Full text of Economic Review (Federal Reserve Bank of Atlanta) : March/April 1979, Volume 64, Number 2

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The Burden of Fed
Membership Revisited

mtm

Consumer Debt: How Heavy
a Burden?
Update on Florida Bank
Branching

Bank

Environmental Regulations:
A Constraint on Southeastern
Productivity
Current Issues in Bank
Supervision and Regulation:
A Caribbean Basin Perspective j
Entry, Exit, and Change in
Banking Market Concentration

Bulk Rate
U.S. Postage

PAID

Atlanta, Ga.
Permit 292

FEATURES:
The Burden of Fed Membership Revisited

23

New evidence suggests that the burden of Federal Reserve membership on
southeastern banks is least for the largest banks and greatest for the smallest
banks, modifying the conclusions of a study presented in an earlier issue of this
Review.

Consumer Debt: How Heavy a Burden?

24

Of all the popular measures of the consumer debt burden, the ratio of
household debt to financial assets is most useful for short-term spending
forecasts.That ratio's rapid climb indicates that a downturn in outlays for new
homes and durable goods is long overdue.

Update on Florida Bank Branching —

34

A 1977 change in Florida law that allowed banks to establish branches gave the
state's multibank holding companies incentives to cut costs by consolidating
their affiliates. To date, the number of such mergers has been well below
potential.

Environmental Regulations:
A Constraint on Southeastern Productivity

36

The tightening of environmental protection standards has consumed a rising
share of manufacturing resources since 1973. The resulting output losses have
been greater in the Southeast than nationwide, largely because of the region's
faster manufacturing growth and its high concentration of those industries
required to make the heaviest pollution control expenditures.

Current Issues in Bank Supervision and Regulation:
A Caribbean Basin Perspective

—

40

This summary of an international conference at the Federal Reserve Bank of
Atlanta highlights the issues facing bank supervisors and regulators in the U.S.
and throughout the Caribbean Basin.

Entry, Exit, and Change in Banking Market Concentration 50
This study confirms the effect of changes in the number of competitors on
deposit concentration in southeastern banking markets, implying that bank
regulatory agencies' decisions have a powerful influence on the performance of
¡"dividual markets.

Director of Research: H a r r y B r a n d t
Editing: Patricia F a u l k i n b e r r y
Editing Assistance: A d o l p h a J o r d a n
Production and Graphics:

Martha S. Moss and Eddie W. Lee, Jr.

Economic Review, V o l . LXIV, N o . 2. Free s u b s c r i p t i o n a n d add i t i o n a l copies available u p o n request t o t h e Research D e p a r t m e n t , Federal Reserve Bank o f A t l a n t a , A t l a n t a , G e o r g i a 30303.
M a t e r i a l h e r e i n m a y be r e p r i n t e d o r a b s t r a c t e d , p r o v i d e d this
Review, t h e Bank, a n d t h e a u t h o r are c r e d i t e d . Please p r o v i d e this
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w h i c h s u c h m a t e r i a l is r e p r i n t e d .

Note to readers: In addition to those credited, Donald R. Dean and Yvonne F. Davies
(now at the Department of Housing and Urban Development) made substantial
contributions to the article, "The Southeast in 1978: Expansion for a Fourth Year/
which appeared in the January/February 1979 issue of this Review.
22




M A R C H / A P R I L 1979

THE BURDEN OF F
REVISITED
by Stuart C.

MEMBERSHIP

Hoffman

In the N o v e m b e r / D e c e m b e r 1978 Economic
Review, an article appeared o n t h e
burden of Federal Reserve System membership for Sixth District banks. 1 O n e of its
conclusions was that t h e b u r d e n of
m e m b e r s h i p in 1977, measured as f o r e g o n e
earnings as a percent of actual earnings,
was highest for t h e District's f o u r largest
banks (those w i t h total deposits b e t w e e n
$11/4 and $2 b i l l i o n each). The estimated
b u r d e n for those banks was about 15
e r c e n t , c o m p a r e d t o 10-12 1 /2 percent for
anks with less than $1 VA billion in deposits.
The conclusion that the District's largest
m e m b e r banks are m o r e b u r d e n e d than its
smaller banks stands in m a r k e d contrast
to t h e findings of several o t h e r studies
o n this t o p i c . As n o t e d in t h e original
article, the analysis of the large banks' burden
may have been distorted by unusually
l o w pretax earnings in 1977 for t w o of
these banks. This p o t e n t i a l bias m o t i v a t e d
a f o l l o w - u p b u r d e n analysis based o n data
for 1978.
The 1978 Burden. Last year, the District's
f o u r largest banks h e l d $338.2 m i l l i o n in
reserves at t h e Federal Reserve, an increase
of 6 percent over t h e a m o u n t h e l d in
1977. Since reserves h e l d at t h e Fed are
the major c o n t r i b u t o r t o the b u r d e n of
System m e m b e r s h i p , a reasonable a p p r o x i m a t i o n of t h e large banks' 1978 b u r d e n ,
in terms of foregone pretax earnings, w o u l d
be $6.5 m i l l i o n , or 6 percent higher than
in 1977. H o w e v e r , d u r i n g t h e year, t h e
District's largest banks registered a
substantial i m p r o v e m e n t in actual pretax
earnings—an 86-percent rise to $75.1 million.
Thus, tneir m e m b e r s h i p b u r d e n , measured
as f o r e g o n e earnings as a percentage
of t o t a l e a r n i n g s , e q u a l e d 8.7 percent last
year, d o w n substantially f r o m the 15-percent
estimate f o r 1977. Because 1978 represents
a m o r e n o r m a l year f o r bank earnings,
the lower burden estimate is m o r e accurate.

C

' S t u a r t G. H o f f m a n , " T h t B u r d e n of Fed M e m b e r s h i p f o r S i x t h
District B a n k s , " Economic Review, F e d e r a l R e s e r v e B a n k of Atlanta,
N o v e m b e r / D e c e m b e r 1978.

FEDERAL RESERVE B A N K OF A T L A N T A




Indeed, the District's largest bank still had
a below-average r e t u r n o n assets in 1978,
suggesting that t h e 8.7-percent b u r d e n
estimate may yet be o n the high side.
A second issue, not explicitly addressed
in the original article, concerns the membership b u r d e n for t h e very smallest District
banks—those w i t h total deposits of less
than $10 million. In 1977, there were 83 such
m e m b e r banks that had been in o p e r a t i o n
for the f u l l year. Fifty-nine of these smallest
m e m b e r banks had positive i n c o m e b e f o r e
taxes that year, w h i l e 24 banks w e r e
u n p r o f i t a b l e (i.e., negative i n c o m e b e f o r e
taxes). D u p l i c a t i n g t h e m e t h o d o l o g y used
in t h e original article, t h e estimated
income foregone by the group of profitable
m e m b e r banks was $766,000. The group's
i n c o m e b e f o r e taxes t o t a l e d $4.7 m i l l i o n
in 1977, i n d i c a t i n g an average m e m b e r s h i p
b u r d e n of 16.3 percent. That is, t h e
g r o u p ' s i n c o m e c o u l d have been 16.3 percent higher in 1977 had each bank been a
n o n m e m b e r . For all 83 small banks, the
estimated average b u r d e n in 1977 was 26.8
percent. It appears that inclusion of
u n p r o f i t a b l e banks biases u p w a r d t h e
burden estimate, since their negative pretax
incomes reduce t h e algebraic sum of t h e
roup's total income. 2 This same u p w a r d
ias may plague o t h e r estimates ot t h e
membership burden for the smallest banks.
In c o n c l u s i o n , m o r e recent e v i d e n c e
indicates that t h e average b u r d e n of
m e m b e r s h i p is lowest, not highest, for t h e
District's largest banks. F u r t h e r m o r e , t h e
very smallest m e m b e r banks are apparently
the most heavily b u r d e n e d by System
m e m b e r s h i p . H o w e v e r , evidence o n t h e
m a g n i t u d e of t h e b u r d e n d i f f e r e n t i a l
b e t w e e n very small and very large banks
is tentative. •

E

2

A p o s s i b l e s o l u t i o n to t h e statistical bias w o u l d b e t o use t h e s u m of t h e
a b s o l u t e v a l u e s of p r e t a x i n c o m e s a s t h e d e n o m i n a t o r of t h e b u r d e n ratio.
C a l c u l a t e d in this w a y , t h e e s t i m a t e d a v e r a g e b u r d e n for t h e g r o u p of 83
s m a l l b a n k s in 1977 w a s 14.7 p e r c e n t . T h e r a t i o n a l e is that f o r e g o n e
income associated with m e m b e r s h i p could be used to reduce a bank's
p r e t a x loss. For e x a m p l e , a s m a l l m e m b e r w i t h e s t i m a t e d f o r e g o n e
e a r n i n g s of 8 1 , 0 0 0 a n d a 8 5 , 0 0 0 p r e t a x loss c o u l d v i e w w i t h d r a w a l
a s a w a y t o i n c r e a s e its i n c o m e (i.e, r e d u c e its loss) by 2 0 p e r c e n t .

23

CONSUMER DEBT:
HOW HEAVY A BURDEN?
by Patricia Faulkinberry

Alarmed by the sustained rapid expansion
of consumer debt in the past two years,
economists have debated now to measure
its strain on household resources and its
threat to future consumer spending.
O ur research indicates that popular
"debt burden" measures which compare
outstanding debts or repayment obliga­
tions to consumer income cannot be
used successfully in short-term con­
sumer spending forecasts. But ratios
derived from household balance sheets,
particularly ratios of outstanding debts
to financial assets, are reasonably accurate
spending predictors. Historically, we
have found, whenever consumers have
raised their outstanding liabilities relative
to their savings, it has held down consumer
outlays, especially for new homes and
durable goods, for a full year thereafter.
The large back-to-back increases in the
debt/assets ratio that have resulted from
the recent borrowing spree suggest that
a downturn in consumers' big-ticket
purchases is now long overdue.
W HAT D O DEBT BURDEN MEASURES
TELL US?
In the past two years, consumers have
been borrowing at a rate of more than
$500 billion a year. Their hearty appetites
for new homes, cars, and other durable
goods whetted by the ready availability of




credit and fears of inflation, house­
holds have accumulated liabilities far
faster than their financial resources have
expanded (see Chart 1). In the eight
quarters ended Decem ber 31, 1978, co n ­
sumers' total outstanding debts climbed
nearly 36 percent and consumer instal­
ment debt jumped a massive 49 percent.
Meanwhile, disposable personal in­
come rose 24 percent and the growth
of households' financial assets— bank
accounts, savings deposits, holdings of
stocks and bonds, and the like— lagged
even further at only 15 percent. This
discrepancy has raised fears that con­
sumers have become "overextended" and
that the mounting strain of debt on their
resources may require a retrenchment in
consumer spending that could make the
difference between recession and further
econom ic expansion in 1979.
The consumer's "debt burden" has
gotten a lot of press and created a lot
of confusion. Economists have proposed
a number of ratios by which to measure the
debt burden— debt-to-incom e ratios,
repayments-to-income ratios, and balance
sheet measures like debt-to-assets and
debt-to-net-worth ratios. Many variations
of these basic forms have been used,
some with disposable income substituted
for personal income, some with mortgage
debts excluded and others using all
types of debt, and some with financial
M A RCH /A PRIL 1979, E C O N O M IC REVIEW

r

CHART 1
GROWTH RATES:
C O N S U M E R DEBT vs. RESOURCES

PERCENT

Total
Debt

40

P e r c e n t c h a n g e f r o m D e c e m b e r 31. 1976, to D e c e m b e r 31, 1978.

assets replaced or s u p p l e m e n t e d by
equities in tangible possessions.
The approach that analysts have taken
has typically been t o watch a favorite
ratio, c o m p a r i n g its level t o historical
postings. Presumably, w h e n t h e ratio
reached some danger level, usually
t h o u g h t t o be at or near its previous
peak, a slide in consumer s p e n d i n g w o u l d
ensue. In recent m o n t h s , ratios o f o u t standing debt t o i n c o m e , financial assets,
and net w o r t h have advanced well past
earlier records, but repayments-to-income
ratios have h o v e r e d near previous
peaks and ratios of d e b t to tangible
assets have r e m a i n e d b e l o w historical
highs. Spending p r o j e c t i o n s have thus diff e r e d a c c o r d i n g t o t n e forecaster's c h o i c e
of ratios.
Predictions have been understandably
vague. Besides t h e uncertainty of w h i c h
ratio is a p p r o p r i a t e , the links b e t w e e n
the various indicators and c o n s u m e r
s p e n d i n g had not been q u a n t i f i e d . No
o n e was sure h o w h i g h any of the measures
c o u l d go b e f o r e s p e n d i n g w o u l d be aff e c t e d , h o w great t h e impact w o u l d be,
FEDERAL RESERVE B A N K O F A T L A N T A




or what t h e t i m i n g of t h e effects was
likely t o be. Since t h e last t i m e c o n sumers w e n t o n a credit b i n g e (1973-74),
the rise in t w o - i n c o m e households and
changes in loan terms have altered their
d e b t - c a r r y i n g capacity t o an u n k n o w n
extent, perhaps m o v i n g t h e " t r i g g e r
o i n t " or otherwise b l u n t i n g t h e d e b t
urden's effects. Inflation may have
made d e b t m o r e palatable by r e d u c i n g
" r e a l " l o n g - r u n b o r r o w i n g costs. But
bv p r o m p t i n g consumers t o m o v e u p p u r chases p l a n n e d for t h e f u t u r e , it may
delay and ultimately aggravate any spending
weakness induced by an overload of debt.
Fortunately, e m p i r i c a l research can
answer many questions i n h e r e n t to t h e
d e b t b u r d e n issue. By testing t h e statistical
relationship of d e b t b u r d e n measures t o
s p e n d i n g , w e have discovered w h i c h
ratios are t h e best predictors of spending,
isolated t h e types of s p e n d i n g that are
most strongly affected, and measured t h e
average m a g n i t u d e and d u r a t i o n of t h e
impact. (The A p p e n d i x describes the
testing t e c h n i q u e s and data used.) Some
of t h e results w e r e surprising.

C

THE ANSWERS
Which Ratio(s)? Judging f r o m o u r test
results, t h e most c o m m o n l y cited d e b t
b u r d e n measures—those w n i c h relate o u t standing debts or s c h e d u l e d repayments
t o disposable personal i n c o m e — c a n n o t
readily be used t o forecast c o n s u m e r
spending. A l t h o u g h these ratios typically
snow a close, negative relationship t o
s p e n d i n g levels, o v e r p o w e r i n g l o n g - r u n
trends in t h e data make s h o r t - r u n predictions unreliable. But c o n s u m e r balance
sheet measures, particularly t h e ratio of
o u t s t a n d i n g debts t o financial assets,
p r o v e d t o oe reliable and pretty p o w e r f u l
s p e n d i n g predictors.
H o w can w e explain these findings?
Proponents of i n c o m e - b a s e d d e b t b u r d e n measures, notably the r e p a y m e n t s /
i n c o m e ratio, have argued persuasively
that these measures most faithfully reflect t h e drain of d e b t o n h o u s e h o l d
resources and, thus, its p o t e n t i a l threat
t o spending. O u r test results suggest that
this is t r u e in a l o n g - r u n sense, perhaps
c o n f i r m i n g that trends t o w a r d longer
25

loan maturities and t w o - i n c o m e households, w h i c h h o l d d o w n t h e r e p a y m e n t s /
i n c o m e ratio, t e n d t o raise the level of
c o n s u m e r spending. But many i n d i v i d u a l
c o n s u m e r s p e n d i n g decisions may be m o r e
strongly i n f l u e n c e d by " w e a l t h " than by
b u d g e t constraints alone, m a k i n g t h e
assets-based ratios m o r e suitable i n d i cators of cyclical or n e a r - t e r m s p e n d i n g
prospects.
Financial assets are a m u c h broader
measure of h o u s e h o l d resources than is
i n c o m e . Since they i n c l u d e c h e c k i n g
accounts, they reflect c u r r e n t i n c o m e
to some extent. O t h e r financial assets—
savings deposits and securities h o l d i n g s —
m i g h t be t h o u g h t of as h o u s e h o l d
" r e s e r v e s " that can be l i q u i d a t e d or
used as collateral to support s p e n d i n g
and b o r r o w i n g ; they act as a b u f f e r
against u n p l a n n e d expenses or i n c o m e
losses. T o o many claims o n these assets
d i m i n i s h consumers' financial security,
their " c o n f i d e n c e , " and their willingness
to make purchases, particularly major
ones that c o u l d i n c u r m o r e liabilities. 1
M o r e o v e r , d e b t b u r d e n measures based
o n financial assets reflect the p i n c h of
d e b t - r e l a t e d expenses like d o w n payments or f r o n t - e n d b o r r o w i n g costs that
w o u l d not be d e t e c t e d by t h e i n c o m e based ratios.
The c o n t r i b u t i o n of tangible assets t o
c o n s u m e r d e b t - c a r r y i n g capacity remains
unclear. In the past few years, consumers'
equities in homes have been a g r o w i n g
source of funds for payment of existing
debts and purchases of n e w homes ana
a w i d e variety of other goods and services.2
But, in general, real possessions are less
l i q u i d t h a n financial assets and thus p r o v i d e less effective s u p p o r t for s p e n d i n g .
O u r tests s h o w e d that d e b t b u r d e n ratios
based o n tangible assets or total assets
are less closely l i n k e d t o s p e n d i n g than
those w h i c h i n c l u d e o n l y financial assets,

1

The effects o f f i n a n c i a l assets o n c o n s u m e r s p e n d i n g have b e e n d o c u m e n t e d
i n e a r l i e r research. See, f o r instance, Frederic M i s h k i n , " W h a t D e p r e s s e d
t h e C o n s u m e r ? H o u s e h o l d Balance Sheets a n d t h e 1973-75 R e c e s s i o n , "
Brookings Papers on Economic Activity, 1977:1.

1

D a v i d Seiders a n d Charles L u c k e t t , " H o u s e h o l d B o r r o w i n g i n t h e
R e c o v e r y , " Federal Reserve Bulletin, M a r c h 1978.

26




and they present statistical p r o b l e m s that
severely limit their usefulness in forecasting.
As l o n g as t h e d e b t b u r d e n measure
is based o n financial assets, it w i l l p r e d i c t
spending nearly as well with repayments in
the n u m e r a t o r as w i t h o u t s t a n d i n g d e b t .
Repayments and outstandings usually
move t o g e t h e r , of course. But because
some f i n a n c i n g terms—interest rates,
maturities, and t h e t i m e a l l o w e d b e t w e e n
creation of a debt and the first r e p a y m e n t vary f r o m loan to loan and over t i m e ,
changes in outstandings are not passed
t h r o u g h to r e p a y m e n t obligations in a
constant p r o p o r t i o n . The v o l u m e of d e b t
outstanding is more responsive to the most
recent c r e d i t extensions, particularly
w h e n loan maturities are l e n g t h e n i n g
and prices are rising. For n e a r - t e r m
forecasting purposes, the newest loans,
w h i c h largely d e t e r m i n e m o v e m e n t s in t h e
d e b t b u r d e n , are critical. A n d c o n c e p tually, o u t s t a n d i n g debts are a m o r e app r o p r i a t e match for financial assets t h a n
are repayments.
O d d l y , d e b t b u r d e n measures w h i c h
use c o n s u m e r instalment d e b t alone perf o r m as well as or slightly better than
those w h i c h i n c o r p o r a t e all types of
c o n s u m e r debts. Perhaps this is because
c o n s u m e r instalment credit is m o r e
sensitive to e c o n o m i c c o n d i t i o n s or because a somewhat larger p o r t i o n of
A m e r i c a n households have c o n s u m e r
instalment debts t h a n mortgages, 3
w h i c h make u p the b u l k of o t h e r c o n s u m e r
liabilities. It may be, t o o , that m o r t gage debts are actually less b u r d e n s o m e
than o t h e r liabilities, since they displace
rent expenses.
How? The negative effect of d e b t /
assets ratios o n c o n s u m e r s p e n d i n g is n o t
direct. In fact, t h e levels of these ratios
are, for the most part, closely and positively
c o r r e l a t e d w i t h real s p e n d i n g levels,
i m p l y i n g that t h e higher their d e b t b u r dens, t h e m o r e consumers spend. Since
many purchases, particularly large
ones, are d e b t - f i n a n c e d , it is n o t surprising that s p e n d i n g a n d debt/assets

J Ibid.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

<

/

•

•

X

CHART 2
REAL CONSUMER SPENDING vs.
DEBT/ASSETS RATIO
BILLIONS
O F 1972

PERCENT

400 —

^

— 2

I

I

I

I

I

I

I

I

I

0

'69 7 0 '71 '72 '73 '74 '75 7 6 '77 7 8
Total c o n s u m e r s p e n d i n g includes household

\

investment in residential construction.

y

ratios rise and fall t o g e t h e r . But they
d o n ' t m o v e precisely in t a n d e m — t h e
ratios t e n d t o lag s p e n d i n g by t h r e e or
f o u r quarters (see Chart 2). O b v i o u s l y ,
it w o u l d be d i f f i c u l t t o forecast w i t h
a lagging indicator.
The e x p e c t e d negative relationship
between the debt/assets ratio and spending
appears in an analysis of t h e changes
in the t w o , w i t h a t i m i n g that facilitates
forecasting. A n increase in t h e debt/assets
ratio reduces constant dollar s p e n d i n g
g r o w t h in each of t h e f o u r f o l l o w i n g
quarters; a decrease has an equally l o n g lasting stimulative effect. Thus, the impact
of a rising d e b t b u r d e n is not delayed

FEDERAL RESERVE B A N K O F A T L A N T A




until some t h r e s h o l d is reached; in fact,
a b o u t 70 p e r c e n t of the loss in s p e n d i n g
usually comes w i t h i n t w o quarters after
each rise in t h e debt/assets ratio.
The i m m e d i a c y and longevity of t h e
effects of debt/assets changes are
easily explained. As the debt/assets ratio
rises, regardless of its level, m o r e and
m o r e i n d i v i d u a l households f i n d their
financial positions u n c o m f o r t a b l e and
m o v e to restore a m o r e desirable balance.
The r e b u i l d i n g of financial security is
understandably slow w h e n a larger p o r t i o n
of i n c o m e has b e e n c o m m i t t e a to repayment of debts. In fact, f o u r quarters is
r o u g h l y t h e average life of a consumer
instalment loan. W n e n t h e debt/assets ratio
falls, a g r o w i n g n u m b e r of consumers feel
secure e n o u g h to spend m o r e freely.
How Much? Since s p e n d i n g g r o w t h
in any o n e auarter is i n f l u e n c e d by
changes in t h e d e b t b u r d e n in each of
t h e f o u r p r e c e d i n g quarters, particularly
t h e latest t w o , t h e impact's m a g n i t u d e depends o n t h e size, d i r e c t i o n , and t i m i n g
of t h e changes. Some types of s p e n d i n g
are affected m o r e t h a n others, t o o . The
effects are heavily c o n c e n t r a t e d o n o u t lays for new homes and durable goods, or
wnat w e m i g h t call " t a n g i b l e investm e n t " by consumers. Because these bigticket purchases are largely nonessential,
p o s t p o n a b l e , and d e b t - f i n a n c e d , they
are the first cut w h e n consumers f i n d
their balance sheets o u t of line. Spending for n o n d u r a b l e goods and services
responds t o debt/assets changes to
a m u c h lesser degree.
Thus, a series of debt/assets increases
large e n o u g h to i n d u c e a d e c l i n e in c o n sumer t a n g i b l e investment may not be
sufficient to do m o r e than slow the
g r o w t h of total c o n s u m e r spending.
Judging f r o m historical averages, a rise
of .13 in the ratio of c o n s u m e r instalment
debt t o financial assets (expressed as a
percentage) for f o u r consecutive quarters
w o u l d r e d u c e real tangible investment
g r o w t h t o zero in t h e f o l l o w i n g quarter.
But it w o u l d take f o u r quarters of backto-back .23-point increases to h o l d total
constant dollar c o n s u m e r s p e n d i n g
unchanged.

27

forecasting w i t h o u r simplistic f o r m u l a
is not t o m a k e superior predictions but
to illustrate t h e d e b t b u r d e n ' s link t o t h e
current spending outlook.
Chart 4 compares t h e percentage
changes in real c o n s u m e r t a n g i b l e investment (spending for d u r a b l e goods and
residential construction) that actually
o c c u r r e d in 1969-78 w i t h those that w e
w o u l d have p r o j e c t e d solely o n t h e
basis of changes in t h e c o n s u m e r instalment d e b t / f i n a n c i a l assets ratio. O v e r t h e
past t e n years, the p r o j e c t i o n s have t r a c k e d
tangible investment g r o w t h pretty w e l l ;
their l o n g - r u n accuracy averages a b o u t 59
percent. But total changes p r o j e c t e d
for t h e expansion and c o n t r a c t i o n
phases of t h e last business cycle have
c o m e closer to the actual changes.
In o t h e r w o r d s , a " m i s s " in o n e quarter
tends t o be offset in o t h e r quarters. This
peculiar accuracy is d i s t u r b i n g because
t a n g i b l e investment has been o v e r s h o o t i n g p r o j e c t i o n s pretty consistently since
early 1977.

IMPLICATIONS FOR CURRENT PROSPECTS

Since debt/assets changes lead tangible investment changes, w e have been
able to show a first-quarter 1979 p r o jection, a moderate decline. Looking
f u r t h e r ahead, w e k n o w that each recent
change in t h e debt/assets ratio w i l l exert
some i n f l u e n c e for a b o u t f o u r quarters.
These have mainly b e e n increases that are
likely t o restrain f u t u r e spending. The
t h i r d - q u a r t e r 1978 decline in t h e ratio
s t e m m e d largely f r o m a stock market rally
w h i c h eave a o n e - s h o t boost to financial
assets that has since been reversed. Thus,
its effect may lack some of the typical
d u r a b i l i t y , a l t h o u g h it d i d result in a
correct p r e d i c t i o n of t h e f o u r t h - q u a r t e r
1978 u p t u r n in real tangible investment.

Using t h e f o r m u l a g e n e r a t e d by o u r
e m p i r i c a l t e s t s (see A p p e n d i x f o r specifics)
and data o n changes in t h e ratio of c o n sumer instalment d e b t o u t s t a n d i n g t o
h o u s e h o l d financial assets ( p i c t u r e d in
Chart 3), w e can make " p r o j e c t i o n s " of
changes in real c o n s u m e r s p e n d i n g for new
homes and d u r a b l e goods w i t h reasonable
accuracy. Sophisticated e c o n o m e t r i c
models that i n c o r p o r a t e a b r o a d e r range
of i n f o r m a t i o n p r o d u c e m u c h m o r e
accurate p r o j e c t i o n s . O u r p u r p o s e in

Further projections w i l l , h o w e v e r ,
d e p e n d heavily o n changes in t h e d e b t /
assets ratio in t h e m o n t h s ahead. U n f o r t u n a t e l y , a c o n t i n u a t i o n of very large
increases in this ratio is likely. In past
business cycles, it has c o n t i n u e d t o advance
until w e l l after an e c o n o m i c d o w n t u r n has
been established. In fact, the greatest
rises typically f o l l o w declines in real inc o m e and spending. B o r r o w i n g usually
tapers l o n g b e f o r e , b u t w h e n households f i n d themselves in financial straits,
they o f t e n t u r n to stopgap relief measures

28



M A R C H / A P R I L 1979, E C O N O M I C REVIEW

CHART 4
ACTUAL AND EXPECTED PERCENTAGE CHANGES
IN REAL TANGIBLE INVESTMENT
PERCENT

P r o j e c t e d o n t h e basis of c h a n g e s
in t h e ratio of c o n s u m e r i n s t a l m e n t
d e b t t o f i n a n c i a l assets.

10.0

8.0

— 6.0

—

8.0

— 10.0

I

I

I

I

I

I

I

I I

I

'69 '70 '71 '72 '73 '74 '75 '76 '77 '73 '79

like f o r e g o i n g savings, d e b t refinancing,
asset l i q u i d a t i o n , or d e l i n q u e n c y or default
in loan repayments. Such behavior drives
u p t h e debt/assets ratio rapidly and calls
f o r m o r e severe s p e n d i n g restraints.
Thus, t h e debt/assets ratio has been
signaling p o o r prospects for real c o n sumer s p e n d i n g f o r d u r a b l e goods and
new houses. A n d , largely because of
the r e c o r d first-quarter 1978 increase in
the ratio, small declines in total consumer
s p e n d i n g have been indicated for
t h r e e of t h e past f o u r quarters, i n c l u d i n g
t h e first quarter of 1979. Total spending,
h o w e v e r , is m o r e sensitive t o influences
o t h e r than t h e d e b t b u r d e n than is
tangible investment. Spending for n o n d u r a b l e goods and services, w h i c h
constitutes t h e lion's share of h o u s e h o l d
e x p e n d i t u r e s , is m o r e responsive to direct
i n c o m e effects. If disposable i n c o m e
g r o w t h can be m a i n t a i n e d , it s h o u l d
help mitigate the impact of p o t e n t i a l ,
large d e b t b u r d e n increases o n aggregate
e c o n o m i c activity.
Inflation adds a q u e s t i o n mark t o t h e
s p e n d i n g o u t l o o k and perhaps also to t h e
projections given above. Besides e r o d i n g
consumers' b u y i n g p o w e r and raising their
taxes, c h r o n i c inflation affects consumers'
expectations and, thus, their b o r r o w i n g
and investment decisions. It may, t h e n ,
increase their t o l e r a n c e for d e b t e n o u g h
t o change t h e link b e t w e e n t h e i r balance
sheets and spending. W e have d e f i n e d t h e
relationship in terms of historical averages
that c a n n o t fully reflect t h e latest trends.
But because o u r p r o j e c t i o n s are based o n
changes in d e b t b u r d e n measures and
s p e n d i n g , rather t h a n levels, they m i n i m i z e
t h e inaccuracies that w o u l d result f r o m
such a shift. It is q u i t e likely, t o o , that
t h e A m e r i c a n consumer's recent unp r e c e d e n t e d capitalizing o n inflation via
advance b u y i n g w i l l p r o v e t o be a t e m porary p h e n o m e n o n , serving o n l y t o
p o s t p o n e and exacerbate the d e b t b u r den's typical impact o n s p e n d i n g . «

" T a n g i b l e I n v e s t m e n t " = c o n s u m e r p u r c h a s e s of g o o d s p l u s
household residential investment.

FEDERAL RESERVE B A N K O F A T L A N T A




29

^—APPENDIX
The Data. The empirical tests consisted of a comparison of the statistical performance
of 12 debt burden measures with respect to 6 categories of consumer spending. The specific
ratios tested were:
consumer instalment
consumer instalment
total household debt
total household debt
consumer instalment
consumer instalment
total household debt
total household debt
consumer instalment
total household debt
consumer instalment
total household debt

debt outstanding/disposable personal income;
debt repayments/disposable personal income;
outstanding/disposable personal income;
repayments/disposable personal income;
debt outstanding/household financial assets;
debt repayments/household financial assets;
outstanding/household financial assets;
repayments/household financial assets;
debt outstanding/household tangible assets;
outstanding/household tangible assets;
debt outstanding/total household assets; and
outstanding/total household assets.

The spending categories were:
personal consumption expenditures for durable goods (DUR);
personal consumption expenditures for nondurable goods and services (ND&S);
total personal consumption expenditures (PCE);
household residential investment (HHRES);
"tangible investment" (i.e., personal consumption expenditures for durable
goods plus household residential investment) (Ti); and
total consumer spending (i.e., total personal consumption expenditures plus
household residential investment) (CS).
The data on debt outstandings, debt repayments, household assets, and household
residential investment were estimated by the Federal Reserve Board. Repayments, as used
here, refer to scheduled, rather than actual, debt liquidations; " t o t a l " repayments actually include only consumer instalment and mortgage obligations. Household residential investment
is that portion of residential construction outlays attributable to consumers rather than the
business sector. Other spending and disposable personal income data came from the Commerce Department's National Income and Product Accounts. All data were quarterly and,
where appropriate, seasonally adjusted; spending estimates were in 1972 dollars. The results
presented here are for the test period 1968:1—1978:1; identical tests on data for
1960:1—1978:1 produced very similar results.
a f'ul °V,r P u r P ° s e s ' t h e m o s t reasonable pairing of " s t o c k " (assets, outstanding debts)
and " f l o w " (income, repayments) variables required that beginning-of-period stock data be
used. Since the source agency reports them as of the quarter's end, all the stock data were
actually lagged one quarter before the ratios were calculated.

V
30




M A R C H / A P R I L 1980, E C O N O M I C REVIEW

-t

A
The Methodology. The testing employed both correlation and regression analysis.
The first step was to calculate correlation coefficients for each spending type (S) versus each
debt burden measure (DB) led 1-4 quarters and lagged 0-8 quarters. The ratios of debt
and repayments to the various household asset measures generally showed a close positive
association with each S for all the leads and lags covered. However, the lagged values of
the ratios of debt and repayments to disposable income were closely negatively related to
spending levels, with the lowest r's on the 5-quarter lag. Regressions of each S on the
repayments/income ratios lagged 5 quarters obtained very good fits and highly significant
t-statistics on the coefficients, but the extremely low Durbin-Watson statistics cast suspicion
on these results. Attempts to eliminate the autocorrelation—by applying the Hildreth-Lu
correction scheme, by adding a trend term as an independent variable, and by using "detrended" versions of the dependent variables—failed to raise the Durbin-Watson statistics to
tolerable levels.
The correlation analysis was duplicated using the changes in both the Ss and DBs
(using percentage changes in each S and percentage point differences in each DB). Here,
the closest negative relationships were found between spending changes and changes in
the asset-based ratios, particularly those using financial assets, lagged 0-3 quarters. Since there
was little correlation among these lagged values, all four were used together as independent
variables in a series of ordinary least squares regressions. The form was thus

% ASt- a + hj A D Bt + b2 A DB m +b 3 A D Bt_2 - b4 A D Bt_3.
The number of statistics and parameters generated by our tests was far too voluminous
for a thorough presentation here. The table summarizes the results of the best regressions—
those using debt burden measures based on financial assets. Generally, the intercepts
and the coefficients for the debt burden changes lagged zero, one, and three quarters were
significant, while the coefficients on the two-quarter lag were of questionable or of no
significance. However, in the residential investment equations, coefficients for the twoquarter lag were highly significant but those estimated for the three-quarter lag were not.
The corrected coefficients of determination were significant for all but the nondurable goods
and services equations. The Durbin-Watson statistics revealed no serial correlation problems
in most cases; a few fell into the inconclusive ranges.
Detailed results not presented here will be made available on request. A few more
specifics bear mention, however. Changes in the income-based debt burden measures were
negatively correlated with spending changes, but the relationship was not close enough to
produce satisfactory regression results. Spending changes were also negatively related to
changes in dfebt/tangible assets ratios, but the correlation coefficients were significant
only on the longest lags (lags probably too long for the relationship to be meaningful).
Moreover, the lagged values of changes in these ratios were closely collinear and, thus, unsuitable for multiple regression analysis.

J

I

FEDERAL RESERVE B A N K O F A T L A N T A




31

REGRESSION RESULTS FOR EQUATIONS IN FORM
%ASt=a +

A D B t + b 2 A DBt_1 + b 3 A D B t _ 2 + b 4 A D B , _ 3
(t-statistics in parentheses)

Spending
Type (S)

a

b1

b2

b3

b4

D-W

R*

DB = consumer instalment debt outstanding/financial assets
TI

2.585
(6.353)***

-6.117
(-3.642)***

-7.493
(-4.357)***

-2.125
(-1.274)

-3.758
(-2.308)**

2.176

.593

CS

1.225
(9.162)***

-1.729
(-3.132)***

-1.647
(-2.915)***

-.447
(-•817)

-1.393
(-2.604)**

2.089

.470

PCE

1.128
(8.387)***

-1.458
(-2.627)**

-1.458
(-2.566)**

-.050
(-.091)

-1.245
(-2.321)**

2.173

.366

DUR

2.359
(4.628)***

-5.610
(-2.667)**

-7.994
(-3.712)***

.116
(0.056)

-3.648
(-1.789)*

2.585 + +

.434

HHRES

3.371
(5.021)***

-7.968
(-2.875)***

-5.679
(-2.001)*

-4.174
(-1.554)

1.293 +

.491

ND&S

.923
(9.189)***

-.730
(-1.760)*

-.409
(-0.965)

-.805
(-2.004)*

1.915

.142

-.727
(-1.963)*

2.112

.571

-9.226
(-3.354)***
-.023
(-.056)

DB = total household debt outstanding/financial assets
TI

2.527
(6.075)***

-1.410
(-3.619)***

-1.814
(-4.586)***

-.395
(-1.047)

CS

1.209
(8.856)***

-.405
(-3.167)***

-.400
(-3.084)***

-.008
(-•671)

-.271
(-2.232)**

2.047

.444.

PCE

1.115
(8.223)***

-.338
(-2.661)**

-.357
(-2.772)***

.002
(.020)

-.244
(-2.019)*

2.150

.351

DUR

2.312
(4.555)***

-1.257
(-2.644)**

-1.954
(-4.049)***

.101
(.220)

-.712
(-1.577)

2.554+ +

.435

HHRES

3.280
(4.733)***

-1.963
(-3.024)***

-1.317
(-1.999)*

-1.964
(-3.123)***

-.784
(-1.272)

1.245 +

.453

ND&S

.916
(9.060)***

-.176
(-1.862)*

-.101
(-1.051)

-.155
(-1.724)*

1.905

.123

-.001
(-.014)

• S i g n i f i c a n t at t h e 9 0 - p e r c e n t c o n f i d e n c e level ( t w o - t a i l e d test).
" S i g n i f i c a n t at t h e 9 5 - p e r c e n t c o n f i d e n c e level ( t w o - t a i l e d test).
" ' S i g n i f i c a n t at t h e 9 9 - p e r c e n t c o n f i d e n c e level ( t w o - t a i l e d test).
+ T e s t for p o s i t i v e a u t o c o r r e l a t i o n is inclusive at t h e 9 5 - p e r c e n t c o n f i d e n c e level.
+ + T e s t for negative a u t o c o r r e l a t i o n is inclusive at t h e 9 5 - p e r c e n t c o n f i d e n c e level

V
32




/
M A R C H / A P R I L 1979, E C O N O M I C REVIEW

REGRESSION RESULTS FOR EQUATIONS IN FORM
% A S t = a +b, A DB t + b 2 A D B M + b 3 A D B , _ 2 + b 4 A D B t _ 3
(t-statistics in parentheses)

Spending
Type (S)

D-W

R2

DB = consumer instalment debt repayments/financial assets
TI

2.372
(5.495)***

-5.482
(-2.948)***

-8.816
(-4.804)***

-3.135
(-1.775)*

-4.074
(-2.250)**

2.007

.530

CS

1.169
(8.400)***

-1.459
(-2.436)**

-2.017
(-3.411)***

-.843
(-1.482)

-1.381
(-2.367)**

1.870

.407

PCE

1.089
(8.005)***

-1.124
(-1.919)*

-1.789
(-3.094)***

-.429
(-.770)

-1.230
(-2.155)**

1.911

.318

DUR

2.217
(4.373)***

-4.378
(-2.005)*

-9.361
(-4.343)***

-.992
(-.478)

-4.044
(-1.902)*

2.399+ +

.413

HHRES

2.937
(4.191)***

-9.233
(-3.059)***

-6.837
(-2.295)**

-4.013
(-1.365)

1.374+

.436

ND&S

.903
(8.866)***

-.570
(-1.301)

-.581
(-1.344)

-.704
(-1.649)

1.674+

.091

-9.875
(-3.444)***
-.266
(-.639)

DB = total household debt repayments/financial assets
TI

2.575
(5.657)***

-4.812
(-3.143)***

-7.029
(-4.677)***

-2.210
(-1.529)

-2.916
(-1.971)*

1.900

.509

CS

1.220
(8.347)***

-1.227
(-2.496)**

-1.600
(-3.316)***

-.640
(-1.380)

-1.028
(-2.165)**

1.807

.386

PCE

1.131
(7.958)***

-.966
(-2.021)*

-1.406
(-2.996)***

-.311
(-.688)

-.920
(-1.993)*

1.868

.303

DUR

2.400
(4.550)***

-4.092
(-2.306)**

-7.375
(-4.235)***

.436
(-.260)

-2.903
(-1.693)

2.327+ +

.404

HHRES

3.200
(4.336)***

-7.266
(-2.927)***

-5.732
(-2.352)**

-2.869
(-1.196)

1.303+

.413

ND&S

.920
(8.690)***

-.436
(-1.224)

-.448
(-1.282)

-.546
(-1.587)

1.662+

.078

-7.791
(-3.324)***
-.235
(-.699)

" S i g n i f i c a n t at t h e 9 0 - p e r c e n t c o n f i d e n c e level ( t w o - t a i l e d test).
" S i g n i f i c a n t at t h e 9 5 - p e r c e n t c o n f i d e n c e level ( t w o - t a i l e d test).
• " S i g n i f i c a n t at t h e 9 9 - p e r c e n t c o n f i d e n c e level ( t w o - t a i l e d test).
+ T e s t for p o s i t i v e a u t o c o r r e l a t i o n is i n c l u s i v e at t h e 9 5 - p e r c e n t c o n f i d e n c e level.
+ + T e s t for n e g a t i v e a u t o c o r r e l a t i o n is i n c l u s i v e at t h e 9 5 - p e r c e n t c o n f i d e n c e level.

»

FEDERAL RESERVE B A N K O F A T L A N T A

I



33

UPDATE ON FLORIDA BANK
BRANCHING
by Joel Parker

Florida b a n k i n g law c h a n g e d January 1,
1977, t a k i n g Florida o u t of t h e realm
of u n i t b a n k i n g by a l l o w i n g c o u n t y w i d e
branching. The n e w b r a n c h i n g capabilities
gave t h e state's m u l t i b a n k h o l d i n g
companies an opportunity to cut operating
costs and increase o r g a n i z a t i o n a l efficiency. By facilitating c o n s o l i d a t i o n of
h o l d i n g c o m p a n y affiliates, t h e change
also created a p o t e n t i a l for a sizable
shift of deposits t o Federal Reserve member
banks. In an earlier article in this
Review, Ruth Goeller r e p o r t e d o n banks'
reactions t o their n e w prerogatives
t h r o u g h August 1977.1 This article w i l l
update the consequences t h r o u g h
D e c e m b e r 1978.
U n t i l 1974, Florida law a l l o w e d banks
t o operate only o u t of main offices
and facilities o n military bases. B e g i n n i n g
in 1974, each bank c o u l d establish o n e
o f f i c e w i t h i n o n e mile of its main o f f i c e to
accept deposits and loan payments. The
1977 law permitted each bank t o create t w o
new branches per year in its h o m e
c o u n t y . Also, t w o or m o r e banks w i t h i n a
c o u n t y c o u l d m e r g e , leaving o n e surviving
bank w i t h t h e others as branches. But
once a bank merged and became a branch,
it c o u l d n o longer establish branches
of its o w n .
Branching by merger seemed t a i l o r e d
to solving some of t h e p r o b l e m s that
u n i t b a n k i n g has caused Florida's m u l t i bank h o l d i n g companies. U n d e r u n i t
b a n k i n g , each bank in a h o l d i n g c o m p a n y
m a i n t a i n e d its o w n a c c o u n t i n g , a u d i t i n g ,

' R u t h G o e l l e r , " T h e N e w C h a p t e r in Florida B a n k i n g , " this Review,
N o v e m b e r / D e c e m b e r 1977, p p . 144-46.

34




and data processing departments. The 1977
law p r o v i d e d a legal means for h o l d i n g
companies t o centralize such f u n c t i o n s
into o n e bank in each c o u n t y . The
h o l d i n g c o m p a n i e s themselves i n d i c a t e d
that they e x p e c t e d sizable yearly savings
f r o m these consolidations. M o r e e f f i c i e n t
bank services w e r e a n o t h e r p u r p o r t e d
benefit of t h e n e w law. Bank h o l d i n g c o m pany officers predicted simplified servicing
of loan participations and overall i m p r o v e ments s t e m m i n g f r o m better intrabank
c o m m u n i c a t i o n and a m o r e h o m o g e n o u s
package of services. 2
If Florida bank h o l d i n g companies had
p u r s u e d t h e c o s t - c u t t i n g and streaml i n i n g measures t o the fullest permissible
extent, h o w w o u l d t h e state's b a n k i n g
e n v i r o n m e n t have b e e n changed? Three
h u n d r e d fifty-six h o l d i n g c o m p a n y affiliates, almost half of Florida's banks, became
eligible to m e r g e o n January 1, 1977. Had
they all d o n e so, 252 banks w o u l d have
b e c o m e branches by m e r g i n g into 104
surviving banks. Total c o m m e r c i a l bank
charters in Florida w o u l d have fallen
by o n e - t h i r d .
Of t h e 356 eligible banks, 180 w e r e
Federal Reserve m e m b e r s and 176 w e r e
nonmembers. Full utilization of the merger
p o t e n t i a l w o u l d have significantly
c h a n g e d t h e d i s t r i b u t i o n of deposits bet w e e n m e m b e r and n o n m e m b e r banks,
b r i n g i n g a larger share u n d e r System
reserve r e q u i r e m e n t s . At the b e g i n n i n g of
1977, Florida bank holding companies cont r o l l e d $17 b i l l i o n of deposits, of w h i c h
$12 b i l l i o n w e r e in m e m b e r banks.
M e r g e r s into t h e largest subsidiary in each

2

lbid.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

c o u n t y w o u l d have shifted $1.4 b i l l i o n
f r o m n o n m e m b e r to m e m b e r banks, increasing holding companies' member bank
deposits by 8.3 percent and total m e m b e r
bank deposits by 5.2 p e r c e n t in the state.
In spite of t h e postulated advantages
for Florida bank h o l d i n g companies, t h e
n u m b e r of mergers so far has been o n l y
a b o u t t h r e e - f i f t h s of potential. O f the
eligible 356 h o l d i n g c o m p a n y banks, 205,
or just over a quarter of all banks in
Florida, had merged by December 31, 1978.
O f t h e m e r g e d banks, 105 w e r e m e m b e r s
and 100 n o n m e m b e r s . O n e h u n d r e d
t h i r t y - n i n e (67 m e m b e r s and 72 n o n members) of t h e m e r g e d banks became
branches; 38 m e m b e r banks and 28
nonmembers survived. The mergers shifted
$278.5 m i l l i o n in deposits f r o m n o n m e m b e r banks t o m e m b e r s by t h e end of
1978. This represents o n l y o n e - f i f t h of t h e
p o t e n t i a l deposit gain and o n e p e r c e n t
of all state deposits. 3
The state's larger h o l d i n g companies
have m o v e d quickest t o take advantage of
their new cost-cutting and organizational
streamlining capabilities. O f t h e largest
o n e - t h i r d of Florida h o l d i n g c o m p a n i e s ,
90 percent had d o n e some c o n s o l i d a t i o n
by t h e e n d of 1978. O f t h e mid-sized
third, 50 percent had merged some of their
affiliates, and of the smallest t h i r d ,
o n l y 20 p e r c e n t had consolidated any of
their banks.
Both t h e total n u m b e r of mergers and
the m e m b e r bank deposit gains have
been short of p o t e n t i a l because of h o l d i n g
c o m p a n i e s ' c o n t i n u e d reluctance to
proceed with countywide consolidation
mergers. The earlier article in this Review
cited f o u r factors c o n t r i b u t i n g t o their
hesitation. First, t h e possible adverse reaction of b a n k personnel t o merger and
t h e c o n c o m i t a n t w o r k f o r c e adjustments
might cause h o l d i n g c o m p a n y officials to
move slowly. Second, mergers displace

' O f t h e deposits o f t h e 205 b a n k s that m e r g e d , $5.7 b i l l i o n b e l o n g e d t o
m e m b e r banks a n d $3.0 b i l l i o n t o n o n m e m b e r i n s t i t u t i o n s . T h e larger
t y p i c a l size of t h e m e m b e r banks e x p l a i n s most o f t h e d i f f e r e n c e . O f banks
w h i c h b e c a m e branches, m e m b e r s c o n t r i b u t e d deposits of $1.9 b i l l i o n a n d
n o n m e m b e r s , $1.6 b i l l i o n , t o their r e s p e c t i v e survivors.

FEDERAL RESERVE B A N K O F A T L A N T A 35




some directors. H o l d i n g companies may
f i n d this d i f f i c u l t t o deal w i t h , as bank
directors are o f t e n i n f l u e n t i a l c o m m u n i t y
leaders. T h i r d , m e r g i n g d i f f e r e n t a c c o u n t ing systems can be a difficult and expensive
u n d e r t a k i n g . F o u r t h , h o l d i n g companies
may be p o s t p o n i n g mergers u n t i l subsidiary banks have established their o w n
branches. This w o u l d effect q u i c k
branch saturation, desirable in some
circumstances. 4
To these deterrents to merger, we w o u l d
add that some h o l d i n g companies have
appeared t o avoid mergers across banking markets, even t h o u g h t h e banks
w e r e in t h e same c o u n t y . Such behavior
is probably aimed at preventing the pricing
p r o b l e m s of o p e r a t i n g o n e bank in t w o
markets w h e r e prices of bank services
differ. 5 For example, Barnett Banks effected
t w o separate mergers in Polk C o u n t y to
maintain t h e segregation of its banks
in the Winter Haven area f r o m those in the
Lakeland area.
The burden of Federal Reserve membership probably also influences consolidation
decisions w h e n t h e merger w o u l d
involve a n o n m e m b e r bank and a member.
W h i l e each h o l d i n g c o m p a n y wants
and needs o n e m e m b e r bank t o give it
access t o t h e Federal Reserve's discount
w i n d o w and c h e c k - c l e a r i n g facilities,
some h o l d i n g c o m p a n i e s seem to t h i n k
that m o r e t h a n o n e is superfluous.
The m e m b e r s h i p b u r d e n m i g h t dissuade
a h o l d i n g c o m p a n y f r o m such m e r g i n g or
i n d u c e it t o structure t h e merger so as
to leave t h e n o n m e m b e r as t h e surviving
bank.
Considerable p o t e n t i a l remains for
bank affiliate mergers w i t h i n Florida h o l d i n g companies. Even so, m u l t i b a n k
holding company response to 1977 branching law has r e d u c e d t h e n u m b e r of
Florida banks, t u r n e d 19 p e r c e n t of t h e
state's banks into branches, created larger
banks, and increased deposits subject to the
Federal Reserve's reserve r e q u i r e m e n t s . •
a

G o e l l e r , o p . cit.

'David W h i t e h e a d , f r o m a f o r t h c o m i n g article about h o m e office pricing
as p r a c t i c e d by b a n k h o l d i n g c o m p a n i e s in Florida.

ENVIRONMENTAL REGULATIONS:
A CONSTRAINT ON SOUTHEASTERN
PRODUCTIVITY
by Charlie

Carter

G o v e r n m e n t r e g u l a t i o n of t h e private
e c o n o m y has received g r o w i n g a t t e n t i o n
recently. Given the large a m o u n t of private
resources r e q u i r e d t o adhere t o standards
i m p o s e d by t h e Environmental Protection
A g e n c y , the O c c u p a t i o n a l , Health and
Safety A d m i n i s t r a t i o n , and the Food and
D r u g A d m i n i s t r a t i o n , as well as many state
and local g o v e r n m e n t agencies, t h e att e n t i o n is not surprising. C o m p l i a n c e w i t h
g o v e r n m e n t r e g u l a t i o n nas been suggested
as a major c o n t r i b u t o r t o rising business
costs. Businessmen f r e q u e n t l y c o m p l a i n
of the t i m e r e q u i r e d t o prepare c o m pliance reports and blame regulations for
alterations of n o r m a l p r o c e d u r e s t o meet
standards, delays in p r o d u c t i o n p e n d i n g
o u t c o m e of hearings or inspections,
and sometimes o u t r i g h t cancellation of
p r o p o s e d projects. Insofar as they r e q u i r e
activities w h i c h w o u l d not o t h e r w i s e be
u n d e r t a k e n , these regulations divert
resources f r o m p r o d u c t i o n p e r se t o o t h e r
uses. The costs of these o t h e r uses are
likely t o be passed t h r o u g h to o u t p u t
prices, directly c o n t r i b u t i n g to inflation.
The purpose of this article is to examine
t h e i n f l u e n c e of just o n e type of government regulation—environmental
p r o t e c t i o n — o n v a l u e - a d d e d (output) by
manufacturers in t h e U.S. and t h e southeastern region. 1 Previous studies have
s h o w n that m a n u f a c t u r i n g firms in the
Southeast have d e v o t e d a larger p r o p o r t i o n of their capital s p e n d i n g t o env i r o n m e n t a l p r o t e c t i o n than have their

' T h e s o u t h e a s t e r n states i n c l u d e A l a b a m a , Florida, G e o r g i a , Louisiana,
Mississippi a n d Tennessee.

36




counterparts n a t i o n w i d e 2 and that
e n v i r o n m e n t a l regulations r e d u c e d nat i o n a l p r o d u c t i v i t y by as m u c h as o n e percent in 1975.3 Since 1973, e n v i r o n m e n t a l
p r o t e c t i o n standards have been made
m o r e restrictive. B o r r o w i n g t e c h n i q u e s
f r o m t h e earlier inquiries, w e a t t e m p t e d to
d e t e r m i n e t h e effect of t h e stiffer env i r o n m e n t a l regulations o n p r o d u c t i v i t y in
the U.S. and southeastern m a n u f a c t u r i n g
industries f r o m 1973-76. 4 L i m i t i n g o u r
analysis t o m a n u f a c t u r i n g establishments
s h o u l d not be regarded as a significant
handicap, since m a n u f a c t u r i n g industries
c o n t r i b u t e most t o t h e overall behavior
of p r o d u c t i v i t y . M o r e o v e r , e n v i r o n m e n t a l
regulations since 1973 have b e e n largely
i m p o s e d o n m a n u f a c t u r i n g industries.
FINDINGS
W e f o u n d that t h e costs i n c u r r e d by
businesses to meet a d d i t i o n a l e n v i r o n mental requirements significantly restrained
m a n u f a c t u r i n g o u t p u t in b o t h t h e U.S.
and t h e Southeast d u r i n g the 1973-76
p e r i o d . M o r e o v e r , t h e extent t o w h i c h
p o l l u t i o n a b a t e m e n t costs constrained
m a n u f a c t u r i n g p r o d u c t i o n was increasing.

2

See W i l l i a m D. Toal, " P r o d u c t i v i t y a n d C h a n g e i n t h e Southeast's M a n u f a c t u r i n g S e c t o r , " Economic Review, Federal Reserve Bank o f A t l a n t a
( S e p t e m b e r 1976), p p . 118-27, a n d W i l l i a m D. Toal, " C a p i t a l S p e n d i n g
f o r P o l l u t i o n A b a t e m e n t , " Economic Review, Federal Reserve Bank o f A t l a n t a
( A u g u s t 1976), p p . 110-12.

'For m o r e details o n m e t h o d o l o g y , see Edward F. D e n i s o n , " E f f e c t s of Selected
C h a n g e s in t h e I n s t i t u t i o n a l a n d H u m a n E n v i r o n m e n t u p o n O u t p u t Per
U n i t of I n p u t , " Survey of Current Business (January 1978), p p . 21-44.
' O n e a s s u m p t i o n is c r i t i c a l t o o u r analysis: all labor a n d o t h e r resources
used t o satisfy stiffer e n v i r o n m e n t a l r e g u l a t i o n s w o u l d o t h e r w i s e have b e e n
used t o g e n e r a t e a d d i t i o n a l o u t p u t .

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

The constraint was greater in t h e Southeast than nationally. For e x a m p l e , if
e n v i r o n m e n t a l regulations haa r e m a i n e d
as they were in 1973, the resources
(workers, m a c h i n e r y , plants, etc.) used
in m a n u f a c t u r i n g in 1976 w o u l d have
p r o v i d e d f o u r - t e n t h s of o n e percent
m o r e value-added than they actually d i d
in the Southeast, c o m p a r e d to o n l y t w o tenths of o n e percent more for the nation
as a w h o l e .
Total Costs. Between 1973 and 1976,
actual costs for p o l l u t i o n abatement
increased 131 percent in t h e Southeast,
c o m p a r e d to 86 percent nationally. Except
for Georgia and Tennessee, all southeastern states' s p e n d i n g for p o l l u t i o n
abatement in m a n u f a c t u r i n g rose m o r e
rapidly than nationally (see Table 1). The
faster g r o w t h in t h e Southeast p r o b a b l y
reflects several factors. O n e of t h e most
significant is its d i f f e r e n t industry mix.
Six m a n u f a c t u r i n g industries (food, paper,
chemicals, p e t r o l e u m and coal, stone,
clay, a n d glass, and metal fabrication)
a c c o u n t e d for the b u l k of U.S. p o l l u t i o n
abatement o p e r a t i n g expenditures in
1973-76. These industries generated over
45 percent of total m a n u f a c t u r i n g o u t p u t
in t h e southeastern states, c o m p a r e d t o
about 30 percent n a t i o n w i d e . Given t h e
greater-than-national c o n c e n t r a t i o n

METHODOLOGY
Manufacturing firms were presumably environmentally conscious even before government environmental
regulations were imposed. Thus, some resources would
have been devoted to environmental protection without
additional environmental regulations. However, we were
concerned with the additional cost that businesses have
incurred as a result of more restrictive environmental
legislation since 1973. Thus, involuntary
pollution
abatement costs were measured as the difference between actual pollution abatement costs and the costs
that manufacturing industries would have incurred
without additional environmental regulations. Since
value-added in manufacturing measures payments for
productive resources, the ratio of involuntary pollution
abatement costs to value-added serves as a proxy for
the proportion of additional resources that are diverted
to pollution abatement.
Actual pollution abatement costs are available from
the Census Bureau by state for selected manufacturing
industries f r o m 1973-76. Separate cost estimates are
provided for labor, depreciation, equipment leasing,
and materials and supplies. Inadequate data on returns
to capital preclude estimation of imputed returns to
pollution abatement capital on a regional basis. Pollution abatement costs that manufacturing industries
would have incurred in the absence of additional environmental regulations were estimated by assuming
that voluntary pollution abatement costs would have
grown in proportion to increases in value-added and
that the relationship of actual pollution abatement costs
to value-added in manufacturing has been constant
since 1973.*
" T h e c h o i c e of 1973 a s a b a s e p e r i o d w a s i n f l u e n c e d by d a t a l i m i t a t i o n s .
P o l l u t i o n a b a t e m e n t s p e n d i n g by state is not a v a i l a b l e p r i o r to 1973.
H o w e v e r , in o u r view, t h e r e w a s n o t h i n g a b n o r m a l a b o u t t h e r e l a t i o n s h i p
of p o l l u t i o n a b a t e m e n t s p e n d i n g in 1973 t o v a l u e - a d d e d t h a t w o u l d h a v e
d i s t o r t e d t h e m a i n c o n c l u s i o n s of t h e a n a l y s i s

TABLE 1
POLLUTION ABATEMENT OPERATING COSTS OF
MANUFACTURING INDUSTRIES, 1973-76
(millions of dollars)

State
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
Southeastern
States*
U. S.

Percent
Change
1973-76

1973

1974

1975

1976

38
44
37
79
21
60

56
75
47
113
32
79

74
80
55
150
41
96

93
118
66
211
48
110

143
166
79
168
126
82

280
2,445

401
3,103

494
3,662

645
4,539

131
86

• F i g u r e s m a y not s u m t o total d u e t o r o u n d i n g .
S o u r c e : U. S. D e p a r t m e n t of C o m m e r c e .

V
FEDERAL RESERVE B A N K O F A T L A N T A




37

of these types of industries in t h e Southeast, it is not surprising that p o l l u t i o n
abatement efforts are m o r e intense here.
The relatively rapid expansion of southeastern m a n u f a c t u r i n g also helps explain
t h e region's brisk r u n - u p of p o l l u t i o n
a b a t e m e n t costs. Between 1973 and 1976,
new capital expenditures increased 69
percent in t h e Southeast, c o m p a r e d t o
50 percent n a t i o n w i d e . Value-added in
t h e Southeast's m a n u f a c t u r i n g sector
grew 25 percent faster (i.e., 33 percent vs.

27 percent) than nationally (see Table 2).
In Louisiana, v a l u e - a d d e d by manufact u r i n g grew t h r e e times as rapidly as nationally. H o w e v e r , g r o w t h in Mississippi's
output was on par with the nation's
and Tennessee's fell short.
"Involuntary" Costs. Reflecting t h e
m o r e rapid g r o w t h in total p o l l u t i o n cont r o l costs, " i n v o l u n t a r y " costs—those
i n c u r r e d by the t i g h t e n i n g of e n v i r o n mental standards—also grew m o r e rapidly
here t h a n nationally (see Table 3). Again,

TABLE 2
VALUE-ADDED BY MANUFACTURING, 1973-76
(millions of dollars)

1973

State
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
Southeastern
States
U.S.

1976

1975

1974

Percent
Change
1973-76

5,841
6,497
8,619
4,845
3,477
8,773

6,859
7,425
9,476
6,925
3,786
9,564

6,623
7,461
9,785
7,346
3,686
9,298

7,716
8,280
11,093
8,423
4,393
10,724

32
27
29
74
26
22

38,052
404,376

44,035
452,478

44,199
441,850

50,629
511,471

33
27

S o u r c e : U S. D e p a r t m e n t of C o m m e r c e .

TABLE 3
ESTIMATED INVOLUNTARY POLLUTION ABATEMENT COSTS FOR
MANUFACTURING, 1974-76
(millions of dollars)

State
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
Southeastern
States
U.S.

1976

Percent
Change
1974-76

1974

1975

10.6
23.8
6.3
.9
8.9
13.0

30.3
28.5
12.9
31.0

42.8
61.0
18.4
73.8

18.0

21.1

31.9

36.2

304
156
192
810
137
177

63.5
367.4

152.6
991.2

253.3
1,447.4

299
294

Source: See "Methodology.'

38




M A R C H / A P R I L 1980, E C O N O M I C REVIEW

f

>

TABLE 4
INPUTS DIVERTED TO POLLUTION ABATEMENT
RELATIVE TO TOTAL INPUTS IN MANUFACTURING, 1974-76

(percent)
State

1974

1975

1976

Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
Southeastern
States
U.S.

.155
.319
.066
.013
.235
.135

.455
.381
.132
.410
.487
.342

.552
.732
.165
.868
.478
.336

.144
.081

.345
.224

.500
.282

Source: See "Methodology."

Louisiana, w i t h its heavy incidence of
chemicals and p e t r o l e u m r e f i n i n g , led t h e
r e g i o n , w i t h s p e n d i n g for p o l l u t i o n abatem e n t g r o w i n g almost t h r e e times as rapidly as nationally (810 percent vs. 294
percent). Judging f r o m o u r estimates of
i n v o l u n t a r y cost, t h e y e a r - e n d 1976 capital
stock in the Southeast c o u l d have been
as m u c h as 11 percent greater and that
of t h e U. S., 8 percent larger, if e n v i r o n mental regulations had r e m a i n e d as they
w e r e in 1973.
The ratio of i n v o l u n t a r y p o l l u t i o n
a b a t e m e n t costs t o v a l u e - a a a e d in m a n u f a c t u r i n g serves as o u r measure of t h e extent
to w h i c h p r o d u c t i v e resources may have
been diverted f r o m production of measurable output to environmental protection.
The ratios for both the southeastern states
and the U. S. are shown in Table 4. In 1976,
involuntary pollution abatement costs were
0.500 and 0.282 percent of manufacturing
output in the Southeast and U. S., respectively. This means that, had environmental
regulations been as they were in 1973, the
p r o d u c t i v i t y of resources used by m a n u f a c t u r i n g industries in 1976 w o u l d have
been one-half of o n e p e r c e n t greater
in t h e Southeast and nearly three-tenths
of o n e percent greater for the U. S.
Thus, tighter e n v i r o n m e n t a l regulations
since 1973 have constrained m a n u f a c t u r i n g
FEDERAL RESERVE B A N K OF A T L A N T A




o u t p u t in the Southeast m o r e than nationally. A l t h o u g h small in percentage
terms, t h e constraints had m o u n t e d t o a
$470-million loss of v a l u e - a d d e d in the
Southeast and a $2.8-billion loss in t h e
U. S. by 1976. N o t o n l y have post-1973 env i r o n m e n t a l regulations i m p a i r e d p r o d u c tivity, b u t t h e i m p a i r m e n t nas been
g r o w i n g . The o u t p u t loss increased f r o m
just u n d e r t w o - t e n t h s of o n e percent in
1974 t o five-tenths of o n e percent in 1976
in t h e Southeast and f r o m under o n e - t e n t h
of o n e percent t o nearly t h r e e - t e n t h s of
o n e percent in t h e U. S.
Conclusions. The o b j e c t i v e of this
analysis is not t o p o n d e r t h e usefulness
of programs designed t o i m p r o v e t h e
quality of o u r e n v i r o n m e n t nor t o express
value judgments. However, it does quantify
t h e cost of using part of o u r p r o d u c t i v e
resources t o p r o t e c t t h e e n v i r o n m e n t .
Do the benefits f r o m e n v i r o n m e n t a l p r o t e c t i o n o u t w e i g h t h e cost of f o r e g o n e
o u t p u t ? The question is d i f f i c u l t to answer
because the costs and benefits yardsticks
are d i f f e r e n t . Benefits are usually gauged
by mortality statistics and various measures
of air a n d water p o l l u t i o n . Perhaps a measure w h i c h converts dollars to mortality
statistics or vice versa w o u l d be h e l p f u l .
H o p e f u l l y , f u t u r e analyses w i l l examine
the benefits side of this crucial q u e s t i o n . !
39

CURRENT ISSUES IN BANK
SUPERVISION AND REGULATION:
A CARIBBEAN BASIN PERSPECTIVE
by Donald Baer
From August 1-3, 1978, delegates representing the central banks and superintendents
of banks from 18 Basin economies, as well as from the U.S. and multinational Basin
financial institutions, participated in a conference sponsored by the Federal Reserve Bank
of Atlanta on Current Issues in Bank Supervision and Regulation: A Caribbean Basin
Perspective. At the Conference, 27 papers were delivered by the participants on various
topics relevant to Basin bank supervision and regulation. This article presents an overview
of the current issues in bank supervision and regulation, many of which were brought
out in the Conference.
Banking and finance increasingly are giving
broader answers t o t h e f u n d a m e n t a l
questions of w h o t o serve as w e l l as h o w ,
what, w h e r e , and w h y . This d y n a m i c bank
environment is affected by but simultaneously
affects monetary authorities. N o w h e r e are
such effects m o r e e v i d e n t t h a n in banking s u p e r i n t e n d e n t offices.
In t h e Caribbean Basin, b a n k i n g sup e r i n t e n d e n t s must c o p e increasingly w i t h
t h e surging i n t e r n a t i o n a l i z a t i o n of industrial e c o n o m i e s ' banks and t h e g r o w i n g
internationalism of t h e i r o w n . O n t o p of
this, t h e increased local o w n e r s h i p of t h e
f o r e i g n banks o p e r a t i n g in their e c o n o m y
and t n e d e v e l o p m e n t of new 100 percent
i n d i g e n o u s banks—some private, some
public—have created additional challenges
and responsibilities. This article evaluates
some of the issues facing monetary authorities in supervising and regulating their
o w n banks as wellas banks f r o m abroad. The
conclusion that banking supervision is
m o r e i n t e r n a t i o n a l l y i n t e r d e p e n d e n t than
ever should come as no surprise—just look
at the banks!
W H Y REGULATE BANKS?
All e c o n o m i e s r e q u i r e some p u b l i c
sector r e g u l a t i o n of their b a n k i n g and

• R e p r i n t e d f r o m t h e F e d e r a l R e s e r v e B a n k of A t l a n t a ' s C a r i b b e a n Basin
Economic Survey, J a n u a r y / F e b r u a r y / M a r c h 1979. T h e C a r i b b e a n B a s i n is
here defined to include the following economies: Mexico, Colombia, a n d
V e n e z u e l a ; C e n t r a l A m e r i c a , i n c l u d i n g Belize a n d P a n a m a ; t h e C a r i b b e a n
Islands; a n d G u y a n a , S u r i n a m , a n d F r e n c h G u i a n a .

40




financial sector, a l t h o u g h t h e r e is c o n siderable d i f f e r e n c e of o p i n i o n as t o just
h o w m u c h is appropriate. The t r a d i t i o n a l
rationale for a p u b l i c role in t h e overseeing of b a n k i n g activity has rested, in
g o o d part, o n t h e belief that b a n k i n g has
i m p o r t a n t externalities (benefits and
costs w h i c h are diffused in a widespread
fashion). 1 W i t h o u t r e g u l a t i o n , t h e argum e n t goes, private forces w o u l d lead t o
n o n o p t i m a l p e r f o r m a n c e . W h a t are these
externalities and rationales for regulation?
First, banks t h r o u g h d e m a n d deposits
create a significant p o r t i o n of t h e m o n e y
supply, as well as p r o v i d e various quasimoney instruments. M o n e t a r y policy
affects t h e actual m o n e y supply, in part,
t h r o u g h regulation of tnese banks. The
effectiveness of monetary policy depends
u p o n c o n t i n u e d p u b l i c c o n f i d e n c e in and
use of banks. In t h e Basin, b a n k - c r e a t e d
demand deposits constituted an average of
59 percent of the simple m o n e y supply, M-,
( d e m a n d deposits plus currency and c o i n
in circulation). In t h e Bahamas, Costa
Rica, and Venezuela, t h e p r o p o r t i o n surpasses 70 p e r c e n t (see Table 1).
Second, an e c o n o m y ' s savings are, in
g o o d part, c h a n n e l e d into b a n k i n g institutions. The existence of viable banks
encourages such placements and limits the
p r o p o r t i o n of i n c o m e and w e a l t h h e l d in
cash, durables, j e w e l r y , etc.
' P e t e r I, B e r m a n , " T h e D e s i g n of Financial I n t e r m e d i a r i e s f o r D e v e l o p i n g
C o u n t r i e s , " I T C C Review, July 1977, p. 27.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

TABLE 1
BASIN DEMAND DEPOSITS IN
MONEY SUPPLY (M,) AND THE
NUMBER OF BASIN BANKS
AND OFFICES, 1978
Demand
Deposits
M,
Bahamas
Barbados
Belize
Bermuda
Cayman Islands
Colombia
Costa Rica
Dominican Republic
El Salvador
French Guiana
Guadeloupe
Martinique
Guatemala
Guyana
Haiti
Honduras
Jamaica
Leeward Islands
Antigua
Montserrat
St. Kitts-Nevis-Anguilla
Mexico
Netherlands Antilles
Nicaragua
Panama
Puerto Rico
Surinam
Trinidad-Tobago
Venezuela
Windward Islands
Dominica
Grenada
St. Lucia
St. Vincent
Total Caribbean Basin
U.S.

Number
of
Banks

,783
.62*
n.a.
n.a.
n.a.
.67'
,71s
,564
.586
n.a.
n.a.
n.a.
• 454
,475
,252
,462
.644

210
8
47
47
2287
267
97
117
127
27
87
T
11
67
6'
n.a.
8

n.a.
48
177
137
n.a.
1,0717
2477
897
937
47
277
117
87
227
127
1818
159

n.a.
n.a.
n.a.
.53'
,525
.625
.76'
n.a.
,436
• 713
.77"

5
2
6
318 7
42 s
8
65s
16s
V
87
31

14
4
16
5,0807
758
194
97s
233 s
117
817
920

n.a.
n.a.
n.a.
n.a.
.59
,726

4
4
6
5

13
13
23
18

1,087

8,873

' D e c e m b e r 1977.

''June 1978

' M a r c h 1978

" J u l y 1978

3

Number
of
Offices

A p r i l 1978

"1977

• M a y 1978.

M 976

Bank r e g u l a t i o n can affect such allocations, as well as t h e g r o w t h of savings placed in financial institutions.
Banks channel such savings t o investors.
In most Basin e c o n o m i e s , such allocations
are determined by market forces, although,
increasingly, Basin bank regulation is
used t o limit credit t o n o n p r i o r i t y (particularly commercial) sectors. The t h i n k ing b e h i n d credit p o r t f o l i o r e g u l a t i o n
rests in the belief that priority sectors
entail positive externalities (social
benefits), such that market forces w o u l d
t e n d t o misallocate financial resources.
Such credit guidelines emphasize f u n c tions in t h e c o m m u n i t y but present a
basic d i l e m m a t o regulators of bank
soundness versus bank service (and greater
risk taking). Credit allocation in the
Basin is used either in place of or c o m plementary to government-owned development bank activity. W h e t h e r or not sucn
credit guidelines actually i m p r o v e
resource allocation and t h e effects of
such guidelines o n bank p e r f o r m a n c e are
controversial questions w o r t h y of f u r t h e r
evaluation.
Finally, failure of a bank can entail
the loss of personal and business l i q u i d
assets. O t h e r forms of saving, h o w e v e r ,
also entail risk. But because t h e financial stability of m o d e r n economies is
d e p e n d e n t o n p u b l i c c o n f i d e n c e that
placements of Tunds in banks are relatively riskless, losses affecting depositors f r o m
the failure of a single bank can have a
d o m i n o effect on tne rest of the financial
system.2 Such effects go far beyond the
bank's o w n depositors, creditors, and immediate territory. The goal of forestalling
bank failure ana ensuing damage to the
economy has, in fact, been the major cornerstone b e h i n d bank regulation. 3
EFFECTS OF REGULATING BANKS
The regulatory o b j e c t i v e of l i m i t i n g
bank failures has i m p o r t a n t effects. Regulators purposely h o p e to maintain
adequate p r o f i t a b i l i t y of financial institutions—this, in itself, may cause banks

n.a. = not a p p l i c a b l e
M, = D e m a n d d e p o s i t s p l u s c u r r e n c y a n d c o i n in c i r c u l a t i o n .
Banks = F u l l - s e r v i c e c o m m e r c i a l a n d o f f s h o r e banks.

' O r v i l l e O. W y r i c h , " T h e G e n e r a l N a t u r e of Bank S u p e r v i s i o n , " Bank
Supervision, F e d e r a l Reserve B a n k of St. Louis, 1963, p. 1.
3

Sources:

V

I n t e r n a t i o n a l M o n e t a r y F u n d , international Financial
Statistic*, W a s h i n g t o n , a n d i n d i v i d u a l B a s i n c o u n t r y
sources.

FEDERAL RESERVE BANK O F A T L A N T A




A r c h i e K. Davis, " B a n k i n g R e g u l a t i o n T o d a y : A B a n k e r ' s V i e w , "
Law and C o n t e m p o r a r y Problems, a u t u m n 1966, p. 640, a n d G e o r g e
J. B e n s t o n , B a n k E x a m i n a t i o n , The Bulletin, N e w Y o r k , N e w York
University, G r a d u a t e S c h o o l of B u s i n e s s , Institute of F i n a n c e ,
N o s . 89-90, M a y 1973.

41

t o be m o r e c o m p l a c e n t than o t h e r
c o r p o r a t i o n s w h i c h d o not e n j o y such a
puolic c o m m i t m e n t t o maintain their
solvency. 4 Partially t o assure adequate profitability t h r o u g h l i m i t i n g c o m p e t i t i o n and
partially to keep marginal banks f r o m
b e i n g f o r m e d , it is accepted t h r o u g h o u t
t h e Basin that monetary authorities must
a p p r o v e all n e w bank f o r m a t i o n s as w e l l
as new bank offices. To offset the ensuing,
o f t e n oligopolistic, bank structures w h i c h
e m e r g e , o a n k i n g r e g u l a t i o n may set interest rates and d e t e r m i n e what services
are to be o f f e r e d . In part, the central
bank in oligopolistic markets may perceive
itself as a c o u n t e r v a i l i n g p o w e r to offset
such i m p e r f e c t i o n s in tne financial
marketplace. 5
Unless bank regulation is airtight or
flexible e n o u g h to cover new financial
d e v e l o p m e n t s (often r e s p o n d i n g t o t h e
regulations), n e w financial instruments or
institutions not covered by t h e c u r r e n t
regulations t e n d to be d e v e l o p e d t h r o u g h
market forces. The surge in U.S. o f f shore " s h e l l " b r a n c h i n g , in part, was
m o t i v a t e d by t h e U.S. V o l u n t a r y Credit
Restraint Program. The rapid g r o w t h in
Eurocurrency markets and the d e v e l o p ment of Basin parallel financial markets
and quasi-banks are all, in part, stimulated
by bank regulations. 6
RESPONSIBILITIES O F THE
BANK SUPERINTENDENT
In the Basin, the central bank and
monetary board, finance ministry, and
legislature all c o n t r i b u t e to t h e establishment of b a n k i n g regulations. It is
t h e responsibility of t h e bank superint e n d e n t t o see tnat banks and other
financial institutions c o m p l y w i t h t h e
regulations set o u t .
Because of the close ties b e t w e e n
banks and o t h e r financial institutions,
t h e Basin b a n k i n g s u p e r i n t e n d e n t is n o r mally given a u t h o r i t y over investment
banks and sometimes stock exchanges,
warehouses, savings and loan associations,
"See W i l l i a m G a s s e r , " B a n k R e g u l a t i o n a n d t h e E x e c u t i o n of M o n e t a r y
P o l i c y , " p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in B a n k
S u p e r v i s i o n a n d R e g u l a t i o n : A C a r i b b e a n B a s i n P e r s p e c t i v e , Atlanta,
A u g u s t 1978.
5

s

See Desiree S p r i n g e r a n d C l y d e J o h n s o n , C e n t r a l B a n k of B a r b a d o s ,
" S u p e r v i s i o n of F o r e i g n Bank B r a n c h e s in an I n d i v i d u a l B a s i n E c o n o m y
with S p e c i a l R e f e r e n c e to B a r b a d o s , " p a p e r p r e s e n t e d at the C o n f e r e n c e
o n C u r r e n t Issues in Bank S u p e r v i s i o n a n d R e g u l a t i o n : A C a r i b b e a n
Basin Perspective, Atlanta, A u g u s t 1978.
S e e W i l l i a m G a s s e r , op. cit.

42




insurance companies, and even large-scale
housing projects. 7
In many Basin economies, the banking
s u p e r i n t e n d e n t is also responsible for
the a u d i t i n g of the c e n t r a L b a n k . In
these cases, t h e bank s u p e r i n t e n d e n t is
directly responsible t o t n e f i n a n c e minister or the monetary board.
The b a n k i n g s u p e r i n t e n d e n t exercises
his responsibilities t n r o u g h various
means, bank e x a m i n a t i o n b e i n g o n l y o n e
of several tools utilized. Basin bank superintendents o f t e n participate in an active
or advisory capacity o n the monetary board
(or central bank board), w h i c h , in t u r n ,
determines bank regulation. Basin bank
superintendents process and pass j u d g m e n t
o n applications for the f o r m a t i o n of new
banks, branches, and bank mergers. It is
easier t o scrutinize a new a p p l i c a t i o n
and refuse it t h a n t o have t o revoke a
bank's license later. 8 In certain Basin
e c o n o m i e s such as M e x i c o , new f o r e i g n
banks are p r o h i b i t e d f r o m o p e n i n g fullservice branches or subsidiaries. In t h e
Basin international b a n k i n g centers of t h e
Bahamas, Cayman Islands, and Panama,
f o r e i g n banks are e n c o u r a g e d . All bank
applications are not a p p r o v e d by bank
superintendents, of course. In t n e U.S.,
f r o m 1975 t o 1977, 47 p e r c e n t of t h e applications f o r national bank charters
w e r e rejected by t h e supervisory a u t h o r ities. Similarly, 44 p e r c e n t of state bank
charter applications w e r e rejected by
state authorities. 9
In Panama, applications f o r b a n k i n g
licenses are assessed in terms of t h e
bank's relative i m p o r t a n c e in its r e g i o n
and in the w o r l d , its p r o p o s e d b a n k i n g
activity, as w e l l as t h e bank's c o u n t r y
of origin. Panama's aim is t o have a
balanced financial market w i t h a w i d e
diversity of countries represented in its
financial center. 1 0
' S e e Luis R i c a r d o P a r e d e s , S u p e r i n t e n d e n c i a B a n c a r i a d e C o l o m b i a , " E l
A l c a n c e I n s t i t u c i o n a l d e la S u p e r i n t e n d e n c i a B a n c a r i a , " p a p e r p r e s e n t e d
at t h e C o n f e r e n c e o n C u r r e n t Issues in S u p e r v i s i o n a n d R e g u l a t i o n :
A C a r i b b e a n B a s i n P e r s p e c t i v e , Atlanta, A u g u s t 1978.
" F r a n k A. G. Davis, C e n t r a l B a n k of the B a h a m a s , " C r i t e r i a Utilized
in E v a l u a t i n g L i c e n s i n g of Financial I n s t i t u t i o n s — V a l u e of D i f f e r e n t T y p e s
of L i c e n s e s f o r Financial I n s t i t u t i o n s , " p a p e r p r e s e n t e d at t h e C o n f e r e n c e
o n C u r r e n t Issues in B a n k S u p e r v i s i o n a n d R e g u l a t i o n : A C a r i b b e a n
B a s i n P e r s p e c t i v e , Atlanta, A u g u s t 1978.
" C o m p t r o l l e r of t h e C u r r e n c y a n d C o n f e r e n c e of S t a t e B a n k

Supervisors.

'"Nicolas Q u i n t a n a , C o m i s i o n B a n c a r i a N a c i o n a l d e P a n a m a ,
" A l g u n a s C o n s i d e r a c i o n e s S o b r e el S i s t e m a B a n c a r i o P a n a m e n o , "
p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in B a n k
Supervision and Regulation: A Caribbean Basin Perspective,
Atlanta, A u g u s t 1978.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

It is i m p o r t a n t that the bank superi n t e n d e n t have the a u t h o r i t y t o criticize
and halt flagrant abuses by banks or o t h e r
financial institutions over w h i c h he has
responsibility. O f t e n t h e s u p e r i n t e n d e n t
has the a u t h o r i t y to revoke b a n k i n g
licenses o r , in less severe cases, t h e
p o w e r to call a halt t o specific practices.
In the Bahamas, for e x a m p l e , 27 financial
institutions had their licenses r e v o k e d
for various reasons f r o m 1973 t o 1977.11
In the U.S., t h e Financial Institutions
Supervisory Act (the Cease and Desist
Act) e m p o w e r s U.S. supervisory agencies
t o issue cease and desist orders f o r
specified unsafe or u n s o u n d activities.
A f t e r hearings, these orders have t h e
effect of law, and, if violated, responsible officers or directors are subject t o
removal. 1 2 In Barbados, w h e n i n t e r v e n t i o n
is perceived as necessary, the b a n k i n g
s u p e r i n t e n d e n t can r e c o m m e n d that
t h e finance minister issue an order req u i r i n g the criticized bank t o take
corrective action. Such an order is issued
after t h e views of t h e bank's m a n a g e m e n t
are also expressed. 13
BANK E X A M I N A T I O N
Bank e x a m i n a t i o n , h o w e v e r , is t h e
major tool employed by bank superintendents in discharging their duties. In most
Basin e c o n o m i e s , bank e x a m i n a t i o n is
perceived as a c o n t i n u o u s process. In a
few economies, h o w e v e r , bank inspection
is undertaken only w h e n the finance minister or a g r o u p of stockholders believes
that a licensed bank is carrying o n its
business in a d e t r i m e n t a l manner. 1 4
Bank e x a m i n a t i o n can be f o r m a l and
f o l l o w rigid established procedures or
can be flexible. The Bank of England has
used a f l e x i b l e i n f o r m a l a p p r o a c h for
years, d e p e n d i n g , in part, o n r e c o g n i t i o n
given a bank by o t h e r banks and trie
marketplace, as w e l l as o n qualitative
" F r a n k A. G. Davis, " C r i t e r i a Utilized in E v a l u a t i n g L i c e n s i n g of
F i n a n c i a l I n s t i t u t i o n s — V a l u e of D i f f e r e n t T y p e s of L i c e n s e s for
F i n a n c i a l I n s t i t u t i o n s , " op. cit.
"A g o o d d i s c u s s i o n of c e a s e a n d d e s i s t o r d e r s is f o u n d in T h e Bankers
M a g a z i n e , a u t u m n 1975, p p . 65-7.
,3

D e s i r e e S p r i n g e r a n d C l y d e J o h n s o n , " S u p e r v i s i o n of F o r e i g n B a n k
B r a n c h e s in an I n d i v i d u a l B a s i n E c o n o m y with S p e c i a l R e f e r e n c e t o
B a r b a d o s , " op. cit.

'"This is t h e c a s e of A n t i g u a a n d St. K i t t s - N e v i s - A n g u i l l a . S e e G e o r g e
T h e o p h i l u s , " P r o s p e c t s f o r B a n k S u p e r v i s i o n in t h e E.C.C.A. T e r r i t o r i e s , '
p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in B a n k
Supervision a n d Regulation: A Caribbean Basin Perspective, Atlanta,
A u g u s t 1978.

FEDERAL RESERVE B A N K O F A T L A N T A




j u d g m e n t s of bank m a n a g e m e n t o b t a i n e d
t h r o u g h personal, c o n t i n u o u s interrelationships. 1 5 Increasingly, h o w e v e r ,
i n f o r m a l approaches are giving way to
s o m e w h a t f o r m a l i z e d supervision d u e to
t h e increased n u m b e r of banks r e q u i r i n g
e x a m i n a t i o n and the increased c o m p l e x i t y
of banking. For t h e same reason, paradoxically, rigid e x a m i n a t i o n procedures
are b e c o m i n g m o r e flexible.
Typically, Basin bank supervisors are
required by law to examine all banks under
their j u r i s d i c t i o n annually. This is o f t e n
d i f f i c u l t to accomplish. In t h e Basin,
there are over 1,000 banks and 8,600
branches in o p e r a t i o n (see Table 1). Bank
superintendents n o w utilize an array of
alternative kinds of on-site examinations
t o c o p e w i t h the large n u m b e r of r e q u i r e d
inspections. The t r a d i t i o n a l full-scope
exam is t h e most t i m e - c o n s u m i n g b u t
periodically is p e r f o r m e d o n all c o m m e r cial banks. Increasingly, b a n k i n g superintendents periodically utilize m o d i f i e d
scope exams w h i c h c o n c e n t r a t e o n
potential problem areas.16 W h e r e problems
are encountered, limited " o n - s i t e " reviews
may be p e r f o r m e d at 30-, 60-, or 90-day
intervals to k e e p abreast of progress. 17
Such an array of p o t e n t i a l exams provides
flexibility t o the b a n k i n g s u p e r i n t e n d e n t ,
p e r m i t t i n g the use of o n e a p p r o a c h o n e
year and a n o t h e r t h e next. 18 M o r e o v e r ,
bank e x a m i n a t i o n is less and less an audit
of the b a n k ; this is accomplished by a
bank's internal a n d / o r external auditors.
Instead, bank e x a m i n a t i o n is placing
greater a t t e n t i o n o n appraisal of bank
p e r f o r m a n c e and less o n p u r e v e r i f i c a t i o n .
U.S. bank regulators have initiated
an evaluation of each e x a m i n e d bank o n
five overall characteristics: Capital
A d e q u a c y , Asset Q u a l i t y , M a n a g e m e n t /
A d m i n i s t r a t i o n , Earnings, and Liquity.
These five dimensions, t e r m e d CAMEL in
U.S. supervisors' lingo, are each rated on

' 5 G e o r g e B l u n d e n , " T h e S u p e r v i s i o n of t h e U.K. B a n k i n g S y s t e m , "
Bank of E n g l a n d , Quarterly Bulletin, L o n d o n , J u n e 1975.
' " S e e t h e C a r i b b e a n Basin Economic Survey, " C e n t r a l B a n k i n g a n d
M o n e t a r y Policy in M e x i c o , " F e b r u a r y - M a r c h 1977, p. 2.
" J a c k D u n n , C o m m i s s i o n e r of B a n k i n g a n d Finance, S t a t e of G e o r g i a ,
" A l t e r n a t i v e F o r m s f o r W r i t e - u p of Bank I n s p e c t i o n Results," p a p e r
p r e s e n t e d at t h e C o n f e r e n c e on C u r r e n t Issues in B a n k S u p e r v i s i o n
a n d R e g u l a t i o n : A C a r i b b e a n B a s i n P e r s p e c t i v e , Atlanta, A u g u s t 1978.
" C h a r l e s B. Hall, " U p d a t e : C h a n g e s in t h e L o a n E x a m i n a t i o n a n d
R e p o r t i n g P r o c e s s , " Journal of C o m m e r c i a l Bank Lending,
D e c e m b e r 1976.

43

a o n e t o five basis, w i t h o n e r e f l e c t i n g
the highest rating a n d five t h e most
critically d e f i c i e n t . A single summary c o m posite rating, again o n a o n e to five basis,
is then obtainecfby weighting each financial
dimension. 1 9 W h i l e Basin bank superintendents d o not use the same a c r o n y m ,
they evaluate similar facets in their bank
e x a m i n a t i o n . These can be c o n v e n i e n t l y
discussed by utilizing t h e CAMEL checklist.
Capital Adequacy. Capital adequacy
entails an evaluation of capital as related
to the v o l u m e of risk assets, t h e v o l u m e
of inferior quality assets, the structure of
deposits ana liabilities, and bank past
ana expected g r o w t h . A n examiner needs
t o evaluate w h e t h e r a bank's capital is
sufficient to protect t h e bank against u n anticipated adversity. Some risk must be
a l l o w e d , h o w e v e r , since r e q u i r i n g a
bank t o maintain a capital oase sufficient t o p r o v i d e against total e c o n o m i c
collapse or a massive r u n o n deposits
w o u l d be t o o confining. 2 0
Bank examiners may c o m p a r e deposit
liabilities and b o r r o w e d funds t o a
bank's capital and reserves. In Jamaica,
banks may not incur deposit liabilities
exceeding 25 times their p a i d - u p capital
reserve f u n d and special debentures. 2 1
In Venezuela, t h e general rule is 20
times paid-in capital plus reserves. 22
U.S. banks do not face a rigid liabilityto-capital ratio, a l t h o u g h national banks
are limited to borrowed funds' indebtedness
in an a m o u n t not e x c e e d i n g net paidin capital plus 50 percent of surplus, w i t h
certain i m p o r t a n t exceptions (certain
Federal funds purchased, obligations t o repurchase securities sold, and Dills payable
t o a Federal Reserve Bank). 23
Capital-adequacy also can be evaluated by c o m p a r i n g capital and reserves
w i t h t h e value of the bank's fixed assets
as well as its investments in subsidiaries
and associated companies. Such assets
" B o a r d of G o v e r n o r s of t h e Federal R e s e r v e S y s t e m , Uniform Interagency Bank Rating System, 1978.
" C o m p t r o l l e r of t h e C u r r e n c y , Comptroller's Handbook lor National
Bank Examiners, C o m m e r c i a l , I n t e r n a t i o n a l , W a s h i n g t o n , U.S.
D e p a r t m e n t of t h e T r e a s u r y , M a y 1977, S e c t i o n 3 0 3 . 1 .
2,

U o y d M u s c h e t t e , Bank of J a m a i c a , " A s s e s s i n g C r e d i t W o r t h i n e s s of
C r e d i t a n d I n v e s t m e n t P o r t f o l i o , " p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n
C u r r e n t Issues in B a n k S u p e r v i s i o n a n d R e g u l a t i o n : A C a r i b b e a n B a s i n
P e r s p e c t i v e , Atlanta, A u g u s t 1978.

" " O r g a n i z a t i o n of A m e r i c a n S t a t e s , " A S t a t e m e n t of the Laws of
Venezuela in Matters Affecting Business, W a s h i n g t o n , 1977.
" C o m p t r o l l e r of t h e C u r r e n c y , Comptroller's Handbook for National
Bank Examiners, op. cit.. S e c t i o n 302.1.

44




s h o u l d be f u n d e d o u t of capital rather
than f r o m deposits or b o r r o w e d f u n d s ,
as a general rule. 2 4
Asset Quality. Loans normally constitute
the major c o m p o n e n t in j u d g i n g asset
quality. Examiners accordingly spend a
g o o d deal of e f f o r t in assessing a bank's
loan procedures and guidelines as w e l l as
some of t h e loans themselves. Typically,
t h e largest loans, collateral o n loans, loans
to b a n i directors, and loans that are not
p e r f o r m i n g in accordance w i t h their terms
are analyzed individually. 2 5 In t h e loans
w h i c h are e x a m i n e d individually, points
w h i c h receive t h e examiners' a t t e n t i o n
i n c l u d e the b o r r o w e r ' s capacity t o repay, the project s u p p o r t e d , realism of
repayment terms, t h e equity p o s i t i o n of a
b o r r o w e r , and t h e risks posea by foreseeable trends in business conditions. 2 6
Examiners o f t e n i n t e r p r e t significant
changes in a bank's loan p o r t f o l i o as a
signal that closer evaluation is required. 2 7
In Jamaica, practically the entire
p o r t f o l i o of smaller banks is evaluated by
examiners w h i l e a p p r o x i m a t e l y 60 percent
of the value of larger banks' loans is
analyzed individually. 2 8 U.S. regulators
typically evaluate b e t w e e n 70 and 80 percent of the value of a bank's p o r t f o l i o .
Examiners check o n large c o n c e n t r a tions o f credit t o individuals and related
parties as w e l l as t o particular sectors.
A diversified p o r t f o l i o is perceived as
r e d u c i n g risks and better able t o w i t h stand changes in external e c o n o m i c c o n ditions. Z e r o risk b a n k i n g , of course,
is not t h e o b j e c t i v e of bank supervision,
and examiners recognize that b a n k i n g
involves m a k i n g j u d g m e n t s and t a k i n g
reasonable risks. 29 A bank's l e n d i n g
policy s h o u l d strive for diversification

" S e e R o b i n A. V. B e n b o w , I n s p e c t o r of B a n k s a n d T r u s t C o m p a n i e s ,
C a y m a n I s l a n d s , p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues
in Bank S u p e r v i s i o n a n d R e g u l a t i o n : A C a r i b b e a n B a s i n P e r s p e c t i v e ,
Atlanta, A u g u s t 1978.
" C o m p t r o l l e r of t h e C u r r e n c y .
J6

G a r y G. G i l b e r t a n d M a r y T. M i t c h e l l , F e d e r a l D e p o s i t I n s u r a n c e
C o r p o r a t i o n , " A n A s s e s s m e n t of S e c t o r a n d C o u n t r y R i s k , " p a p e r
p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in B a n k S u p e r v i s i o n
a n d R e g u l a t i o n : A C a r i b b e a n B a s i n P e r s p e c t i v e , A t l a n t a , A u g u s t 1978.

" C h a r l e s M a n s f i e l d , Jr.. " A n A p p r o a c h t o E v a l u a t i n g F o r e i g n B a n k
C r e d i t R i s k , " Journal of C o m m e r c i a l Bank Lending, A u g u s t , 1977, p. 49.
" L l o y d M u s c h e t t e , " A s s e s s i n g C r e d i t W o r t h i n e s s of C r e d i t a n d I n v e s t m e n t
P o r t f o l i o , " op. cit.
" G o v e r n o r H e n r y C. W a l l i c h , International Banking Operations, H e a r i n g s
B e f o r e t h e S u b c o m m i t t e e on Financial Institutions, S u p e r v i s i o n , R e g u lation a n d I n s u r a n c e of t h e C o m m i t t e e o n B a n k i n g , F i n a n c e a n d U r b a n
A f f a i r s , H o u s e of R e p r e s e n t a t i v e s , M a r c h 23, 24, a n d A p r i l 5, 6, 1977, p. 7.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

w i t h i n t h e p o r t f o l i o in order to o b t a i n a
balance b e t w e e n m a x i m u m yield and
m i n i m u m risk. 30
Because d i f f e r e n t sectors entail
d i f f e r e n t risks, such diversification makes
sense. Construction and land development
are perhaps most volatile in a business
cycle. In t h e Basin, t h e t o u r i s m industry
experiences severe ups and d o w n s o n a
r e c u r r i n g basis. In 1977, 60 percent of
Jamaica's b a n k i n g system's unsatisfactory
assets w e r e c o n c e n t r a t e d in t h e c o n struction, land d e v e l o p m e n t , and tourist
sectors. 31
Bank examiners also evaluate loan
concentrations to individuals and related
parties. U.S. national banks are n o r m a l l y
l i m i t e d in l e n d i n g t o a single entity n o
m o r e than 10 percent of tneir capital
and surplus. 3 2 In Jamaica, no m o r e t h a n
20 percent of a bank's capital, reserves,
and special d e b e n t u r e s can be advanced
u n g u a r a n t e e d t o any o n e entity. 3 3
D u r i n g t h e process of assessing t h e
loan p o r t f o l i o , t n e bank inspector may
specifically criticize certain credits
d e e m e d as r e q u i r i n g closer a t t e n t i o n by
management. Such criticized credits are
v i e w e d by the examiner as i n v o l v i n g m o r e
than n o r m a l risk and entail loss
characteristics. 34
U.S. regulators' criticized loans
are categorized into f o u r classifications:
Other Loans Especially M e n t i o n e d (OLEM),
Substandard Loans, D o u b t f u l Loans, and
Loss Loans. 35 Examiners c o m p a r e t h e
Substandard, D o u b t f u l , and Loss Loan
classifications t o a bank's capital and reserves in order t o assess the bank's
viability and the effect of asset quality
o n capital adequacy. Basin e c o n o m i e s are
either using or d e v e l o p i n g similar distinctions t o assess weak credit effects o n
asset quality.
Management, Earnings. Earnings and
m a n a g e m e n t / a d m i n i s t r a t i o n assessments
30

3,

C o m p t r o l l e r of t h e C u r r e n c y , Comptroller's Handbook for National
Bank Examiners, op. cit., S e c t i o n 205.1, p. 3.

L l o y d M u s c h e t t e , " A s s e s s i n g C r e d i t W o r t h i n e s s of C r e d i t a n d Investm e n t P o r t f o l i o , " op.

32

cit.

12 U.S.C. 84, U.S. C o m p t r o l l e r of t h e C u r r e n c y , National Banking Laws.

" L l o y d M u s c h e t t e , " A s s e s s i n g C r e d i t W o r t h i n e s s of C r e d i t a n d Investm e n t P o r t f o l i o , " op.

cit.

34

See B o a r d of G o v e r n o r s of t h e F e d e r a l R e s e r v e S y s t e m , Manual of
Examination Procedures, S e c t i o n 5 (a) a n d 5 (b), a n d t h e C o m p t r o l l e r
of t h e C u r r e n c y , Comptroller's Handbook for National Bank

are interrelated w i t h t h e other facets
analyzed. Examiners assess m a n a g e m e n t
quality t h r o u g h management's c o m p l i a n c e
w i t h bank regulations, bank p l a n n i n g ,
self-dealing tendencies, quality of bank
services r e n d e r e d , asset-liability managem e n t , internal c o n t r o l s , and a bank's
earnings. Examiners c o m p a r e t h e bank's
earnings t o past trends and t o peer groups
and assess t n e d i s t r i b u t i o n of earnings
to dividends and retained earnings. Low
c u r r e n t earnings c o m p a r e d t o past or
peer earnings are seen as an i n d i c a t i o n
that close evaluation is r e q u i r e d . M o r e
and m o r e , emphasis is b e i n g placed by
U.S. examiners o n assessment of internal
controls and audits i m p o s e d by
management.
Liquidity. A bank's liquidity is a key
factor in bank e x a m i n a t i o n . A b a n k must
be able t o meet n o r m a l shortfalls in
anticipated cash flows. Liabilities need t o
be diversified in terms of time and amount.
The degree of f o r e i g n c u r r e n c y liabilities, an i m p o r t a n t facet in t h e Basin,
also requires close evaluation. Examiners
pay special a t t e n t i o n t o banks d e p e n d e n t
o n n o n d e p o s i t liabilities for a significant
p o r t i o n of their asset f u n d i n g (e.g..
Eurocurrency b o r r o w e d funds). A change
in market c o n d i t i o n s can rapidly affect
t h e availability of such f u n d s and cause
severe l i q u i d i t y disruptions. Liquidity
evaluation also involves assessment of past
and p r o b a b l e deposit volatility, availability of assets readily c o n v e r t i b l e into
cash, and a bank's access t o ready sources
of cash. 36
EARLY-WARNING SYSTEMS
M o s t bank s u p e r i n t e n d e n t offices
collect r e c u r r e n t statistical data f r o m t h e
financial institutions u n d e r their responsibility. The data are c h e c k e d and
c o m p i l e d t o p r o v i d e aggregate financial
data t o t h e monetary a u t h o r i t y and o t h e r
interested parties. Increasingly, such data
are r e c o g n i z e d as c o n t a i n i n g an i m p o r t a n t
resource for bank e x a m i n a t i o n itself.
U.S. regulators, in the last f e w years, have
been using such data t o b u i l d a c o m p u t e r based surveillance system capable of
alerting examiners t o banks w i t h certain

Examiners, op. cit., S e c t i o n 215.1, f o r a c o m p l e t e d e s c r i p t i o n of
36

"Classified Credits."
^ C o m p t r o l l e r ' s Handbook for National Bank Examiners, op.

FEDERAL RESERVE B A N K O F A T L A N T A




cit.

B o a r d of G o v e r n o r s of t h e F e d e r a l R e s e r v e S y s t e m , Uniform Interagency Bank Rating System, 1978.

45

p r o b l e m characteristics. W h e n fully imp l e m e n t e d , t h e system anticipates
i m p r o v i n g t h e quality of inspection as well
as saving scarce inspection resources. It
w i l l n o t , h o w e v e r , displace on-site
exams or t h e h u m a n j u d g m e n t r e q u i r e d in
examination. 3 7
The surveillance system is based o n
t h e hypothesis that p r o b l e m and failed
banks e x h i b i t characteristics w h i c h set
t h e m apart f r o m healthy banks. This U.S.
surveillance e f f o r t is called an "EarlyW a r n i n g System" and appears t o have
significant p o t e n t i a l as a p r e e x a m i n a t i o n
t o o l a c c o m p l i s h e d by t h e bank superintendent's office.
The financial ratios used in the
Early-Warning System are selected because they measure facets of risk. The
c o n c e p t u a l i z a t i o n and q u a n t i f i c a t i o n of
risk in a d y n a m i c setting are c o m p l e x ,
and the Early-Warning System c o n t i n u e s
to be refined. Early-Warning Systems
reinforce t h e g r o w i n g a g r e e m e n t that a
b r o a d e n e d risk assessment s h o u l d i n c l u d e
not only asset quality but also o t h e r
p e r f o r m a n c e concepts, such as p o r t f o l i o
c o m p o s i t i o n , earnings and expenses,
l i q u i d i t y , and t h e ability to w i t h s t a n d
shocks.
The c o m p u t e r i z e d Early-Warning
System may nave m o r e p o t e n t i a l in
countries w i t h a large n u m b e r of b a n k i n g
institutions, as the U.S. a n d M e x i c o ,
than in e c o n o m i e s w i t h f e w b a n k i n g institutions. Still, t h e t e c h n i q u e d e v e l o p e d
in an Early-Warning System of c o m p a r i n g
strategic financial ratios of a bank t o its
peer banks has potential applicability
t h r o u g h o u t t h e Basin. Such an EarlyW a r n i n g System offers t h e p o t e n t i a l of
t r a n s f o r m i n g bank supervision f r o m
surveillance t o analysis w i t h predictive
value.
" J o s e p h S i n k e y , " T h e C a u s e s , P r o b l e m s , a n d Financial C h a r a c t e r i s t i c s
of D i s t r e s s e d B a n k s : I m p l i c a t i o n s for B a n k S u p e r v i s i o n a n d E x a m i n a t i o n , " p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in Bank
Supervision a n d Regulation: A Caribbean Basin Perspective, Atlanta,
A u g u s t 1978. S o u r c e s f o r m o r e i n f o r m a t i o n : R o b e r t A . E i s e n b e i s ,
B o a r d of G o v e r n o r s of t h e F e d e r a l R e s e r v e S y s t e m , " F i n a n c i a l EarlyWarning Systems: The Implications for Supervisory Techniques,"
p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in B a n k S u p e r vision a n d Regulation: A Caribbean Basin Perspective, Atlanta,
A u g u s t 1978, a n d D a v i d P. S t u h r a n d L e o n K o r o b o w , F e d e r a l R e s e r v e
Bank of N e w Y o r k , " N e w D e v e l o p m e n t s in Early W a r n i n g a n d S u r v e i l l a n c e at t h e F e d e r a l R e s e r v e , " p a p e r p r e s e n t e d at t h e C o n f e r e n c e
on C u r r e n t Issues in Bank S u p e r v i s i o n a n d R e g u l a t i o n : A C a r i b b e a n
Basin P e r s p e c t i v e , A t l a n t a , A u g u s t 1978. A l s o , see L e o n K o r o b o w ,
David S t u h r , a n d D a n i e l M a r t i n , "A N a t i o n w i d e Test of Early W a r n i n g
R e s e a r c h in B a n k i n g , " F e d e r a l R e s e r v e B a n k of N e w Y o r k , Quarterly
Review, a u t u m n 1977.

46




INTERNATIONAL SUPERVISION
The w i d e s p r e a d surge in i n t e r n a t i o n a l
b a n k i n g w o r l d w i d e has necessitated taking sucn i n t e r n a t i o n a l i z a t i o n i n t o account
in bank r e g u l a t i o n and supervision. International supervision requires c o n f r o n t i n g
issues, such as how f o r e i g n c o u n t r y risk
should be i n c o r p o r a t e d in assessing credit
quality, h o w c o n c e n t r a t i o n ratios s n o u l d
be a p p l i e d to i n t e r n a t i o n a l credits, h o w
the f o r e i g n offices of locally based banks
as well as t h e local offices of f o r e i g n based banks are to be supervised, and h o w
t o e x p a n d c o m m u n i c a t i o n , experiences,
and k n o w l e d g e internationally a m o n g
b a n k i n g s u p e r i n t e n d e n t s w i t h o u t unw a r r a n t e d disclosure of i n f o r m a t i o n
s u b m i t t e d in c o n f i d e n c e . Each of these
issues can n o longer be i g n o r e d by bank
superintendents.
_
Country Risk Analysis and International
Credit Diversification. The principal supervisory d i s t i n c t i o n b e t w e e n domestic and
i n t e r n a t i o n a l l e n d i n g is t h e c o u n t r y risk
factor. C o u n t r y risk involves an appraisal of
e c o n o m i c , social, legal, and political
factors w h i c h may affect credit quality
t h r o u g h d i s r u p t i o n of t h e orderly p a y m e n t
of interest and principal irrespective of
the quality of trie b o r r o w e r . C o u n t r y
risk applies t o p u b l i c sector as w e l l as t o
private sector credits. Possibility of
nationalization or e x p r o p r i a t i o n , g o v e r n m e n t r e p u d i a t i o n of external debts, f o r e i g n
exchange shortfalls, f o r e i g n exchange
controls, and social or political upheaval
are all factors i n v o l v e d in c o u n t r y risk. 38
Factors w h i c h may be evaluated in determ i n i n g such c o u n t r y risk m i g h t i n c l u d e
trends in t h e balance of trade and payments, f o r e i g n exchange reserves, external d e b t ana debt-service ratios, Gross
National Product g r o w t h , inflation, and
political stability, a m o n g others. 3 9
U.S. examiners have been w o r k i n g t o
standardize their approach t o c o u n t r y
risk analysis. They nave c o n c l u d e d that
c o u n t r y exposure involves elements of
risk q u i t e d i f f e r e n t f r o m those in n o r m a l
38

See R o b e r t F. G e m mill, B o a r d of G o v e r n o r s of t h e F e d e r a l R e s e r v e
S y s t e m , p a p e r p r e s e n t e d at t h e C o n f e r e n c e o n C u r r e n t Issues in B a n k
S u p e r v i s i o n a n d Regulation: A C a r i b b e a n B a s i n Perspective, A t l a n t a ,
A u g u s t 1978. A l s o , see " A N e w S u p e r v i s o r y A p p r o a c h t o F o r e i g n
L e n d i n g , " F e d e r a l R e s e r v e Bank of N e w Y o r k , Quarterly Review,
s p r i n g 1978, p. 2.

" C o m p t r o l l e r G e n e r a l of t h e U n i t e d S t a t e s , Federal Supervision of State
and National Banks, W a s h i n g t o n , 1977, p. 4-31.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

y

credit risk and has d i f f e r e n t degrees of
p r o b a b i l i t y . From a supervisory p o i n t
of view, diversification, perhaps,
affords the best p r o t e c t i o n against these
kinds of u n c e r t a i n risk. The supervisory
a p p r o a c h b e i n g taken emphasizes, therefore, the e v i d e n c e of c o n c e n t r a t i o n of
credit t o b o r r o w e r s in o n e c o u n t r y .
Bank s u p e r i n t e n d e n t s f u r t h e r believe
that heavy c o n c e n t r a t i o n s of credit relative
to a bank's capital t o any single f o r e i g n
b o r r o w e r , sector, maturity, etc., entail
greater risk than a m o r e diversified international p o r t f o l i o . Still, it may be possible
t o have a diversified p o r t f o l i o , even w i t h in a single e c o n o m y , or an undiversified
o n e in many e c o n o m i e s w h e r e t h e loans
are highly d e p e n d e n t o n similar factors. 40
International l e n d i n g , in fact, may
reduce certain banks' overall risk t h r o u g h
diversifying their credit p o r t f o l i o . This
r e d u c e d risk occurs w h e r e a bank's loanloss ratio o n f o r e i g n credit is b e l o w t h e
c o m p a r a b l e ratio for domestic credit
as w e l l as t h r o u g h the r e d u c e d p r o p o r t i o n
of loans subject to the same domestic
p r o d u c t i o n cycles. 41
U.S. national banks generally c a n n o t
lend m o r e than 10 percent of their capital
plus surplus to any single b o r r o w e r (see
Asset Q u a l i t y section above). This enforces some diversification. The U.S.
C o m p t r o l l e r , in January 1978, f u r t h e r e d
such diversification through proposing that
the 10-percent r u l i n g apply t o t h e c o m b i nation of credits made by a bank t o a
f o r e i g n g o v e r n m e n t , its agencies, and
instrumentalities, w h e r e t n e b o r r o w e r
fails t o meet a " p u r p o s e and m e a n s " test.
By " p u r p o s e " is meant that the b o r r o w e r
uses the loan proceeds in t h e c o n d u c t of
its o w n business and for t h e purpose detailed in the loan agreement. By " m e a n s "
is meant that t h e b o r r o w i n g entity has
resources or i n c o m e of its o w n sufficient
to service its o w n d e b t obligations.
Where a state-owned borrower has distinct
"purposes" and "means," the " c o m b i n i n g "
r u l i n g w o u l d not apply. 4 2
M o s t Basin authorities have not yet
c o n f r o n t e d t h e issues of assessing c o u n t r y
40

risk or a p p l y i n g aggregated credit c o n c e n t r a t i o n ratios aoroad. This is because
few of their h e a d q u a r t e r e d banks have
placed significant p r o p o r t i o n s of their
assets abroad. But as Basin-headquartered
banks increasingly enter into f o r e i g n
l e n d i n g , such questions w i l l have t o be
faced. M o r e o v e r , Basin economies are
affected by t h e measures taken by industrial e c o n o m i e s ' bank superintendents
in dealing w i t h these questions.
On-site International Examination and
Host-Parent Responsibilites. The n u m b e r
of bank branches established abroad has
m u s h r o o m e d in t h e past t w o decades.
Certain branches have been established as
full o p e r a t i n g banks, w h i l e a g o o d
n u m b e r of others have been set u p in
offshore financial centers t o solely avail
t h e parent bank of direct access t o
Eurocurrency funds offshore. 4 3 These
latter branches are o f t e n t e r m e d " s h e l l "
branches. The n u m b e r of U.S. bank
branches abroad m o r e than d o u b l e d f r o m
1965 t o 1970 and increased another 50
p e r c e n t f r o m 1970 t o 1977. By t h e e n d of
1977, U.S. banks m a i n t a i n e d 738 branches
abroad, 40 percent of t h e m in Basin e c o n o mies (see Table 2). The expansion i n t o
branch b a n k i n g has not been c o n f i n e d t o
industrial economies. By mid-1978, banks
headquartered
in Basin economies (excluding t h e Bahamas and t h e Cayman Islandsh e a d q u a r t e r e d banks) m a i n t a i n e d 21
branches abroad and another 49 representative offices. This expansion into branch
b a n k i n g abroad has i m p o r t a n t implications
for banK supervisors.
In the past, it has b e e n assumed that
a bank's head office guaranteed not o n l y
its branches but also t h e solvency of its
subsidiaries abroad. Therefore, for f o r e i g n
banks, it was assumed that t h e ensuing
bank supervisory responsibilities rested
o n t h e head o f f i c e - d o m i c i l e d bank
s u p e r i n t e n d e n t . In this e n v i r o n m e n t ,
Basin supervisory authorities' p r i n c i p a l
a t t e n t i o n was c o n c e n t r a t e d o n t h e indigenously f o r m e d banks. 44 N o w that f o r eign o w n e r s h i p is increasingly b e i n g

See G a r y G. G i l b e r t a n d M a r y T. M i t c h e l l , op. cit., p. 10.

" ' S e e F r e d B. R u c k d e s c h e l . " R i s k in F o r e i g n a n d D o m e s t i c L e n d i n g
Activities of U.S. B a n k s , " International Banking Operations,
H e a r i n g s , op. cit.. p p . 220-5.
" S e e Federal Register, Vol. 43, No. 8, T h u r s d a y . J a n u a r y 12, 1978,
pp. 1800-1.

FEDERAL RESERVE B A N K OF A T L A N T A




" S e e t h e C a r i b b e a n Basin Economic Survey, " B e h i n d t h e B a s i n ' s O f f s h o r e
B a n k i n g B o o m , " A p r i l - M a y 1977.
" S e e Desiree S p r i n g e r a n d C l y d e J o h n s o n , " S u p e r v i s i o n of F o r e i g n
B a n k B r a n c h e s in an I n d i v i d u a l B a s i n E c o n o m y w i t h S p e c i a l R e f e r e n c e
t o B a r b a d o s , " op. cit., p. 16.

47

TABLE 2
FOREIGN B R A N C H E S OF U.S. B A N K S IN T H E
BASIN AND THE

WORLD

1965

Bahamas
Barbados
Cayman Islands
Colombia
Dominican Republic
El Salvador
Guatemala
Guyana
Haiti
Honduras
Jamaica
Mexico
Netherlands Antilles
Nicaragua
Panama
Panama Canal Zone
Puerto Rico
Turk Islands
Trinidad-Tobago
Venezuela
U.S. Virgin Islands
British Virgin Islands
West Indies (other)
Total Caribbean Basin
Total World

3
-

n.a.*
6
4
1
2
1
-

1
5
-

1
12
2
15
1
3
4
4
2
-

67
211

1970

60
3
n.a.*
26
12
1
3
1

1977

74
6
58
-

3
6
5
2
3
29
2
19
1
6
4
16
3
7

19
2
3
1
4
3
8
5
4
4
33
2
23
1
6
4
25
2
6

212
532

293
738

-

' I n c l u d e d in West Indies (other).
Source: B o a r d of Governors of the Federal Reserve System, A n n u a l
Report, 1965. 1970, and 1977

l i m i t e d t o m i n o r i t y positions in various
Basin e c o n o m i e s , the supervisory responsibilities b e t w e e n f o r e i g n and Basin superintendents are no longer so clear-cut.
The G r o u p of Ten Committee o n Banking Regulation and Supervisory Practices,
headquartered at the Bank for International
Settlements, has c o n c l u d e d that t h e responsibility for t h e solvency of f o r e i g n
branches must rest, in t h e first place, o n
the h o m e c o u n t r y supervisory a u t h o r i t y .
H o w e v e r , this does not mean that the host
c o u n t r y authorities have n o supervisory
responsibilities for a facility of a f o r eign bank in their c o u n t r y , particularly
in the case of subsidiaries. M o r e o v e r ,
the l i q u i d i t y of t h e local facilities
is already a responsibility of the local
48




authorities, t h o u g h it c a n n o t be j u d g e d
i n d e p e n d e n t of t n e parent. 4 5
U.S. bank supervisors have felt a
need to carry o u t some on-site inspection
of overseas branches. At t h e b e g i n n i n g
of 1976, 68 countries p e r m i t t e d on-site
examinations by U.S. bank supervisors. 4 6
The U.S. C o m p t r o l l e r ' s O f f i c e , in 1976,
made 145 f o r e i g n on-site examinations;
this c o v e r e d a b o u t a auarter of t h e U.S.
nonshell branches ana 99 percent of U.S.
nonshell branch assets in tnat year. 47
The examinations are a c c o m p l i s h e d by a
p e r m a n e n t U.S. C o m p t r o l l e r 6-person
e x a m i n i n g staff in L o n d o n and t h r o u g h
sending an average of 120 examiners t o
a b o u t 25 countries for 5 to 6 weeks each
year. 48
The i n t e r n a t i o n a l b a n k i n g operations,
u n d e r t a k e n f r o m the head o f f i c e or placed
o n shell branches, are generally e x a m i n e d
at the head office. M o s t Basin bank
s u p e r i n t e n d e n t s inspect their o w n headq u a r t e r e d banks' i n t e r n a t i o n a l activities
at the h o m e office. H o w e v e r , t h e prospect
of f o r e i g n on-site examinations is n o
longer ignored 4 9 and t h e issue of the
host-parent responsibility becomes m o r e
and m o r e relevant t o Basin supervisors as
their o w n banks o p e n branches in the
Netherlands Antilles, Panama, and t h e
U.S.
Multinational Cooperation. To c o p e
w i t h the e x p a n d e d internationalism OT
banks, as w e l l as t o i m p r o v e the quality of
international supervision, bank supervisors
are increasingly r e c o g n i z i n g t h e need
for m u l t i n a t i o n a l c o o p e r a t i o n . Bank
supervisors of t h e European Economic
C o m m u n i t y (EEC), as w e l l as the C o m mittee o n Banking Regulation and
Supervisory Practices at t h e Bank for
International Settlements, meet p e r i o d i cally t o discuss issues relevant t o their
supervisory responsibilities. U n i f i c a t i o n
5

See G e o r g e B l u n d e r , "International C o o p e r a t i o n in B a n k i n g S u p e r v i s i o n , "
Bank of England, Quarterly Bulletin, L o n d o n , S e p t e m b e r 1977, p. 328.
6
" G A O Responses to Questions S u b m i t t e d , " International B a n k i n g
Operations, Hearings, op. cit., p. 300.

" R o b e r t Bloom, I n t e r n a t i o n a l B a n k i n g O p e r a t i o n s , Hearings, op.
p. 558.

cit.,

' ' H a r o l d D. Schüler, Office of the C o m p t r o l l e r of the Currency, paper
presented at the C o n f e r e n c e o n Current Issues in Bank S u p e r v i s i o n a n d
Regulation: A C a r i b b e a n Basin Perspective, Atlanta, A u g u s t 1978.
" S e e Jesus Tovar Villegas, " S u p e r v i s i o n Internacional y M u l t i n a c i o n a l de
las A c t i v i d a d e s d e los Bancos Domésticos y Extranjeros: La
Experiencia Venezolana," paper presented at the C o n f e r e n c e o n
Current Issues in Bank S u p e r v i s i o n and Regulation: A C a r i b b e a n
Basin Perspective, Atlanta, August 1978.

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

of supervisory t e c h n i q u e s is n o t t h e goal;
t h e varied legal, financial, and political
structures limit such u n i f o r m i z a t i o n .
Still, such sessions o f f e r the possibility f o r the d e v e l o p m e n t of personal
contacts and discussing supervisory
techniques and innovations. 5 0 H a r m o n i z a t i o n of bank a c c o u n t i n g techniques a n d
balance sheet formats is also b e i n g evaluated by t h e C o m m i t t e e . The C o m m i t t e e
o n Banking Regulation and Supervisory
Practices rejected the possibility of
establishment of a m u l t i n a t i o n a l EarlyW a r n i n g System (see above) because of
legal questions and p r o b l e m s of c o o r d i n a t i o n and d u p l i c a t i o n of efforts. 5 1
The b a n k i n g s u p e r i n t e n d e n t s of Costa
Rica, El Salvador, Guatemala, Honduras,
and Nicaragua have created t h e Central
American Council of Banking Superintendents (Consejo C e n t r o a m e r i c a n o de
Superintendentes de Bancos, de Seguros,
v otras Instituciones Financieras) w i t h
neadquarters n o w in El Salvador. This
C o u n c i l n o r m a l l y meets at least annually
in o r d e r to worK t o w a r d e x p a n d e d interchanges and h a r m o n i z a t i o n of specified
supervisory p r o c e d u r e s a m o n g m e m b e r s .
C o m m i t t e e s have b e e n f o r m e d to assess
c u r r e n t supervisory practices in Central
America in o r d e r to facilitate f u t u r e
c o o r d i n a t i o n . 5 2 Still, it is r e c o g n i z e d
that full m u l t i n a t i o n a l c o o p e r a t i o n is
a d i f f i c u l t task.
The j u r i s d i c t i o n and c o n f i d e n t i a l i t y
relationship between banking superintendents and the banks u n d e r tneir a u t h o r i t y
c a n n o t be casually breached. Still, the
need for e x p a n d e d i n t e r n a t i o n a l data and
i n f o r m a t i o n c a n n o t be i g n o r e d . At the

50

S e e G e o r g e B l u n d e n . " T h e S u p e r v i s i o n o f t h e U.K. B a n k i n g S y s t e m , "
op. cit., p. 192.

5l

G e o r g e B l u n d e n , " I n t e r n a t i o n a l C o o p e r a t i o n in B a n k i n g S u p e r v i s i o n , "
op. cit

" S e e B a n c o C e n t r o a m e r i c a n o d e I n t e g r a c i ó n E c o n o m i c a , Revista d e la
Integración y el Desarrollo de C e n t r o a m e r i c a , T e g u c i g a l p a , Vol. 21,
1978, pp. 9 7 - 1 0 7 .

FEDERAL RESERVE B A N K O F A T L A N T A




Federal Reserve Bank of Atlanta Conference
on C u r r e n t Issues in Bank Supervision and
Regulation: A Caribbean Basin Perspective, Federal Reserve Board G o v e r n o r
Philip C o l d w e l l p r o p o s e d that a study of
t h e present level of c o o p e r a t i v e supervisory relationships be made w i t h t h e e n d
of r e c o m m e n d i n g new ways to e x p a n d the
ties b e t w e e n bank supervisors in t h e
H e m i s p h e r e . Such a study m i g h t be
sponsored by the Conference of Governors
of the Central Banks of t h e Western
H e m i s p h e r e or by t h e Center for Latin
A m e r i c a n M o n e t a r y Studies (CEMLA). The
need for closer c o m m u n i c a t i o n b e t w e e n
bank s u p e r i n t e n d e n t s is clearly e v i d e n t .
CONCLUSION
Bank supervision and r e g u l a t i o n is
amidst a most dynamic p e r i o d . This has
given rise t o a n u m b e r of questions o n
the p r o p e r extent of bank regulations.
M o s t b a n k i n g authorities are aware of t h e
need t o i m p r o v e t h e quality of bank supervision w h i l e also anxious t o m i n i m i z e t h e
cost in m a n p o w e r and funds. As b a n k i n g
gets increasingly c o m p l e x , so must bank
s u p e r i n t e n d e n t s b e c o m e increasingly
sophisticated.
Bank examination now requires evaluat i o n of capital adequacy, m a n a g e m e n t ,
earnings, and l i q u i d i t y as well as asset
quality. Increasingly, bank examiners
w i l l p e r f o r m as assessors rather than
auditors of such factors. Early-Warning
Systems and o t h e r in-house e x a m i n a t i o n
aids w i l l s u p p l e m e n t t h e on-site exam.
As banks have increasingly b e c o m e international institutions, so must b a n k i n g
superintendents. This may call for c o u n t r y
r i s t analysis, f o r e i g n on-site exams, and
increasing international interpretations
t o domestic supervision policy directives.
Increasingly, it is calling for m u l t i national c o o p e r a t i o n a m o n g b a n k i n g
superintendents.»

49

ENTRY, EXIT, AND CHANGE
IN BANKING MARKET
CONCENTRATION
by B. Frank King
The following article summarizes a more complete study that is available as part of a series of
Federal Reserve Bank of Atlanta Working Papers. Single copies of this and other studies are
available upon request to the Research Department, Federal Reserve Bank of Atlanta, Atlanta,
Georgia 30303.

Economists' theories about h o w markets
operate place considerable emphasis
o n t h e n u m b e r of c o m p e t i t o r s . A d d i n g
c o m p e t i t o r s is t h o u g h t t o i m p r o v e a
market's p e r f o r m a n c e , leading t o l o w e r
prices and greater o u t p u t . A d d i t i o n a l
c o m p e t i t o r s c o m p l i c a t e any c o o r d i n a t i o n
of sellers' decisions t o raise prices and
reduce o u t p u t and, potentially, lead rival
sellers t o i n t r o d u c e new p r o d u c t s and
services in o r d e r to maintain their market
positions. Loss of c o m p e t i t o r s simplifies
coordination.
In b a n k i n g , m a n y decisions that
i n f l u e n c e t h e n u m b e r of c o m p e t i t o r s in
local markets are made by Federal
and state regulatory agencies. W h e n these
agencies a p p r o v e or deny applications
for n e w bank charters or branches,
they o f t e n affect t h e n u m b e r of c o m p e t itors in b a n k i n g markets. W h e n they
d e c i d e w h e t h e r t o allow a t r o u b l e d bank
to fail or to merge and w h e n they
d e c i d e w h e t h e r or not to invite o r g a n i zations f r o m outside the market to bid for
a f a i l i n g bank, these agencies also
i n f l u e n c e t h e n u m b e r of separate b a n k i n g
organizations o f f e r i n g their services
to customers in a market area. Thus, bank
regulators are responsible for a set
of decisions that, at least in t h e o r y , are
i m p o r t a n t influences o n the prices
ana services o f f e r e d in local b a n k i n g
markets.
50




Do these decisions that l o o m so
i m p o r t a n t in t h e o r y have any i n f l u e n c e
in practice? The research presented here
was an attempt t o answer this question. 1 Its
results indicate that entry and exit
( t h r o u g h failure or absorption) of banks
have i m p o r t a n t influences o n t h e c o n c e n t r a t i o n of business a m o n g banks
in local markets.
Simple comparisons of t h e rates of
change in t h e n u m b e r of c o m p e t i t o r s
w i t h t h e rates of change in deposit
c o n c e n t r a t i o n in local b a n k i n g markets
suggested that changes in the t w o are
closely associated. H o w e v e r , t h e s i m p l e
comparisons left t w o questions unanswered: D i d o t h e r factors a c c o u n t
f o r changes in b o t h c o n c e n t r a t i o n and
t h e n u m b e r of competitors? D i d changes
in n u m b e r cause chanees in c o n c e n t r a t i o n
or vice versa? O u r isolation of t h e
i n f l u e n c e of entry and exit f r o m that
of o t h e r factors and evaluation of e v i d e n c e
o n t h e d i r e c t i o n of cause failed to
shake t h e c o n c l u s i o n d r a w n f r o m t h e
simple comparisons. Greater rates
of increase in t h e n u m b e r of banks are
associated w i t h increasing d i f f u s i o n
of deposits a m o n g banks, and lower rates
of increase or declines in t h e n u m b e r

' A t e c h n i c a l paper that d e v e l o p s h y p o t h e s e s a n d discusses research
t e c h n i q u e s is a v a i l a b l e o n request f r o m t h e Research D e p a r t m e n t
o f t h e Federal Reserve Bank o f A t l a n t a .

M A R C H / A P R I L 1980, E C O N O M I C REVIEW

of banks are associated w i t h rising
c o n c e n t r a t i o n of deposits in a f e w banks.
These tendencies w e r e apparent in
markets w i t h a w i d e range of sizes,
c o n c e n t r a t i o n , and rates of g r o w t h . Since
earlier research has l i n k e d greater
deposit c o n c e n t r a t i o n in b a n k i n g markets
to h i g h e r prices and lower o u t p u t ,
it seems reasonable to c o n c l u d e that
changes in t h e n u m b e r of banks i n f l u e n c e
market p e r f o r m a n c e (prices and o u t p u t ) .
The conclusions of o u r research w e r e
d r a w n f r o m analysis of t w o sets of
b a n k i n g markets. The first set i n c l u d e d
all 262 counties in t h e states of t h e
Sixth Federal Reserve District w i t h t h r e e
or m o r e banks. 2 Data o n changes in
t h e structure of t h e i r b a n k i n g markets
f r o m 1960 t o 1970 had been r e c o r d e d
d u r i n g t w o previous studies. The second
set i n c l u d e d 104 b a n k i n g markets in
Alabama, Florida, and Tennessee. Structure
changes in these markets f r o m 1970 t o
1974 nad also been traced for an earlier
study. O n average, market c o n c e n t r a t i o n
decreased in b o t h sets of areas d u r i n g
t h e t i m e periods c o v e r e d , d e c l i n i n g
by almost 10 percent in t h e larger sample
and by almost 17 in the smaller. 3 All
i n d i v i d u a l areas d i d not have c o n c e n t r a t i o n declines, h o w e v e r .
A l t h o u g h t h e n u m b e r of market
participants was generally rising, each
sample had a substantial n u m b e r of
areas in w h i c h t h e n u m b e r of c o m p e t i t o r s
d e c l i n e d because of mergers or failures.
The n u m b e r of c o m p e t i t o r s c h a n g e d
in a b o u t half of t h e areas in t h e larger
sample and in a b o u t t h r e e - f o u r t h s in
t h e smaller.
To d e t e r m i n e w h e t h e r changes in t h e
n u m b e r of c o m p e t i t o r s and changes
in c o n c e n t r a t i o n w e r e related, t h e
areas w i t h i n t h e samples w e r e g r o u p e d
a c c o r d i n g t o t h e d i r e c t i o n of t h e change
in c o n c e n t r a t i o n and in t h e n u m b e r o f
c o m p e t i t o r s . Very f e w markets in
either sample e x p e r i e n c e d declines
in b o t h the n u m b e r of c o m p e t i t o r s and
c o n c e n t r a t i o n or increases in b o t h .

2

T h e Sixth Federal Reserve District i n c l u d e s all o f A l a b a m a , Florida, a n d
G e o r g i a a n d parts o f Louisiana, Mississippi, a n d Tennessee.

C o n c e n t r a t i o n was m e a s u r e d by t h e H e r f i n d a h l I n d e x o f m a r k e t
c o n c e n t r a t i o n . See C. D. Salley, " C o n c e n t r a t i o n i n B a n k i n g M a r k e t s :
R e g u l a t o r y N u m e r o l o g y o r Useful M e r g e r G u i d e l i n e ? , " M o n t h l y Review,
Federal Reserve Bank of A t l a n t a , Vol. 57 ( N o v e m b e r 1972), p. 188.

FEDERAL RESERVE B A N K O F A T L A N T A




C o m b i n a t i o n s of decreasing c o n c e n t r a t i o n and rising n u m b e r s of
c o m p e t i t o r s or rising c o n c e n t r a t i o n
and f a l l i n g n u m b e r s w e r e most o f t e n
f o u n d in markets in w h i c h t h e r e had been
entry or exit. As w e had expected,
greater n u m b e r s w e r e associated w i t h
less c o n c e n t r a t i o n .
It was possible, h o w e v e r , that o t h e r
changes a c c o u n t e d for t h e changes
in b o t h n u m b e r s and c o n c e n t r a t i o n .
Entry and exit of banks have sometimes
been f o u n d t o be closely related to
market g r o w t h ; some studies have
t i e d higher g r o w t h rates t o l o w e r rates
of c o n c e n t r a t i o n change. These
associations m i g h t l e a d o n e to attribute
c o n c e n t r a t i o n change t o entry or exit
w h e n it really results f r o m the i n f l u e n c e
of g r o w t h . A f t e r d e t e r m i n i n g that t h e r e
was some relationship of both g r o w t h
and changes in n u m b e r s to c o n c e n t r a t i o n
change in b o t h o u r samples, w e tested
a series of c o n c e n t r a t i o n change models
w i t h m u l t i p l e regression techniques.
These tests indicated that (1) changes
in the n u m b e r of c o m p e t i t o r s s h o w e d
a consistently close, negative relationship w i t h c o n c e n t r a t i o n changes; (2) this
relationship seemed to occur in
all types of b a n k i n g markets—large and
small, highly c o n c e n t r a t e d and loosely
c o n c e n t r a t e d , and fast g r o w i n g and
stagnant; (3) t h e positive relationship
b e t w e e n changes in n u m b e r s and g r o w t h
was n o t close e n o u g h t o cast serious
d o u b t s o n t h e first t w o conclusions;
and (4) a l t h o u g h o t h e r factors, such
as market g r o w t h , market size, and
market c o n c e n t r a t i o n at t h e b e g i n n i n g
of the p e r i o d u n d e r study w e r e related
to c o n c e n t r a t i o n change in some tests,
n o n e w e r e so consistently related as
t h e change in n u m b e r of c o m p e t i t o r s .
The tests indicated that t h e relationship of n u m b e r s change t o c o n c e n t r a t i o n change was not o n l y close but
also t h e strongest of the relationships
tested. Tests of t h e relative strength
of association of c o n c e n t r a t i o n cnange
w i t h changes in t h e n u m b e r of c o m petitors, g r o w t h , market size, and market
c o n c e n t r a t i o n s h o w e d that the association
of changes in n u m b e r s and c o n c e n t r a t i o n change was a m o n g the strongest
in all cases and the strongest in most.
51

In short, t h e tests c o n f i r m e d a
relationship b e t w e e n n u m b e r s change
and c o n c e n t r a t i o n change and indicated
that of t h e influences tested, entry
a n d exit had t h e greatest impact o n
c o n c e n t r a t i o n . This left o p e n t h e matter
of t h e d i r e c t i o n of causality, a q u e s t i o n
that was a p p r o a c h e d indirectly w i t h
t w o types of evidence.
It c o n v e n t i o n a l theories are c o r r e c t ,
o n e w o u l d expect entry and exit t o
initiate c o n c e n t r a t i o n change. O n e
m i g h t argue, h o w e v e r , that t h e causal
i n f l u e n c e runs the o t h e r way, that is,
that a greater d i f f u s i o n of deposits
attracts n e w banks w h i l e a higher c o n c e n t r a t i o n repels t h e m . H o w e v e r ,
o u r results and those of others in studies
of bank entry are inconsistent w i t h
this latter a r g u m e n t . W e f o u n d that h i g h
initial c o n c e n t r a t i o n levels w e r e generally
associated w i t h subsequent c o n c e n t r a t i o n declines rather than c o n c e n t r a t i o n
increases. In a d d i t i o n , o t h e r studies
of the d e t e r m i n a n t s of entry have f o u n d
entry to be p r o m o t e d rather than i n h i b i t e d
by high c o n c e n t r a t i o n . Thus, causality
appears t o run as o n e w o u l d e x p e c t —
f r o m changes in t h e n u m b e r of c o m p e t i tors t o changes in c o n c e n t r a t i o n .
The relationships f o u n d in these
tests are consistent w i t h those f o u n d in

o t h e r studies of the effects of bank entry. 4
If these results are generally applicable,
they indicate that e n t r y and exit are t h e
most i m p o r t a n t existing and p o t e n t i a l
influences o n the changes in c o n c e n t r a t i o n of deposits in local b a n k i n g
markets. Thus, policy choices directly in
t h e hands of bank regulatory agencies
can have i m p o r t a n t effects o n ' b a n k i n g
market structure and, by i m p l i c a t i o n ,
o n market p e r f o r m a n c e . State bank
regulators, t h e FDIC, t h e Federal
Reserve, and t h e C o m p t r o l l e r of t h e
C u r r e n c y make entry, merger, and exit
decisions u n d e r standards that allow
t h e m considerable l a t i t u d e in determ i n i n g t h e p u b l i c interest. Less stringent
entry policies, stricter m e r g e r policies,
and greater efforts t o b r i n g in merger
partners for failing banks f r o m outside
t h e failing banks' markets rather
than merging them with competitors
w o u l d w o r k t o w a r d reductions in
concentration. •

4

R. H. C a n d r o s s , " T h e I m p a c t of N e w Bank Entry o n U n i t Banks i n
O n e Bank T o w n s , " journal of Bank Research, V o l . 2 ( a u t u m n 1971),
p p . 22-30; A . S. M c C a l l a n d M . O . Peterson, " T h e I m p a c t o f de novo
C o m m e r c i a l Bank E n t r y , " FDIC W o r k i n g Paper 76-7 ( W a s h i n g t o n ,
FDIC, 1976); P. S. Rose a n d D. R. Eraser, " B a n k C o m p e t i t i o n a n d
P e r f o r m a n c e i n a U n i t B a n k i n g E n v i r o n m e n t , " Proceedings of a C o n ference o n Bank Structure and C o m p e t i t i o n ( C h i c a g o , Federal Reserve
Bank of C h i c a g o , 1971), p p . 86-93; a n d E. K o h n a n d C. ). C a r l o , The
Competitive Impact of N e w Branches ( N e w Y o r k State D e p a r t m e n t
o f Banking, 1969).

NEW PUBLICATIONS
WORKING PAPER SERIES
Regional Credit Market Integration: A Survey and Empirical Examination
by Robert E. Keleher
An Empirical Analysis of Sectoral Money Demand in the Southeast
by Stuart G. Hoffman
Entry, Exit, and Market Structure Change in Banking
by B. Frank King

Copies of these publications are available f r o m t h e Research D e p a r t m e n t , Federal Reserve
Atlanta, Georgia 30303. Please include a c o m p l e t e address w i t h ZIP c o d e to ensure delivery.

52




Bank of

Atlanta,

M A R C H / A P R I L 1980, E C O N O M I C REVIEW