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World Savings Banks Institute - aisbl European Savings Banks Group – aisbl Rue Marie-Thérèse, 11 B-1000 Bruxelles Tel: + 32 2 211 11 11 Fax: + 32 2 211 11 99 E-mail: first [email protected] Website: www.savings-banks.com Why does the US have a weak mutual savings banks sector? Daniel R. WADHWANI March 2011
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Why does the US have a weak mutual savings banks sector? · What caused their precipitous decline? While it is common to attribute the decline of mutual savings banks in the ... Savings

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Page 1: Why does the US have a weak mutual savings banks sector? · What caused their precipitous decline? While it is common to attribute the decline of mutual savings banks in the ... Savings

World Savings Banks Institute - aisbl – European Savings Banks Group – aisbl Rue Marie-Thérèse, 11 ■ B-1000 Bruxelles ■ Tel: + 32 2 211 11 11 ■ Fax: + 32 2 211 11 99 E-mail: first [email protected] ■ Website: www.savings-banks.com

Why does the US have a weak mutual savings banks sector?

Daniel R. WADHWANI

March 2011

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Prof. R. Daniel Wadhwani, Assistant Professor, University of the Pacific

R. Daniel Wadhwani, Assistant Professor of Management andFletcher Jones Professor of Entrepreneurship at the University ofthe Pacific, received his B.A. from Yale University and his Ph.D. fromthe University of Pennsylvania before studying on a NewcomenFellowship in Business History at Harvard Business School. He was alecturer on the faculty of the Harvard Business School prior tojoining the University of the Pacific in 2006. He has conductedextensive primary source research on the history of savings banksin the United States and is currently completing a book on the roleof savings banks in the development of the market for personalfinance in America. He has also examined the development ofsavings banks from a comparative-historical perspective.

Over the last three decades, mutual savings banks have experienced aprecipitous decline in their role in the American financial system.Dozens of savings banks have failed and hundreds have chosen toconvert from their traditional “mutual” form into joint-stock institutionsthat are akin to commercial banks. The 82 mutual savings banks thatremain in existence today account for less than 1% of the assets of theAmerican banking system (OTS 2010: 9-10).

Their position was not always this weak. At their height in the late 19thcentury, mutual savings banks accounted for over a quarter of the assetsin the American banking system and financed infrastructure and housingdevelopment that was crucial to the growth of the industrial economy(Welfling 1968). For most of the 19th century mutual savings banks werethe fastest growing financial institution in the US and generally had areputation as conservative but well-managed institutions (Kroos Hermannand Martin Blyn 1971).

WHY DOES THE US HAVEA WEAK MUTUAL SAVINGSBANK SECTOR?

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Why, then, have mutual savings banks become so marginal in theAmerican banking system? What caused their precipitous decline?While it is common to attribute the decline of mutual savings banks in theUnited States to the period of bank deregulation beginning in the 1980s,the inability of American savings banks to compete in a deregulatedenvironment has deeper historical roots. Savings banks in some otherparts of the world – Spain and Germany, for instance – have successfullycompeted in the deregulated bank environment that has developed inthe last three decades. To understand why American savings banks wereunable to compete like their Spanish and German counterparts we needto understand the historical development of savings banks in the UnitedStates and their relatively weak capabilities. Their decline holds lessons forsavings bank managers in other parts of the world today.

Part of the decline of savings banks, as we shall see, was attributable tofederal regulation, and especially to deposit insurance. By insuringcommercial bank and savings and loan deposits as well as savings bankaccounts, federal deposit insurance wiped out mutual savings banks’most significant advantage in the eyes of depositors: their reputation forsafety. But deposit insurance only accounts for part of the story. Mutualsavings banks in the United States also remained regional rather thannational institutions, failed to aggressively innovate their products andservices when given the opportunity or presented the need to do so, andrefused to cooperate as a group to engage in meaningful collectiveaction. It was these historical weaknesses in the capabilities of mutualsavings banks – as much as the regulatory environment – that led to theeventual decline of the institution when deregulation no longer protectedits market from competitors.

The paper is organised as a chronological account of the developmentand decline of mutual savings banks in the United States, focusing inparticular on the weaknesses that would lead to their eventual demise inthe late 20th century. Part I examines the origins and growth of savingsbanks in the United States. Part II considers the emergence ofcompetitors in the market for personal savings, including commercialbanks, S&Ls, and other intermediaries. Part III examines why savingsbanks failed to innovate and diversify their services in response to thecompetitive threats that emerged in the late 19th century. In part IV,I examine the lack of effort at collective action among savings banks inthe United States; though they formed an association, it provided a verylimited array of services when compared to similar savings bankassociations around the world.

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Part V examines the regulatory environment both before and after theNew Deal and shows how it both protected savings banks fromcompetitors while eliminating the key source of the savings banks’competitive advantage. The sixth section examines the crisis of the lastquarter of the 20th century. I conclude by considering some of theimplications of the American experience for the managers of savingsbanks in other parts of the world today.

Figure 1: Mutual Savings Banks’ Share of Assets of SelectedFinancial Intermediaries

Sources: FDIC, White, “Were Banks Special Intermediaries.”

Notes: Intermediaries include savings banks, commercial banks, and savings & loans.

1. Origins and Early Growth, 1810s-1870s

The financial system in the United States during the 19th century wascomprised of an array of institutions, each designed to provide a specificand often quite limited bundle of services. Its cornerstone was thecommercial banks that state legislatures chartered to maintain a moneysupply and extend short-term commercial credit. Prior to the NationalBanking Act of 1863, commercial banks were regulated by the states;after 1863, some also came to be regulated by the federal government.

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1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2009

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While commercial banks were extremely important for conductingbusiness, they were only rarely used by individuals of modest means whowished to set aside small sums for future needs. The needs of small saverswere met by a variety of other financial institutions, of which the mostimportant were the mutual savings banks.

The first savings banks in the United States were established during the1810s in Philadelphia, Boston, New York and Baltimore, based on themodel of the British Trustee Savings Banks. These savings banks acceptedsmall-denomination savings deposits from the general public, which theywere charged with investing in prescribed “safe” asset classes, usuallygovernment debt and high-grade mortgage loans. However, sincemutual savings banks were state rather than nationally charteredinstitutions, the rules governing their investment practices varied fromstate to state (Olmstead 1976; Wadhwani 2006).

From the outset, these institutions had been intended primarily to enablepersons of modest means to save a portion of their present income tomeet future needs. They furnished, as the founders of the Bank for Savingsin New York explained in 1819, a “secure place of deposit” for “all whowish to lay up a fund for sickness, for the wants of a family, or for oldage” (Manning 1917: 125). Savings banks were state charteredinstitutions that were prohibited from branching, and so remained “unitbanks” targeted at serving savers in the local community (Welfling, 1968;Wadhwani, 2002).

Though these early savings banks were based on a seemingly simplebusiness model, it is easy to underestimate their innovative accomplishments.Prior to their establishment, no formal intermediaries existed that servedthe mass market for personal finance, and most “ordinary households”saved, borrowed and insured through direct personal transactions withpeople they knew. Over their first half-century, savings banks proved theviability and profitability of serving the mass market for personal finance.Much of their success lay in the credibility and trust they had developedamong the general public, a growing portion of which entrusted theirsavings to the institutions (Wadhwani 2002). A critical element of thedevelopment of this credibility was the innovative corporate governancestructure of mutual savings banks, which (like their British counterparts)were established as trusteeships on behalf of depositors, without aconflicting class of joint-stock shareholders (Wadhwani, forthcoming).

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Throughout the 19th century savings banks grew extremely rapidly,buoyed by the rise of the urban, wage economy in which ordinaryAmericans found ways to manage their income and save for periods ofold age, sickness and unemployment. With few competitors in this urbanenvironment, mutual savings banks became the fastest growing financialintermediary in the United States between the 1820s and the 1870s.Between 1820 and 1910, the number of mutual savings banks inthe country rose from 10 to 637, while their deposits soared from USD1 million to USD 1 billion (Lintner 1948, Welfling 1968). In fact, inthe 1870s, mutual savings banks controlled nearly a quarter of the assetsof financial intermediaries in the United States – a moment thatin retrospect represented the high water mark in their share ofthe American banking market.

The rapid aggregate growth of savings banks in mid-19th-centuryAmerica, however, masked one significant weakness. Throughout theirhistory, mutual savings banks remained a regional institution rather thana national one. Mutual savings banks were chartered in only 19 states,primarily in New England and the Mid-Atlantic. In fact, historically morethan 95% of savings deposits in mutual savings banks were accountedfor by only nine states: Connecticut, Massachusetts, Maine, New Hampshire,New Jersey, New York, Pennsylvania, Rhode Island and Washington(FDIC 1997, Lintner 1948). Outside the urban north-east, policymakersand local institutions remained sceptical of what was seen as an eliteEuropean-influenced institution and promoted instead the small localcommercial and community banks as places for small savers.These regional limitations circumscribed the influence of mutual savingsbanks once banks and banking regulation became controlled at a nationallevel. As a national banking infrastructure and regulations developed,mutual savings banks came to be seen as a regional institution ratherthan a national one.

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Interior of the Bowery Savings Bank, 1870

Source: Harper’s Weekly 1870

Note: At its height in the late nineteenth century, the Bowery Savings Bank in New York was

the largest savings bank in the United States. The Bowery catered to a wide cross-section of

New York’s working class population.

2. The Emergence of Competition, 1870s-1920s

Despite their regional isolation, for most of the 19th century the growthof savings banks outpaced that of other intermediaries. In large part,this was because savings banks remained largely uncontested in themarket for the personal savings of ordinary Americans. Beginning inthe last quarter of the 19th century, however, this began to change,as commercial banks as well as a host of new intermediaries entered themarket for personal savings. By 1930, savings banks’ share of financialintermediaries’ assets had slipped to below 10%, where it remained formost of the 20th century. Savings banks faced direct competition fordeposits and, to some extent, for borrowers, from commercial banks.Moreover, the incumbent savings banks faced competition from a host ofnew entrants, including trust companies, industrial banks, savings andloan associations and insurance companies, which competed in large partbased on the new financial products they introduced to the market(Lintner 1948, Welfling 1968, Wadhwani 2002). Despite a keenawareness of this competition and the new products they introduced,savings banks largely failed to offer competing products.

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The first and most significant challenge to savings banks came from savingsand loan associations, which offered innovative small-denominationamortised mortgage loans to members. While savings banks investedheavily in mortgage loans, their loans were typically not targeted at themass market savers who comprised their depositors. In order to achievesafety and processing efficiency, their mortgage loans went typically towealthy borrowers. Moreover, the terms of late-19th-century mortgageloans made them onerous to small borrowers; loans were typicallyrestricted to 50% of the underlying property value, had three- to five-year maturities, and included a massive balloon payment at the end ofthe period. In contrast, savings and loans (or, as they were then called,building and loans) offered innovative and favourable mortgage lendingto members in their mutual societies. Members subscribed to anassociation’s plan, in which they paid in capital that was lent on a rotatingbasis to other members for the purposes of building homes. The systemallowed small denomination lending, lower monitoring costs, and a self-liquidating feature that eliminated the large and risky balloon paymentthat traditional mortgages featured. By the 1910s and 1920s, savings andloans were effectively acting much as traditional intermediaries, taking insavings deposits as well as traditional membership dues and makingamortised eight- and ten-year loans to small borrowers (Mason 2001).

A second major set of competitive innovations originated from existingplayers and new entrants in the life insurance industry. Though lifeinsurance companies were as old as savings banks, they had traditionallyserved primarily affluent customers and had remained relatively modestin size in their early years. Their first major expansion took place in theantebellum era, when they began to aggressively promote certainfeatures of their plans as “investments” for middle-class investors.Their most rapid growth, however, began in the 1880s and 1890s with anumber of product innovations that moved them directly into traditionalsavings bank customer and product markets. One significant innovationwas the tontine insurance policy, which combined an ordinary lifeinsurance policy with deferred savings and an investment feature thatbenefitted surviving policyholders at a specified date. The addition of a“savings feature”, first introduced by the Equitable Life AssuranceCompany in 1867, proved a significant engine for growth; as much astwo-thirds of insurance in force by 1905 were tontines. Another significantproduct innovation was industrial life insurance, small denominationinsurance with face values as low as $100 targeted at the mass market.

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In contrast to ordinary life policies, which typically have minimum facevalues of several thousand dollars, industrial life insurance directlytargeted the mass market customers that savings banks traditionallyserved. Industrial life insurance was directly and aggressively marketedto homes door-to-door. Several new entrants into the industry, includingthe John Hancock Company (1862), the Metropolitan Life InsuranceCompany (1868), and the Prudential Insurance Company of America(1875) entered the market based on the introduction of industrial life.By the First World War, life insurance companies had become the leadingtype of financial intermediary in the United States, in large part becauseof the innovations they introduced in savings banks’ traditional productand customer segments (Murphy 2002, 2010, Welfling 1968).

Commercial banks and trust companies introduced yet another setof product innovations that directly challenged savings banks.Commercial banks in antebellum America had traditionally raised capitalthrough equity offerings and banknote issues, not deposits; thoughcommercial bank demand deposits had been introduced and had begunto grow before the Civil War, bank balance sheets show that they wereunlike the highly leveraged intermediaries with which we are familiarwith today (Lamoreaux 1994). As state bank notes became taxed out ofexistence following the National Banking Acts (1863, 1864), state-chartered banks began to actively search for new sources of liabilities.By the 1880s and 1890s, the rapidly proliferating number of state banksin the US began to offer interest-bearing deposit accounts that mimickedthe essential features of the savings banks’ core product: the savingsaccount. Though national banks were prohibited from offering similarservices, many of them managed to circumvent the regulation until thelaw itself was relaxed by the Federal Reserve Act of 1907 (White 1983).

Trust companies, largely unregulated state-chartered intermediaries thatbegan to proliferate in the late 19th century, presented an even greaterchallenge by offering not only interest-bearing deposit accounts but alsoa one-stop retail shop for all financing needs, from saving and investmentto insurance to small business loans to brokerage services (Wadhwani2002). Commercial banks and trust companies hence mimicked the basicsavings bank account while offering potential customers enhanced rangeof services.

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In many ways, savings banks were in a strong position to capitalise on thiswave of innovations in personal finance in the late 19th century. They hadestablished high levels of trust among savers in the mass market, whowere generally far more suspicious of malfeasance among commercialbanks and other intermediaries. They had facilities and staff familiar withretail finance that could be leveraged to expand their scope of productofferings. And, in general, they were perceived favourably by regulators.Yet, American savings banks made little effort to capitalise on productinnovations and made only limited efforts to respond to competitivepressures. Between 1870 and 1930 they made no efforts to establishdemand accounts, serve small business, create amortised mortgage loansor consumer loans, and made late and futile efforts to offer life insuranceto their savings customers.

In contrast, the savings bank sector in other industrialising countriesreacted very differently to the wave of product innovations, makingsignificant attempts to enter one or more of the product categoriesdescribed above. In Great Britain, trustee savings banks and the postalsavings bank began to offer life insurance and annuities relatively early(Gosden 1996). In Germany, savings banks began to offer checkabledeposits, giro transfers, small business loans and mortgage loans (Mura1996). In Japan, the postal savings system developed extensive lifeinsurance and pension products, in addition to basic savings accounts(Anderson 1990).

The most appropriate comparison for American savings banks is probablywith their German counterparts. Like American savings banks, theGerman savings banks were seen as distinctively local institutionsoverseen by a federalist regulatory state. In the 1880s, their balancesheets looked very similar to those of American savings banks, as did theirposition in the market as institutions designed to serve the savings needsof local wage earners and middle classes. The German savings banksbegan experiencing competitive pressures from new entrants, such ascredit cooperatives and credit banks, similar to those experienced byAmerican savings banks beginning in the 1890s. Most notably, after theturn of the century, the large credit banks began establishing deposit-taking branches that competed directly with the traditional business ofthe savings banks (Guinnane 2002; Fear and Wadhwani 2011).

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Strikingly unlike their American counterparts, however, German savingsbanks had reacted by embracing a number of innovations and competingdirectly with commercial banks on local, regional and national levels.They successfully implemented a system of demand deposits and anational giro payments system. They moved aggressively into smallbusiness lending, and even underwrote and marketed securities in orderto compete with the large credit banks. In the 1920s, they establishedbuilding associations and expanded their mortgage lending (Fear andWadhwani 2011).

Why did American savings banks fail to innovate and to effectivelyrespond to competition? The following three sections examine in turnfirm-level capabilities, network or associational capabilities, and regulatoryinstitutions as reasons why American savings banks failed to innovateand to respond to competition. Their failure to deal effectively withcompetition in the late 19th and early 20th centuries, I will argue,would have significant implications for their demise a century later.

3. Limited Response to Innovation, 1870s-1920s

By the late 19th century, savings banks developed a number of clearcapabilities and resources that served as the basis of their competitiveadvantage in the market. Their most significant competitive capabilitieswere their relatively low-cost business model, their operational ability tohandle a large volume of retail customers, and their cultivated reputationas especially safe and trustworthy intermediaries. Archival evidence fromsavings banks and other primary sources shed light on the extent towhich these factors served to inhibit savings bank managers and trusteesin adopting the product innovations discussed above. While their low-cost business model and their operating capabilities do not seem to havebeen significant handicaps, savings bank managers’ positioning of theirfirms as safety-oriented institutions became a significant source of inertia.Other factors, including the trusteeship organisational form and a provincialoutlook, also contributed to their inability to react to innovation.

Savings banks’ hesitant and limited entry into life insurance and annuitiesprovides an example. Despite its establishment as a viable expansionopportunity by savings banks in the UK and Japan, savings bank lifeinsurance (SBLI) had a slow and difficult start in the United States.

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In fact, the concept of SBLI was first promoted not by savings banks at allbut rather by Progressive Era reformers, especially Louis Brandeis, whosaw an opportunity to provide wage workers with low-cost, over-the-counter life insurance through savings banks. Remarkably, the majority ofMassachusetts savings banks not only opposed the measure but alsofought its adoption once it was passed. Some of the savings bankers’arguments against the adoption of SBLI rested on the weak reasoningthat the provision of life insurance did not complement the capabilities ofsavings banks. “We have trouble enough as it is now, from depositorswho are hardly able to write their names, and if an insurance departmentwere to be added here I don’t see how we could find time or floor spaceto handle it”, argued one Boston savings bank manager (Welfling 1968:189-190).

Much more common a concern, and perhaps a more reasonable one,was that the provision of life insurance might somehow compromisethe savings banks’ reputation and position as especially safe financialinstitutions. Savings banks had developed and protected a reputation asconservatively run organisations by trustees who put safety first(Wadhwani 2006). Now, with life insurance, as with other products,savings bankers were concerned that it might compromise that position.“The main barrier in the campaign [for SBLI] was the ultra-conservatismof savings bank officials themselves”, explained one observer.“Vague apprehension prevailed lest insurance departments thusengrafted in savings banks should somehow impair the latter’s integrity”(Welfling 1968). Even after the enabling legislation was passed and majoremployers like Edward Filene made efforts to publicise SBLI, most savingsbanks showed little interest in the product. As late as 1922, 15 years afterthe enabling legislation was passed, only four savings banks in the stateoffered SBLI. Outside of Massachusetts SBLI was not adopted untilthe late 1930s and 1940s, by which time life insurance companies hadonce again regained their reputations and re-established their dominanceover the product.

Life insurance provides a particularly vivid case of how savings bankmanagers’ focus on safety and reputation became a source of inertia thatled to their failure to act on new product opportunities. Similar storiesabound in mortgage and consumer lending, which expanded rapidlythroughout the 1910s and 1920s owing to the proliferation of S&Ls andindustrial banks.

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Though savings banks did begin to offer slightly lower denominationmortgages, there was little effort to adapt the terms of the product asS&Ls had done. By the eve of the Great Depression, when S&Ls in somecities had begun to introduce mortgage loans that were amortised,required as little as 20% down and had maturities of ten years, savings banksclung to the traditional structure of the mortgage loan as it had existedin the 19th century: 50% loan-to-value maximums, three- to five-yearmaturities, with enormous balloon payments at the end (Wadhwani 2002).

By positioning themselves as ultra-conservative institutions, savings bankshad created a comparative advantage in the 19th century that served asthe basis for growth of the general public’s trust in formal financialintermediaries. With the introduction of new product innovations,however, this same positioning and organisational asset became a liabilityto savings bank managers’ ability to react to innovations that weretransforming the industry.

Relying solely on such firm-level explanations, however, make it difficultto explain why American savings bank managers were so much moreconservative than their German counterparts. German savings banks,after all, were also positioned as particularly safe and trustworthy localinstitutions. Yet German savings bank directors and managers reactedvery differently to the introduction of new innovations and thecompetitive threats they represented, aggressively seeking to adoptinnovations that would allow them to effectively compete on the regionaland national level with the large credit banks. To understand thesenational differences, we need to move beyond firm-level factors andconsider the ways in which regulatory institutions and inter-firm networksand associations differed between the two countries.

4. Limited Efforts at Collective Action, 1890s-1930s

While firm-level factors clearly contributed to American savings banks’apparent lack of ability to embrace product innovations, they tell us littleabout why these capabilities to innovate differed so much in Germany.Given their similar market positions and histories, why were Americansavings banks so much more conservative about engaging in innovationthan their German counterparts?

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One factor that helps us understand why German savings banks wereable to integrate innovations better than American savings banks was thegreater extent to which they developed stronger networks andassociations. In recent years, scholars have devoted considerableattention to the role of alliances and associations in the introduction ofinnovation (Brandenberger and Nalebuff 1996), and in the case ofGerman savings banks inter-firm cooperation seems to have been criticalto their ability to adopt innovations. By the 1910s and 1920s, Germansavings banks had transformed a set of informal relationships into a“group” structure that linked autonomous local savings banks to largerregional or state level institutions (such as the Landesbanken), whichwere in turn members of a national savings bank association and anational-level clearing bank (Mura 1996).

Informal cooperation between local savings banks and the state-levelLandesbanken had begun in the early 19th century, but it was not untillate in the century that significant levels of coordination between firmsbegan. The impetus for the coordination was more practical than strategic:the creation of a regional and national clearing system. For decades,workers’ associations had lobbied for the creation of facilities to transferfunds across institutions at low cost, arguing that high rates of mobilitycombined with the difficulty of moving their savings discouraged the useof savings banks. To create a national giro-based transfer system, thesavings banks created the Girozentrale to facilitate transfers and clearaccounts across banks. Opposition to these moves by the larger creditbanks intensified the associational movement among savings banks.By the early 20th century, the association was actively involved in fightingfor legislation permitting savings banks to offer checkable accounts.The pursuit of these practical and political activities eventually led to theformation of a formal “savings bank group” or association, whichcoordinated activities between local banks, regional landesbanken andthe national clearing bank (Guinnane 2002, Schultz 2008, Fear andWadhwani 2011). Local savings banks remained formally autonomousbut benefited from the scale that the national association offered.

The benefits of the creation of a strong association among savings banksare most apparent in the introduction of the giro system and checkabledeposits by the German savings banks. The association allowed thecreation of national payments capabilities that local savings banks bythemselves would have found difficult or impossible to provide.

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As German savings banks began to serve small businesses as well as the massmarket for personal finance, such regional and national transfer capabilitieswould prove critical. Coordination between savings banks hencefacilitated product innovations that required regional and national reach.

The savings bank association aided product innovation in less direct andobvious ways as well. Though the initial impetus for the association waspractical, it soon became important for its strategic value. Because of itsnational reach, the savings bank association could help local institutionsunderstand how the broader competitive landscape was changing andcould help transfer best practices, innovation and ideas to localinstitutions that were limited in their resources and their understandingof competitive threats. For instance, the association played a critical rolein helping transfer practical knowledge and practices about smallbusiness lending and mortgage lending to local savings banks whichmight otherwise be more reluctant and less capable of taking on the risksof such product introductions. In later years, they would also play acritical role in the introduction of consumer lending to local savingsbanks. More broadly, the association allowed the local savings banksaccess to strategic information and advice that helped mitigate risks ofnew product introductions and better understand the liabilities of stickingto their current position (Fear and Wadhwani 2011).

In contrast, the associational and network capabilities of Americansavings banks were extraordinarily limited. Savings banks in a few states,including Massachusetts and New York, created state-level associations.These associations, however, served very limited roles, primarily outliningpolitical and regulatory positions rather than aiding members in strategicdecision-making or introducing innovative capabilities. At the nationallevel, associational efforts were even weaker, perhaps in part becausesavings banking in the US was not as geographically dispersed as inGermany. A savings bank association was created within the auspices ofthe commercial bank-dominated ABA (American Bankers Association).Whereas the German savings bank association played a critical role inpositioning savings banks as a group to compete against credit banks, theAmerican savings bank association was embedded and co-opted withinthe commercial bankers association, inherently limiting its strategic value(Wadhwani 2002).

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Even after a separate national savings bank association was formed around1920, the organisation primarily served as a lobbying and marketingorganisation rather than one that developed a wider range of “group-level” capabilities. Efforts during the Great Depression to expand inter-savings bank cooperation to provide liquidity and consulting servicesproved short-lived (Steiner 1944).

The relative weakness of associational capabilities among Americansavings banks also played a direct role in limiting the ability of savingsbanks to engage in product innovations that required regional or nationalcoordination. One of the often repeated arguments that savings bankerslaunched at SBLI was that the local institutions were not capable ofserving customers who moved. As one manager stated, “It appears to methat the average savings bank cannot well conduct an insurance businessbecause the bank is a local institution only. The machinery of insurancewould be costly even if there were a central association to keep us intouch with our policyholders in other parts of the state” (Quoted inWelfling 1968: 189). While American savings banks were struggling toconceive of the viabilities of such regional capabilities, German savingsbanks had already created the network and associational structures thatmade such product introductions possible.

For both German and American savings banks, deep local knowledge ofcustomers and the economy had long served as a source of competitiveadvantage. In the end, for American savings banks, this intensely localorientation also turned into a liability as the autonomous savings banksproved incapable of dealing with competitive changes that were regionalor national in scale and incapable of introducing products that requiredthis broader knowledge and organisational capabilities. Germany’s savingsbanking system was able to overcome this, not by giving up local autonomyand positioning but by associating and creating inter-firm ties thatallowed them access to regional and national information networks,strategic perspectives and organisational capabilities. Lacking suchassociational capabilities, American savings banks hence left open suchregional and national innovative opportunities to be tapped by newentrants into the field.

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5. Political and Regulatory Constraints on Innovation

While firm-level rigidities and limited inter-firm capabilities played asignificant role in inhibiting product innovation among American savingsbanks, so did factors beyond their control. In particular, political andregulatory constraints played a large role in inhibiting innovation amongAmerican savings banks, especially when we compare them to theirGerman counterparts. German regulations in the late 19th and early 20thcenturies supported competition through incumbent innovation, whereasAmerican regulations worked to fragment and segment financialmarkets, unintentionally paving the way for innovation by new entrants.

Business historians’ comparisons between American and Germanmanagement has often employed the trope of German “cooperation” todistinguish it from American “competition”. Chandler’s (1989) analysis ofnational differences in industrial management, for instance, distinguishedbetween German “cooperative managerial capitalism” and American“competitive managerial capitalism”. These broader generalisations arebased largely on the notion that American and German economicregulation took different paths, with the former choosing antitrust as thecornerstone of economic policy while the latter permitted and evenenforced cartelisation agreements. In the context of personal financeregulation, however, this simple distinction between pro-competition andpro-cooperation policy proves misleading (Fear, forthcoming). Ratherthan eliminating or reducing competition, German regulation evolved inways that fostered “group-level” national competition between savingsbanks, credit banks and cooperatives, in turn permitting and evenencouraging product innovation within each of these groups. In contrast,US regulations tended to enforce fragmentation and segmentation as away of preventing concentration, channelling innovative and creativeopportunities toward new entrants rather than incumbents.

Until the 1880s and 1890s, the regulation of savings banks in the twocountries was remarkably similar. There was a relatively clear division oflabour between savings banks and commercial or credit banks, with theformer focusing on personal finance for the mass market and the latterfocusing on enterprise finance and investment opportunities for thewealthy. Regulations helped enforce this division. In particular, there wereasset class restrictions on savings banks in both countries, typically limitingthem to investment in real estate-backed lending and government debt.

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The restrictions were designed to help ensure the safety of theinstitutions on behalf of small savers who were naturally in a poorposition to monitor their investments (Wadhwani 2006; Guinnane 2002).In both countries, the regulatory framework began to change whencommercial banks and other intermediaries aggressively entered themarket for deposits, undermining the market divisions that hadpreviously existed. In both countries, popular and regulatory concernsgrew over the possibility of banking sector concentration and the threatthat regional deposits might flow to national urban centres.

In Germany, Deutsche Bank and the other large Berlin credit banks beganto rapidly establish retail branches to accept deposits beginning in thelate 19th century. Along with regional credit banks, they also createdlarger strategic groups (or konzern) and eventually a credit banking cartelto stabilise interest rates (Guinnane 2002). Regulators reacted byallowing savings banks to develop offsetting regional and nationalcapabilities to compete with the credit banking group. It was in theprocess of responding to the competitive pressures created by the creditbanks that savings banks made headway into innovative new products,enabled along the way by German competition policy. The savings banks’late 19th-century development of a national giro payments system was inpart aided by this policy. Similar regulatory accommodations followed inthe early 20th century as savings banks made strategic moves into newproducts that allowed them to compete with the credit banking group.In 1909, regulators bent to pressure from the savings bank association toallow savings institutions to offer checkable deposits and current accountcredits, despite the fact that this had traditionally been the market servedby commercial banks. Similarly, in 1915 and 1921, new legislation waspassed allowing savings banks to underwrite and broker securities andto make loans to businesses. As Guinnane (2002) has pointed out, thisregulation-supported competitive dynamic created pressures for emulationand “universalisation” among Germany’s “small banks” as well asamong its big banks. From the point of view of product innovation, itcreated a regulatory environment that was conducive to productinnovation and experimentation by the incumbent savings banks.

Like their German counterparts, American regulators and politicians grewincreasingly concerned that strategic moves by larger national banksmight lead to concentration and consolidation in the industry.

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Unlike the German system that fostered the creation of competinggroups of banks, however, the US system more directly intervened toenforce fragmentation, most famously by maintaining anti-branchingprovisions (White 1983). Well before the Great Depression-eraregulations that codified banking segmentation at a national level, state-level regulations had worked to maintain local unit banking and enforcemarket segmentation. Though innovations and new entrants (particularlytrust companies) challenged this segmentation, regulators were slow toliberalise restrictions, particularly in the case of savings banks.

In the case of savings banks, state legislatures and courts throughout the19th century had emphasised that the institutions’ charters permittedthem to engage in only a very limited set of activities, essentially empoweringthem to accept savings deposits and invest them in a highly restricted setof asset classes. The strict rules circumscribing manager and trusteediscretion were designed largely as way to protect the safety of depositors.When a number of savings banks failed in the 1870s, state courts placedfurther sanctions on managerial risk-taking by holding trustees andofficers personally liable for contracts and activities that extended beyondthe narrow bounds of the charter. Savings bank regulations and bankcompetition policy hence directly restricted innovative activity in order tomaintain market segmentation and exposed managers and trustees toextraordinarily high levels of personal risk if they made changes in theprescribed structure of their balance sheets (Wadhwani 2006).

The US regulatory system in turn unintentionally favoured new entrants,which were typically not subject to the same statutory restrictions andcommon law standards as incumbents. This pattern was most apparentin the case of trust companies in the late 19th century, which were largelyunconstrained by regulation and hence moved most rapidly towardthe introduction of new products and services to the point where theyresembled small universal banks. While heavily regulated, commercialbanks and insurance companies were somewhat less constrained bysegmentation rules than savings banks because the dual state and federalregulatory structure they were subject to allowed them to play regulatorsoff of one another (White 1983). Savings banks, which were exclusivelystate-chartered, did not have this luxury and were subject to theenforcement of the tight regulations discussed above.

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Tight regulatory constraints on the scope of savings banks created astrong constraint on the ability of incumbent savings banks to innovate.Though control over these regulations were largely beyond the control ofsavings banks by the early 20th century, it would be inaccurate tocharacterise the regulatory institutions that evolved as entirely distinctfrom the organisational and associational capabilities described above.German savings banks and their associations were favoured with aconducive regulatory environment in no small part because they shapedlocal and national political institutions in the process of development.In addition to developing key market capabilities, the savings bankassociation developed essential political capabilities, winning allies in thelabour movement and developing the ability to effectively lobby thegovernment (Guinnane 2002). The US savings banks had shown littleinterest in developing these political capabilities throughout their historyand by the early 20th century the rules they were subject to were largelyout of their control.

6. Depression and the New Deal: Deposit Insurance &Segmented Markets, 1930s-1970s

Despite their ineffective response to competition between the 1870s andthe 1920s, mutual savings banks were presented with a uniquely goodopportunity to expand their role in the banking system in the 1930s.Unlike other intermediaries, savings banks performed very well duringthe banking panics of the Great Depression. Few mutual savings banksexperienced panics and, in fact, the mutual savings bank system experiencedrapid growth in deposits as savers sought out safe havens for their moneyamidst the turmoil. Highlighted by the Great Depression, savings banks’reputation for safety and security remained the one core capability thattruly distinguished it from other institutions (Ornstein 1985).

Ironically, however, the disaster of the 1930s would undermine savingsbanks’ competitive advantage despite their being the only institutionsthat had clearly managed the crisis well. The biggest long-term impact ofthe Depression on savings banks came not as a result of the financialcrisis but as a result of the government reaction to it. In 1933, the federalgovernment introduced federal deposit insurance through the newly formedFederal Deposit Insurance Corporation for any bank – federal or state-chartered – in the United States.

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Commercial banks flocked to deposit insurance as a way of re-instillingdepositor confidence and regaining its deposit base. By backing depositsin all institutions regardless of size or corporate form, deposit insuranceessentially wiped out the one significant competitive advantage thatsavings banks had: their reputation for safety. S&Ls received a similarguarantee from a separate federal deposit insurance program, alsoestablished in the 1930s (Wadhwani 2002).

Lacking strong collective action capabilities, and content with their healthyresponse to the banking crises of the 1930s, mutual savings banks largelyfailed to take advantage of their excellent performance in the crisis toshore up their position within the banking system. Initially, few savingsbanks even signed up for deposit insurance, feeling that they had beenessentially immune to the crisis that affected smaller institutions thatexperienced runs. Remarkably, savings banks also resisted efforts to enlargetheir significance within the American banking system. Several proposalsto manage the crisis by expanding the role of mutual savings banks intothe commercial arena and by expanding them nationally failed to garnerstrong support from savings banks. In contrast, commercial bankers andthe S&L association worked closely with the Roosevelt administration onbanking reform and benefitted most from the blanket security providedby deposit insurance (Wadhwani 2002).

In addition to introducing deposit insurance, the regulatory reforms ofthe New Deal also sharply segmented the financial and banking marketby circumscribing the roles of various institutions and by putting intoplace tight restrictions on both sides of the balance sheet. Most NewDealers felt that the severity of the banking crisis had been largelyattributable to the high level of competition between intermediaries inthe previous decades. As commercial banks, savings banks and S&Lscompeted for the same savers and same assets, their cost of funds hadrisen and their yield on assets had shrunk, in turn squeezing margins andleaving the institutions with vulnerably small capital and reserve accounts.New Deal regulations sought to control this competition by dividing upthe markets that commercial banks, savings banks and S&Ls would beentitled to. Savings banks and S&Ls – or thrifts, as they came to be calledfollowing the New Deal – would focus on taking in savings and timedeposits and investing in long-term, fixed rate assets, especially mortgageloans and (to a lesser extent) bonds (Ornstein 1985).

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These New Deal regulations effectively controlled both sides of thebalance sheet. Commercial banks were prohibited from paying intereston demand deposits, leaving savings banks to tap the market for timeand savings deposits. Moreover, to prevent competition over deposits,federal regulators introduced a ceiling on the interest rates commercialbanks could pay on time deposits. Savings banks and S&Ls werepermitted to pay a slightly higher interest rate, guaranteeing a source offunds while controlling the overall cost of those funds from gettinghigher. On the asset side of the balance sheet, restrictions on the kinds ofinvestments that savings banks could make – long a feature of stateregulations – were now federalised. Savings banks were essentiallylimited to long-term fixed rate lending (Ornstein 1985).

The overall effect of this segmentation was that it preserved the place ofexisting mutual savings banks within the banking system over thefollowing four decades and hid the underlying weaknesses in their lackof real competitive advantage over other intermediaries. With their targetmarkets essentially protected from competition, mutual savings banksmaintained a steady 10% share of financial intermediary assets between1940 and 1970. The number of mutual savings banks also remainedsteady at approximately 500 institutions. New Deal regulations essentiallyworked to preserve the status quo in terms of the position and share ofvarious intermediaries. It hid, however, the fact that underlying theregulation mutual savings banks had essentially lost any real competitiveadvantage they had enjoyed over other intermediaries.

7. Crisis and Decline

In many ways, the regulations that sheltered savings banks throughoutmuch of the 20th century made them especially vulnerable to the risinginterest rate environment that would lead to the crises of the last quarterof the 20th century. The interest rate ceilings and investment regulationsthat segmented the savings banks’ market and protected them fromcompetition worked only so long as the interest rate environmentremained relatively stable and as long as regulation remained effective indampening competition. Both these conditions began to change in the1970s, leading to the crises of the 1980s and 1990s.

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The crisis was initiated by the rise of interest rates, especially in the late1970s and early 1980s. In the early 1980s, interest rates on three-monthtreasury bills hit a high of 16%. The spike in rates prompted rapiddisintermediation as savers moved their money out of low-yieldingdeposits and into capital markets, government securities and eventuallyinto money market mutual funds. Some institutions lost as much as 30%of their deposit base in a short period of time. Mutual savings banks inNew York faced particularly difficult circumstances as regulatoryrestrictions combined with aggressive competitors rapidly placed the city’ssavings banks in a compromised financial state (FDIC 1997).

Disintermediation placed increasing pressure on savings banks to paydepositors just as the long-term, fixed rate assets held by savings banksbecame less valuable on the market. The result was widespread andsevere losses for mutual savings banks that ate into reserve funds and lefta dozen institutions on the brink of failure. Between 1980 and 1982,mutual savings banks experienced USD 3.3 billion in losses, accountingfor 28% of their aggregate reserves. The FDIC was forced to step in toassist weaker institutions that were about to fail. Rather than allowingoutright failures, FDIC used a programme of “assisted mergers” thateffectively allowed stronger institutions to acquire weaker ones whilecovering losses. These savings banks had lost USD 1.8 billion or about12% of their assets (FDIC 1997; Ornstein 1985).

The crisis also led to calls to dismantle the restrictions on mutualsavings banks in order to allow them to more effectively compete.Serious discussions of deregulating the banking system, and particularlythe segmentation of various intermediaries, had taken place throughoutthe 1970s but had been opposed by various interest groups, includingthe savings banks themselves. Reflecting their long history of conservatism,the savings banks, as one FDIC report noted, “were reluctant to competedirectly with banks.” But the reforms gained particular urgency with thefailures and mergers of the early 1980s. The Depository InstitutionsDeregulation and Monetary Control Act of 1980 finally instituted a phaseout of Regulation Q, the nationally imposed ceiling on deposit interestrates and the favourable treatment of mutual savings bank deposits.It also liberalised restrictions on the assets that savings banks could hold,allowing modest amounts of commercial lending and other types of assetholding. Finally, it made it easier for mutual savings banks to convert intostock savings banks as a way of recapitalising savings banks. The reformsessentially allowed savings banks to act more like deregulated banks

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The result of the deregulation was a dramatic decline in the ranks ofmutual savings banks from approximately 500 in 1970 to fewer than 100today. Some of this decline took place as scores of mutual savings banksconverted themselves into stock savings banks, or even commercialbanks. But the decline was also attributable to the failure of dozens ofother savings banks. Between 1985 and 1994, scores of savings banksfailed, many of them institutions that the FDIC had saved just a few yearsearlier through mergers. The net impact was a significant reduction ofmutual savings banks in the United States (FDIC 1997).

Contemporary observers and social scientists often attributed the failuresand decline of savings banks to proximate causes, such as deregulationand the movement of savings banks into new lines of activity that hadnot previously fallen within their purview. The FDIC, for instance,attributed the failures “to activities in which the banks became involvedafter the introduction of expanded powers.” But, as this paper hasshown, the inability of savings banks to deal effectively with heightenedcompetition in a deregulated environment actually lay in causes that werehistorically deeper. In their conservatism and failure to expand bothgeographically and in terms of product scope in the early 20th century,savings banks in the United States had undermined their ability todevelop the range of capabilities needed to compete against banks,markets and other intermediaries, in stark contrast to their Germancounterparts. The New Deal regulatory regime both undermined savingsbanks single remaining competitive advantage (their superior safetyrecord) and protected the institutions for decades by segmenting thebanking market. That combination of weakened capabilities andregulatory dependence had virtually ensured that the institutions wouldnot be able to effectively respond to competition.

8. Managerial Implications

The decline of mutual savings banks in the United States providesimportant lessons for the managers of savings banks in other parts of theworld today.

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First, it highlights the risks of complacent growth. Throughout the earlydecades of the 20th century, many of the mutual savings banks in theUnited States continued to grow, even though as a system mutualsavings banking was rapidly losing market share to new, more innovativeintermediaries and products. The relative stability and success ofindividual firms masked the declining competitiveness of mutual savingsbanking as a model of intermediation within the financial system.Ultimately, however, the long-term viability of individual savings bankswas closely linked to the competitiveness and relevance of mutual savingsbanking as a category of financial intermediation; the success of savingsbanks rested on the ability of consumers to distinguish them as a uniquetype of intermediary and on their treatment as a group by regulators.Individual firm growth thus proved deceptive in the long run because itallowed managers to be complacent about the declining competitivenessof mutual savings banks as a group.

The importance of “group-level” competitiveness also indicates thecrucial importance of collective action capabilities to the long-termsuccess of savings banks as type of intermediary. American mutualsavings banks remained intensely local firms that knew their local marketsand customers well. This local knowledge, however, also became ahandicap in their ability to react to changes in the market that requiredregional and national capabilities. Unlike their German counterparts,American managers’ efforts to “coordinate” innovations and developregional and national capabilities remained limited and this ultimatelyconstrained the ability of individual firms to introduce innovations thatrequired regional and national scope.

Lastly, American mutual savings banks’ narrow adherence to their originalproducts and markets proved detrimental to their long-run competitiveness.Unlike some of their counterparts in other parts of the world, Americansavings banks remained focused on their traditional customer base andproducts throughout their 200-year history. However, because marketsand regulations changed so significantly over time, this narrow focus onproviding savings accounts to small savers and investing in long-term,fixed-rate assets such as mortgages made them extremely vulnerable tochanges in market conditions, disruptive innovations and shifts inconsumer preferences. Their narrow vision for the scope of their role inthe financial system ultimately proved harmful as the structure ofAmerican financial system itself changed.

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Ultimately, these implications suggest that deregulation and competitionby themselves did not determine the fate of mutual savings banks.Rather, the long-term effects of managerial decision-making andresponses to competition ultimately undermined the survival of mutualsavings banking in the United States.

“Irish Depositors ofthe Emigrant Savings Bankwithdrawing money to sendto their suffering relatives inthe old country”Source: Frank Leslie’s Illustrated Newspaper

(March 13, 1880). Library of Congress.

Notes: Some savings banks catered to

specific ethic groups. The Emigrant catered

primarily to Irish immigrants, many of

whom remitted large amounts of savings

to relatives in the home country.

Banknote of theSomerset and WorcesterSavings Bank Notes: Prior to the Civil War, some

savings banks issued their own

currency.

Bank Run on the Seamen’sSavings Bank During thePanic of 1857Notes: Bank runs were a common

experience in the nineteenth and early

twentieth centuries in the United States,

and savings banks were not immune.

Source: Harper’s Weekly. Library of Congress.

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