ANALYSIS OF THE BANKING INDUSTRY
Project 2 entailed researching an industry that has been recently turned upside down by a
landslide of regulations and deregulatory actions…the Banking Industry. These changes have
caused a scramble to be the first to capitalize on this new freedom. In addition to the shake up
within the banking industry, there has also been a move in the other financial industries, such as
Insurance Companies and Brokerages to use this freedom to align and corner the financial
services market. In order to best analyze this vastly changing industry and forecast the direction
this industry is heading, Team 2 looked at the following areas. We briefly touched on the history
of the banking industry including such points as historical events affecting banking and financial
legislation. Our primary focuses, however, were consolidation due to deregulation, globalization,
and technological advances.
Today, the United States banking industry is worth about $520 billion and has more than
9,100 commercial banks along with approximately 1,800 thrifts. The timeline of this industry has
a detailed path and has come a long way (Dr. Rakes Class Lecture). Starting from the nineteenth
century when Alexander Hamilton founded the Bank of New York, the banking industry has
steadily progressed into what it is today. The United States of America had no banks, no
national currency, and no credit infrastructure until after the American Revolution. Throughout
the nineteenth century, small, local banks slowly began to emerge but ―were vulnerable to runs
and failures.‖ In 1907, J.P. Morgan heads off a banking panic and used his power to get the
Federal Reserve System established in 1913 to regulate the money supply. Changes were
beginning to occur (http://www.hoovers.com/industry/snapshot/0,2204,7,00.html). In 1929, the
Fed realized that it could not sustain its policy of setting below market interest rates and low
reserve requirement. It began to raise interest rates, which led to the Stock Crash and the banking
panic (Standard & Poor‘s). In 1933, the economy began to expand again due partly to President
Franklin D. Roosevelt‘s new policies. President Franklin D. Roosevelt closed every U.S. bank to
examine their practices. It was from these in-depth examinations that the Federal Deposit
Insurance Corporation (FDIC) and the Securities and Exchange Commission (SEC) came to life.
(http://www.amatecon.com/gdoverview.html) Another policy put into effect was the Glass-
Steagall Act of 1933 which ―authorized deposit insurance and restricted banks‘ ability to engage
in debt and securities underwriting.‖ This act protected bank depositors from the risks that occur
when a bank ―sells or underwrites securities‖ and allowed commercial banks to engage in
specific securities activities (with certain limitations). Banks could earn up to five percent of
revenues from securities underwriting. (The Glass-Steagall Act was revised in 1989, 1996, and is
now under scrutiny again) (Standard & Poor‘s). Many reforms and regulations occurred for the
next 40 years, leading up to the 1970‘s.
According to, Dr. G. Kaye Rakes, chair of the Finance Department at Ohio University,
the United States still did not have a central bank in the 1970‘s. ―Soaring inflation and interest
rates in the 1970‘s drove bank and thrift customers into higher yield money market funds.‖ It
was clear that the banks needed to do something. Banks started to see the need to combine
separate companies into a single, more powerful conglomerate. Because of this need,
consolidation was born. ―Consolidation is driven by banks‘ hunger for market share and the
economies of scale that result from elimination of redundant operations.‖ Unfortunately the U.S.
government wouldn‘t cooperate. Consolidation was not an option for U.S. banks. Small banks
started to group banks together calling them ―one bank holding companies‖ to get away from the
government regulations without actually breaking them
1979 - 1985
The period 1979-1985 was known as the consolidation period. The ―holding companies‖
began to plan for international strategies. Regional Super Banks began to emerge. A major
stepping-stone in the banking industry is when a state compact was put into effect that allowed
New England banks to branch into each other. The year 1982 brought about changes for the
banking industry. Congress began to relax the requirements imposed by the Glass-Steagall Act.
In 1985, the number of regional banks began to increase. Consolidation sparked this new growth.
The Industry began moving away from Savings & Loan‘s and started moving towards other
services like lending such as Commercial Real Estate (Dr. Rakes Class Lecture).
1985 - Present
Mega-banks began to arise in 1995. Banks began to realize that they could get the same
amount of work done for less money and with fewer people, thus beginning to ―right size‖ their
organizations. Banks also started horizontal integration. Changes, due to relaying of regulations
and increased competition, started occurring more frequently, which brings us to the present day
(Dr. Rakes Class Lecture).
Are banks really banks anymore?
Statistics say that Savings Banks and Savings and Loans have combined assets of
approximately $1 trillion. Banks have assets worth more than $5 trillion. The U.S. government
has made many reforms regarding deregulation that cause banks to head in a new direction.
Banks want to be known as ―financial service companies‖ and are offering more of a variety of
services and options to their customers. For example, banks are now venturing into brokerage
services, securities underwriting, and insurance. Insurance companies and brokerages are
beginning to offer basic banking services in order to compete. These steps have brought about a
new breed of banking referred to as ―non-bank banks‖. These banks are companies such as Visa
and MasterCard that are bound by the same rules as banks but are only offering credit cards.
Banks and other financial service institutions are also jumping on the Internet bandwagon and
are offering various services online to make ―banking‖ more convenient to customers. These
companies are also testing waters internationally by coming up with strategies and services to
appeal to overseas clients as well as U.S. companies that have expanded internationally.
However, all these changes bring about the question of banks‘ long-term survival. In a world that
is constantly changing, it is imperative for the financial service industry to adapt to the growing
needs of its customers (Dr. Rakes Class Lecture).
In the last twenty-five years, our nation‘s banking industry has been in the process of
gradual change (See appendix B for FDIC Banking Legislation history). The change is a
movement away from the heavy government regulation that has characterized it and prevented
expansion in the past. There have been many small pieces of state legislation along the way that
subtly removed regulations here and there allowing modest but steady consolidation in the
banking industry itself and consolidation of separate financial industries. As of late, there have
been two federal deregulatory acts that have, in respect to the type of regulation they deal with,
removed many major restrictions in one fell swoop. They are the Reigle-Neal Interstate Banking
and Branching Efficiency Act of 1994 and the Gramm-Leach Bliley Act of 1999. Some
companies have prepared and even leapt ahead of the changes brought about by these acts while
others have been left behind with spinning heads.
Consolidation within Banking Industry
The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 is the federal
act that, in a most basic sense, takes state borders out of the banking scheme. It has finished
the legislation begun at the state level. The act was implemented in 1997 and it allows for
bank holding companies to acquire banks in any state as well as provisions for the merging of
banks at an interstate level. This has transformed a previously stagnant industry into one of
high competition. The old restrictions permitted for small, poorly managed banks to carry out
business as usual without worry of customer turnover. Now the doors are open for the
efficient and hungry banks to take their piece of the market with little regard for those who do
With no border or regional protection banks not only have to worry about
maintaining a customer base, they must expand it. One way banks can deal with this harshly
competitive environment is to consolidate (See appendix D and E for more information on
consolidation and mergers). This is the most logical reaction to the added pressure to gain
market share. A bank benefits in several ways from a merger or acquisition. There is no
longer competition from the added bank but the addition of its market share is gained. Also,
there is an increase in financial leverage as well as the amount of financial products offered.
The bottom line is that consolidation produces efficiency and diversity and continues to be the
trend that followed by the banks controlling the industry.
With restrictions regarding consolidation removed, those banks that are most efficiently
run will emerge as the leaders and expand into new markets. This should be beneficial to the
economy for several of reasons.
The banks that provide the best services at the best prices will be the ones growing and
doing the majority of the providing.
The overall economy will grow faster because the most proficient banks will be
handling the majority of the services (well-managed money is good for the economy).
Banks unwilling to do what is necessary to elevate efficiency and diversity will fade
from the market.
Those managing and making decisions within banks will perform with added
motivation due to the increase in pressure of competition and loss of protection from
Consolidation of Separate Financial Services
The Gramm-Leach Bliley Act of 1999 is the single most important piece of financial
industry legislation in the past year and recent years. It is the federal act that has all but made
the word bank, obsolete. For years, banks as well as investment and insurance companies
have been lobbying for the right to provide a full selection of financial services under one
roof. That is now a reality. Not so long ago, a perspective seeker of full financial service
would have to go through all three firms. The aforementioned act has quickly made a
separation of financial services a vehicle on its way to extinction. The financial services
company, a hybrid of the entire realm has risen from the ashes.
Banks have been calling for this legislation due to the loss of significant profit from
savings and loan. The loss is due to a decline in the spread that is a result of the prime rate
being to close to the Federal Funds Rate. Banks are now focusing on other areas in the
financial arena for their major source of profit. Diversifying services brings many advantages
as well as disadvantages to the newly dubbed ―financial services companies.‖
Adding diversity is something that every company looks to do whenever possible,
whether financial in nature or otherwise. The more diverse a company is the less susceptible
it is to harsh conditions. This is particularly relevant to the banking industry. When the
Federal Reserve allows for high interest rates this tends to negatively affect a bank‘s earnings.
With the newly diversified range of financial services provided by banks they are less
susceptible when the Fed chooses to raise interest rates.
The possibility of passing an act like Gramm-Leach Bliley has been circulating in
congress for several years now. Some companies have continued business as usual while
others have paid close attention and poised themselves to take full advantage of the
possibility. Two companies have shown such vision that they merged prior to Gramm-Leach
Bliley with the possibility of a costly separation had it not passed. Those companies are
Citibank and Travelers Group and they became Citigroup in October of 1998. They are now
reaping the benefits of a prophecy fulfilled.
Due to the merger, Citigroup is an extremely diversified holding company that provides
financial products and services, through its many subsidiaries, to individuals, businesses,
governments and financial institutions in nearly 100 countries as well as throughout the
United States. Due to their great diversity and steadily increasing revenues they have become
stock market darlings as of late. With a stock price hovering around sixty in recent months, it
is among the most preferred stocks in the entire financial service arena
To summarize, the super-merger that produced Citigroup allowed two companies with
superior foresight to capitalize on an industry now defined by such forces as deregulation and
globalization. They are the prototype financial services hybrid that has set a standard for a
vastly changing financial world. Essentially, Citigroup has predicted the future and
capitalized on their prediction. The only question now is who will be able to keep up.
This would not be a complete report without giving an alternate viewpoint. There are
also worries that come along with unlimited consolidation. Glass-Steagall was enacted as
damage control during the depression era. Some feel that repealing it relinquishes too much
control and leaves an open door for disaster. Another worry is the possibility of over-
consolidation creating too much power in the banking industry and ultimately allowing it to
have an excessive pull on the economy. Present conditions would indicate that these concerns
are needless but time is the only true test.
Also, by calling themselves financial services companies, the smaller regional banks put
themselves on the national playing field with the national and international powerhouses.
This sets them up for such intense competition that entering into this realm under-prepared
could be more of a detriment than not entering at all. Keeping that in mind, there is a worry
of financial services companies growing too large to the point that the average customer is no
Banking and Wall Street
As time passes, companies in the banking industry have been emphasizing their stock
value more and more. It has gotten to the point of being the bottom line of a bank‘s success.
This presents a problem, due to the fact that Wall Street has always looked at the stocks of
banks in a negative light. What this means is, the stock of a bank is generally undervalued
when weighed against the stock of a comparable company in a different industry. Banks are
now reformatting themselves to offer the services that will gain them value in the eyes of Wall
Street. These ―Wall Street-friendly‖ attributes are consistency, high margin and revenue
growth. There are services that banks are now focusing on that will give them these coveted
attributes. These services are low credit risk services with high margin and a focus on fee
revenue that is a banking movement in its own right. The following are examples of some of
Treasury management is a service banks offer to companies to give them immediate
knowledge of their cash flows. Bills owed to a company employing this service are not sent to
the company to undergo the always-slow accounting process but are sent directly to the
management provider. Once the payment is received it is instantly added into the company‘s
pre-designated account of choice and the time-consuming paperwork is done later. This allows
a company a virtually up to the minute knowledge of its cash flows. It works the same when a
company pays a bill. The minute the management provider is aware of a cleared check the
company‘s account is adjusted accordingly.
Having this instant cash flow knowledge is invaluable to a company because if they
know where they stand they can always be invested to the full amount. Some treasury
management programs will automatically insert excess funds into short-term investments.
Capital marketing is a service offered to large companies seeking a loan of significant
size. The company providing this service acts as an intermediary, finding a loaner other than
itself to provide the loan at a value greater than it could offer and is paid a finding fee for this
Private banking is essentially financial advising for affluent individuals. It is primarily
an investment-based service.
Processing is simply fund transfer done electronically for a fee. This is a high volume
service and one that comes naturally to a bank. They are companies with significant amounts of
capital lying in equipment and electronic devices with a primary function of processing
transactions. Providing this service simply makes extremely efficient use of a resource the bank
already has (Interview with David Payne).
Global Banking Trends
As competition and growth continues to soar in the banking industry, the expansion of
banking in countries throughout the world is beginning to become a more prevalent trend. In the
United States, borders have been removed due to the relaxation of previous regulations as the
industry has broadened it resources nationwide. Another worldwide trend is the consolidation of
banks on the international level because of improvements in technology, aggressive competition
in the marketplace, and the need for reductions in operating costs.
The World Trade Organization, WTO, has created possibilities for the globalization of
the banking industry. The WTO's Financial Services Agreement answers some of these demands
and leaves the door wide open for global financial services. The new Financial Services
Agreement came into effect in March 1999. The new statements now allow commercial presence
of foreign financial service suppliers by eliminating or relaxing limitations on foreign ownership
of local financial institutions and allow for expansion on an international level.
Banking is following the trends of the business world in general. The rapid acceleration
of globalized banking can be considered an answer of many other industries to expand their
presence internationally. In order to keep the business of companies competing on a worldwide
level, banks need to follow them into new locations on the international level. By expanding
outside of the United States banks can offer services such as domestic and international wire
transfers, multiple-currency accounts, international treasury management, foreign exchange
trading and hedging services (http://www.53.com).
Some recent trends and overviews (as of 1999) in foreign banking for different parts of
the world are as follows:
In Asia and Southeast Asia, the economies are slowly turning around from previous years
plagued with bad economies, decreasing currency value and banking. Many forecasters believe
that the yen will remain stable over the millennial year due to Japan‘s recovering economy, thus
helping to resuscitate much of Asia from their economic slumps. China has had twenty-two
straight causing an increase in non-performing assets at many of their banks and the Chinese
currency is expected to soon devalue.
Latin America and Europe
Latin America is currently in a period of recession hitting banks extremely hard due to
the lack of money in the economy. On the brighter side for Latin America, Mexico‘s economy is
expected to grow somewhere close to 3% this coming millennial year. The keys to a major
turnaround for Latin America are Brazil and the United States‘ strong economy as well as
commodity prices that are higher. The financial soundness of Latin American banks all depends
on whether or not the economies of these countries improve.
Throughout Europe everything is looking good. The European economy is expected to
pick up this year making the Euro stable. Interest rates are likely to pick up making the cost of
funds rise, thus creating a slight setback for European banks.
United States, Australia and Canada
The main powerhouse of the world‘s economic growth is still the United States. Many
U.S. banks are moving to a global level with improvements in technology and the opening of
many European, Asian and Latin American economies. This is creating a closer link between
banks on an international level.
Australian and Canadian banks are doing well and are financially stable and sound
Institution of International Bankers
Started in 1966, the Institute of International Bankers (IIB) is an association that is entirely
committed to the representation and betterment of the international community of bankers
throughout the United States. With over 200 banking organizations that reside in about 50
foreign countries, the power of the IIB is quite evident. The IIB‘s main job is to ―ensure that
federal and state banking laws and regulations provide international banks in the United States
with competitive opportunities as domestic banking organizations.‖ These banks filter billions
of dollars every year into the U.S. economy because the IIB employs well over 100,000 U.S.
citizens throughout the U.S. Miscellaneous capital and operating expenditures are some other
reasons why the IIB puts so much money into the U.S. economy. The IIB also serves as a source
of information to policy makers, media and other organizations that are interested in international
banking (http://www.iib.org). Federal Reserve Chairman Alan Greenspan sums up why it is
beneficial for the United States to have foreign and international banks reside in the nation:
―The participation of foreign banks has added to the liquidity and depth
of the U.S. banking environment and has helped to assure the continued
importance of the United States in international financial markets.
Foreign banks have been a significant source of credit for all types of
American businesses in all parts of this country.‖
Regulation of banking occurs at both the state and federal levels. The government has
agencies set up that strictly regulate financial institutions within the banking industry. The
primary regulators of banks on the federal level are the Federal Deposit Insurance Corporation
(FDIC) and the Federal Reserve (See appendix F for information on how the FED affects the
money supply). After the Depression, Congress established the FDIC. The FDIC is an
independent deposit insurance company set up to keep stability and trust in the U.S. banking
system by regularly identifying, monitoring, and addressing risks to insured depository
institutions. In 1913, Congress founded the Federal Reserve System. Along with supervising
and regulating banks, it conducts monetary policy in the United States by influencing money and
credit conditions. Other agencies are set up to control the different financial institutions. There
is the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the
National Credit Union Association (NCUA). The Office of the Comptroller basically issues
rules and regulations, approves and denies applications for bank charters, and generally functions
as administrator to national banks (http://www.occ.treas.gov/). The Office of Thrift Supervision
is the primary regulation force in among thrift institutions, which includes savings banks and
savings and loan associations (http://www.ots.treas.gov/). The NCUA regulates Credit Unions.
Since banks are merging into Financial Services Companies, the regulator role is being
added to. The Securities and Exchange Commission regulates bank broker-dealer functions.
Also, the Department of Justice‘s Anti-trust division acts as the enforcer of anti-trust rules. The
Department of Justice reviews bank mergers and determines that there are in direct compliance
with the Clayton Act. The Clayton Act prohibits mergers or acquisitions that are likely to lessen
competition in an industry (Standard & Poor‘s).
In the global arena, the Office of Foreign Assets Control (OFAC), along with other
duties, is in charge of regulating economic and trade sanctions against targeted foreign countries
What’s to come in the future?
Internet and online banking are buzzwords in the financial world today. Banks are not the
only companies involved in the Internet banking revolution, though all over the country and the
world non-traditional financial institutions are popping up with virtual and Internet banks. These
banks do not have any physical location except in the cyber universe. So why would banks want
to get into cyber space and move away from the traditional bricks and mortar locations? The
answer is simple. First banks are going to want to have a presence on the Internet and to be seen
as a leader. Also banks are going to have to make changes in order to compete in customer
retention in response to the competition from non-traditional companies. Banks locating on the
Internet provides several benefits for those who choose to try the cyber route.
Internet banks are open 7 days a week 24 hours a day
Internet banks are less expensive to run once a stable presence on the web has been
Self-service banking, essentially customers would be able to rearrange their finances
and perform ―what-if‖ calculations to help them make decisions
Create a more in depth portfolio of each individual customer of what their needs and
Be able to provide services to each customer that are customized to their individual
Possibly offer goods and services outside the traditional banking business
Increase the competition (See appendix G for more in depth explanation on Internet
Benefits such as these present a tempting opportunity for many of these non-bank
financial institutions to become a profitable business venture. Many non-bank institutions have
chosen to try to become a presence causing increased competition in the banking industry. This
causes banks to reevaluate their current structure for business and possibly rethink a new one
What makes non-bank institutions so special?
Non-Bank institutions on the Internet have one distinct advantage in the banking industry
- they have no physical location. Because of that fact, many expenses incurred by maintaining
branches, vanish. These non-bank institutions are then able to offer many more attractive rates
to their customers. They can also attract a customer base from anywhere the Internet is located,
while banks must settle for a customer base of where their branches are located. For example,
Bank One has an impressive network of ATM‘s that span the area of 15 states. If Bank One
Corp. decides to offer services to the other 35 states, how will their customers receive ATM
support? A solution for this problem must be addressed if Bank One wants to continue to be a
strong presence in the banking industry.
The Bank of Montreal decided to experiment with a new virtual bank, "mbanx", a stand-
alone institution that was affiliated with the bank, but was only to be used on the Internet. Eighty
percent of its accounts came from Bank of Montreal. Quickly they found out that an Internet
only bank is not what the customers wanted. If a well-known bank decides to lend its name to a
virtual bank then the customers are going expect both the services of the online bank as well as
the services that their branches offer (http://www.bai.org).
Is Internet banking a new channel or a new business?
Non-bank institutions have turned the new virtual banking market into a new business.
Traditional banking companies have a bigger challenge to attempt. They must not make Internet
banking a new business but turn it into a new channel that their customers can use to access their
services. By opening an Internet site, banks immediately devalue their bricks and mortar sites
because of possible reduction in use. This downfall could be easily overlooked if money is made
on the new Internet sites. This point brings up another dilemma; banks can reduce their
overhead costs by attempting to open up the Internet market. The problem is that in this present
day market advertisement is expensive on the web. It is quite possible for a bank to use all the
money it saved on overhead costs on marketing costs trying to recruit and retain customers.
Statistics show that online banks have not exactly retained customers either. Almost a third of
the 9.4 million people who have tried using online banking have discontinued the service. Only
35% of those people who have stopped online banking are thinking about trying it again
(http://www.bai.org). So gaining and retaining a customer base will be a challenge as well. The
company that comes up with the best compromises between online banking and branch services
will win the race to success. Since, Internet traffic is doubled every one hundred days, these
statistics favor success (http://www.arraydev.com).
Is online banking going to be an easy process?
Unfortunately, if a bank decides to go online, they are not going to automatically be
successful. 63% of U.S. households own a computer but surprising, only 12% use them for
banking transactions. Another important aspect that could be a problem to banks is crime
(http://www.bai.org). With the online banking being so new there are going to be several
loopholes that criminals may be able to capitalize on. President of ABAecom, an e-commerce
affiliate of the American Bankers Association says, ―If, after a couple of hundred years, people
can still get away with something as mundane as writing bad checks, think of what they can do
on the Internet.‖ The American people realize the side that online banks might not be safe. ―We
really sell two products in banking—money and trust. If you don‘t succeed on the trust side, you
don‘t succeed on the financial side,‖ says Steve Katz, Citicorp‘s chief information officer. In
order to try and build up that trust that consumers need to be comfortable many banks are
making full use of 128-bit encryption. According to the experts 128-bit encryption is nearly
impossible to break. According once again to Steve Katz, CIO of Citicorp, ―Trying to break
128-bit code would be like sifting through data ‗the size of the Pacific Ocean‘ a task that would
take even the most brilliant hacker about 100 years.‖ Other aids in security that may be seen in
the future are voice and iris recognition machines and fingerprint readers (http://www.bai.org).
It is nearly impossible to measure how much e-crime has been committed thus far in the
realm of financial institutions. In fact according to a survey conducted by the Computer Security
Institute, in 1999 e-crime increased for the third year in a row. This is primarily the case because
there is no agency that is directly responsible for monitoring and tracking criminal activity in this
arena, although the FBI has been adding computer crime divisions over the last five years to
offices around the country (www.bai.org).
So what is a bank to do?
There is no clear-cut answer as to what a bank is to do in the present day in regards to
online banking. The cyber world seems to be the direction that virtually every business is going
in. Many financial service companies have already started down the road into the unknown, so
for now if banks want to survive, then they must head that way too. According to Daniel W.
Latimore a consultant for Mainspring Inc., ―An increasing proportion of your customer base is
going to migrate across channels, and they‘re either going to migrate with you or from you. If
you don‘t cannibalize, then somebody else is going to eat your lunch for you.‖ The important
thing to remember when venturing into the new territory of Internet banking is that the customer
needs to come first. Wells Fargo & Co., which is clearly the online banking leader with
approximately one million Internet customers, CEO Richard M. Kovacevich, states, ―Our
competitive advantage is that customers have access to all of the channels they want to use.‖
As quickly as the industry is moving, no one company has the market dominated,
according to Chris Musto, a senior analyst with Gomez Advisors, ―Although no one firm
currently dominates the Internet financial services marketplace, banks are clearly in the ‗driver‘s
seat‘ to do so. Banks have the keys to Internet banking success because they have three key
elements working in their favor – the customers, the infrastructure, and the transactions.‖ Banks
now entering the twenty first century must re-evaluate how they approach business opportunities.
Banks have the customer base now to try these new techniques, those who come up with the
most creative and cunning ideas will be the ones to survive.
If there is one word to describe the banking industry it is change. The industry has
undergone an almost complete transformation, and is still changing on a nearly daily basis. With
all the deregulation there has been a massive insurgence of consolidation not only within banks
but also between all the financial industries. This makes the ―banking‖ industry continually
harder to define. Also, with a fading focus on traditional banking there is a scramble for banks to
move into to the future with the use of all the available technology.