History and Structure of the Banking Industry Chapter 10.

History and Structureof the Banking Industry

History and Structureof the Banking Industry

Chapter 10Chapter 10

OverviewOverview

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

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 BankThe 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

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 OrleansThe Battle of New Orleans

No Central Banking PeriodNo 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

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 1863National 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

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 RegulationIncreasing 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

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 regulationMore 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

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…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

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

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

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. SmallBig 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

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 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

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 regulationNew regulation

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

everything

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

everything

For and againstFor 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

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 BankingDecline 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

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?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

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 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

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 UnionsCredit 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

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 BankingInternational 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

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 abroadU.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.

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.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

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 BankingInternational 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

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