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A review by the 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 Business Conditions The diminishing trade surplus 3 Competition in banking: the issues 8 BUSINESS C O N D IT IO N S 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." Subscriptions to Business Conditions a re a v a ila b le 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 . Articles m ay be re p rin te d p ro v id e d source is 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 y e a r's d eve lo p m e n ts in business, a g ric u ltu re a n d b a n k in g , a n d a 2 4 -p a g e illu stra ted fe a tu r e a r t i cle, " M a c h in e ry a n d e q u ip m e n t—key industries in 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 20 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 . 1961 1962 1963 1964 1965 1966 reliable data are avail - Affe cte d by dock strikes in December 1962-Ja n u a ry 1963 and Jo n u o ry - M arch 1965 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 industrial moterials capital equipment consumer durables food and beverages Industrial supplies show moderate increase in imports January-September Selected imports 1965 1966 Change (million dollars) (percent) Fuels a n d lu b ric a n ts 1,653 1,715 + 832 1,074 +29 864 864 0 549 725 +32 T e x tile fib e rs 329 358 + L um ber 282 3 19 + 13 N o n f e r r o u s b a s e m e ta ls 4 Iro n a n d s te e l m ill p ro d u c ts C h e m ic a ls 9 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 stantial. Imports of consumer goods rise appreciably January-September Selected imports 1965 1966 Change (million dollars) (precent) Durable goods N e w c a rs 433 840 C lo th in g 389 458 + 18 G e m s a n d d ia m o n d s 239 3 09 + 29 +47 +94 R a d io a n d T V sets 118 173 M o t o r c y c le s 102 156 + 53 F o o tw e a r 118 141 + 19 M u s ic a l in s tru m e n ts 105 135 +29 1,413 1,712 + 21 C o ffe e 692 820 + 18 M eat 300 442 +47 Fish 348 404 + 16 Sugar 298 3 77 +27 W h is k e y 181 226 +25 O th e r 903 945 + O th e r co n su m e r g o o d s Foods and beverages 5 SOURCE: U.S. Department of Commerce. Large jump in imports of machinery and transportation equipment January-September Selected imports 1965 1966 Change (million dollars) (percent) T r a n s p o r ta tio n e q u ip m e n t 803 1,546 +93 M a c h in e r y E le c tr ic a l 428 6 87 + 60 P o w e r g e n e r a tin g 138 239 +72 +31 T r a c t o r a n d a g r ic u lt u r a l 149 195 T e x tile 108 162 +49 O f f ic e 94 131 + 40 M e t a lw o r k in g 43 88 + 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. 5 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 billion 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 6 Western Europe Conado Latin Far East America (excluding Japan) Jopan machinery transportation equipment chem icals agricultural products 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 January-September Selected exports 1965 1966 Change (million dollars) (percent) E le c tr ic a l m a c h in e r y 1,219 1,393 C o n s tr u c tio n m a c h in e r y 727 743 + P a rts f o r m o t o r v e h ic le s 617 735 + 19 a n d a p p a r a tu s + 14 2 C o a l a n d p e tr o le u m 675 688 + C a r s a n d tru c k s 524 6 53 + 25 E ngines 498 5 89 + 18 A ir c r a f t 601 576 - S c ie n tific in s tru m e n ts 345 413 + 20 O f f ic e m a c h in e r y 333 395 + 19 2 4 Iro n a n d s te e l 437 391 -1 1 A g r ic u lt u r a l m a c h in e r y 338 357 + 6 M e t a lw o r k in g m a c h in e r y 239 246 + 3 1,710 1,957 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 tively. Conclusions 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 imports. 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 machinery machinery equipment Chemicals prices and reduced domestic sup (percent of world exports) plies of dairy products and eggs— 3 2 .7 2 8 .3 33.1 29.6 1960 combined with increased output 26.9 1963 3 0 .2 2 6 .8 2 8 .2 of these commodities in our larg 2 4 .0 24.7 1965 3 0 .8 2 7 .6 est market, Western Europe— 1966 resulted in a decline in these 1st q u a r t e r 2 9 .4 3 0 .7 25.1 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 agencies. 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 prominent. 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 charges. 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 10 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 ment. 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 quences. Num ber of commercial banks rises in recent years following many years of decline thousands 11 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 State Banks Branches attempt to reduce interbank com classification* Number Percent Number Percent Number Percent petition by erecting strict legal Branch banking barriers to entry has been at least 3 ,9 2 2 24 -3 2 3 -2 3 3 , 5 9 9 118 Statewide a major contributing cause to the 60 5,1 18 6,0 97 290 Limited -9 7 9 -1 5 rapid and continuing growth of 21 1,018 17 3 3 8 f 14 8 f 1 ,3 56 Unit banking such nonbank financial intermedi 56 -2 8 4 2 1 0 , 3 5 7 2 6 0 1 0 ,0 7 3 Total 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 competition. included. 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 cash. 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 12 R e p o rt 1964 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 markets. 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 strongly. 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- 13 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 * 1960 1962 1964 Branch banking Statewide Baltimore 59 78 Los Angeles Portland, Ore. 73 72 75 90 71 77 74 87 60 Seattle 68 79 72 Limited Atlanta 72 75 Birmingham 93 93 97 Boston 79 83 83 Buffalo 77 82 93 84 95 Cincinnati Public policy to w a rd b a n k m erg ers San Francisco 89 Cleveland 78 77 76 72 84 Columbus 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 88 87 93 Detroit 78 76 74 Indianapolis 97 96 96 Louisville 68 76 76 Memphis 93 93 93 Nashville 89 92 93 New Orleans 85 80 New York 53 79 54 Philadelphia 49 64 62 64 Pittsburgh 82 83 81 Richmond 80 78 73 Toledo 90 88 88 Washington, D. C. 74 75 73 48 53 52 80 79 76 Denver 69 68 68 Fort Worth 77 76 73 64 Unit banking Chicago Dallas 14 60 59 79 63 75 61 72 Miami Milwaukee 41 40 68 43 67 Minneapolis 60 62 60 Oklahoma City 70 72 71 Omaha 82 80 St. Louis 52 50 79 48 San Antonio T hese and other measures of the degree of com petition are discussed in Business Conditions, December 1965, pp. 11-16. Houston Jacksonville Kansas City, Mo. 67 64 62 Tulsa 81 79 76 *M e tro p o lifa n areas of Reserve C ities 58 66 having 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 bank. 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 15 Federal Reserve Bank of Chicago 16 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. Conclusion 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.