Worldwide overcapacity is forcing banks to restructure, which may result in fewer but larger institutions, according to the Bank for International Settlements.

The bank, based in Basel, Switzerland, serves as a central bank to central bankers.

It said in its latest annual report that deregulation, technological advances, and market forces are intensifying pressures on banks to reorganize. It also emphasized that longer-term forces such as a steady rise in the cost of retail funding, more expensive capital, a shift by borrowers to capital markets, and pressures from shareholders for higher returns "are of a much more permanent character."

That banks earned higher profits in most countries last year "should not obscure the serious challenges facing the industry." Margins generally have declined since the mid-1980s, the settlement bank said. Also, credit ratings have weakened, and bank share prices have lagged the overall index in many countries.

"Looking ahead, there is little reason to believe that the forces of change will abate," the report stated.

In a break with previous studies, which tended to focus on upgrading the supervisory system and improving capital adequacy, the settlement bank this year came out firmly in support of structural transformation.

"The key policy change (needed) in the years ahead is to facilitate the orderly restructuring of the financial industry. This means strengthening and complementing those market mechanisms that discipline individual institutions, while at the same time preserving the safeguards against systemic risk," the report stated.

In other words, "what we are essentially arguing for is a reduction in capacity in the banking industry," said one official of the bank. "The message is that we would like to see market forces operating more strongly in the banking industry."

The shift in emphasis toward allowing freer play of market forces follows similar thinking at other regulatory institutions. Officials at the Federal Reserve Bank of New York, for example, recently asked banks to come up with their own methods for controlling foreign exchange settlement risk. The Federal Reserve Board has also argued that banks are their own best risk managers.

Among the changes the recommended by the Bank for International Settlements to accelerate a worldwide restructuring of banking:

*Privatizing government-owned banks;

*Easing regulatory constraints on acquisitions among financial institutions;

*Reducing inflexibilities in the labor market;

*Enhancing public disclosures; and,

*Reducing government intervention in banking.

Given how difficult it can be to close unprofitable banks, the report noted that mergers and acquisitions have become the principal instrument of restructuring.

As a result, the number of banks worldwide has been shrinking for several years. Since its peak in 1980 to yearend 1995, the number of banks in the United States has declined 36% to 12,067. In From their respective peaks, banks in Germany were down 35% to 3,487, while in France, banks dropped 43% from their peak to 593. In Sweden, the number was down 81% to 112.

At the same time, fewer banks hold a bigger share of the banking business in most countries. From yearend 1980 to yearend 1995, the top 10 U.S. banks increased their share of total assets to 21% from 14%; in Sweden, to 93% from 71%, and in Switzerland to 62% from 56%.

Officials of the settlement bank and analysts said they were uncertain whether individual banks can respond to increased demand for new services.

"There's a growing need for different types of services like asset management, retirement planning, and new payment systems," said Mark Gross, a banking credit analyst with the rating agency IBCA Inc. "Getting into these services can be expensive, and all you have to do is look at the growth in deposits versus mutual funds and you see that banks missed out on that."

Analysts also observed that frequently restructuring requires an economic crisis to set it in motion.

"It sort of goes region by region," said Andre Cappon, president of CBM Group. "In Latin America, where the crisis has been deepest, restructuring has come fastest, whereas in Europe, where economic conditions have been more stable, it's been more deliberate."

When economies do well, he added, "it postpones the day of reckoning."

The report stressed that consolidation is not without risks and that there is an "inherent conflict" between an individual bank's ambitions and marketplace dynamics.

This, the settlement bank warned, could prompt some institutions to favor "size and growth over profitability," add on extra merger-related costs, and impair bankers' ability to scale back or close unprofitable operations.

"The restructuring process in any industry is fraught with difficulties," the report observed. "For an individual firm, the choice of the right combination and scale of activities is no easy task."

Speaking to the British Bankers Association recently, Andrew Crockett, the general manager of the international settlement bank, said bluntly: 'There is no free lunch."

Changes in the banking industry, he said, "hold forth the promise of great benefits, but also raise commensurate risks."

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