Financial Markets and Institutions (2-downloads)

Assets

Number of 

Banks

Share of 

Banks (%)

Share of 

Assets Held (%)

Less than $100 million

2,525

36.9

1.2

$100 million–$1 billion

3,800

55.6

9.4

$1 billion or more

514

7.5

89.4

Total

6,839

100.00

100.00

Source:

http://www2.fdic.gov/sdi/main.asp

.

TA B L E   1 9 . 3

Ten Largest U.S. Banks, 2009

Bank

Assets

($ millions)

Share of All 

Commercial

Bank Assets (%)

1. Bank of America Corp

1,082

9.13

2. JP Morgan Chase & Co

1,013

8.55

3. Citigroup

706

5.96

4. Wachovia Corp

472

3.98

5. Wells Fargo & Co

403

3.40

6. US BC

209

1.76

7. Suntrust Banks Inc

177

1.49

8. HSNC North America Inc

151

1.27

9. Keybank

89

0.75

10. State Street Corp

88

0.74

Total

4,390

37.0589

Source:

http://www.allbanks.org/top_banks.html

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Part 6 The Financial Institutions Industry

Restrictions on Branching

The presence of so many commercial banks in the United States actually reflects past

regulations that restricted the ability of these financial institutions to open branches

(additional offices for the conduct of banking operations). Each state had its own reg-

ulations on the type and number of branches that a bank could open. Regulations

on both coasts, for example, tended to allow banks to open branches throughout a

state; in the middle part of the country, regulations on branching were more restric-

tive. The McFadden Act of 1927, which was designed to put national banks and

state banks on an equal footing (and the Douglas Amendment of 1956, which closed

a loophole in the McFadden Act), effectively prohibited banks from branching across

state lines and forced all national banks to conform to the branching regulations of

the state where their headquarters were located.

The McFadden Act and state branching regulations constituted strong anticom-

petitive forces in the commercial banking industry, allowing many small banks to stay

in existence, because larger banks were prevented from opening a branch nearby.

If competition is beneficial to society, why have regulations restricting branching

arisen in America? The simplest explanation is that the American public has histor-

ically been hostile to large banks. States with the most restrictive branching regu-

lations were typically ones in which populist antibank sentiment was strongest in the

nineteenth century. (These states usually had large farming populations whose rela-

tions with banks periodically became tempestuous when banks would foreclose on

farmers who couldn’t pay their debts.) The legacy of nineteenth-century politics

was a banking system with restrictive branching regulations and hence an inordi-

nate number of small banks. However, as we will see later in this chapter, branch-

ing restrictions have been eliminated, and we are heading toward nationwide banking.

Response to Branching Restrictions

An important feature of the U.S. banking industry is that competition can be repressed

by regulation but not completely quashed. As we saw earlier in this chapter, the exis-

tence of restrictive regulation stimulates financial innovations that get around these

regulations in the banks’ search for profits. Regulations restricting branching have

stimulated similar economic forces and have promoted the development of two finan-

cial innovations: bank holding companies and automated teller machines.

Bank Holding Companies

A holding company is a corporation that owns several

different companies. This form of corporate ownership has important advantages for

banks. It has allowed them to circumvent restrictive branching regulations, because

the holding company can own a controlling interest in several banks even if branch-

ing is not permitted. Furthermore, a bank holding company can engage in other

activities related to banking, such as the provision of investment advice, data pro-

cessing and transmission services, leasing, credit card services, and servicing of loans

in other states.

The growth of the bank holding companies has been dramatic over the past three

decades. Today, bank holding companies own almost all large banks, and more than

90% of all commercial bank deposits are held in banks owned by holding companies.

Automated Teller Machines

Another financial innovation that avoided the restric-

tions on branching is the automated teller machine (ATM). Banks realized that if they

did not own or rent the ATM, but instead let it be owned by someone else and paid

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Chapter 19 Banking Industry: Structure and Competition

475

for each transaction with a fee, the ATM would probably not be considered a branch

of the bank and thus would not be subject to branching regulations. This is exactly

what the regulatory agencies and courts in most states concluded. Because they

enable banks to widen their markets, a number of these shared facilities (such as

Cirrus and NYCE) have been established nationwide. Furthermore, even when an

ATM is owned by a bank, states typically have special provisions that allow wider

establishment of ATMs than is permissible for traditional “brick and mortar” branches.

As we saw earlier in this chapter, avoiding regulation was not the only reason

for the development of the ATM. The advent of cheaper computer and telecommu-

nications technology enabled banks to provide ATMs at low cost, making them a prof-

itable innovation. This example further illustrates that technological factors often

combine with incentives such as the desire to avoid restrictive regulations like branch-

ing restrictions to produce financial innovation.

Bank Consolidation and Nationwide Banking

As we can see in Figure 19.3, after a remarkable period of stability from 1934 to the

mid-1980s, the number of commercial banks began to fall dramatically. Why has

this sudden decline taken place?

The banking industry hit some hard times in the 1980s and early 1990s, with bank

failures running at a rate of over 100 per year from 1985 to 1992 (more on this later

in the chapter; also see Chapter 18). But bank failures are only part of the story. In

the years 1985–1992, the number of banks declined by 3,000—more than double

1935

1945

1955

1965

1975

1985

1995

2000

2010

2005

0

2,000

6,000

8,000

10,000

12,000

14,000

16,000

Number

of Banks

4,000

F I G U R E   1 9 . 3

Number of Insured Commercial Banks in the United States,

1934–2010

Source:

www2.fdic.gov/qbp/qbpSelect.asp?menuitem=STAT

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Part 6 The Financial Institutions Industry

the number of failures. And in the period 1992–2007, when the banking industry

returned to health, the number of commercial banks declined by a little over 3,800,

less than 5% of which were bank failures, and most of these were of small banks. Thus

we see that bank failures played an important, though not predominant, role in the

decline in the number of banks in the 1985–1992 period and an almost negligible role

in the decline in the number of banks up through 2007. The 2007–2009 financial

crisis has, however, led to additional declines in the number of banks because of

bank failures.

So what explains the rest of the story? The answer is bank consolidation. Banks

have been merging to create larger entities or have been buying up other banks.

This gives rise to a new question: Why has bank consolidation been taking place

in recent years?

As we have seen, loophole mining by banks has reduced the effectiveness of

branching restrictions, with the result that many states have recognized that it would

be in their best interest if they allowed ownership of banks across state lines. The

result has been the formation of reciprocal regional compacts in which banks in one

state are allowed to own banks in other states in the region. In 1975, Maine enacted

the first interstate banking legislation that allowed out-of-state bank holding com-

panies to purchase banks in that state. In 1982, Massachusetts enacted a regional

compact with other New England states to allow interstate banking, and many other

regional compacts were adopted thereafter until by the early 1990s, almost all states

allowed some form of interstate banking.

With the barriers to interstate banking breaking down in the early 1980s, banks

recognized that they could gain the benefits of diversification because they would

now be able to make loans in many states rather than just one. This gave them the

advantage that if one state’s economy was weak, another state in which they oper-

ated might have a strong economy, thus decreasing the likelihood that loans in dif-

ferent states would default at the same time. In addition, allowing banks to own

banks in other states meant that they could increase their size through out-of-state

acquisition of banks or by merging with banks in other states. Mergers and acqui-

sitions explain the first phase of banking consolidation, which has played such an

important role in the decline in the number of banks since 1985. Another result of

the loosening of restrictions on interstate branching is the development of a new

class of banks, the superregional banks, 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 (New York, Chicago, and San Francisco). Examples of these

superregional banks are Bank of America of Charlotte, North Carolina, and Banc One

of Columbus, Ohio.

Not surprisingly, the advent of the Web and improved computer technology is

another factor driving bank consolidation. Economies of scale have increased, because

large up-front investments are required to set up many information technology plat-

forms for financial institutions (see the E-Finance box, “Information Technology and

Bank Consolidation”). To take advantage of these economies of scale, banks have

needed to get bigger, and this development has led to additional consolidation.

Information technology has also been increasing economies of scope, the ability

to use one resource to provide many different products and services. For example,

details about the quality and creditworthiness of firms not only inform decisions about

whether to make loans to them, but also can be useful in determining at what price

their shares should trade. Similarly, once you have marketed one financial product

to an investor, you probably know how to market another. Business people describe

Access

www2.fdic.gov/

SDI/SOB

to gather

statistics on the banking

industry.

G O   O N L I N E

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Chapter 19 Banking Industry: Structure and Competition

477

economies of scope by saying that there are “synergies” between different lines of busi-

ness, and information technology is making these synergies more likely. The result

is that consolidation is taking place not only to make financial institutions bigger,

but also to increase the combination of products and services they can provide. This

consolidation has had two consequences. First, different types of financial interme-

diaries are encroaching on each other’s territory, making them more alike. Second,

consolidation has led to the development of what the Federal Reserve has named