Commercial banking - 1991 U.S. Industrial Outlook

Commercial Banking

Competition will be the key word for the 1990s as financial institutions vie for superiority in the highly contested arena of commercial banking, investment banking, insurance, and real estate. This rivalry among competing industries will lead to improved and less expensive services for consumers, possibly including the much-heralded one-stop financial center.

Continued economic expansion, relatively stable interest rates, and low inflation contributed to the fundamental soundness of the U.S. banking system in 1990. However, as a result of the late stage of the business cycle, the soft real estate market, and the continuing international debt problems, commercial bank loans were expected to grow at a slower rate in 1990 than in 1989, from $2,197 billion to $2,329 billion, a 6 percent increase. Bank investments, which usually change in inverse proportion to the rate of loan growth, are expected to grow faster than in 1989, from $550 billion to $605 billion, an increase of 10 percent.

Profitability of Banks

The profitability of insured commercial banks declined in 1989 after having rebounded in 1988. Higher loan loss provisions by large banks with substantial loans to developing countries helped drive down the average return on assets, measured by net income as a percentage of average fully consolidated assets, to 0.51 percent in 1989. This compares with 0.84 percent in 1988. By contrast, banks with less than $300 million in assets increased their return on assets from 0.74 percent in 1988 to 0.88 percent in 1989.

The average return on equity, measured by net income as a percentage of average equity capital, also decreased for the industry as a whole, falling from 13.52 percent in 1988 to 7.94 percent in 1989. As with return on assets, banks with less than $300 million in assets experienced a different trend. Their return on equity increased from 8.89 percent in 1988 to 10.32 in 1989.

During the first half of 1990, profits of large banks continued to suffer as a depressed real estate market forced them to make additional loss provisions. Surveys by Federal Reserve Banks revealed that credit for real estate - and especially for commercial real estate - has been tightened. Credit also has been tightened for commercial and industrial loans to small- and medium-sized businesses.

Failures and Problem Banks

As a result of the poor quality of many loan portfolios, a record 206 banks failed in 1989. This drained the assets of the Bank Insurance Fund by $851 million, leaving it with $13.2 billion to back up nearly $1.9 trillion of insured deposits. As a result, the fund's reserves were equal to only 0.7 percent of insured deposits at the end of 1989, down from 0.8 percent a year earlier. In 1990 the fund was expected to have lost as much as $2 billion, which would lower its reserves to an estimated 0.55 percent of insured deposits. To make up for the losses, the Federal Deposit Insurance Corporation (FDIC) raised its premiums from 12 cents for every $100 of insured deposits in 1990 to 19.5 cents in 1991.

The number of bank failures, which has risen every year since 1984, was expected to be lower in 1990 than in the previous year.

The length of the FDIC's list of problem banks reflects the poor quality of many bank loans. However, the decline in problem banks that began a few years ago continued into 1989, when 1,110 banks made the list. This compares with 1,415 in 1988, 1,443 in 1987, and 1,484 in 1986.

INTERNATIONAL COMPETITIVENESS

The number of foreign bank offices in the United States grew steadily throughout the 1970s and 1980s, reaching 716 at the beginning of 1990 (Table 2). These offices include branches, agencies, subsidiaries, Edge Act and Agreement corporations, and New York State investment companies. Of the total, 361 are branches, 218 are agencies, 101 are subsidiaries more than 25 percent owned by foreign banks, 26 are Edge Act corporations, and 10 are investment companies. Nearly one-half of the offices are in New York, with most of the rest in California, Illinois, and Florida. Japan, Canada, the United Kingdom, and France 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 $738 billion in 1989. [Tabular Data Omitted]

Branches of foreign banks are full-service banking offices that compete directly with local banks and are subject to all local banking laws and regulations.

Agencies can make commercial and industrial loans and finance international transactions. But they cannot accept deposits or perform trust functions, and hence they are not subject to reserve requirements or loan limits.

A commercial bank subsidiary is 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 are 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 are state-chartered Edge Act corporations. All told, there were 110 Edge corporations with 47 branches at the end of 1989.

As the name implies, New York State investment companies are chartered in New York. They engage only in wholesale international commercial banking activities. Like agencies, the companies cannot accept deposits and they are limited to short- and medium-term lending.

In addition, there are so-called representative offices that handle no banking business but maintain contact with correspondent banks, monitor local business conditions, and serve as a contact point for clients.

Foreign Branches of U.S. Banks

Under the Federal Reserve Act, member banks must have Federal Reserve Board approval in most cases to establish foreign branches. In reviewing proposed foreign branches, the Board considers the requirements of the law, the condition of the bank, and the bank's experience in international business. In 1989, the Board approved 10 new foreign branches.

By the end of 1989, 133 member banks were operating 819 branches in foreign countries, a decline from the high of 916 at the end of 1985. Foreign branch assets grew considerably in the 1970s, reaching a peak of about $400 billion in 1983. Subsequently, foreign lending declined, falling to an estimated $264 billion in 1989.

Export Trading Companies

The Bank Export Services Act of 1982 amended the Bank Holding Company Act to permit bank holding companies or their subsidiaries to invest in export trading companies. The goal is to facilitate the export of U.S. goods and services. The Export Trading Company Act amendments of 1988 gave bank holding companies additional flexibility to engage in export trading company activities. Since 1982 the Federal Reserve Board has given 47 bank holding companies the go-ahead to establish export trading companies.

International Banking Facilities

To facilitate international banking and trade, in 1981 the Federal Reserve Board permitted International Banking Facilities (IBFs) to be established in the United States. An IBF is essentially a set of asset and liability accounts that is segregated from other accounts. Deposits from and credit extended to foreign residents or other IBFs can be booked at these facilities free from domestic reserve requirements and interest rate limits. IBFs may be established by U.S. depository institutions, Edge and Agreement corporations, and by U.S. branches and agencies of foreign banks. By the end of 1989, 533 IBFs had been established. For a full discussion of the Edge and Agreement Corporation, see Chapter 52 (Commercial Banking) in the 1990 edition of the U.S. Industrial Outlook.

Outlook for 1991

Following eight years of uninterrupted expansion, the U.S. economy will enter 1991 in fairly good shape, with monetary authorities striving to maintain a sustainable level of economic growth and with a wary eye on prices and the twin deficits of the Federal budget and the balance of payments. The mix between bank loans and investments will depend on how the economy performs, the stability of interest rates, and the Government's fiscal and monetary policies.

Long-Term Prospects

Technological Developments

Although still a small part of the total payment system, electronic funds transfer (EFT) is continuing its slow but steady growth as consumers make increasing use of automated teller machines. ATMs are growing in number and popularity, especially ATM shared networks, which allow a cardholder of one institution of withdraw cash and make deposits at terminals of other institutions.

Also making significant strides are point-of-sale (POS) terminals that transfer funds from a buyer's to a seller's account. However, commercial banks, other depository institutions, and retail merchants still have to work out a number of problems to achieve uniform standards, lower costs to customers, and to ensure security.

Telephone bill paying and home banking, which seemed to show great promise a few years ago, have fallen far short of expectations. After an initial burst of enthusiasm, use of personal computers in the home failed to catch on in a big way. In addition, marketing and operating the services proved to be expensive, and some of the service providers experienced financial problems. Recently, more innovative telephone bill paying and home banking services have been introduced and, along with novel marketing approaches, the services may yet attain greater public acceptance.

National Treatment Study

As part of the effort to open foreign markets to U.S. financial institutions, the 1990 National Treatment Study, mandated by the Omnibus Trade and Competitiveness Act of 1988, is under way. At least every four years, the law requires the Secretary of the Treasury, in conjunction with the Secretary of State, the Board of Governors of the Federal Reserve Systems, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Department of Commerce to report to Congress on progress in reducing foreign barriers to U.S. financial institutions. Similar studies were conducted in 1979, 1984, and 1986.

Opening overseas markets to U.S. financial institutions is also the aim of a bill introduced in early 1990 by the chairman of the Senate Banking Committee. The Fair Trade in Financial Services Act of 1990 would give Federal regulators authority to deny applications from financial institutions in countries that discriminate against U.S. companies, and calls on the Treasury Secretary to seek fair treatment through negotiations. The Administration opposes the bill on the ground the U.S. policy is to encourage other countries to open and liberalize their markets rather than threaten to deny them access to the American market.

Nationwide Branching

To spur the growth and international competitiveness of U.S. banks, identical bills were introduced in mid-1990 in the House and Senate to allow full interstate banking and branching by 1994. The legislation would authorize the Federal Reserve to approve applications by bank holding companies to acquire out-of-state banks; permit interstate branch banking as of January 1, 1994 (but give individual states until December 31, 1993 the right to exempt themselves), and delay until January 1, 1993 renewed entry by banks into other states.

Banking and Securities Activities

Commercial banks have for years been trying to enter investment banking, initially through the discount brokerage business and more recently through the full-service brokerage business. Banking analysts predict that the industry will eventually dominate in retailing securities to individual investors because banks' costs are lower than those of many brokerage houses.

Banks are also trying to underwrite corporate debt, which is prohibited by the Glass-Steagall Act. The law, which dates to 1933, prohibits banks from affiliating with any entity that is engaged principally in the issue, flotation, underwriting, public sale, or distribution of stocks, bonds, debentures, notes or other securities. Of late, the Federal Reserve Board has approved certain new securities activities for subsidiaries of bank holding companies (BHCs), including underwriting and dealing in certain mortgage-backed securities, municipal revenue bonds, commercial paper, consumer-related securities, and corporate debt. To win Federal Reserve approval, however, BHCs are subject to substantial capital and operating restrictions. What is more, the subsidiaries can not be "principally engaged" in securities activities. Under this standard, a subsidiary can not derive more than 5 percent of its gross revenues from underwriting over any two-year period. Consequently, the securities activities of BHCs are still quite restricted.

In addition to the Federal Reserve Board, the Comptroller of the Currency and the FDIC have permitted commercial banks to expand into securities activities. And though a major banking bill is not expected to emerge before 1991, Congress eventually will have to repeal Glass-Steagall before events in the marketplace and piecemeal regulatory decisions make the law irrelevant. - Wray O. Candilis, (202) 377-0339, August 1990. [Tabular Data Omitted]

PHOTO : Figure 47-1 Failed and Problem Banks

PHOTO : Figure 47-2 International Banking Operations of U.S. Banks

Additional References

1990 U.S. Industrial Outlook, U.S. Department of Commerce. Available

from Superintendent of Documents, Government Printing Office,

Washington, DC 20402-9325. Telephone: (202) 783-3238. S/N003-009-00562-1,

$27. ABA Banking Journal, American Bankers Association, Washington, DC,

various issues. Telephone: (202) 620-7200. American Banker, New York, NY, various issues. Telephone: (212)

943-6700. Candilis, Wray O. (ed.), United States Service Industries Handbook,

Praeger, 1988. Telephone: (212) 685-5300. Annual Report 1989, Board of Governors of the Federal Reserve System,

Washington, DC, 1990. Telephone: (202) 452-3000. Braverman, Philip, The Weekly Credit Market Report, DKB Securities

Corporation, various issues. Telephone: (212) 488-0500. Manelski, Denis and Simon Nahnybida, "Electronic Dinosaurs," United

States Banker, January 1990. Telephone: (203) 869-3200. Duca, John V. and Mary M. McLaughlin, "Developments Affecting the

Profitability of Commercial Banks," Federal Reserve Bulletin, Board

of Governors of the Federal Reserve System, Washington DC, July

1990. Telephone: (202) 452-3000. Federal Reserve Bulletin, Board of Governors of the Federal Reserve

System, Washington, DC, various issues. Telephone (202) 452-3000. United States Banker, Kalo Communications, Inc., Greenwich, CT,

various issues. Telephone: (203) 869-3200.

COPYRIGHT 1991 U.S. Department of Commerce
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