Regional President Speech

\ \ THE CHANGING FINANCIAL STRUCTURE Vanderbilt University Remarks by Silas Keehn, President Federal Reserve Bank of Chicago April 6, 1988 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Major changes in the 1980s ~ /4-( C1 (1,'b"v 1~1')'-' -<i? e--.(,(1 s-,c~ , Nonbank competition • ~ c.i'-",-u..~t~· Interstate banking vt: ~ CJ r->P- '· i ,~ /W7. Globalization of financial markets I~ I 13 1 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Have banks become less competitive? Changes in stru~ture Inappropriate legislation 2 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Banks role as financial intermediaries Role of regulation Issues concerning restructuring 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Banks role as financial intermediaries 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Financial intermediaries ASSETS LIABILITIES Cash deposits Securities Other borrowings Loans Capital 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ASSET Households Businesses Deposits Deposits Mutual fund shares Mutual fund shares Life insurance reserves Commercial paper Pension fund reserves Financial intermediaries ASSETS LIABILITIES Cash Deposits Securities Other borrowings Loans Capital 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ASSET Households Businesses Deposits Deposits Mutual fund shares Mutual fund shares Life insurance reserves Commercial paper Pension fund reserves Financial intermediaries ASSETS LIABILITIES Cash Deposits Seurities Other borrowings Loans Capital Households Businesses Mortgage loans Commercial loans Auto loans Commercial mortgages Credit card loans LIABILITY 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Intermediated claims of consumers percent 66 62 58 54 50 46 42 38 intermediated claims as a % of total financial assets 34 30 1950 '54 '58 '62 '66 '70 '74 '78 '82 '86 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Intermediated claims of consumers percent 66 62 deposits as a % of intermediated claims 58 54 50 46 42 38 intermediated claims as a% of total financial assets 34 30 1950 '54 '58 '62 '66 '70 '74 '78 '82 '86 9 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Intermediated claims of nonfinancial corporations percent 110 100 90 80 70 intermediated claims as a% of liquid assets 60 50 1951 '54 '58 '62 '66 '70 '74 '78 '82 '86 10 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Intermediated claims of nonfinancial corporations percent 110 bank liabilities as a% of total 100 corporate intermediated claims 90 80 70 intermediated claims as a % of liquid assets 60 50 1951 '54 '58 '62 '66 '70 '74 '78 '82 '86 11 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Bank intermediated claims of nation's largest firms percent of liquid assets 65 55 45 35 25 1973 '74 '75 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 12 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Bank loans to small firms (firms with assets below $1 bil.) percent of total debt 50 45 40 35 30 1975 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 13 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Bank lending to big manufacturers percent 50 40 30 ------------- 20 banks' share of total debt ........ 10 0 '-----'-------'----'-------'-----'---__.._-----'-------'-------'-----' 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 14 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Traditional credit process 1 Identify potential borrowers 2 Make credit evaluation 3 Fund the loan with bank deposits 4 Service the loan 15 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Investment banking activities of large U.S. banks . . .. .. .· ··. ···································:· ..... ·.·:········ ... ··:·:·······•·······)\? Value $ billions Number of deals Merger & acquisitions 6 115 Tax-exempt bonds 23 2,471 Private placements 13 713 16 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Investment banking activities of U.S. banks overseas Eurocommercial International Eurobonds paper Equities X X X Citicorp X X X BankAmerica X X X Chase Manhattan X X Manufacturers Hanover X X J.P. Morgan & Co. X X X Chemical NY Corp. X X Security Pacific Corp. X X X Bankers Trust X X First Interstate Bancorp. X X X First Chicago 9 10 7 17 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis "Turning loans into securities mm • Financial institutions make loans Loans are bundled and sold as securities Digitized for FRASER 18 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Loan sales by top 1O banks $ millions % of assets 36,367 1. Bankers Trust 66.9 ) 24,824 2. Citibank 16.9 13,735 3. Chase Manhattan 16.3 6,581 4. Morgan Guaranty 9.6 6,340 5. Manfacturers Hanover 10.4 4,039 6. First NB of Chicago 11.3 3,114 7. Security Pacific 6.6 2,749 8. Chemical Bank 4.5 992 9. Bank of America 1.2 376 10 . Wells Fargo Bank 1.0 19 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Loan commitments and standbys permit anks to Originate, fund and service loans While bearing only a portion of risk 20 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Standby letter of credit Account Beneficiary party Bank (Issues SLOC) 21 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Unused portion of loan commitments percent of total debt 18 16 14 12 10 8 6 1975 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 22 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Impact of off-balance-sheet guarantees 40 With guarantees 35 J Traditional products only 30 1975 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 23 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Role of regulation 24 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Advantages Disadvantages Loan origination "Booking" loans Loan servicing 25 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Costs s~·nefits Deposit insurance premium Discount window Reserve requirements Deposit insurance Capital requirements 26 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Fed membership shrinking Burdensome reserve requirements High interest rates 27 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Fed response to shrinking membership DIDMCA Lower reserve requirements Reserve requirements for all depository institutions 28 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Commercial paper vs. bank loans bank loans/total debt commercial paper/total debt 25 4 ◄ '-,_ _______________ _,,,,,~,,,,,..----------------- 20 ► 3 15 10 5 0 0 1975 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 29 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Capital requirements tax Debt and equity treated differently for tax purposes Capital that would be held absent regulation 30 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The burden of regulation basis points (per dollar of assets) 70 60 \ total regulatory taxes \ \ ,, 50 \ '-,. ,,,. ____ __ 40 reserve requirements tax \ \ , ... ..... 30 ~-, , ~._ 20 ' 10 0 1976 1978 1980 1982 1984 1986 31 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The burden of regulation basis points (per dollar of assets) 70 60 50 40 reserve requirements tax 30 20 10 0 1976 1978 1980 1982 1984 1986 32 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The burden of regulation basis points 10 8 6 Deposit insurance premium 4 2 0 1976 1978 1980 1982 1984 1986 33 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ---- CJ Market capit lization percent of assets 9 8 7 Banks with less than 6 10 bil. in as~~s ) 5 4 3 Banks with more than 2 $1 Q bil. in assets 1 0 1977 '78 '79 '80 '81 '82 '83 '84 '85 '86 34 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The burden of regulation basis points (per dollar of assets) 40 30 20 capital requirements tax 10 0 1976 1978 1980 1982 1984 1986 35 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The burden of regulation basis points (per dollar of assets) 70 60 \ total regulatory truces \ \ 50 \ ,, - - '-, ... .,,,. ,,,. 40 reserve requirements tax \ ,, \ ... 30 ~-, '--, 20 10 0 1976 1978 1980 1982 1984 1986 36 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Regulatory taxes and bank's share of big business lending basis points (per dollar of assets) percent 70 20 ," ~ total regulatory truces 60 ,.A, 18 I .,,,,~ ' I \ ,"' \ I \ \ 50 16 \ I \ , I \ I \)GP-\ l,1 , \ \ I G vv--/' (l '1.,,v. 40 \ \ __ , , 14 f)Y . ~ L . r.-1 ~ ,/ e,/1...\ \ _, ~ 30 banks' share of total debt -.. 12 20 10 1976 1978 1980 1982 1984 1986 37 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Regulatory taxes encourage growth of Commercial paper Loan sales Standby letters of credit Loan commitments Eurodollar deposits 38 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Growth of eurodollar deposits percent of total deposits 40 35 30 25 20 ·n 1975 '76 '78 '79 '80 '81 '82 '83 '84 '85 '86 39 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Growth of standby letters of credit billions of dollars 200 150 100 50 0 1973 '74 '75 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 40 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis /i<;ur~ bj §ta letters of credit Increase with increases in capital requirements Increase with increases in reserve requirements)< Eurodollars Increase with increases in reserve requirements 41 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Impact of regulation Increases in capital requirement tax would significantly increase issuance of standby letters of credit Increases in reserve requirement tax would significantly increase Eurodollar deposits 42 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Other reasons for nontraditional activities Bank risk - standby letters of credit Comparative advantage in origination and servicing - loan sales and securitization 43 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Dollar amount securitized ($ millions) $11,154 General Motors 513 Sperry 215 Mack Truck 187 Nissan 150 Volkswagen 93 American Airlines 63 Mattel 44 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Issues concerning restructuring 45 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Deregulation Reg Q Interstate banking 46 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Next phase of deregulation Glass-Steagall Investment banking Real estate Insurance 47 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Minimal impact of crash Financial system unscathed Glass-Steagall reform move unchanged 48 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Important restructuring issues Safety net Separation of banking and commerce Regulatory fragmentation 49 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Safety net Federal Reserve FDIC 50 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Safety net Federal Reserve -Lender of last resort - discount window -Open market operations FDIC - deposit insurance 51 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Safety net Federal Reserve -Lender of last resort - discount window -Open market operations FDIC - deposit insurance -Protects deposits -Can be abused by bankers 52 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Corporate separateness Can firewalls be created? 53 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Separation of banking and finance Long-standing tradition Assumptions about corporate separateness crucial 54 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Regulatory fragmentation One regulator Many, many regulators 55 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Proposals for regulatory reform occ Corrigan ABHC Heller ARCB FDIC Bank FSHC/ Double Organizational form BHC FSHC Repeal subs BHC umbrella Yes Yes Consolidated official supervision No No No No (Fed} (OCC} Permissible affilliates Financial Yes Yes Yes Yes Yes Yes Nonfinandal No (?} No Yes Yes Yes Corporate separateness No Yes Yes Yes Yes Yes ( 10 0% effective} 56 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Narrow bank proposal Seeks to correctly price safety net "Narrow bank" holds only government securities 57 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Problems with narrow bank Credit markets may be disrupted Benefits of financial holding companies may not be realized Not enough short-term government securities 58 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Problems with other proposals Do not price safety net Firewalls may be breached 59 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Chicago Fed proposal Bank capital Restrictions on bank activities Some consolidated oversight Firewalls Separation of banking and commerce 60 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Chicago Fed proposal Bank capital Restrictions on bank activities Some consolidated oversight Firewalls Separation of banking and commerce 61 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Market capitalization percent of assets 9 8 7 Banks with less than 6 $1 0 bil. in assets 5 4 3 Banks with more than 2 $10 bil. in assets 1 0 1977 '78 '79 '80 '81 '82 '83 '84 '85 '86 62 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Improved capitalization Reduces unfair competitive advantage Reduces incentives to break through firewalls Increases depositor protection 63 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Size of bank capital cushion At least 8 percent Possibly higher 64 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Risked-based capital proposal Weight Cash and equivalents 0% U.S. Government and agency securities 30% State and municipal securities, commercial letters of credit, and standby letters of credit backing SCM securities 60% All assets found in a typical loan portfolio and other standby letters of credit 100% 65 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Chicago Fed proposal - Bank capital Restrictions on bank activities Some consolidated oversight Firewalls Separation of banking and commerce 66 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Chicago Fed proposal Bank capital Restrictions on bank activities Some consolidated oversight Firewalls Separation of banking and commerce 67 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Chicago Fed proposal Bank capital Restrictions on bank activities Some consolidated oversight Firewalls Separation of banking and commerce 68 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Possible restrictions on bank holding companies Bank loans to affiliates Asset sales between banks and affiliates Liquidity or capital requirements Parent liability 69 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Chicago Fed proposal Bank capital Restrictions on bank activities Some consolidated oversight Firewalls Separation of banking and commerce 70 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Benefits of nonbank diversification Financial Nonfinancial Synergies obvious Synergies doubtful Increased competition Weak competitive effect Monitoring possible Monitoring difficult 71 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The changing financial structure Financial services industry and banks' role changing Regulation is partly responsible Time for regulatory reform 72 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Silas Keehn (1988, April 5). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19880406_silas_keehn

@misc{wtfs_regional_speeche_19880406_silas_keehn,
  author = {Silas Keehn},
  title = {Regional President Speech},
  year = {1988},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19880406_silas_keehn},
  note = {Retrieved via When the Fed Speaks corpus}
}