10: Chapter Banking Industry: Structure and Competition
Econ 330: Money and Banking Fall 2007 Prof. Joseph Santos
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[1] History of U.S. Banking in the Eighteenth and Nineteenth Centuries
A major controversy in the banking industry in its early years was whether the federal government or the states should charter banks.
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
The Federalists, particularly Alexander Hamilton, advocated greater centralized control of banking and federal chartering of banks. Agricultural and other interests were quite suspicious of centralized power and hence advocated chartering by the states.
Bank of the U.S (1791) and the Second Bank of the U.S. (1816) The National Bank Act of 1863 created a new banking system of federally chartered banks (national banks), supervised by the Office of the Comptroller of the Currency, a department of the U.S. Treasury. Dual-banking system
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[2] History of U.S. Banking in the Twentieth Century
Central banking and the Federal Reserve System (1913)
All national banks were (are) required to join the Fed and were (are) subject to Fed regulation. State banks could (can) choose to become members of the system, and most did (have) not because of the high costs of membership stemming from the Fed's regulations.
Deposit insurance and the Federal Deposit Insurance Corporation (1933)
Members of the Federal Reserve System were (are) required to purchase FDIC insurance; non-members could (can) choose to purchase the insurance, and most of them did (do).
In effect, the Glass-Steagall Act separated the activities of commercial banks from those of the securities industry. The Glass-Steagall Act was effectively repealed in 1999.
Underwriting prohibitions and the Glass-Steagall Act (1933)
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[3] Multiple Regulatory Agencies
Office of the Comptroller of the Currency (OCC) has the primary supervisory responsibility of the roughly 2,100 national banks that own more than half of the assets in the commercial banking system. The Fed and the state banking authorities have joint primary responsibility of the roughly 1,200 state banks that are members of the Fed. The Fed has sole regulatory responsibility over companies that own one or more banks (called bank holding companies) and secondary responsibility for the national banks. The FDIC and the state banking authorities jointly supervise the roughly 5,800 state banks that have FDIC insurance but are not members of the Federal Reserve System. The state banking authorities have sole jurisdiction over the fewer than 500 state banks without FDIC insurance.
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[4] Financial Innovation and the Evolution of the U.S. Banking System
To maximize their profits, financial institutions develop products to satisfy their needs as well as the needs of their customers.
A change in the financial environment will stimulate a search by financial institutions for innovations that are likely to be profitable.
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
Starting in the 1960s, individuals and financial institutions operating in financial markets were confronted with drastic changes in the economic environment:
Inflation and interest rates climbed sharply and, hence, both became harder to predict, a situation that changed demand conditions in financial markets. The rapid advance in information technology changed supply conditions. Financial regulations became more burdensome.
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[5] Responses to Changes in Demand Conditions
In the 1950s, the interest rate on three-month Treasury bills ranged from 1% to 3.5%; in the 1970s, it ranged from 4% to 11.5%; in the 1980s, it ranged from 5% to over 15%. This increase in interest-rate risk in the 1970s lead to an increase in the demand for financial products and services that could reduce that risk.
Adjustable-Rate Mortgages
The first adjustable rate mortgage was issued in 1975 by a California S&L. Hedging and futures contracts Financial derivatives emerged in 1975.
Financial Derivatives
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[6] Responses to Changes in Supply Conditions
The most important source of the changes in supply conditions has been the improvements in information technology (IT).
IT has lowered the cost of processing financial transactions, making profitable it for financial institutions to create new financial products and services for the public. IT has made it easier for investors to acquire information, thereby making it easier for firms to issue securities.
These rapid developments in IT have resulted in many new financial products and services, such as:
Bank credit and, later, debit cards Electronic banking
Automated teller machines (ATMs) Automated banking machines (ABMs) Virtual banks
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
Junk bonds Commercial paper market (and the money market mutual fund) Securitization
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[7] Avoidance of Regulations
Two sets of regulations have seriously restricted the ability of banks to make profits.
Reserve requirements
A tax on reserves Disintermediation
Restrictions on interest paid on deposits (and Regulation Q)
Banks' desire to avoid such regulation led to two important financial innovations
Money market mutual funds Sweep accounts (made feasible, in part, by the growth of IT)
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[8] Structure of the U.S. Commercial Banking Industry
Restrictions on branching
The McFadden Act of 1927 and the existence of many small banks in the industry Bank holding companies
Bank holding companies can raise money directly in the financial markets and, thus, enable the bank to tap, in effect, into non-deposit sources of funds.
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
Response to branching restrictions
Automated Teller Machines
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[9] Bank Consolidation and Nationwide Banking
The Riegle-Neal Interstate Banking and Branching Efficiency Act (1994)
Before Riegle-Neal: Reciprocal regional compacts in the late-1970s and early 1980s Economies of scale and economies of scope the latter refers to the ability to use one resource to provide many different products and services Rise of the so-called superregional bank
These are bank holding companies that have begun to rival the money-center banks in size but whose headquarters are not in one of the money-center cities NY, Chicago, and San Francisco.
Why the bank consolidation?
Rise of the large, complex banking organization (LCBO).
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
What will the structure of the U.S. banking industry look like in the future? Are bank consolidation and nationwide banking good things?
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[10] Banking and Securities Industries Consolidation
Erosion of Glass-Steagall
Section 20 of the Glass-Steagall Act allowed BHCs, beginning in 1987, to underwrite previously prohibited classes of securities.
Gramm-Leach-Bliley Financial Services Modernization Act (1999)
States retain regulatory authority over insurance activities, while the SEC continues to have oversight of securities activities. The OCC has the authority to regulate bank subsidiaries engaged in securities underwriting, but the Fed continues to have the authority to oversee BHCs, under which all real estate and insurance activities and large securities operations are to be housed.
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University
[11] Banking and Securities Industries in Other Countries
Universal banking (Germany, Netherlands and Switzerland) provides no separation between the banking and securities industries. British style universal banking (UK, Australia, and Canada) engages in securities underwriting, but differs from German style universal banking in three ways.
Separate legal subsidies are more common. Bank equity holdings of commercial firms are less common. Combinations of banking and insurance firms are less common.
[1] History of Banking in the 18th and 19th Centuries [2] History of Banking in the 20th Century [3] Regulatory Agencies [4] Financial Innovation [5] Responses to Demand [6] Responses to Supply [7] Avoidance of Regulations [8] Structure of U.S. Banking [9] Bank Consolidation [10] Banking and Securities Industries Consolidation [11] Banking and Securities Industries in Other Countries
The third framework features some legal separation of the banking and other financial services industries, as in Japan.
A major difference between the U.S. and Japanese banking systems is that Japanese banks are allowed to hold substantial equity stakes in commercial firms, whereas American banks cannot. In addition, most American banks use a BHC structure, which is not legal in Japan.
This outline draws from Frederic Mishkin's Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation.
Department of Economics South Dakota State University