1. 1 Lecture 20: Bank consolidation and separation of business Mishkin Ch 10 – part B page 261-277

2. 2 Review Regulation dual banking system  multiple regulatory agencies Glass-Steagall Act (Banking Act of 1933) Financial Innovation – driven by desire for profit  response to change in demand  response to change in supply  response to regulation Decline of traditional banking  decline in cost advantages  respond by enter into risky lending and off-balance sheet activities

3. 3 Outline Many small banks v.s. bank consolidation Separation v.s. combination

4. 4 In other countries, only a few big dominant banks, concentrated banking industry. In the U.S., there are many small commercial banks, approximately 8,000, about 10 percent of these banks are relatively small, with less than $25 million in assets Why?

5. 5 Restrictions on branching (1863—1985) McFadden Act, 1927  prohibited national banks from opening branches outside their home state.  Intention was to foster competition by preventing large banks from driving smaller banks out of business by opening a nearby branch.  The actual result was lack of competition, however. Inefficient small banks remain in business, even if they offered poor services, because their customers had nowhere else to go. Branching restrictions explain the large number of banks in U.S.; and have stimulated financial innovations to get around them.

6. 6 Banks’ responses Competition can be repressed by regulation but not completely quashed. 1. Bank holding companies  are allowed to purchases banks outside state;  are allowed to engage in a wider scope of activities  is the dominant form of corporate structure for banks (90%) 2. ATM (automated teller machines)

7. 7 Number of banks has declined! Maybe size of banks increased?

8. 8 Bank consolidation Reasons?  Bank failures (1980s-1990s) ?  Bank consolidation: banks merging or buy up other banks to getter bigger; and to take advantages of (1)economies of scale, (2)scope from information technology, (3)diversification Results?  bigger banks; combination of services and products; merge of different financial intermediaries; large, complex baking organizations (LCBOs)

9. 9 Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allows full interstate branching extend to the whole nation promotes further consolidation 1998, merge of Bank of America and NationsBank  first bank with branches on both coasts

10. 10 Predict future Will we have as many banks as we do now? Will the U.S. have as few banks as other countries, say Japan? Answer: Several thousand banks.

11. 11 Benefits and costs of bank consolidation Benefits  increased competition  efficiency  economies of scale and scope  efficiency  more diversified portfolios  lower risk Costs  elimination of community banks may lead to less lending to small business  rush to consolidation may increase risk

12. 12 Separation Another feature of banks in the U.S. until recently is separation of the commercial banking and other financial services industries – such as securities, insurance and real estate – mandate by the Glass- Steagall Act of 1933.

13. 13 Glass-Steagall Act of 1933 Prohibited commercial banks from underwriting corporate securities or engaging in brokerage activities Section 20 loophole was allowed by the Federal Reserve enabling affiliates of approved commercial banks to underwrite securities as long as the revenue did not exceed a specified amount. U.S. Supreme Court validated the Fed’s action in 1988. Banks are allowed to engage in real estate and some insurance activities.

14. 14 Gramm-Leach-Bliley Financial Services Modernization Act of 1999 Abolishes Glass-Steagall Act, and allows banking, real estate, securities, insurance businesses to enter into each other’s territories. Financial service activities are consolidated.

15. 15 Three basic world frameworks Universal banking  No separation between banking and securities industries  Germany, Netherlands, Switzerland British-style universal banking  Banks may engage in security underwriting  U.K., Canada, Australia, U.S. Some legal separation  Japan