The Transformation of the U.S. Banking Industry: What a Long, Strange Trip It's Been

This paper summarizes and quantifies past changes in the U.S. commercial banking industry and forecasts what the future may hold. It emphasizes regulatory changes and technical and financial innovations as the central driving forces behind transformation of the industry. Changes in the regulatory environment include the deregulation of deposit accounts, several major changes in capital requirements, reductions in reserve requirements, expansion of bank powers, and liberalization of geographic restrictions on intrastate and interstate banking. Important technical innovations that have affected the banking industry include the advances in information processing and telecommunications technologies that facilitate the low-cost, rapid transfer of information and funds that fuel modern financial markets. Innovations in applied finance include those that have allowed the securitization of many traditional bank assets and have expanded the scope and volume of financial derivative activity. Many of these regulatory, technical and financial changes have altered the way in which banks compete with each other, and have brought about substantial external competition to U.S. banking organizations from foreign banks and from nonbank financial intermediaries. To document and assess the effects of these forces, the authors examine the evolution over time of the balance sheets, off-balance sheet activities, and income statements of all insured U.S. commercial banks from 1979 through 1994. The authors believe the most novel aspect of their analysis derives from the estimation of the patterns of bank lending to borrowers of different sizes over time. A key question they examine is how the well-known reduction in bank commercial and industrial lending of the early 1990s affected different sizes of borrowers. They estimate a 34.8 percent real contraction in loans to borrowers with bank credit of less than $1 million during the first half of the 1990s, a substantial decline in lending to large borrowers, with lending to medium sized borrowers at nearly the same level before the 1990s. In looking at the future, the authors suggest that several thousand banking organizations are likely to disappear under nationwide banking, but that the remaining banks will still number in the thousands. They also predict further contraction in the extension of bank credit to small businesses, although not as large as reductions in the first half of the 1990s. They suggest that because of organizational diseconomies, it may be difficult for the larger organizations to invest profitably in relationship-based small business loans. The loss of share for small loans due to the consolidation of banking assets predicted by the model should be considered as an upper bound, because other banks or nonbank competitors will likely step in and reissue some of these loans. Nonetheless, many of the eliminated loans likely will not be reissued because they are negative NPV investments. The authors predict that these changes will occur within the first five years after the implementation of nationwide banking.