Strong Dissent to an Analysis of Banking
Bove, Richard X., American Banker
Strong Dissent To an Analysis Of Banking
The banking industry has been in a state of dynamic change for the past decade. These changes reached flashpoint in the past two years, forcing government regulators and the industry to adjust operating strategy.
Bank managements have been forced to rethink their businesses, cost structures, and their ability to compete within a broad spectrum of financial products.
While the process has been inordinately painful, the industry is benefiting from the exercise. Change is now proceeding at an even more rapid rate.
It is therefore discouraging to read analyses of banking that are essentially backward looking in nature and unmindful of the current forces impacting the industry. This type of analysis was evidenced in the three-article segment about the industry published in May by Institutional Investor Magazine.
During the past three decades, the traditional service-oriented banking business in the United States has been battered by three forces:
* Emergence of the Eurocurrency markets. Today, reliable estimates indicate that this fund source is double the size of the domestic money supply as measured by M-2 ($7.0 trillion versus $3.4 trillion). An organization that wishes to offer banking products does not need a branch-banking system and core deposits to obtain a ready supply of funds.
* Improvement in technology. Any company with off-the-shelf products can develop systems that account for millions of transactions in real time, daily, or be up to the minute on market prices around the world for virtually any financial instrument.
* A major change in the nature of the American industrial corporation. As a result of the adoption of outsourcing techniques, cash flows inside these companies have changed. Money that once was diverted to the building of stamping plants or opening iron-ore mines in Brazil is now utilized for the purchase of financial assets.
Companies such as General Electric, Ford, Sears, and AT&T were able to establish banking capabilities - even though they lacked branch-banking systems. To operate as banks, however, these companies had to wean American consumers and corporations away from their traditional method of handling financial transactions: They had to get the customer out of the bank.
This was done by crafting systems that sold financial products on demand. For example, you, personally, undoubtedly have the capability of direct depositing your paycheck into a financial institution (bank or nonbank) without leaving your office. Through the use of sophisticated cash-management systems, your company has the same capabilities.
The key to obtaining financial business is to have systems that provide products on demand and to provide the products at lowest cost. The key to losing the business is to operate from obsolete distribution systems that are inherently high-cost in nature; that is, to practice service-oriented relationship banking.
The problem with the FDIC arose because the government reacted incorrectly to the above trends. Thrift institutions had become obsolete because they did not have the capability of providing low cost/high yield services on demand.
The CMA account at Merrill Lynch and the newly evolving mortgage markets had obviated the need for thrifts. The inverted yield curves of the 1960s and 1970s were only the last straws.
The government could have solved this problem either by regulating the new financial-product sellers or by letting the thrifts die. It did the opposite. It let Merrill Lynch and others get at the FDIC through brokered deposits and increased its subsidy of the thrifts through a variety of techniques.
As the nonbank banks systematically took market share from the depository-institution banks, the inevitability of large losses grew. …