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September I, 1989 eCONOMIC COMMeNTORY Federal Reserve Bank of Cleveland Have the Characteristics of High-Earning Banks Changed? Evidence from Ohio by Paul R. Watro Many factors affect bank earnings, including the overall quality of management, risk preferences, economic and Numerous studies have examined bank earnings to isolate factors that account for differences in banks' financial condi- Regulatory and technological changes in the banking industry have had a pronounced effect on bank operations in the last decade. By analyzing the average return on competitive conditions, revenues, cost controls, and luck. The relative impor- tion. The general approach of these studies has been to examine a range of tance ofthese factors is important not only to bank managers and investors, but also to regulators, who are concerned about banks' financial condition. bank operating ratios and to identify the ones that could best explain earnings differences among banks in a given year or time period. Researchers generally con- Bank regulators and others have been increasingly concerned with the presumably greater risk-taking by lenders, declining earnings, and a con- expenses, particularly noninterest expense ratios, has been the most important determinant of bank profitability. financial institutions earned higher returns after deregulation, while the Although this evidence is fairly consis- earnings of poorly managed banks deteriorated. clude that management's control over tinued rise in bank failures in this decade. 1 During the I980s, banks have been charging off loans at about twice the rate that was experienced in the 1970s. Banks' return on assets and equity has also fallen significantly, and the number of bank failures has jumped from a yearly average of less tent and strong, the majority of the previous studies either were conducted prior to deregulation or used data collected when regulatory and legislative constraints were more restrictive with regard to bank location, products, and prices. than 10 during the 1970s to 100-200 ISSN 0428-1276 - per year over the last four years. This Economic Commentary identifies the characteristics of high-earning While financial distress in banking has been attributed mostly to recessions in banks in Ohio before and after deregulation, showing that they have changed the agriculture and energy industries and to the international debt problem in the early 1980s, studies have generally concluded that management is the key because of differences in the banking environment. It also finds a greater element between the ultimate success or failure of banks.f earning institutions generating higher disparity between the best- and worstperforming banks, with the highreturns than they did prior to deregulation. assets for both high- and low-earning banks in Ohio over five-year periods in the mid-1970s and mid-1980s, the author finds that the top-performing • Sample and Analysis We limit the analysis to banks in one state to control for branching laws, ownership constraints, and regional economic conditions. Ohio is a good state to examine for several reasons. Its banks have not generally been involved in a large amount of energy, agriculture, and international lending, so bank earnings have not been significantly affected by the boom-andbust cycles that occurred in these sectors. Also, Ohio branching laws were liberated in 1979, and interstate bank acquisitions were authorized in 1983. These major reductions in locational constraints, coupled with interest-rate deregulation, afforded bank management new opportunities to achieve superior performance. In addition, bank operations and earnings may have been affected significantly by the expanded powers of the savings and loan (thrift) industry since the early I980s, particularly since these institutions have a sizable presence in Ohio. Thus, it is reasonable to expect that differences in the characteristics of Ohio bank earnings between the mid1970s and mid-I 980s can be largely attributed to regulatory and technological changes. Earnings were measured by the average return on assets for all Ohio banks that operated continuously over either the 1973-1977 or the 1983-1987 period. Earnings over each of the fiveyear periods were used to reduce the variation due to chance. Banks that ranked in the top 20 percent were classified as high earners; those in the bottom 20 percent were designated as low earners. Each group contained 94 banks in the prederegulation period, but only 56 banks in the postderegulation period. The substantial drop in this sample reflects the continued consolidation in the Ohio banking industry through mergers. Data were collected on institutional size, ownership, branches, growth, asset holdings, loan quality and composition, deposit structure, revenues, and expenses. Additional data were gathered on local competitive and economic conditions, such as market concentration, the share of deposits held by thrift institutions in age, because the capital positions of these banks also improved substantially. the market, and personal income growth in the market.' Each of these factors may influence bank earnings, although • Size, Ownership, Concentration only some of them are under the direct control of bank management. For each of the variables, we calculated mean values for the high and low earners for nificant differences in size, ownership, and market concentration between the high and low earners (table 2). High- both periods. Using a standard statistical test, we determined if the means were different between the two bank groups in either period. • Findings Results are presented in tables I through 4. Table I gives the mean values and differences for the high- and low-earning banks during the pre- and postderegulatory period. As expected, we found large differences, which varied considerably over time. Caution should be exercised in applying these findings to banking in general, however, since results are based on data and ment. The high earners generated a 1.62 percent return on their assets over the last five years, compared to 1.46 percent over the 1973-77 period. Also, these banks did not experience a significant rise in earnings volatility, as the low-earning banks did in recent years. Moreover, higher earnings by the most profitable banks did not appear to result from using greater financial lever- office, compared to $13.6 million per office for the low-earning banks. In 1973-1977 1983·1987 All High Banks Earners Low Earners Banks Earners Low Earners High All 1.46 (0.24) 0.52 (0.25) 0.98 (0.56) 1.62 (0.27) 0.21 (0.64) earning banks were smaller, were more likely to be independent, and were headquartered in more concentrated Percent return on equity 12.1 (3.51) 15.0 (2.26) 7.6 (3.74) 10.9 (6.60) 14.8 (3.33) (9.57) banking markets. After deregulation, however, these factors were not statisti- Capital Equity as a percent of assets 8.2 (2.12) 10.0 ( 1.89) 7.2 (1.54) 8.8 (2.70) 11.6 cally associated with bank earnings. Even when thrift institutions are taken into account, the local structure of banking markets may no longer ac- 2.4 7.4 (1.64 ) (3.71 ) NOTE: A t-testindicatedthatthedifferencesinthemeanvaluesforhigh-andlow-earning bankswerestatisticallydifferentfromzeroat the I percentlevelineachperiod.Standarddeviationsareinparentheses. SOURCE: FederalFinancialInstitutions ExaminationCouncil'sReportsof IncomeandConditionforBanks. curately reflect the competitive conditions for banking services in an area.4 The threat of entry by financial institutions outside the market may act as an In the last five years, banks have been earning about the same returns on as- ings. However, the high-earning banks apparently were quite successful in capitalizing on the opportunities that arose from a less-regulated banking environ- OF OHIO BANKS 0.99 (0.35) which would force local institutions to react to price and service changes from outside suppliers. In the postderegulatory period, the worst-performing banks experienced much lower and more volatile earn- AND CAPITAL Earnings Percent return on assets from only one state and on a single cross-section study. earnings, as indicated by the standard deviation for the return on assets and equity, has increased significantly, suggesting that banking is generally more risky today than in the past. EARNINGS addition, more than two-fifths of the high-earning banks were unit banks in both periods examined. Before deregulation, there were sig- effective disciplinary force and exert downward pressure on earnings. Alternatively, bank customers may no longer be limited by geographical area, sets, but have been earning lower retums on equity than they did in the 1973-1977 period, as shown in table I. In addition, the variability in bank - TABLE 1 The effect of institutional size and ownership on bank earnings has underlying implications for the future banking structure. Given the wave of technological changes, deposit-rate competition, and widespread movement toward eliminating geographic banking barriers, the survival of small and independently owned banks has been in question for many years. Although we sti II find some of these banks outperforming larger banks belonging to bank holding companies, the probability of being a high-earning bank is no longer greater for small or independent banks in the less regulatory and more competitive environment. What seems to be important from an institutional standpoint is now office size. In order to compete aggressively on a price basis, banks have been forced to reduce overhead costs to offset the higher explicit rates being paid on deposits. The high-earning banks had deposits of $19.6 million per _ TABLE 2 INSTITUTIONAL AND MARKET Earners Institutional factors Deposit size ($ mil) Asset growth over period (%) Number of offices Average office size ($ mil) Unit bank (%) Bank holding company subsidiary (%) Multibank holding company subsidiary (%) Market concentration" Herfindahl index Thrift market deposit share (%) Economic conditions Personal income growth over period (%) earnings in banking (tables 3 and 4). Bank costs are generally classified into two major components: interest and noninterest costs. Given the level of interest rates, interest cost depends on the volume and mix of liabilities. Prior to deregulation, high-earning banks kept interest costs down by holding a larger share of noninterest-bearing demand deposits, which enabled them to pay significantly less for deposits (table 3). Highearning banks also held fewer higherpaying time deposits, including large certificates of deposit. FACTORS 1973-1977 High • Expenses and Revenues Cost containment continues to be the key for achieving consistently high 1983-1987 Low Earners Earners Low Earners 136.3 56.5 6.9 13.6 25.0 37.5 High 39.la 64.6 2.8b 9.8 42.6b 9.2 23.4 203.9 66.0 6.5 19.6b 42.9b 19.1b 44.7 42.9 86.5 64.8 5.4 12.8b 35.1 19.6 21.4 2475a 2066 2441 2163 31.6 32.9 32.4 34.2 52.8 51.1 42.8 41.0 a. Denotessignificanceat 5 percentlevel. b. Denotessignificance at I percentlevel. c. Figuresfor 1975 and 1984 only. NOTE: A t-testwasusedtodetermineifthedifferencesinthemeanvaluesforhigh-andlow-earning banks werestatisticallydifferentfromzerowithineachtimeperiod. SOURCES: FederalFinancialInstitutionsExaminationCouncil'sReportsof IncomeandConditionfor Banks,Summaryof DepositDatafromtheBoardofGovernorsoftheFederalReserveSystem,andU.S. BureauoftheCensus. After deregulation, the interest-expense gap between the high and low earners was cut in half as their deposit composition and rates became similar. Nevertheless, through less reliance on expensive borrowed funds, the high earners still maintained significantly lower interest expenses. Noninterest expenses have been increasing throughout the lasi two decades. These expenses include all expense items involved in overall bank operations, such as employee compensation, advertising costs, legal fees, insurance premiums, and directors' fees, as well as expenses of premises and fixed assets. In an effort to enhance earnings, banks have been closely monitoring personnel and occupancy costs. Some banks have elected to streamline operations through staff reductions, branch closings, and consolidation of operations. In addition, with the liberalization of Ohio branching restrictions, some bank holding companies have consolidated and merged subsidiary banks on a regional or state basis in an effort to increase centralization and efficiency. Al- • Sample and Analysis We limit the analysis to banks in one state to control for branching laws, ownership constraints, and regional economic conditions. Ohio is a good state to examine for several reasons. Its banks have not generally been involved in a large amount of energy, agriculture, and international lending, so bank earnings have not been significantly affected by the boom-andbust cycles that occurred in these sectors. Also, Ohio branching laws were liberated in 1979, and interstate bank acquisitions were authorized in 1983. These major reductions in locational constraints, coupled with interest-rate deregulation, afforded bank management new opportunities to achieve superior performance. In addition, bank operations and earnings may have been affected significantly by the expanded powers of the savings and loan (thrift) industry since the early I980s, particularly since these institutions have a sizable presence in Ohio. Thus, it is reasonable to expect that differences in the characteristics of Ohio bank earnings between the mid1970s and mid-I 980s can be largely attributed to regulatory and technological changes. Earnings were measured by the average return on assets for all Ohio banks that operated continuously over either the 1973-1977 or the 1983-1987 period. Earnings over each of the fiveyear periods were used to reduce the variation due to chance. Banks that ranked in the top 20 percent were classified as high earners; those in the bottom 20 percent were designated as low earners. Each group contained 94 banks in the prederegulation period, but only 56 banks in the postderegulation period. The substantial drop in this sample reflects the continued consolidation in the Ohio banking industry through mergers. Data were collected on institutional size, ownership, branches, growth, asset holdings, loan quality and composition, deposit structure, revenues, and expenses. Additional data were gathered on local competitive and economic conditions, such as market concentration, the share of deposits held by thrift institutions in age, because the capital positions of these banks also improved substantially. the market, and personal income growth in the market.' Each of these factors may influence bank earnings, although • Size, Ownership, Concentration only some of them are under the direct control of bank management. For each of the variables, we calculated mean values for the high and low earners for nificant differences in size, ownership, and market concentration between the high and low earners (table 2). High- both periods. Using a standard statistical test, we determined if the means were different between the two bank groups in either period. • Findings Results are presented in tables I through 4. Table I gives the mean values and differences for the high- and low-earning banks during the pre- and postderegulatory period. As expected, we found large differences, which varied considerably over time. Caution should be exercised in applying these findings to banking in general, however, since results are based on data and ment. The high earners generated a 1.62 percent return on their assets over the last five years, compared to 1.46 percent over the 1973-77 period. Also, these banks did not experience a significant rise in earnings volatility, as the low-earning banks did in recent years. Moreover, higher earnings by the most profitable banks did not appear to result from using greater financial lever- office, compared to $13.6 million per office for the low-earning banks. In 1973-1977 1983·1987 All High Banks Earners Low Earners Banks Earners Low Earners High All 1.46 (0.24) 0.52 (0.25) 0.98 (0.56) 1.62 (0.27) 0.21 (0.64) earning banks were smaller, were more likely to be independent, and were headquartered in more concentrated Percent return on equity 12.1 (3.51) 15.0 (2.26) 7.6 (3.74) 10.9 (6.60) 14.8 (3.33) (9.57) banking markets. After deregulation, however, these factors were not statisti- Capital Equity as a percent of assets 8.2 (2.12) 10.0 ( 1.89) 7.2 (1.54) 8.8 (2.70) 11.6 cally associated with bank earnings. Even when thrift institutions are taken into account, the local structure of banking markets may no longer ac- 2.4 7.4 (1.64 ) (3.71 ) NOTE: A t-testindicatedthatthedifferencesinthemeanvaluesforhigh-andlow-earning bankswerestatisticallydifferentfromzeroat the I percentlevelineachperiod.Standarddeviationsareinparentheses. SOURCE: FederalFinancialInstitutions ExaminationCouncil'sReportsof IncomeandConditionforBanks. curately reflect the competitive conditions for banking services in an area.4 The threat of entry by financial institutions outside the market may act as an In the last five years, banks have been earning about the same returns on as- ings. However, the high-earning banks apparently were quite successful in capitalizing on the opportunities that arose from a less-regulated banking environ- OF OHIO BANKS 0.99 (0.35) which would force local institutions to react to price and service changes from outside suppliers. In the postderegulatory period, the worst-performing banks experienced much lower and more volatile earn- AND CAPITAL Earnings Percent return on assets from only one state and on a single cross-section study. earnings, as indicated by the standard deviation for the return on assets and equity, has increased significantly, suggesting that banking is generally more risky today than in the past. EARNINGS addition, more than two-fifths of the high-earning banks were unit banks in both periods examined. Before deregulation, there were sig- effective disciplinary force and exert downward pressure on earnings. Alternatively, bank customers may no longer be limited by geographical area, sets, but have been earning lower retums on equity than they did in the 1973-1977 period, as shown in table I. In addition, the variability in bank - TABLE 1 The effect of institutional size and ownership on bank earnings has underlying implications for the future banking structure. Given the wave of technological changes, deposit-rate competition, and widespread movement toward eliminating geographic banking barriers, the survival of small and independently owned banks has been in question for many years. Although we sti II find some of these banks outperforming larger banks belonging to bank holding companies, the probability of being a high-earning bank is no longer greater for small or independent banks in the less regulatory and more competitive environment. What seems to be important from an institutional standpoint is now office size. In order to compete aggressively on a price basis, banks have been forced to reduce overhead costs to offset the higher explicit rates being paid on deposits. The high-earning banks had deposits of $19.6 million per _ TABLE 2 INSTITUTIONAL AND MARKET Earners Institutional factors Deposit size ($ mil) Asset growth over period (%) Number of offices Average office size ($ mil) Unit bank (%) Bank holding company subsidiary (%) Multibank holding company subsidiary (%) Market concentration" Herfindahl index Thrift market deposit share (%) Economic conditions Personal income growth over period (%) earnings in banking (tables 3 and 4). Bank costs are generally classified into two major components: interest and noninterest costs. Given the level of interest rates, interest cost depends on the volume and mix of liabilities. Prior to deregulation, high-earning banks kept interest costs down by holding a larger share of noninterest-bearing demand deposits, which enabled them to pay significantly less for deposits (table 3). Highearning banks also held fewer higherpaying time deposits, including large certificates of deposit. FACTORS 1973-1977 High • Expenses and Revenues Cost containment continues to be the key for achieving consistently high 1983-1987 Low Earners Earners Low Earners 136.3 56.5 6.9 13.6 25.0 37.5 High 39.la 64.6 2.8b 9.8 42.6b 9.2 23.4 203.9 66.0 6.5 19.6b 42.9b 19.1b 44.7 42.9 86.5 64.8 5.4 12.8b 35.1 19.6 21.4 2475a 2066 2441 2163 31.6 32.9 32.4 34.2 52.8 51.1 42.8 41.0 a. Denotessignificanceat 5 percentlevel. b. Denotessignificance at I percentlevel. c. Figuresfor 1975 and 1984 only. NOTE: A t-testwasusedtodetermineifthedifferencesinthemeanvaluesforhigh-andlow-earning banks werestatisticallydifferentfromzerowithineachtimeperiod. SOURCES: FederalFinancialInstitutionsExaminationCouncil'sReportsof IncomeandConditionfor Banks,Summaryof DepositDatafromtheBoardofGovernorsoftheFederalReserveSystem,andU.S. BureauoftheCensus. After deregulation, the interest-expense gap between the high and low earners was cut in half as their deposit composition and rates became similar. Nevertheless, through less reliance on expensive borrowed funds, the high earners still maintained significantly lower interest expenses. Noninterest expenses have been increasing throughout the lasi two decades. These expenses include all expense items involved in overall bank operations, such as employee compensation, advertising costs, legal fees, insurance premiums, and directors' fees, as well as expenses of premises and fixed assets. In an effort to enhance earnings, banks have been closely monitoring personnel and occupancy costs. Some banks have elected to streamline operations through staff reductions, branch closings, and consolidation of operations. In addition, with the liberalization of Ohio branching restrictions, some bank holding companies have consolidated and merged subsidiary banks on a regional or state basis in an effort to increase centralization and efficiency. Al- _ TABLE3 EXPENSES AND REVENUES though high-earning 1973-1977 High Earners Expenses Interest A verage deposit rate Noninterest Salaries Average salary ($) Premises Provisions for loan losses Low Earners 5.20a 3.06a 3.33a 2.15a 1. lOa 6.78 3.87 3.89 2.94 1.43 9,015 0.27a 0.12a Revenues Interest A verage loan rate Noninterest 1983-1987 8,912 0.45 0.34 7.88 7.40 7.82 7.27 8.89 0.43 8.71 0.34b High Earners 8.24a 5.60b 6.29 2.66a 1.33a 20,730c 0.33a 0.28a Low Earners banks had lower salary expenses as a percentage of their assets, they paid significantly higher average salaries per employee than the low earners over the last five years. 9.51 6.02 6.43 Noninterest costs are also affected by the volume and mix of assets and 3.57 1.69 liabilities. Some assets, such as loans, are typically riskier and more costly to 19,384 0.54 0.72 make and to service than investments in government securities. Lenders also 11.06b 1O.45a 10.73 10.01 12.10 0.61 11.97 0.54 a. Denotes significanceat the I percent level. b. Denotessignificanceat the 5 percent level. c. Denotessignificanceat the 10 percent level. NOTE: Figuresare based on percentageof averageassets, except for average salary. A t-test was used to determine if the differences in the mean values for high- and low-earningbanks were statisticallydifferent from incur higher costs in extending certain types of credit, such as business and commercial real estate loans, which historically have higher default rates than consumer installment and mortgage loans. Banks that operate more branch offices are also likely to have higher occupancy expenses. zero within each time period. Table 4 shows that high-earning banks held a larger share of their assets in SOURCE: FederalFinancial InstitutionsExaminationCouncil's Reportsof Incomeand Conditionfor Banks. securities and a smaller share in both loans and premises and other fixed assets than low-earning banks in both _ TABLE 4 ASSET, LOAN, AND DEPOSIT COMPOSITION 1973-1977 Earners 93.4a 48.4a 35.6a 91.8 96.5a 55.3 27.5 2.05 48.2a 35.3a l.04a 13.2a 17.5a 35.0 0.8 44.6 6.8 18.4 13.4 9.0 36.0 1.2 41.7 15.3 28.5 1.4 Earners Asset structure (%) Earning assets Loans Securities Premises Loan composition Business Farm Consumer Credit card Real estate Commercial Deposit composition Demand Other transaction Savings Time Large time 1983-1987 Low Earners High 1.25a periods examined. High Low Earners 94.1 52.7 25.2 1.83 (%) (%) 36.4a 0 31.3b 32.3b 4.3a 7.0 29.5 0 34.7 35.8 6.7 48.2 6.5c 16.2 11.7 26.3 45.8 6.0 15.0 12.5 28.6 0.9 50.1 8.1 15.3 12.5 26.3 45.9 6.6 a. Denotes significanceat the I percent level. b. Denotessignificanceat the 5 percent level. c. Denotessignificanceat the 10 percent level. NOTE: A t-test was used to determine if the differencesin the mean values for high- and low-eamingbanks were statisticallydifferent from zero withineach time period. SOURCE: Federal FinancialInstitutionsExaminationCouncil's Reportsof Incomeand Condition for Banks. These factors helped the high-earning banks maintain significantly lower outlays for overhead expenses, including those for salaries, premises, and loan-loss provisions. Rather than decreasing in importance, the noninterest expense difference between the high- and low-earning banks became larger across the board in the postderegulatory period. Somewhat surprisingly, the composition of loans was similar in the 1983-1987 period, except that the high earners made fewer commercial real estate mortgages. In contrast, the low earners made more business loans and fewer farm loans in the prederegulatory period. Before similar banks, earners deregulation, revenues were for the high- and low-earning but after deregulation, the high generated greater income even though they held fewer and presumably higher-quality loans. Higher revenues came from holding a significantly larger share of earning assets and from generating higher yields on investments. • Conclusion • Characteristics of high-earning banks 1. Many economists argue that the mispric- in Ohio have changed significantly since the mid-1970s. Prior to deregulation, a larger number of the high earners were not affiliated with a multibank holding company and operated in more concentrated markets. After deregulation, however, ownership or market concentration did not seem to matter. Perhaps independent banks have lost any edge that they may have had over multibank holding company banks, and perhaps the threat of potential competition has become strong enough to offset any differences in the existing local banking structure. Although bank size continues to have no meaningful effect on bank earnings, office size helped to explain profitability differences among banks in recent years. The high-earning banks kept operating costs down by having more deposits per banking office than low-earning banks. In the more competitive environment, we found greater disparity in earnings between the high- and low-earning banks in Ohio. The poorly managed banks experienced a significant earnings deterioration, which caused the aggregate figures to suggest that banking has become less profitable. However, the well-managed banks benefited from the opportunities created by deregulation, and the top-performing institutions earned higher returns than they did in the past. Footnotes ing of federal deposit insurance has en- Paul R. Watro is currently an economics couraged greater risk-taking by depository instructor for the University of Kentucky at institutions. Jefferson Community College. He wrote this 2. Office of the Comptroller of the Cur- article while he was an economist at the rency, Bank Failure: An Evaluation of the Factors Contributing to the Failure of Na- Federal Reserve Bank of Cleveland. The author would like to thank Mark S. Snider- tional Banks, June 1988; Larry D. Wall, man and James B. Thomson for helpful "Why Are Some Banks More Profitable Than Others?" Journal of Bank Research, comments and John Sheridan for research assistance. vol. 15, no. 4 (Winter 1985),240-256; and Myron L. Kwast and John T. Rose, "Pricing, author and not necessarily those of the Operating Efficiency, and Profitability Federal Reserve Bank of Cleveland or of the Among Large Commercial Banks," Journal Board of Governors of the Federal Reserve System. of Banking and Finance, vol. 6, no. 2 (June 1982), 233-54. 3. Banking markets are approximated by metropolitan statistical areas in urban areas and by counties in rural areas. 4. See Gary Whalen, "Concentration and Profitability in Non-MSA Banking Markets," Economic Review, Federal Reserve Bank of Cleveland, Quarter I, 1987,2-9; and "Actual Competition, Potential Competition, and Bank Profitability in Rural Markets," Economic Review, Federal Reserve Bank of Cleveland, Quarter 3, 1988, 14-23. The views stated herein are those of the Recent Federal Reserve Bank of Cleveland publications on issues related to banking and bank earnings are listed below. Single copies of any of these titles are available through the Public Affairs and Bank Relations Department, 216/579-2157. Economic Commentary Economic Review Working Papers Bank Holding Company Voluntary Nonbanking Asset Divestitures Concentration and Profitability in Non-MSA Banking Markets Gary Whalen January 15, 1986 Gary Whalen Ist Quarter, 1987 Rival Stock Price Reactions to Large BHC Acquisition Announcements: Evidence of Linked Oligopoly? Competition and Bank Profitability: Recent Evidence How Will Tax Reform Affect Commercial Banks? Gary Whalen November I, 1986 Thomas M. Buynak 2nd Quarter, 1987 Loan Quality Differences: Evidence from Ohio Banks A Comparison of Risk-Based Capital and Risk-Based Deposit Insurance Paul R. Watro January I, 1987 Robert B. Avery and Terrence M. Belton 4th Quarter, 1987 Ohio Banks: Hitting the Interstate Acquisition Road Thomas M. Buynak and John N. McElravey May 15, 1987 Interbank Exposure in the Fourth Federal Reserve District James B. Thomson August I, 1987 Local Thrift Competition and Bank Earnings Paul R. Watro November I, 1987 Economic Principles and Deposit-Insurance Reform Using Financial Data to Identify Changes in Bank Condition Gary Whalen and Richard L. Mugel WP 8605, July 1986 Capital Requirements and Optimal Bank Portfolios: A Reexamination William P. Osterberg and James B. Thomson WP 8806, August 1988 Predicting De Novo Branch Entry into Rural Markets Gary Whalen WP 8903, March 1989 Gary Whalen and James B. Thomson 2nd Quarter, 1988 Actual Competition, Potential Competition, and Bank Profitability in Rural Markets Gary Whalen 3rd Quarter, 1988 Bank Capital Requirements and the Riskiness of Banks: A Review William P. Osterberg and James B. Thomson Ist Quarter, 1989 James B. Thomson May 15, 1989 Rethinking the Regulatory Response to Risk-Taking in Banking W. Lee Hoskins June I, 1989 Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address Correction Requested: Please send corrected mailing label to the above address. Material may be reprinted provided that the source is credi ted. Please send copies of reprinted materials to the editor. BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385 • Conclusion • Characteristics of high-earning banks 1. Many economists argue that the mispric- in Ohio have changed significantly since the mid-1970s. Prior to deregulation, a larger number of the high earners were not affiliated with a multibank holding company and operated in more concentrated markets. After deregulation, however, ownership or market concentration did not seem to matter. Perhaps independent banks have lost any edge that they may have had over multibank holding company banks, and perhaps the threat of potential competition has become strong enough to offset any differences in the existing local banking structure. Although bank size continues to have no meaningful effect on bank earnings, office size helped to explain profitability differences among banks in recent years. The high-earning banks kept operating costs down by having more deposits per banking office than low-earning banks. In the more competitive environment, we found greater disparity in earnings between the high- and low-earning banks in Ohio. The poorly managed banks experienced a significant earnings deterioration, which caused the aggregate figures to suggest that banking has become less profitable. However, the well-managed banks benefited from the opportunities created by deregulation, and the top-performing institutions earned higher returns than they did in the past. Footnotes ing of federal deposit insurance has en- Paul R. Watro is currently an economics couraged greater risk-taking by depository instructor for the University of Kentucky at institutions. Jefferson Community College. He wrote this 2. Office of the Comptroller of the Cur- article while he was an economist at the rency, Bank Failure: An Evaluation of the Factors Contributing to the Failure of Na- Federal Reserve Bank of Cleveland. The author would like to thank Mark S. Snider- tional Banks, June 1988; Larry D. Wall, man and James B. Thomson for helpful "Why Are Some Banks More Profitable Than Others?" Journal of Bank Research, comments and John Sheridan for research assistance. vol. 15, no. 4 (Winter 1985),240-256; and Myron L. Kwast and John T. Rose, "Pricing, author and not necessarily those of the Operating Efficiency, and Profitability Federal Reserve Bank of Cleveland or of the Among Large Commercial Banks," Journal Board of Governors of the Federal Reserve System. of Banking and Finance, vol. 6, no. 2 (June 1982), 233-54. 3. Banking markets are approximated by metropolitan statistical areas in urban areas and by counties in rural areas. 4. See Gary Whalen, "Concentration and Profitability in Non-MSA Banking Markets," Economic Review, Federal Reserve Bank of Cleveland, Quarter I, 1987,2-9; and "Actual Competition, Potential Competition, and Bank Profitability in Rural Markets," Economic Review, Federal Reserve Bank of Cleveland, Quarter 3, 1988, 14-23. The views stated herein are those of the Recent Federal Reserve Bank of Cleveland publications on issues related to banking and bank earnings are listed below. Single copies of any of these titles are available through the Public Affairs and Bank Relations Department, 216/579-2157. Economic Commentary Economic Review Working Papers Bank Holding Company Voluntary Nonbanking Asset Divestitures Concentration and Profitability in Non-MSA Banking Markets Gary Whalen January 15, 1986 Gary Whalen Ist Quarter, 1987 Rival Stock Price Reactions to Large BHC Acquisition Announcements: Evidence of Linked Oligopoly? Competition and Bank Profitability: Recent Evidence How Will Tax Reform Affect Commercial Banks? Gary Whalen November I, 1986 Thomas M. Buynak 2nd Quarter, 1987 Loan Quality Differences: Evidence from Ohio Banks A Comparison of Risk-Based Capital and Risk-Based Deposit Insurance Paul R. Watro January I, 1987 Robert B. Avery and Terrence M. Belton 4th Quarter, 1987 Ohio Banks: Hitting the Interstate Acquisition Road Thomas M. Buynak and John N. McElravey May 15, 1987 Interbank Exposure in the Fourth Federal Reserve District James B. Thomson August I, 1987 Local Thrift Competition and Bank Earnings Paul R. Watro November I, 1987 Economic Principles and Deposit-Insurance Reform Using Financial Data to Identify Changes in Bank Condition Gary Whalen and Richard L. Mugel WP 8605, July 1986 Capital Requirements and Optimal Bank Portfolios: A Reexamination William P. Osterberg and James B. Thomson WP 8806, August 1988 Predicting De Novo Branch Entry into Rural Markets Gary Whalen WP 8903, March 1989 Gary Whalen and James B. Thomson 2nd Quarter, 1988 Actual Competition, Potential Competition, and Bank Profitability in Rural Markets Gary Whalen 3rd Quarter, 1988 Bank Capital Requirements and the Riskiness of Banks: A Review William P. Osterberg and James B. Thomson Ist Quarter, 1989 James B. Thomson May 15, 1989 Rethinking the Regulatory Response to Risk-Taking in Banking W. Lee Hoskins June I, 1989 Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address Correction Requested: Please send corrected mailing label to the above address. Material may be reprinted provided that the source is credi ted. Please send copies of reprinted materials to the editor. BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385
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