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F e d e r a l R e s e rv e B a n k o f C h ic a g o


The diminishing trade surplus


Competition in banking: the issues




is published monthly by

th e F ed era l Reserve Bank o f C h icag o . Joseph G .
K vasnicka w a s p rim a r ily responsible fo r th e a r t i­
cle, "The d im in is h in g tra d e surplus" a n d L arry R.
M o te fo r "C o m p e titio n in b a n k in g : th e issues."
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to th e p u b lic w ith o u t ch arg e . For in fo rm a tio n con­
cern ing b ulk m a ilin g s , ad d ress inq u iries to the
F ed era l Reserve Bank o f C h icag o , Box 8 3 4 , C h i­
cago , Illinois 6 0 6 9 0 .

m ay


re p rin te d

p ro v id e d



cred ite d .
A N N U A L REPORT: The 1 9 6 6 A n n u a l Report o f the
F ed era l

Reserve Bank o f C h icag o contains the

b an k's fin a n c ia l statem ents, b rie f re view s o f last
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th e M id w e s t." Copies o f th e A n n u a l Report m a y
be o b ta in e d fro m th e Research D e p a rtm e n t.

Business Conditions, January 1967

The dimin ishing trade surplus
T „ increasing prosperity in the United
able), imports topped the 1965 total by 19
States during 1966 was accompanied by un­
percent. During the same period, exports at
favorable developments in the nation’s for­
an annual rate of 29.1 billion dollars ex­
eign trade accounts. The trade surplus
ceeded the 1965 level by only 10 percent. In
(traditionally the source of strength in our
any other year, such an export performance
overall balance of payments) deteriorated
would have been viewed as excellent; in 1966
substantially from a seasonally adjusted
it has been insufficient to offset burgeoning
annual rate of 5 billion
dollars during the first
three quarters of 1965
Merchandise imports rise
to about 3.8 billion
faster than exports, beginning in 1965
during the same period
billion dollars
in 1966. This reduc­
30 '
tion has been largely
the result of a sharp
25 increase in imports.
T h roughout the
economic expansion
in the Sixties, United
States imports have
15 been increasing at an
average rate of about
12 percent annually.
At an annual rate of
25.3 billion dollars
during the first nine
months of 1966 (the
latest period for which
reliable data are avail­


Affe cte d

by dock strikes

in December 1962-Ja n u a ry



Jo n u o ry - M arch


Federal Reserve Bank of Chicago

imports—hence, the deterioration of the
trade surplus.
Causes o f rising im ports

The rise in imports may be attributed in
part to the continued advances in domestic
industrial output. United States industry re­
lies on imports of raw materials and indus­
trial supplies and, thus, with production of
finished goods rising, these categories of im­
ports should also increase. As the table on
this page indicates, however, gains in these
categories have been relatively small. More­
over, the rate of growth of imports of indus­
trial supplies comparing the first nine months
of 1966 with the same period of 1965 was
somewhat lower than the rate of growth for
1965 compared with 1964. For example,
imports of crude petroleum and iron ore rose
less than last year while imports of steel mill
products were virtually unchanged. This was

All m ajor imports
advance sharply in 1966
billion dollars




food and

Industrial supplies
show moderate increase
in imports
Selected imports

1966 Change
(million dollars) (percent)

Fuels a n d lu b ric a n ts













T e x tile fib e rs




L um ber


3 19

+ 13

N o n f e r r o u s b a s e m e ta ls


Iro n a n d s te e l
m ill p ro d u c ts
C h e m ic a ls


SOURCE: U.S. Department of Commerce.

in contrast with the abnormally large rise of
60 percent last year caused by hedge buying
in anticipation of the steel strike.
A far more important cause of the sharp
increase in imports appears to lie in the
strains on United States resources in mid1966, resulting from five years of uninter­
rupted rapid expansion. The slack that ex­
isted in the economy in the early phases of the
expansion had been mostly absorbed by
early 1966. The unemployment rate dropped
to the lowest levels since the early Fifties,
and the rate of utilization of manufacturing
capacity reached the highest level since 1955.
Moreover, increased defense requirements
during early 1966 were superimposed on an
already booming economy; thus, while
domestic output continued to expand at a
rapid pace, it could not keep up with the
even more rapid increases in total spending.
As a result, prices rose and demand for
foreign-produced goods to supplement do­
mestic production expanded.

Business Conditions, January 1967

These demand pressures were particularly
marked in the capital goods sector. Domestic
expenditures on new plant and equipment by
American firms in 1966 rose 17 percent from
the record level reached last year. The order
backlog of United States machinery and
equipment producers totaled 23.8 billion dol­
lars in August 1966—a 29 percent increase
from the previous year. Delays in deliveries
and long lead times caused some purchasers
of capital goods to turn to foreign suppliers.
Competitive prices and increasingly more de­
pendable service from foreign suppliers en­
couraged this trend. Consequently, imports
of capital equipment have risen sharply. For
example, imports of metal-cutting tools
jumped 135 percent from January through
September 1966— more than twice the
growth rate of the comparable period of
1965. As the table below indicates, the
increases in other categories also were sub­

Imports of consumer goods
rise appreciably
Selected imports

1966 Change
(million dollars) (precent)

Durable goods
N e w c a rs



C lo th in g



+ 18

G e m s a n d d ia m o n d s


3 09

+ 29


R a d io a n d T V sets



M o t o r c y c le s



+ 53

F o o tw e a r



+ 19

M u s ic a l in s tru m e n ts






+ 21

C o ffe e



+ 18

M eat







+ 16



3 77


W h is k e y




O th e r




O th e r co n su m e r g o o d s

Foods and beverages


SOURCE: U.S. Department of Commerce.

Large jump in imports
of machinery and
transportation equipment
Selected imports




(million dollars) (percent)
T r a n s p o r ta tio n e q u ip m e n t




M a c h in e r y
E le c tr ic a l


6 87

+ 60

P o w e r g e n e r a tin g




T r a c t o r a n d a g r ic u lt u r a l



T e x tile




O f f ic e



+ 40

M e t a lw o r k in g



+ 106

SOURCE: U.S. Department of Commerce.

The higher prosperity of the United States
consumer was reflected in United States im­
ports. Arrivals of consumer durable goods
increased more than 1 billion dollars through
September— a 35 percent gain over the first
nine months of last year. The most notable
increases occurred in the imports of passen­
ger cars, motorcycles and electronic prod­
ucts (mostly radios and TVs from Japan).
The acceleration of the upward trend in im­
ports of cars was brought about largely by the
relaxation of duties on automobile imports
from Canada under the Automotive Products
Trade Act of 1965, but imports of cars from
West Germany, Sweden and Japan also rose.


Federal Reserve Bank of Chicago

In addition, consumer purchases of im­
ported foods and beverages advanced sharply
in the first nine months of 1966. For exam­
ple, imports of beef, mainly from Australia
and New Zealand, increased 60 percent.
Larger supplies of feeder cattle from Canada
and Mexico reflected strong domestic demand
and higher United States prices.

M a jo r exports rise
but less sharply than imports

d ollars

7 r

Rising e x p o rts

While overshadowed by the exceptionally
rapid increase in imports, the United States
export performance in the first three quarters
of 1966, nevertheless, was excellent. Perhaps
the most significant aspect of the export ex­
pansion has been its uniformity both in re­
spect to areas of destination and to individual
categories of goods exported. This was in
sharp contrast with 1965 when the bulk of
the rise in exports represented shipments of
nonagricultural goods to Canada. As indi­
cated below, with the exception of a slight

United States exports
expand to most areas
billion dollars





Far East


(excluding Japan)




chem icals


decline for Oceania (mainly Australia and
New Zealand), the advance in exports in the
first three quarters of 1966 was well dis­
tributed among all areas. In terms of goods
exported, the expan­
sion was evenly distri­
buted between agricul­
tural and nonagricul­
tural products. During
the first nine months
of 1966, agricultural
shipments were run­
ning about 14 percent
higher and nonagricul­
tural products about
12 percent higher than
in the co m parable
period in 1965.
Among agricultural
products, the most sig­
nificant increase oc­
curred in the ship^
ments of wheat. Com■ ■ J H i
mercial sales of wheat
New Zealand
(mainly to Western

Business Conditions, January 1967

Most exports rise
in first nine months of 1966
Selected exports




(million dollars) (percent)
E le c tr ic a l m a c h in e r y


C o n s tr u c tio n m a c h in e r y




P a rts f o r m o t o r v e h ic le s



+ 19

a n d a p p a r a tu s

+ 14

C o a l a n d p e tr o le u m




C a r s a n d tru c k s


6 53

+ 25

E ngines


5 89

+ 18

A ir c r a f t




S c ie n tific in s tru m e n ts



+ 20

O f f ic e m a c h in e r y



+ 19



Iro n a n d s te e l


-1 1

A g r ic u lt u r a l m a c h in e r y





M e t a lw o r k in g m a c h in e r y







m ill p ro d u c ts

O t h e r n o n e le c t r ic a l
m a c h in e r y

SOURCE: U.S. Department of Commerce.

+ 14

tributed among various major categories. But
the specific subcategories reflected the pre­
emptive pressures of domestic demand and
military requirements. For example, while
the shipments under the general category
“machinery” increased 12 percent, metal­
working machinery and construction machin­
ery increased only 3 and 2 percent, respec­

Deterioration of the nation’s trade surplus,
coming at the time when efforts have been
aimed at the reduction in the overall balance
of payments deficit, has been disappointing.
While various measures undertaken by
United States corporations and banks in re­
sponse to the President’s voluntary balance
of payments program have achieved and
even exceeded the goals set up in the previ­
ous year, the improvements attained by these
programs have been obscured by the rise in
Some encouraging signs, however, may be
noted. Most important of these has been the
strong performance of exports and a good
prospect for further increases. The world’s
economic progress—and with it the demand

Europe, South Africa and Japan) accounted
for about four-fifths of the increase. The re­
mainder has been taken up by increases in
shipments of wheat under the PL-480 aid
program. Growing livestock feed
requirements in Western Europe
and Japan account for the steady
The United States share
rise in American exports of corn
of world exports increases in 1966
and other feed grains, as well as
Nonelectrical Electrical Transportation
for increases in soybeans. Higher
prices and reduced domestic sup­
(percent of world exports)
plies of dairy products and eggs—
3 2 .7
2 8 .3
combined with increased output
3 0 .2
2 6 .8
2 8 .2
of these commodities in our larg­
2 4 .0
3 0 .8
2 7 .6
est market, Western Europe—
resulted in a decline in these
1st q u a r t e r
2 9 .4
3 0 .7
2 4 .3
exports in 1966.
2nd q u a rte r
2 5 .0
3 0 .9
2 5 .6
2 8 .3
The gains in nonagricultural
SOURCE: U.S. Department of Commerce, International Commerce
products have been evenly dis­
(various issues).

Federal Reserve Bank of Chicago

for United States exports—shows no signs of
slackening. While there has been some “cool­
ing off” of demand in the economies of some
of the major United States customers (such
as the United Kingdom), others (for example,
France and Italy) are undergoing a vigorous
expansion that will undoubtedly mean furtheir increases in United States exports.
Also encouraging has been the reversal in
the decline of the United States share of
world exports of manufactured goods re­
corded in the first half of 1966 (see table).
However, some of these categories might
have been influenced by a dock strike in Bri­
tain—our major competitor. Thus, it would
be premature to draw conclusions on the basis
of this preliminary evidence. Also, the over­
heating of the economy that became increas­
ingly apparent during the first three quarters

of 1966 appears to be subsiding. Imports of
industrial materials other than steel and
petroleum did not increase in the third quar­
ter after having risen in each of the previous
four quarters. Moreover, there are indications
that domestic demand for machinery and
equipment is moderating. This, together with
increases in capacity, may slow the rise of
this category of imports. Of course, any
leveling in demand for domestic uses will free
more goods for export. With minor excep­
tions, United States manufacturers’ unfilled
export orders for machinery have been ex­
panding since late 1963; and this rate acceler­
ated in 1966. Developments in 1967 may
give the United States manufacturers an
opportunity to “catch up” and thus contribute
to an improvement of our balance of trade
in the months ahead.

Competition in banking: the issues
I n an economy characterized by private
property and production for profit, competi­
tion among buyers and sellers has long been
considered a prime prerequisite of economic
efficiency—efficiency in this context being
construed to include both the maximizing of
output for any given resource used and the
allocation of resources among all possible
uses such that total production is maximized.
So strong has been the American belief in
impersonal market forces to set prices and
guide production, as opposed to joint deci­
sions among producers or the decrees of gov­
ernment boards, that our country early put on
the books the strictest and most comprehen­

sive antitrust legislation in the world. The
basic statutes are the Sherman Act of 1890
and the Clayton and Federal Trade Commis­
sion Acts of 1914.
To be sure, it has long been recognized
that the technologies of some industries pre­
clude primary reliance upon competition to
guide investment, production and pricing. In
these so-called “natural monopolies,” such as
the production and distribution of electric
power and other “public utilities,” the disci­
pline of the marketplace has been replaced
by the deliberations of public regulatory
Still other industries, although not consid-

Business Conditions, January 1967

ered natural monopolies, have been acknowl­
edged as greatly affecting the public interest
and have been partially shielded from the
impact of unrestrained competition. Put
another way, the failure or other malfunc­
tioning of an individual establishment in these
industries has been deemed to have adverse
effects on the economy over and beyond the
injury accruing to the firm’s stockholders.
Consequently, public regulation has been im­
posed in order to assure that certain minimal
operating and fiduciary standards are met.
Of the industries accorded such treatment,
commercial banking is probably the most
W h y banks a re re g u la te d

Demand deposits of commercial banks
provide the primary means of payment and,
hence, are the major component of the money
supply. Widespread failures of banks and
sharp declines in the money supply have
been associated with economic crises in past
years. Furthermore, banks, while presumed
by the public to be safe depositories, typic­
ally have liabilities that are very large in pro­
portion to their capital and consequently
could provide an attractive temptation to
gambling by reckless entrepreneurs. These
conditions alone would suggest the desira­
bility of regulation to assure the liquidity and
solvency of commercial banks. In addition
historical experience lends support to the
view that permitting banks to engage in un­
restrained competition may lead to disastrous
results. The evils of the past—specifically, the
chaos and instability that attended the era of
“free banking” between 1837 and 1863, the
large numbers of bank failures in the 1920s
and the banking collapse and economic de­
pression of the early 1930s—have sufficed to
convince most people that some measure of
Government intervention is not only desira­

ble but an absolute necessity.
The Federal and state governments have
responded to the apparent need by construct­
ing over the years a highly detailed and ex­
tensive system of commercial bank regulation
that includes specific lending and borrowing
restrictions, usury laws, ceilings on rates that
banks may pay on time deposits, the prohibi­
tion of interest on demand deposits, capital
and management requirements for the estab­
lishment of new banks, geographical restric­
tions on branching, requirements for periodic
publication of statements of condition and
examinations by public officials.
W h y c om petition in b an kin g ?

Since official regulation imposes numerous
limitations on the activities of banks, vigorous
competition among banks may appear both
superfluous and inconsistent. After all, one
may ask, is not the public’s interest in having
quality services provided at reasonable prices
protected in banking through public regula­
tion, as it supposedly is for electric utilities
and transportation? The answer, clearly, is in
the negative.
Although commercial banks are subject to
a great number of specific regulations limiting
the scope of their activities, a broad range of
discretion still remains open to them. As far
as their lending and investment activities are
concerned, banks retain the prerogative of
emphasizing particular kinds of loans (for
example, business, consumer, agriculture and
mortgage loans) and of setting prices for
these loans at whatever levels they choose,
subject only to the ceilings on some types of
loans established by state usury laws. Thus,
there is ample room for the play of competi­
tive forces to establish the actual levels of
The scope for nonprice competition in
banking is even wider. The services provided

Federal Reserve Bank of Chicago

in conjunction with the bank’s lending and
deposit business provide a variety of oppor­
tunities for nonprice maneuvers designed to
win new customers and retain old ones. It is
the incomplete nature of regulation which,
while imposing definite constraints on each
bank’s choice of alternative policies, never­
theless permits a wide latitude for the exer­
cise of individual discretion that provides a
meaningful role for competition in banking.
This is the consideration that lay behind the
Supreme Court’s dictum in U. S. vs. Philadel­
phia National Bank that the regulated charac­
ter of banking “makes the play of competi­
tion not less important but more so.”
C hanging view s on com petition


Interest in banking competition has inten­
sified in recent years. After virtually ignoring
the commercial banking industry for many
years, the Justice Department brought suit
in the late 1950s in a number of cases involv­
ing clearinghouse agreements to set uniform
service charges. In more recent years, despite
a long and widely held belief to the contrary,
the courts have ruled that the antitrust laws
apply to acquisitions and mergers in banking
as well as in other areas.
It may appear rather anomalous that the
Federal Government, having established a
superstructure of regulation designed at least
in part for the purpose of limiting competi­
tion in banking, now undertakes to restrict
banks’ actions which might tend to reduce
competition. The issue is further confused by
the fact that the Office of the Comptroller of
the Currency and the Department of Justice
—two agencies of the Federal Government—
have been on occasion cast in the roles of
opposing parties in recent bank merger cases.
It would be inaccurate to portray these events
as reflecting merely a jurisdictional dispute
between Federal agencies. Instead there

appears to be a growing conviction on the
part of public officials and bankers alike that
a reevaluation and revision of policy may now
be in order—though there is little agreement
on specific issues.
Until recently students of banking were
generally agreed that competition was not
only less essential in banking than in most
other industries but in many circumstances
inherently destructive. Flowever, new evi­
dence and reexamination of old arguments
now suggest that competition in banking may
not have been the culprit it has been painted
to be in bringing about the financial crises of
earlier days. The banking troubles of the era
before 1863 are now considered to have been
the result of the absence of a uniform national
currency as well as excessive competition and
the lack of detailed controls over banking.
This deficiency was remedied in part by the
passage of the National Banking Act of 1863,
which substituted national bank notes for
the bewildering variety of state bank issues
then in circulation.
Similarly, the periodic epidemics of bank
failures of the late nineteenth and early
twentieth centuries, as well as the striking
and unprecedented attrition of banks in the
decade following World War I, appear to
have had their roots more in cyclical factors
and secular changes in transportation and
agriculture than in any inherent tendency
toward destructive competition in banking.
Even the banking debacle of the early 1930s
is no longer uncritically viewed as the inevita­
ble result of imprudent banking practices
attributable largely to excessive competition
for deposits. On the contrary, all of these
instances of injury to the banking system—
and in most cases, to the economy as well—
are now generally agreed to have had their
major cause in developments much broader
than local competition and often far removed

Business Conditions, January 1967

from the sphere of individual bank manage­
Moreover, today there exist numerous
safeguards against any widespread and self­
reinforcing epidemic of bank failures. To the
extent that violent cyclical fluctuations in
aggregate economic activity may have been
responsible for the waves of bank failures in
the past, the announced readiness of the Fed­
eral Government and the Federal Reserve
System to take whatever fiscal and monetary
measures are required to maintain a high and
growing level of income and employment

serves as protection against similar future dis­
turbances. To the extent that bank failures
were the result of “runs” on banks occasioned
by general fears on the part of the public of
the inability by banks to redeem their depos­
its for currency, Federal Deposit Insurance
and the readiness of the Federal Reserve to
act as the lender of last resort appear to
afford a sufficient remedy. These safeguards
suggest that competition can play a more im­
portant role in banking than it has until re­
cently without leading to undesirable conse­

Num ber of commercial banks
rises in recent years
following many years of decline



Federal Reserve Bank of Chicago

Regulation frequently has been
Increased number of branches
unsuccessful in suppressing com­
more than offsets decline in number of banks
petition even where it has under­
Change, 1946-64
taken to do so. For example, the
Banking offices
attempt to reduce interbank com­
Number Percent Number Percent Number Percent
petition by erecting strict legal
Branch banking
barriers to entry has been at least
3 ,9 2 2
-3 2 3 -2 3
3 , 5 9 9 118
a major contributing cause to the
5,1 18
6,0 97 290
-9 7 9 -1 5
rapid and continuing growth of
3 3 8 f 14 8 f 1 ,3 56
Unit banking
such nonbank financial intermedi­
-2 8 4 2 1 0 , 3 5 7 2 6 0 1 0 ,0 7 3
aries as savings and loan associa­
*lncludes 50 states and District of Columbia.
tions, a growth that has brought
flndudes offices that do not offer a full line of banking services. In
with it increased interindustry
addition, a few full service branches that were established before legal
prohibitions of branching or after removal of such prohibitions are
The attempt to relieve effects of
SOURCE: U. S., Comptroller of the Currency,
(Washington, 1965).
unduly severe competition among
banks by prohibiting them from
has been declining until very recently.
paying interest on demand deposits has been
After a small immediate postwar rise
only partially successful at best. Far from
from 14,011 in 1945 to 14,181 in 1947, the
eliminating competition, the prohibition sim­
number declined steadily, reaching a low of
ply caused banks to substitute less overt but
13,427 at the end of 1962. Since then the
nonetheless vigorous nonprice rivalry for the
number of banks has increased slightly to
rate competition that previously existed. In
13,784 in November 1966. The net decrease
effect, “interest” on demand deposits con­
of 227 banks since World War II—an aver­
tinues to be paid through an earnings credit
age of about 10 a year—is small compared
offset to deposit service charges and numer­
to the rate that prevailed throughout the gen­
ous “free” services, all dependent largely on
the size of the average balance and the num­
erally prosperous 1920s when the average net
annual attrition exceeded 700. However, in
ber of transactions associated with each
contrast to the earlier period when a signifi­
account. On the other hand, the depositor has
cant part of the attrition resulted from bank
been deprived of the option of being paid in
failures and voluntary liquidations, virtually
all the recent decline has been the result of
Changes in num ber o f banks
mergers and acquisitions that have absorbed
formerly independent banks.
While much of the recent interest in com­
petition in banking has been focused on the
Num bers and com petition
system of bank regulation as presently consti­
To many observers this decrease in the
tuted, expressions of concern have also been
voiced concerning the merging and branching
number of banks provides evidence that the
availability of alternative sources of supply
activities of the banks themselves. Despite
virtually uninterrupted prosperity and popu­
of banking services, and hence the vigor of
competition, is undergoing a decline. This
lation growth in the postwar period, the number of commercial banks in the United States
conclusion is based on the theory that the
A n n u a l


R e p o rt


Business Conditions, January 1967

chances of collusion are less and the likeli­
hood of independent rivalry greater when
sellers are many than when they are few.
However, in evaluating the effect of the
decline in the number of banks, it must be
noted that all of the more than 13,000 banks
in the United States do not compete in a
single, nationwide market. A relatively few
giant banks do operate in what is loosely re­
ferred to as the “national banking market”—
the market for the loans and deposits of the
largest corporations that have banking con­
nections throughout the country.
But it is a widely acknowledged fact that,
for most bank customers, the national market
is segmented by the real and psychic cost of
distance into relatively narrow regional and
local submarkets. For this less mobile ma­
jority of customers, the most relevant con­
sideration is the number of independent
banks within the confined area in which their
reputations are known and in which they find
it practicable to seek accommodation. This
number of banks, however, is not deducible
from a knowledge of how many banks there
are in some broader area, such as the state.
Given the ability of banks to have branch
offices in approximately two-thirds of the
states, it is possible for the average number
of individual banks competing in each local
market to increase even though the number
of banks in these states or in the nation over­
all is declining.
Although states which permit branch bank­
ing have experienced wide declines in the
number of banks, it does not necessarily
follow that significantly fewer different banks
are represented in individual communities in
these states than in those that prohibit branch
banking. This apparent contradiction is ex­
plained by the great expansion in the num­
ber of branch offices during the past several
decades. Similarly, even when mergers have

decreased the total number of banks in the
country and the number of alternatives avail­
able to customers in particular local markets,
they may have added to the number of effec­
tive competitors in the markets serving largeand medium-sized corporate customers by
permitting the merging banks to attain the
minimum size required to operate in these
Concomitant with the decline in the num­
ber of banks, the average size of bank and the
percentage of banking resources concentrated
in the hands of a relatively few large banks
have increased in many broad areas of the
country. Concentration in this sense is often
considered to have a potentially adverse
effect on competition because, however large
the total number of banks in a market, if one
or a few of them control most of the total
supply, they will be able to influence prices
Available data on concentration of depos­
its in major metropolitan areas indicate that
concentration levels were generally higher in
the early 1960s than a decade earlier. On the
other hand, they appear to have been lower
than in the prewar year of 1939. Inasmuch
as concentration and changes in concentra­
tion have significance for competition only in
relation to specific product markets and par­
ticular groups of customers, it is necessary to
take account of important interarea differ­
ences. For the period 1960-64 increases in
concentration have been typical in metropoli­
tan areas in states where statewide branching
is prevalent (see table on page 14). In metro­
politan areas where restricted branch banking
is the rule, increases and decreases were about
equally frequent. Decreases predominated in
these areas where unit banking was the most
common form of bank organization.
Some would interpret these figures as
demonstrating that unit banking is more con-


Federal Reserve Bank of Chicago

ducive to competition than branch banking.
However, such a conclusion follows only if
certain conditions are satisfied. Among these
is the rather crucial assumption that metro­
politan areas serve equally well as approxi­
mations to local banking markets under both
branch and unit banking. To the extent that
locational convenience serves to restrict the
practicable range of alternatives of some cus­
tomers to an area smaller than the whole
metropolitan area, concentration in unit
banking areas is understated by the measure
used here. A more important qualification is
that competition has not been shown to de­
pend in any simple and reliable way on the
degree of concentration in bank markets.1

M e tro p o lita n areas in statewide
branch banking states show
greatest increases in concentration
Percent o f to ta l deposits
held by th re e larg e st banks

SMSAs including
reserve c itie s *




Branch banking


Los Angeles
Portland, Ore.


























Public policy to w a rd b a n k m erg ers

San Francisco









In deciding whether to approve or dis­
approve a particular application to merge, the
appropriate regulatory agency must arrive at
a judgment concerning the probable effect
of the merger on the public interest. The
fundamental questions that must be answered
include the justification of the consolidation
in terms of economies of scale or the ability
of a larger bank to render better, cheaper
and more complete banking services and its
effect, via changes in the number and size
distribution of banks, on the competitive re­
lations among the remaining firms. It is over
answers to these questions that much of the
interagency conflict has arisen.
For example, advantages in the form of
lower operating costs have often been ad­
vanced as a major factor in bank mergers.
Yet, available empirical studies tend to indi­
cate that such economies may be quite modest
—at least when the differences in output mix
between large and small banks are taken into
























New Orleans



New York



















Washington, D. C.














Fort Worth




Unit banking
















Oklahoma City







St. Louis




San Antonio

T hese and other measures of the degree of com­
petition are discussed in Business Conditions,
December 1965, pp. 11-16.

Kansas City, Mo.








*M e tro p o lifa n




C ities



populations in excess o f 400,000 as o f A p ril 1, 1960.
SOURCE: Federal D eposit Insurance C o rp o ra tio n ,
A n n u a l R e p o rts .

Business Conditions, January 1967

consideration, as they must be.
A second argument in support of mergers
emphasizes the ability of a bank with greater
resources to hire better management and to
utilize more fully the services of a large
number of specialists. This argument appears
to have fairly general validity as indicated by
both casual observation and a number of
recent studies. Large banks generally do offer
a broader variety of services than is obtaina­
ble at small banks in the same locality. How­
ever, whether this constitutes a net advantage
is not immediately obvious. It must be deter­
mined whether a decrease in the number of
alternative sources of banking services is ade­
quately compensated by the availability of a
number of special, but infrequently utilized,
services that only large banks can supply.
Branch b a n k in g

Any discussion of the relative merits of
large and small banks must include consider­
ation of the arguments in support of and
opposition to branch banking. One of the
major advantages claimed for branching is
that it is often the quickest way a bank can
grow to large size. Also, since the full re­
sources and facilities of the bank can be made
available to the customers of each branch,
branch banking provides a means of bringing
a fuller range of banking services and larger
lending capacity to individual communities.
The advantages and disadvantages of
branch banking constitute one of the oldest
and most vitriolic controversies in American
banking. The arguments involve questions
both political and economic in character.
Without evaluating the merits of the argu­
ments, it may be noted that the unit-branch
issue is an inseparable part of the larger pub­
lic debate over competition in banking re­
viewed above.
The precise relationship between the

branch banking and banking competition is a
matter of dispute. A number of economists,
bankers and public officials maintain that
branching is an essentially procompetitive
form of banking that facilitates the penetra­
tion of additional banking markets and brings
to bear the force of potential competition on
even the smallest and most isolated banking
markets. On the other hand, many students
of banking hold that branching is a monopo­
listic device whose prime purpose is the at­
tenuation of competition. Which characteri­
zation is the more accurate may depend as
much on what one understands by competi­
tion as on the objectively determinable facts
of the case.
It is hardly open to serious doubt, for ex­
ample, that some portion of the criticism of
branch banking is of a protectionist nature,
more concerned with preserving locally
owned unit banks than with fostering vigor­
ous interbank rivalry. Independent bankers
frequently feel themselves threatened by the
presence of a nearby office of a large branch
On the other hand, it is not always easy to
distinguish in practice between the protec­
tion of competitors and the preservation of
competition. One reason is related to the dif­
ference between the incentives required to
induce merger and those required to induce
de novo establishment of a new bank or
branch. It appears easier for two existing
banks to come to terms on a merger agree­
ment which has as one of its “fringe bene­
fits” the elimination of competition than it is
for a potential entrant into the banking field
to obtain financing and run the regulatory
gauntlet required to obtain a charter for a
new bank. As was indicated above, it is in
these areas where the possibility of operating
an acquired bank as a branch maximizes the
incentive to merge that the disappearance of


Federal Reserve Bank of Chicago


banks and the concentration of banking have
proceeded most rapidly. This pronounced
assymmetry between merger and entry is the
primary reason why branching via merger,
which ipso facto involves the elimination of
an independent source of supply, may have
adverse and irreversible effects on competi­
tion. It is also one of the considerations that
prompted Congress in 1950 to strengthen the
Clayton Act and to pass the Bank Merger
Acts of 1960 and 1966.
It might still be maintained, on the other
hand, that de novo branching could have
nothing but beneficial effects on competition.
Its immediate effect is always to introduce a
new competitive force into a banking market
or submarket. When, for example, a branch
bank sees a potentially profitable location for
a banking office and opens a branch there—
perhaps years in advance of the time when it
would have been profitable to organize a new
unit bank—it benefits the community to have
banking facilities where none existed before
or would otherwise have existed for a con­
siderable period of time. Whether this is a
net gain in the long term depends on the po­
tential benefit to the local populace of having
an independent source of supply of banking
services when it would become feasible to
open a new unit bank.
Where banks find it easy to establish
branches within a local banking market they
may—and often do— anticipate profitable
locations and saturate entire areas with
branches, thereby largely foreclosing future
entry by competitors. In this they may be
inadvertently aided and abeted by the regu­
latory agencies, which are frequently re­
luctant to grant a new charter that could
conceivably result in “overbanking.” Over­
banking typically implies a situation in which
insufficient banking business is considered to
exist to support all of the banking institutions

in the area and which must eventually result
in the forced exit of one or more of them.
At a theoretical level a good case can be
made for removing all geographic restrictions
on branching, while simultaneously discour­
aging concentration in particular local bank­
ing markets. However, this would require a
uniform national policy with respect to
branching and the chartering of new banks, a
development not now on the horizon. Legis­
lation regarding branching traditionally has
been left to the states. Nevertheless, the com­
petitive environment created by state branch­
ing restrictions is clearly one of the many
factors that must be taken into account in
Federal Agency decisions governing mergers.

There exists a great deal of uncertainty at
the present time as to what public policy
would promote optimum competition in
banking. Ideally, policy should undertake to
attain a degree of interbank rivalry that
assures that consumers will be provided bank
services of high quality at minimum cost,
without sacrificing the private and public
benefits of large-scale production or the regu­
latory aim of ensuring the liquidity and solv­
ency of the banking system. The extent to
which these goals can be realized simultane­
ously and even the direction in which policy
should move to approach them as closely as
possible is still imperfectly understood. How­
ever, a start toward collecting and interpret­
ing the data that would permit a more objec­
tive basis for deciding these issues has been
made. In a subsequent article the limited but
growing body of empirical knowledge of the
relationship between banking structure and
performance will be reviewed. This informa­
tion, limited and inconclusive as it is, consti­
tutes the hard-won fruit of numerous past and
current research studies.

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102