Historical Development of the Banking Industry

Outcome:MultipleRegulatoryAgencies
1. FederalReserve
2. FDIC
3. OfficeoftheComptrolleroftheCurrency
4. StateBankingAuthorities

10-1

Financial Innovation
Innovationisresultofsearchforprofits
ResponsetoChangesinDemand
Majorchangeishugeincreaseininterestrateriskstartingin1960s
Example: Adjustableratemortgages
FinancialDerivatives

ResponsetoChangeinSupply
Majorchangeisimprovementincomputertechnology
1. Increasesabilitytocollectinformation
2. Lowerstransactioncosts
Examples:
1. Bankcreditanddebitcards
2.Electronicbankingfacilities
3. Junkbonds(increasedinfo)
4. Commercialpapermarket(shorttermdebt)
5. Securitization(loansandmortgagestransformedintosecurities,original
bankservicestheaccount,bundlingforstandardization)
10-2

Avoidance of Existing Regulations

RegulationsBehindFinancialInnovation
1. Reserverequirements
Taxondeposits=ir
2. Depositrateceilings(RegQ)
Asi,loopholeminetoescapereserve
requirementtaxanddepositrateceilings
Examples
1. Moneymarketmutualfunds
2. Sweepaccounts(overnighttransferintointo
timedeposit)
2004 Pearson Addison-Wesley. All rights reserved

10-3

The Decline in Banks

as a Source of Finance

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10-4

Decline in Traditional Banking

LossofCostAdvantagesinAcquiringFunds(Liabilities)
ithendisintermediationbecause
1. DepositrateceilingsandregulationQ
2. Moneymarketmutualfunds

LossofIncomeAdvantagesonUsesofFunds(Assets)
1. Easiertousesecuritiesmarketstoraisefunds:commercialpaper,
junkbonds,securitization
2. Financecompaniesmoreimportantbecauseeasierforthemto
raisefunds

10-5

Banks Response
Lossofcostadvantagesinraisingfundsand
incomeadvantagesinmakingloanscauses
reductioninprofitabilityintraditionalbanking
1. Expandlendingintoriskierareas:e.g.,realestate
2. Expandintooffbalancesheetactivities
3. CreatesproblemsforU.S.regulatorysystem
Similarproblemsforbankingindustryinother
countries

2004 Pearson Addison-Wesley. All rights reserved

10-6

Structure of the Commercial Banking

Industry

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10-7

Ten Largest U.S. Banks

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10-8

Branching Regulations
BranchingRestrictions:McFaddenActandDouglas
Amendment
Veryanticompetitive

ResponsetoBranchingRestrictions
1.BankHoldingCompanies
A. Allowedpurchasesofbanksoutsidestate
B.BHCsallowedwiderscopeofactivitiesbyFed
C.BHCsdominantformofcorporatestructureforbanks

2.AutomatedTellerMachines
Notconsideredtobebranchofbank,sonetworksallowed

2004 Pearson Addison-Wesley. All rights reserved

10-9

Bank Consolidation and Number of

Banks

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10-10

Bank Consolidation and Nationwide

Banking
BankConsolidation:Why?
1. Branchingrestrictionsweakened
2. Developmentofsuperregionalbanks
RiegleNealActof1994
1. Allowsfullinterstatebranching
2. Promotesfurtherconsolidation
FutureofIndustryStructure
Willbecomemorelikeothercountries,butnotquite:
Severalthousandbanks,notseveralhundred

2004 Pearson Addison-Wesley. All rights reserved

10-11

Bank Consolidation and Nationwide

Banking
BankConsolidation:AGoodThing?
Cons:
1. Fearofdeclineofsmallbanksandsmallbusinesslending
2. Rushtoconsolidationmayincreaserisktaking
Pros:
1. Communitybankswillsurvive
2. Increasecompetition
3. Increaseddiversificationofbankloanportfolios:lessens
likelihoodoffailures

2004 Pearson Addison-Wesley. All rights reserved

10-12

Separation of Banking and

Other Financial Service Industries
ErosionofGlassSteagall
Fed,OCC,FDIC,allowbankstoengageinunderwritingactivities
GrammLeachBlileyFinancialModernisationServicesActof1999:
RepealofGlassSteagall
1.Allowssecuritiesfirmsandinsurancecompaniestopurchasebanks
2.Banksallowedtounderwriteinsuranceandengageinrealestateactivities
3.OCCregulatesbanksubsidiariesengagedinsecuritiesunderwriting
4.Fedoverseebankholdingcompaniesunderwhichallrealestate,insuranceand
largesecuritiesoperationsarehoused
Implications:Bankinginstitutionsbecomelargerandmorecomplex

SeparationinOtherCountries
1. Universalbanking:Germany
2. Britishstyleuniversalbanking
3. U.S./Japanseparation

10-13

Savings and Loans

Regulators
1. OfficeofThriftSupervision
2.FederalHomeLoanBankSystem(FHLBS)
3. FDICsSavingAssociationInsuranceFund
(SAIF)
4. Statebankingauthorities
Structure
1. Fewerrestrictionsonbranching

2004 Pearson Addison-Wesley. All rights reserved

10-14

International Banking
TheReasonsforRapidGrowth
1. Rapidgrowthofinternationaltrade
2. Banksabroadcanpursueactivitiesnotallowedinhomecountry
3. TapintoEurodollarmarket
U.S.BanksOverseas
1. Regulators
A. FederalReserve(RegulationK)

2. Structure
A. InternationalBankingFacilities(notsubjecttolocalregulation)

ForeignBanksinU.S.
1. Regulators
A. SameasforU.S.domesticbanks

2. Structure
A. 500officesinU.S.
B. 20%oftotalU.S.bankassets

2004 Pearson Addison-Wesley. All rights reserved

10-15

Ten Largest Banks in the World

2004 Pearson Addison-Wesley. All rights reserved

10-16