Does traditional banking have a future?

From Mexico City to New York and Tokyo, bankers are rethinking what role, if any, their institutions will play. And it's not a minor question.

"Technology, deregulation, and competition have altered the banking industry to a remarkable degree, and few bankers have the luxury of simply continuing to do what they have always been doing," writes Serge Bellanger, executive vice president and general manager for Compagnie Financiere de CIC et de l' Union Europeene in New York.

"Banking has become an industry in which strategic questions are critical."

Unless banks adapt to and use rapidly expanding digital communications and electronic delivery systems, they may, as Chemical Banking Corp. chairman Walter Shipley observed recently, find themselves as obsolescent as railroads when cars and airplanes became the prime modes of transportation.

That means that everything from bricks and mortar branch banking to high finance has to be rethought.

"Banks seem to be losing their traditional franchise as new cash transmission systems are set up and the forces of disintermediation grow in both the retail and corporate sectors," observes Stephen Kingsley, a financial markets analyst with Arthur Anderson & Co. in London.

"So much change is ... sparked in large part by developments in technology, considerable reductions in cost and its use on a global basis," says Dennis Weatherstone, chairman of the board and chief executive of J.P.. Morgan & Co.

"It's clear to me that the management of technology and people, with the proper balance between them ... is the key to success in the change challenge."

Deregulation, too, has played its part. Banks, formerly barred from engaging in a host of financial activities, such as insurance, are now stepping into new markets they hope will compensate for a decline in their lending activities.

Reevaluating Role

As deposits move into more lucrative investments, such as mutual funds, and corporate customers turn increasingly to capital markets for their funding, and while nonbanks play a larger role in supplying credit, banks are rethinking what purpose they should serve.

"The role of traditional banking with its functions of deposit collection and the provision of credit is being revolutionized by technology both domestically and internationally," says Mr. Weatherstone.

"The links between banking credit and the capital and securities markets on a global basis have increased geometrically."

As technology takes hold, banks are also looking to pump up profits by squeezing costs out of their operations. "Lose control of expense and you lose control of your ability to compete," Mr. Weatherstone adds.

That could mean as little as replacing switchboard operators with automated answering services. Or, it could mean eliminating branches and replacing them with automated teller machines, merging separate back office operations into a single, consolidated unit or, merging with other banks.

"Surprising as it seems, I am often asked the question 'are banks relevant?'" notes Thomas Labrecque, chairman of Chase Manhattan Corp.

"The fact that people are asking the question indicates a sufficient degree of concern that I think the answer requires something beyond a flat 'yes.'"

Mr. Labrecque cites several

areas in which banks have made progress over the last few years: trading, risk management, operating services such as payments processing, cash management, and securities custody.

These, along with cost cutting and a positive yield curve, have helped banks in the United States post almost $43 billion in profits last year or 2.5 times what they earned in 1991.

Mr. Labrecque however adds that offsetting the improvement, in banks financial situations over the last two years has been a protracted decline of market shares held by banks in a variety of asset and deposit markets.

"The historical rationale for the existence of banks is eroding," Mr. Labrecque admits.

Losing Ground

The banker cites four main reasons for the erosion of banks' franchise:

* Nonbanks, with lower operating and capital costs, can offer financial services at a lower cost than banks.

* Declines in the cost of communications and information processing will give more people access to financial services even if there isn't a bank in their neighborhood.

* Growing securitization has induced banks to undertake to act more as a capital markets intermediary, making them less likely to lend directly and hold the loans.

* Many banks are not diversified enough to take advantage of new opportunities. This is particularly true of the United States.

Outside the United States, banks tend to have broader powers and can offset some of the decline in their traditional lending with other businesses.

Just how fast banks will lose their customers to capital markets and nonbanks in any one country depends to a great extent on how far the information revolution has advanced there.

Markets adequately supplied with information and networks capable of transmitting it are more likely to use capital markets, Mr. Labrecque predicts. In contrast, he adds, "information-poor societies" still rely relatively extensively on banks for their borrowing needs.

Bankers cite various obstacles preventing banks from adapting quickly.

One reason banks are coming under pressure, Mr. Labrecque notes, is because they have large existing branch networks that no longer serve the purpose for which they were conceived.

The other is restrictive regulation and, especially, capital requirements on banks that non-bank providers of financial services don't have.

Still, the debate on banking's future comes, paradoxically, as banks are finding more and more opportunities and room to expand internationally.

Economic growth in regions once closed to Western financial institutions, such as China, Vietnam and Eastern Europe, have created an insatiable demand for fresh credit.

Other regions, such as Southeast Asia, are registering double digit growth while deregulation in Latin America is opening up markets for U.S. and European banks in places like Mexico and Argentina.

"The market is growing and that's clearly a reflection of what's happening in the world economy," observes Mr. Labrecque.

Exports from Asian and Latin American countries are growing at 10% or more annually, points out Jacques de Larosiere, president of the European Bank for Reconstruction and Development. Meanwhile, direct investments into developing countries and Eastern Europe reached $56 billion last year, or one third of the worldwide total.

Rising opportunities in the developing world are prompting big Western and Japanese banks to embark on a new round of international expansion.

In Latin America, more than a dozen U.S. banks hope to set up banking subsidiaries in Mexico under the recently approved North American Free Trade Agreement.

Banks are also expanding into Asia and Africa. CoreStates, a Philadelphia based superregional bank, for example, has plans to open offices in Shanghai and Kuala Lumpur; Germany's Dresdner Bank has applied for banking licenses in Shenzhen and Guangdong in China, and will open a representative office in Vietnam.

Last year, Dresdner Bank opened an off-shore banking unit in Bangkok, a branch in Shanghai, and, received licenses for an off-shore branch in Malaysia and a representative office in Kuala Lumpur.

Meanwhile, Holland's ING Bank is adding outposts around the world from Havana to Moscow, while Citicorp is returning to South Africa and plans to open offices in Tanzania later this year.

Third World Expansion

Banks from developing countries, too, are spreading their wings. In London, for example, the number of foreign banks rose to more than 500 for the first time last year as banks from Russia the Czech Republic, Slovenia, China, and Thailand opened offices.

Economic development has also spurred the creation, modernization, and expansion of banks in formerly heavily controlled economies. In Russia alone, for example, more than 2,000 banks have been created since 1989.

Mexico, which has substantially deregulated its own financial markets, authorized 14 new banks, forcing established banks to streamline their own operations, cut costs, and focus on activities where they have a strategic advantage.

Big U.S. and European banks also are becoming more diversified. Demand from the most creditworthy borrowers is declining rapidly as better rated corporate customers turn to capital markets for funding.

This, in turn, has forced banks to extend operations into areas like fund management and the underwriting, distributing, and trading of securities.

"We don't put the business we do on the books any more," remarks Mr. Labrecque. "We underwrite, distribute it, securitize it."

Some banks, like J.P. Morgan & Co., have opted to concentrate on underwriting and trading. Others, like big French, Swiss, German, and British banks, have split operations between large, multipurpose retail financial Services companies at home and global capital markets and wholesale finance operations abroad.

"We may be very different from [U.S. banks] for historical reasons but we are very close to each other in the [international] market," says Hilmar Kopper, chairman of Germany's Deutsche Bank.

Deutsche's own priorities, he says, are to build its trading activities, corporate finance, and wholesale asset management internationally.

At home, Mr. Kopper says, its objective is quite simply "to be the biggest retail bank in my country."

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