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February 17, 1984

Western Finance
The deregulation of deposit rates hit western
banks and savings and loan associations
with full force in 1983. Two developments,
in particular, virtually swept away the structure of deposit rate regulation and, in the
process, dramatically restructured the balance sheets of depository institutions. First
came the introduction of the money market
deposit account (M M D A) in mid-December
1 982 and the Super-N OW in January 1983.
Second, the deregulation of all new time
deposits with original maturities greater than
31 days followed in October. Depositors'
response to these actions was unequivocal:
billions of dollars flowed into these new
accounts (especially the M M D A) out of
lower-yielding regulated accounts and
uninsured money market mutual funds.
This deregulation of deposit accounts
coupled with weak loan demand greatly
intensified competition among depository
institutions. The tremendous inflow of funds
to M M D A accounts, in particular, induced
banks and S&Ls aggressively to seek out
profitable lending opportunities. Because
the demand for business and, to some
extent, real estate loans, continued
to be weak, they concentrated on consumer
lending.
Increased competition notwithstanding,
many depository institutions in this region
managed to post significant gains in earnings. There were, however, some major
differences among institutions and between
the banking and thrift industries generally.
While most banks reported solid earnings
gains for 1983, sizeable losses sustained by
several of them lowered aggregate earnings
for all western banks from $1.5 billion in
1 982 to $1.3 billion. In contrast, savings and
loan associations recorded a phenomenal
turnaround in profitability, posting $1.1
billion in earnings after adisastrous $805
million loss in 1982. Thus, although industry
analysts predicted that deregulation would

play havoc with banks' and thrifts' cost of
funds, many depository institutions in the
West demonstrated a remarkable ability to
manage the risks introduced by deregulation.

Shifting market shares
By year-end, it had become apparent that a
major factor in a depository institution's
ability to build market share for retail
savings-type deposits was its willingness to
offer premium rates for M M D A deposits in
the early going. This market, estimated to be
about $250 billion, includes balances held
in savings accounts, small-denomination
time deposits, personal M M D As and money
market mutual fund shares that are purchased by households in the West. Thus, by
initially offering above-market yields on
M M D As, the banking industry emerged as
the clear leader in the M M D A battle in the
West and in the nation. Its generally more
aggressive pricing strategies induced households to sever existing deposit relationships
with less aggressive institutions. And once
households moved their funds, they showed
little inclination to shop around for slightly
higher yields.
By capturing 54 percent of the personal
M M D A market, western banks' share of the
overall retail savings deposit market rose
by three percentage points to 45 percent.
Meanwhile, savi ngs and loans, mutual
savings banks, and credit unionsin the West
all lost market share but were still able to
attract significant new inflows with M M D As
because of growth in the market. The money
market funds, on the other hand, lost not
only market share, but also suffered significant net outflows of funds.

Fundingwith MMDAs
The introduction of the M M D A in late 1982
produced a sharp change in the structure of
depository institutions' balance sheets. For
example, by year-end, western banks held
more than $51 billion in M M D As and thrifts

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equity markets during much of the year
allowed many corporations to reduce their
dependence on short-term bank borrowing.
The economic rebound also improved businesses' cash flows and profits, and thereby
reduced their need for external financing.
In addition, there was little evidence of
increased'demand for capital project financing ascapital expenditures were slow to pick
up despite major cutbacks during the recession. Overall, then, western banks recorded
a meager (3.5 percent) increase in domestic
commercial and industrialloans($65 billion
at year-end).

held $35 billion, In both cases, M M D As
accounted for more than one-fifth of total
domestic deposits by the end of the year,
As much as one-third of these funds were
"new" money that enabled theseinstitutions to reduce their reliance on "purchased
funds" such as large denomination negotiable CDs, fed funds and repurchase agree-'
ments. At western banks, for example, large
CDs outstanding declined from 32 percent
to 20 percent of liabilities, The success of
the M M DAs, however, was not costless, as
western banks and S&Ls also reported a $14
billion decline in 5.25 percent passbook
savings deposits,

Western consumers' renewed interest in
housing and consumer durables, by contrast,
translated into increased demand for mortgage and installment credit. Much of the
strength in the residential mortgage market
'reflected the increased popularity of second
mortgages, thedesire of recent purchasers to
refinance at lower rates, and increased
usage of adjustable-rate-mortgages. Savings
and loan associations extended the).ipn's
share of mortgage credit in the West. Their
mortgage loans outstanding grew by 17
percent in 1983 and their originations
exceeded $45 billion for the year, while
western banks' real estate loans outstanding
grew only 3 percent to $73 billion.

Slow asset growth
The influx of M M D A funds sent banks and
S&Ls scrambling to find profitable lending
opportunities in 1983, but private credit
demand remained weak and kept downward pressure on loan rates. Nonetheless,
western savings and loan associations
recorded a dramatic 19 percent increase in
their loan portfolios. Western banks, by
contrast, recorded a slight contraction in
their foreign loan portfolios ($56 billion at
year-end) and a modest 5 percent gain (to
$200 billion) in their domestic loans.
Paradoxically, improvement in the overall
level of economic activity had a chilling
effect on western banks' commerical and
industrial lending. The general reduction in
interest rates from their 1982 levels and the
consequent improvement in the debt and

Consumer credit provided one of the more
attractive lending markets in 1 983particularly for western banks. Timed with
the rise in consumer spending on durable
goods, banks' efforts to promote installment and credit card loan products produced the first sustained increase in western
banks' consumer lending since 1979.
Although still modest, the $1.5 billion
(6 percent rate) increase in consumer loans
during 1 983 ($34 billion at year-end) was
significant given the keen competition
in this market from finance companies and
thrifts.

Earningsin 1983
Earnings of western banks and S&Ls fared
remarkably well in the new, deregulated
2

environment of 1983. M M D As and other
deregu lated deposit products enabled banks
and thrifts to reduce their reliance on
higher-cost purchased funds. Moreover, the
general decline in the level of interest rates
produced a slight improvement in western
banks' net interest margins and a substantial
improvement in those of S&Ls.

that were formerly offered to customers
without charge. Thus, fee income as well
as fiduciary income rose by more than 25
percent.
By contrast, most of the savings and loan
associations' remarkable 39 percent
increase in net worth during 1983 was due
not to a rise in non-interest income, but
to a substantial improvement in interest
margins. S&Ls enjoyed the same reduction
in interest expense as banks, but because
of their large fixed rate mortgage loan portfolios, did not suffer the same erosion
in interest income. Moreover, S&Ls' loan
losseswere less problematic than those
of banks.

For banks, the lower level of interest rates
and weak credit demand in 1983 reduced
interest income substantially. Western
banks recorded reductions in revenues from
overseas investments (down 30 percent),
domestic lending (down 15 percent) and fed
funds sales (down 20 percent). Only interest
income from securities holdings showed an
increase (5 percent), reflecting the large
build-up of u.s.Treasurysecurities holdings
early in the year. However, the decline in
interest rates also reduced banks' interest

The outlook for 1984
Loan growth in 1984 is likely to improve
with the continued recovery-particularly
in the area of commercial and industrial
lending. The deregulation of deposit rates
will allow banks and S&Ls to obtain sufficient funds to finance these increased credit
demands profitably. Moreover, the increased investment and lending powers that
have been granted S&Ls in recent years will
enable them, like banks, to hedge better
against changes in interest rates. Finally,
as the last vestiges of regulated deposit
products are swept away, banks and thrifts
will face increasing pressure to trim noninterest expenses, such as large branch
networks, while recovering the costs of
providing retail banking services.
Gary Zimmerman and

expense.
On balance, interest expense fell more
sharply than interest income, producing
a slight improvement in net interest margins.
Changes in banks' funding mix also helped
lower the cost of funds. Thus, the combination of lower rates and reduced reliance on
purchased funds enabled banks to reduce
their interest expense on large time deposits
by 50 percent and their offshore borrowing
expense by one-third.
This modest improvement in interest
margins, however, was not sufficient to
offset the costs associated with the rapid
deterioration in overall credit quality. Loan
loss provisions were boosted by 50 percent
in the West to handle the anticipated loan
chargeoffs-particularly loans to lessdeveloped countries and energy-related
loans.

Barbara Bennett

The main source of earnings growth for
western banks, then, was the sharp increase
in non-interestincorne, particularly from
fees earned on deposit services. As deposit
interest rates were deregulated, banks raised
fees to recoup the cost of providing services
3

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BANKING DATA-TWELFTHFEDERAL
RESERVE
DISTRICT
(Dollaramountsin millions)
SelectedAssetsand liabilities
large Commercial Banks
loans, leases and Investments] 2

Loansand.leases15
Commercial and Industrial

Realestate
Loans to Individuals

Leases
U.S. Treasury and Agency Securities2
Other Securities 2

Total Deposits
Demand Deposits

DemandDepositsAdjusted3
Other Transaction Balances4

Total
Balances
MoneyMarketDeposit
Accounts-Total
Time Deposits in Amounts of
$100,000or more

Other liabilities for BorrowedMoneyS
WeeklyAverages
of Daily Figures
ReservePosition,All ReportingBanks
ExcessReserves
(+ )/Deficiency(-)
Borrowings
Net free reserves(+ )/Net borrowed(-)

Amount
Outstanding

2/1/84
175,290
154,979
45,389
59,022
26,655
5,019
12,208
8,103
185,308
44,005
29,050
12,059
129,244

Change from
year ago
Dollar
Percent

Change
from
1/25/84

1,409
1,381
223
80
5
20
69
41
3,360
3,511
912
359
- 151

39,636

-

56

38,167
19,599

-

289
466

-

-

-

Weekended

Weekended

2/1/84

1/25/84

NA
NA
NA

75
10
65

1,844
3,186
140
1,094
2,100
307
653

-

1.1
2.1
0.3
1.9
7.9
5.8
5.3

NA
NA
NA
NA
NA
NA

NA
NA
NA
NA
NA
NA

NA

NA

8,645
3,696

-

18.5
15.9

Comparable
year-agoperiod
256
9
247

Includes,lossreserves,unearnedincome,excludesinterbankloans
Excludestradingaccountsecurities
3 ExcludesU.S.government
anddepositoryinstitutiondepositsandcashitems
4 ATS,NOW,SuperNOW andsavingsaccountswith telephonetransfers
5 Includesborrowingvia FRS,IT&l notes,FedFunds,RPsandother.sources
6 Includesitemsnot shownseparately
Editorialcommentsmaybeaddressed
to theeditor (GregoryTong)or to theauthor.... free copiesof
FedetalReservepublicationscanbe obtainedfrom the'PublicInformationSection,FederalReserve
Bankof SanFrancisco,'P.
O. B'o,x7702,SanFrancisco94120.Phone(415)
1
2