Financial Innovation and the Decline of Traditional Banking
-As a source of funds for borrowers, market share has fallen
-Commercial banks share of total financial intermediary assets has fallen
-No decline in overall profitability
-Increase in income from off-balance-sheet activities
-Decline in cost advantages in acquiring funds (liabilities)
--Rising inflation led to rise in interest rates and disintermediation
--Low-cost source of funds, checkable deposits, declined in importance
-Decline in income advantages on uses of funds (assets)
-Information technology has decreased need for banks to finance short-term credit needs or to issue loans
-Information technology has lowered transaction costs for other financial institutions, increasing competition
Banks Responses
-Expand into new and riskier areas of lending
--Commercial real estate loans
--Corporate takeovers and leveraged buyouts
-Pursue off-balance-sheet activities
--Non-interest income (earned by not by traditional bank activities)
--Concerns about risk (unregulated activities increase with unknown risks for the system as a whole)
Structure of the U.S. Commercial Banking Industry: Geographic Restrictions beginning in 1927 and then deregulation (no restrictions) by national 1994 law.
-Restrictions on branching (not allowed across state lines)
--McFadden Act (1927 effectively prohibiting interstate banking; branching only allowed (in one state) to extent permitted by each states laws) and state branching regulations.
-Response to branching restrictions
--Bank holding companies.(banks allowed branching only in some states in only one state by 1956 law; allowed nationally by 1994 repeal law)
--Automated teller machines.
Bank Consolidation and Nationwide Banking
-The number of banks has declined over the last 30 years (this is usually called Increased National Concentration (also, the largest banks have grown the most to become even more dominant nationallyto hold greater share of total assets in the entire banking industry = less competitive banking/financial sectordepending on how one measures competition, nationally (less), for investors (less), or for choices available to individual consumer (more)
--Bank failures and consolidation.makes increased concentration
--Deregulation: Riegle-Neal Interstate Banking and Branching Efficiency Act f 1994--- Branches allowed across state lines makes it easier for increased concentration
--Economies of scale and scope from information technologymakes it easier for increased concentration (although more choices for individuals among more market participants in local markets)
-Results may be not only a smaller number of banks but a shift in assets to much larger banksleads to increased bank concentration if nationally measured
USA: Separation of the Banking and Other Financial Service Industries: 1933-1999
=SEGREGATION OF BANKING FROM SPECULATIVE ACTIVITIES gradually reduced in power (Erosion of Glass-Steagall Act of 1933 = the US law that prohibited banks from buying stocks or engaging in non-traditional banking activities from 1933-1999)
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--Prohibited commercial banks from underwriting corporate securities or engaging in brokerage activities
--Section 20 loophole was allowed by the Federal Reserve enabling affiliates of approved commercial banks to underwrite securities as long as the revenue did not exceed a specified amount
--U.S. Supreme Court validated the Feds action
in 1988
--British call this separation ring-fencing banking
=DEREGULATION LAW: (Gramm-Leach-Bliley Financial Services Modernization Act of) 1999
--Nationally END of SEGREGATION LAW (ends the Glass-Steagall Act)
--Regional/Local Regulators: States regulate insurance activities
--Government Regulator: SEC keeps oversight of securities activities
--Government Regulator: Office of the Comptroller of the Currency---regulates bank subsidiaries engaged in securities underwriting
--Federal Reserve oversees bank holding companies
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