Full text of Economic Perspectives (Federal Reserve Bank of Chicago) : May/June 1985, Volume IX, Issue 3

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PERSPECTIVES




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Banks and nonbanks: The
horse race continues
Cautious play marks S&L approach
to commercial lending

ECONOMIC PER SPEC T IV ES
M ay/June 1985

Volume IX, Issue 3
E d ito ria l C o m m ittee

H arvey Rosenblum, vice p r e s id e n t a n d

a sso cia te d ire c to r o f research

Robert Laurent, research eco n o m ist
John J. D i Clemente, research eco n o m ist
Edward G. Nash, e d ito r
Christine Pavel, a s s is ta n t e d ito r
Gloria Hull, e d ito r ia l a s sista n t
Roger Thryselius, g r a p h ic s
Nancy Ahlstrom, ty p e se ttin g
R ita M olloy, typ e sette r

Economic Perspectives is
published by the Research Depart­
ment of the Federal Reserve Bank
of Chicago. The views expressed are
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reflect the views of the management
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IS S N 0 1 6 4 -0 6 8 2




C o n te n ts
Banks and nonbanks: The
h orse ra c e continues

Banks are holding their own
quite nicely against their nonbank
competitors, especially when the
regs are relaxed

Cautious play m a rk s S&L
ap p roach to co m m e rcia l lending

Armed with new lending powers,
S&Ls in Wisconsin and Illinois are
getting theirfeet wet carefully—one
toe at a time

3

18

Banks and nonbanks: The horse race continues
Christine Pavel and Harvey Rosenblum

Financial services have been provided by
individuals and commercial enterprises at least
since Biblical times. During the last few cen­
turies, some business firms began to specialize
by providing only financial services. Until re­
cently, the specialization tended to be very
narrow; some firms provided insurance, others
home mortgage lending, and still others con­
sumer lending. Even commercial banks, which
now serve a wide range of commercial, house­
hold, and government customers by intermedi­
ating across a wide range of financial products,
for many years restricted themselves to com­
mercial lending.
During the last decade, several trends
have reshaped the financial services industry.
Many specialized financial firms have sought
to diversify themselves and have begun to offer
a wider range of financial products than they
had offered previously. For example, S&Ls
and mutual savings banks now offer commer­
cial and consumer credit in addition to their
more traditional product, home mortgages, and
credit unions have begun to offer home mort­
gages in addition to their traditional product,
consumer credit. Further, all three of these
depository institutions have begun to offer a
wider range of deposit instruments, particularly
transaction accounts, that they had not offered
previously. In addition to depository insti­
tutions, many other financial firms have sought
to increase the breadth of their product array.
For example, insurance companies have ac­
quired securities companies, consumer finance
companies, and banks.
Also over the last decade, firms whose
primary orientation has been nonfmancial have
become much more heavily involved in finan­
cial services, both related and unrelated to their
primary product lines. Not only have these
firms been making inroads into the market
share of banks with some of the products they
offer, but the pace of these new competitive
thrusts seems to have accelerated during the
last five years (see Table 1).
The list of bank competitors now includes
not only depository institutions—commercial
banks, savings and loan associations, mutual
savings banks, and credit unions—but wellF e d e ra l R e s e rv e B a n k o f C h ic a g o




known nondeposit-based competitors such as
American Express, Merrill Lynch, and Sears
as well as lesser-known nonbank competitors
such as National Steel, J. C. Penney, and
Westinghouse. Some of these nonbank firms
have been more successful than others in pro­
viding financial services. Some firms are re­
trenching, while others are integrating and
regrouping, after recently acquiring or estab­
lishing financial services operations.
This article examines competition in fi­
nancial services over the past few years and
analyzes how the financial services operations
of nondeposit-based firms have fared relative to
banking firms and relative to each other. The
article is the third annual review of this subject
by the authors and differs from the previous
studies in that it is able to distinguish a few
emerging trends that were not available in the
prior “snap-shot,” cross-sectional analyses. In
addition, the use of 1983 and some 1984 data
allows us to speculate on deregulation’s impact
upon the ability of commercial banks to deal
with the nondeposit-based rivals. The financial
services activities of 30 nonbank companies,
classified into four groups—retailers, industrialbased companies, diversified financial firms,
and insurance-based companies—are examined
along with publicly available accounting data
for the 30 firms, the 15 largest bank holding
companies, and all insured, domestic commer­
cial banks. (For a list of the nonbank compa­
nies in each group and the 15 largest bank
holding companies, see Table 2.)
Most of the data are for the years 1981,
the first year for which information on the in­
dividual companies was gathered, and 1983,
the last year for which annual report informa­
tion was readily available. When available,
however, 1984 data are used. Unless stated
otherwise, total consumer lending includes
consumer installment and one-to-four family
residential mortgages; commercial lending in­
cludes commercial and industrial (C&I) loans
Christine Pavel is an associate economist at the Federal
Reserve Bank o f Chicago, and Harvey Rosenblum is vice
president and associate director o f research. Helpful re­
search assistance was provided by Dorothy Robinson, who
was a summer intern at the Bank during 1984.

3

Table 1
Financial services o ffe re d by selected non fin an cial com panies
General
Motors

Ford

ITT

General
Electric

Control
Data

BorgWarner

Westinghouse

1944

1960

1954-5

1965

*

1961

1919

1959

1971

1932
1970

1968
1968
1968
1971

1950

1954

1919

1959
1966

1964
1964
1983

1964
1965

1968
1968
1983

1953
1969

1959

1983

1981
1981

1982
1982
1979
1972
1981

1982
1982

Commercial finance:
Commercial lending
Factoring
A/R and inventory finance
Venture capital
Consumer finance:
Sales finance
Personal finance
Credit card
Real estate:
Mortgage banking
Residential first mortgages
Residential second mortgages
Real estate development
Real estate sales & management
Commercial real estate & finance
Insurance:
Credit life insurance
Regular life insurance
Property & casualty insurance
Accident & health insurance
Leasing:
Equipment and personal
property
Real property leasing
Lease brokerage

1975
1925

1981

Investment services:
Investment management
Mutual fund sales
Corporate trust & agency
Custodial services
Business and personal services:
Travel services
Cash management services
Tax preparation services
Financial data processing services
Credit card management services

1972
1969

1965
1970

1960

1980

1960
1983
1963

1962
1974
1959

1964
1964
1964
1964

1973
1973
1970
1973

1968
1968
1968
1968

1966

1968

1963

1968

1982

1982

1969

1969
1969
1969

1970

Sears

Marcor

J. C.
Penney

1966

1911
1962
*
1972
1961
1961
1960
1960
1961

1917
1966
1957

1958
1970
1958
1970
1981

1966
1970
1970
1966

1970
1970
1970

1960
1957
1931
1958

1966
1966
1968

1970
1970
1970
1967

1960
1981

1970

1970

1982
1966
1966

1969
1969

1970

1968

1968

1978

1961
1981

1970

1971
1966-70

1965

1968
1965

1970
1969

1969
1982

'Entry date unavailable.
SOURCE: Cleveland A. Christophe, Competition in Financial Services (New York, First National City Corporation, 1974), Company
Annual Reports, and phone conversations with company spokesmen.

and commercial mortgages; and total finance
receivables include consumer loans, commer­
cial loans, and lease finance receivables.
Overview and background

In 1972, at least ten nonfinancial firms
had significant financial services earnings,1 and
by 1981 this list had grown over three-fold.2
Further, in 1981, these nonbank companies
posed a competitive threat to banks and other
depository institutions in a number of their
traditional product lines.
In the area of consumer lending, nonbank
firms seemed to have dominated in 1981. Of
the 15 largest consumer installment lenders, ten
4



were nonbank firms, and General Motors
topped the list with over $31 billion in con­
sumer finance receivables. These ten firms ac­
counted for 24 percent of all consumer
installment credit outstanding.3 This is quite
impressive since the remaining 76 percent was
accounted for by over 15,000 commercial
banks, 3,100 savings and loan associations, 400
mutual savings banks, 3,100 credit unions, as
well as numerous other nondeposit-based com­
panies, primarily finance companies. Never­
theless, market shares in consumer installment
lending are quite fluid: the new business vol­
ume accounted for by any supplier changes
drastically with changes in the economy.
E c o n o m ic P e rs p e c tiv e s

By 1981, nonbank firms had also
encroached on commercial banks’ prime
turf—business lending—although commercial
banks were, and still are, the dominant com­
mercial lenders. At year-end 1981, the top 15
bank holding companies had nearly $300
billion in C&I loans outstanding worldwide,
while the selected 30 nonbank companies had
less than one-third of that total. However, 14
selected industrial-based firms did outweigh the
bank holding companies in lease financing, and
a mere five insurance-based firms bested the
bank holding companies in commercial mort­
gage lending.
Throughout 1982, nonbank competitors
continued to make inroads in the financial ser­
vices industry. Sears, for example, opened its
first in-store financial service center, and sev­
eral securities-based firms and a furniture store
acquired “nonbank banks.” Nevertheless, com­
mercial banks were beginning to regain some
of the market share that they had lost, mostly
in consumer lending, over the previous four or
five years. By 1983, the entire banking indus­
try was reacting vigorously to the competitive
threats posed by the nonbanks, aided in part
by the virtual demise of Regulation Q, and the
creation (in December 1982) of the Money
Market Deposit Account. Banks of all sizes and
locations began to offer new services such as
discount brokerage and to find other ways to
compete more effectively in a new and chang­
ing environment.4
During 1983, the nonbanks continued to
increase their financial services earnings (Table
3). The profits from financial activities of 30
selected nonbank companies increased 19 per­
cent between 1981 and 1983, exceeding the
earnings growth of the 15 largest bank holding
companies and all domestic, insured commer­
cial banks. At year-end 1983, the 30 nonbank
firms’ profits from financial activities were $8
billion, more than half of the combined profits
of the nation’s 15,000 commercial banks.
Over the 1981-83 period, the nonbanks
increased their total finance receivables as well.
The combined finance receivables of the 30
nonbank firms increased 16 percent from 1981
to 1983, slightly faster than the top 15 bank
holding companies, but slower than all com­
mercial banks.5
All nonbank firms are clearly not alike in
providing financial services. They do not offer
all of the same financial products and services,
F e d e ra l R e s e rv e B a n k o f C h ic a g o




Table 2
List o f 30 nonbank firm s and
15 largest BHCs ranked by assets
NONBANKS:
Retailers:
Sears
J.C. Penney
Montgomery Ward
Industrials:
General Motors
Ford Motor
Chrysler
IBM
General Electric
Westinghouse
Borg-Warner
Gulf & Western
Control Data
Greyhound
Dana Corp.
Armco Corp.
National Intergroup
ITT Corp.

Diversified Financials:
American Express
Merrill Lynch
E.F. Hutton
Household International
Beneficial Corp.
Avco Corp.
Loews Corp.
Transamerica
Insurance companies:
Prudential
Equitable Life Assurance
Aetna Life & Casualty
American General Corp.
The Travelers

BANK HOLDING COMPANIES
Citicorp
BankAmerica Corp.
Chase Manhattan Corp.
Manufacturers Hanover Corp.
Continental Illinois Corp.
Chemical New York Corp.
J.P. Morgan & Co.
First Interstate Bancorp
Security Pacific Corp.
Bankers Trust New York Corp.
First Chicago Corp.
Wells Fargo & Co.
Crocker National Corp.
Marine Midland Banks, Inc.
Mellon National Corp.

and they do not target the same markets. Some
nonbank firms primarily target consumers,
while some do not provide financial services to
consumers at all. Also, some nonbank firms
have outperformed other nonbanks as well as
banks, whereas others have struggled to earn a
profit.
To gain more insight into these nonbank
competitors and, therefore, competition in the
financial services industry, it is helpful to clas­
sify the nonbanks into groups based on each
firm’s primary line of business and then analyze
each group in relation to traditional suppliers
of financial services—banks and bank holding
companies—before examining them in relation
to one another.
5

Table 3
Financial services at a glance: 1981-83
($ billions)
Total finance
receivables

3 retailers
14 industrialbased firms

Consumer loans

1983

% change
1981-83

1982

% change
1981-83

26.4

38

26.4

38

Commercial loans
1983

% change
1981-83

-

-

Lease financing
1983

-

Financial
services earnings

% change
1981-83

1983

-

0.9

50

% change
1981-83

133.3

16

72.0

14

43.8

17

17.5

22

2.2

57

8 diversified
financial firms

38.7

8

29.7

9

7.4

14

1.6

26

> 1.6

18

5 insurance-based
firms

63.3

13

14.4

18

48.3

13

0.6

-33

3.3"

Total, 30 nonbanks 262.3

16

142.5

17

99.5

15

19.7

18

8.0

19

295.5

14

104.4

26

175.1

8

16.0

12

3.6

0

1,136.5

21

383.8

13

563.7

24

14.2

8

15.7

6

Top 15 bank holding
companies (domestic)
All domestic, insured
commercial banks

3

SOURCE: Company annual reports and Federal Reserve Bulletin, various issues.

R etailers

Retailers compete with banks and other
financial services providers primarily in
consumer-oriented product lines. Retailers’
concentration in consumer-oriented financial
services should not be surprising because many
of them entered the financial services industry
by offering credit in conjunction with retail
purchases. Sears, perhaps the most famous and
aggressive of the retailers that provide financial
services, began offering retail credit in 1910.
Similarly, J. C. Penney and Montgomery Ward
became involved in financial services by fi­
nancing their retail sales.
Retailers, however, offer many financial
products and services besides retail credit.
Some offer many of the same financial products
and services to consumers that banks do. In
addition, they offer insurance products and
maintain offices across state lines.
One explanation for the retailers’ foray
into financial services can be found in the retail
trade. Retailing has undergone several changes
over the last few years. Such retailers as Sears,
J.C. Penney, and Montgomery Ward have
been faced with stiff competition from the new
discount stores and the specialty stores. Fur­
thermore, according to Moody’s Industry
Outlook, only moderate growth in retailing is
expected over the next five years, and the
6



retailers that will “show some growth are offprice retail[ers] and some companies in the
upscale discounting and specialty fields.”6
Such an environment has sent, retailers
like Sears searching for ways to capitalize on
their extensive distribution networks, large
customer bases, and solid reputations. To­
gether these three retailers operate over 2,600
stores nationwide, giving them the underlying
basis for a retail branching network that banks,
at least for the time being, are prohibited from
duplicating. In addition, Sears, Penney, and
Wards combined have 50 million credit cus­
tomers, many of whom utilize these stores on a
regular basis.
Given their experience in credit oper­
ations and, for some, their experience in pro­
viding insurance, retailers seem particularly
well-suited to expand their activities in finan­
cial services. In addition, these retailers are
getting closer and closer to providing one-stop
financial shopping. A consumer can obtain
many of his financial services at some Sears or
Penney stores, and shop for clothes, furniture,
or hardware at the same location.
Some retailers have been
very aggressive in providing financial services,
including installment credit, to consumers.7 In
1981, the three retailers had combined con­
sumer installment receivables of $16 billion.
B usiness volum e.

E c o n o m ic P e rs p e c tiv e s

By 1983, the three retailers increased their total
consumer installment credit almost 40 percent
to $23 billion. Sears alone in 1981 held nearly
$10 billion in consumer installment credit, and
by 1983 had increased its holdings of such debt
45 percent to $14 billion.
In comparison, over the same two years,
all insured, domestic commercial banks in­
creased their installment credit by 17 percent,
but the 15 largest bank holding companies’ in­
stallment credit outstanding jumped 35 per­
cent. Citicorp, perhaps the most aggressive of
the top 15 bank holding companies in con­
sumer financial services, increased its consumer
installment credit 61 percent over the 1981-83
period.
Although there are banks like Citibank,
which are aggressively pursuing the consumer
market, the commercial banking industry as a
whole has neither gained nor lost market share
in consumer installment lending. Commercial
banks held about 44 percent of consumer in­
stallment debt in 1981 and in 1983. And even
though a few retailers are very actively offering
financial services to consumers, retailers have
not increased their share of consumer credit
outstanding, holding about 9 percent of all
consumer installment credit since 1978. The
15 largest bank holding companies, however,
increased their share of consumer installment
credit outstanding nearly 2 percentage points
from 13.0 percent to 14.9 percent over the
1981-83 period, while Sears, Wards, and
Penney increased their combined share from
5.4 percent to 5.8 percent.
C red it ca rd s .
Retailers’ consumer finance
receivables are mostly credit card receivables.
In this narrow area of consumer lending, the
retailers seem to be more successful than the
banks, although banks have come a long way
since 1972. Since that year, the number of
bank cards outstanding has more than doubled,
and annual customer charge volume has grown
nearly eightfold.
In credit card operations, however, the
retailers still have the edge. At year-end 1983,
all retailers had over $46 billion in credit card
receivables, while banks held $38 billion in
Visa and MasterCard credit card receivables.
No individual bank had more customer ac­
count balances outstanding at that time than
Sears, and on the basis of customer charge vol­
ume and cards issued, no individual bank came
F e d e ra l R e s e rv e B a n k o f C h ic a g o




close to Sears in 1983. In fact, Sears had more
customer charge volume than the two largest
issuers of bank cards (Bank of America and
Citibank) combined.8
The Sears credit card, of course, is only
accepted in Sears stores, but has achieved
widespread acceptance and usage in spite of
this disadvantage largely because of the size of
Sears relative to other retailers. Visa,
Mastercard, and American Express cards are,
at least to their users, reasonably good substi­
tutes for money in conducting many day-to-day
transactions. Because of its drastically more
limited acceptance (it can be used in only
about 800 locations), the Sears card is almost
useless as a money substitute. In order to
overcome this disadvantage Sears announced
plans in February 1985 to introduce a universal
credit card that would compete directly with
Visa, MasterCard, and American Express.
The financial services oper­
ations of the retailers mentioned above are
profitable. In 1981, Sears, Wards, and Penney
had combined financial services earnings of
nearly $600 million, and in 1983, the financial
earnings of these three retailers had increased
more than 50 percent to $927 million. This is
about equal to the total 1983 earnings of
Bank-America, Chemical New York, and
Manufacturers Hanover, the fourth, fifth, and
sixth largest bank holding companies ranked
by earnings. Also, by 1983, the three retailers
had a combined ROE of 12 percent from fi­
nancial services activities, higher than their
combined ROE from retailing and higher than
the ROE for all commercial banks.
Furthermore, in 1981 and 1983, financial
services earnings represented a significant por­
tion of total earnings for these retailers. For
Sears, financial services account for more than
half of its total profits. And were it not for its
finance subsidiary, Wards would have shown a
net loss in 1983, as it did for 1981.

P rofitab ility.

It is probably too soon to
conclusively assess the impact that the retailers
have, or could have, on the competitive posi­
tion of commercial banks and other depository
institutions. So far only a few retailers have
significant financial services operations, and
only recently has Sears, the predominant fi­
nancial services provider among the retailers,
committed to becoming a major supplier of fi­

Long-run im p act.

7

nancial services. Penney and Wards are still
“experimenting” with financial services. Yet
the retailers are making money from their fi­
nancial businesses; they are increasing their fi­
nance receivables; they are expanding their
financial operations; and the number of retail­
ers that offer financial services in their stores is
increasing. Kmart and Kroger are offering
various financial products and services in their
retail outlets in conjunction with depository
institutions and insurance companies. It ap­
pears, therefore, that the financial businesses of
retailers have met with success—so far.
The success of a few retailers, however,
does not imply the demise of over 15,000 com­
mercial banks as providers of financial services
to consumers. In October 1982, ABA Banking
Journal asked bankers in the eight cities where
Sears had launched its financial network
whether the in-store centers posed a threat.9
At that time, none of the bankers thought Sears
threatened their competitive positions. One
year later, ABA Banking Journal repeated its
survey and found:
In g e n e r a l, c o m m u n i ty b a n k e rs in citie s
w h e re in -s to r e c e n te r s h a v e o p e n e d c a n ’ t
im a g in e e v e r fe e lin g s e rio u sly t h r e a te n e d by
S e a rs — n o m a t t e r h o w n u m e r o u s n o r g e n e r -

o

a lly a c c e p te d s u c h c e n te r s m ig h t b e c o m e .

10

Industrial-b ased firm s

Industrial-based firms provide a variety
of financial services through subsidiaries. At
least 14 industrial firms have significant finan­
cial services operations (see Table 2). Four of
these are captive finance subsidiaries of their
manufacturer-parents (General Motors Ac­
ceptance Corp., Ford Motor Credit Co.,
Chrysler Financial Corp., and IBM Credit
Corp.), and three were captive subsidiaries but
have become independent providers of finan­
cial services (General Electric Credit,
Westinghouse Credit, and Borg-Warner Ac­
ceptance Corp.). The other seven have always
been independent of their parents.
The captive finance subsidiaries of the
auto companies were originally formed to
bolster the sales of their parents’ products, es­
pecially when demand is weak or other lenders
such as banks and independent finance com­
panies are decreasing their auto lending. Thus,
in a period, such as the 1978-82 period, which
was characterized by a decrease in domestic car
8




sales, liberalized bankruptcy laws, soaring costs
of funds, and interest rate volatility, the captive
finance companies of the U.S. auto-makers of­
fered below-market-rate financing to support
the sale of their parents’ automobiles. During
this period, the auto captive finance companies
increased their share of auto loans outstanding
and greatly increased their share of new auto
lending volume (see Figure l).11
Even though their primary mission re­
mains to support the sale of their parents’
products, some of these captives are expanding
into other areas of financial services. For ex­
ample, in March 1985 General Motors an­
nounced plans to purchase two mortgage
banking subsidiaries. Also, Chrysler is consid­
ering expanding its financing operations to in­
clude nonautomobile financing.
Some captive finance companies have
become independent providers of financial ser­
vices. These finance companies have the ad­
vantage of once having been under their
parents’ wings. Borg-Warner Acceptance Cor­
poration, for example, gained experience and
customers by offering inventory financing to
dealers of Borg-Warner products. Today,
BWAC provides this service for some of the
same customers, but it finances the inventories
of products from other manufacturers.
One disadvantage, however, that the fi­
nance subsidiaries of industrial-based firms
have is that financial services is very different
from their parents’ traditional lines of business.
To some extent this has been overcome by the
captives and the once-captives, as financial
services activities developed as a complement
to their parents’ manufacturing operations.
For at least one of the independents, this dis­
advantage could not be overcome. As a result
of its huge losses in financial services, Armco
sold its insurance operations in 1983. As stated
in the 1983 Armco Annual Report, “This change
in strategic direction reflects a renewed em­
phasis on the businesses and market niches we
know best.”12
volum e.
The industrial-based
firms, as a group, provide financial services to
consumers as well as to businesses. Ten of the
14 industrial firms provide consumer financing;
these ten companies held over $72 billion in
consumer credit outstanding at year-end 1983,
nearly all of which was consumer installment
credit (Table 3). These 10 industrial firms held
B usiness

E c o n o m ic P e rs p e c tiv e s

Figure 1

S h a re s of auto loans o utstan ding
1 98 2

1 97 8

NOTE: The shares for 1983 w ere as follows: Banks, 47% G M A C , 26%: Ford M otor Credit. 8%; Chrysler Financial, 1%: and other. 18%.
SOURCE:

F e d e r a l R e s e r v e B u lle t in

and company annual reports.

nearly 16 percent of all consumer installment
credit outstanding, while the top 15 bank
holding companies held 15 percent. Further,
in 1983, GMAC alone held over $40 billion,
more than the combined consumer installment
credit held at the four largest bank holding
companies.
Consumer finance receivables held by the
ten industrial firms grew by 14 percent over the
1981-83 period, yet they did not keep pace with
the bank holding companies. Similarly, in
consumer installment lending the ten industrial
companies increased their outstandings 19 per­
cent over the two-year period, but again they
did not keep pace with the top 15 bank holding
companies.
Each of the 14 selected industrial firms
offers commercial financing or lease financing.
At year-end 1983, these 14 industrial firms held
nearly $44 billion in commercial loans (C&I
loans and commercial mortgages); C&I loans
account for nearly all of this amount. Never­
theless, the 14 industrial firms accounted for
about 8 percent of all C&I loans outstanding
at the end of 1983, while the top 15 bank
holding companies accounted for 31 percent.
GMAC, however, held $11.4 billion in C&I
loans, roughly equal to the domestic C&I loans
F e d e ra l R e s e rv e B a n k o f C h ic a g o




of Chase Manhattan Corp., the third largest
bank holding company.
The industrial-based companies increased
their C&I loans 14 percent between 1981 and
1983, outpacing the bank holding companies
but not all commercial banks, which increased
their C&I loans by 25 percent. Borg-Warner
and Commercial Credit Corp. led the indus­
trial firms, increasing their C&I loans 43 per­
cent each.13
The 14 industrial firms increased their
commercial mortgage receivables 74 percent
from 1981 to 1983, much faster than the top
15 bank holding companies and all insured
domestic commercial banks. The industrial
firms, however, have only $3.4 billion in com­
mercial mortgages, less than one percent of all
commercial mortgages outstanding in 1983,
and only six of the 14 industrials make com­
mercial real estate loans.
Lease financing is the area in which the
industrial companies shine. At year-end 1983,
they had a combined $17.5 billion in lease
receivables, more than the 15 largest bank
holding companies and more than all domestic,
commercial banks. Further, the industrial
firms increased their lease receivables 22 per­
cent over the 1981-83 period. Bank holding
9

companies increased their lease receivables only
12 percent, and banks, 8 percent during this
period.
One reason for the industrial firms’ suc­
cess in leasing is that companies such as GECC
and Westinghouse, which have parents with
large and growing profit bases, gain a compet­
itive advantage by exploiting an opportunity
in the tax laws. In their leasing activities, the
finance subsidiaries retain ownership of the
equipment they lease; therefore, their parents
get to apply the depreciation, investment tax
credits, and, in some cases, energy credits to
their taxable income (since the finance subsid­
iaries are consolidated with the parent and
other subsidiaries for tax purposes). These tax
savings can then be passed on to the finance
subsidiaries’ customers in the form of lower
leasing rates, thus allowing the finance subsid­
iaries to undercut the compedtion. Banks and
bank holding companies have the same oppor­
tunity to use leasing to shelter income from
taxes. But from 1981-83 the net income of
banks and bank holding companies grew very
slowly, providing comparatively little incentive
to banks to expand their leasing operations.
Only five of the 14 industrial-based firms
take deposits, and each of these four owns de­
pository institutions. As of year-end 1983, these
firms—Dana, National Steel, ITT, Control
Data—had $8.4 billion in deposits, 3 percent of
the deposits of the five largest bank holding
company based on deposits.
Financial services have been
profitable for most of the selected 14
industrial-based firms. The combined financial
services earnings of the 14 companies was $2.2
billion in 1983, nearly two-thirds as much as
the earnings of the top 15 bank holding com­
panies. GMAC was by far the biggest money­
maker among the finance subsidiaries of the
industrial-based firms, with 1983 earnings over
$1 billion. All other finance subsidiaries earned
less than half as much as GMAC, and only one
financial services subsidiary posted a net loss for
1983.
The industrial-based firms’ financial ser­
vices earnings grew rapidly (57 percent) over
the 1981-83 period, while the total earnings of
the top 15 bank holding companies were virtu­
ally unchanged over this same period. On an
individual basis, however, earnings growth
among the manufacturers was mixed. For five
P rofitab ility.

10




industrial companies, financial services
earnings fell, while financial services earnings
more than doubled for four others.
Returns on equity (ROEs) for the indus­
trial firms’ financial operations exceeded those
of their nonfinancial operations in 1981, but
the reverse was true in 1983. In 1983 their
nonfinancial operations returned 20 percent on
equity, outperforming their financial operations
by nearly 5 percentage points. Nonetheless, the
financial operations of the manufacturers, as a
group, experienced a higher ROE in 1983 than
did the top 15 bank holding companies or all
domestic commercial banks. To some extent,
these differences reflect cyclical behavior. The
earnings of retailers and manufacturers tend to
be coincident with the business cycle; 1981 and
1982 were recession years while 1983 was a
year of strong economic rebound. Bank per­
formance tends to lag behind the general
economy. Clearly, several more years of prof­
itability data are necessary before conclusions
can be drawn regarding the changing compar­
ative profitability of banks and nonbanks.
Long-run im p act. In some business lines,
these industrial companies are formidable
competitors of commercial banks. Further­
more, if changing technology provides any ba­
sis for economies of scale in offering consumer
lending, some of these industrial companies
may be even more formidable competitors in
the future.
Prior to 1985 none of the industrial firms
seem to have posed a competitive threat to
banks in commercial or consumer mortgage
lending. However, a few, such as General
Electric and Borg-Warner, have made aggres­
sive moves into mortgage banking.14 And as
mentioned earlier, General Motors has pro­
posed to acquire two mortgage banking firms.
If there are economies of scope in mortgage
banking or, more importantly, if these indus­
trial firms perceive that there are economies of
scope, then certain industrial firms do pose
some competitive threat to banks, particularly
since Regulation Q no longer confers a cost-offunds advantage to banks.13
In areas in which banks and the industrial
firms do compete, the industrial firms’ results
have been mixed. Some industrial companies
have increased their finance receivables in the
various lending categories faster than banking
organizations, while others have actually de­
E c o n o m ic P e rs p e c tiv e s

creased their receivables over the 1981-83 pe­
riod. Of course, some firms in the latter group,
such as General Electric and Westinghouse,
have intentionally decreased their holdings of
certain receivables to devote their attention
and resources to other financial services areas.
Also, some industrial firms have maintained
highly profitable financial services operations,
but the financial earnings of other firms’
plummeted over the 1981-83 period.
D iversified F in an cials

Eight diversified financial firms have been
identified as having a significant presence in the
financial services industry (see Table 2).
American Express, Merrill Lynch, and E.F.
Hutton are large national distribution compa­
nies; they have many offices throughout the
country and the world, and they offer a wide
array of financial services to both consumers
and commercial customers. Beneficial and
Household are primarily consumer finance
companies, and the remaining three firms are
truly diversified, having financial as well as
nonfinancial operations.
These diversified financial firms compete
with banking firms, and it seems that some, but
not all, may pose competitive threats to bank­
ing firms in providing financial services to con­
sumers as well as business customers. These
eight firms compete with banks in most product
areas, and they offer a few services that banks
are prohibited from offering, such as life and
property-casualty insurance.
The diversified financials have extensive
distribution networks. These networks give
them a nationwide presence, allow them to de­
liver their services to millions of customers, and
enable them to experiment with new products
and services at a lower cost than would be
possible without their existing distribution net­
works. These networks, however, may be laden
with a history, culture, and tradition that pre­
clude these firms from fully exploiting their
advantages.
For example, while Merrill Lynch’s de­
livery network is one of its major strengths, it
is also one of its major weaknesses. Indeed,
Merrill Lynch’s extensive nationwide branch
network of over 400 branches employing nearly
9,000 brokers is the primary reason that it
generates huge sales volume. But because its
F e d e r a l R e s e w e B a n k o f C h ic a g o




brokers get a cut of all they sell and are moti­
vated primarily by commission income incen­
tives, this approach has tended to be a
high-cost distribution system. Furthermore,
this type of product delivery system has an in­
herent inflexibility that makes Merrill Lynch
vulnerable at a time when discount brokering
and other low-cost distribution methods are
gaining market share.16 The fact that Merrill
Lynch operates essentially as a brokerage house
also stymies its innovations. At first, Merrill
Lynch’s Cash Management Account met with
much opposition from the brokers because it
pays no commission.17
Like Merrill Lynch, other diversified fi­
nancials have found the need to change as more
and more financial services concerns are mov­
ing toward becoming financial conglomerates;
these diversified financial firms are finding
change difficult but necessary. American Ex­
press, for instance, was until 1981 essentially a
travel services company. In 1981, American
Express began an acquisition campaign in or­
der to become a major diversified financial
services competitor. These acquisitions did al­
low American Express to enter new markets,
including securities brokerage (Shearson), mid­
dle market investment products distribution
(Investors Diversified Services) and investment
banking (Lehman Brothers), and target new
customer bases, but the company is now faced
with the delicate task of integrating and man­
aging its recently acquired financial businesses.
And the success of American Express in these
endeavors is not a foregone conclusion; in the
early 1970s, American Express entered the
brokerage business by acquiring a 25 percent
interest in Donaldson, Lufkin, Jennrette, but
divested it a few years later.
A characteristic among the diversified fi­
nancials, which some (especially bankers who
want to enter the industry) view as an advan­
tage, is their ability to underwrite and market
insurance. Whether insurance products really
confer an advantage, however, is open to seri­
ous question because the property-casualty in­
surance industry has suffered losses recently,
losing money every year since 1978, and 1983
was the worst year ever.18 Income from invest­
ments, which saved the industry from losses in
the past, did not keep pace with underwriting
losses. Also, fierce price competition in this in­
dustry has contributed to the problem.
77

The eight diversified fi­
nancial firms engage in both consumer and
commercial lending. At year-end 1983, they
had about $30 billion of consumer finance
receivables outstanding, of which over three
quarters was installment credit (see Table 3).
In fact, almost all of the mortgage loans of the
diversified financials are second mortgages and
could, therefore, be classified as installment
lending as well. This $30 billion represented a
9 percent increase over 1981, but a smaller in­
crease than those of all commercial banks and
the top 15 bank holding companies.
The range of growth in consumer receiv­
ables among the diversified financial firms is
quite large. Loews’ consumer finance receiv­
ables fell 58 percent, while E.F. Hutton’s con­
sumer receivables grew 37 percent over the
two-year period. Loews’ drop in consumer
loans reflects the sale of its consumer finance
subsidiary in 1983, and Hutton’s growth re­
flects more margin lending. American Express
and Merrill Lynch also increased their margin
account lending quite rapidly over this period
because of the bull market that began in late
1982 and ran through much of 1983. Since
bull markets come and go, this high rate of
consumer credit expansion is probably not
sustainable.
All eight diversified financial firms engage
in some form of commercial lending. Over the
1981-83 period, the eight diversified financials
increased their holdings of commercial loans
faster than the top 15 bank holding companies
but slower than the growth rate for all com­
mercial banks. As with the growth of consumer
loans, however, the range of commercial loan
growth among the eight firms was quite wide.
Merrill Lynch increased its outstandings 152
percent, while Household decreased its out­
standings 44 percent. Furthermore, the abso­
lute size of the combined commercial loan
portfolio of the eight diversified financial firms
is small—only $7.4 billion, 1 percent of all C&I
loans outstanding at year-end 1983. In con­
trast, the eight largest bank holding companies
accounted for over 20 percent of all C&I loans
at that time.
The diversified financial firms are weak,
relative to the banking firms, in C&I lending
but are somewhat stronger in lease financing
and commercial mortgage lending. At yearend 1983, the eight diversified financials held
only 3 percent of the C&I loans held by the top

Business volum e.

72



15 bank holding companies, but they held 11
percent of the lease receivables and 16 percent
of the commercial mortgage loans of the bank
holding companies.
The diversified finan­
cial firms offer products that compete with
bank deposits as well as the lending products
just reviewed. Four of the diversified financial
firms managed money market funds. At yearend 1984, these four had money fund assets of
about $67 billion. Merrill Lynch alone man­
aged more than $39 billion, which is roughly
equivalent to the deposits of Chemical New
York Corp., the sixth largest bank holding
company. In addition, six of the eight diversi­
fied financial firms own depository institutions,
which combined had over $15 billion in de­
posits at year-end 1983.
The ownership of money market funds by
the diversified financials and others may have
represented a competitive threat to banks in
the past, but the threat in the current environ­
ment seems minimal because money market
funds (MMFs) have become a less attractive
substitute for money or bank deposits. The
Garn-St Germain Act of 1982 granted banks
and thrifts the right to offer a money market
deposit account (MMDA) that is directly com­
petitive with MMFs. MMDAs were an instant
success, growing from zero to more than $350
billion is just a few months. Over this same
period, MMF balances declined by more than
20 percent. By year-end 1984, MMF balances
had grown to $236 billion, about the same level
as they were when MMDAs were first intro­
duced. Nonetheless, general purpose MMFs
declined from 9.2 percent of M2 (the Federal
Reserve’s broadly defined money supply) in
December 1982 to 7.1 percent in December
1984.
There are several reasons for this decline:
1) MMDAs are covered by federal deposit in­
surance while MMFs are not; 2) MMDAs can
pay the same market rates as MMFs; and 3)
MMDAs allow a depositor to maintain an ac­
count directly competitive with MMFs at the
same depository institution where he conducts
the rest of his deposit business, thus affording
the convenience of one-stop shopping.
MMFs, however, do have some advan­
tages over MMDAs. MMFs generally allow a
greater number of checks to be written than
MMDAs, although they usually impose a high
Deposit su b stitutes.

E c o n o m ic P e rs p e c tiv e s

minimum denomination on each check. Also,
many MMFs are part of a “family” of mutual
funds and allow convenient shifting among
members of the mutual fund family, a service
that banks cannot match.
Nevertheless, banks can apparently com­
pete very well against their less regulated
competitors—such as those diversified financial
firms that offer MMFs—when regulatory barri­
ers are relaxed sufficiently for them to compete
on a roughly equal footing.
Financial services seem to be
quite profitable for the diversified financial
firms. In 1983, the combined eight firms
earned more than $1.6 billion from financial
operations, 18 percent more than they earned
two years earlier. In comparison, the 15 largest
bank holding companies earned $41 million less
than they earned in 1981; however, the top
eight bank holding companies earned 16 per­
cent more than they earned in 1981 and twice
as much as the eight diversified financial firms.
American Express earned $515 million, the
highest 1983 net earnings of the diversified fi­
nancials and more than any bank holding
company except Citicorp (the largest).
All of the diversified financial firms’
product lines are not necessarily profitable.
Five of the selected eight diversified financial
firms have been hurt recently by problems that
have plagued the property-casualty insurance
industry. Also, some of these firms have re­
cently exited certain financial businesses. Fur­
ther, two diversified financial companies,
Baldwin-United and Walter E. Heller Interna­
tional, which were included in the Chicago
Fed’s two previous studies, have fallen on bad
times and were removed from the sample.

P rofitab ility .

The financial services op­
erations of the diversified financial firms seem
to be in a state of flux, so whether or not, as a
group, they are a significant threat to tradi­
tional suppliers is uncertain.
In consumer finance, the combination of
the eight diversified financial firms did not do
as well as the 15 largest bank holding compa­
nies. None of the diversified financials pose any
kind of threat in making residential first mort­
gage loans: almost all of the diversified finan­
cial firms’ residential mortgages are second
mortgages. Only four of the diversified finan­
cials “take deposits” through money market

Long-run im p a ct.

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




funds, but six own nonbank banks or have
savings and loan subsidiaries.
Some diversified financial firms are ex­
panding their offerings of financial products
and services to businesses. Yet even those di­
versified financial firms that have growing
commercial operations accounted at the end of
1983 for too small of a share of total commer­
cial lending and deposit-taking to pose a serious
threat to commercial banking firms in these
product areas in the near future.
In su ran ce-b ased com panies

Insurance companies compete with com­
mercial banks and other depository institutions
primarily through their investment portfolios.
Some insurance companies also compete in the
financial services industry through other
means. Five of these insurance-based firms are
Prudential, Equitable Life Assurance, Aetna
Life & Casualty, American General, and
Travelers. Among the noninsurance activities
of these five firms are mutual funds, brokerage,
cash management, mortgage banking, leasing,
and consumer finance.
At year-end 1983, life in­
surance companies held $69.5 billion in con­
sumer loans, over three-fourths of which was
consumer installment credit (policy loans).
The five insurance-based companies mentioned
above held $12.3 billion, or about 3 percent,
of all consumer installment loans outstanding.
But installment credit held at the 15 largest
bank holding companies grew almost three
times as fast over the 1981-83 period as install­
ment credit at these five insurance companies.
This is what would be expected as interest rates
decline, since the demand for policy loans in­
creases when interest rates rise.
In consumer mortgage lending, insurance
companies are dwarfed by commercial banks.
At year-end 1983, life insurance companies
held less than one-tenth of the consumer mort­
gages held by all commercial banks. More­
over, only two of the selected five
insurance-based firms had consumer mortgages
on their books in 1983; however, one (Equita­
ble) increased its holdings 24 percent, faster
than all commercial banks and faster than the
top 15 bank holding companies.
In commercial lending, insurance-based
firms are only significant in mortgage lending.

B usiness volum e.

13

In 1983, the five insurance companies held 8
percent of all commercial mortgage loans
outstanding—more than the top 15 bank hold­
ing companies and about one-third that of all
insured commercial banks. Commercial mort­
gages, however, grew at a faster pace over the
1981-83 period at commercial banks than they
did at insurance companies.
P rofitab ility.
Total earnings for the five
insurance-based firms exceeded $3.3 billion,
nearly as much as the worldwide earnings of
the top 15 bank holding companies. Over the
1981-83 period, however, the combined
earnings of the five insurance firms increased
only 3 percent, and for three of the firms,
earnings fell.

Insurance companies do
not seem to be a threat to banking firms. In
fact, banks have certain attributes that would
contribute to their success in offering insurance.
These include their image as providers of fi­
nancial services, their existing customer base,
and their existing distribution networks. Con­
sequently, the insurance industry has expressed
more concern about banks invading the turf of
insurance companies than vice versa.
Long-run im p act.

How they all stack up

All nonbank firms do not compete with
all banking firms or with each other. The
retailers offer financial products and services,
almost exclusively, to consumers, while many
of the industrial-based companies devote a
greater proportion of their financial services
activities to commercial customers than to
consumers. Also, of those firms that provide
financial services to consumers, not all target
the same ones. Some, like Merrill Lynch and
American Express, target the “upscale” cus­
tomer, while others, especially the retailers,
target “middle America.”
Also, as would be expected, each group
of nonbank competitors has not been as suc­
cessful as other groups in providing financial
services, and within the groups, some compa­
nies have not done as well as others. Further­
more, banks and bank holding companies have
been more successful than the nonbanks in
some areas.
In 1983, the nonbank firms held about
$262 billion in finance receivables, almost as
14




much as that held by the top 15 bank holding
companies. The industrial firms accounted for
over half of this amount; however, the retailers
led the nonbanks in receivables growth over the
1981-83 period, while the diversified financial
firms brought up the rear.
In the consumer finance area, the 30
nonbank firms accounted for over 30 percent
of all consumer installment credit outstanding
in 1983. At that time, seven nondeposit-based
firms each held over 1 percent of all consumer
installment credit (see Table 4). An industrial
firm, General Motors, held over 10 percent,
and a retailer, Sears, held 3.5 percent. In
contrast, Citicorp, the largest consumer install­
ment lender among the bank holding compa­
nies, held about 4 percent.
In commercial financing, the only rele­
vant nonbank groups (so far) are the industrial
firms and the insurance companies. The
retailers do not engage in commercial financ­
ing, and the eight diversified financials held less
than one percent of all commercial loans in
1983.
The insurance-based firms and the
industrial-based firms each had about a 4 per­
cent share of all commercial receivables at
year-end 1983, with $48.3 billion and $43.8
billion, respectively. General Motors and IBM
had the largest shares of C&I loans among the
nonbanks with 2.3 percent and 1.5 percent, re­
spectively. In contrast, BankAmerica, the
largest C&I lender among the bank holding
companies had a 4.1 percent share. In com­
mercial mortgage lending, Prudential and Eq­
uitable had the largest shares, each with about
2 percent. Citicorp held less than 1 percent of
all commercial mortgage loans outstanding in
1983.
In lease financing, the only significant
group of nonbank firms is the industrial-based
companies. They held almost 90 percent of the
lease receivables held by the 30 nonbank firms
in 1983. Over the 1981-83 period, however,
the diversified financial firms increased their
lease financing receivables 26 percent, a faster
pace than the industrial firms’ 22 percent in­
crease. The industrial firms that dominate this
lending category are General Electric, General
Motors, Ford, Greyhound, and Control Data.
Each held over $1 billion in lease receivables
at year-end 1983.
The 30 nonbank firms reported $8 billion
in earnings from financial services in 1983. The
E c o n o m ic P e rs p e c tiv e s

Table 4
Top 10 consum er in s ta llm e n t
lenders: 1983
1983_________ 1981

General Motors

$ bil

Market*
share $ bil

Market*
share

$40.2

10.2% $31.1

9.3%

Citicorp

15.4

3.9

9.6

2.9

Sears

13.8

3.5

9.5

2.8

Ford Motor

11.9

3.0

11.9

3.5

BankAmerica Corp

11.4

2.9

9.7

2.9

American Express

7.7

1.9

5.0

1.5

Prudential

6.7

1.7

5.1

1.5

Merrill Lynch

6.1

1.5

4.7

1.4

J.C. Penney

5.5

1.4

4.4

1.3

Security Pacific

5.5

1.4

3.8

1.1

124.2

31.4

94.8

28.2

‘ Market shares for the nonbank firms are slightly understated
because second mortgages are excluded from consumer in­
stallment credit for these companies.
SOURCE: Company annual reports and Flow of Funds A c­
counts, Assets and Liabilities Outstanding 1960-83, Board of
Governors of the Federal Reserve System.

five insurance companies accounted for the
largest share of these earnings. The insurance
companies, however, although appearing
strong in absolute earnings, lag the other non­
bank firms in earnings growth. Over the
1981-83 period, the 14 industrial-based firms
increased their financial services earnings 57
percent, while the earnings of the insurance
companies grew only 3 percent. Five nonbank
firms had both high financial services earnings
in 1983 and high earnings growth over the
1981-83 period. Three are industrial-based
firms—General Motors, Ford, and General
Electric. The other two are Sears and Ameri­
can General. No diversified financial firm
made this list.
C onclusions

When attention began to be focused on
nonbank competitors—such as Sears, American
Express, General Motors, Prudential, and
Merrill Lynch—early in the 1980s, their new
competitive thrusts seemed to represent a real
and immediate danger to the banking industry.
With the benefit of hindsight and the research
discussed in this and our previous studies, we
conclude those fears are unwarranted, although
F e d e ra l R e s e rv e B a n k o f C h ic a g o




some nonbank firms have gained substantial
market shares in some product lines and are
increasing their presence at a very fast pace.
The environment at the beginning of the
1980s must be kept in mind. The banking in­
dustry was still reeling from three unantic­
ipated forces: 1) deregulation brought on by
the Depository Institutions Deregulation and
Monetary Control Act passed in March 1980,
which opened up a new era in price competi­
tion by phasing out Regulation Q ceilings; 2)
prolonged downward sloping yield curves con­
taining record level interest rates all along the
maturity spectrum; and 3) record high
volatility, or lack of predictability of interest
rates. If this were not enough, these events
were followed by the steepest recession of the
post-World War II period; an international
debt crisis; a period of disinflation that under­
mined the value of tangible assets such as real
estate and commodities; and an oil glut. To
sort out the separate impact of each of these
simultaneous events on the performance of
banks would be nearly impossible. To evaluate
the impact on bank performance resulting from
increased nonbank competition during a period
when banks were being buffeted by these other
events is even more difficult, if not impossible.
Despite these caveats and the fact that only
three or four years of data have been analyzed
extensively, we offer a few tentative conclusions
on financial industry competition.
By far the safest observation that can be
made from our analysis is that the banking in­
dustry has shown an amazing degree of
resiliency in the face of these changes. Small
banks gained market share in commercial
lending relative to large banks and nonbanks.
Large banks gained market share in consumer
lending relative to small banks and all non­
banks except retailers. In this hostile macroeconomic environment, bank profitability
suffered relative to nonbanks. Yet, in those
areas where banks were deregulated in recent
years, they have fared quite well against their
nonbank competitors. The MMDA vs MMF
battle is a case in point.
Prior to 1980, banks were subject to price
regulation (Regulation Q and usury ceilings),
product restrictions, and geographic re­
strictions. To be sure, banks do have federal
deposit insurance while nonbank competitors
do not, but nonbank competitors were subject
only to usury ceilings. Since 1980, the driving
15

force behind the contentiousness of banks and
nonbanks has shifted to issues such as the
Glass-Steagall Act, and the McFadden Act and
the Douglas Amendment to the Bank Holding
Company Act.
The nonbanks increased their emphasis
on the financial services and products offered
by banks because they saw profitable opportu­
nities to be exploited in going against compet­
itors like banks that were not free to adjust
their price, product, and geographical mix.
Many of these nonbank competitors at the time
were not doing particularly well in their own
primary product lines where they faced com­
petition that had equal price, product, and ge­
ographical freedom.
They also recognized some synergies be­
tween their primary lines of business and fi­
nancial services. For the retailers, financial
services allows them to take advantage of their
extensive distribution networks, large customer
bases, and years of credit experience. Simi­
larly, industrial firms can capitalize on their
captive financing experience and, in some
cases, their distribution systems. Diversified fi­
nancials and insurance companies also have
extensive distribution systems, and are recog­
nized as suppliers of financial services.
This is not to say that all nonbanks will
do well in financial services. Some will do well,
others will not. Our research to date does not
indicate any particular nonbank firm or group
of firms that seems destined to outperform their
banking and nonbank competitors. By the
same token, no particular bank or group of
banks seems destined for success or extinction.
However, the limited evidence we have re­
viewed suggests that banks will improve their
chances of competing successfully against their
nonbank competitors as geographic and prod­
uct restrictions are relaxed. That is, many of
the regulations designed to protect banks from
one another have hurt them by limiting their
ability to formulate strategies and actions to
deal effectively with their nonbank competitors.1
1 Cleveland A. Christophe. Competition in Financial
Services, (New York: First National City Corpo­
ration, 1974).
Harvey Rosenblum and Diane Siegel. Competition
in Financial Services: The Impact of Nonbank Entry,
Staff Study 83-1, Federal Reserve Bank of Chicago,
May 1983; and Harvey Rosenblum and Christine

2

76




P a v e l, Financial Services in Transition: The Effects of
Nonbank Competitors, S ta f f M e m o 8 4 - 1 , 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 , 1 9 8 4 .
3 C o n s u m e r in s ta llm e n t c r e d i t fo r th e n o n b a n k
firm s is s lig h tly u n d e r s ta te d b e c a u s e it e x c lu d e s
s e c o n d m o r tg a g e s , w h ic h , fo r th e n o n b a n k s , w e re
g ro u p e d w ith c o n s u m e r first m o r tg a g e s .
4 H a r v e y R o s e n b lu m a n d C h ris tin e P a v e l, “ 1 9 8 3 :
T h e Y e a r in R e v i e w ,”
165 (D e ­
ce m b e r 3 1 , 1 9 8 3 ) pp. 1 0 -1 1 .

Commercial West,

0 B a n k a ssets e x p a n d e d a t a fa s t r a t e d u r in g th e
1 9 8 1 - 8 3 p e rio d p a r t ly b e c a u s e o f a v ig o r o u s e c o ­
n o m ic e x p a n s io n , a c c o m p a n ie d b y a n e a s ie r m o n e ­
t a r y p o lic y b e g in n in g in J u l y 1 9 8 2 .

6 Moody’s Industry Outlook Retail Industry, (N e w
M o o d y ’s In v e s to r s S e r v ic e , I n c .)

Y o rk :
A u gu st 2 4 , 1 9 8 4 ,

p. 4.
7 M o r t g a g e lo a n s a r e e x c lu d e d h e re b e c a u s e o n ly
S e a rs m a k e s m o r tg a g e lo a n s , th r o u g h S e a r s S a v in g s
B a n k in C a lif o r n ia .

8 Nilson Report, n o .

3 3 7 (A u g u s t 1 9 8 4 ) , p .4 a n d n o.
3 3 8 (A u g u s t 1 9 8 4 ) , p. 3 .

9 “ T h e o n ly th in g w e h a v e to f e a r is S e a r s its e lf,”
(O c to b e r 1 9 8 3 ) pp. 5 8 -6 0 .

ABA Banking Journal
10 I b i d ., p . 5 8 .

11 F o r a v a r i e t y o f re a s o n s , th is in c r e a s e d m a r k e t
s h a re w a s p u r c h a s e d
t h r o u g h v ig o r o u s p r ic e c u tt i n g .

For

d e ta ile d

d iscu ssio n

see

H arv ey

R o s e n b lu m a n d C h ris tin e P a v e l, “ B a n k in g S e rv ic e s
in T r a n s i t i o n ,”
1984,

Handbook for Banking Strategy,
Economic

p p . 2 1 9 - 2 6 , a n d D o n n a V a n d e n b r i n k , “ D id u s u ry
c e ilin g s
h o ld
dow n
a u to
s a le s ? ”

Perspectives, S e p t e m b e r / O c t o b e r 1 9 8 4 ,
12 A r m c o Annual Report, 1983, p . 1 0 2 .

pp. 2 4 -3 0 .

13 W h ile it is d ifficu lt to p ro v id e a d e fin itiv e i n t e r ­
p r e t a ti o n , th ese fin d in g s a r e c o n s is te n t w ith r e c e n t
tre n d s t h a t sh ow th e l a r g e r b a n k s e m p h a s iz in g
m id d le m a r k e t le n d in g a n d n o n c r e d i t s e rv ic e s b e ­
c a u s e o f th e sh rin k in g p ro f ita b ility o f le n d in g to
la r g e c o m p a n ie s t h a t h a v e a c c e s s to n a ti o n a l o r
g lo b a l m o n e y a n d c r e d i t m a r k e ts . S m a l le r a n d
m e d iu m -s iz e b a n k s h a v e a lw a y s c o n fin e d th e ir
c o m m e r c ia l le n d in g to sm a ll a n d m e d iu m -s iz e c u s ­
to m e rs w h ic h , b e c a u s e o f th e ir lim ite d a c c e s s to th e
n a tio n a l m o n e y m a r k e ts , a r e fo r c e d to m a in ta in
th e ir c r e d i t re la tio n s h ip s w ith b a n k s a n d s u p p lie rs
o f t r a d e c r e d i t. T h e s e d a t a s u g g e s t t h a t th e la r g e r
b a n k s a n d b a n k h o ld in g c o m p a n ie s h a v e a lo n g
w a y to g o in lu r in g s o -c a lle d m id d le m a r k e t c u s ­
to m e rs a w a y fro m th e ir re la tio n s h ip s w ith lo c a l a n d
r e g io n a l b a n k s, t r a d e c r e d i t su p p lie rs , a n d c o m ­
m e r c ia l fin a n c e c o m p a n ie s . W h e n c o m b in e d w ith
th e e v id e n c e o n c o n s u m e r le n d in g , th ese d a t a s u g ­
g e s t a s ig n ific a n t c h a n g e in th e p e r c e iv e d r e la tiv e
o p p o r tu n itie s a n d
c o n s u m e r le n d in g .

p r o f ita b ility

o f c o m m e r c ia l vs.

E c o n o m ic P e rs p e c tiv e s

14 S in c e

1981,

G ECC

has en g ag ed

in m o r tg a g e

b a n k in g th r o u g h tw o s u b s id ia rie s , G e n e r a l E le c t r i c
M o rtg a g e
S e c u r itie s

C o rp .
C o rp .

an d G e n e ra l E le c tric M o rtg a g e
C o n t r o l D a t a h a s e n g a g e d in

m o r tg a g e b a n k in g sin ce 1 9 8 2 th r o u g h a s u b s id ia ry
o f C o m m e r c ia l C r e d i t C o r p .
15 E c o n o m ie s o f s c o p e re s u lt w h e n th e r e is a c o s t
a d v a n t a g e to p r o d u c in g tw o p r o d u c ts s im u lta n e ­
o u s ly r a t h e r t h a n e a c h s e p a r a te ly .

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




16 “ M e r r ill L y n c h ’s B ig D il e m m a ,”

Business Week,

J a n u a ry 16, 1 9 8 4 , pp. 6 3 -6 7 .
17 I n 1 9 8 4 , M e r r ill L y n c h re s p o n d e d to this a p p a r ­
e n t d is a d v a n t a g e b y a d o p tin g a r e o r g a n i z a ti o n p la n
d e s ig n e d to tr a n s f o r m

th e c o m p a n y fro m a sales-

o r ie n te d firm in to a m a r k e tin g o n e .
18 “ I n s u r e r s ’ M o u n t in g T r o u b l e s ,”

New York Times,

1 4 F e b r u a r y 1 9 8 4 , sec. D , p p . 1 , 1 7 .

17

Cautious play marks S&L approach
to commercial lending
Christine Pavel and Dave Phillis
The boundaries of the financial services
industry are being redrawn by nonbank com­
petitors developing new distribution networks
and repackaging old products into new ones,
and by large banking organizations searching
for and exploiting loopholes in the regulatory
framework. But where do thrifts fit in this
changing financial services industry?1
Congress has granted the thrift industry
a number of new powers over the last four years
(see Table 1), including the power to make
commercial loans and accept commercial de­
mand deposits—the essence of commercial
banking according to the the Supreme Court.2
Thrifts, however, have been slow in utilizing
their new powers. One way to evaluate the
position of thrifts in this rapidly changing fi­
nancial environment is to examine how they
have used their new powers, in particular, their
commercial lending powers. In doing so, we
can better understand the regulatory debate
over the relevance of commercial banking as a
distinct line of commerce in merger analysis.3
Since 1974, controversy has centered on
whether and to what extent thrifts provide
competition to commercial banks in traditional
banking services.4 In 1974, most thrift insti­
tutions were limited to offering time and
savings deposits and making residential mort­
gage loans. In the few states where thrifts were
allowed to offer transactions accounts and con­
sumer and commercial loans, thrifts had very
small market shares. The Supreme Court de­
termined, therefore, that they did not compete
with commercial banks, though the Court did
acknowledge that thrifts may become signif­
icant competitors in the future should trends
apparent at that time continue.
The issue of thrifts as commercial banks’
competitors resurfaced in the 1980s when Con­
gress granted all thrifts the power to make
consumer and commercial loans and to issue
transactions accounts. Congress passed the
Depository Institutions Deregulation and
Monetary Control Act of 1980 (DIDMCA) to
help the thrift industry retain its deposit base
and improve its profitability. DIDMCA al
18




lowed thrifts to make consumer loans up to 20
percent of their assets, issue credit cards, accept
Negotiable Order of Withdrawal (NOW) ac­
counts from individuals and nonprofit organ­
izations, and invest up to 20 percent of their
assets in commercial real estate loans.
DIDMCA, however, did little to alter the
thrift industry’s behavior and therefore resolve
the fundamental problem of the thrift
industry—maturity mismatching, i.e., short­
term liabilities funding long-term assets. Fur­
ther deregulation occurred in 1982 with the
passage of the Garn-St Germain Depository
Institutions Act (Garn). As shown in Table 1,
Garn increased the proportion of assets that
thrifts could hold in consumer and commercial
real estate loans and allowed thrifts to invest 5
percent of their assets in commercial loans (7.5
percent for savings banks) until January 1,
1984, when this percentage limitation was
raised to 10 percent.
Since the passage of DIDMCA and Garn,
many studies have examined how S&Ls have
utilized their commercial lending powers to
determine whether these new powers have en­
hanced thrifts’ profitability and to determine
the extent to which thrifts compete with com­
mercial banks.5 These studies look to the fi­
nancial statements of thrifts for answers. In
general, they have found that thrifts have been
slow to use their commercial lending powers
and that thrifts have not used them to the full
extent of the law. These studies conclude that
thrifts will continue to experience problems due
to the maturity mismatch of their portfolios
and that they have not yet become significant
competitors of commercial banks.
Financial statements, however, provide
limited information. In this article, we report
the results of a survey of all S&Ls in Illinois
and Wisconsin concerning their commercial
lending activities and examine the financial
statements of the S&Ls.6 The survey was conChristine Pavel and Dave Phillis are associate economists
at the Federal Reserve Bank o f Chicago. Helpful research
assistance was provided by Janet Zimmerle, who was a
summer intern at the Bank during the fall o f 1984.

E c o n o m ic P e rs p e c tiv e s

Table 1
N e w pow ers g ranted to fed e rally c h a rtere d th r ifts

Consumer loans

Garn-St. Germain

DIDMCA

New powers

(Effective March 31, 1980)

(Effective October 15, 1982)

Consumer loans up to 20 percent
of total assets

Consumer loans up to 30 percent
of total assets

Educational loans up to 5 percent
of total assets
Issue credit cards
Commercial loans

Commercial real estate up to
20 percent of total assets

Commercial real estate loans up
to 40 percent of total assets

Unsecured construction loans up
to 5 percent of total assets

Other commercial loans up to 5 percent
of total assets prior January 1, 1984
(7.5 percent of total assets for savings
banks) and up to 10 percent of total
assets thereafter
Equipment leasing up to 10 percent
of total assets

Transaction
accounts

Now accounts from individuals
and nonprofit organizations

Now accounts from governmental units
Demand deposits from persons or
organizations that have established
"a business, corporate, commercial
or agricultural loan relationship"
with the institution

ducted during the fall of 1984.7 Because of the
high response rate (81 percent), the samples are
representative of the thrift industry in the two
states, and as shown in Figure 1, these two
states are typical of the thrift industry in the
nation.
We describe how S&Ls in two states have
reacted to their new commercial lending pow­
ers. In so doing, we shed some light on the
proper distinction between banks and thrifts in
the competitive analysis of bank mergers and
acquisitions. The first section describes which
S&Ls in Illinois and Wisconsin have used their
commercial lending powers, and the second
describes how they have used these
powers—what products are offered and what
markets are targeted. The third section iden­
tifies the characteristics of S&Ls that make
commercial loans. The fourth section discusses
how these institutions view the commercial
lending environment. The last section reviews
the most important findings of this study and
discusses their implications for bank merger
analysis.
F e d e ra l R e s e rv e B a n k o f C h ic a g o




The p layers and the sp ectato rs

One-quarter of the S&Ls surveyed in
Illinois and Wisconsin engage in commercial
lending (lenders) or, in the fall of 1984, were
planning to do so (planners). Almost half of
these S&Ls have chosen to operate separate
commercial lending departments staffed by one
or two experienced commercial loan officers.
Another 25 percent indicated that they will
employ at least one full-time commercial loan
officer at the end of the first full year of business
lending.
The remaining three-quarters of the re­
spondents do not make commercial loans and
are not planning to make such loans (nonlend­
ers), but almost half of these S&Ls have con­
sidered engaging in commercial lending. When
asked to explain in their own words what in­
fluenced their decisions not to offer commercial
loans, these S&Ls executives typically cited a
perceived high level of risk, high start-up costs,
and lack of prior experience as the primary
reasons. Other reasons given by the nonlenders
19

Figure 1
A s s e t c o m p o s itio n o f S & Ls: 1 9 8 3
U.S. S&Ls

Illinois and Wisconsin S&Ls

median total assets = $ 7 5 million

median total assets = $ 6 9 million

com mercial
loans

com m ercial
loans
0. 2%

0.4%

loans

loans
4%

2%

commercial
m ortgages

m ortgages

6%

other

3.8%

1.6 %

were the small size of the association, the high
degree of competition among commercial
lenders, poor regional and national economic
conditions, and concomitant low demand for
commercial loans.
Planners and lenders were asked to ex­
plain why they decided to engage in commer­
cial lending. Both groups cited the potential
for profits and improved asset and liability
management. Planners and lenders also cited
the need to diversify their lending activity, to
accommodate existing customers, to attract
businesses’ savings and demand deposits, and
to become a “full service” association. In ad­
dition, several lenders said they wanted to at­
tract new customers. One S&L executive
commented, “We had to [make commercial
loans] to be able to attract business from the
banking industry.”
The gam e plan

Overall, S&Ls have been slow to make
commercial loans. As shown in Figure 2, at the
end of 1983, only 31 associations (9 percent of
all S&Ls in Illinois and Wisconsin) were mak­
ing commercial loans. By the end of 1984,
however, 59 associations (about 16 percent)
were making such loans, and we estimate from
the survey responses that by the end of 1985,
20




over 20 percent of the S&Ls in Illinois and
Wisconsin will be making commercial loans.
Nevertheless, commercial loans still account for
a very small portion of thrifts’ total assets. At
year-end 1983, commercial loans accounted for
only 0.6 percent of assets for those associations
in Illinois and Wisconsin that engage in com­
mercial lending.
However, the S&L executives responded
that commercial loans would represent about
1.6 percent of their associations’ total assets at
the end of their first full year of business lend­
ing, and nearly twice that after the second full
year. If these S&Ls allocate their assets as in­
dicated, they should increase their commercial
loans outstanding more than fourfold within
two years even if their total assets remain the
same.
Many S&Ls seem to be testing the waters
and trying to gain experience in this lending
area before building volume. One S&L exec­
utive said that his association plans “to offer
commercial loans to a few firms which have
requested them and with which we are famil­
iar. After some experience we will decide
whether we want to expand further into this
area.” Some S&Ls, however, indicated that
they are merely offering commercial loans to
meet existing customers’ needs and to retain
these customers.
E c o n o m ic P e rs p e c tiv e s

One (of the many) reasons for the slow
growth of commercial lending at S&Ls so far
is that they are not simply buying commercial
loans to hold in their portfolios. Rather, they
are actively writing commercial loans (Figure
3). Almost all (92 percent) of the planners and
lenders in Illinois and Wisconsin expect to
originate commercial loans, but less than onefourth of these anticipate selling loan partic­
ipations. Furthermore, many of those
institutions that do sell loan participations are
acting as syndicators of very large loans. The
average commercial loan originated by S&Ls
and outstanding at the end of the first full year
of business lending was about $150,000. In
comparison, the typical size of a loan partic­
ipation sold by an S&L to other institutions
was $450,000.
Some of the planners and lenders have
chosen to supplement their commercial lending
activity by purchasing commercial loans from
other financial institutions. One-third of the
planners and lenders purchase, or plan to pur­
chase, commercial loans. Only 4 of the 74
planners and lenders have chosen to rely solely
on the purchases of commercial loans. In genFigure 2
C o m m e r c ia l le n d in g p a rtic ip a tio n
o f S & L s in Illin o is a n d W is c o n s in
number of institutions

90

S&Ls with less
than S50
million in
assets

S&Ls with
betw een S50
million and
S I OO million
in assets

S&Ls with
betw een $ 1 0 0
million and
$ 5 0 0 million in
assets

S&Ls with
m ore than
$ 5 0 0 million in
assets
1983

1984*

•Estimated based on survey responses.

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




Figure 3
S o u r c e o f c o m m e r c ia l lo a n s fo r
p la n n e r s a n d le n d e r s
percent

originate

originate
and sell

purchase

eral, S&Ls seem to prefer to buy loans from
banks, but they are indifferent as to whom they
sell participations.
Lenders that originate commercial loans
and planners that expect to originate them
were asked about the customers they target
(Tables 2a and 2b) and the products they offer
(Figure 4). Very few associations target large
businesses (with sales of over $25 million).
Most S&Ls (79 percent) target small companies
(with annual sales from $50,000 to $1
million).8 Over half of the lenders are making
commercial loans to construction companies,
retailers, and professionals. Most of the plan­
ners intend to make loans to these customer
groups as well, but they also intend to make
loans to manufacturers. The specific types of
commercial products and services that S&Ls
have chosen to offer to small businesses include
equipment lease financing, construction loans,
inventory financing, commercial mortgage
loans, and commercial checking accounts.
Identifying the players

The S&Ls that make commercial loans
and those that are planning to, have several
characteristics in common.9 These character­
istics include familiarity with commercial
mortgage lending, the acceptance of commer­
cial demand deposits, and large size. Also,
thrifts in metropolitan areas that are charac­
terized by a large proportion of small businesses
and dominated by a few commercial banks are
likely to engage in commercial lending.
21

Table 2
Business targeted by planners and lenders
(a)
Planners (n = 21)

Construction
Manufacturers
Wholesalers
Retailers
Auto dealers
Farmers
Professionals

Sales
under
$50,000

Sales
$50,000$1 (mil.)

Sales
$1 (mil.)
$25(mil.)

Sales
over
$25(mil.)

10%
5
10
24
10
33
19

29%
29
19
29
5
10
62

19%
24
24
14
5
5
24

57
62
52
67
19
38
90

48

76

43

0%
10
5
5
0
0
0
10

62
43
32
79
51
32
77

Total

(b)
Lenders (n = 47)
Construction
Manufacturers
Wholesalers
Retailers
Auto dealers
Farmers
Professionals

11
4
0
21
2
6
17

43
26
23
57
26
26
62

13
17
11
11
23
0
2

0
2
2
0
2
0
0

30

79

38

2

Table 3
Total assets and capital-to-assets ratios of respondents
(a)
Nonlenders

Planners

Lenders

Row total

Total assets (1983)
less than $50 million
$50-100 million
100-500 million
more than $500 million
Total

77
53
79
217

6
7
3
23

11
12
22
6

94
72
104
21

217

23

51

291

(b)
Nonlenders

Planners

Lenders

Row total

Capital-to-assets (1983)
less than 1%
1% to 3%
3% to 5%
more than 5%
Total

22




19
52
58
88

4
0
8
11

2
15
22
12

25
67
88
111

217

23

51

291

E c o n o m ic P e rs p e c tiv e s

Many planners (87 percent) and lenders
(94 percent) offer commercial real estate loans.
Experience gained in making commercial
mortgages may provide an S&L with the ex­
pertise and customer contacts to make nonreal
estate commercial loans, and therefore move
the S&L along the experience curve, reducing
its costs of providing such loans. One S&L
executive commented, “We had a business re­
lationship with real estate companies and com­
mercial loans to them were a natural starting
point.” Commercial real estate lending may
also help an association establish its commit­
ment to building a long-term relationship with
business customers.
The ability to offer commercial demand
deposits also seems to influence an S&L’s deci­
sion to engage in commercial lending. Garn
permits an association to offer commercial de­
mand deposits only to customers that have a
lending relationship with the association. As
mentioned above, many S&Ls said that they
decided to make commercial loans in order to
attract the deposits of businesses. Commercial
demand deposits also help reduce the cost of
commercial lending by providing in-house in­
formation on business customers through the
deposit relationship.
As shown in Table 3a, large S&Ls tend
to be planners and lenders. Of the 21 insti­
tutions in Illinois and Wisconsin with assets in
excess of $500 million, nearly two-thirds are
planners or lenders, whereas only 17 of the 94
institutions with less than $50 million in assets
(18 percent) are planners or lenders. This is to
be expected since large institutions are better
able to absorb the start-up costs of offering a
new product. Nevertheless, only 4 percent of
those S&Ls that are either planners or lenders
are large institutions because S&Ls with over
$500 million in assets account for only a small
percentage of all S&Ls in Illinois and
Wisconsin. Thus, while large institutions seem
more likely to engage in commercial lending,
most of the institutions that are making com­
mercial loans, or are planning to do so, are
medium-sized institutions.
Small and medium-sized institutions, on
average, are better capitalized than large insti­
tutions. Since most of the S&Ls that are lend­
ers or planners are medium size, most S&Ls
that engage in commercial lending are ade­
quately capitalized according to regulatory
standards. As shown in Table 4b, 72 percent
F e d e ra l R e s e rv e B a n k o f C h ic a g o




Figure 4

Comm ercial products and services
offered by planners and lenders
percent
0

20

40

60

80

100

~1
accounts
receivable
financing

equipm ent
financing

lease financing
(real property)

com m ercial
m ortgages

construction
loans

inventory
financing

com m ercial
checking
accounts

cash
m anagem ent

loans to
purchase
securities

of the planners and lenders had capital-toassets ratios of at least 3 percent, and 31 per­
cent had capital exceeding 5 percent of assets
at year-end 1983. However, 17 percent of the
planners had capital-to-assets ratios below 1
percent. All but one of these institutions were
large associations, with total assets in excess of
$500 million.
Almost two-thirds of all S&Ls in Illinois
and Wisconsin were able to report profits, no
matter how small, in 1983. Similarly, about
two-thirds of the nonlenders, planners, and
lenders earned profits in 1983. Profits, there­
fore, do not distinguish an S&L that makes
commercial loans from one that does not.
23

Table 4
Risk and cost perceptions of respondents

(a)
Nonlenders

Planners

Lenders

0%
50%
50%

8%
61%
31%

Planners

Lenders

17%
65%
17%

15%
67%
19%

Risk
Low
Moderate/average
High

1%
29%
70%
(b)
Nonlenders

Cost
Low
Moderate/average
High

5%
46%
49%

Most S&Ls in Illinois and Wisconsin (68
percent) are located in metropolitan areas. As
shown in Figure 5, a large proportion of plan­
ners and lenders (73 percent) are located in
metropolitan statistical areas (MSAs).10 This is
not surprising since metropolitan areas are
home to a large number of businesses.
The three largest metropolitan areas in
the two states are Chicago, Milwaukee, and the
portions of suburban St. Louis located in
Illinois. In the Milwaukee and St. Louis met­
ropolitan areas, 35 percent and 39 percent of
the S&Ls are planners or lenders, a higher
proportion than the 25 percent for the whole
sample. In Chicago, however, only 20 percent
of the S&Ls are planners or lenders. In fact,
Chicago looks very similar to the nonmetro­
politan areas in this regard.
One possible explanation is that S&Ls
find it more difficult to identify niches that they
can profitably fill in these areas, for quite dif­
ferent reasons. Commercial lending is highly
competitive in Chicago, with some 350 banks
competing in the Chicago areas. In addition,
dozens of out-of-state banks compete for com­
mercial loan customers in Chicago through
loan production offices and nonbank subsid­
iaries of their bank holding companies. On the
other hand, nonmetropolitan areas simply do
not have many businesses and therefore lack
the demand for commercial loans. It may be
very difficult to find an unfilled niche in the
Chicago market, and it may be very difficult
to find any niche in nonmetropolitan areas.
24




S&Ls that make commercial loans also
tend to be found in areas with a high concen­
tration of small businesses.11 Planners and
lenders account for 33 percent of the S&Ls in
the five metropolitan areas in Illinois and
Wisconsin with the highest proportion of small
businesses (business with less than 50 employ­
ees). Of the S&Ls in the five MSAs with the
lowest proportion of small businesses, only 16
percent are planners or lenders.
The playing field

The S&Ls surveyed were asked to assess
the environment for commercial lending in the
markets they serve based on the following fac­
tors: competitiveness, costs, risks, demand,
prior experience, and profitability. Nonlend­
ers, planners, and lenders alike generally
agreed that commercial lending is moderately
profitable and moderately to highly compet­
itive. These factors are consistent with uncon­
centrated markets.
Thrifts that are located in highly concen­
trated areas are more likely to engage in com­
mercial lending because they can easily gain
customers by undercutting the banks’ high
prices and still cover costs.12 Of the S&Ls in the
five most concentrated MSAs in Illinois and
Wisconsin that responded to the survey, twothirds are planners or lenders.13 In contrast,
only one-quarter of the S&Ls in the five least
concentrated MSAs are planners or lenders.
However, four times as many S&Ls that are
planners or lenders are located in the five least
E c o n o m ic P e rs p e c tiv e s

concentrated MSAs than are located in the five
most concentrated MSAs. This is because, in
general, more S&Ls are located in relatively
unconcentrated markets. Thus, while S&Ls in
concentrated markets are more likely to engage
in commercial lending, most of the S&Ls that
do make commercial loans are located in un­
concentrated markets.
Of course, commercial lending is not lim­
ited to an S&L’s local market. Many S&Ls in
Illinois and Wisconsin have branches statewide.
But when asked what percentage of their com­
mercial loan customers would be in a 25-mile
radius of the home office, most S&Ls indicated
that they were staying close to home. The av­
erage response was 81 percent for planners and
87 percent for lenders. Also, many S&Ls
executives explained that they would be mak­
ing loans to meet existing customers’ needs and
the needs of the local community.
Perceived costs and risks were the only
discernible differences among nonlenders,
planners, and lenders when asked about the
environment for commercial lending (Tables
4a and 4b). Nonlenders generally perceive
commercial lending to be very costly, whereas
planners and lenders generally characterize the
Figure 5
L o c a tio n o f n o n le n d e r s , p la n n e r s a n d le n d e rs
percent

Chicago

M ilw a u k ee

St. Louis
(Illinois Suburbs)

other
m etropolitan
areas

costs associated with commercial lending as
moderate. Nonlenders also perceive the
riskiness of commercial lending as high, while
planners and lenders find it to be moderate.
The differences between mortgage loans,
which account for well over half of a typical
S&L’s assets, and commercial loans may ac­
count for the different risk perceptions between
lenders and nonlenders.14 Mortgage loans are
long-term loans secured by real property,
whereas commercial loans are generally short­
term and unsecured. A commercial loan,
therefore, requires knowledge of the borrower’s
business and financial condition, while a mort­
gage loan requires skills in appraising real es­
tate. Nonlenders have no experience in making
commercial loans, but lenders have some expe­
rience in this lending area. Nonlenders, there­
fore, would be expected to perceive commercial
lending as riskier than do lenders.
To gain further insight into the
competitiveness of commercial lending, the
S&Ls were asked what reactions existing com­
mercial lenders had or would have to a new
entrant. Most S&Ls did not think that their
commercial lending activities would alter their
competitors’ strategies. When asked specif­
ically, however, about competitors’ reactions in
terms of pricing, service, and marketing, most
S&Ls acknowledged that they did not know
what their competitors would do. This uncer­
tainty may help explain why some S&Ls have
been slow to use their new powers; many may
have adopted a wait-and-see attitude.
The S&Ls were also asked if commercial
lending would affect their retail customers. All
respondents generally agreed that it would not.
Of the dozen or so S&Ls that said commercial
lending would affect their retail customers, all
agreed that the effect would be positive. Many
of these S&Ls indicated that they have retail
customers who own small businesses. By mak­
ing commercial loans, these associations can
provide more services to their small business
customers, retain their business and cross-sell
retail and commercial products and services.
At the end o f the firs t inning

nonm etropolitan
areas
‘ Percent of total.
SOURCE: C ounty Business Patterns and Survey Data.

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




S&Ls have been slow to adopt their
commercial lending powers. They are gaining
experience in making commercial loans by
carefully and selectively marketing this new
product.
25

Commercial loans are very different than
residential mortgage loans, which account for
over half of a typical thrift’s assets. Before ex­
tending credit to a business, a thrift must ana­
lyze the business’s financial statements and
evaluate its cash flow projections. A thrift must
also be willing to stand in line with other un­
secured creditors in the event of the business’s
bankruptcy. These are gigantic steps for an
industry that has been accustomed to making
secured loans for less than the full value of the
collateral, which has been likely to appreciate
in value over time.
S&Ls seem to be following one of two
strategies. Some associations are marketing
commercial loans primarily to existing custom­
ers. Others are writing commercial loans only
at the request of existing customers and have
expressed no plans or desires to expand their
commercial lending activities further. If the
S&Ls that are following the first strategy, and
even those following the second, find commer­
cial lending to be profitable, then S&Ls will
increasingly pose a competitive threat to banks
and other business lenders, especially in lending
to small and medium-sized businesses.
Furthermore, if S&Ls find commercial
lending profitable, more associations can be
expected to offer commercial loans. The S&Ls
that responded to our survey indicated that it
took only four months from the time they
started planning to make commercial loans to
the time such a loan was actually made.
The S&Ls that are making commercial
loans seem to be carving out a niche for them­
selves. They are primarily targeting small
businesses and, in doing so, they are capitaliz­
ing on their existing customer base. S&Ls, in
general, are not yet significant competitors of
commercial banks in commercial lending and
deposit taking, although in some markets a few
individual S&Ls may be. S&Ls should notjvet
be included wholesale in the analysis of bank
mergers and acquisitions. Rather, they should
be considered on a case-by-case basis if a pro­
posed merger raises serious concerns on a
bank-only basis.
1 T h e th r if t in d u s try in c lu d e s s a v in g s a n d lo a n a s ­
s o c ia tio n s ( S & L s ) a n d sa v in g s b a n k s ; h o w e v e r , this
a r tic le is o n ly c o n c e r n e d w ith s a v in g s a n d lo a n s .

2 United

States v. Philadelphia National Bank & Trust
Co., 3 7 4 U .S . 3 2 1 ( 1 9 6 3 ) . In th is c a s e , th e S u p re m e

26




C o u r t d e te r m in e d t h a t th e s e rv ic e s o ffe re d b y c o m ­
m e r c ia l b a n k s w e re u n iq u e a n d t h a t th rifts w e re n o t
c o m p e tito r s b e c a u s e th e y d id n o t p ro v id e a c o m ­
p le te lin e o f b a n k -lik e s e rv ic e s .
3 For a
b a n k in g

m o r e d e ta ile d d iscu ssio n o f c o m m e r c ia l
as a d is tin c t lin e o f c o m m e r c e
see

R o s e n b lu m , Di C le m e n te , a n d O ’ B r ie n , “ T h e
p r o d u c t m a r k e t in c o m m e r c ia l b a n k in g : C l u s t e r ’s
la s t s t a n d ,” Economic Perspectives, J a n u a r y / F e b r u a r y
1985.

4 United

States v. Connecticut National Bank, 4 1 8 U .S .
6 5 6 ( 1 9 7 4 ) . T h is c a s e in v o lv e d th e in clu s io n o f
s a v in g s b a n k s in th e lin e o f c o m m e r c e d e fin itio n .
T h e D is tr ic t C o u r t in c lu d e d s a v in g s b a n k s in th e
d e fin itio n a n d th e r e b y u p h e ld th e p ro p o s e d m e r g e r ,
b u t th e S u p re m e C o u r t o v e r t u r n e d th e d e c is io n ,
a r g u in g t h a t s a v in g s b a n k s d id n o t y e t p ro v id e sig ­
n if ic a n t c o m p e titio n to b a n k s.
1 S ee C o n s ta n c e D u n h a m , “ M u tu a l S a v in g s B a n k s :
A re T h e y N o w o r W ill T h e y E v e r B e C o m m e r c ia l
B a n k s ? ” New England Economic Review, F e d e r a l R e ­
s e rv e B a n k o f B o s to n , ( M a y / J u n e 1 9 8 2 ) , p p . 5 1 - 7 2 ;
C o n s ta n c e D u n h a m a n d M a r g a r e t G u e r in -C a l v e r t ,
“ H o w Q u ic k ly C a n T h r if ts M o v e in to C o m m e r c ia l
L e n d in g ? ” New England Economic Review, F e d e r a l
R e s e r v e B a n k o f B o s to n , ( N o v e m b e r /D e c e m b e r
1 9 8 3 ) , p p . 4 2 - 5 4 ; R o b e r t A . E is e n b e is , “ N e w I n ­
v e s tm e n t P o w e rs fo r S & L s : D iv e r s if ic a tio n o r S p e ­
c i a li z a t io n ? ” Economic Review, F e d e r a l R e s e r v e B a n k
o f A t l a n t a (J u ly 1 9 8 3 ) , p p . 5 3 - 6 2 ; R o b e r t E .
G o u d r e a u , “ S & L s U s e o f N e w P o w e rs :
A C om ­
p a r a t iv e S tu d y o f S t a t e - a n d F e d e r a l - C h a r t e r e d
A s s o c ia tio n s ,” Economic Review, F e d e r a l R e s e r v e
B an k o f A tla n ta (O c to b e r 1 9 8 4 ), p p . 1 8 -3 3 ; an d
J a n i c e M . M o u l t o n , “ A n t i tr u s t I m p lic a tio n s o f
T h r i f t s ’ E x p a n d e d C o m m e r c ia l L o a n
P o w e r s ,”
Business Review,
F ed eral
R eserv e
Bank
of
P h ila d e lp h ia , ( S e p t e m b e r /O c t o b e r 1 9 8 4 ) , p p . 1 1 - 2 1 .
6 U n le s s o th e rw is e s t a te d , “ c o m m e r c ia l le n d in g ” is
d efin ed as n o n re a l e s t a te b u sin ess le n d in g a n d
“ c o m m e r c ia l l o a n ” is d e fin e d as n o n r e a l e s ta te
b u sin ess lo a n .

‘

T h e F e d e r a l R e s e r v e B a n k o f C h ic a g o c o n d u c te d
a s u rv e y o f all sa v in g s a n d lo a n a s s o c ia tio n s in
Illin o is a n d W is c o n s in d u r in g th e fall o f 1 9 8 4 . A
q u e s tio n n a ir e w a s m a ile d to e a c h a s s o c i a t io n ’s
p re s id e n t. O f th e 2 7 6 S & L s in Illin o is, 7 9 p e r c e n t
re s p o n d e d , a n d o f th e 8 4 S & L s in W is c o n s in , 8 7
p e r c e n t re s p o n d e d .
8 T h e F e d e r a l S a v in g s a n d L o a n I n s u r a n c e C o r p o ­
r a tio n ( F S L I C ) h a s lim ite d th e a m o u n t o f c r e d i t
t h a t a n in su re d s a v in g s a n d lo a n a s s o c ia tio n c a n
e x t e n d to a sin g le b u sin ess c u s to m e r to p r e v e n t
c o n c e n t r a t i o n o f c r e d i t, w h ic h c o u ld r a p id ly e ro d e
a n a s s o c ia tio n ’s c a p i t a l in th e e v e n t o f d e f a u lt b y
th e b o r r o w e r . T h e F S L I C uses th e s a m e s t a n d a r d s
t h a t a p p ly to n a ti o n a l b a n k s , w h ic h lim it s u c h lo a n s
to 15 p e r c e n t o f a b a n k ’s u n im p a ir e d c a p i t a l a n d

E c o n o m ic P e rs p e c tiv e s

su rp lu s a n d a n a d d itio n a l 10 p e r c e n t i f fu lly s e c u re d
b y re a d ily m a r k e t a b le c o l la t e r a l .
T h is r e g u la tio n h a s n o t fo r c e d le n d e rs to lim it
th e ir a c t iv i ty to sm a ll b u sin esses. A f te r re m o v in g
“ r e g u la t o r y e q u i ty ” fr o m r e p o r te d e q u ity , th e t y p ­
ic a l S & L in Illin o is a n d W is c o n s in c a n le n d slig h tly
o v e r $ 5 0 0 , 0 0 0 to a sin g le c u s to m e r .
T h e ty p ic a l
b a n k in th e se tw o s ta te s is lim ite d to $ 3 7 5 , 0 0 0 in
lo a n s to o n e c u s to m e r .
9 D u n h a m a n d G u e r in -C a l v e r t , “ H o w Q u ic k ly C a n
T h r if ts M o v e I n t o C o m m e r c ia l L e n d in g ? ” p p .
4 2 - 5 4 . In e x a m i n in g th e c o m m e r c ia l le n d in g a c t i v ­
ities o f m u tu a l s a v in g s b a n k s in N e w E n g la n d ,
D u n h a m a n d G u e r in -C a l v e r t fo u n d th e se s a m e
c h a r a c t e r i s t i c s , o r f a c to r s t h a t w o u ld in flu e n ce a
th r if t’s c o m m e r c ia l le n d in g d e c is io n .
In g e n e r a l,
th e re s p o n se s to o u r s u rv e y s u p p o r t th e ir fin d in g s.
10 A n M S A c o n sists o f o n e o r m o r e c o u n tie s , w h ich
h a v e a s ig n ific a n t d e g r e e o f s o c ia l a n d e c o n o m ic
i n t e g r a t io n ; a la r g e p o p u la tio n n u c le u s ; a n d a t le a s t
o n e c e n t r a l c ity .

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




11 D u n h a m

and

G u e rin -C a lv e rt,

“ H ow

Q u ic k ly

C a n T h r if ts M o v e I n to C o m m e r c ia l L e n d in g ? ” p p.
4 2 -5 4 .
12 Ib id .
13 M S A s a r e u sed as p r o x ie s fo r b a n k in g m a r k e ts .
C o n c e n t r a t io n

is

m easu red

u sin g

a

H e rf in d a h l-

H ir s c h m a n I n d e x .
11 J o s e p h G a g n o n , “ W h a t is a c o m m e r c ia l lo a n ? ”

New England Economic Review.

F e d e ra l R eserv e B ank

o f B o s to n ( J u ly / A u g u s t 1 9 8 3 ) , p p . 3 6 - 4 0 .
N O T E : F o r m o r e d e ta ile d in f o r m a tio n o n th e
re s u lts

of

th e

s u rv e y

of

S& Ls

in

Illin o is

and

W is c o n s in , p le a s e w rite to :
P u b lic I n f o r m a t i o n C e n te r
F e d e r a l R e s e r v e B a n k o f C h ic a g o
P .O . B o x 8 3 4
C h ic a g o , Illin o is

60690

27

es

BULK RATE
E C O N O M IC

PERSPECTIVES
P u b lic I n f o r m a t i o n C e n t e r
F e d e ra l R eserv e Bank
o f C h ic a g o
P .O . B o x 8 3 4
C h i c a g o , Illin o is

60690

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