-9- and last

the geographical expansion and strengthen their areas which determine the need for additional expansion.

With the right to consolidate, the industry would consist of larger, but fewer banks. The ability of the industry to attract capital would be greatly enhanced and the ability to supply the future needs for credit would be improved.

ENTRY POLICY*

Branching

By Thomas M. Havrilesky and William P. Yohe

Approval for branches of national banks is the responsibility of the Comptroller of the Currency; for state banks it lies with the state banking commission, with deposit insurance subject to approval by the Federal Deposit Insurance Corporation. However, the McFadden Act constrains national banks to the same branching standards as the state banks in a state. Only 12 states permit both statewide branching and have not vetoed holding company activities. federal law prevents banks or bank holding companies from operating bank offices in more than one state.

Moreover,

In the past decade and a half, banking firms (fueled by chronically inflationary monetary policy) have had the wherewithal (and internal organizational incentive) to grow. Because investment in new branches is confined to certain geopolitical areas and because of severe constraints on competition for deposits through explicit payment of interest, commercial banks instead compete for deposits by making concessions to customers in other areas of banking and non2 banking activity." Consequently, there has been, on a nationwide basis, an in

*

We thank Martin Bronfenbrenner, Kalman Cohen and Edward Kane for helpful comments. We alone are responsible for error.

1 The 1970 amendments to the Bank Holding Company Act permit the Federal Reserve to establish guidelines for determining when "controlling influence" may exist even if 25% or more of stock is not held b the holding company. Present guidelines include 5% or more of stock plus interlocking directors or offices or combined ownership by officers, directors, major shareholders, and holding companies of 25% or more of operating bank's stock. (William H. Kelley, "Bank Structure-Consolidation of Banks Reshaping Texas Markets," Business Review, Federal Reserve Bank of Dallas, January 1972, pp. 1-7, esp. p. 2.)

2

This is a key aspect of many of the problem areas in modern banking-e.g., bank and bank holding company expansion into nonbanking activities. See the remarks of Thomas Havrilesky in Chapter 11, "Banking and the Economy."

2

efficient allocation of investment in branches-to little in some parts of the country, too much in others. For example, a number of only marginally profitable branches have been started in recent years. As an example of this disproportionate allocation, in mid-1972, banks in the nineteen statewide branching states accounted for about twenty-three percent of total U.S. deposits but thirty-five percent of new branches opened from 1960 to 1972.3

Mergers and New Charters

is

charters for national banks

Approval of mergers and centered in the Office of the Comptroller of the Currency.

It has consistently been easier to get the Comptroller's approval for mergers and charters than when the jurisdiction lay with the Federal Reserve (mergers where survivor would be state member bank) or FDIC (mergers where survivor would be a state nonmember bank and all branch and charter applications of state chartered banks).4 Further, there have been cases where new state banks, faced with FDIC disapproval, have sought and obtained Federal Reserve membership,because this forces the FDIC to provide deposit insurance. In these cases, the Federal Reserve has overreacted to the recent and substantial declines in membership by state banks (caused by mergers and voluntary withdrawals to take advantage of lower state reserve requirements).

5

3 Compiled from data in FDIC, Summary of Accounts and Deposits in All Commercial Banks-June 30, 1972: National Summary (Washington, D.C.: FDIC, 1973).

Robert Eisenbeis, "Differences in Federal Regulatory Agencies' Bank Merger Policies," Proceedings of a Conference on Bank Structure and Competition, October 26-27, 1972, Federal Reserve Bank of Chicago, 1973.

5 Edward G. Boehm, "Falling Fed Membership and Eroding Monetary Control:

What Can Be Done?" Business Review, Federal Reserve Bank of Philadelphia, June 1974, pp. 3-15.

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3

Regulatory Reform

The approval of mergers, charters and branches should be administered by a single regulatory agency. To minimize conflict of regulatory interest and excessive closeness of the regulating body to the banking industry, this agency should not be the agency that conducts bank examinations, nor should it be the agency responsible for monetary stabilization policy. Professional evaluation should be conducted and no regulatory personnel should be political appointees or too closely associated with the banking industry. This would minimize the likelihood of coloring the approval process with invidious considerations.

All banks should be permitted to compete through branching, either by fullservice outlets or through automated "facilities," on a nationwide basis. This would end dual regulation and its effect of excessively protecting existing banking firms in some areas from new entry with little apparent improvement in bank 6 safety. Regulatory laxity in approving mergers and the enormous cost of resolving merger problems would be reduced, because a nationwide branching system would encourage de novo entry rather than entry by merger and acquisition. Regulatory caprice in approving entry would be reduced because bank managers rather than bank regulators would decide which markets were "overbanked." "7,8 Excessive concen

6 Safety in banking can be improved and bank customers and bank managers can have better information and react more efficiently to risk by a system of deposit insurance premiums graduated to reflect the riskiness of a bank's portfolio, a likely feature of a private deposit insurance industry. See Sam Peltzman, "The Costs of Competition: An Appraisal of the Hunt Commission Report," Journal of Money Credit and Banking, November 1972.

7

The failure to define banking markets makes branch approval a rather superficial procedure. The regulatory authorities have never agreed upon precise ways to delineate the market area of a bank or branch in merger, branch and charter cases. Counties, Census tracts, townships, SMSA's, urbanized areas, Ranally Metropolitan Areas, and various marketing techniques have all been used. Further, the Survey of Consumer Finances no longer publishes the distribution of checking account holdings by individuals by income brackets; these are needed to implement the American Bankers Association method of establishing deposit potentials. See Paul R. Schweitzer, "The Definition of Markets," mimeograph, Banking Markets Section, Board of Governors of the Federal Reserve System, 1973.

8

below.

For further details see our remarks on the convenience and needs doctrine

tration of offices and pre-emptive branching in any local market could be minimized by a rule limiting any bank to a specific number of offices per 100,000 population per country. Excessive national concentration could be handled by enforcement of anti-trust laws.

9

All banks under the proposed system would be subject to the same set of reserve requirements on all classes of funds. The end of dual regulation would end the tendency of the Federal Reserve to provide incentive for membership through regulatory laxity and monetary stabilization policy would not be impeded by deposit shifts between member and nonmember banks.

10

Recently, considerable criticism has been leveled at the dangers associated with the expansion of banks and bank holding companies into nonbank activities. The drift into nonbanking activities is, in part, explained by the geographical constraints imposed on the fixed capital investment of banking firms as well as legal constraints on competing for funds through payment of interest on deposits. The proposed system would encourage efficient and growth-oriented commercial banks to grow within the banking industry and not to spread their managerial ability too thinly into nonbanking activities. It will tend to keep banking expertise more efficiently allocated within the banking industry proper. It would thereby reduce the many problems associated with the nonbanking activities of expansion-minded banking firms.

To some extent the problems associated with excessive marginally profitable branching within small geographic areas also arise because branching competition

9 The Federal Reserve's proposal for uniform reserve requirements is given in Boehm, op. cit., p. 13. The costs and benefits of zero reserve requirements deserve close inspection.

10 To place this issue in a fuller focus, see Thomas Havrilesky's remarks in Chapter XI.