Nonbanks Don't Pull Their Weight
Bankers should be both sad and mad as they compare the reality of the industry's condition with the public's perception of it.
Judging by the complaints of lawmakers and activists, one would think that banks were still sitting on vaults full of cash that they are too stingy to use to help their communities, and especially the less fortunate.
Some of these complaints may have been justified in the days before deregulation, when banks had little competition for deposits or loan business and interest rate ceilings kept them from having to pay going rates on funds.
If you gave away services without covering costs through service charges, so what? You paid very little for deposits and made up the outflow that way.
Help from Inflation
Similarly, if you lent money at below-market rates or took excessive risks, cheap funds made up the difference. And if they didn't inflation would bail out bad loan decisions by raising the value of the real estate or other collateral on which the less circumspect loans were based.
Now all this is gone. Deregulation has made banks pay top dollar for deposits. Commercial paper issuance has drawn away a good portion of banks' business loans. Securitization of mortgages, credit card paper, and other consumer loans has brought new competition in lending to individuals and drastically narrowed spreads between costs of deposits and what banks can earn on loans.
The stark reality is that domestic banks now hold only about 25% of total private credit, versus 32% a decade ago and 36% in the early 1970s.
Quid Pro Quo
But the perception remains - the banks must do more for their communities because they have too much profit. We are bombarded with demands that merging banks pay a price for approval in more loans to lower-income people and that unprofitable offices continue to operate as usual, no matter what.
Those familiar with banking can only laugh (or maybe cry) when they see the mayor of Trenton, N.J., complain about the loss of a local thrift branch after an acquirer felt it could not afford to absorb the office's losses.
"Why should Trenton care so much? There are lots of other banks and thrifts in town," the mayor was asked.
His answer: "This was the only one with no service charges, low or no minimum balance required on deposit size, and low loan rates."
Cost of Remaining Open
Maybe there was a reason why the branch was losing so much money that it had to be closed. Would the mayor have complained as loudly if the branch had been maintained and charges and rates had been raised to the level of its competition?
And take the case of Professor Ross Cheit of Brown University, a member of the team that investigated the failure of Rhode Island's insurance fund for credit unions. He had kept his money in the Brown University credit union and thus was not able to touch his deposits from the beginning of 1991 until October. He said he put his money there because the credit union paid a much higher rate than the FDIC-insured banks and had no service charges.
"Now I know where they got the money to pay these high rates and avoid charges - from me," he told a conclave at the University of Providence.
But the real issue is this: Banks compete with money market funds, mortgage bankers, and securitizers of other credits. Yet only the banks are taken to task for not doing enough for their communities.
When has a money fund that took in millions from a community ever been asked to put something back?
When has a mortgage banker who packaged mortgages and sold them on the secondary market spotlighted as not doing enough to serve the community?
It is because the banks have high visibility that they have been made the focus of efforts to right the economic ills of our society.
Too Many Branches
What is ironic is that many banks would do far better with fewer offices. While consumer advocates cry that banks are not serving the community but are draining it of funds to lend elsewhere, many bankers feel that it is cheaper to buy funds in the open market than it is to run full-service branches in many locations.
Others may answer: "The banks get federal deposit insurance and in this way they can get cheap deposits. So they should pay for this through community service, low charges, and more lenient lending standards.
This is a hard issue to refute. And it is the reason why some friends of banking advocate a separation of deposits into insured and uninsured, with insured deposits invested far more cautiously than the uninsured, so that banks compete on an even keel with other lenders and deposit seekers in the uninsured realm.
But be this as it may, if we keep on demanding more and more from banks and let the other institutions off the hook, we will have even an further decline in the role of local banks and further growth of an impersonal financial structure in which our lenders will be known by their 800 numbers rather than their familiar faces in a local lobby.
Mr. Paul S. Nadler is a contributing editor of the American Banker and professor of finance at the Rutgers University Graduate School of Management.
