Commercial banking - Industry Overview

Commercial Banks (SIC 602) rebounded vigorously from the difficulties they encountered in 1991. With the assistance of regulatory authorities, banks increased the availability of credit to respond to the economic upturn.

The economic slump in 1991, lower interest rates, and reduced inflationary pressures, induced corporations to eschew banks and to return to the stock and bond markets to fund their short-term liabilities. For that reason, aggregate commercial bank loans dropped from $2,309 million in 1990 to $2,284 billion in 1991. Bank investments jumped 16 percent, from $606 billion to $705 billion.

Following the 1991 cautious credit stance on the part of both lenders and borrowers, 1992 saw a slight rebound in loan demand in such areas as residential mortgages, home equity loans, and consumer lending. On the other hand, credit standards for commercial real estate loans continued to be tight while banks throughout the country maintained a wary attitude towards loans to underdeveloped countries, leveraged buyouts, and junk bonds. Consequently, as long as economic activity maintained its steady but slow upward trend, bank loans in 1992 were expected to fare a little better, rising a modest 2 percent from $2,284 billion in 1991 to $2,330 billion in 1992. Bank investments are expected to rise about 12 percent, going from $705 billion in 1991 to $790 billion in 1992.

Furthermore, the decrease in interest rates on savings accounts and certificates of deposit in 1991 and 1992 has had a dampening effect on the level of bank deposits. Bank deposits increased 1.2 percent in 1991, going from $2,363 billion in 1990 to $2,392 billion in 1991.

As banks tried to compete with other savings instruments and other financial institutions offering higher rates of return, bank deposits in 1992 were expected to show only a 3 percent increase, going from $2,392 billion in 1991 to $2,465 billion in 1992.

Competition from other financial institutions is pressuring banks to continue fighting the numerous regulations that restrict them from entering such areas as insurance and securities. Indeed, some larger banks have established subsidiaries that bank regulators allowed to compete to a limited extent in securities and insurance markets.

Profitability of Banks

As a result of declines in short-term interest rates and of gains in securities transactions, commercial bank profitability rates edged up slightly in 1991 but not enough to lift banks out of their 1989-1991 depressed profit picture (Table 1). Banks, however, improved their capital and liquidity position during the first half of 1992, eased credit standards, and are in a better position to respond effectively to a livelier rate of loan demand.

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The average return on assets, measured by net income as a percentage of average fully consolidated assets went from 0.49 percent in 1990 to 0.54 in 1991. The most progress was experienced by large banks, other than the 10 largest, their return on assets going from 0.28 to 0.58 percent. The 10 largest banks suffered the biggest decline, going from 0.47 to 0.21 percent.

The average return on equity, measured by net income as a percentage of average equity capital, also grew slightly for the industry as a whole, going from 8.02 percent in 1990 to 8.09 in 1991. As with the return on assets, the most progress was experienced by large banks, other than the 10 largest, their return on equity jumping from 5.82 percent to 9.40. The 10 largest banks suffered the biggest decline, falling from 10.11 percent to 4.26.

Failures and Problem Banks

The improvement in the financial health of commercial banks is also reflected by the number of failed banks in 1991 that dropped to 124, from 168 in 1990, and 206 in 1989 (Figure 45-1). The number of banks on the problem list of the Federal Deposit Insurance Corporation (FDIC), however, were slightly up, going from 1,046 in 1990 to 1,090 in 1991. This compares to 1,110 in 1989, 1,415 in 1988, 1,575 in 1987, and 1,484 in 1986.

As a consequence of these bank failures and the depletion of the Bank Insurance Fund, the FDIC increased the premium rates it charges banks from a flat 23 cents for each $100 of insured deposits to an average of 25.4 cents beginning January 1, 1993, with healthy banks continuing to pay 23 cents and weak ones as much as 31 cents. A report by the FDIC, required by Congress, predicts that the premiums will remain constant for at least four years before starting to decline. It also predicts that the Fund will show a deficit through 1999 then start edging up to the prescribed level by 2006. The prescribed level has been mandated by Congress and is 1.25 percent of insured deposits.

INTERNATIONAL ACTIVITIES

The number of foreign bank offices in the United States rose steadily throughout the past two decades, reaching 747 at the beginning of 1992 (Table 2).

Table 2: Foreign Bank Off ices in the United States
  (as of December 31, 1991)
Country           U.S. Offices
Japan             162
Canada             51
France             37
United Kingdom     36
Hong Kong          31
South Korea        29
Italy              26
Brazil             25
Israel             25
Germany            23
Netherlands        23
Spain              23
Switzerland        19
Venezuela          18
Australia          15
Mexico             14
Taiwan             14
Thailand           11
Indonesia          10
India               9
Ireland             9
Singapore           9
Philippines         8
Colombia            7
Pakistan            7
Other             106
Total             747
SOURCE: Board of Governors of the Federal Reserve System.

These offices include 385 branches, 231 agencies, 99 subsidiaries more than 25 percent owned by foreign banks, 19 Edge Act and Agreement Corporations, and 13 New York State Investment Companies. Nearly one-half of the offices are in New York, with most of the rest in California, Illinois, and Florida. Japan, Canada, France, and the United Kingdom have the largest number of bank offices in the United States. Assets of foreign bank offices in the United States have increased significantly in recent years, rising from $198 billion in 1980 to $864 billion in 1991 or approximately one-fourth of the total banking assets.

In contrast to foreign banks in the United States, US. banks abroad have been restructuring and consolidating their activities during the past several years. By the end of 1991, 123 Federal Reserve member banks were operating 794 branches in foreign countries and overseas areas of the United States, a decline from 916 branches at the end of 1985. Of the 123 banks, 92 were national banks operating 674 branches, and 31 were state banks operating the remaining 120 branches.

Technological Developments

Although still a small part of the total payments system, electronic funds transfer (EFT) is likely to play an increasingly important role during the decade of the 1990's. Currently, bank customer use of EFT is mainly concentrated on automated teller machines (ATMs), with the bulk of the payments system still consisting of cash, checks, and credit cards.

Meanwhile the growth of ATMs in the United States is slowing as a certain saturation point is being reached. On the contrary, purchases of ATMs in Japan and Europe are soaring, according to Retail Banking Research, a London-based consulting group. Specifically, ATMs installed in Japan reached 98,500 in 1991, compared to 83,500 in the United States and 82,000 in Europe.

In the years ahead, it is the debit card that will dominate since it can be used not only in conjunction with an ATM for the withdrawal of funds but also in conjunction with a point-of-sale (POS) terminal for the transfer of funds from a buyer's account to a seller's account (on-line transaction) or through an automated clearinghouse (off-line transaction). Supermarkets and the petroleum industry will be the easiest to convert to POS.

Further on the horizon is the smart card whose usage remains quite modest in the United States but has had enormous success in France and Japan. The smart card has a microprocessing chip inserted in it as opposed to the standard magnetic stripe on regular cards. The chip provides not only logic and memory but is more difficult to counterfeit, a formidable argument in view of the bank card industry's approximately $1 billion a year fraud problem.

During the early 1980's much was written about home banking and its likelihood of becoming a commonly used method of delivering financial services. Several attempts at home banking failed, however, because it was an expensive proposition both for the customers and the banks. But this time banks are offering less expensive equipment and a broader array of services. The equipment entails a telephone with a screen that can review account balances, open new accounts, move money from one account to another, and pay bills. As home banking becomes more popular it could develop into a broad information package that would include such nonbank matters as insurance, entertainment, travel as well as general news and sports scores.

Although spending for technological improvements in the 1990's is expected to be far less than a decade earlier, a survey conducted by the American Banker and Ernst & Young reveals that US. banks spent $14.1 billion on technology in 1991. Specifically the survey estimates that 1991 automation expenditures rose 2.3 percent compared to the 13 percent average annual spending growth in the 1980's. Of course, banks that are in a consolidation and downswing mode are spending far less than the average while banks that are in an acquisition mode are spending much more. For 1992 and 1993 the survey estimates expenditures on technology will remain modest, rising 2 to 3 percent annually.

Legislative Issues

Both the Administration and Congress in 1991 considered sweeping new proposals to modernize and strengthen the commercial banking industry. The proposals represented the most far-reaching restructuring of the industry since the 1930's and included abolishing restrictions related to interstate banking and investment banking.

The bill that would have reformed the US. banking industry, entitled Financial Institutions Safety and Consumer Choice Act (see 1992 US. Industrial Outlook) failed to garner the support needed and instead a much narrower bill entitled the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991, was passed in the final hours of the 1st Session of the 102nd Congress. This bill, which contains the Foreign Bank Supervision Enhancement Act of 1991, provided, among other things, for FDIC authority to borrow from the Treasury enough to bail out the Bank Insurance Fund, for instituting a number of reforms to the deposit insurance system, for restricting Federal Reserve ability to extend credit to undercapitalized banks, and for increasing the authority of the Federal Reserve Board to approve, terminate, supervise, and examine branches and agencies of foreign banks.

Mid-1992 saw two legislative proposals being considered by Congress, although there were serious doubts as to their immediate passage. The first of the bills was the result of repeated discussions between some of the largest regional banks on the one hand and insurance agent groups on the other. The former were pushing for interstate banking while the latter were arguing for restricted bank insurance activities as a price for ending their opposition to nationwide banking. To add to the difficulties of such a bill being passed, neither the banking nor the insurance factions in these discussions represented the views of the totality of their respective industries.

The second of the bills was an Administration effort to roll back some of the regulations incorporated in the FDICIA of 1991. Among other things, it would have repealed certain provisions that require regulators to establish specific operational standards on loan underwriting and executive compensation; accept bank examinations from state agencies regulators every year rather than every other year; allow regulators to skip a bank's annual examination if they have already examined 80 percent of its holding company's assets; simplify compliance with the Community Reinvestment Act; and delay the effective dates that some of the new regulations take effect.

Outlook for 1993

The economic upturn that began in 1991 will most probably sustain itself at least through 1993, giving the commercial banking industry the opportunity to satisfy the needs of both businesses and individuals. Monetary authorities will continue to keep an ever-vigilant eye on the Federal budget picture as they follow a cautious path to prevent conflicts between private and public borrowing, a buildup of inflationary pressures, and the stalling of the economic recovery.

Long-Term Prospects

There will be constant pressure on legislators and regulators alike in 1993 and beyond to address many of the problems afflicting the US. banking industry. The decade of the 1990's will see increased competition not only from other financial institutions both domestic and foreign, but also from nonfinancial corporations that are eager to enter the banking field. Competition will most likely take the form of innovation, such as new products and delivery systems; of securitization, such as converting assets into marketable certificates; and of internationalization, such as the elimination of geographic barriers. These challenges have always been the mainstay of the banking community and the result can only be the establishment of a more efficient, customer-oriented, and globally-attuned financial system.--Wray O. Candilis, Office of Service Industries, (202) 482-0339, September 1992.

Glossary

Types of Foreign Banks in U.S.

Branches of foreign banks--Full-service banking offices that compete directly with local banks and are subject to all local banking laws and regulations. Agencies-Agencies make commercial and industrial loans, and finance international transactions, but cannot accept deposits or perform trust functions; not subject to reserve requirements or loan limits. Commercial bank subsidiary--Any bank that is majority-owned or effectively controlled by a foreign bank. Unlike branches, which are administratively and legally integral parts of a foreign bank, subsidiaries are separate entities. Edge Act corporations--Banks chartered by the Federal Reserve to engage only in international banking and financing. They are allowed to have offices in more than one state. Agreement corporations--State-chartered Edge Act corporations. New York State Investment Companies--New York State charters only for wholesale international commercial banking activities. Like agencies, the companies cannot accept deposits and they are limited to short- and medium-term lending. Representative offices--These maintain contact with correspondent banks, monitor local business conditions, and serve as a contact point for clients, but handle no banking business.

Principal U.S. Banking Laws

McFadden Act of 1927--Prevents interstate deployment of bank branches and gives states authority to set branching standards for banks within their jurisdictions. Bank Holding Company Act of 1956-Known as the Douglas Amendment, this prohibits multibank holding companies and one-bank holding companies from acquiring a bank in another state, unless the law of the state in which the bank to be acquired is domiciled affirmatively provides for such entry. National Banking Act of 1933-Known as the Glass-Steagall Act, this bans affiliations between banks and securities firms, and generally prevents banks from engaging in the issue, flotation, underwriting, public sale, or distribution of stocks, bonds, debentures, notes, or other securities.

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Additional References

1992 U.S. Industrial Outlook, US. Department of Commerce. Available from Superintendent of Documents, Government Printing Office, Washington, DC 20402-9325. Telephone: (202) 783-3238. (S/N 003-003-00597-3, $32.) ABA Banking Journal, American Bankers Association, 1120 Connecticut Ave., NW, Washington, DC 20036. Telephone: (212) 620-7200. American Banker, (various issues), One State Street Plaza, New York, NY 10004. Telephone: (212) 943-6700. Annual Report 1989, Board of Governors of the Federal Reserve System, Washington, DC 20551. Telephone: (202) 452-3000. Braverman, Philip, The Weekly Credit Market Report, DKB Securities Corporation, One World Trade Center, Ste. 5047, New York, NY 10048. Telephone: (212) 488-0500. Brunner, Alan D., Hancock, Diana, and McLaughlin, Mary M., "Recent Developments Affecting the Profitability and Practices of Commercial Banks," Federal Reserve Bulletin, July 1992, Board of Governors of the Federal Reserve System, Washington, DC 20551. Telephone: (202) 452-3000. Federal Reserve Bulletin, (various issues), Board of Governors of the Federal Reserve System, Washington, DC 20551. Telephone: (202) 452-3000. Modernizing the Financial System: Recommendations for Safer More Competitive Banks, February 1991, U.S. Department of the Treasury, Washington, DC 20220. Telephone: (202) 566-2000. National Treatment Study 1990, U.S. Department of the Treasury, Washington, DC 20220. Telephone: (202) 566-2000. "Reform of the U.S. Banking System," Business Economics, July 1992, 28790 Chagrin Blvd., Cleveland, OH 44122. Telephone: (216) 464-7986. United States Banker, (various issues), Kalo Communications, Inc., 10 Valley Dr., Greenwich, CT 06831. Telephone: (203) 869-8200.

COPYRIGHT 1993 U.S. Department of Commerce
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