Deregulation, innovation, concentration. Add to that inflation, disintermediation, recession. It has been quite a year for the banking community, and next year may be worse.
Last March, the Depository Institute Deregulation and Monetary Control Act was passed, the most significant omnibus banking legislation in two-thirds of a century. The act's primary purpose was to equalize competition between different types of financial institutes: commercial and savings banks, savings and loan associations and credit unions. It was also intended to make banking more equitable for different classes of savers.
Its major deregulation provisions are: a six-year phase-out of interest rate ceilings on deposits, extension of checking-with-interest (or NOW -- for negotiable order of withdrawal -- accounts) nationwide, expanded asset powers for thrift institutions, a federal override of state usury laws, and simplification of the Truth-in-Lending law.
To oversee the act, Congress created the Depository Institutions Deregulation Committee (DIDC), composed of federal banking regulations. DIDC, to the dismay of many thrift institution executives, has interpreted its mandate as phasing out interest rate ceilings as rapidly as possible. At the same time, the "deregulations" have created a host of new regulations, some as minute as how many gifts a bank may give a depositor as incentives in a given period.
Bankers are being pushed -- sometimes kicking and screaming -- into 21st-Century banking. Savings and loans, for example, will no longer simply lend out as 30-year home mortgages the savings customers leave on deposit. They are expected to become "family financial centers."
Mortgages will have variable rates and/or be sold in the secondary market. Funds will come from such once-esoteric sources as Euro-borrowings and pass-through securities. S&Ls will maake auto loans and invest funds held in trust. Of course, these transformations, which will require costly expertise, won't happen overnight at most institutions.
The first critical test comes on Dec. 31 when banks and thrifts can begin offering NOW accounts. In their eagerness to draw new customers, some institutions may underprice their products, as happened in New England, where NOW accounts originated.
The cost of paying 5 1/4 percent interest on checking accounts can be partially offset by the economies of electronic banking, such as not returning checks. However, rising interest rates on savings accounts, as well as the cost of money, make the outlook for already troubled institutions downright sobering.
The Federal Home Loan Bank Board is predicting a significantly higher number of mergers in the near future and conversion of mutual associations to stock corporations as a means of raising extra capital.
The second main purpose of the act -- control of the money supply by the central bank -- was enacted to stop the hemorrhage of banks from the Federal Reserve System. Starting Nov. 1, all institutions offering checking-type accounts will be subject to uniform reserve requirements, although those with less than $1 million in assets, mainly credit unions, will get a six-month exemption. Since the uniform reserves will amount to less than before for Fed member banks, the cost of business for them will decline. It will conversely rise for present nonmembers, mainly smaller institutions.
Apart from regulatory changes, the economy is bound to have a significant effect on profits for the rest of the year.
Large commercial or money center banks enjoyed a whopping average 37 percent increase in profits during the second quarter of this year after a mere 4 percent rise in the first quarter, according to New York bank analyst Richard A. Leech of Keefe, Bruyette and Woods. The gains were a result of ample spreads (between loan and deposit interest rates) made possible when the prime rate lingered higher than normal following a plunge in interest rates. Extraordinary gains also were made in bond trading and foreign exchange.
With interest rates once again on the rise, some analysts feel that earnings will be weaker for the rest of the year, even though banks now seem to be raising the prime rate faster than demand would dictate to preserve good spreads. Also, the rollover this fall of certificates of deposit purchased at 16 percent last spring will reduce banks' cost of funds somewhat.
Lawrence R. Fuller of Drexel Burnham Lamber is buoyant about earnings. He says all money center banks should show gains of 10 percent to 15 percent during the third quarter and perhaps 15 to 20 percent during the fourth quarter. Smaller banks, however, may not do as well.
The outlook for mutual savings banks is not optimistic. In 1979 they had deposit outflows of $6.9 billion, the worst year since records have been kept, according to Jack Rubinson of the National Association of Mutual Savings Banks. During the first six months of 1980, the outflow amounted to $3.3 billion, although small gains were registered in July and early August. During the second quarter, net income as a percentage of assets -- a measure of earnings -- was negotative (minus 0.11 percent) for the first time since the fourth quarter of 1959.
Average return of assets during the first half was minus 0.04 percent, compared with a positive 0.3 percent a year earlier.
After suffering disintermediation for so many months as customers withdrew funds to place them in higher-yielding investments elsewhere, savings banks recently have experienced an increase in passbook savings. Depositors are parking their money to wait for higher interest rates or wait out the recession; sales of 30-month certificates also have risen. But the recovery has been "moderate and disappointing," said Rubinson.
Federal Home Loan Board Chairman Jay Janis expects that total net new savings for 1980 will be about $8 billion, compared with $15 billion last year. sYet the figures for the first eight months make Janis' prediction seem optimistic. Net new savings amounted to just $4.2 billion, down 70 percent from 1979, according to the U.S. League of Savings Associations.
The bank board reports that net income during the past year dropped nearly three-quarters, from 0.65 percent return on assets to 0.17 percent in the first half of 1980. The second quarter was the worst in history, with 2,000 out of 4,700 savings institutions running in the red, according to Jonathan Gray, an analyst with Sanford C. Bernstein. He predicts that fourth-quarter earnings for savings and loans will equal those of the first quarter, that is, they will offer 30 to 40 percent from the same period in 1979. He expects the average return on assets in 1980 to equal 20 or 30 cents per $100 after taxes, compared with 70 cents in 1979.
As for loan activity, it will amount to $60 million, down from $108 billion, last year, or 7.75 percent of outstanding loans, compared with 13.5 percent.
Competition for market share will be more cutthroat then ever in the 1980s. While the Depository Institutions Deregulation and Monetary Control Act makes the relationships among blacks, thrifts and credit unions nearly equal and competitive, it does not address the growing problem of nondepository competitors in the financial services business.
These "near-banks" include money market mutual funds brokerage houses and even retail stores. They offer directly, or through subsidiaries, a form of checking account, savings account, personal loans, mortgage loans, mortgage insurance, credit cards and investment banking services. Their names -- Merrill Lynch, E. F. Hutton, American Express, Seares Roebuck, J. C. Penney -- get instant recognition nationwide. Merrill Lynch, for example, generates two-thirds of its profits from interest, rather than brokerage commissions. Citabank Chairman Walter Wriston has called Merrill Lynch his toughest competitor.
And yet the near-banks are not subject to the same federal banking regulations or reserves that real banks and thrifts are. The real banks claim they are at a disadvantage vis-a-vis near-banks when they have to compete for funds in capital markets. Moreover, the Fed does not regulate the near-banks and so does not have control over a growing part of the money supply.
The choice is whether to try to control these de facto banks -- the Fed temporarily put reserve requirements on money market funds last spring, but removed them before the industry had a chance to test that authority in court -- or whether to deregulate banking institutions further to allow them to compete more effectively. Given the deregulation fever sweeping Washington, the latter course seems more likely.
The next big banking battle will be over branching. Since the McFadden Act was passed in 1927, and the Douglas Amendment to the Bank Holding Company Act was added in 1964, banks and their holding companies have been prohibited from establishing branches across state lines. Recently the Carter administration indicated it favors rescinding the ban on holding companies and permitting them to establish full-service branches on a regional basis.
The idea is to foster competition with other banking and non-banking institutions. However, it is most unlikely branching legislation will be considered by Congress before next year.
In the year since Congress revised the 61-year-old Edge Act, making it easier for U.S. banks to establish offices outside their home states to do international banking, ther has been a surge of applications for new offices. For example, Bank of America, through its subsidiary Bank America International, plans to establish Edge offices in Seattle, Dallas, Minneapolis and Cleveland before year's end and to open branches in St. Louis, Atlanta and Boston next year. These are in addition to its headquarters in San Francisco and existing Edge offices in Houston, Chicago, Miami, New York and Nassau.
Citibank InterAmerica is planning to nearly double its Edge offices to 11. Others that have applied to the Fed to convert or establish such offices include Manufacturers Hanover Trust, Continental Illinois, First National Bank of Chicago and Security Pacific.
Bank of America, already the country's largest, makes no secret of its aim to have a nationwide network in place when interstate branching is permitted. Officers now limited to handling international banking transactions with foreign and U.S. customers can be swiftly transformed into full-service branches once the law is changed.
The trend forshadows the possibility of a banking system one day dominated by a select number of large institutions at the expense of smaller banks, much of the way Visa and Master-Card supplanted many local charge cards. Another scenario foresees the growth of super-regional banks while the money center banks seek to imitate the financial services of nonbanking financial institutions.
Bank of America also admits this expansion will enable it to compete more equally with foreign banks. Five of the 14 banks that have applied to the Federal Reserve to establish Edge officers are foreign. Overseas banks were prohibited from doing so before the recent revision of banking laws.
Among other things, the International Banking Act of 1978 aimed at equalizing the treatment of domestic and foreign banks. However, it left the latter with the distinct advantage of being able to establish multistate operations, still prohibited for American banks by the McFadden Act. By so doing, overseas banks are able to acquire U.S. banks that other domestic banks cannot. This week the Fed sent Congress a request for more authority over Edge Act corporations and foreign banking organizations.
Another form of competition may eventually be permitted. The Fed is expected to consider this fall a proposal to allow U.S. banks to set up international banking facilities in a New York "free zone." There domestic banks could do business with non-residents without being subject to reserve requirements and interest-rate ceilings, thus allowing them to compete with other nonregulated banking centers overseas.
During the 1970s, overseas banks or holding companies, bought 34 U.S. banks while foreign individuals bought another 59, according to a study by the General Accounting Office. In addition, there have been several more this year, including the takeover of Crocker National Bank, the country's 14th-biggest, by Midland Bank Ltd. of London and that of Financial General Bankshares by a group of Mideast investors backed by the Bank of Credit and Commerce International operating out of London. That raises foreign control to 15 percent of U.S. banking assets.