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Deregulation, the Internet, and the competitive viability of large banks and community banks

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  • Robert DeYoung
  • William C. Hunter
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    Abstract

    Deregulation, technological change, and increased competitive rivalry are transforming U.S. commercial banking from an industry dominated by thousands of small, locally focused banks into an industry where a handful of large banks could potentially span the nation and control the majority of its bank deposits. This paper examines the comparative strengths and weaknesses of large and small banks in this new environment, and outlines the strategic opportunities and threats that new technology - especially the Internet - pose for U.S. banks. We begin by documenting recent trends in bank size, industry structure, competitive conditions, and bank product mix. We argue that these trends are consistent with a simple competitive strategy framework in which commercial banks choose between two profitable business strategies: (a) a community bank business model in which banks have a local focus, a high cost structure, and sell low volumes of personalized service at high margins, and (b) a global bank business model in which banks have a national or international focus, a low cost structure, and sell high volumes of standardized financial products at low margins. Finally, we discuss how Internet banking is likely to affect this strategic equilibrium. In particular, we analyze how a shift away from brick and mortar branches and toward the Internet delivery channel will reduce the switching costs that currently dissuade retail deposit customers from changing banks. Based on the foregoing analysis, we conclude that the number of small banks will continue to decline in the future - not because the community bank business model is flawed, but because most of the small banks that use this model are poorly run. In the long-run, our analysis suggests that well-run community banks should be able to adapt their business practices to technological change and profitably co-exist with large, globally focussed banks.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-01-11.

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    Date of creation: 2001
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    Handle: RePEc:fip:fedhwp:wp-01-11

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    Related research

    Keywords: Banks and banking ; Financial institutions;

    This paper has been announced in the following NEP Reports:

    References

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    6. Allen N. Berger & Robert De Young, 2001. "The effects of geographic expansion on bank efficiency," Finance and Economics Discussion Series 2001-03, Board of Governors of the Federal Reserve System (U.S.).
    7. Robert DeYoung, 2001. "Learning-by-doing, scale efficiencies, and financial performance at Internet-only banks," Working Paper Series WP-01-06, Federal Reserve Bank of Chicago.
    8. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon, 2000. "Recovering risky technologies using the almost ideal demand system: an application to U.S. banking," Working Papers 00-5, Federal Reserve Bank of Philadelphia.
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    Cited by:
    1. William Keeton, 2003. "The role of community banks in the U.S. economy," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 15-43.
    2. Dolar, Burak & Shughart II, William F., 2011. "Enforcement of the USA Patriot Act's anti-money laundering provisions: Have regulators followed a risk-based approach?," Global Finance Journal, Elsevier, vol. 22(1), pages 19-31.

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