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 • banknotes as local currency • failures, fraud were common

• 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

• 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

• 1863-1907 • no central bank • regular financial crises • panic of 1907 --bankers demanded a central bank Federal Reserve System (1913) • .

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• restricted intra and interstate branching of national banks • meant to protect small banks & increase competition • repealed 1994 (Riegle-Neal) .

S. 1/3 of all U. banks failed • Congress responded w/ legislation • FDIC • federal insurance for bank deposits • banks pay premiums .D. Great Depression • 1930-33.

• Glass-Steagall Act • separated permissible activities of commercial. investment banks • idea: limit risk for commercial banks • weakened over time • repealed 1999 .

• Regulation Q • ceiling on interest rates on deposits • no interest on checking deposits • repealed 1980 .

Regulators • Comptroller of the Currency • • national banks Federal Reserve • bank holding companies • state member banks • national banks (secondary) .

• FDIC • • nonmember state banks state regulators • state banks (secondary) .

Decentralization & Consolidation McFadden Act resulted in many small banks • meant to protect small banks & increase competition -.II.limited economies of scale . Bank Structure A.but protected inefficient banks -.

deposits or loans. not both -.owned several banks -.limited service banks -.bank holding companies -.• loopholes -.ATMs • repealed 1994 .

000 banks in 1985 • less than 8.000 today .Consolidation • bank failures in 1980s • loopholes in McFadden • repeal of McFadden • Over 14.

.

A good thing? • economies of scale • diversification • But • risks with expansion? • responsive to small customers? .

B. Commercial & Investment Banking • separated by Glass Steagall 1933 • commercial banks banned from -.securities brokerage -.real estate sales -.corporate underwriting -.insurance .

• 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 .

• Glass Steagall weakened over time • bank holding companies • Federal Reserve weakened restrictions repealed 1999 (Gramm-Leach-Bliley) • .

049) • FDIC insured • own regulators: -. Thrift Industry • S&Ls.FHLBS -.OTS .III. credit unions • dual banking systems • Savings & Loans (1.

6 trillion • regulator: NCUA • own federal deposit insurance • nonprofit .• credit unions (10.000) • < 10% of commercial bank assets • $600 billion • commercial banks $7.

IV. International Banking • global economy means global • • banking often less regulation overseas alternative structures .

bank overseas • more favorable regulation .Edge Act corporations • subsidiary of U.S.

. • loans and deposits to foreign • customers favorable regulation. tax status • keep the business in the U.S.IBFs • international banking facilities • in the U.S.

S.S. subsidiary • U. regulations U.S.S. • Agency office • • • not full service • but less regulated Full service branch • U.Foreign banks in the U. regulations .

V. Decline of Traditional Banking • traditional bank activities • decline in profitability • decline in importance .

declining share of loans .

.rising profitability…..

but due to nontraditional activities share of income NOT from interest .

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 • 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 • 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 • .

• 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 • easier to issue with improvements in • credit risk screening demanded by money market mutual funds replaced corporate short-term borrowing from banks • .

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 .

leases.• most often down with mortgages • • 2/3 of all mortgages securitized also down with auto loans. credit cards .

service the loan -.• the implication • other financial institutions take a part of the lending process -.issue and sell security • finance companies that just specialize in originating loans .originate the loan -.

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: • bank failures .

• newer activities • fee income • credit cards • commercial real estate .

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