Regional President Speech

THE BANKING ENVIRONMENT OF THE EIGHTIES Remarks to 1980 Credit Conference of the Tennessee Bankers Association Nashville, Tennessee February 12, 1980 by Monroe Kimbrel, President Federal Reserve Bank of Atlanta Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The turn of each new decade brings a spate of commentaries on the upcoming ten years. Maybe it is timely to express some views on the forces that will affect banking. Although not new, these forces clearly will bring one of the most turbulent decades in our history for banking. Inflation and the Economy The Eighties will be characterized by a continuation of our Number One economic problem — inflation. Direct energy costs alone have become a massive inflationary factor, and they get worse with each meeting of OPEC. The dramatic increase in the direct cost of energy has serious economic and social implications. Higher oil and gasoline prices are diverting consumer expenditures from other goods and services. This shift in spending also diminishes the savings potential of our citizens, which in turn reduces the flow of investment in our industries. The social implications from price actions by OPEC also carry potential economy impacts: low income persons are affected most severely, and govern­ ments devise programs to offset some of the effect on their incomes. Also, programs designed to develop alternative sources of energy call for increased levels of government spending. This could have an unfavorable impact on domestic prices depending on how the spending is financed, and whether the programs are successful. Coping with an inflationary economy will surely be the challenge of the Eighties for Federal Reserve policy makers. The measures we took on October 6 were designed to establish credibility in our continuing determi­ nation to combat inflationary pressures. Federal Reserve authorities must be willing to keep restrictive policies in effect. To be successful, monetary policy must be reinforced by sound fiscal policies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2 - - Escalation of Competition With prolonged inflation, we also face a changing institutional environment that will feature escalating competition in addition to legis­ lation and regulation with strong impacts on banking. You wonder if competition can grow much more intense. Savings and loan associations and credit unions are competing effectively for savings deposits. They offer checking services in the form of share drafts and other "payable through" instruments. In the Northeast, aided in part by NOW accounts, thrift institutions have penetrated deeply the market share of commercial banks. International banks and the international departments of domestic banks are pursuing opportunities in our region. Many banks from other regions have opened loan production offices. Consumer credit affiliates have expanded into local market areas as have business finance affiliates and mortgage companies. Also, a variety of investment advisory services have become more active. This form of increased competition in the absence of brick and mortar structures is deceptive because a financial institution can be adequately represented by a few officers calling on your customers. It is sobering to look through the telephone directory for our major cities and see the listings of services offered by major money center banks. In the years ahead, I look for at least two of these competitive sources to escalate their competition with commercial banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 3 - Obviously, nonbank thrift institutions will generate the most com­ petitive pressure on commercial banks. Very likely, third-party payment powers will be extended to all depository institutions. They may be em­ powered to extend additional kinds of credit. The ease with which Congress passed the bill extending ATS and share draft authority for thrifts indicates that enlarged powers for those institutions could be granted soon. This will represent powerful competition both for deposits and for lending outlets. An early indication of the competitive strategy is the swiftness with which some S&L's moved to offer bill paying service, and the vigor with which they are pushing the new 2-1/2-year money market certificate. Foreign banks will become another potent source of competition. As of October 1979, about 278 foreign bank branches and agencies were operating in this country. Foreign banking institutions continue to charter or purchase domestic banks in growing numbers. Initially, foreign bank operations in the U. S. were directed to financing the foreign trade and business of their home countries. However, they rapidly diversified into the domestic banking business, particularly by making low-risk, highly profitable business loans to U. S. corporations. In addition, foreign branches have experienced a rapid growth in deposits from U. S. customers, mostly corporate depositors. Word from several sources is that foreign banks and international departments of domestic banks are competing for domestic business loans. Occasionally, it is stated that the prime rate has lost some of its punch because of foreign competition where terms are quoted on a London Inter Bank Offer Rate, or LIBOR, plus a percentage. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 4 In 1974, with a view toward eliminating inequities, the Federal Reserve proposed to the Congress legislation dealing with U. S. activities of foreign banks. Such efforts probably contributed to passage of the Inter­ national Banking Act of 1978. This Act is an example of the changes needed in the laws and regulations to equalize treatment and to accommodate dramatic innovations in the financial industry. Specifically, the Act requires the President, in consultation with the banking agencies, to review the McFadden Act and inform Congress on the impact it has on the nation's banking structure. A report is due shortly. The McFadden Act limits the branching powers of national banks to those allowed to state chartered banks under state laws. In contrast, the branching powers of Federally-chartered S&L's have not been limited to state branching regulations. Also, Federally chartered credit unions, such as the Navy Credit Union, may branch across state lines. Liberalizing the provisions of the McFadden Act and the state restrictions on branching would reduce competitive inequities. At the same time, however, competition in the banking industry could become even more intense. Clearly, the advent of interstate "branching" would have far-reaching ramifications for state lawmakers and for state and Federal banking authorities. Still, the branching question may soon become a moot point. The de­ ployment of terminals nationwide may be authorized within a few years. Terminals of the increasingly "smart" variety, those that open accounts and accept loan applications could cause retail brick and mortar branches to become less important in the long run. Further, limited-function facilities, such as loan production offices or consumer finance companies wholly owned Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 5 - - by the parent bank holding company, coupled with sophisticated terminals, might be considered de facto nationwide branching. These problems aside, it is possible the pace of events will overtake the lawmakers and regulators. The industry seems to be moving toward expanded interstate competition. Bank holding companies currently engage in "nonbanking" activities across state lines. Electronic funds transfer has increased dramatically the ease with which service facilities can be placed in remote locations. In the end, the rule-makers may be forced to accommodate these changes, not stand in their way. Legislative and Regulatory Environment Legislation proposed to shore up the Federal Reserve System's eroding membership base is an element in the environment for banking in the Eighties. A total of 254 banks have withdrawn from membership over the past five years. Even though many of the banks withdrawing from the System are small, there is a growing trend for larger member banks to convert. Eleven of the 99 banks that left the Federal Reserve in 1978 had deposits in excess of $100 million. Just last month, Equibank Bank of Pittsburgh, with deposits of $2 billion, announced its intention to withdraw. Because of the decline in membership, since 1974 the proportion of total commercial bank deposits held by member banks in the nation has dropped from 77 percent to 72 percent. This trend threatens to weaken the nation's financial system and poses an obstacle to the effectiveness of monetary policy. It is important that legislation be passed to place all banks on more equal competitive grounds, both with each other and with thrift institutions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6 Membership legislation has become merged with general legislation relating to powers of thrift institutions, interest rate ceilings, and, in general, financial deregulation. Whether considered judgment can be applied to all facets of this diverse legislation is yet to be seen. The stage is set for major financial legislation. Whether Congress this year will enact such a legislative package is uncertain. If not, it ultimately will act, in my opinion, and the impact on financial institutions will be enormous. Consider a marketplace where the distinguishing lines between credit unions, mutual institutions, and banks are more and more blurred. Your nonbanking competition may attain much broader asset powers, the rate differential may pass out of existence, and bankers may have to cope with a rapidly growing network of electronic payment capabilities, possibly shared by other financial institutions. Another aspect of the changing regulatory dilemma is that regulatory agencies like the Federal Reserve Board really do not act on their own initiative. The agencies genuinely try to set guidelines they believe reflect the will of Congress. To anticipate further regulatory reactions, we need to examine the action — and the direction — of the Congress. The 96th Congress is reputed to be more conservative than its prede­ cessors, possibly more in tune with the public. Congress, nevertheless, seems enamored with social legislation, which has political appeal but requires little direct outlay of public funds. Even if Congress did nothing else — which many of us believe might be an appealing alternative — a large volume of social legislation is already with us. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 7 - - Another regulatory issue persisting in the Eighties concerns capital adequacy to support the growth in bank assets. It appears certain that bank supervisory agencies will emphasize capital adequacy as an integral part of bank examination and evaluation. Sources of capital available to banks for supporting growth in assets and liabilities are likely to be critical. The "bottom line" is the increased premium that will attach to manage­ ment of funds and pricing of services to attain a reasonable return on investment. Bank profits must increase to generate meaningful amounts of new capital either from retained earnings or sale of equity shares. Clearly the emphasis on funds management and pricing strategy will be a central goal for bankers in the years ahead. With respect to funds for bank loans and investments, increased competition between banks and other financial institutions will intensify the search for new funds. A successful pursuit in our struggle against inflation will not bring a lower level of interest rates, at least in the near term. Relatively high interest rates will further compound the impact of increased competition for funds. Our sustained efforts should bring an eventual down­ ward trend in rates. In any event, "managed liabilities" and "marginal cost of funds" are terms that will be around for a long time. With the tendency of your "raw material" — deposits — to be high in cost and the sources competitive, pricing your services becomes critical. The analysis of customer accounts takes on added meaning. The coming competitive thrust in pricing is to put each area on its own as a profit center. Emphasizing fee income does not depend on increases in deposits or assets, and hence does not require additional capital. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 8 - - In the Seventies, there were rapidly changing forces that affected your ability to compete, the nature of your competition, and your ability to earn reasonable returns on investment. As to the Eighties, the environmental forces may be a good deal more threatening. Competition certainly will escalate further. But on the plus side, you will compete on a more equitable footing as financial institutions become more alike in terms of services offered. Viewing the market environment in the years ahead is less of a problem than determining what to do about it. Probably every banker in the room will do a lot of homework and critical analysis as he develops a strategy for coping with the challenging environment. As a starting point, each banker may well pause to assess his bank. What kind of institution is it? What services is it selling? Who are its customers and what do they really require? Who are the competitors? What unique advantages does your bank have in providing services compared with your competitors, and how might these advantages be exploited? The development of a strategic plan by each banker to cope with the threatening forces in the Eighties takes on a new dimension of urgency. Evidently some bankers are well along in developing their strategies. Adapting to our new environment will be a challenge for all of us — bankers, bank customers, and especially central bankers. If we exploit the opportunities available to us through embracing constructive change, rather than resisting it, we can meet the challenge. I believe we will do just that. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monroe Kimbrel (1980, February 11). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19800212_monroe_kimbrel

@misc{wtfs_regional_speeche_19800212_monroe_kimbrel,
  author = {Monroe Kimbrel},
  title = {Regional President Speech},
  year = {1980},
  month = {Feb},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19800212_monroe_kimbrel},
  note = {Retrieved via When the Fed Speaks corpus}
}