speeches · January 11, 1999
Speech
William Poole · President
The Structure of Our Changing Banking Industry:
Let the Market Decide
MissouriBankersAssociation
SeniorBankManagementConference
Acapulco,Mexico
January12,1999
The United States is now thoroughly Commercialbanks,asthemosttightlyregulated
committed to historic change in the ofallfinancialfirms,haveoftenfoundthemselves
regulation of its banking industry. In atacompetitivedisadvantageinanincreasingly
our nation’s 19th century vision for diverseandinnovativemarketplace.Itisnotsur-
the bankingindustry,reinforcedbylegislative prisingthatbankersoftenfeeloverregulatedand
changesin the 1930s, government regulation under-loved.
severely constrainedthegeographiclocationof Iagreethatbanksareoverregulated.Asfor
eachbank’s offices and the services it was per- bankersbeingunder-loved,wellIprobablycan’t
mitted to provide its customers. Each bank domuchaboutthat.Iamremindedofasummer
could maintain offices for accepting deposits in jobIhadduringgraduateschoolatabankin
only one state, andinsomestatesinonlyone Wilmington,Delaware,whereIgrewup.Oneof
county.Unitbanking states permitted each bank theguysIatelunchwithworkedintheautoloan
to maintain only one office. Banks could offer departmentandwasresponsibleforrepossessing
traditional banking services, including deposits cars.Hewanderedaroundneighborhoodsatnight
and loans, but little more.Insuranceservices lookingforthecarshehadtofind,andwithhis
werebanned,andsecuritiesunderwritingwas fistfulofkeyscoulddriverightoff.Hehadsome
severelylimited.Clearly, law and administrative frighteningtales,includingsomeofbeingshotat.
regulation have been critical in determining Perhapsaftermyspeechyoucangivemesome
banking structure in the United States. goodideasabouthowIcanpersuadethepublic
WhenItalkof“bankingstructure”Iintenda tolovethebankerwho’srepossessingitscars!
verybroaddefinitionofindustrycharacteristics, Actually,theproblemisprettysimple—you
includingthegeographicspreadofoffices,the bankersjustneedtolearnhowtolendmoney
financialproductsofferedandtheorganizational withouteverhavingtotryhardtocollectit!
formsofbankingenterprises.Itisnotanexaggera- Anyway,Idowanttodiscussmyviewson
tiontosaythathistoricallythebankingindustry whereweoughttobeheadedwithbankingregu-
hasbeenoneofthemostcomprehensivelyregu- lation.Asensiblediscussionrequiressomeback-
latedindustriesinthecountry.Financialservices, groundonhowwegottowhereweare,andwhat
however,areinherentlyaprettycompetitivebusi- regulationsoughttoremain.That’smyfirstmajor
ness:Manydifferenttypesoffinancialfirms,and theme.
thepublicsecuritiesmarkets,offeroverlapping Mysecondmajorthemeconcernstheprobable
products,andmanyoftheoverlapsaresoclose futureenvironmentforcommunitybanks.My
thattheproductsarefunctionallyidenticalor punchlineissimple:Ibelievethatcommunity
nearlyso.Especiallyoverthelastquartercentury, bankswillcontinuetoplayanimportantrolein
themarketshavebeenderegulatingthemselves. theU.S.economy.Ican’tofferaguarantee,butI
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FINANCIALMARKETS
canoffermybestguessthatlargebanksandcom- outthenationandlendthesefundsinfinancial
munitybankswillcompetesidebysideinmany centers.Localbusinesses,sotheargumentwent,
markets,andthatcommunitybankswillbeevery wouldbestarvedofthecredittheyneededto
bitasprofitableaslargebanks.Isimplycannot prosper.Peopleincommunitiesthroughoutthe
believethatcommunitybanksareadyingbreed nationviewedbranchingbylargebankingorgan-
whenMissourigranted15newbankcharters izationsasathreattotheeconomichealthof
overthelastthreeyears. theirlocaleconomies.Anobjectiveofgovernment
BeforeIgetanyfurtheralong,letmeempha- regulationofbankstructurewastocreateabank-
sizethattheviewsIexpressherearemyown; ingindustrycomposedlargelyofsmallbanks
theseregulatoryissuesarecomplicatedandcon- thatwouldlendtosmallbusinesseslocatedin
troversial,andIamnottheonetoannounceoffi- theircommunities.
cialpoliciesoftheFederalReserveSystem.What Thegovernmentalsoattemptedtomakebanks
Iwilldoispresentmyviewsontrendsinbanking safebyrestrictingcompetitionamongbanks.
anddesirablechangesinregulationthatwould Governmentrestrictedentryintobankinginthe
givemarketforcesgreaterfreedomtoshapethe early1930sinanefforttolimitthenumberof
industry. bankfailures.Underthispolicy,government
agenciesoftendeniedapplicationsforcharters
becausenewbanksmighthaveadverseeffects
THE 19TH CENTURY REGULATORY ontheprofitsofexistingbankslocatedintheir
samecommunities,underminingtheirviability.
VISION
Thegovernmentalsoattemptedtorestrictcom-
The19thcenturyvisionforbankingwasbased petitionamongbanksthroughceilinginterest
onsomebasicideasabouttheroleofbanksin ratesondeposits,includingaceilingrateofzero
societyandtheconditionsnecessaryformaintain- ondemanddeposits.
ingasafeandsoundbankingsystem.Experience, Governmenthaslimitedtheservicesoffered
particularlythetraumaofbankingpanicsand bybanksandthetypesoffirmswithwhichbanks
failuresinthe1930sandtheGreatDepression, affiliatedtolimitthepossibilitythatlosseson
alsoshapedbankingregulation.Manyoftheideas loansandinvestmentswouldcausebankstofail.
thatsupportedthis19thcenturyvisionhavebeen Forinstance,reducingtheriskofbankfailurewas
discredited,andmuchofthesepriorregulatory oneoftheobjectivesofthefederalgovernmentin
arrangementshasbeenabandoned.Butwestill separatinginvestmentandcommercialbanking
havemoreregulatoryheritage—regulatorybag- inthe1930s.
gage,Ithink—thanweneed. Theroleofthegovernmentinregulatingthe
Oneobjectiveofgovernmentpolicyonbank- bankingindustryinthepastreflectsthepolicy-
ingstructurehasbeentolimitthepoweroflarge makers’understandingofbanking,andthebalance
financialinstitutions.Throughoutthehistoryof ofpoliticalforcesinourfederalandstatelegisla-
theUnitedStates,governmentpolicyhasbeen tures,atthetimeregulationswereimposed.How-
shapedbyafearthatlargefinancialinstitutions ever,itisimportanttorecognizethattremendous
wouldexerciseexcessiveeconomicandpolitical intellectualdevelopmentintheunderstandingof
power.Publicpolicylimitedthegrowthofbanks bankinghastakenplaceinrecentdecades.Astute
throughrestrictionsonentry,branchingand observers,bothacademicsandpractitioners,
mergers. believethatmanyofthepropositionsjustifying
Anotherobjectivehasbeentopromotelend- regulationhistoricallyarefalse.Considerthe
ingtosmallbusinesses.Ourbankingregulations restrictionsthegovernmentimposedonbank
reflectaconcernthatifmarketforcesdetermined competitioninthe1930s.Economiststodaygen-
bankingstructure,largebankingorganizations erallyagreethatthelargenumberofbankfailures
wouldattractdepositsatofficeslocatedthrough- inthe1930sdidnotresultfromexcessivecom-
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TheStructureofOurChangingBankingIndustry:LettheMarketDecide
petition.Researchhasunderminedtheviewthat cialservices?Todiscusstheseissues,wemust
restrictionsoncompetitionarenecessarytopre- considerbankregulationasawhole,ratherthan
servethestabilityofthebankingindustry.Inaddi- focusseparatelyonthepartsimplementedby
tion,researchhasnotsupportedtheargument theFederalReserveorotherbankregulatory
thatthesecuritiesunderwritingactivitiesof authorities.
bankingorganizationscausedbankfailuresand Idonothaveadetailedblueprintforthe
theGreatDepression. futureoraspecificproposaltopromote.Idohave
Governmentregulationofbankingstructure somebasicprinciplesthatshapemythinking
hasbeenrelaxedsubstantiallysinceWorldWarII. abouttheseissues,however,andtheseprinciples
Nevertheless,therecentfederallawthatmandated leadmetosomeconclusions.
nationwideinterstatebankinghassomefeatures Thefirstprincipleisthatthegovernment
thatreflectthehistoryofpublicpolicyinshaping continuestohaveacompellingreasontosupport
bankingstructure.Thislegislation,enactedin bankingserviceswithdepositinsuranceandother
1994,requiresbankingorganizationswithoffices elementsofthefinancialsafetynet.Thisprinciple
inmorethanonestatetomeetstandardsforlend- isbasedonthefactthatbanksservetwoimportant
ingfundsinthestateswheretheyattractdeposits. purposesinoureconomy:Theyprovidecreditto
Thisprovisionreflectsafearthatlargebranch borrowerswhodonothavedirectaccesstocredit
bankswillstarvesmallbusinessesofcreditby inthesecuritiesmarketsand,evenmoreimpor-
usingdepositsreceivedthroughtheirbranchesto tantly,theyprocesspaymentordersfortheir
lendinfinancialcenters.Inaddition,thislegis- depositors.Experienceindicatesthatmajordis-
lationsetslimitsonthesharesofbankingdeposits ruptionsintheselendingandpaymentsfunctions
causedisruptionsineconomicactivity.
thatcanbecontrolledbyanyoneorganizationin
Thesecondprincipleisthat,whilemaintain-
astateandinthenation.Theselimitsreflectthe
ingdepositinsuranceandthefinancialsafetynet
fearofaconcentrationoffinancialpower.Thus,
forbanks,weshouldrelyonmarketforcesrather
ideasthatshapedour19thcenturyvisionofbank
thanregulationasmuchaspossibletoshapethe
regulationcontinuetoshapebankinglegislation
structureofthebankingindustry.Attemptsto
today.
preservetherolesofparticulartypesofbanks,
likecommunitybanks,throughregulationwould
notbeinthepublicinterest.Suchregulations
THE NEW VISION
wouldinterferewiththepublic’sabilitytofreely
Ifwehaveabandonedthe19thcenturyvision chooseitsprovidersoffinancialservices,andin
ofbanking,ifnotallitsresidue,wherearewe ourhighlycompetitiveeconomy,wouldeventu-
headed?Whatisthenewvisionfortheroleof allybeself-defeatingforbanksthemselves.
banksinsociety?Doesthegovernmentcontinue WhydoIsay“self-defeating?”Considerthe
tohavecompellingreasonstosupportbanking exampleoftheprohibitionofinterestondemand
serviceswithdepositinsuranceandotherele- depositsandRegulationQinterestrateceilings.
mentsofthefinancialsafetynetforthebanking Bankerswelcomedtheseregulationswhenthey
industry?Willtheencroachmentofnonbanking wereintroducedinthe1930s,becauseinterest-
firmsintotheactivitiesofbankscontinueuntil rateconstraintshelddownthecostoffundsto
thereisnocleardistinctionbetweenbanksand banks.ButwhenReg.Qceilingswereextended
otherprovidersoffinancialservices?Docommu- tothriftsinthe1960s,ceilingratesweresethigher
nitybankshaveanimportantroleinthefinancial forthriftsthanforbanks,leavingbanksatacom-
systeminthefuture?Ifwewanttopreservean petitivedisadvantage.Andinthe1970s,both
importantroleforcommunitybanks,doweneed banksandthriftswereatadisadvantagerelative
toestablishnewbarrierstocompetitionfrom tomoneymarketmutualfunds,whichcouldoffer
largerbanksandfromotherprovidersoffinan- ratesoncheckableaccountswithoutregulatory
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constraint.Inarapidlychangingmarketplace, developmentofoursystemofbanksupervision
RegulationQbecamearegulatoryalbatrossinstead andregulationandthesafetynetinthefirstplace.
ofaregulatoryprotectionforbanks. Ibelievethatwecanavoideitherofthese
Thebiggestchallengeinreconcilingthe undesirableoutcomesbymaintaininggovernment
safetynetforbankingservicesandmarketforces supervisionandregulationandthesafetynetfor
involvesthepowersofbanksandtheencroach- banks,whilegivingmarketforcesagreaterrole
mentofnonbankprovidersoffinancialservices inshapingthestructureofthebankingindustry.
ontheturfofbanks.Onewaythegovernment Ifgovernmentpoliciesareconsistentwiththe
mightrespondtothisencroachmentwouldbeto basicobjectiveofmaintainingfinancialstability,
extendbanksupervision,regulationandthe wecanrelyonmarketforcestoshapethestruc-
financialsafetynettothesenonbankfirms.If tureofthebankingindustryinawaythatiseffi-
lendingandtheoperationofthepaymentssys- cientandsociallydesirable.Thetopicthat
temareimportantinmaintainingastableecon- requiresthegreatestthoughtisregulationof
omy,whylimitsupervisionandregulationand bankpowersandtheaffiliationofbankswith
thesafetynettobanks?Whynottreatallfirms nonbankfirms.Isuspectthatwewillbeliving
thatlendorprovideanypaymentsservicesas withuneasycompromisesonthismatterfora
banks? longtime.Quitefrankly,ifIhadabrilliantsolu-
Althoughthereisacertainlogictothecall tion,I’dlovetoofferit.ButIdon’t.
forextendinggovernmentregulationoverall
financialfirms,Iamconvincedthatdoingso
wouldbehighlyundesirableforseveralreasons. THE SHAPE OF OUR FUTURE
First,thegovernment’scommitmenttosupport
BANKING STRUCTURE
thebankingsystemthroughdepositinsurance
wouldbeextendedtoalargershareoftheprivate I’llnowturntosomeremarksonthelikely
sector,andthegovernmentwouldexpanditsrole directionofbankingmarketsinthefuture.Ido
assupervisorandregulator.Governmentguaran- notbelievethatcommunitybankswillneedspe-
teeswouldbecomevastlylargerthantheyare cialprotectioninordertothrive.Experienceindi-
today,aswouldtheriskstothetaxpayer.Second, catesthatcommunitybankscananddooperate
giventheintimateconnectionsbetweenfinancial successfullyinthesamegeographicmarkets,and
andnonfinancialactivitiesinourenterprisesys- inmanyofthesameproductmarkets,asmuch
tem,wewouldrisknever-endingextensionsof largerbankingorganizations.Communitybanks
governmentcontrolfarbeyondfinancialactivi- havesomeimportantadvantages,includingoppor-
tiesperse. tunitiesfortheircustomerstohavepersonalrela-
Anotherapproachtoreformingbankregula- tionshipswithtopdecision-makers,andability
tionwouldinvolvenarrowingthesafetynetby tocompetewithoutthechallengeofcoordinating
placinggreaterrestrictionsonthetypesofservices theactivitiesoflargenumbersofemployees.
thatbanksmayoffer,andtighterrestrictionson Whilewedonotyethaveacompleteblue-
theriskthatbanksmayassume.Thisapproach, printforanewvisionforbankingregulation,
Iamconvinced,isnotaviableoptionoverthe andthereforedonothaveafirmideaabouthow
longrunbecauseofcompetitionfromnonbank regulationwillshapethefutureofbanking,we
firms.Bankssubjecttocontinuingtightgovern- cangainsomevaluableinsightintotheforces
mentregulationwouldlosetheirshareofthe thatshapethebankingindustrybyexamining
businesstononbankcompetitors.Intime,the howregulationandmarketforcesshapedthe
mostimportantlendersandprovidersofpayments bankingindustryinthepast.Ifwegobacktothe
serviceswouldoperatebeyondthejurisdiction periodbefore1980,thebankingindustryofmany
ofgovernmentsupervisors,leavingtheeconomy statesconsistedofmanysmallbanks,eachwith
vulnerabletothetypesofshocksthatledtothe oneoratmostafewoffices.Therewereafew
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TheStructureofOurChangingBankingIndustry:LettheMarketDecide
relativelylargebanks,thoughtheywouldnotbe haveclosertiestotheircommunities,yielding
consideredlargebytoday’sstandards. advantagesinassessingcreditrisk.Ofcourse,only
Althoughregulationshavebeenamajorforce largebankswithlargeamountsofcapitalcan
shapingthestructureofthebankingindustry, makethelargeloansrequiredbysomeborrowers,
theyhavenotbeenuniformacrossstatesorover butthatfactdoesnotmeanthathugebankswill
time,andwecanusethatfacttoprovideinsight bemoreefficientthansmallbanksinmakinglarge
intotheindustrystructurethatwillemergeas numbersofindividuallysmallloans.
marketforcesplayanincreasinglygreaterrolein Allowingmarketforcestoshapethebanking
shapingthebankingindustry. industrywillnotbetheendofthecommunity
Missouri,historicallyaunit-bankingstate, bank.Thisexaminationofbankingstructurein
hadatotalof497bankingorganizationsin1980, thepastindicates,liftingconstraintsontheoper-
andthefivelargestaccountedfor45percentof ationofmarketforcesleadstotheemergenceof
assets.Butinabankingindustryshapedprimarily largebankingorganizationswithmanybranches
bymarketforces,wouldthelargebanksdriveall butdoesnoteliminatetherelativelysmallcom-
oftherelativelysmallbanksoutofbusiness?We munitybank.
knowthatalotofconsolidationwouldtakeplace;
italreadyhas.Theissueiswhetherallcommunity
bankswouldbeforcedtoconsolidate.Thebest A PROGRAM FOR LETTING
evidencewehaveonthisquestionistheexperi- MARKET FORCES SHAPE THE
enceinstatesthathavepermittedstatewide
BANKING INDUSTRY
branchingformanyyears.Considerfourofthe
statesthatpermittedstatewidebranchingpriorto Howwouldweimplementapolicyofletting
1980:twointheWest(CaliforniaandIdaho)and marketforcesshapethestructureofthebanking
twointheEast(MarylandandNorthCarolina). industry?Becauseoftheimportanceofentryinto
Theaverageshareofbankingassetsatthefive anindustryfordeterminingitsstructure,thebest
largestbankingorganizationsinthesestatesin placetobeginthisdiscussioniswiththegranting
ofcharters.Underdepositinsuranceandother
1980was74percent.Howmanybankingorgani-
elementsofthefinancialsafetynetforthebanking
zationsoperatedinthesestatesin1980?Hereare
industry,itisreasonableforthegovernmentto
thenumbers:
setstandardsforgrantingcharters.Thesestan-
• California 291
dardsincludechecksonthebackgroundsofbank
• Idaho 25 organizers,topreventgrantingcharterstocrimi-
• Maryland 87 nals.Thesestandardsalsorequireaminimum
levelofcapitalfornewbanks.Undermyapproach
• NorthCarolina 79
oflettingthemarketdecide,thesewouldbethe
Thesefiguresindicatethatmanycommunity onlystandardsforgrantingcharters.Allapplicants
banksoperatedinthesamemarketsasbankswith whoqualifywouldreceivecharters.
far-flungbranchsystems. Thegovernmentwouldpermitbankstoopen
Whydocommunitybanksdosowell?You branchesanywheretheywant.Governmentagen-
knowtheanswersbetterthanIdo.Somecus- cies,includingtheFed,wouldapprovebanking
tomersprefersmallbanksbecausetheyhave mergersandacquisitionsunlesstheyreduced
personalrelationshipswithtopdecision-makers competitionorthefinancialstrengthofthebanks
insuchbanks,whereasitwouldnotbepossible involvedinthemergersandacquisitions.Aslong
forthemtohaverelationshipswiththetopdeci- asneworganizationswererelativelyfreetoenter
sion-makersatlargerbanks.Relativelysmallbanks intobanking,mostmergerscouldbepermitted
maybemoreefficientthanlargerbanksindeliv- withoutconcernthatbankscouldgainmarket
eringsomeservices.Smallbanksarelikelyto powerthroughmergers.
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FINANCIALMARKETS
Finally,limitsonthepercentageofdeposits
inastateorinthenationheldwithanyonebank
areinconsistentwithlettingmarketforcesshape
bankingstructure.Wedonotneedtolimitthe
marketpowerofbanksthroughsuchregulations.
Competitionisamoreeffectivetoolforlimiting
suchpower.Anybankthatattemptedtoraise
interestratesonloans,raiseservicechargesor
reducetheinterestratesitpaysondepositswould
losebusinesstoitscompetitors.Iwouldeliminate
thelimitsonthepercentageofdepositsatany
onebankasunnecessaryandundesirablelimits
onthefreedomofmarketforcestoshapethebank-
ingindustry.Thisprogramforlettingthemarket
decidewouldnothaveadverseeffectsonthe
safetyandsoundnessofthebankingsystempro-
videdthatregulatorsenforceeffectivecapital
requirements,asisnecessarytosustainthedeposit
insurancesystem.
Mybottomlineissimple.Smallfirmsare
prosperingacrosstheentireU.S.industrialland-
scape.Inonlyahandfulofindustriesarelarge
firmsincreasingtheirmarketsharebecauseof
compellingeconomiesofscale.Bankingisno
differentinthisrespectfromthetypicalU.S.
industry.Althoughlargebanksaregrowingas
artificialbranchingandline-of-businessrestric-
tionsaresweptaway,smallbanksareprospering
whentheyarewellmanagedandwhentheyselect
thepropermarketniches.Abanker’slifeiscer-
tainlymoreintensethanitusedtobeintheold,
highlyregulateddays,buttherewardsforentre-
preneurialbankersandtheircustomersaretobe
celebratedratherthanbemoaned.Iforoneam
onlytoohappytobreakoutthechampagne!
ACKNOWLEDGMENT
IespeciallywanttothankAltonGilbertofthe
researchdepartmentoftheFederalReserveBank
ofSt.Louisforextensiveassistance.Anumberof
othercolleaguesprovidedveryhelpfulcomments.
6
Cite this document
APA
William Poole (1999, January 11). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19990112_poole
BibTeX
@misc{wtfs_speech_19990112_poole,
author = {William Poole},
title = {Speech},
year = {1999},
month = {Jan},
howpublished = {Speeches, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/speech_19990112_poole},
note = {Retrieved via When the Fed Speaks corpus}
}