Regional President Speech

THE NEW COMPETITIVE ENVIRONMENT Remarks of John J. Balles, President Federal Reserve Bank of San Francisco Western Independent Bankers 25th Bank Presidents' and Senior Officers- Policy Seminar San Francisco, California March 24, 1981 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The New Competitive Environment My assignment on this afternoon's program is to assess, from an outsider's viewpoint, the new competitive banking* environment of the 1980's. K|y basic conclusion is that the new competitive environment will be shaped largely by the speed and direction of deregulation in the coming decade. The decade already has come to be known as the Era of Deregulation, and I for one am encouraged by the prospects. The Depository Institutions Deregulation and Monetary Control Act — MCA for short — represents a limited, although significant, step in this direction of increased competition. Types of tegulation Regulations affecting financial institutions can be classified broadly into two general areas. On the one hand, we have a whole host of regulations, such as truth-in-lending, which Congress imposed on banks and other financial institutions as a means of protecting the consumer. These regulations have come under heavy attack in recent years. In fact, the Senate Banking Committee under Senator Jake Gam has promised oversight hearings which would consider dismantling some current regulations. But still, the signs today don't suggest that Congress will repeal significant amounts of existing consumer legislati The second group of regulations — those which we are addressing today — involves restrictions on product lines and geographic markets for banks, thrifts, and other financial institutions. There are many laws on the books which circumscribe deposit rates, product lines, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2 - - and geographic markets of financial institutions. For the most part, legislation in this area finds its genesis in the financial collapse and subsequent banking panic of the 1930's. Congress passed the Banking Acts of 1933 and 1935, the Glass-Steagall Act of 1933, and the Securities and Exchange Act of 1934 ostensibly to "establish a sound financial system." But these laws in practice tended to limit competition, especially bank competition, and led to increased Federal regulation of financial and banking markets. Later, as financial institutions innovated to avoid such restrictions, Congress acted to plug these loopholes — for example,by passing and then amending the Bank Holding Company Act, and by extending interest-rate ceilings to savings-and-loan associations. Many of these restrictions became untenable in the 1970's, however, because of high and variable interest rates, credit crunches due to Reg. Q ceilings, and technological changes such as computerized cash- management techniques. Banks created new sources of funds not subject to interest-rate ceilings; credit unions created share-draft accounts» money-market funds came into being as alternatives to bank checking and savings accounts; and banks began to withdraw from the Federal Reserve System to avoid the rising burden of reserve requirements. The regulators reacted by removing Reg. Q ceilings in piecemeal fashion, by permitting the creation of money-market certificates, and by proposing legislation to solve the problem of eroding Federal Reserve System membership. Monetary Control Act The Monetary Control Act, however, represents a unified approach to many of the piecemeal financial changes of the 1970's. The Act Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 4 - - Carter Administration report on geographic restrictions — the so-called McFadden Act report. The report proposed to expand interstate banking through the holding-company vehicle, largely because it would minimize the threat to our existing dual-banking system — and would do least to stir up the issue of states' rights. Against this background, what direction will geographic deregulation take in the 1980’s? First, holding companies or their banks might gain permission to expand or extend their deposit and loan facilities across state lines within metropolitan areas — beginning perhaps with the Washington, D.C., area. (Such activities, however, might be restricted initially to automatic teller machines.) Second, banking organizations might gain permission to bid for takeovers of failing banks across state lines — a step which could ease the problems of regulators in their efforts to effect smooth transitions of failing institutions. Third, we might eventually see interstate acquisitions in contiguous states or within special regions — California-New York interstate banking, for example. In this connection, permission to cross state lines through merger or acquisition might be limited to smaller institutions — which would limit large holding companies to de novo entry or perhaps to operating only in large metropolitan areas. Will any of this happen very soon? I doubt it. But some form of geographic deregulation seems to be in the cards eventually, perhaps in line with the scenario I've outlined here. But at present, Senator Gam for one is predisposed to approach these issues with great caution, and has promised his own review of the White House Report. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 5 - - Forces Behind Deregulation A number of forces will affect the direction of further deregulation. At the forefront is the issue of states' rights, which could dominate the debate in the 1980's. However, there is some irony in the current situation. A few states, by competing with favorable tax treatment and regulations, presently are attempting to attract certain holding company activities. (Delaware and South Dakota come readily to mind.) But by their actions, these states are promising an environment with fewer regulations, which effectively means deregulation. In addition, if competition among states becomes fierce enough, we might see some relaxation of the Douglas amendment at the Federal level. Rapidly changing technology will be another major influence in the 1980‘s. Automatic teller machines and point-of-sale terminals are already economically viable, and are proving increasingly popular with consumers. This means further pressure on branching laws and interstate restrictions, at least within metropolitan areas. Moreover, thrift institutions are also experiencing the merits of ATMs and shared computer technology, and they seem likely to expand their consumer services through these means. A third factor affecting deregulation will be the increasing competition from outside the banking and thrift industries. I am speaking here of money-market funds and the Merrill lo'nch, Sears, and American Express plans, which are all paving the way towards integrated cash management for individuals. These developments are hastening the removal of Reg. Q ceilings and eroding product-line restrictions on financial institutions. In this connection, we've heard much talk lately about Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 6 - - placing reserve requirements on money-market funds. This is a complicated question. For example, simply extending reserve requirements to money- market funds may not be legal under current legislation. (The imposition of reserve requirements last spring represented a temporary restraint under the Credit Control Act.) Moreover, money-market funds could easily qualify as savings vehicles -- by limiting withdrawals to three per month or by omitting checking — and as such would be subject to a zero reserve require­ ment. The force of deregulation, including the legislative charge of the DIDC, argues for a different solution -- extending to banks and thrifts the deposit powers to compete with money-market funds. Survival of Small Institutions In light of the MCA and the prospect of further deregulation, many observers wonder about the ability of some thrifts and community banks to survive in the coming decade. But the present problems of these institutions result much more from low-yielding assets than from increased competition. Still, competitive factors will aggravate the difficult situation that they face in the years ahead. For this reason, the DIDC is approaching its task of eliminating Reg Q ceilings with great caution. Yet even with a methodical phase-out over the six-year period, some institutions could have trouble surviving — in the absence of a sharp decline in interest rates. But aside from this widespread problem of an overhang of low-yielding assets, small institutions generally should be able to prosper even if they are no longer protected by regulations restricting product lines and geographic competition. For example, in the highly competitive California environment, more than seventy-five unit banks (and many with only a few branches) compete effectively against the major banks. Moreover, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 7 - - with the relaxation of intrastate branching laws in New York State several years ago, the large city banks found it difficult to make inroads into upstate New York. Economies of scale thus do not seem to be paramount in banking; in fact, many studies suggest that unit costs actually rise slightly after a bank reaches a $100-million deposit size. Moreover, there is a substantial demand for the tailored products that many small banks provide, particularly in small communities. But when all is said and done, the 1980's will be a difficult period for all financial institutions. The widespread development of electronic funds transfers is a certainty. Under present legislation, we will witness the complete removal of Reg. Q ceilings, and we might also see further deregulation across product lines and geographic markets. In this environment, small institutions will have to rely much more heavily on the services provided by network banking, particularly for cost-saving automated services. Concluding Remarks In summary, the Monetary Control Act has meant a limited, but significant, step towards deregulation, The extension of transaction . accounts to thrifts, the payment of interest on these accounts, and the ultimate removal of Reg. Q ceilings -- all mean dramatic changes in the shape of the playing field. Moreover, the pricing of, and expanded access to, Fed services will affect correspondent banking for some time to come. Stf11, the MCA is only a limited step in what ultimately will be further deregulation of the banking environment. And in the last analysis, the health of all your institutions can only be achieved through an improvement in the health of the national Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 8 - - economy, as we overcome the inflation which has done so much havoc to the financial conmunity's balance sheets. This means that the Federal Reserve must gradually reduce the growth of the money supply, to create the environment for non-inflationary economic growth. But the Fed's task cannot be accomplished without a parallel reduction in the Federal government's borrowing demands, to reduce the inflationary tinder created by the severe deficit-financing pressures of the past decade. # # # Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

John J. Balles (1981, March 23). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19810324_john_j_balles

@misc{wtfs_regional_speeche_19810324_john_j_balles,
  author = {John J. Balles},
  title = {Regional President Speech},
  year = {1981},
  month = {Mar},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19810324_john_j_balles},
  note = {Retrieved via When the Fed Speaks corpus}
}