History and Structure of the Banking Industry

Chapter 10

Overview

     History of U.S. banking Commercial Bank Structure Thrift Industry Structure and Regulation The Rise of International Banking The Decline of Traditional Banking

The History of the National Bank

   Combination between central bank and ‘national bank’ 1st National Bank: 1791-1811  Alexander Hamilton  First charter allowed to lapse 2nd National Bank: 1816-1836   Abuses of state banks War of 1812

The Battle of New Orleans

No Central Banking Period

  1836-1863: no central control!

   Farmers distrust, advocate state charters Jackson, proponent of ‘states rights’ (before civil war) State banknotes become popular currency Problems with state currency     Lax regulations on bank capital Moral hazard and adverse selection Banknotes become worthless Fraud widespread

National Bank Act of 1863

  Attempt to address state currency issue     Creation of Comptroller of Currency New federal chartered banking system Taxed state banknotes Civil War funding Dual Banking system  States get around taxing by inventing checking accounts and demand deposits!

 Both state and federal banks survived, creating unique system

Increasing Regulation

   Bank crashes and great depression Federal Reserve System - 1913  Not the same as a 3rd National Bank   Required national banks to become members Members must follow tighter set of regulations McFadden Act: 1927  Restricts interstate branching  Required national banks to follow state rules

More regulation

  Bank investing in securities and the stock market blamed for so many bank failures and the great depression Glass-Steagall Act - 1933    Creation of FDIC No interest on demand deposits Commercial banks: no underwriting or dealing securities   Investment banks: no commercial bank activities Set ceilings on savings account interest

This is getting confusing…

 Office of Comptroller  Supervises 2000 national banks (50%)  Federal Reserve and State Authorities   1000 state banks Holding companies  FDIC and State Authorities  5000 state banks not in Fed

Erosion of Branching Restrictions

   Early innovative strategies   Bank holding companies Non-bank banks: just loans or ATM’s Regional compacts in 70s and 80s  Rise of super-regional banks Riegle-Neal Act - 1994  Overturns McFadden Act of 1927   Extended regional compacts nationwide Holding companies can consolidate

Big vs. Small

   Small banks opposed until…  Provision: Big banks must buy up small banks Big banks like less restriction on branching  Economies of scale     Economies of scope Diversification benefits (interest rate risk) Technology (web) Big banks support Result   Banks drop from 14,000 to 8,000 Trend will continue

Erosion of Glass-Steagall

  1987: Bank holding companies can underwrite securities Gramm-Leach-Bliley 1999  Banks can again underwrite securites, sell insurance, and deal in real estate  Pushed by large holding companies and mergers  Citigroup (Citicorp and Travers group)  Holding companies become investment/commercial/insurance    Bank of America J.P Morgan Chase Wachovia

New regulation

    States watch over insurance SEC watches over securities Comptroller watches banks that underwrite Fed watches holding companies that do everything

For and against

 Against: Security and Insurance  Depression argument   Non-bank demand deposits no FDIC Sec. industry too risky  For: Banks    Wanted ‘fair play’ Competition will lower underwriting costs Changing industry

Decline of Traditional Banking

 Took away banks traditional liabilities   Money market mutual funds Regulation Q eliminated   No interest on checkable deposits Ceiling on time deposits  Took away traditional assets too     Junk bonds Commercial Paper Securitization Finance companies

What can banks do?

     Be riskier  With repeal of Glass-Steagall, start investment banking Commercial real estate loans Finance takeovers Off-balance sheet services Innovate  Sweep accounts

Savings and Loans (S&L)

    Savings accounts and mortgages  2,000 in U.S. (dropped since crisis in 80’s, chap. 11) 1932: Federal Home Loan Bank System (like the Fed Reserve System)  Fewer branching restrictions S&L Insurance fund (FDIC, used to be something else before S&L crisis) Office of Thrift Supervision   Regulates asset, capital requirements, info reporting Audits

Credit Unions

   Cooperative lending institutions  12,000 in U.S.

  Common bond (profession, religion) Tax-exempt and small 50% are chartered by Fed, rest by states Supervised by National Credit Union Association  Deposit Insurance

International Banking

   1969: 8 U.S. banks abroad ($4 billion) Now: 100 U.S. banks abroad ($1.5 trillion) Why?

    More trade (WTO) means more integration International Banking Act (1978) End of Glass-Steagall and McFadden restrt.

More eurodollars  Widely used currency  Offshore low regulation

U.S. banks abroad

   Normal branches common now, less regulation Edge Act corporation (1919)  U.S. bank subsidiary overseas   Can branch, as long as international business Own controlling interest in overseas banks International Banking Facilities - IBF’s (1981)  Within the U.S. to deal with foreigners   Not subject to RR or Interest restrictions, taxes Treated like foreign banks, but within U.S.

Foreign Banks in U.S.

     HSBC, UBS, Credit Suisse (since 1940!) 10% of total bank assets 16% of lenders to U.S. corporations U.S. subsidiaries and branch offices   Full service Subject to U.S. regulations Agency office  Can loan but not take deposits  Not subject to U.S. regulations

International Central Banking

   Universal Banking (Germany, Swiss)  Complete fusion of banking and securities industries U.K, Canada, now U.S.

 Universal, but…  more subsidiaries   not much commercial equity holdings Banking and insurance combo less common Japan  Like U.S. before repeal of Glass-Steagall   Can buy stock, and commercial equity common No holding companies allowed