Regional President Speech

Final copy CHANGING TIMES IN BANKING Remarks of John J. Balles, President Federal Reserve Bank of San Francisco Conference of State Bank Supervisors Monterey, California October 31, 1975 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Changing Times in Banking To begin our dialogue from my supervisory standpoint, let me review some of the major developments now affecting the banking industry, partly through Congressional and regulatory decisions, and partly through underlying tech­ nological and economic trends. You are certainly just as familiar as I am with all these developments. But since changes are coming today so fast and furiously, and since they are interrelated in so many ways, it would be useful for us to red-flag some of the major developments--to show how, as a group, they generate changing times in banking. Letfs consider in turn the challenges arising from the technological, institutional and regulatory sectors. Challenges--Computers and Consumers The subject of technological innovation has been discussed at great length at many banking conferences, including this one, but let me add one brief word more. One of the most significant impacts of technology may be in the area of bank branching. Banks in many cases have increased the size and penetration of their market areas by branching, but at the cost of higher operating expenses and diluted profits. We now realize, however, that branching is not the only possible method of supplying convenient banking services and of improving a bankfs effectiveness. Bank managers now have an alternative way of reaching customers through flexible and rela­ tively inexpensive electronic devices. This question may be moot at present, in view of the Federal court ruling that electronic terminals are equiva­ lent to branches, and thus subject to the 48-year-old McFadden Act lim­ iting bank branching. We may have to await a Supreme Court decision on this matter, or perhaps some Congressional decision--remember, Sen. McIntyre Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2 has suggested that Congress take a good hard look at the McFadden Act. Mean­ while, the technology remains available to support far-reaching institutional changes in coming decades. Against this background, consider the impact of bank customers—espe­ cially through the consumer movement--on the reshaping of the nation1s finan­ cial system. Sophisticated consumers are now able to obtain high returns from various market instruments and also from money-market funds. Aggres­ sive consumerists meanwhile continue to press for the termination of bank- deposit interest ceilings, -which range from zero on demand deposits to 7% percent on longer-term time certificates. The response is evident in the recent actions of the Senate Banking Committee, which essentially would per­ mit payment of interest on demand deposits at the end of next year and phase out Reg Q ceilings on time-and-savings deposits in 5% years. Meanwhile, an increasing number of banks are de-emphasizing the corporate end of the market, in view of all the pitfalls of liability management, and instead are cultivating a larger consumer deposit and loan base. The con­ sumer market is comparatively stable, statistically predictable, compara­ tively insensitive to interest-rate changes, and potentially profitable with the help of modern electronic processing. The question then becomes, howill the consumer respond to the importunings of the no\7-ardent banks? Challenges from Nonbank Institutions The ansxtfer depends on the interaction between the rising competitive challenge from thrift institutions and the far-ranging changes in regulatory ground rules. The institutional changes now underway are rapidly blurring the distinction between demand accounts and time-and-savings accounts-- primarily of course through the development of NOW accounts. The public Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 3 increasingly holds its transaction balances and precautionary balances in time-and-savings accounts, with commercial banks and thrift institutions competing directly for such balances. In this situation, we might expect the regulatory authorities to attempt to enforce roughly similar ground rules for these competing institutions, in line with a basic Hunt Commission principle. Thus, we have several Federal Reserve actions which would help bring banks into line with thrift-institution practices--the authorization for commercial banks to offer passbook-savings accounts to corporate customers, and the authorization for banks to offer a bill-paying service to savings-accounts customers. Moreover, we have the Senate Banking Committee's set of proposals, which would further blur the distinction between the different types of institutions, such as by allowing the expansion of all thrift institutions into the consumer-loan and NOW- account fields. But the challenge arises not just from the thrifts but from other com­ petitors as well; for example, data-processing and communications firms, credit-card companies, and national and regional retailers. These newer enterprises see the change-over in payments technology as an opportunity to enter the payments business without the operating handicap of having to use paper checks processed through commercial-bank channels. Indeed, as George Mitchell has argued, while the banks and thrifts zealously try to limit each other’s competitive effectiveness by statutory or regulatory action, they overlook the very strong challenge being launched by unregulated enterprises. But remember that banks as well as nonbanks can benefit from shifting market boundaries. In recent years, we have seen the expanding power of bank holding companies in a number of non-bank areas, and we1re likely to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 4 hear a great deal also about the growing strength of the banks in the secu­ rities industry. Yet here again, there are changing groundrules. Thus we have the new guidelines proposed not only by the bank regulatory authorities but also by the SEC in its role as protector of investors in bank holding companies. These guidelines represent a difficult compromise between in­ vestors' rights and bank customers' rights. In developing them, we have had to weigh carefully the type and form of disclosure imposed on banks, so that we don't undermine the banks' willingness to assume risk—and also don't erode the confidence of depositors, which after all is a key determinant of the banks' ability to attract the funds needed to finance future lending activities. Uniform Reserve Requirements One of the best examples of the drive for common groundrules is the Federal Reserve's continuing attempt to achieve uniform reserve requirements. As you know, the Board again this year has asked Congress for authority to extend reserve requirements to nonmember institutions, but with several new features. In contrast to last year's bill, the new proposal would extend reserve requirements on time-and-savings deposits to nonmember depositary institutions, instead of confining them to demand deposits and NOW accounts. In addition, the proposed reserve-requirement ranges would be adjusted down­ wards, and the proposed exemption of the first $2 million of deposits would be deleted. The broadened proposal for extension of the coverage of reserve require­ ments reflects the Fed's strong emphasis on the need for equity among com­ peting institutions; thus, all institutions offering similar deposit services should be subject to similar requirements, especially now that the deposit Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 5 functions served by the various institutions are becoming more nearly alike* The proposal for lower reserve-requirement ranges recognizes the need to maintain the active participation of deposit institutions in credit markets to promote economic growth, and also to assure the flow of credit to key economic sectors such as housing. The withdrawal of the proposed exemption for small nonmember institutions reflects an attempt not to discriminate against small member banks, especially since an exemption of this type could encourage such banks to withdraw from, the System. While recognizing the validity of some of the opposing arguments, I submit that two overriding factors support these proposals. First, they would enhance the effectiveness of monetary policy by tightening the rela­ tionship between bank reserves and the nation1s deposits. Second, they would promote equity in competition among similar institutions, in a world where the distinction between demand accounts and time-and-savings accounts is being rapidly blurred. Remember the basic principle involved--equivalent cash reserves should be held against similar deposits that serve as a part of the public’s money balances, no matter where those funds are deposited. That principle has been upheld by the Fed for years in regard to the thrift institutions1 assumption of third-party payments powers, and I'm sure it is universally valid. Concluding Remarks What conclusions can we draw from this brief review? Above all, bankers should remember that we live in changing times, affected not only by shifts in regulations but also by shifts in the general banking environment. Tech­ nological change is a constantly disturbing element, posing a major challenge to such established practices as bank branching. The demands of a more af­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 6 fluent and more sophisticated consumer are another disturbing force. Thrift institutions and (increasingly) nonfinancial institutions, by their rapid adaptation to this new environment, provide a serious challenge in many aspects of the banking business• But banks themselves have the potential to expand in new areas by proper adaptation to institutional and technolog­ ical change. The proper regulatory response in all cases, I believe, would both support an effective economic policy and provide equitable treatment for all concerned--as in the case of uniform reserve requirements. To help cope with changing times in banking, we might consider several principles first suggested several years ago to the Hunt Commission by a Special ABA Committee which I chaired. Basically, our committee argued that 1) maximum reliance should be placed upon free-market forces to assure an innovative financial system; 2) regulatory processes should be reviewed continually to ensure that all regulations are justified and administra­ tively workable; 3) public-policy measures for financing the nation’s social priorities should provide incentives to all lenders and not just certain specialized institutions; and 4) the ground rules for competition among financial institutions should be equitable, with no substantial limitations on the ability of these institutions to compete with one another. I submit that these principles have held up well, and that they provide a basis for developing an industry-wide position on the issues first chrys- tallized by the Hunt Commission. But: it seems essential that bankers close their ranks and work to forge a unified position on these crucial issues. If they don't, they will only lose their markets, in a piecemeal fashion, to other institutions. Jf. JU JU ir ir ir Ir Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

John J. Balles (1975, October 30). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19751031_john_j_balles

@misc{wtfs_regional_speeche_19751031_john_j_balles,
  author = {John J. Balles},
  title = {Regional President Speech},
  year = {1975},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19751031_john_j_balles},
  note = {Retrieved via When the Fed Speaks corpus}
}