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Chapter 10. The Banking Industry: Structure and Competition. A Brief History Structure Thrifts International Banking The Decline of Traditional Banking. I. A Brief History A. dual banking system. banking at state level until Civil War state charters, regulation

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chapter 10 the banking industry structure and competition
Chapter 10. The Banking Industry:Structure and Competition
  • A Brief History
  • Structure
  • Thrifts
  • International Banking
  • The Decline of Traditional Banking
i a brief history a dual banking system
I. A Brief HistoryA. dual banking system

banking at state level until Civil War

  • state charters, regulation
  • banknotes as local currency
  • failures, fraud were common
slide3
National Bank Act 1963
    • federal charters for banks
    • Comptroller of the Currency
    • federal banknotes
    • tax on state banknotes
    • state banks survived by accepting deposits

-- dual banking system

b a central bank
B. A central bank
  • U.S. had two prior central banks
    • the Bank of the U.S. (1791-1811))
    • the Second Bank of the U.S.

(1816-63)

  • U.S. central banks not popular w/
    • ranchers & farmers
    • states rights
slide5
1863-1907
    • no central bank
    • regular financial crises
    • panic of 1907

--bankers demanded a central bank

  • Federal Reserve System (1913)
c branching restrictions
C. Branching Restrictions
  • McFadden Act 1927
    • restricted intra and interstate branching of national banks
    • meant to protect small banks & increase competition
    • repealed 1994

(Riegle-Neal)

d great depression
D. Great Depression
  • 1930-33, 1/3 of all U.S. banks failed
  • Congress responded w/ legislation
  • FDIC
    • federal insurance for bank deposits
    • banks pay premiums
slide8
Glass-Steagall Act
    • separated permissible activities of commercial, investment banks
    • idea: limit risk for commercial banks
    • weakened over time
    • repealed 1999
slide9
Regulation Q
    • ceiling on interest rates on deposits
    • no interest on checking deposits
    • repealed 1980
regulators
Regulators
  • Comptroller of the Currency
    • national banks
  • Federal Reserve
    • bank holding companies
    • state member banks
    • national banks (secondary)
slide11
FDIC
    • nonmember state banks
  • state regulators
    • state banks (secondary)
ii bank structure a decentralization consolidation
II. Bank StructureA. Decentralization & Consolidation

McFadden Act resulted in many small banks

  • meant to protect small banks & increase competition

-- but protected inefficient banks

-- limited economies of scale

slide13
loopholes

-- bank holding companies

-- owned several banks

-- limited service banks

-- deposits or loans, not both

-- ATMs

  • repealed 1994
consolidation
Consolidation
  • bank failures in 1980s
  • loopholes in McFadden
  • repeal of McFadden
  • Over 14,000 banks in 1985
    • less than 8,000 today
a good thing
A good thing?
  • economies of scale
  • diversification
  • But
    • risks with expansion?
    • responsive to small customers?
b commercial investment banking
B. Commercial & Investment Banking
  • separated by Glass Steagall 1933
    • commercial banks banned from

-- corporate underwriting

-- securities brokerage

-- real estate sales

-- insurance

slide18
why?
    • many believed investment activities led to bank failures of 1930s
      • not really true…
  • problems
    • less diversification
    • restricting economies of scale
    • disadvantage w/ global competition
slide19
Glass Steagall weakened over time
    • bank holding companies
    • Federal Reserve weakened restrictions
  • repealed 1999

(Gramm-Leach-Bliley)

iii thrift industry
III. Thrift Industry
  • S&Ls, credit unions
  • dual banking systems
  • Savings & Loans (1,049)
    • FDIC insured
    • own regulators:

-- FHLBS

-- OTS

slide21
credit unions (10,000)
    • < 10% of commercial bank assets
      • $600 billion
      • commercial banks $7.6 trillion
    • regulator: NCUA
    • own federal deposit insurance
    • nonprofit
iv international banking
IV. International Banking
  • global economy means global banking
  • often less regulation overseas
  • alternative structures
edge act corporations
Edge Act corporations
  • subsidiary of U.S. bank overseas
  • more favorable regulation
slide24
IBFs
  • international banking facilities
  • in the U.S.
  • loans and deposits to foreign customers
  • favorable regulation, tax status
    • keep the business in the U.S.
foreign banks in the u s
Foreign banks in the U.S.
  • Agency office
    • not full service
    • but less regulated
  • Full service branch
    • U.S. regulations
  • U.S. subsidiary
    • U.S. regulations
v decline of traditional banking
V. Decline of Traditional Banking
  • traditional bank activities
    • decline in profitability
    • decline in importance
but due to nontraditional activities
but due to nontraditional activities

share of income

NOT from

interest

why the decline
why the decline?
  • liability side:
    • cost of acquiring funds has risen
  • asset side:
    • income generated has declined
  • causes:
    • financial innovation since 1970s
money market mutual funds
Money market mutual funds
  • substitute for checking account from investment companies
    • pay interest
    • not insured (but low risk)
  • banks had to offer own version
    • raised the cost of funds
junk bond market
Junk bond market
  • no market for new, low-rated debt prior to 1980
    • only for ratings of Baa (BBB) or better
  • improvements in credit risk screening created market for new risky debt
slide33
before 1980
    • low-rated firms relied on banks
  • after 1980
    • low-rated firms could borrow by issuing junk bonds
  • junk bond markets competing with banks for lending business
commercial paper
Commercial Paper
  • easier to issue with improvements in credit risk screening
  • demanded by money market mutual funds
  • replaced corporate short-term borrowing from banks
securitization
Securitization
  • transform illiquid loans

into liquid debt securities

  • individual loans bundled together
  • debt securities issued, backed by

pool of loans

    • owners of security get a share of the loan payments
slide36
most often down with mortgages
    • 2/3 of all mortgages securitized
  • also down with auto loans, leases, credit cards
slide37
the implication
    • other financial institutions take a part of the lending process

-- originate the loan

-- service the loan

-- issue and sell security

    • finance companies that just specialize in originating loans
in total
in total
  • higher cost of obtaining funds
    • due to competition from money market
  • lower income from loans
    • due to competition from

-- junk bond market

-- commercial paper market

-- financial companies

result of decline
Result of decline:
  • bank failures
slide40
newer activities
    • fee income
    • credit cards
    • commercial real estate