The 3-6-3 Rule: An Urban Myth?

By Walter, John R. | Economic Quarterly - Federal Reserve Bank of Richmond, Winter 2006 | Go to article overview

The 3-6-3 Rule: An Urban Myth?


Walter, John R., Economic Quarterly - Federal Reserve Bank of Richmond


Observers often describe the banking industry of the 1950s, 1960s, and 1970s as operating according to a 3-6-3 rule: Bankers gathered deposits at 3 percent, lent them at 6 percent, and were on the golf course by 3 o'clock in the afternoon. The implication is that the industry was a sleepy one, marked by a lack of aggressive competition. Further, the often heard phrase "bankers' hours" also seems to point to a lack of competitive zeal. Tight regulation is thought to have limited competition and allowed the 3-6-3 rule and the concept of bankers' hours to survive.

The banking industry was indeed subject to a raft of regulations that were introduced during the Great Depression and only began to be removed in the early 1980s. Included were restrictions that limited the formation of banks and the location of bank branches. These regulations also limited the interest rates they could pay depositors and charge borrowers.

In today's banking environment, one can hardly imagine bankers operating by anything close to a 3-6-3 rule because the market is clearly quite competitive and is likely more competitive than during the 1950s, 1960s, and 1970s. Consider an example of today's competitive setting: A visit to the Internet allows a mortgage borrower the choice of hundreds of mortgage lenders from around the country, any of whom are happy to lend. Price comparisons are fairly simple since all of these mortgage lenders openly advertise their interest rates and, to a lesser degree, their fees. Further, with numerous offers of home equity loans and an average of 4 billion credit card solicitations mailed per year, consumers have ample options for financing non-real-estate consumption (Lazarus 2003). Last, most shopping areas contain several bank branches (including those from out-of-state banks) and consequently provide consumers with a wide choice of deposit facilities, as well as ATMs from banks not located in the shopping area. Much of this type of competition was not in place before the 1980s, in part because delivery technology had not matured. Undoubtedly, restrictions on banks prior to the 1980s also played a role.

There is a good deal of evidence that restrictions in place before the 1980s limited the competitiveness of banking markets and thereby granted some banks monopoly power. For example, Flannery (1984) presents evidence that banks in unit banking states (i.e., states that largely prohibited branches) were less efficient than those in states allowing less restrictive branching. Flannery also indicates that branching restrictions reduced competition, allowing banks in unit branching states to earn above-normal profits. Similarly, Keeley (1990, 1192) finds that branching restrictions "provide a degree of protection from competition." Others also have found evidence that branching restrictions were anti-competitive, allowing banks to charge higher interest rates on loans and pay lower rates on deposits.1

Nevertheless, how widespread was the influence of these restrictions on the banking industry and its customers? When the restrictions were binding, they likely had significant effects; however, a review of the regulations indicates that they were often not binding or were at times sidestepped. Limits on the formation of new banks, while fairly strict from the Depression through the 1950s, were loosened afterward. As a result, bank formation in the 1960s and 1970s was not very different from that in the 1980s and 1990s. Whileanumber of states maintained stringent restrictions on branching, aggregated across the United States, the number of bank branches grew quite rapidly well before branching restrictions were removed in the 1980s. Interest rate restrictions were binding for only part of the period. Further, even if the restrictions had been consistently binding, the opportunity for banks to exercise monopoly power was checked to some degree by intense competition from nonbank providers of most of the same products offered by banks. …

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