The Role of Retail Banking in the U.S. Banking Industry: Risk, Return, and Industry Structure

By Clark, Timothy; Dick, Astrid et al. | Federal Reserve Bank of New York Economic Policy Review, December 2007 | Go to article overview

The Role of Retail Banking in the U.S. Banking Industry: Risk, Return, and Industry Structure


Clark, Timothy, Dick, Astrid, Hirtle, Beverly, Stiroh, Kevin J., Williams, Robard, Federal Reserve Bank of New York Economic Policy Review


* In recent years, retail banking has become a key area of strategic emphasis in the U.S. banking industry, as evidenced by rising trends in retail loan and deposit shares on commercial bank balance sheets and a continuing increase in the number of bank branches.

* This "return to retail" contrasts with the 1990s, when banks sought to diversify revenues, deemphasize branch networks, and target financial services to a broader range of clients.

* An analysis of this strategic shift suggests that interest in retail banking fluctuates in predictable ways with the performance of nonretail banking and financial market activities.

* The recent "return to retail" episode may be more persistent than past cycles because it is being driven almost entirely by the very largest U.S. banks, which have been building large branch networks and investing in other retail banking infrastructure.

1. Introduction

he U.S. banking industry is experiencing renewed interest in retail banking. These activities--broadly defined as the range of products and services provided to consumers and small businesses--have grown in importance over the past several years. Retail-related positions now account for larger shares of commercial bank balance sheets, and the number of bank branches continues to grow. The recent focus on retail contrasts sharply with industry views held during the 1990s, when banks' attention turned to broadening products, diversifying revenues, substituting alternative delivery channels for branches, and offering a multitude of financial services to all types of retail, corporate, and wholesale customers.

This "return to retail" is reflected in a greater number of media reports on retail banking activities, in the frequency with which retail banking activities have been mentioned in banks' public statements, and in the attention given to these activities by industry analysts. (1) A 2004 report by Standard and Poor's--"Retail Sector Anchors Large Complex Banks in U.S."--and a 2003 Salomon Smith Barney discussion of U.S. banking becoming "refocused on retail" typify the view that retail has become a key area of strategic emphasis in the U.S. banking industry. Indeed, the renewed focus on retail activities seems to have been a key motivation behind a number of recent large-bank mergers, such as Bank of America's acquisition of FleetBoston Financial and JPMorgan Chase's acquisition of Bank One. (2)

This article documents the "return in retail" in the U.S. banking industry and offers some insight into why this shift has occurred. Trends in retail loan shares, retail deposit shares, the balance sheets of U.S. consumers, and the number of bank branches all indicate an increased focus on retail activities. We discuss the effect of this focus on individual banks and ask whether the related investment in infrastructure--principally, branch networks--is justified and sustainable for the industry as a whole. We examine a range of external sources: reports by equity analysts, rating agencies, and consulting firms; discussions and data provided by banking companies in annual reports, investor presentations, and other public outlets; and academic research examining various aspects of retail banking.

At the bank level, the principal attraction of retail banking seems to be the belief that its revenues are stable and thus can offset volatility in the nonretail businesses, such as corporate and commercial real estate lending, trading, and capital market activities. Some banking industry analysts go even further, claiming that retail banking offers high returns along with low risk. We present some evidence that retail banking activities offered high risk-adjusted returns relative to nonretail activities in the early 2000s, but that more recently the returns from retail and nonretail banking have converged. More formal analysis of large, publicly traded bank holding companies from 1997 to 2004 by Hirtle and Stiroh (forthcoming) suggests that both risk and return decline as these firms become more focused on retail banking activities. …

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