Contrary to Opinion, Banks Aren't Fading

LAST May, economists John Boyd and Mark Gertler punctured a common myth about commercial banking: that it is a declining industry.

Banks, they said at a Federal Reserve Bank of Chicago conference, have not been losing market share in the United States to finance companies, investment firms, brokers, and other financial institutions. Rather, banks' share of total financial intermediation - that is, the taking in of deposits and making loans with that money - has been roughly stable over the last four decades. Banks perhaps suffered a slight loss of market share in the late 1980s and early '90s. But it was a transitory loss. Indeed, as their analysis implied, banks are now posting hefty profits and are eagerly seeking new loans and pushing investment services.

Alan Greenspan, chairman of the Federal Reserve, testified before Congress recently that bank examiners and surveys find that ``banks are competing more aggressively for loans, and they are relaxing their credit standards.''

``Lending margins in particular - and especially for medium and large corporate customers - have declined, and loan covenants and collateral requirements have eased,'' he said.

William McDonough, president of the Fed branch in New York, last month told a bank symposium: ``While it is natural in a growth cycle to observe a moderate shift away from the often-stringent credit standards instituted during a down cycle, it would be a mistake to let the pendulum swing too far.''

It was an earlier swing of the pendulum that partially raised the specter of a declining banking industry. Between 1985 and year-end 1990, more than 1,000 banks failed. They suffered record losses on loans to the third world, the real estate industry, farmers, and oil businesses. Moreover, nonbank credit alternatives - the finance companies, etc. - were growing rapidly.

``The banking industry is becoming irrelevant economically, and it's almost irrelevant politically,'' William Isaac, a former chairman of the Federal Deposit Insurance Corporation in Washington, now a consultant, was quoted as saying.

Economists Jane D'Arista and Tom Schlesinger, writing a paper on ``The Parallel Banking System,'' last year called commercial banking ``competitively disadvantaged.''

A simple measure of the share of commercial banks of total US financial intermediation backs up such views. Banks held 45 percent of the total in 1974 and only 34 percent in 1992.

But Mr. Boyd, from the Fed branch in Minneapolis, and Mr. Gertler, from New York University, found that what has really happened is that commercial banking has changed - not shrunk. Over the last 15 years, banks have increased the amount of business they do off the balance sheet, taking advantage of deregulation and financial innovation. They sell some of the loans they originate (such as mortgages and auto loans) to other financial institutions. They increasingly support loans by other institutions (such as those issuing commercial paper) with backup lines of credit and guarantees. Banks also increasingly share risk with their clients by providing, for a price, what are called ``derivatives.'' For example, a borrower may hedge against the financial risk of a loan with a variable interest rate by getting an interest rate ``swap'' from a bank.

Taking account of this off balance-sheet trend and of an increasing share of the US market held by foreign banks, Boyd and Gertler conclude in an article in the Minneapolis Fed's Quarterly Review that banks remain ``central'' to the nation's finances as providers of liquidity and credit to the economy.

During the late 1980s and early '90s, banks rebuilt their capital bases to meet the stricter financial requirements of the 1988 Basel Accord among major industrial nations. This process led banks to impose a ``credit squeeze,'' which some economists blame for the slow recovery from the 1990-'91 recession.

That period is past. Mr. Greenspan noted that US banks' capital now amounts to 7.8 percent of assets, the strongest in nearly 30 years. Banks are expected to report a third year of record profits in 1994. Their return on assets reached 1.23 percent in 1993, the highest level in decades. This year, a change in accounting rules has reduced the return on assets slightly.

Banks, in other words, are not dying; they are robust.

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