The Incredible Shrinking Banking Industry: Fewer Players in a Riskier, More Complex Game
Tannenbaum, Carl R., Business Economics
To some, the tumultuous events in the credit markets in the summer of 2007 came on suddenly and without context. While the extent and magnitude of the dislocations were certainly unexpected, the author argues that the groundwork for such events was gradually formed over the past generation by evolution within the financial services industry. The resulting new architecture of this industry has much to recommend it, but it may present a new type of systemic risk that will challenge policy makers.
According to the old saying, we should be careful what we wish for, because we just might get it.
When I was interviewing for my job at the bank almost a quarter-century ago, I peppered my responses with tired bromides like:
"I am a people person. I really want to work with people." "My greatest strength is that I recognize my weaknesses." "I want a job that is always changing. I never want to get stale."
It was this last platitude that kept haunting me as I was preparing this valedictory commemorating the completion of my year as President of NABE. The change that has enveloped the world of finance has come at a dizzying pace over the past generation, leaving those of us who work in the financial services industry wishing for a few moments of boredom.
I thought I would use this address to reflect on how banking and the financial markets have evolved over the past quarter-century. This exploration may contribute to better understanding of recent events, and offer some hints of the evolution yet to come.
When I was growing up, banking seemed like a very sedate vocation. Everything was orderly and formal, with imagery designed to create an aura of safety. My parents' generation, as survivors of the Depression, wanted assurance that their money was secure behind those Ionic columns; the FDIC sign in the window meant something to them. My brother and I were raised to value thrift, joining the weekly lines to have our passbooks updated shortly after beginning grade school.
Landing a job within a bank back then promised lifetime employment. The industry was very stable, with competition limited by regulations that controlled everything from the rates that could be paid on deposits to the geography of branches. Business was said to follow "the rule of threes": you paid three percent to your customers, lent the money out at a three percent spread, and played golf at three each afternoon.
1. Paradise Lost
Alas, the idyll didn't last. Figure 1 shows that the decade following the first oil shock of 1973 brought record levels of both interest rates and interest rate volatility. Many factors contributed to this development, but easy monetary and fiscal policy through the 1960s and 1970s certainly played a role.
The series of recessions that were endured during that decade battered loan portfolios and hampered profitability. Depositors that had once been content with three percent yields realized that their purchasing power was eroding at a rapid pace, and clamored for better returns.
Technology provided the means for customers to act on their discontent. Money and information began to move further and faster, and brokerage firms (ridiculed as "non-banks" back then) moved aggressively to capitalize. This began a process of "disintermediation" that continues to this day.
The industry that I entered in the early 1980s was in turmoil. Thrift institutions were paying ten percent for funding to support four percent mortgages. Commercial banks were stretching, lending to riskier sectors such as energy exploration, developing countries, and highly leveraged companies. Sound familiar?
All too often, these initiatives added to the industry's woes. More than 1,000 banks failed between 1980 and 1990. (1) Many others were forced to consolidate with stronger institutions. Today, we have only about half the number of commercial banks as we did twenty years ago. …