Consolidation is afoot in financial services. Only the informationally challenged could be oblivious to the mergers, alliances, and changing fortunes in the industry.
Travelers' proposed purchase of Salomon appears to have grabbed analysts' attention, both for the sheer size of the new firm and the cross- industry reach. Indeed, the joining of Travelers and Salomon speaks volumes about the future of financial services in general and banking in particular.
Simply put, markets are doing what legislation has failed to accomplish: creating universal financial services firms. Such firms unite banking, securities, and insurance in one business entity, thereby responding to competitive forces.
Travelers and Salomon, Morgan Stanley and Dean Witter, and NationsBank and Montgomery Securities have merged to better satisfy the demands of their customers.
Aided by technology, financial innovation continuously generates new products for retail and wholesale customers. One common feature of many of these products is that they are financial hybrids: a mixture of traditional banking, securities, and insurance. Consider the following:
Money market mutual fund. Ostensibly a security (hence not subject to banking regulation), it walks, talks, and quacks like a checking account.
Variable annuity sold by a bank. It combines security and insurance features in a bank-offered product.
Credit-enhanced security. A security and a banking product with insurance-like features.
Each product serves customers' needs, despite the difficulty of categorizing it. Customers are not interested in legal casuistry about whether a particular product falls into the category of "banking," "insurance," or "securities."
Customers just want to be able to procure such products inexpensively from reliable sources. Recently mergers are being crafted to create just such reliable providers.
Traditional banking, while remaining a profitable business, is not the growth part of the industry-at least not in developed countries.
Mergers wholly within commercial banking largely reflect attempts to benefit from economies in distribution. In that, banking consolidation has much in common with the consolidation that occurred in grocery stores decades ago.
To grow, banks and others increasingly must be able to cross-market financial products to their customers and to develop new hybrid products. As a practical matter, that means uniting securities, insurance, and banking under one roof in a universal financial services firm.
Among providers of financial services, however, banks are subject to a disproportional regulatory burden. The problem here is straightforward. Three kinds of producers are offering the same or similar products in the financial marketplace: banks, securities firms, and insurers. If one purveyor-banking-is subject to differential regulation, it will decline relative to the other two.
Differential regulation is a form of commercial euthanasia.
Two examples of differential regulation are illustrative. First, banks are restricted from affiliating with insurance companies. So banking and insurance cannot be efficiently joined within a banking organization. But banking and insurance can be merged outside the banking industry as, for instance, it will be in Travelers/Salomon.
That entity will be able to offer a full range of not only securities and insurance products, but also banking services in all but name. (Indeed, once Travelers' pending application for a thrift charter is approved, even that caveat will be eliminated.)
Second, banks are subject to a greater array of "consumer protection" laws and regulations than are other financial services providers. This is true even when banks are selling identical products-such as mutual funds.
Customers wanting to purchase a mutual fund from a banking affiliate must be virtually Mirandized first. Not so if they acquire a mutual fund from Merrill Lynch, Dean Witter, or Smith Barney.
Certainly a case can be made that some products ought not to be sold directly in an insured bank, but only through a subsidiary or affiliate. There is no compelling public policy reason, however, why a banking firm (including the banks' affiliates and subsidiaries) ought not to be able to offer any financial product. And similarly for securities and insurance firms.
The demise of financial modernization legislation presents an opportunity that should be grasped. Congress can adopt financial modernization as practiced in the marketplace by facilitating the production of hybrid products.
In HR 10, however, Congress focuses on categorizing products as "banking," "insurance," or "securities." That focus generates intractable turf battles and sterile debates over functional regulation.
To advance a charter that makes U.S. financial services firms globally competitive, Congress should recognize there is ultimately only one product: financial services. All providers should have a franchise to compete equally in offering all or any subset of that product, without regard to traditional distinctions.
That would be true modernization.
