimensions: production capacity and time.


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B. Fixed Cost and Capacity

Fixed costs can support activities (or production) only up to a given level;

beyond that point the firm will have to incur additional fixed costs. When a bank's

activity level is below this given (maximum feasible) level, the bank will have 'excess

capacity.' As long as the increased activity level due to interstate expansion remains

below this maximum, the bank will show higher profitability in terms of either profit

margin or rate of return. But once the activity level reaches the maximum level,

additional fixed costs are incurred, and profitability is likely to show a decline in

relation to that from the previous level of activity.

It seems obvious that whether a bank shows 'economic efficiency' upon its

foray in the interstate arena is an empirical question. However, such an investigation

is not as straightforward and simple as it sounds. For instance, when a bank incurs

additional fixed cost, it is also creating excess capacity. It is also possible that

prospects of even larger scale of activity may prompt the bank to choose a

'production technology' that would not have made sense at the earlier, smaller scale.

In either case, the bank may be poised for even greater expansion; and its prospects

for long run profitability may improve, although the short run evidence may seem to

contradict that.

At the same time, it is also possible that the larger scale of operations may

necessitate additional layers of organization that may entail longer decision time lag,

less decision making flexibility at lower echelons of the organization, and higher

monitoring cost to prevent sabotage of rules and procedures. Interstate expansion

through bank mergers exacerbates this problem further when two merging banks have

different corporate cultures and operating styles.12

In the banking literature, empirical evidence on economies of scale and scope

has been extensively studied and analyzed, and results are far from clear. For

instance, Berger and Humphrey [1991] found the average cost rising for a bank with

12 An officer of more than 15 years of service with an Atlanta bank, which has now out-of-state

headquarters, talked recently in a wistful voice about 'good old days' (more than seven years ago

when) the bankers like her were able to behave with professional dignity that no longer exists

because of the “uncouth out-of-state top management.”

https://www.researchgate.net/publication/222122153_The_Dominance_of_Inefficiencies_Over_Scale_and_Product_Mix_Economies_in_Banking?el=1_x_8&enrichId=rgreq-66808657-524e-4a34-834d-e515f1b6fb9e&enrichSource=Y292ZXJQYWdlOzI2NTc0NjcwMTtBUzoyMzE5MTMwMjE1MDU1MzdAMTQzMjMwMzc4MTQzNg==


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assets of $500 million. Hunter and Timme [1991] found that the average production

cost rises beyond the asset level of $10 billion. Finally, Bernstein [1996] found that a

bank with low nonperforming loans could reap benefits of scale economies up to the

level of assets of $50 billion.

C. Fixed Cost and Time Dimension

A more substantive issue, related to the fixed cost component, has not

received the attention it deserves. Over long run, fixed costs are no longer fixed. In a

very short time period, such as a week or month, even variable costs may be outside

the range of decision control, and thus may be indistinguishable from fixed costs.

Fixed costs for a bank can be broadly classified into two categories: corporate

(or headquarters) level and branch level. The distinction is important for the

following reason. In the short run context of a decision, the corporate-level fixed cost

is still fixed and thus irrelevant; justification for the decision thus requires that it

should generate a positive contribution to the branch-level fixed cost. During bad

times, the ‘best’ decision should at least have a positive contribution to the branch-

level fixed costs. However, in the long run, a ‘best’ decision should not only cover

the branch level overhead completely, but also contribute positively to the corporate

level overhead.

When a bank acquires another (out-of-state) bank, it is important to consider

at which level the fixed costs (at the headquarters level or at the branch level) will be

affected and how. Consider the case of a bank that plans on reducing the staff size at

the headquarters level upon acquisition of another bank. If the subsequent integration

process highlights the need for greater reporting requirements at the branch level for

monitoring purposes, the bank has essentially traded a reduction in fixed cost at the

headquarters level for increased cost at the branch level. In turn, this tradeoff has

significant implications in terms of flexibility in times of adversity.13 Computation of

net profitability gains is then no longer an easy and straightforward task even if one

leaves aside impact of this tradeoff on employee morale and productivity or customer

satisfaction.

13 Deregulation and increased competition are likely to magnify prospects for such adversity.


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D. Reduced Competition

Arguments against interstate banking revolve around increased market share

of surviving banks and its deleterious impact on various stakeholders such customers

both businesses and individuals, state and local governments, and investors. The

reasoning is that if there are fewer banks, they would be large, and the increase in size

will give them an edge against various stakeholders.

• Depositors will be provided lower interest rates.

• Borrowers as well as customers using bank services will be charged

higher rates.

• Governments will be jawboned into providing tax relief or service

subsidies.

• Stockholders will be provided less adequate returns through greater perks

to management.

• A combination of the above actions.

This argument presumes failure of two mechanisms: regulatory and market.

Delayed, or at the extreme even a lack of, response by regulatory bodies is certainly

conceivable, but unlikely in the U.S. Similarly, abuses of market power by large

banks are possible. However, given the dual nature of the fixed cost – at the corporate

and at the branch levels– it is very likely that large banks may be unable to compete

against and crush small local banks that have both flexibility of maneuvering and an

advantage of low cost [see Box A]. Essentially it would be strictly a case of niche

playing. A rapid increase in formation of local banks nationally and their prosperity

underscores small banks’ ability to exploit their niche.


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Box A

Even in Granite Falls, a town of 3,253 in the hills of western North Carolina, Mr Forlines's bank is no colossus. Three of America's biggest financial institutions, NationsBank, First Union and Wachovia, have offices in the area. At 2.7%, its return on assets is a full percentage point over that of the average commercial bank. Its success comes from following the basic rules of small-town banking: keep it cheap, motivate employees, and treat customers like humans. Its costs consume only 32% of income, half the figure for many of America's big banks. Loan customers are mostly medium-sized local businesses, which might be too small to get much attention from a bank with national aspirations. Smaller companies with fewer choices, of course, must pay a bit more for their money: Granite's average loan margin--the difference between the interest it pays depositors and the interest it collects from borrowers--is 5%, a full percentage point over the industry mean. The bank keeps its risks under control by selling off mortgage and credit-card receivables to bigger institutions. Bad loans stand at a mere 0.3% of the total, because retrieving debts can be easier in a small town than in a big city. Granite set up an Internet site and bought a check-scanning machine to cut processing costs and help with marketing. The bank has also introduced 24-hour phone banking to lure younger customers, and has started to diversify into leasing, insurance and annuities. Fees from such businesses grew by 50% last year.

Source: The Economist, "The Value of Good Housekeeping," pp.70-1. January 1, 1998.


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For the state of Georgia, Table 5 provides the deposit base of single-facility

banks for the years 1994 and 1998.14 Between 1994 and 1998,15 36 single-facility

banks came into existence and 39 banks ceased to remain single-facility entities (due

to a variety of reasons such as a conversion into multi-unit facilities and liquidation).

The remaining 76 banks had single-facility operations in both these years (see

Appendix A for a list). The mean deposit base also was stable at $52 million. Finally,

seventy-six banks that were in existence during both the years had their deposit base

expand by 33 percent (both in terms of median and mean when two outlying

observation were removed16), with the range from –99 percent to 159 percent. This

expansion translated into a 7 percent annualized growth rate, a growth rate in step

with the growth rate of the state’s economy and in excess of that of the U.S.

economy. Overall, these statistics indicate that one-facility, small banks showed

remarkable resilience in terms of both the number and the deposit-base stability and

growth, in spite of accelerated pace of interstate banking movement in 1990s.

It is also conceivable that competition emanating from globalization of

financial markets also keeps in check any abuses of market power by big banks. Note

that the actual existence of competition is not needed to observe actions consistent

with such competition. The contestable market theory suggests that all that is needed

is the threat: the economic entities enjoying monopolistic power would behave as if

such competition exists; and they would not take actions that enhance short-run

profitability only at the expense of long-run profitability jeopardized by attracting

potential competition in the market place.

14 This information is obtained from the Web site maintained by the Federal Deposit Insurance Corporation (FDIC). 15 Integrated reporting of interstate branches in 1999 makes t1998 the last year for having the access to the data on the deposit base. 16 Monogram Credit Card Bank in Fulton County had the deposit base expand from $12million to $673million, an expansion of 5,431% during the period! Similarly, Central Carolina Bank in Muscogee County had the deposit base shrink from $14million to $100,000, or –99%.


21

TABLE 5. DEPOSIT BASE OF SINGLE-FACILITY BANKS IN GEORGIA: 1994-1998

Deposits (In $000s) Expansion

Bank Name County 1994 1998 A. IRR B. RATE

1 Central Carolina Bank - Georgia Muscogee $ 13,564 102 -71% -99.2%

2 The Tattnall Bank Tatnall 29,314 4,587 -37% -84.4%

3 Bank of Ellaville Gilmer 31,774 8,627 -28% -72.8%

4 The Prudential Bank and Trust Company Fulton 882,593 665,799 -7% -24.6%

5 The Prudential Savings Bank, FSB Dekalb 167,739 156,107 -2% -6.9%

6 The Carver State Bank Chatham 18,846 17,985 -1% -4.6%

7 The Knight State Bank Laurens 14,298 14,012 -1% -2.0%

8 The Security State Bank Telfair 25,854 26,726 0.83% 3.4%

9 The Gordon Bank Wilkinson 28,383 29,446 0.92% 3.7%

10 The Bank of Perry Houston 42,029 43,740 1.00% 4.1%

11 Jones County Bank Jones 3,538 3,738 1.38% 5.7%

12 First National Bank of Union County Union 40,052 42,632 1.57% 6.4%

13 The Citizens State Bank Taylor 21,027 22,391 1.58% 6.5%

14 The Peoples Bank of Talbotton Talbot 12,503 13,488 1.91% 7.9%

15 Bank of Camilla Mitchell 39,200 42,341 1.95% 8.0%

16 The Citizens Bank of Swainsboro Emanuel 42,625 46,048 1.95% 8.0%

17 Wilkinson County Bank Wilkinson 18,231 19,782 2.06% 8.5%

18 Rochelle State Bank Wilcox 14,067 15,287 2.10% 8.7%

19 Pineview State Bank Wilcox 11,914 13,293 2.78% 11.6%

20 First National Bank of West Point Troup 82,144 92,207 2.93% 12.3%

21 The Merchants & Citizens Bank Telfair 34,298 38,854 3.17% 13.3%

22 Pineland State Bank Candler 25,935 29,600 3.36% 14.1%

23 Bank of Hancock County Hancock 44,990 51,439 3.41% 14.3%

24 Bank of Dawson Terell 49,639 57,184 3.60% 15.2%

25 The Greenville Banking Company Meriwether 15,173 17,644 3.84% 16.3%

26 The Bank of Spalding County Spalding 48,410 56,295 3.84% 16.3%

27 The Woodbury Banking Company Meriwether 15,790 18,506 4.05% 17.2%

28 The Bank of Soperton Trentlen 30,348 35,935 4.32% 18.4%

29 The Commercial Bank Oglethorpe 35,825 42,480 4.35% 18.6%

30 Thomaston Federal Savings Bank Upson 39,200 46,599 4.42% 18.9%

31 Monroe County Bank Monroe 28,358 34,301 4.87% 21.0%

32 Bank of Wrightsville Johnson 38,107 46,451 5.07% 21.9%

33 Peoples Bank, Lavonia, Georgia Franklin 32,341 40,080 5.51% 23.9%

34 Newton Federal Savings and Loan Association

Newton 81,470 104,918 6.53% 28.8%

35 Gwinnett National Bank Gwinnett 32,427 42,002 6.68% 29.5%

36 The Citizens Bank of Cochran Blackley 39,418 52,100 7.22% 32.2%


22

37 First National Bank of Coffee County Coffee 32,577 43,458 7.47% 33.4%

38 Quitman Federal Savings Bank Brooks 27,092 36,146 7.47% 33.4%

39 Bank of Dooly Dooly 28,458 38,442 7.81% 35.1%

40 Bank of Georgia Oconee 34,852 47,446 8.02% 36.1%

41 Peoples State Bank Twiggs 10,487 14,352 8.16% 36.9%

42 Central Bank & Trust Crisp 36,729 50,370 8.22% 37.1%

43 Bank of Gibson Glascock 6,435 8,874 8.37% 37.9%

44 Peoples State Bank & Trust Appling 27,303 37,738 8.43% 38.2%

45 Jordan Banking Company Calhoun 5,323 7,363 8.45% 38.3%

46 The Citizens Exchange Bank Atkinson 12,835 17,756 8.45% 38.3%

47 Bank of Lumber City Telfair 9,869 13,664 8.47% 38.5%

48 The Four County Bank Wilkinson 22,102 30,627 8.50% 38.6%

49 Talbot State Bank Talbot 20,394 28,315 8.55% 38.8%

50 First National Bank of South Georgia Dougherty 39,706 55,879 8.92% 40.7%

51 First National Bank of Baldwin County Baldwin 41,110 58,094 9.03% 41.3%

52 United Security Bank Hancock 8,131 11,577 9.24% 42.4%

53 Bank of Monticello Jasper 31,573 45,509 9.57% 44.1%

54 Bank of Adairsville Bartow 24,437 35,735 9.97% 46.2%

55 Bank of Worth Worth 29,327 43,071 10.09% 46.9%

56 Barwick Banking Company Brooks 5,260 7,790 10.32% 48.1%

57 Liberty Bank & Trust Stephens 13,889 20,899 10.76% 50.5%

58 The Eastside Bank & Trust Company Gwinnett 42,941 66,110 11.39% 54.0%

59 Tippins Bank & Trust Company Evans 19,146 29,598 11.51% 54.6%

60 The United Banking Company Berrien 36,947 57,380 11.63% 55.3%

61 Bryan Bank & Trust Bryan 37,994 59,595 11.91% 56.9%

62 AmTrade International Bank of Georgia Fulton 35,674 56,836 12.35% 59.3%

63 Bank of Newington Screven 18,754 30,553 12.98% 62.9%

64 Wayne National Bank Wayne 22,697 37,160 13.12% 63.7%

65 Dorsey State Bank Wilcon 3,880 6,358 13.14% 63.9%

66 Valdosta Bank and Trust Lowndes 36,586 61,128 13.69% 67.1%

67 Frederica Bank & Trust Glynn 37,765 63,397 13.83% 67.9%

68 The Westside Bank & Trust Company Cobb 38,716 72,404 16.94% 87.0%

69 Bank of Loganville Walton 25,624 51,555 19.10% 101.2%

70 Bank Atlanta Dekalb 30,539 64,786 20.69% 112.1%

71 Towns County Bank Towns 29,715 63,798 21.05% 114.7%

72 Bank of Gray Jones 53,018 115,175 21.40% 117.2%

73 First Clayton Bank & Trust Company Rabun 32,277 73,249 22.74% 126.9%

74 The Bankers Bank Fulton 35,315 86,489 25.10% 144.9%

75 First Capital Bank Gwinnett 46,746 120,973 26.83% 158.8%

76 Monogram Credit Card Bank of Georgia Fulton 12,160 672,552 172.71% 5430.9%

*One-Facility banks in existence in both 1994 and 1998


23

E. Diversification

Expansion of banking activities across state borders is supposed to reduce a

bank's dependence on activities in a given state, and thereby generate more stable

returns for its investors (see the Calomiris quote in the previous section). That

diversification brings in its wake returns stability (or reduced risk) needs two major

qualifications.

• Stockholders could have achieved similar diversification by directly acquiring

shares of the two banks. They do not need a bank to do it for them. As a

matter of fact, consolidation reduces opportunities for the investor to attain

the magnitude of risk that he or she desires in the portfolio. Further, the basic

premise of the finance function is the relationship between returns a security

is expected to generate and the risk volatility such returns entail. But not all

(volatility) in earnings estimates matter. Indeed, the only relevant risk is the

risk that cannot be diversified when all securities trading in the market, i.e.,

the market portfolio, are considered. Thus, there is no guarantee that the

relevant risk will be reduced in the first place through acquisition of another

bank.

• That interstate banking activities reduce failure risk rests on two

premises:

o Different states go through different phases of the business cycle at

any given time. Although different regions exhibit varying levels of

economic activities, the difference among contiguous states is hardly

significant.

o If a bank is sufficiently big, regulators may not allow it to fail for the

fear of its repercussion on other banks. The premise of "too big to

fail" equates business failure with its liquidation. From the

stockholders' perspective, a bank may not be technically liquidated in

that its assets are taken over by regulators and sold to another bank(s).

But stockholders do not receive any compensation in such

transactions. In this respect, failure of a bank is no different from a

failure of any unregulated (i.e., not protected by regulatory

authorities) business.


24

Consideration of the impact of a bank merger on the relevant or systematic

risk allows us to examine the above premises in an indirect but straightforward

manner. A 'beta' of a security is the index of the relevant risk; it reflects the security's

risk contribution to the market portfolio. A larger beta implies greater risk.

Suppose we are considering an investor who holds such a market portfolio

before the merger of two banks, A and B. The market portfolio, by assumption,

contains stocks of A and B. Suppose the value of the combined beta of A and B

before the merger is 1.02.17 After the merger is consummated, if the stock of the

combined bank implies the beta value of, say, 0.95, one can reasonably infer

economic efficiency due to economies of scale and/or scope. On the other hand, a

post-merger beta value of 1.20 would imply diseconomies of scale and/or scope.18

The change in the beta value, in turn, gives us a clue regarding returns

required by the investors: the larger the value of beta for a given security, the higher

the return demanded by the investors. When a bank stock beta increases in value

upon its expansion of interstate banking activities, it will incur higher cost of

financing. This increased cost will force the bank, among other things, to

• charge higher interest rates on loans to its customers,

• ration credit to its customers,

• levy higher charges for services rendered to its customers,

• reduce the array of services it offers, or

• a combination of the above measures.

The reverse will happen when the beta value decreases as a result of the

bank's interstate foray. Consequently, effectiveness of interstate expansion of a bank

may be tested by the impact of such a decision on its stock’s beta.

17 The weights for each security in the combination may be equal, or based on the market values of the securities. If, for instance, the market values of shares of A and B are $6 billion and $4 billion, and their betas are 1.1 and 0.9 respectively, the combined beta would be [ 6billion / (6 billion +4 billion)] (1.1) + [ 4 billion / (6 billion +4 billion)] (0.9)

= 0.66 + 0.36 = 1.02. 18 A valid comparison naturally requires a given level of the returns. When returns change due to a merger, the theory allows us to adjust the value of the benchmark beta against which the observed beta value is assessed.


25

The stock beta values, however, may be prone to misleading inferences. The

financial leverage, or the proportion of debt in a firm's capital structure, positively

affects a stock beta. Although the proportion of debt in banks is high, its magnitude is

not uniform across the board. Thus, a bank's entry in interstate banking might have

allowed it to gain greater economic efficiency and thereby lower its stock beta;

another bank might not have been so fortunate, and might have managed to raise its

stock's beta value. Suppose, however, that the former bank significantly increased its

financial leverage, while the latter lowered it. These actions would raise the former

bank's beta, and lower the latter bank's beta. The inference, that the former bank's

entry in interstate banking was not justifiable in economic sense whereas the latter's

was, does not accurately portray the reality. Hence, it is desirable to use the ‘asset

beta’ (or pure-equity beta)19 that purges the impact of financial policies from the

stock's leveraged beta, both before and after the interstate foray, to observe the impact

of the economies of scale and scope in the interstate bank merger or acquisition. The

relationship between the stock beta (βs) and the asset beta (βa) is defined as follows:

βa= βs/ [1 + (1 – Tax rate)Debt / Equity]

where debt and equity are represented by their market values.

Finally, the stability of its asset beta value over time can be a good barometer

of whether the bank behaves as if there is competition (even when it does not

encounter such competition currently). Greater beta value stability then underscores

keener bank awareness of the contestable market theory. Otherwise the beta value

over time will be unstable and possibly increasing.

A note of caution is necessary here. The dynamic nature of the banking industry

suggests that changes in the nature and scope of the industry, and not just the

behavior of an individual bank, may be reflected in the changing beta values over

time. Hence, inferences of a given bank behavior on the basis of the changing beta

values are by necessity tentative.

19 See, for instance, Ross, Westerfield, and Jaffe (1999), p.303 for the relationship between the stock beta and the asset beta.


26

Empirical Tests: Results

Statistical results provided in this paper as well as elsewhere are more

suggestive than conclusive because of the small sample size and the very nature of

the statistical tests. Further, two of our major concerns, i.e., impact of interstate

banking (a) on various stakeholders (other than stockholders), and (b) on the

economy of the state of Georgia in general, would require surveys or elaborate tests

that are beyond the scope of the present study.

Figures 1-4 display the behavior of asset betas of the Atlanta-based banks

referred to in Table 3. Several observations are pertinent.

• Historical beta values of Atlanta-based banks prior to the merger were

slightly above the corresponding values of the acquiring out-of-state

banks. Thus, the Atlanta banks' returns were slightly more closely related

to the security market than banks from North Carolina.

• Just prior to mergers, beta values of the Atlanta banks sharply declined,

presumably reflecting increased equity values due to merger rumors or

anticipation that buyout offers would be significantly above the market

value of equity.20

• The combined beta values, both pre-merger and post-merger, in general

did not show a significant change. The significant exception was the

NationsBank (now BankAmerica), which registered a jump in the beta

value upon merger.

• Certain patterns are industry-wide. For instance, during 1988-1990, the

values declined, and subsequently they reversed the course. Two

explanations may be advanced.

o After the stock market crash of October 1987, the Fed substantially

increased market liquidity, thus lowering the cost of borrowing by the

banks.

o Two years later, recessions of varying degrees hit the economies of

the U.S., Japan, and Europe, which dampened the demand for bank

credit.

20 Changes in share price and its beta are inversely related. Hence, when an acquiring bank offers shareholders of the target bank a premium over the existing market price in order to induce them to a merger agreement, the stock beta declines.


27

FIGURE 1. BETA VALUES (WACHOVIA BETA AND FIRST ATLANTA BETA)


28

FIGURE 2. BETA VALUES (SUNTRUST*, SUNTRUST BETA, TRUST BETA, AND SUN BETA)


29

FIGURE 3. BETA VALUES (FIRST UNION BETA AND FIRST RAILROAD BETA)


30

FIGURE 4. BETA VALUES (NCNB BETA AND C&S BETA)


31

The above observations rule out the economies of scale or scope, at least with

respect to our small sample. Again, the only exception is the NationsBank, whose

deteriorating asset-beta values do not rule out diseconomies of scale.

• Volatility in beta values over time is significantly high for the NationsBank

(BankAmerica). First Union and SunTrust exhibit similar but less pronounced

behavior. Wachovia shows the most stable behavior over time. Thus the bank

behavior in general is not inconsistent with respect to the contestable market

theory.

Given the openness of the Georgian economy during the test period vis-à-vis the

historical situation, the above evidence points to

• A lack of economies of scale or scope due to mergers and acquisition for

Georgian banks; and

• An absence of increased profitability possibly due to (a) stable prices for their

services to their customers, and/or (b) sufficient returns to depositor-investors

to prevent their funds' flight to alternative investments.

In brief, these mergers have not materially generated either favorable or

unfavorable economic impact on stakeholders in Georgia, in light of our hypothesis

concerning the asset beta behavior.

A high-level executive with a major bank wryly observed that deregulation is

a myth in that his bank (having interstate banking presence) has to generate far more

reports for the regulators now than ever before. He contended that mergers in the past

failed to generate sizable benefits for the acquiring banks because they were unable to

consolidate their interstate operations (prior to implementation of the IBBEA in 1997,

as mentioned in the Introduction). As a result, he argued, the acquiring banks could

not reduce the duplicated overhead, especially related to data and report processing

units. For instance, client firms conducting business across state borders often ended

up with multiple accounts with different bank subsidiaries belonging to a single BHC,

and they obtained separate reports for these accounts.

Although this argument is plausible, it overstates potential benefits of

consolidation in the wake of IBBEA implementation. Essentially, the onus for

generating benefits for the acquiring bank centers on reduction of detailed paperwork

at the branch level. Sound performance evaluation procedures, however, require that

pertinent data for an activity center such as a branch should be disaggregated from the


32

rest of the bank's related data. If these data are to be generated for effective

management control, it is highly unlikely that conversion of interstate subsidiaries

into branches allowed since June 1997 would result in significant benefits for the

parent.

Finally, some bankers insist that the ability for generating benefits for the

acquiring bank primarily depends on measures taken to reduce overlapping branch

network. An extension of this argument suggests that an out-of-state bank acquiring

multiple banks in a state should show significantly more benefits than a counterpart

bank acquiring only one bank. Casual observations suggest that NationsBank

(BankAmerica) and First Union belonged to the former group, and SunTrust and

Wachovia to the latter. Our evidence does not corroborate lower or more stable beta

for the former group vis-à-vis the latter group.


33

Emerging Trends in the Banking Industry

Observers agree that historical behavior of the banking industry may not be a

useful guide for the future because of the transformation of its role in the economy.

For instance, the market share of banks in the financial service industry has shown a

dramatic decline in terms of on-the-balance-sheet types of activities (basically,

deposit gathering and providing credit). But that would not warrant a conclusion that

banks are on the verge of extinction. Banks have given up the conventional activities

only to dominate the field of risk management; and they have done it through off-the-

balance-sheet types of measures.

One development with a far-reaching potential is the Internet. Technological

developments have shifted emphasis from face-to-face customer transactions to

computer-based interactive transactions. Banks are now encouraging customers to use

Internet, ATMs, and smart cards that have one element in common: all these

transactional modes make conventional physical form of branches superfluous. Oft-

quoted comparative numbers for different modes of transactions are as follows:

• A face-to-face transaction with a teller costs banks $1.07

• phone banking costs $.54 per call

• a visit to the ATM is $.54

• web-based transaction costs $.01.

Validity of these numbers requires scrutiny of three aspects.

1. Very likely the transaction cost represents full costing comprised of fixed and

variable components. The fixed cost component should be ideally arrived at

by determining

• Estimate of the economic (instead of physical or accounting21) life of the

investment (e.g., the computer or the related programs). This estimate in

turn will help generate the estimate of periodic charge. When the periodic

21 Technological obsolescence, excessive repair & maintenance, and a dramatic decline in acquisition price over time are some reasons why the economic life may be shorter than the physical or accounting life of an investment.


34

charge is allocated to the estimated transaction volume, it will yield the

proper fixed charge per transaction.

Example: If a computer's cost22 is $100,000 and its useful life is 5 years, then

a periodic charge of $20,000 defrayed over an estimated average volume of

50,000 transactions would generate a fixed charge of

$20,000/ 50,000 transactions = $ 0.40 fixed cost per transaction.

It is obvious that variations in estimates of any or all of these items will likely

produce significantly different numbers.

2. Alternative transactional modes have different composition of branch-level

versus headquarter-level fixed costs. The branch-level component will

dominate in the face-to-face transactional mode, whereas the headquarter-

level component will dominate the Internet-based transaction. A proper

treatment of these costs would likely lead to entirely different estimates from

those where these fixed costs are misclassified.

3. From a customer's viewpoint, the cost should not just include what the bank

charges, but also what the customer's own costs are for transacting the

business. For instance, the Internet transaction requires not only computer-

based cost but also the cost of telephone connection and the charge by the

Internet service provider. Thus, the bank providing Internet access to

customers is also shifting a portion of its cost to the customer.

In the final analysis, even when one questions validity of the precise numbers,

one conclusion remains inescapable regarding the relative ranking of the alternatives:

cost of an Internet transaction to the bank is the lowest, and the face-to-face

transaction costs the bank the highest amount.23

22 This cost is comprised of not just the initial equipment and program acquisition cost but also the present value of periodic operating charges, tax-based depreciation allowances, and repair &maintenance cost. It also encompasses-- and is reduced by-- the present value of the net salvage at the end of the asset's useful life. 23 Although the Internet and ownership of a computer have gone hand-in-hand thus far, it may not be so in future, if the current trend of the integration of telephones and televisions for 'surfing' on the Internet were to gather momentum.


35

A dramatic instance is the Atlanta-based Net.B@nk, which has no physical

location for branches, and its customers carry out all transactions via ATMs and the

Internet. It has managed to charge below-average cost to its customers, pay them

above-average interest rates on deposits, and generate a rate of return on investments

that is significantly above the rate earned by conventional, well-managed banks.

Finally, it has provided flexibility to its customers to choose the combination of bank

services they want and when they want.

Three significant implications of strictly Internet-based banks should be

noted. First, the scale economics applicable to conventional banks is virtually

irrelevant. Net.B@nk, for instance, has managed to reach, and exceed, the breakeven

volume much earlier in its existence and for a much smaller customer base than a

comparable conventional bank would have required. Second, conventional banks

grafting the Internet base are generating profits. However, it is questionable whether

they would be able to improve their profitability dramatically. This is simply because

they have added still another layer of fixed cost without significantly reducing the

existing fixed costs. 24

Third, and perhaps the most significant implication, is the impact of the

Internet on interstate restrictions. The Internet makes irrelevant the physical

boundaries between states and even countries and in the process makes the question

moot regarding lifting of the ban on interstate banking. Even if the pre-1970s ban

were in existence today, it would have been rendered irrelevant.

With respect to the impact of lifting the ban on interstate banking on (a) the

nature of competition in banking, and (b) various stakeholders, Internet banking has

changed not only the economic parameters but also the benchmarks for assessment.

If anything, the Internet has (and will continue to do so) intensified competition; and

it has made size an almost irrelevant consideration, as noted above. With respect to

stakeholders, the changing nature of competition is likely to affect favorably

customers and investors alike. Employees very likely have to adapt to new demands

their jobs would entail, such as computer literacy or competency. At the same time,

they may have more flexible work-hours and ability to work from home. States'

24 They would not be able to do anything better, so long as they maintain the physical network of branches.


36

income from granting charters may change depending on whether they manage to

attract or lose banks; however, more significant impact may come from indirect

benefits and costs such as increased consumer spending and higher training and

unemployment benefits for laid off employees. In the final analysis, it looks like a

forgone conclusion that the states' ability is greatly circumscribed when it comes to

controlling out-of-state banks encroaching on the territory of in-state banks, or

regulating or channeling financial resources of in-state banks toward socially

desirable but uneconomic activities.


37

Conclusion

Lifting of the ban on interstate banking affects various groups in a

community, be it a town or a state. Bank customers, both as borrowers and lenders,

employees, stockholders, management and different government bodies have interests

that are neither congruent nor necessarily conflicting. As a result, assessing the

impact of lifting of such a ban is not an easy task. This study took the viewpoint that

the first step for such analysis is to ascertain whether cross-(state-)border activities

generate positive, risk-adjusted benefits. Only after such an assessment is made, the

issue of distributing the largesse among various interest groups becomes pertinent.

This study first considered the impact on small banks in Georgia. During the

period 1995-1998, two out of three small banks remained single-facility operations.

Their deposit base showed a healthy growth over the period. The number of banks

that ceased to remain single-facility entities was replaced by formation of virtually an

equal number of new banks with single operating facilities. Thus the number of such

small banks remained stable. Then the study focused on large banks. It used the

measure of the asset beta, an index of a firm's risk, and considered its behavior over

time, both before merger and after merger, for major banks based in Atlanta and their

out-of-state partners. Results suggested that such mergers have not yielded significant

economic benefits, nor resulted in significant economic costs for various

stakeholders.

Extension of this historical analysis for the future is constrained by two

developments: the 1997 IBBEA and the Internet. The 1997 act that allows conversion

of interstate subsidiaries into branches presumably would generate some cost savings;

however, these savings are likely to be insignificant. The Internet, on the other hand,

not only affects the transaction cost but also changes the basic economics of

breakeven analysis for banks. Thus, transaction cost would be lowered; and the

scale/scope economies, were they to exist, now would be far less significant for

banking business conducted on the Internet. Indeed, the development of the Internet

for banks makes the issue of state or national boundaries irrelevant. Measurement of


38

benefits and costs entailed by expansion of interstate banking will thus be a moot

issue. Of course, superimposition of the Internet on the conventional structure of the

bank is likely to produce far less dramatic benefits or changes. However, an increase

in the number of purely Internet banks without networks of physical branches will

dramatically change the banking industry as we know it today.


39

References

Berger, Allen and D. B. Humphrey. “The Dominance of Inefficiencies Over Scale and Product Mix Economics in Banking,” Journal of Monetary Economics, 28 [1991], pp.117-148.

Bernstein, D. “Asset Quality and Scale Economies in Banking,” Journal of

Economics and Business, XLIII [1996], pp. 157-166. Calomiris, C. “Regulation, Industrial Structure, and Instability in U.S. Banking: An

Historical Perspective” in M. Klausner and L. White (editors), Structural changes in Banking 19-116 [1993], New York: New York University.

The Economist. various issues. The Federal Deposit Insurance Corporation (FDIC). Web site. Hunter, W. C. and S. G. Timme, “Technological Change in Large U.S. Commercial

Banks,” Journal of Business, LXIV[1991], pp.339-362. Jayratne, J. and P. Strahan. “The Benefits of Branching Deregulation,” Economic

Policy Review, Federal Reserve Bank of New York, 3, #4[1997], pp.13-30. Rose, Peter S. “Diversification and Cost Effects of Interstate Banking,” Financial

Review, XXXIII [1996], #2. Rose, Peter S. Banking Across State Lines: Public and Private Consequences,

Westport: Quorum books, [1997]. Ross, S. A., R. Westerfield, and J. Jaffe. Corporate Finance, 5th edition [1999],

Chicago: Irwin/McGraw-Hill. Sylla, R., J. Legler, and J. Wallis. “Banks and State Public Finance in the New

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40

About The Author

Dileep R. Mehta is Professor of International Banking and Finance in the

Robinson College of Business at Georgia State University. Dr. Mehta is an expert in

the areas of international banking and corporate finance and is the author and co-

author of several research papers concerning bank management, corporate financial

management and international finance that have appeared in leading financial

journals. Dr. Mehta has consulted numerous organizations, including the United

Nations, Chase Manhattan Bank, AT&T, and General Mills. He received his D.B.A.

from Harvard University.

About The Fiscal Research Program

The Fiscal Research Program provides nonpartisan research, technical

assistance, and education in the evaluation and design of state and local fiscal and

economic policy, including both tax and expenditure issues. The Program’s mission

is to promote development of sound public policy and public understanding of issues

of concern to state and local governments.

The Fiscal Research Program (FRP) was established in 1995 in order to provide

a stronger research foundation for setting fiscal policy for state and local governments

and for better informed decision making. The FRP, one of several prominent policy

research centers and academic departments housed in the School of Policy Studies,

has a full-time staff and affiliated faculty from throughout Georgia State University

and elsewhere who lead the research efforts in many organized projects.

The FRP maintains a position of neutrality on public policy issues in order to

safeguard the academic freedom of authors. Thus, interpretations or conclusions in

FRP publications should be understood to be solely those of the author.


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FISCAL RESEARCH PROGRAM STAFF David L. Sjoquist, Director and Professor of Economics Margo Doers, Administrative Support Alan Essig, Senior Research Associate Catherine Freeman, Senior Research Associate Lakshmi Pandey, Research Associate William J. Smith, Research Associate Dorie Taylor, Associate to the Director Jeanie J. Thomas, Senior Research Associate Sally Wallace, Associate Director and Associate Professor of Economics ASSOCIATED GSU FACULTY James Alm, Chair and Professor of Economics Roy W. Bahl, Dean and Professor of Economics Kelly D. Edmiston, Assistant Professor of Economics Martin F. Grace, Associate Professor of Risk Management and Insurance Shiferaw Gurmu, Associate Professor of Economics Julie Hotchkiss, Associate Professor of Economics Ernest R. Larkin, Professor of Accountancy Gregory B. Lewis, Professor of Public Administration and Urban Studies Jorge L. Martinez-Vazquez, Professor of Economics Dileep Mehta, Professor of Finance Julia E. Melkers, Assistant Professor of Public Administration Theodore H. Poister, Professor of Public Administration Ross H. Rubenstein, Assistant Professor of Public Admin. and Educational Policy Studies Benjamin P. Scafidi, Assistant Professor of Economics Bruce A. Seaman, Associate Professor of Economics Mary Beth Walker, Associate Professor of Economics Katherine G. Willoughby, Associate Professor of Economics PRINCIPAL ASSOCIATES Mary K. Bumgarner, Kennesaw State University Richard W. Campbell, University of Georgia Gary Cornia, Brigham Young University Dagney G. Faulk, Indiana University Southeast Richard R. Hawkins, University of West Florida L. Kenneth Hubbell, University of Missouri Jack Morton, Morton Consulting Group Francis W. Rushing, Independent Consultant Saloua Sehili, Centers for Disease Control Stanley J. Smits, Workplace Interventions, Inc. Kathleen Thomas, University of Texas Thomas L. Weyandt, Atlanta Regional Commission Laura Wheeler, Independent Consultant GRADUATE RESEARCH ASSISTANTS Hsin-hui Chui Ana Rios Lynn Comer Jones Marian Velik John Matthews


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RECENT PUBLICATIONS

(All publications listed are available at http://frp.aysps.gsu.edu or call the Fiscal Research Program at

404/651-2782, or fax us at 404/651-2737.)

Interstate Banking and Georgia-Based Banks. (Dileep R. Mehta)

This report explores whether the easing of the restrictions on interstate banking

has generated positive, risk-adjusted benefits. FRP Report 58 (May 2001)

Urban Welfare-to-Work Transitions in the 1990s: Patterns in Six Urban Areas. (John Baj, Julie L. Hotchkiss, et. al.)

This report focuses on patterns of welfare use and employment for welfare leavers for central counties in each of six metropolitan areas. FRP Report 57 (April 2001)

The Georgia Sales Tax Revenue Impact From Electronic Commerce. (Richard R. Hawkins)

This report presents estimates of sales tax revenue loss by Georgia counties due to e-commerce. FRP Report 56 (March 2001)

A Single-Factor Sales Apportionment Formula in The State of Georgia: Issues and

Consequences (Kelly D. Edmiston)

This report provides an analysis of revenue and economic development

implications of the corporate income tax apportionment formula. FRP

Report/Brief 55 (February 2001)

Estimates of the Effects of Education and Training on Earnings. (William J. Smith)

This report reviews literature on the effect of training on earning and provides

additional empirical evidence. FRP Report/Brief 54 (January 2001)

Impact of the 1996 Summer Olympic Games on Employment and Wages in Georgia.

(Julie L. Hotchkiss, Robert E. Moore, and Stephanie M. Zobay)

This report estimates the effect on employment and wages resulting from the

1996 Olympics. FRP Report 53 (December 2000)

Trends in Corporate Income Tax Receipts. (Sally Wallace)

This report analyzes trends in state corporate tax receipts and explanations for the

decline in corporate tax revenue growth. FRP Report/Brief 52 (December 2000)


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School Flexibility and Accountability. (Ben Scafidi, Catherine Freeman, and Stanley DeJarnett)

This report presents a discussion and a menu of alternatives for school flexibility

and accountability. FRP Report 51 (November 2000)

Defining and Measuring High Technology in Georgia. (Susan M. Walcott)

This report defines and measures the high technology sector in Georgia. FRP

Report/ Brief 50 (December 2000)

State and Local Government Choices in Fiscal Redistribution. (Roy Bahl, Jorge Martinez-Vasquez and Sally Wallace)

This report explores the factors that are associated with the level and nature of

states’ income redistribution programs. FRP Report/Brief 49 (October 2000)

Profile of Georgia State Revenues 1974 – 1999. (M. Kathleen Thomas)

This report provides detailed information on trends in Georgia’s major revenue

sources over the period 1974-1999. FRP Report/Brief 48 (October 2000)

Economic Development: Report of Statewide Results of Georgia Poll July 2000. (Fiscal Research Program/Applied Research Center)

This report presents results of an annual survey on economic development

activities in the State. FRP Report 47 (July 2000).

A Decade of Budget Growth: Where Has the Money Gone? (Alan Essig) This report presents an analysis of state budget growth between fiscal years 1991

and 2000. In specific, policy decisions that drive the budget increases are

highlighted. FRP Report/Brief 46 (September 2000)

International Trade in Georgia: Review of State Programs, Policies, and Recent

Trends. (Robert E. Moore) This report provides a review of the recent trends on international trade in

Georgia and reviews Georgia’s policy and programs related to international

trade. FRP Report/Brief 45 (July 2000)

(All publications listed are available at http://frp.aysps.gsu.edu or call the Fiscal Research Program at 404/651-2782, or fax us at 404/651-2737)

interstate banking and georgia based banks interstate banking and georgia-based banks

Documents