Strong Dissent To an Analysis Of Banking

The banking industry has been in a state of dynamic change for the past decade. These changes reached flashpoint in the past two years, forcing government regulators and the industry to adjust operating strategy.

Bank managements have been forced to rethink their businesses, cost structures, and their ability to compete within a broad spectrum of financial products.

While the process has been inordinately painful, the industry is benefiting from the exercise. Change is now proceeding at an even more rapid rate.

It is therefore discouraging to read analyses of banking that are essentially backward looking in nature and unmindful of the current forces impacting the industry. This type of analysis was evidenced in the three-article segment about the industry published in May by Institutional Investor Magazine.

During the past three decades, the traditional service-oriented banking business in the United States has been battered by three forces:

* Emergence of the Eurocurrency markets. Today, reliable estimates indicate that this fund source is double the size of the domestic money supply as measured by M-2 ($7.0 trillion versus $3.4 trillion). An organization that wishes to offer banking products does not need a branch-banking system and core deposits to obtain a ready supply of funds.

Technology Trailing

* Improvement in technology. Any company with off-the-shelf products can develop systems that account for millions of transactions in real time, daily, or be up to the minute on market prices around the world for virtually any financial instrument.

* A major change in the nature of the American industrial corporation. As a result of the adoption of outsourcing techniques, cash flows inside these companies have changed. Money that once was diverted to the building of stamping plants or opening iron-ore mines in Brazil is now utilized for the purchase of financial assets.

Companies such as General Electric, Ford, Sears, and AT&T were able to establish banking capabilities - even though they lacked branch-banking systems. To operate as banks, however, these companies had to wean American consumers and corporations away from their traditional method of handling financial transactions: They had to get the customer out of the bank.

This was done by crafting systems that sold financial products on demand. For example, you, personally, undoubtedly have the capability of direct depositing your paycheck into a financial institution (bank or nonbank) without leaving your office. Through the use of sophisticated cash-management systems, your company has the same capabilities.

The key to obtaining financial business is to have systems that provide products on demand and to provide the products at lowest cost. The key to losing the business is to operate from obsolete distribution systems that are inherently high-cost in nature; that is, to practice service-oriented relationship banking.

Incorrect Reaction

The problem with the FDIC arose because the government reacted incorrectly to the above trends. Thrift institutions had become obsolete because they did not have the capability of providing low cost/high yield services on demand.

The CMA account at Merrill Lynch and the newly evolving mortgage markets had obviated the need for thrifts. The inverted yield curves of the 1960s and 1970s were only the last straws.

The government could have solved this problem either by regulating the new financial-product sellers or by letting the thrifts die. It did the opposite. It let Merrill Lynch and others get at the FDIC through brokered deposits and increased its subsidy of the thrifts through a variety of techniques.

As the nonbank banks systematically took market share from the depository-institution banks, the inevitability of large losses grew. When they occurred, the Congress and the regulators "freaked." Bank "bashing" then drove the losses to totally unnecessary losses.

Congress today clearly does not understand what happened. Therefore, it is adopting reactionary, defensive policies. Its only interest is in restricting the access of depositors to government insurance of their funds.

Congress is willing to dismantle the nation's banking system, rather than to solve its problems if, by the former action, it will reduce exposure to FDIC guarantees.

The Trade Issue

In the writing of the U.S. Treasury Department, it is evident that this government believes it is at a disadvantage in the trade fight because the economic units in the United States are too small. The administration wants American conglomerates similar to Japanese keiretsu like Mitsui and Mitsubishi, or German universal banks such as Deutsche and Dresdner Bank.

Therefore it has conveniently turned its head as one industrial corporation after another broke Glass-Steagall prohibitions.

Understand that only industrial corporations - not banks - have broken this law. With the awarding of Bank of New England to Kohlberg Kravis Roberts (in association with Fleet/Norstar Financial Group), all inhibitions concerning following either the letter or spirit of the law were trashed.

Among other things, the Institutional Investor series fails to recognize that the current battle over banking power is not between big and little banks. It is between banks and nonbanks - and the banks are losing almost everywhere.

Potholes on the Highway

Other issues overlooked in the Institutional Investor series:

* From 1945 to the 1960s, the banks were dynamic forces in stimulating the growth of the postwar economy. They did this by shifting their balance sheets out of Treasury securities and into loans.

* Walter Wriston invented the certificate of deposit and tried to take his bank in a new direction, in an attempt to regain market share and open new lines of business.

* Banks did, in fact, go after the middle-market business and establish a dominant position in this sector, pushing out the finance companies.

* The industrial sector, not the banks, are breaking the Glass-Steagall laws. Sears collects deposits that are FDIC insured, in some instances. It makes loans to both consumers and corporations, and it operates both stand-alone banks and industrial companies. No bank in this country has the same power.

The key point that the Institutional Investor relates, but does not seem to understand, is in the quote from the ex-government official: "... I don't know if we need banks."

Nonbanks Waiting in the Wings

That issue needs to be addressed because the actions of this administration are motivated toward reducing the number of banks in this country in favor of noninsured nonbanks. This will not be a populist move because, when the banks go, so will their customers - the small corporations.

Backing on Wall Street

Let's face it, the Bush banking bill is supported by Wall Street, large industrial corporations, the President, and those trade advocates that believe in the creation of American keiretsu.

And when you think about it, this bill is de facto law because the administration refuses to enforce Glass-Steagall on anyone other than the banks. Congress has rendered itself totally ineffective on banking issues through internecine fighting and questions of propriety.

In this vacuum, the banking regulators are "legislating" what they choose - unfettered by any fear that the Justice Department will make them obey the law.

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