As its title suggests, "Commercial Banking Structure, Regulation, and Performance: An International Comparison," an economics working paper from the Office of the Comptroller of the Currency (OCC) describes the banking structure, permissible banking activities, regulatory structure, deposit insurance schemes, and supervisory practices in the 15 European Union countries, Canada, Japan, Switzerland, and the United States. It also suggests that the more inclusive practices of countries other than the United States have no effect on performance.

Part of the inspiration for the empirical part of the study, which examines the relationship between regulation and performance, was a statement made by Federal Reserve Bank of Cleveland President Jerry L. Jordan: "Banking companies should not be required to get permission from regulators before doing something new. Rather, they should notify authorities of their intentions. If regulators want to prevent the action, the burden should be on them to intervene in a timely way to demonstrate that the costs exceed the benefits."

Says co-author James R. Barth, Lowder Eminent scholar in Finance, College of Business at Auburn University: "We wanted to say, 'Now, look. You may not be persuaded that the U.S. is out of line with other countries and that we should grant our banks broader powers. But we did empirical work to see if that affected performance negatively and we couldn't find any evidence of it.'"

no lapse in performance found

The empirical analysis found no evidence that unrestricted securities, insurance, and real estate activities affect bank performance positively or negatively. However, the report concludes that the joint significance of the securities and insurance variables provides weak support for the "industry" claim that allowing banks a broader range of permissible activities might lead to improved performance.

Overall, while neither the "industry" nor the "overreaching" positions receives much support from the analysis, the results are consistent with what may be called a third viewpoint on permissible banking powers. That "marketplace" view holds that broader activities for banks assure neither improved nor diminished performance. This position is consistent with a public policy stance advocating reduced bank restrictions, thus allowing bank performance to be determined more by market forces and less by regulatory measures. The report urges extreme caution in drawing any policy implications from this tentative analysis.

Through a series of comprehensive tables, the comparison among various nations which makes up the body of the document shows a wide range of banking structures and supervisory practices, and a roughly equal division between countries that rely on the central bank as the chief banking supervisor and those that do not. All the countries have deposit insurance schemes, which differ widely. Cross-country comparisons of the different aspects of banking do reveal one common characteristic: almost all allow a wide range of banking activities, including underwriting, dealing, and brokering in both securities and insurance. These activities can generally be conducted in a bank or through a bank subsidiary, rather than through a holding company structure. The notable exceptions to this tendency are the United States and Japan.

The OCC report points out that the United States and many other countries have experienced serious banking difficulties during the past 15 years, and that this troublesome situation has been attributed to a mixture of bad luck, bad policies and bad banking; specifically, an increase in bankers' inclinations and incentives to take risk. In response, the United States and some of the other countries grappling with banking problems implemented new laws to resolve existing banking problems and lessen the likelihood of future problems. Designed to ensure that banks operate in a "safe and sound" manner, new bank standards for capitalization, risk exposure, and information disclosure were established. In addition, modifications were made on restrictions on the pricing of bank products; activities of banks; the extent to which banks could own and be owned by nonbank firms; restrictions on geographical expansion of banks through branching, merger and acquisition; supervisory practices to contain risk- taking behavior; and the insurance or guarantee schemes to protect depositors from bank failures.

Many of these changes were the result of a general movement towards greater regional, if not international, cooperation and uniformity through the workings of such groups as the Basle Committee on Banking Supervision (established by the central bank governors of the Group of Ten (G-10) countries and under the aegis of the Bank for International Settlements (BIS)), and the European Commission (established as the executive and administrative body for the member countries of the European Union (EU)). The extent to which this trend will continue remains unclear.

U.S. is out of step with others

The 19 countries chosen for comparison account for a relatively small percent of the world's population, but 79 percent of the world's gross domestic product (GDP) and 86 percent of the world's banking assets. The United States and EU are frequently compared because they are roughly equal in terms of shares of both population and GDP. Yet the EU accounts for a significantly larger share of the world's banking assets than the United States. The same 19 countries account for 96 percent of the world's mutual fund assets, 88 percent of the world's equity market capitalization, and 77 percent of the world's international debt securities. By examining banking developments in these 19 countries, one is not only obtaining information about those countries accounting for the vast majority of the world's banking and other selected assets, but also indirectly obtaining information about future bank regulatory, supervisory, and deposit- insurance developments because many emerging markets countries follow the lead of the EU and G-10 nations.

The report concludes that the United States is "out of step" with most other countries in terms of allowing banks to engage in securities, insurance, and real estate activities. In most other countries, for instance, banks may engage in a full range of securities and insurance activities directly in the bank and without mandated firewalls. This relatively limited regulatory intervention partly reflects recent EU actions to provide flexibility to all member countries to establish universal banking systems. To differing degrees, such systems have existed for some time in France, Italy, the Netherlands, and, most notably, Germany. Switzerland should be added to this group, though it is not a EU member. As a result of these recent actions, the divergence in activities in which EU banks and U.S. banks may engage should widen still further, unless corresponding actions are taken in the United States.

As for banks being permitted to invest in non-financial firms and vice versa, the working paper shows that in 11 countries banks have no restrictions to investing in non-financial firms (see chart). This type of investment is permitted in two countries and restricted in six countries. On the other hand, non-financial firms have wide access to bank ownership in 13 of the countries; the remaining six impose restrictions on such ownership. Once again, U.S. banks find themselves operating under the most restrictive regulatory regime with respect to ownership opportunities. This disparity raises the question of whether the atypical situation in the United States permits funds to flow appropriately from savers to borrowers without impeding risk-sharing opportunities and the efficient allocation of resources.

In view of the debate in the United States over the most appropriate way to regulate the corporate structure of banks, the OCC economics paper notes that in many of the G-10 and EU countries banks can engage in a wide range of activities directly in the bank or through bank subsidiaries, rather than through a holding company. In 11 of the 15 countries surveyed, bank holding companies are permitted, including the United States. In eight of these countries, holding companies are infrequently used. Only in three countries (Italy, the Netherlands, and the United States) are bank holding companies permitted and widely used.

analyzing firms

Beyond this detailed comparison, the working paper investigates the effect of the overall structural and regulatory environment on individual bank performance to evaluate the appropriateness of regulations in countries and proposals for reforming them. Specifically, an exploratory empirical analysis based upon a sample of banks is conducted to assess the effect of the different "regulatory regimes" on the performance of individual banks, controlling for bank-specific and country-specific factors that may also affect performance.

The most dramatic finding of the working paper-the model for evaluating performance based on banking powers-appears in the Appendix. "We put it at the end of an elaborate survey that stands on its own because we see this effort as a first pass," says Barth. "If we had put it up front, people would argue about the empirical results and forget the comparative material, which we thought was, first and foremost, most important."

"These econometric studies don't prove or disprove anything," he adds. "They try to uncover evidence consistent or inconsistent with a point of view on the effects of these powers. We hope other people will do more studies; that was the motivation for our empirical work."

The research team attempted to use statistical or econometric techniques to assess the effect of different restrictions on bank powers on bank performance. The measure was Return on Equity (ROE). The variables were whether there were restrictions on bank activities in securities, insurance, real estate, and bank investment in non-financial firms.

The OCC report also notes other issues to be considered in future work, such as the emergence of electronic banking. The use of electronic payment media brings up issues about the definition of money for monetary policy and concerns about the potential for fraud and money laundering. The countries listed show substantial variations in the extent to which cash is used, as well as in the public's reliance on relatively simple technology like ATMs. This indicates to what degree banks rely on relatively costly cash, check, and other paper-based services versus less expensive payment media such as ATMs and electronic funds transfer point-of-sale terminals. In addition, the OCC report shows the vastly different potential across the EU and G-10 countries for involvement in electronic commerce over the Internet. It suggests that future analysis of institutional performance should try to explicitly incorporate differences in the use of modern information technology and the type of service delivery mechanisms used by banks to facilitate transactions.


Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.