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NET CORPORATE SAVING IN THE 1970’s Timothy Q. Cook The period since the beginning has been one of low net corporate of the 1970’s saving rela- penses on plant and equipment. JVhile this first step seems straightforward, costs for accounting tive to previous periods. 1 This is shown in Chart 1, which compares the movement of the three purposes can be determined The measurement of material major components of gross private saving-corporate saving, personal saving, and capital consumption allowances-over the last twenty years. ation, in particular, has been a matter able controversy in recent years. On an annual basis corporate saving in the 197075 period averaged 3.9 percent of gross private saving compared to an average of 12.1 percent the previous fourteen years. Personal saving, on the other hand, was unusually high over the same period compared to typical levels in previous years. Also shown in Chart 1 is the saving (or surplus) of the U. S. Government as a percentage of gross private saving. It has generally been negative throughout the 1970’s to date, acting as a drain on gross private saving. While the unusually high levels of personal saving and the long p eriod of continued U. S. Government dissaving are of considerable interest, the primary concern of this article is the behavior of net corporate saving in the 1970’s and the consequences of that behavior for the aggregate corporate balance sheet. The first two sections of the article look at the determinants of corporate saving and consider various factors that underlie its weakness in the 1970’s. The next two sections consider the impact of corporate saving over the period on corporate borrowing requirements and interest rates and its cumulative effect on the corporate balance sheet. The last section looks briefly at the role of corporate saving in the “capital crisis” debate. in different ways. costs and depreciof consider- Corporate revenue remaining after the deduction of these costs is divided into two parts: net interest payments to holders of financial claims against corporate income and reported profits. The sum of these two items is generally called property income. The major distinction between the two types of property income is that net interest payments are treated as an expense. Consequently profit taxes are paid on reported profits but not on net interest payments. The third step shown in Table I is perhaps the most difficult to understand but in recent years has been very important. It consists of making two adjustments to reported profits to take into account the distorting effects of inflation on profits when costs are measured on an historical basis. Until recently the vast majority of corporations computed reported profits by deducting the historical costs of inputs from the current value of output. In a period of inflation a portion of profits computed in this way essentially represents capital gains on inventories as they are going through the production process. These Net Corporate Saving Net corporate saving is calculated as the residual after all other claims on gross corporate income have been paid. Table I outlines the items that are deducted from gross corporate income to obtain net corporate saving. The first step shown in Table I is to deduct costs from total revenues. These costs include labor costs, material costs, and indirect business taxes. In addition corporations deduct capital consumption allowances to cover depreciation ex- Table MEASURES OF CORPORATE INCOME, PROFITS, AND SAVING GROSS REVENUES Labor Costs - FEDERAL RESERVE BANK Material Costs Tax Depreciation indirect Business Taxes = - PROPERTY INCOME Net Interest Payments + REPORTED PROFITS (WA + CCAA) = = - OPERATING PROFITS Profit Taxes - AFTER-TAX OPERATING Dividends = ’ In this article “corporations” refers only to domestic nonfinancial corporations. Unless otherwise noted, the data cited in the text and in the charts exclude profits arising in the “rest of the world” and profits of financial institutions. I = NET CORPORATE OF RICHMOND PROFITS SAVING 3 Capital Consumption Allowances Net Corporate Saving U. S. Government surplus I \ - inventory profits cannot be used for taxes, dividends, or expansion of plant and equipment since they must be used to purchase new inputs at current higher nominal prices; that is, they must be used simply to maintain the scale of operations of the firm. For this reason reported profits should be reduced by the amount of these inventory profits to get a truer measure of operating profits-profits that result from operations rather than from inflation. The national income and product accounts (NIA) take this approach by adding to reported profits an adjustment, equal to the negative of inventory profits, called the Another problem with the measame amount. surement of economic depreciation is the possirules that do nolt bility of changin g depreciation reflect the true rate at which capital is being consumed. In recent years more liberal depreciation formulas allowing quicker write-offs of plant and equipment have been introduced. Before 1976 the NIA corporate profit statement reflected tax depreciation. The NIA have just undergone a major revision, however, and now economic capital consumption figures are based on an unchanging formula applied to replacement costs.:! The corporate profit statement has not only art inventory IVA adjustment but also a capital consumption allowance adjustment (CCAA) to reflect the difference between tax depreciation and economic depreciation as computed by the Commerce Department on the basis of replacement costs. As will be shown below, the IVA has been much larger than the CCAA in the 1970’s, although the CCAA has been steadily increasing.3 valuation A second between a period that tax lowances) for tax (IVA). may create profits of inflation preciation figure factor reported adjustment is the (capital of historical behind true economic tax depreciation must consumption depreciation costs. alIn a might based in of de- Corporations depreciation of inflation, profits computation purposes. on the basis period a divergence and operating lag on re- placement costs of plant and equipment at current prices. In such a case reported profits are overstated by the difference between economic depreciation and tax depreciation. Alternatively, the cost of capital consumed is understated by the 4 ECONOMIC REVIEW, ?The procedure is described in [ZO]. 3 Of course, the size of the CCAA depends upon the formula that is used to determine economic capital consumption. Young [ZO] con.. tains a discussion of the reasons behind the choice of the formula to be used by the Department of Commerce in the NIA. Terborgb [IS] has argued that the straight-line write-off assumption used by the Department of Commerce is “in most applications a grievously retarded measure of capital consumption” and has used an alterna.. tive formula that results in a capital consumption adjustment that is a larger offset to reported profits. MAY/JUNE 1976 The last deduction two steps of profit shown taxes in Table I are the and dividends. It should be emphasized that profit taxes are based on reported profits rather than operating profits. Consequently, in a period of rising inflation inventory profits and profits due to under-depreciation of plant and equipment are both taxed at the same rate as operating profits. The consequences of this procedure will be shown below. The Decline in Net Corporate Saving ‘The five measures of corporate income discussed in the previous section are shown in Chart 2, all relative to gross corporate product. Net corporate saving in the 1970-75 period averaged 1.1 percent of gross corporate product compared to an average of 3.4 percent in the previous fourteen years. Several factors have contributed to the prolonged relative weakness in corporate saving in the 1970’s. First, the period included two recessions, the latter of which was very severe. As the chart demonstrates, property income and profits typically fall relative to gross corporate product during recessions, pulling down net corporate saving. Explanations for this phenomenon are of are viewed as two types. 4 First, prices generally being set at a markup over normal long-run costs. In recessionary times output and productivity fall, with the result that current unit costs exceed normal unit costs. Consequently, the difference between current revenues and current costs declines. The second type of explanation, not necessarily incompatible with the first, is that price behavior relative to costs reflects demand pressures. As these pressures decline in a recession and excess capacity develops, the spread between prices and costs tends to fall, resulting in lower profits and saving. A second factor that has had an adverse effect on profits, and hence net corporate saving, in the 1970’s to date is the substantial rise in the percent of property income going to net interest payments. As shown in Table II, this rose from about 10 percent in the mid-1960’s to around 23 percent in 1970 and has remained near that level. in subsequent years. The rising share of prop’ A review of price determination studies is contained in [IS]. Accounts. FEDERAL RESERVE BANK OF RICHMOND 5 erty income going to interest payments was a result both of the changing financial structure of the corporate sector as firms relied more heavily on debt to raise funds and the strong rise in interest rates in the latter half of the 1960’s. ACcording to most views of price determination relative to costs, the shift to a greater reliance on debt financing would necessarily exert a downward pull on profits, since a greater proportion of property income has to be directed to debtholders. (The factors underlying the rise in net interest payments will be discussed in more detail below.) As shown in Chart 2, property income in the 1970’s, compared to previous years, has held up better than reported profits. The third factor that clearly has contributed to the weakness in corporate saving in the 1970’s is inflation. Chart 2 shows the widening gap between reported profits and operating profits as inflation accelerated. The IVA and the CCAA are shown in Table III. The IVA rose sharply in 1973 and 1974 due to large increases in inflation and substantial inventory accumulation. The CCAA has been small in comparison to the IVA because the rising divergence between replacement costs and historical costs of plant and equipment as inflation accelerated has generally been offset, or more than offset, by the impact on tax depreciation of liberalized depreciation formulas. The CCAA increased operating profits slightly from the mid-1960’s to 1973 and decreased operating profits in 1974 and 1975. As can be seen from Table III and Chart 2, the combined effects of the IVA and the CCAA rose throughout the 1966-75 decade, jumpin g sharply in 1973 and 1974. Table II SHARES OF PROPERTY INCOME ($ Billions) Net Interest Reported - Profits - Property Income Net Interest QS a Percent of Property Income 1966 7.4 69.5 76.9 9.6 1967 8.7 65.4 74.1 11.7 12.3 1968 10.1 71.9 82.0 1969 13.1 68.4 81.5 16.1 1970 17.0 55.1 72.1 23.6 1971 17.9 43.3 81.2 22.0 1972 19.1 75.9 95.0 20.1 1973 24.5 92.8 117.3 20.9 1974 31.7 103.8 135.5 23.4 1975 34.3 95.1 129.4 26.5 Bureau of Economic Source: product Accounts. 6 Analysis, National income ECONOMIC and REVIEW, In 1974 inventory under-depreciation percent The saving of reported profits and profits due to of capital assets rose to 39 profits. adverse impact was accentuated of inflation on corporate by the fact that, as indi,- cated above, corporate profit taxes are paid on the basis of reported, rather than operating, Consequently, when inventory profits profits. and/or profits due to under-depreciation of capital assets cause reported profits to be overstated, tax rates on operating profits rise. This phenomenon is shown in Table IV, which compares the effective tax rates on aggregate corporate reported and operating p rofits over the last ten The effective tax rate on reported coryears. porate profits rose in 1968 due to the tax surcharge imposed that year and rose further in 19653 due to the suspension of the investment tax The effective rate subsequently fell folcredit. lowing the removal of the surcharge in 1970 and the reinstitution of the investment tax credit in the second half of 1971. The fall in the effective rate from 1972 through 1974 resulted from the liberalization of depreciation rules in 1971, while the decline in 1975 was primarily due to the increase in the investment tax credit that year. The effective tax rate on operating profits looks quite different. In particular, effective tax rates on operating profits rose sharply over the 1973-74 period, despite the fact that effective tax rates on reported profits were fairly low by historical standards, as the difference between reported profits and operating profits widened. On the other hand, in 1975, when inventory profits fell sharply, very low effective tax rates (by postwar standards) on reported profits were matched by low effective tax rates on operating profits. The share of operating profits going to dividends has also been unusually high in the 1970’s. The reasons for this are not clear. Dividends tend to adjust slowly to changing profits; consequently, fluctuations in the ratio of dividends to reported and operating profits are largely due to short-run fluctuations in profits. In particular, when profits fall in recessionary times, the dividends to profits ratio tends to rise. However, an.other possible factor contributing to the unusu.ally high ratio of dividend payments to operating profits SO far in the 1970’s could be that firms were focusing on reported, rather than operating, profits. This focus, combined with the growing gap between reported profits and operating pro-fits as inflation accelerated, would tend to raise MAY/JUNE 1976 Table 111 ADJUSTMENTS TO REPORTED PROFITS ($ Billions) IVA CCAA Total Adjustments Percent of Reported Profits 1966 -2.1 3.8 1.7 -2.5 1967 -1.7 3.6 1.9 -2.9 1968 - 3.4 3.6 .2 -.3 1969 -5.5 3.5 - 2.0 2.9 1970 -5.1 1.5 -3.6 6.5 1971 - 5.0 1972 -6.6 .5 -4.5 7.1 2.7 -3.9 5.1 1.6 1973 -18.4 -16.8 18.1 1974 - 38.5 -2.1 -40.6 39.1 1975 -10.8 -4.1 - 14.9 15.7 Source: Bureau of Economic Product Accounts. Analysis, National Income and the share of operating profits going to dividends and decrease the share going to net saving.” Some observers have, in fact, argued that as late as 1974 most corporations were still focusing on reported rather than operating profits in their decision-making process and that this focus, combined with accelerating inflation, was a factor contributing to the falloff in operating profits in the 1970’s and especially in 1973 and 1974. There are two types of evidence supporting this view. The first comes from a study by ru’ordhaus  in which he compares pricing equations based on historical costs to pricing equations based on replacement costs. The latter, which would correspond to pricing to maintain operating profit margins, did a much poorer job of explainthan did the former. ing the pricin, Q decision Consequently, Nordhaus concluded, using data through 1973, that “It appears very likely that ‘WA illusion’ constitutes a very large fraction of the current profit squeeze” [II, p. 1911. The second type of evidence is that numerous voices within the nonfinancial corporate sector have acknowledged the continued focus on reported profits into 1974. An example is the statement by George Terborgh : ‘(It is clear that American business has not yet learned to protect itself against inflation” [ 181. In any case, by the second half of 1974 widespread attention was being given to the distortional impact of inflation on reported profits, and increasing focus was being given to the matter of accounting methods in an age of inflation.6 A major consequence has been the switch by many corporations from First In, First Out (historical cost) to Last In, First Out (replacement cost) accounting methods. Under the latter, latest costs become expenses. Therefore, end-of-period inventory is valued at the cost of the first units purchased durin g the period (or the cost of units purchased in previous periods).’ The consequence is that in a period of rising prices the reported value of end-of-period inventory assets are lower, reported profits are lower, and the wedge between reported and operating profits is diminished. As shown in Table III, the IVA fell sharply in 1975. The switch by many firms to LIFO accounting methods undoubtedly played a role in its fall. Other important factors were the substantial fall in the rate of inflation and the net reduction in inventories. Business management can do nothing at present to remedy the problem of a growing discrepancy between since they ances on the basis must less, the switch economic and tax depreciation, determine depreciation of historical by the Commerce costs. Department in “Good examples of this attention are IS] and 1111. The distinction between operating profits and reported profits has also resulted in the introduction of a new term-quality of earnings-into the stock market lexicon. “Good” earnings are those related to operating profits. 7 This is an oversimplification. The major problems with the use of LIFO methods are those associated with the valuation of inventories and the consequent difficulties in interpreting profit statements, and balance sheet ratios that depend on inventory levels. Nelson  contains a discussion of these difficulties. Table IV EFFECTIVE TAX RATES ON AGGREGATE CORPORATE REPORTED AND OPERATING PROFITS (Percent) Reported Profits Operating Profits 1966 42.4 41.4 1967 42.4 41.2 1968 46.7 46.6 1969 48.7 50.2 1970 49.5 52.9 1971 47.2 50.9 1972 44.1 46.5 1973 42.1 51.5 1974 j Unfortunately nothing conclusive can be said by looking at the aggregate corporate data because the dividend figures in the NIA beginning in late 19’78 are not comparable with earlier yearn. The reason for this is the changed status of some multinational COYporations-Aramco. in particular-in the accounts due to increased foreign ownership. allow- Neverthe- 41.1 47.6 1975 38.0 45.6 Source: Bureau of Economic Analysis, ond Product Accounts. FEDERAL RESERVE BANK OF RICHMOND National Income 7 its treatment of capital consumption in the NIA is a major step in recognizing this danger. A fourth factor that almost certainly had an adverse effect on corporate profits and saving during part of the 1970’s was price controls. The evidence from several studies [4; 14; 161 shows that, given previous relationships, prices were unusually low relative to costs in 1971 and 1972 during Phase I and Phase II of price controls. As a consequence, profits failed to rebound as sharply in the years following the 1970 recession as they had following other postwar recessions. In summary, the weakness in corporate saving in the 1970’s to date was the result of several factors including two recessions, high rates of inflation, the increased share of property income going to net interest payments, and, at least in 1971 and 1972, the experiment with price controls. The Corporate Financing Gap Net corporate saving can be combined with tax depreciation and foreign branch profits to get a measure of gross internally generated funds. The difference between total capital investment and gross internal funds-sometimes called the corporate financing gap-corresponds fairly closely to the net funds that corporations have to raise in financial markets. Chart 3 shows that corporate investment was a fairly stable fraction of GNP from the mid-1960’s through 1974, although generally at higher levels than in previous years. Gross internal funds relative to GNP, however, fell over that period,’ primarily due to the decline in corporate saving. As a result the ratio of the corporate financing gap to GNP rose to very high levels by the end of the period, almost twice the previous postwar peaks. Many observers have argued that the rise in the corporate financing gap over this period wa.s a major determinant [5; 71. Their Market mand of the rise in interest reasoning interest rates for and supply is fairly are determined of debt financing od, rising interest competing rates loanable Chart whose The results were REVIEW, higher greater the corporate the corporate financing 4 compares of GNP long-term interest the view that to an average rates and provides on interest rates factor putting in recent inof sector. gap as support the rise in the corporate gap was an important share of short- and for financing upward pres- years.s S Certain comments relating to Chart 3 and Chart 4 are in order. First, the numbers are divided by GNP so that they can be compared over time. Second, corporations raise funds in both the long- and short-term debt markets. The use of the simple average of the short- and long-term interest rates is intended to capture overall interest rate pressures. Third, the graphs and the accompanying discussion are not meant to imply that corporate financing repuir+ ments are the only determinant of the level of interest rates; they are simply intended to provide support for the view that the rising level of these requirements was an important factor underlying the increase in interest rates. Financ;ng Gap ECONOMIC is more goin g to Gross Internal Funds 8 to outbid borrowing and a significantly funds a percent sure As the rose over the peri- rates were necessary borrowers, interest-sensitive. terest by the de- securities. gap of corporations rates straightforward.. MAY/JUNE 1976 4 Corporate Saving, the Corporate Balance Sheet, and Balance Sheet Drag The weakness of corporate saving has also been a factor contributing to two ongoing debates. The first of these debates relates to the significance of the state of the corporate balance sheet as a factor affecting economic activity. The discussion over the state of the corporate balance sheet has focused on certain liquidity and leverage ratios of categories of items from the aggregate corporate balance Liquidity ratios provide rule-of-thumb sheet. measures of a firm’s ability to meet its maturing obligations when it is subjectkd to unexpected variations in income. Two of the most commonly cited aggregate liquidity ratios are the ratio of current assets (less inventories) to current liabilities-the quick ratio-and the ratio of short-term debt to long-term debt. The higher the quick ratio and the lower the ratio of short-term debt to long-term debt, the more liquid is the aggregate corporate balance sheet. Leverage ratios measure the relative contribution of creditors versus owners to the financing of a firm. Two commonly cited aggregate leverage measures are the ratio of equity to total assets and the ratio of net interest payments to property income. The lower the ratio of equity to assets and the higher the ratio of net interest payments Interest Rote to property income, the greater is the claim creditors to corporate income and the greater the risk of bankruptcy. of is What are the appropriate levels of these ratios? Economic and finance theory has very little to Nevertheless, there is a say about the matter. widespread belief among members of the financial and business communities that these ratios as a group reached dangerous levels by the end of 1974. The state of the aggregate corporate balance sheet at that point was alternatively described as “fragile,” “impaired,” “overburdened,” The “imbalanced,” and “illiquid.” “unstable,” behavior over rime of the four ratios cited above is shown in Chart 5.g Two developments are parFirst, all the measures ticularly noteworthy. have been deteriorating since the mid-1960’s. TWO of the four ratios were fairly stable before that time while the other two-equity to total assets and current assets to current liabilities-were continuing trends that began earlier. 0 These ratios while aidely cited, frequently use aggregate balance The sheet categories that include different balance sheet items. consequence is that the same ratio can look quite different from source to source. For example. all bank loans are frequently included in the short-term debt category, whereas in Chart 5 long-term If they had been bank loans are excluded from that category. included, the ratio would have been higher but would still show It should also be noted that current assets and the same trend. current liabilities in Chart 5 exclude trade credit and trade debt since they largely net out for the corporate sector as a whole. FEDERAL RESERVE BANK OF RICHMOND 9 between investment and internally generated funds, one or more of the balance sheet ratios shown in Chart 5 will deteriorate. Corporations, Second, the ratios moved fairly closely with the rise in the corporate financing gap, which in turn was closely related to the decline in corporate profits and corporate saving. In particular, the ratios deteriorated most sharply in 1966, 1969, and 1973 when the financing gap rose most rapidly, and deteriorated least or improved when the financing gap declined during 1967, 1971, and 1975. The extraordinary fall in the financing gap in 1975, in particular, was accompanied by a substantial improvement in all the ratios. The observed relationship between in fact, have been reluctant to issue new stock in Table V shows the net funds recent years. raised by corporations through stock sales as a percent of total net funds raised by the corporate To some extent, sector in financial markets. especially 1974, the reluctance to sell stock was a result of the poor performance of stock prices. Similarly, in some years, rising stock prices have induced the corporate sector to rely more heavily on stock sales. By itself, however, the performance of the stock market cannot explain the dearth of new stock issues in the period covered in Table V. There are several other possible contributing factors. The most important is probably the differential the rise in the corporate financing gap through 1974 and the deterioration of the aggregate balance sheet ratios results from the fact that a financing gap must be financed by depleting liquid assets, increasing short- and long-term debt, or selling new stock. If new stock is not sold to finance the gap Current Assets/Current Equity/Total Liabilities Assets ------------- --z- - --------- Proportion ---------- of Bond Offerings Rated Baa or Lower Short-Term/long-Term ‘.C-.-,N+--./-*--- Interest 2-r ,,e-N#,,,‘t Debt Payments/Property /--- - ,.4---\ --x-c.,/ \ \ .e’-NL.rC-------~,4 10 1 0-0 income -4- ECONOMIC such as 1971 and 1972, /w---e- REVIEW, -I4 MAY/JUNE / 1976 ,‘\ ‘4’ .--em\ \ v-e d--n, tax treatment of dividends and interest payments. Interest payments by corporations to debtholders are not subject to the corporate income tax, while dividend payments to stockholders are. Consequently, a smaller before-tax share of corporate income is needed to give an equal after-tax rate of return to a new debtholder than to a new stockholder. Thus, it is in the interest of existing stockholders, up to a point, for the firm to fund its financing gap through debt rather than equity.lO Another factor contributing to the relationship between the rise in the financing gap and the deterioration of the balance sheet ratios was the simultaneous rise in interest rates. It was argued earlier that the financing gap was probably a major determinant of this rise in interest rates. Whatever the cause, rising interest rates contributed to the deterioration of the ratios in two ways. First, they increased the incentive to finance short-term rather than long-term-thereby adversely affecting the liquidity ratios-and second, they directly contributed to the proportion of property income going to net interest payments. An additional factor, unrelated to the rise in the financing gap, that had an adverse effect on the liquidity ratios in recent years is the greater reliance of corporations on liability management as a hedge against financial uncertainty. According to a recent study [ 171, beginning in the mid1960’s corporations sharply increased their use of bank loan commitments. Clearly, with a guaranteed commitment of funds as protection against unexpected fluctuations in income, the perceived need for a “liquid” balance sheet is lessened. Aside from the widespread talk of financial instability, two concrete consequences of the deterioration of the balance sheet ratios are identifiable. First, as the aggregate ratios deteriorated, a greater number of corporate credit ratings were lowered by the rating agencies [ 11. These ratings are a significant determinant of the cost of borrowed funds for these corporations. Second, the deterioration in the ratios contributed to the development of a two-tier market for long-term funds in which lower-rated companies had an increasingly difficult time raising funds even at an increasingly higher rate. The downward movement in the proportion of publicly-offered straight bond offerings by corporations with a credit rating of Baa or lower during the 1966-74 period is shown in lo Several plans have been proposed to deal with this problem. plan proposed by Henry Wallich , which could be implementeRd without the major complication of an abrupt change in after-tax profits, would be to place an equal tax burden on all types of property income: interest, dividends, and retained earnings. Table V NET FUNDS RAISED THROUGH STOCK SALES AS A PERCENT OF TOTAL NET FUNDS RAISED BY THE CORPORATE SECTOR IN FINANCIAL MARKETS (Percent) 1960 11.8 1968 1961 17.2 1969 8.7 1962 3.2 1970 14.4 1963 -2.4 -.6 1971 24.4 1964 7.4 1972 19.7 1965 0.0 1973 11.0 1966 5.1 1974 5.3 1967 8.1 1975 27.8 Source: Board of Governors Flow of Funds. of the Federal Reserve System, Chart 5 along with the balance sheet ratios. The net result of these two factors was that more companies received lower credit ratings and a smaller percentage of that growing group were able to raise long-term funds. A third consequence of the behavior of the balance sheet ratios was increasing debate over their impact on the rate of growth in the economy following the 1974 recession. Many observers feel that the state of the corporate balance sheet is a factor inhibiting rapid economic growth, at least in the near-term, because many corporations are still in the process of restructuring their balance sheets. Typical statements (made in the summer of 1975) from two of the most well-known proponents of this view are: Currently, the financial base of business corporations needs substantial repair before this sector will be ready to take a fling at inventory speculation and at spending huge sums for plant and equipment [Henry Kaufman, 71. Given the scare that households, firms and financial institutions had in 1973-75, we can expect that these cash flows will be used initially to increase the robustness of balance sheets, rather than as a basis for continuing the trends [similar to those shown in Chart 51 exhibited in the charts [Hyman Minsky, lo]. Many of these same commentators argue not only that the recovery will be moderate but also that it should be moderate. Their reasons for this view stem from the behavior of the ratios shown of slow growth in recent in Chart 5. Periods years have been periods of decline in the corin the porate financing gap and improvement ratios, while periods of more rapid expansion have been periods of increase in the financing gap and deterioration of the ratios. These observers FEDERAL RESERVE BANK OF RICHMOND 11 fear the consequences of continuing the long-run trends shown in Chart 5. As Kaufman puts it, let us recognize that a quick and spectacular advance in economic activity would have terribly adverse implications for the financial position of business. This is because efforts to improve cor- porate liquidity would have to be shoved aside in order to meet the enlarged new demand for inventory and other real assets . They also note that even though the top tier of higher-rated corporations accomplished substantial improvements in their balance sheets in 1975, the second tier of lower-rated firms made much less progress. Parenthetically it should be noted that from the point of view of these observers the best possible circumstance would be a continuation of the rebound in corporate saving shown in 1975, which would allow a greater part of expansion of real assets to be financed internally than has generally been the case in recent years. A central idea in the above discussion is that the state of the balance sheet can be a determinant, aride from its impact on current borrowing Perhaps costs, of a firm’s investment decisions. no other idea is so widespread in business and financial circles and given so little attention in academic circles.ir The corollary to this idea is that overburdened balance sheets can exert a drag on economic activity as corporations reduce investment expenditures in an effort to improve In the the condition of their balance sheets. extreme, widespread efforts to restructure balance sheets could result in a self-defeating decline in income and prices and a rise in real debt burdens. While modern balance sheet watchers have generally not raised this specter in the inflationary environment of recent years, it has in the past been a matter of genuine concern. As Irving Fisher put it 44 years ago: When a whole community is in a state of overindebtedness, the dollar reacts in such a way that the very act of liquidation may sometimes enlarge the real debts instead of reducing them! Nominally, of course, any liquidation must reduce debts, but really . . . it may swell the rreall uxmaid balance 03 every debt in the country, : . . ~caus!ng] a vicious spiral downward-a tailspin-into the trough of depression 13, p. 251.12 Corporate Saving, Capital Crunch, and the Capital Shortage Debate The terms capital crunch, capital shortage, and capital crisis have been lIThat is not to say that the idea has never been considered. M&lam  has a discussion of the limited role balance sheets have played in theoretical economic discourses in the past. 12Fisher’s main prescription for preventing cyclical fluctuations in debt from becoming depressions was. of course, to maintain a stable real value of the dollar through a stable money supply. 12 ECONOMIC REVIEW, widely used the last couple of years in many senses, which can be broadly broken up into two general categories : near-term and long-term. The weakness in corporate saving plays a role in both The weakness in corporate profits discussions. and saving in recent years is the crux of the whole near-term issue. As has been shown in this article, the weak state of corporate saving combined with fairly steady (and relatively high) corporate investment expenditures to create an ever-widening financing gap. These events played an important role in generating concern over deteriorating balance sheets, the development of the two-tier bond market, and rising The combined effects of these interest rates. developments created a growing concern about the ability and/or willingness of corporations to continue to raise funds to finance real investment. The longer-term use of the term capital crisis concerns itself with the adequacy of the projected saving of various sectors of the economy for financing projected investment needs. It is beyond the scope of this article to dwell at length on the numerous recent studies of the issue.l’l Suffice it to say that predictions concerning the behavior of corporate and U. S. saving generally play a major role in the determination of the likelihood of a long-term capital crisis. Specifically, these studies generally require that to avoid a capital shortage corporate saving must return to levels more characteristic of the pre-1970 peri-, od and that, within a couple of years, the U. S. Government budget deficit must be transformed into a budget surplus. Although no attempt to predict the future be-, havior of corporate saving will be made here, it can be pointed out that four factors were already at work in 1975 to increase corporate saving sigThe two most important developnificantly. ments were the rebound in economic activity and the significant deceleration in the rate of inflation. The third factor was the decline in the effective tax rate on corporate operating profits. As indicated earlier, the rise in the effective tax rate on aggregate corporate operating profits in the 1970’s was largely an unintended result of the not conscious government impact of inflation, policy. The effective tax rate on aggregate reported profits has declined every year since 1970. In 1975 the effective tax rates on both reported and operating profits were at low levels by post13See  for a study that concluded with the instantly famous line that “We can afford the future, but just barely” and  for a more pessimistic conclusion. MAY/JUNE 1976 war standards. The fourth factor working “Profits, Share Prices, 5. Hendershott, Patric H. Interest Rates, and Inflation,” memorandum, September 1974. Revised version forthcoming, University of Michigan Business Review, University of Michigan Graduate School of Business Administration, Ann Arbor, Michigan, September 1976. to expand on the corporate saving was the increasing focus impact of inflation on operating profits The switch by many firms and corporate saving. to LIFO accounting methods, the change in the treatment of capital consumption in the NIA, Studies of Invest 6. Jorgenson, D. W. “Econometric ment Behavior: A Survey.” Journal of Economic Literature, (December 1971), pp. 1111-47. and to some extent, the increase in the investment tax credit in 1975 n-ere all a result of that changing focus. 7. Kaufman, Henry. “Liquidity It Will Delay the Recovery.” (June 9, 1975), pp. 25-8. 8. Lintner, John. “Saving and Investing for Future Answers to Inflation and Recession: Growth.” Economic Policies for a Modern Society, Edited by Albert T. Sommers. The Conference Board, Inc., 1975. In summary, several factors comSummary bined in the 1970’s to cause a prolonged weakThis weakness in ness in net corporate saving. con junction with relatively high capital expenditures created unusually large external financing requirements, which, along with other factors, contributed to the deterioration of the aggregate corporate balance sheet and helped spur the capital shortage debate. Last year saw a strong resurgence of corporate operating profits and saving, an extraordinary decline in external financing requirements, and a significant improvement in the aggregate corporate balance sheet ratios. A consequence of these developments has been a marked decline in the intensity of the debates over the state of the corporate balance sheet and If the factors the presence of a capital crisis. that contributed to the deterioration of corporate saving reappear, however, a resurgence of these debates can be expected. References “Inflation, Recession and the 9. M&lam, W. D. Burden of Private Debt.” Banca Nazionale Del Lavoro Quarterly Review, 113 (June 1975), 145-71. “Financial Resonrces in a 10. Minsky, Hyman P. Fragile Environment.” Challenge, (July/August 1975)) pp. 6-13. 11. Morgan Guarantee Trust Company. “Profitability and Investment.” The Morgan Guarantee Survey, (September 1974), pp. 4-13. 12. Nelson, Car1 L. “The Journal of Commercial 1975), pp. 31-9. 2. Bosworth, Barry, James S. Duesenberry, and Andrew S. Carron. Capital Needs in the Seventies, Institution, Washington, D. C.: The Brookings 1975. 3. Fisher, Irving. Booms and Depressions, Some First Princivles. Binchamton. New York: Adelnhi Company, -1932. . 4. Gordon, Robert J. “The Response of Wages and Prices to the First Two Years of Controls.” Brookings Papers on Economic Activity, (3rd quarter, 19’73), pp. 765-80. Big Rush to LIFO.” The Bank Lending, (December 13. New York Stock Exchange. The Capital Needs and Savinas Potential of the U. S. Economu. New ” York- Stock Exchange, inc., 1974. “The Falling Share of 14. Nordhaus, William D. Brookings Papers on Economic Activity, Profits.” (1st quarter, 1974)) pp. 169-217. 15. Nordhaus, William D. “Recent Developments in Price Dynamics.” The Econometrics of Price Determination. Conference sponsored by Board of Governors of the Federal Reserve System and Social Science Research Council. Washington, D. C., October 30-31, 1970. 16. 1. Board of Governors of the Federal Reserve System. “Recent Developments. in Corporate Finance.” F;deral Reserve Bullet%, (August 19’75), pp. 463- Repair Essential, But The Money Manager, Schultze, Charles L. “Falling Profits, Rising Profit Margins, and the Full-Employment Profit.” Brookings Papers on Economic Activity, (2nd quarter, 1975), pp. 449-72. 1’7. Summers, Bruce J. “Loan Commitments to Business in United States Banking History.” Economic Review, Federal Reserve Bank of Richmond, 61 (September/October 1975)) 15-23. 18. Terborgh, George. “Inflation and Profits.” Financial Analysts Journal, (May/June 1974)) pp. 19-23. 19. Wallich, Henry C. “Is There a Capital Shortage?” Challenge, (September/October 1975)) pp. 30-6. 20. Young, Allan H. “New Estimates of Capital Consumption Allowances Revision of GNP in the Survey of Current Business, Vol. 55, Benchmark.” No. 10 (October 1975)) 14-16. FEDERAL RESERVE BANK OF RICHMOND 13 REGULATIONS BETWEEN AFFECTING COMPETITION BANKS AND THRIFT INSTITUTIONS IN THE FIFTH DISTRICT Bruce J. Summers Over the past several years readers of this Revieul have been exposed to a number of articles dealing with the concept of banking structure and, more with the structure of geographic specifically, banking markets in the Fifth Federal Reserve District. These articles are listed in the accompanying bibliography [3 ; 6; S; 111. The approach generally taken has been to examine banks as single product firms, with the institutional scope of competition limited to banks themselves. Until recently this has in fact been the standard apstudies, not only in proach to bankin g structure purely economic literature but also in court antitrust decisions involving banking competition.’ however, banks can be For some purposes, thought of as multiproduct firms offering an array of distinct services, or as “financial department stores” [ 1, p. 3621. It has become increasingly evident that banks enter into direct competition with nonbank financial institutions for some of these products. This article briefly reviews the concept of competition between banks and nonbank financial Its major purpose is to review and institutions. compare the regulations governing market entry and branching by banks and competing nonbank financial institutions (thrift institutions) in the Fifth District. This approach expands an earlier treatment of the subject that appeared in this Review [ 31. Competition Between Banks and Thrifts Both commercial banks and thrift institutions offer a wide array of services. On what basis, then, can a determination be made as to the extent and degree of competition between these different In certain types of financial intermediaries? product lines, for example demand deposits, there is generally no overlap, and the question of competition is, therefore, moot.” In other product 1 In a seminal merger case involving two Philadelphia banks, the Supreme Court decided that competition should be examined solely in Q banking institutions context. See United States Y. Philadelphia National Bank. 33, S.Ct. 1715 (1963). ‘Mutual savings banks in Maryland and several other states. however, have demand deposit powers. 11 ECONOMIC REVIEW, lines, however, there is a great deal of similarity between the offerings of banks and thrifts, and there is some reason to expect that competition may exist for these services. The primary area of overlap for banks and thrift institutions is in the increasingly important field of retail banking services. Although this is a broad field, most research has been centered on competition for A review of this particuretail savings deposits. lar product market is interesting for the insight it gives into the nature of and methods for determining competition. An economic test of the degree of competition between organizations offering similar products would focus upon the degree of substitutability between the respective product offerings. In the case of savings deposits, the assets offered by commercial banks and thrift institutions would be considered good substitutes if an increase (decrease) in the rate of return on one produced a significant decrease (increase) in the amount held of the other. If a change in the rate of return paid on one resulted in a proportionate, hut negative, change in the amount held of the other, the products could be considered identical. An independent relationship would exist if one asset failed to respond to changes in the interest rate paid on the other. There are, of course, several dimensions to the return from holding savings deposits. These include liquidity, safety, convenience, and explicit interest return. With respect to the first two, there is virtually no difference between bank and thrift institution savings deposits. Banks, however, due to their ability to offer a wider array of complimentary services, have an edge with respect to convenience. Thrift institutions, which can offer a g percent differential over bank rates, have an edge with respect to interest return. These four factors all influence the degree to which bank and thrift deposits are substitutes. A number of attempts have been made to measure the degree of substitutability between sa\-ings deposits offered by commercial banks and 1)) MAY/JUNE 1976 thrift institutions. niently These attempts are convein a number of studies [9; summarized 10; 121. In one of these summaries, Gilbert and Murphy conclude that evidence from various time series and cross section studies shows that the savings deposit services offered by thrift institutions, specifically savings and loan associations and mutual savings banks, are close substitutes for commercial bank savings deposit services [9, pp. 10 and 171. They also indicate that competition for savings deposits between these institutional types has increased in recent years [9, p. 141. These conclusions suggest that, for completeness, any consideration of the structure of a market for savings deposits must include both commercial banks and thrift institutions. There are other, although less well researched, product markets where the potential for competition between banks and thrift institutions is high. Due to recent regulatory changes, for example, banks are now allowed to offer business savings accounts up to $150,000 per customer, something that increases their potential for competition with thrift institutions.3 Also, both banks and thrifts offer mortgage loans to consumers. In a related lending area, both make construction loans to builders. To a limited degree, they may also compete for consumer instalment loans. While the number of product markets where banks and thrift institutions offer similar services is limited, competition within any given market may be intense, just as it is in the case of savings deposits. Furthermore, with the nation’s financial structure closer than ever to reforms that could dramatically alter the scope of activities for thrift institutions, the areas of competitive overlap could expand and intensify. These considerations argue for an approach to “banking structure” studies that takes into account interindustry competition. The institutional structure of a given market strongly influences the degree of competition among financial intermediaries; this in turn influences the availability and cost of products or services in that market.4 To a very important extent, the structure of financial markets is determined by regulations governing market entry and branching. These regulations may be explicitly :’ Effective November 10, 1975, the Board of Governors of the Federal Reserve System amended Regulations D and Q to permit profitmaking organizations to hold savings accounts at member banks. The FDIC took similar action regarding state nonmember banks. See “Amendments to Regulations D and Q.” Federal Reserve Bulletin. (October 1975). p. 708. 4 See reference 141 fur a detailed dhcuasion of thr impo&ance UT market structure. based on statutory provisions or may be the result of discretionary action exercised by particular regulatory authorities. Furthermore, the regulations that apply to the various competing organizations may be different. Regulations may differ for the same types of institutions that have different charters (Federal or state), and they may differ among the several institutional types. Any given market will have a structure that is uniquely influenced, depending on the combination of regulations under which its participants operate. The rest of this article will focus on the regulatory makeup of Fifth District financial markets, with special attention given to the major financial intermediaries that operate in the District. In addition to commercial banks, these include savings and loan, or building and loan, associations (S&L’s) and mutual savings banks (MSB’s) .6 Market Entry Entry into Fifth District markets by the financial intermediaries under consideration here is regulated by both the various states and by either the Comptroller of the Currency or the Federal Home Loan Bank Board for Federally chartered banks or S&L’s, respectively. The only exception to the dual chartering system is the District of Columbia, the laws of which require all banks and S&L’s to obtain the approval of the Federal regulatory agencies before they commence business. The various chartering authorities consider a number of factors in reviewing applications to establish new financial organizations. These include needs of the community, quality of proposed management, impact upon existing institutions, and capital adequacy. Capital adequacy is the most objective of these factors and therefore is the easiest to measure. It also, of course, can be interpreted in different ways and can mean a great deal in terms of relative difficulty in gaining access to a market. Minimum capital requirements for market entry by banks are specified in the laws of each District state and in Federal law for national banks.6 For S&L’s, a distinction must be made between stock and mutual associations. Mutual charters are available in every District state and from the Federal Home Loan Bank Board. Virginia is the only state that grants stock charters for S&L’s. The stock form I,Among the Fifth District states, only Maryland charters. Federal charters are not available. grants MSB “The minimum statutory capital requirements. which have non changed for a number of years. are summarized in 13, PP. S-91. FEDERAL RESERVE BANK OF RICHMOND 15 of organization is not available to S&L’s that desire Federal charters. Minimum financial requirements governing market entry, expressed in terms of initial deposit subscriptions and general reserve and/or expense funds, are specified in the laws of Maryland and Virginia. North Carolina, South Carolina, and West Virginia requirements are determined as a matter of policy by the state regulatory authorities. For Federally chartered S&L’s, minimum capital requirements are established by the Federal Home Loan Bank Board. Maryland law requires that newly formed MSB’s have a minimum guaranty fund equal in amount to the minimum capital stock required of newly formed state banks. Table MINIMUM CAPITAL REQUIREMENTS Applicants for Federal March Population of Area* Below 10,000 Total: PermanentStack and Paid-In Surplus; $ I Charter or Insurance 1976 Withdrawable Caoital Stock Applicant - Mutual Applicant - 150,000( 30) $225,000(225) 10,001-25,000 200,000( 40) 300,000(250) 400,000(300) $ 300,000(250) 25,001-50,000 300,000( 60) 375,000(275) 500,000(350) 50,001-100,000 Downtown Other Areas 400,000( 300,000( 80) 60) 400,000(300) 375,000(275) 550,000(400) 500,000(350) 100,001-200,000 Downtown Other Areas 500,000(100) 400,000( 80) 450,000(325) 400,000(300) 600,000(450) 550,000(400) 200,001-350,000 Downtown Other Areas 600,000(120) 500,000(100) 525,000(375) 450,000(325) 700,000(550) 600,000(450) 350,001-500,000 Downtown Other Areas 700,000(140) 600,000(120) 600,000(450) 525,000(375) 800,000(650) 700,000(550) 500,001-750,000 Downtown Other Areas 800,000( 700,000( 160) 140) 675,000(525) 600,000(450) 900,000(700) 800,000(650) 750,001-1,000,000 Downtown Other Areas 900,000(180) 800,000( 160) 750,000(600) 675,000(525) 1,000,000(750) 900,000(700) 950,000(725) 750,000(600) 1,250,000(850) 1,000,000(750) Over 1.OOO,OOO Downtown Other Areas 1,000,000(200) 900,000(180) *In determining population, the basic criterion of measurement is the aggregate metropolitan area. In applying the concept to specific cases, consideration is given to community characteristics, trade patterns, and the nature and degree of real estate development. fGenerally, the amount of paid-in surplus should approximate percent of the amount of permanent stock. 20 ( ) = Minimum number of subscribers. Minimum number of subscribers to withdrawable capital of stock applicant may be reduced by number of others subscribing to permanent stock. Source: 16 Federal Home Loan Bank of Atlanta. ECONOMIC REVIEW, Although state laws and policies are rather specific with regard to the minimum financial requirements that must be met by newly formed state chartered banks and S&L’s, in practice the) are of limited significance. This is so because of the widespread additional requirement that Fed-era1 deposit insurance be obtained before a state charter can be granted. Every District state, either as a matter of law or policy, requires that banks organizing under state charter obtain FDIC insurance. South Carolina and Virginia require FSLIC insurance as part of the charter.ing process for S&L’s, and Maryland and North Carolina require either FSLIC insurance or deposit protection from a state chartered savings share association. Only West Virginia has no insurance requirement for state chartered S&L’s.;’ Maryland requires that MSB’s be insured by the FDIC. Federal deposit insurance is required of all Federally chartered institutions. FDIC insurance qualification is an automatic part of the chartering process for national banks. The Federal Home Loan Bank Board administers the FSLIC program, and the financial requirements for S&L’s organizing under a Federal charter are identical to those for associations organizing under state charter and seeking FSLIC insur.ante. FDIC ganizing financial standards of capital adequacy for orbanks, therefore, constitute the effective requirements governing market entry throughout the Fifth District. FDIC capital ade-. quacy standards are arrived at on the following: basis. An organizing bank’s deposit growth is projected three years into the future, and initial. capitalization, in the form of stock and surplus,, must equal 10 percent of the projected deposit figure. In no event, however, can initial capitali-. zation fall below $ZSO,OOO. Effective financial re-. quirements governing market entry by S&L’s in. South Carolina and Virginia are those established. by the Federal Home Loan Bank Board and are listed in Table I. These requirements also apply to FSLIC insured S&L’s in Maryland and North Carolina; associations in these states opting for savings share association insurance must meet financial requirements established by the states. Maryland law requires S&L’s to have an initial deposit subscription of $100,000, a general reserve 7 It should be noted. however. that there have been no S&L applications for state charters in West Virginia for a number of years. The reasons for this will become clear shortly. West Virginia industrial loan companies must qualify for FDIC insurance before a rlxle charter is aranted. MAY/JUNE 1976 Table II REGULATIONS GOVERNING Fifth Federal BRANCHING Reserve District March 1976 North Carolina Sou+h Cmolino Pcrmi++rd statewide. Prior e+,prova, by Commi‘%io”er of eunkr required. P.,m;,ted .t.+owide. Prior .pp,wol by Bmk Commi,rioncr reqvired. Prohibited. Permitted rtatewid.. Prior .app’o*ol of Adminirtrator of S.vin+,r and Low Divirion required. Not opplic.blo. Pcrmincd stotevridc. P,ior approval by Board of Bclnk cc.ntro, required. Pmnintd rtotwidt. Priw ~pprord by Bard of Sank Control rcqui,cd. F’rohibitrd. Not applimbk. No, appli<able. Not opplicoblc. Pemittcd throughw, +hr Dh‘,ilf. Prior oppmd by Cmptroller of the Currcnry required. No+ applicable. I Soune: Fadarol and r+o,o s+a+u+c~. fund equal to 6 percent of the initial subscription, and an expense fund equal to 25 percent of the initial subscription. North Carolina requires an initial subscription of $750,000 and a reserve fund of $50,000. As already mentioned, MSB’s chartered by the state of Maryland must conform to the FDIC standards specified above. It wouId appear that in those states where not only banks but also S&L’s must meet Federal deposit insurance financial standards, namely South Carolina and Virginia, the relative difficulty of market entry is about equal. The same is true for banks and Federally insured S&L’s in North Carolina; and for banks, Federally insured S&L’s, and MSB’s in Maryland. In these two states market entry by state chartered S&L’s that elect savings share association insurance, however, is considerably easier than for banks or Federally insured S&L’s. Inasmuch as no statutory provision or policy governing Federal deposit insurance or minimum financial requirements exists in West Virginia, it is difficult to judge what standards would apply to S&L’s seeking a state charter. Branching State laws govern the branching activities of both Federally and state chartered commercial banks. This exception to the dual banking system has as its origin the McFadden Act of 1927, which gave national banks explicit sanction to establish full service branches in their home office cities but only in states where state chartered banks were permitted to branch. Subsequently, the Bankin, e Act of 1933 allowed national banks to branch anywhere in their home office state subject to the restrictions imposed on state chartered banks by state law. Table II, a summary of state branching laws in the Fifth District, shows that statewide de novo bank branching is permitted in Maryland, North Carolina, and Virginia allows limited de novo South Carolina. bank branching and statewide branching by merger, while branchin g is prohibited in West Virginia. Federal law permits citywide bank branching in the District of Columbia. The branching regulations that apply to Federally and state chartered S&L’s, unlike commercial banks, are not uniform by state. This is bespecified for Federcause branchin g privileges ally chartered associations are not constrained by Federal chartering of mutual S&L’s state laws. was established by the Home Owner’s Loan Act of 1933, which gave the Federal Home Loan Bank Board general statutory authority for the incorporation, supervision, and regulation of From the outset, the Bank these instituti0ns.s Board interpreted the Act as giving it discretionary authority to authorize branching by Feder*The Federal Home Loan Bank Board came into bein% as part of the Federal Home Loan Bank System, with passage of the Federal Home Loan Bank Act in 3932. As initially established, the System’s primary responsibilities were to provide added liquidity to member associations through direct advances and to meet recurriw needs for more loanable funds than the immediate inflow of deposits might suppls’. FEDERAL RESERVE BANK OF RICHMOND 17 ally chartered S&L’s been challenged, but This the interpretation Federal courts has have ruled that the Bank Board does have such discretionary authority and, furthermore, that this authority is not limited by the extent to which allowed to state chartered associations are branch. Also, a number of unsuccessful attempts have Loan been made to amend the Home Owner’s Act of 1933 by making state branching laws the Federally Current ultimate constraint on branching by chartered S&L’s. Federal Home Loan Bank Board regu- lations permit ate branches, Federally including General chartered S&L’s to opermobile facilities, virtuapplication can be made ally statewide. to establish branches within a 100 mile radius of the home office but not, in any event, across state lines. A recently adopted regulation, effective March 12, 1976, allows Federally chartered S&L’s to establish branches or mobile facilities in rural areas without restriction on distance from home office. Federal associations may conform to state branching laws if these permit greater branching freedom than the Federal Home Loan Bank Board regulations. The laws of four Fifth District states, Maryland, North Carolina, South Carolina, and Virginia, provide for statewide branching by S&L’s. In these states Federally chartered associations also branch statewide. West Virginia law prohibits branching by S&L’s, and Federally chartered associations operating in the state conform to the more liberal Federal Home Loan Bank Board regulations. All District of Columbia S&L’s operate under Federal charters, and branching is permitted citywide. Maryland MSB’s are allowed to branch statewide. With regard to branching privileges, banks and nonbank thrift institutions are treated equally in three District states, Maryland, North Carolina, and South Carolina, and in the District of Columbia. In Virginia S&L’s enjoy somewhat greater branching privileges in comparison to those under which banks operate. In West Virginia there exists a direct asymmetry between banks and state chartered S&L’s on the one hand, which are prohibited from branching, and Federally chartered S&L’s on the other, which enjoy what amounts to statewide branching. Conclusion ing market In reviewing the regulations entry and branching by Fifth governDistrict financial intermediaries, this article has described one set of factors that influence market structure. It is clear that these regulations often differ among states and sometimes among institutional The regulatory types within any given state. setting, therefore, must be given explicit attention in market structure studies that consider competition between banks and thrift institutions. References 1. Alhadeff, David A. “Monopolistic Competition and Banking Markets.” Monopolistic Competition Theory: Studies in Impact. Edited by Robert El. Kuenne. New York: John Wiley & Sons, Inc., 1967. 2. Baxter, Nevins D., David McFarland, and Harold T. Shapiro. “Banking Structure and Nonbank Financial Intermediaries,” National Banking Review, (March 1967)) pp. 305-16. 3. Broaddus, J. Alfred, Jr. “Regulations Affecting Bankina Structure in the Fifth District.” Monthlu Review, Federal Reserve Bank of Richmond, (Dd: cember 1970), pp. ‘7-11. 4. . “The Banking Structure: What It Means and Why It Mat&,” Monthly Review, Federal Reserve Bank of Richmond, . (November . 1971), pp. 2-10. 5. Cohen, Bruce C. and George G. Kaufman. “Factors Determining Bank Deposit Growth by State: An Empirical Analysis,” Journal of Finance, (March 1965), pp. 59-70. 6. Coleman, Thomas Y. and Bradley H. Gunter. “Recent Developments in Fifth District Banking,” Monthly Review, Federal Reserve Bank of Richmond, (December 1972), pp. 9-14. 7. Ettin, Edward sumer Savings C. and Barbara Negri Opper. Conand Thrift Institutions. Staff Eco- nomic Study No. 56. ernors of the Federal Washington: Reserve Board of Gov-. System, 1970. 8. Farnsworth, Clyde H., Jr. “Sources of Bank Exuansion in the Fifth District: Internal and External Growth,” Monthly Review, Federal Reserve Bank of Richmond, (June 1973)) pp. 2-5. 9. Gilbert, Gary G. and Neil B. Murphy. “Competition Between Thrift Institutions and Commercial Banks: An Examination of the Evidence,” Journal of Bunk Research, (Summer 1971), pp. 8-18. 10. Jackson, William. Thrift Institution Competition With Commercial Banks : Empirical Evidence. Working Paper No. 74-l. Federal Reserve Bank of Richmond. 11. Snellings, Aubrey N. “The Changing District Banking Structure,” Monthly Review, Federal Reserve Bank of Richmond, (July 1969), pp. 2-5. 12. Yesley, Joel M. “Defining the Product Market in Commercial Banking,” Economic Review, Federal Reserve Bank of Cleveland, (June/Julv 1972), pp. 17-31. The ECONOMIC REVIEWis produced by the Research Department of the Federal Reserve Bank of RichAddress inquiries to Bank and Public mond. Subscriptions are available to the public without charge. Relations, Federal Reserve Bank of Richmond, P. 0. Box 27622, Richmond, Virginia 23261. Articles may be reproduced if source is given. Please provide the Bank’s Research Department with a copy of any publication in which an article is used.