Full text of Economic Review (Federal Reserve Bank of Atlanta) : May 1984, Volume 69, Number 5

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Economic
Review
BANK OF ATLANTA




MAY 1984

President:

Robert P. Forrestal

Sr. Vice President and
Director of Research:
Sheila Tschinkel

Vice President and
Associate Director of Research:
William N. Cox

Financial Structure:
B. Frank King, Research Officer
Larry D. Wall
Robert E. Goudreau
National Economics:
Robert E. Keleher, Research Officer
Mary S. Rosenbaum
Joseph A Whitt, Jr.
Regional Economics:
G e n e D. Sullivan, Research Officer
Charlie Carter
William J. Kahley
Bobbie H. McCrackin
Joel R- Parker
Database M a n a g e m e n t :
Delores W. Steinhauser
Pamela V. Whigham
Payments Research:
David D- Whitehead
Visiting Scholars:
George J. Benston
University of Rochester
Gerald P. Dwyer
Emory University

Special Issue:
Bank Product
Deregulation

Sectiot

Sectios
j

Sectio

Robert A Eisenbeis
University of North Carolina
John H e k m a n
University of North Carolina
Paul M. Horvitz
University of Houston
Peter Merrill
Peter Merrill Associates

C o m m u n i c a t i o n s Officer:
Donald E. Bedwell
Public Information Representative:
Duane Kline
Publications Coordinator:
Gary W. Tapp
Graphics:
Eddie W. Lee, Jr.
Cheryl D. Berry

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ISSN 0 7 3 2 - 1 8 1 3




V O L U M E LXIX, N O . 5

roduction
Df.k Considerations in
regulating Bank
Iftivities
Dink Product Deregulation:
>me Antitrust Tradeoffs
consumer Demand for
oduct Deregulation

FEDERAL RESERVE B A N K O F A T L A N T A 3




Section IV. Business and Bank Reactions
to New Securities Powers
Section V.

Investment Banking:
Commercial Banks' Inroads
Conclusion

Introduction

4




Legislative walls that have partitioned the
American financial system into separate commercial banking, insurance, investment banking, savings and mortgage lending and nonfinancial
segments have eroded during the past several
years. They seem likely to continue to crumble as
businesses try to diversify their financial offerings
in the future. This issue of our E c o n o m i c Review
will survey the important issues bound up in the
process of product deregulation now occupying
financial markets, regulators and lawmakers. It
parallels our analysis, published in this Review in
May 1983, of the breakdown of geographic
barriers to banking.
The regulatory limits to banks' activities arose
from public concerns about the safety and soundness of banks and the financial system and about
concentration of financial power. Present-day
limits grew primarily from federal laws passed in
reaction to economic problems of the 1930s.
Chaotic conditions in the nation's financial system
accompanied by the failure of one-third of the
nation's banks induced far-reaching reforms.
Congress introduced federal deposit insurance
and improved the Federal Reserve's ability to
provide bank reserves through the discount
w i n d o w and open-market operations in order to
restore and maintain confidence in banks and
the financial system.
In addition, the Congress sought to control
banks' costs by limiting the interest that they
could pay on deposits. It also sought both to
control their risk and to limit concentration of
financial power by limiting banks' activities in the
securities business. This latter limitation, combined with earlier prohibitions against certain
real estate and insurance activities, served to
keep commercial banks specialized in the deposit-taking and lending business until activity
restrictions began to fall in the early 1970s.
A third l i m i t — b a r r i n g interstate b a n k i n g — h a d
been passed earlier and was reaffirmed in the
early 1930s. By prohibiting interstate banking by
national banks, the McFadden Act of 1927 insulated banks from out-of-state competition and
also limited their geographic diversification. State
branching and bank holding company restrictions,
the McFadden Act and, later, the Douglas Amendment to the Bank Holding Company Act, are
largely responsible for the existence of approximately 14,000 commercial banks in the nation
today.
Each of the limitations served to insulate various types of financial firms from price, geographic
M A Y 1984, E C O N O M I C

REVIEW

or product competition. Since the payment of
interest on deposits was limited, interest rate
increases in other markets had limited effects in
raising banks' cost of funds. The McFadden Act
limited deposit and loan competition from outof-state organizations, again holding down the
cost of funds and possibly raising the return on
loans. Activity limitations compartmentalized product offerings, restraining competition and insulating banks from whatever risk may have been
associated with investment banking, insurance
and real estate operations.
Market and legal conditions have changed
since the 1930s. The Depository Institutions
Deregulation Committee has removed interestrate ceilings on all deposits but passbook savings
and transactions accounts. Geographic restraints
imposed by state laws, the McFadden Act and
the Douglas A m e n d m e n t are breaking down,
largely because of bank holding companies'
nonbank activities and states' reciprocal banking
laws.
What's more, product restraints are being
severely tested (witness the N O W accounts
offered by thrifts, money market mutual funds,
and the new financial services offered by nonbanks
such as Merrill Lynch, Sears Roebuck, American
Express and J. C. Penney). These changing market
conditions certainly indicate the need for a
reappraisal of the current product limitations.
Technology has changed, and interest rates show
greater variability today than has historically
been true. Some states are now allowing banks
to engage in nonbanking activities prohibited by
federal banking laws. In addition, various proposals before Congress contemplate increased
bank powers in securities, insurance and real
estate activities. Adding to the confusion, large
banks perform many domestically prohibited
activities in foreign countries. Even the definition of
what constitutes a bank is in question.
The product regulations imposed on commercial banks were designed to preserve the safety
and soundness of the banking system and to
prevent undue concentration of financial power.
The former rationale revolves around a desire to
guarantee the safety of deposited funds in order
to maintain stability of the money supply and to
ensure efficacy of the savings and investment
cycle and the payments mechanism. In terms of
product deregulation, fears are centered on the
increased risk that some assume to be associated
with banks' expanding product offerings. The
fear of concentrated financial power seems to be
FEDERAL RESERVE B A N K O F A T L A N T A




based on concern that concentration of financial
resources through banks' product diversification
may lead to a misallocation of economic resources.
In other words, as the division between banking
and commerce erodes, banks may gain power to
earn excess profits and to allocate credit on the
basis of their own ownership interest ratherthan
on an unbiased view of the investments undertaken.
The first section of this issue of our E c o n o m i c
Review will provide an assessment of the safety
and soundness question. Robert A. Eisenbeis,
Wachovia Professor of Banking at the University
of North Carolina, and Larry Wall, a Federal
Reserve Bank of Atlanta economist, will analyze
the potential impacts on bank and financial system
risk associated with product deregulation in the
financial services industry. The second section,
written by Elinor Solomon, professor of economics
at George Washington University, will assess
issues related to potential concentration of financial power resulting from financial product deregulation. Is this fear of concentrated financial
resources really justified?
The third and fourth sections deal with potential
benefits of deregulation to banks' customers. All
financial institutions would like to believe they
can provide all things to all customers, but
market realities may not support this optimism.
Veronica Bennett, a financial industry research
specialist, will reveal the results of three attitude
surveys that sought to determine how consumers
prefer to receive their financial services. She reports
on a special survey of consumer attitudes undertaken by the Atlanta Fed as well as evidence from
proprietary studies.
Bernell Stone, Mills B. Lane Professor of Banking
and Finance at Georgia Institute of Technology,
will address the same question from corporate
customers' perspective: What do corporate customers want and from w h o m do they want to
receive these services? The fifth section deals
with what we can learn about product deregulation in financial services through a case study of
U.S. banks' experience in the securities industry.
This section was written by Samuel L Hayes III,
Jacob Schiff Professor of Investment Banking at
Harvard University. The concluding section will
pull the evidence together and suggest policy
implications. W e hope you find this issue of our
E c o n o m i c Review interesting and informative.

— B. Frank King
David D. Whitehead
5

Risk Considerations in
Deregulating Bank Activities
Easing restrictions on bank products may carry risks if an
institution's activities are poorly managed, but perpetuating those
limitations poses dangers as well. Here's a look at the arguments
on both sides of the dilemma

Bank activities have long been heavily regulated,
not only because of concern over potential
conflicts of interest, unfair competition, and
undue concentration of resources, but more
important, for safety and soundness reasons.1
Safety and soundness regulations limit banking
organizations' asset and liability portfolios, provide for examinations, provide deposit insurance
and offer access to the discount w i n d o w at the
Federal Reserve.
Proponents of deregulation argue that continued regulation of activities adds n o t h i n g t o t h e
system protecting bank safety and soundness.
They .further contend that regulation places banks

6




at a competitive disadvantage and will allow lessregulated nonbank competitors to assume banks'
role in our financial system. Advocates of continued
regulation argue that deregulation would strain
the rest of the safety and soundness system
and could even undermine the banking system.
We have reviewed the argument that continued
regulation jeopardizes banks' competitive position
and then considered the risks of allowing new
activities. Our conclusion is that deregulation
poses no threat to the stability of the financial
system but that failure to deregulate does pose
such a threat. The risks inherent in deregulation

M A Y 1984, E C O N O M I C

REVIEW

arise because the deposit insurance agency and
the discount w i n d o w bear much of the costs of
bank failure. W e have examined three regulatory
reforms suggested as substitutes for activity deregulation but found significant problems with
each.
W e then considered the effect on bank risk of
allowing banks to expand into currently prohibited
financial activities. Our findings suggest that, had
banking organizations been passive owners of
some prohibited activities, their earnings might
have been less v o l a t i l e d u r i n g t h e 1 970s. But
their earnings might have been more volatile had
they been passive owners of some other activities.

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




W e also found no evidence to indicate that t h e
bond market anticipates significant changes in
the riskiness of acquirers of various financial
firms.

Risks of Continued Regulation
The system set up to maintain bank safety and
soundness exists in large part because banks'
deposit-taking activities play such an important role in the economy. Banks traditionally
have dominated payments services, and we
learned during the 1800s and early 1900s that
protecting bank safety was critical to a smoothly

7

functioning economy. This dominance is being
challenged, however, by competitors from outside
the banking industry.2 These competitors generally
are not sheltered by the protective system covering
banks. Thus, regulation that weakens banks' competitive position—even if it strengthens bank
safety—can weaken the economy by increasing
the growth rate of institutions that offer liabilities
serving as money but that lack access to federal
deposit insurance or the discount window.
Some proponents of deregulation, such as
Charles S. Sanford, Jr. of Bankers Trust Company,
argue that regulation threatens banks' competitive
position. Sanford (1984) contends that commercial and investment banking are becoming

"Our conclusion is that deregulation
poses no threat to the stability of the
financial system but that failure to
deregulate does pose such a threat."

indistinguishable. He also argues that current
restrictions increase banks' riskiness by limiting
their ability to employ risk-management techniques such as selling off credit risk. Other
bankers point to the growing list of retail products
offered by Merrill Lynch, Sears, Prudential and
others as evidence that they need to expand into
new activities to compete effectively.
Given current regulation, the threat nonbank
challengers pose to commercial banks' competitive position depends on consumer preferences and the ability of less regulated firms to
generate synergies between different financial
services. Evidence on individual and corporate
preferences is reviewed elsewhere in this issue.
Also in this issue, Samuel Hayes (1984) discusses
the importance of synergies in various aspects of
investment banking. Regardless of the conclusions
drawn from available evidence, the risk of regulating commercial banks and unknowingly affecting
the structure of the financial system must be considered. Maintaining the soundness of individual
banks is only a means to an end; the ultimate goal
is a safe and sound financial system.
8




T h e Risk Rationale for
Activity Restrictions
Two major types of restrictions on the affiliation
of commercial banks with other firms have been
imposed at different times for different reasons.
Specific restrictions barring commercial banks
from affiliating with investment banking were
adopted shortly after the banking crisis of 1933
and were in part a reaction to that crisis. The
general restrictions on commercial bank affiliations
with other banks and nonbanking firms are
based on the 1956 Bank Holding Company Act
and its 1970 amendments. These restrictions
appear to have been justified primarily by a
desire to prevent concentration of financial power
and conflicts of interest Risk considerations
played a less significant role.
Advocates of continued activity regulation frequently argue that commercial and investment
bankingwere separated by the Glass-Steagall Act
in 1933 to protect commercial banks' safety. A
review of the record suggests, however, that
conflict of interest considerations played a larger
role in the separation. During the late 1920s and
early 1930s, commercial bank affiliates could
engage in investment banking. During this period
some investment banking affiliates engaged in
operations that appeared unethical (though they
were legal at that time). 3
Furthermore, commercial banks were making
loans for securities purchases, and some people
believe the banks were feeding the "...speculative
fever of the late 1920s." 4 The fever ended with a
stock market crash in 1929. The early 1930s saw
a wave of bank failures, culminating in a 1933
panic that struck both strong and weak banks.
That panic forced President Roosevelt to declare
a nationwide bank holiday shortly after he was
inaugurated. Congress responded to the collapse
by passing a series of banking laws, including the
Glass-Steagall Act, which prohibits commercial
banks and their affiliates from engaging in investment banking.
The 1930s collapse of the banking system was
tragic, but it did not prove that the safety and
soundness of the current banking system depends on activity regulation. Many contemporary
analysts doubt that the 1933 collapse was due to
banks' affiliation with securities firms. 5 Most
banks that failed during the 1920s and early
1930s were small and had no large securities
affiliates.6 The prominent commercial banks whose
MAY 1984, E C O N O M I C

REVIEW

affiliates' unethical behavior had upset Congress
remained in business.
Another reason for doubting a current safetyactivity regulation connection is the development of deposit insurance and the more active
role taken by the discount w i n d o w since 1933.
The 1933 banking crisis occurred because even
sound banks became illiquid when the public
lost confidence and withdrew deposits. The
creation of deposit insurance reduced the incentives for people to withdraw money if they
think a bank will fail. Furthermore, as a consequence of changes in Federal Reserve policies
for administering the discount window, the Fed
now provides sound banks with the resources
they need to survive a liquidity crisis.
Federal deposit insurance and strengthening
the Federal Reserve discount w i n d o w have
reduced the probability of a banking system
collapse, but they have created new problems. As
Edward Kane (1983 and 1984) points out, the
government now bears much of the risk of bank
failures. If banks are allowed to engage in new
activities that increase bank risk, then the government will bear those risks.
One problem with the government's bearing
the risk of bank failure is the effect on competition
between firms. If the market believes that banking
organizations' liabilities all have implicit government backing, then it will charge lower risk
premiums on those liabilities. This will give banking
organizations a competitive advantage over firms
not associated with a commercial bank. 7
Fear of concentration of power and conflicts
of interest were far more responsible for the
Bank Holding Company Act of 1956 and its 1970
amendments than was the financial risk of nonbanking activities. 8 Prior to 1956, BHCs could
acquire banks outside their home state and
commercial firms without obtaining permission
from the state of the acquiring bank. Some BHCs
were building interstate networks of banks and
commercial firms. For example, William Upshaw
(1968) notes that Transamerica held 38 percent
of all commercial bank deposits in five western
states in 1946. In 1956, following the Supreme
Court's refusal to uphold the Federal Reserve's
attempt to force a divestiture of Transamerica's
interstate holdings, Congress turned its attention
to BHC activities. It found some BHCs building a
conglomeration of bank and nonbank firms that
raised concerns about the concentration of financial power. A Senate Banking and Currency
FEDERAL RESERVE B A N K O F A T L A N T A




Committee report on the proposed act makes it
clear that the primary rationale for restricting
BHCs was a fear of concentrated power.
" I t is not the committee's contention that
bank holding companies are evil of themselves.
However, because of the importance of the
banking system to the national economy,
adequate safeguards should be p r o v i d e d
against undue concentration of control of
banking activities."
Further support for the concentration of power
theory is given by the fact that the act covered
only multi-bank holding companies. If the primary
concern had been bank safety, one would expect
the controls also w o u l d have been placed on

"Federal deposit insurance and
strengthening the Federal Reserve
discount window have reduced the
probability of a banking system collapse,
but they have created new problems."

one-bank holding companies, but no such restrictions were placed on them. The Senate
report justified this by arguing that:
"Your committee did not deem it necessary to
include within the scope of this bill any
company which manges or controls no more
than a single bank. It is possible to conjure up
visions of monopolistic control of banking in a
given area through ownership of a single bank
with many and widespread branches. However, in the opinion of your committee no
present danger of such control through the
bank holding company device threatens to a
degree sufficient to warrant inclusion of such a
company within the scope of this bill."
Starting in early 1968, many large banks began to
form one-bank holding companies to exploit the
potential diversification opportunities This alarmed
many observers, including then Federal Reserve
Chairman William Martin, w h o argued in 1969
that: "...if we allow the line between bankingand
commerce to be eased, we run the risk of
cartelizing our economy." 9 This concern dealt
more with the potential for problems than the
9

reality of any problems. As the Senate Banking
Committee's report on the 1970 BHC act amendments notes:
" I n making this decision, the committee wishes
to note its agreement with all of the government regulatory agencies who testified that
there have been no major abuses effectuated
through the one-bank holding company device.
It is clearly understood that the legislation is to
prevent possible future problems rather than
to solve existing ones."
Essentially, the one-bank holding company movement exposed a major loophole in the 1956
restrictions and Congress wanted to extend the
restrictions to prevent undue concentration of
power. This interpretation of the 1970 amendments is further bolstered by the statement of
the House managers in the conference committee
report on the amendments. The report details its
concerns with the concentration of e c o n o m i c
resources and power, decreased or unfair competition, adverse competitive effects, and tie-ins.
It then says that the Federal Reserve Board also
should consider potential conflicts of interest
and unsound banking practices when it authorizes
a new activity. Congress was concerned about
bank safety and soundness when it passed the
1970 amendments, but these appear to have
been secondary concerns.
Thus safety and soundness considerations do
not appear to have been the primary factor
behind either the Glass-Steagall restrictions or
the BHC act's activity restrictions. Furthermore,
the development of deposit insurance and the
revision of discount w i n d o w administration minimized the risk of a banking system collapse. The
real problem with removing activity restrictions is
that it could shift risks to the government Such a
shift could strain the safety and soundness system
and give banks a competitive advantage in their
nonbanking endeavors.
The potential problem of allowing traditional
banking organizations to enter into currently
prohibited activities is not one-dimensional. Firms
currently operating in activities prohibited to
banks are acquiring savings and loans and nonbank banks. 10 These thrifts and nonbank institutions can provide most of the asset and liability
services, such as transaction accounts and commercial loans, that have in the past made banks
uniquely important in our financial system. Furthermore, nonbank institutions can be insured by the
federal government and can gain access to the
10



discount window, so their problems can also
impose costs on the system designed to protect
traditional banking organizations. These nonbank bank acquisitions raise the same fundamental questions posed by proposals to expand
permissible bank activities. The conclusions drawn
below, therefore, apply to acquirers of thrifts and
nonbank banks. 11

Other Methods of Maintaining
Bank Safety
The above analysis argues that, given deposit
insurance and the discount window, activity
restraints are not necessary to protect the banking
system from collapse—but they may have a role
in limiting the risks borne by the government
safety and soundness programs when insurance
is not properly priced. 12 This suggests that reform
of the safety and soundness system could substitute for activity regulation. 13 Possible reforms
include proposals to deregulate the activities of
BHC nonbank subsidiaries, proposals to reform
deposit insurance so that banks are charged riskbased premiums, and proposals to increase the
risk borne by private creditors of banks.

"The real problem with removing activity
restrictions is that it could shift risks to
the government (which could) strain
the safety and soundness system and
give banks a competitive advantage in
their nonbanking endeavors"

One proposal to allow activity deregulation
through expanding the permissible activities of
BHC subsidiaries was made by the Treasury Department a couple of years ago.14 It attempts to
ensure safety and soundness by restricting transactions between bank and nonbank subsidiaries
to insulate banks from the risks borne by their
affiliates. It assumes that individual nonbank
subsidiaries within a BHC could fail without
affecting the health of the banking subsidiaries.
This proposal is attractive because it claims to
eliminate the safety and soundness problems
M A Y 1984, E C O N O M I C REVIEW

associated with expanded BHC activity. Unfortunately, as Robert Eisenbeis (1983) points out,
subsidiary banks' risk exposure can be independent of the exposure of its affiliates only if the
BHC is run as a passive mutual fund. If the BHC
controls or coordinates the activities of its subsidiaries to maximize joint (or consolidated)
profit then BHC affiliates' problems will inevitably
affect the bank subsidiaries. Furthermore, existing
evidence suggests that BHCs operate as integrated entities. 15
An important problem is that BHCs have
shown a tendency to draw on all of their resources
to help troubled subsidiaries. For example, BHCs
risked substantial losses in the 1970s to prevent
the real estate investment trusts they sponsored
from failing, even though the BHCs did not even
have substantial ownership interest in those REITs.
The primary stake to individual BHCs in an REIT
failure was their reputation. BHCs logically would
do at least as much for units they own, especially
if those units generate important synergies with
the BHCs' banking subsidiaries. The Treasury
Department argues that regulations can be developed to prevent BHCs from using banks to
help nonbank subsidiaries. Eisenbeis argues, however, that such regulation imposes costs on the

"We imposed deposit insurance to
prevent bank panics, but now are
considering reimposing market
discipline through the threat of runs to
limit the risk exposure of the insurance
system."

BHC and will induce it to shift activities from
subsidiary banks to nonbank affiliates. These
shifts w o u l d increase bank dependence on
nonbank affiliates for customer services and operational support. Thus, attempting to isolate
banks from their subsidiaries could increase their
dependence on subsidiaries.
The risk borne by the government if a bank or
an affiliate is allowed to engage in a new activity
could be controlled by charging the bank a
variable-rate insurance premium based on risk
exposure. The government bears some of the
F E D E R A L RESERVE B A N K O F A T L A N T A




cost of a failure because it fails to charge premiums
based on the banking organization's risk. Thus,
individual banks are in a position to take large
gambles knowing that the bank can keep its
earnings if the risk pays off and that the government will cover the losses if it fails. Furthermore,
even banks not inclined to gamble have less of
an incentive to control their risk exposure than
they would if they were charged for the risks they
take. As Mark Flannery (1982) notes: "...FDIC's
fixed-rate premium structure is unusual and this
constitutes the raison d'etre for other bank
regulations."
Variable-rate insurance may work well in some
theoretical models, but risk-based premiums
would be difficult to implement. In its report to
Congress, for example, the FDIC said that an
"ideal system" with premiums closely tied to
(commercial bank) risk" is simply notfeasible." If
relating insurance premiums to risk for banks is
difficult, it must be even more difficult within a
holding company framework. 1 0
A third way of deregulating while limiting the
risk exposure of government is to shift more of
the risk exposure to the private sector. The FDIC
recently began experimenting with this approach
by limiting full payment on deposits to$100,000
per depositor for selected bank failures. u '
Other possible ways of transferringthe r i s k t o t h e
private sector include substituting private for
government insurance, and requiring banking
organizations to use more equity and subordinated
debt funding.
Before the government can shift more risk to
the private sector, several problems must be
addressed. One is that shifting risk to depositors
and private deposit insurers means that uninsured
depositors will be more likely to panic when
bank solvency becomes a question. 10 As noted
above, the banking collapse of 1933 was due in
part to a loss of public confidence in the system.
Deposit insurance was created in part to prevent
bank runs, and it (along with the discount window) has prevented the reoccurrence of widespread runs. Thus, reducing deposit insurance
coverage to limit bank risk would create an
anomalous situation. W e imposed deposit insurance to prevent such panics, but now are
considering reimposing market discipline through
the threat of runs to limit the risk exposure of the
insurance system. 19
A second problem with shifting risk is that in
order to do so the government must be perceived
11

as willing, and must in fact be willing, to let
troubled banking organizations fail.20 The private
sector will not control bank risk exposure effectively
if it believes the government may not allow
banks to fail. 21 The FDIC report notes that, at
present, many large depositors doubt that multibillion dollar institutions will be closed. 22 The
public's view of large bank failures is represented
in a recent article by Robert A. Bennett in the
New York Times. Bennett states that "...big
banks...are too important to be allowed to collapse.
Public policy has for decades affirmed this doctrine
by keeping banks from going far afield into other
businesses and by propping them up when they
get in trouble."
Each of the three methods of minimizing the
government's exposure to potential losses from
expanded banking activities would be desirable
if they worked as intended. Unfortunately, each
of the three has problems. The separate subsidiary
approach can work only if BHCs operate as
passive mutual funds or if regulations are imposed
to force them to operate that way. The FDIC has
difficulty measuring bank risk now, and these
problems would be increased as banks expanded
into new activities. Finally, greater reliance on the
public sector may be possible, but the issues of
bank runs and the closing of very large banks
must be addressed first.

A n a l y z i n g T h e R i s k i n e s s of
P r o h i b i t e d Activities
There is reason, then, to be concerned about
the riskiness of currently prohibited activities.
Ideally, these concerns would be reduced by
reforming the safety and soundness system.
Unfortunately, no reform proposal appears both
workable and easy to implement. Furthermore,
the financial services industry is evolving too fast
to allow us to take several years to reform the
system. As an interim measure, we could permit
banking organizations to engage in financial
activities that seem unlikely to increase significantly the risk of failure. Limiting the range of
permitted activities to financial activities would
allow banks to compete with the aspiring financial supermarkets, while limiting the types of
risks borne by the government. Prohibiting acquisition of activities likely to increase banking
organizations' risk would further limit the government's exposure.
If risk is to be a criterion for activity reform,
then some method of measurement is needed. A
12




naive approach would be to compare each
activity's variability of earnings and failure rate
with those of banks. A more sophisticated approach is suggested by David Meinster and
Rodney Johnson (1979). Their approach looks at
the effect of diversification on banking organizations' cash flow. It is clearly superior to the
naive approach because it recognizes that some

"Studies that examine earnings data
often find that banking is one of the
riskiest activities and that bank risk
exposure would be reduced if they
diversified."

"risky" activities can actually curtail risk by reducing the variability of a combined organization's cash flow. For example, a risky activity
could produce most of its cash flow when bank
cash flow is weak but produce little when the
bank's cash flow is strong. The variations in flow
from the risky activity would offset variations in
the bank's flow and their combined cash flow
would be less variable than either of their individual flows.
While Meinster and Johnson's approach is an
improvement, it still has some weaknesses. Their
focus on liquidity rather than solvency is inappropriate for most larger banking organizations.
These organizations rely on liability management
for their liquidity rather than cash flows from
operations. Another weakness is the authors' concern about the combined organization's capitalization. Bank regulators can offset any attempt to
undercapitalize the new activities by imposing
capital standards on the bank or BHC. Thus
capitalization appears irrelevant in deciding
whether to allow banking organizations to perform a particular activity. 23
The Meinster and Johnson study's focus on the
effects of diversification is an appropriate first
step in reviewing the risks of allowing banks to
expand into new activities. One way to analyze
the diversification effects is to look at the level
M A Y 1984, E C O N O M I C

REVIEW

and variance of earnings of banking and other
activities, and then look at the correlation between those earnings. Nonbankingactivities can
reduce the riskiness of banking organizations if
either (1) the earnings from a nonbank activity
are less volatile than in banking, or (2) earnings
from the nonbanking activity are negatively correlated with those in banking (that is, if nonbanking profitability is highest when bank profits are
at their lowest and vice versa). A banking organization's risk could increase if it acquires financial
activities that have more volatile earnings than
banking and whose returns are highly correlated
with banking.
Analysis of those diversification effects are
important, but they are not the sole criteria on
which a decision should be based. The way an
activity is managed can also affect its risk significantly. Cautious managers can turn a risky activity
into a safe one, while an aggressive or inept
management can jeopardize a safe activity. Banks
already can take huge, undiversified risks by
speculating on interest rate and foreign exchange
movements, but few banks have failed for these
reasons. This suggests that regulators should
scrutinize a bank's management when considering
whether to let it expand into new activities.
Some activities that may be too risky for banks in
general could be acceptable for a bank that has a
plan for maintaining reasonable risk levels. In
other cases, a bank with weak management
might not be permitted to perform an activity
allowed to most other banks. 24

Riskiness of New Activities:
Prior Studies
Two types of studies may shed some light on
the effect on bank risk of expanding permitted
activities. One type uses accounting data to
study the riskiness of selected activities by themselves and their riskiness in combination with a
banking organization. These studies typically
have assumed that the bank and its prospective
nonbank affiliates were held by a passive holding
company that did not interfere in their operations.
The evidence from these studies suggests that
allowing banks to engage in additional activities
may reduce their riskiness. The other type of
study examines stock market reactions to the
changing activity restrictions and to mergers of
bank and nonbank firms. Studies of stock market
reactions are useful because of their prospective
FEDERAL RESERVE B A N K O F A T L A N T A




nature. The market evaluates a company's expected future earnings and risk, taking account
of any anticipated operating changes. These
studies have found evidence that stock returns
increase when a BHC can undertake geographic
diversification, but that stocks neither gain nor
lose on product diversification.
One of the earliest studies comparing the risks
of banking and nonbanking organizations was
conducted by Arnold Heggestad (1975). Heggestad used industry data to examine a variety of
activities that one-bank holding companies engaged in prior to 19 7 0. 25 He noted that one
weakness of using industry data is that it captures
only cyclical variations in profitability and not
firm specific variations in profits. Heggestad
found that commercial banking is one of the
most risky activities when risk is measured as the
coefficient of variation in profits. He also found
that the returns to some activities (including real
estate agents, brokers and managers and insurance
brokers and agents) are negatively correlated
with banking. These findings suggest that banks
could reduce their risk exposure by diversifying
into new activities.
Johnson and Meinster (1974) also used industry
data and reached conclusions similar to Heggestad's. They also simulated ^various portfolio combinations and found that BHCs that expand
into nonbank activities can be less risky than
BHCs that confine their activities to banking.
Peter Eisemann (1976) looked at a small sample
of firms in different industry groupings and concluded that banking is one of the lowest risk
activities based on profit variability. John Rose
(1978b) reexamined Eisemann's results and concluded that banks were more risky taking into
account both profit levels and variability (using
coefficient of variation in profits). Interestingly,
Eisemann's simulation found that insurance brokerage was in the simulated portfolio that gave
the highest return for low and medium risk
organizations.
Michael Jessee and Steven Seelig (1977) compared the coefficient of variation of profits for
selected BHCs and independent banks to determine whether BHCs were less risky and whether
differences in diversification across BHCs reduced
risk. They found that risk is not lower in BHCs
than independent banks nor is it lower in BHCs
that have a greater share of nonbanking assets.
Rose (1978b) argued, however, that Jessee and
Seeli^s results may reflect econometric problems
with their model. Rose also argued that the
13

reduction in risk due to the BHC diversification
may be offset by increased risk-taking by the
bank and its nonbanking affiliates.
Roger Stover (1982) examined the effect on a
BHC's value of establishing a portfolio of banks
and assorted nonbank subsidiaries. He began by
determining the debt capacity of a portfolio of
bank and nonbank assets given a fixed probability
of failure. He then assumed that an organization's
value increases as its debt capacity increases. His
results also have implications for the portfolio's
risk. In his model, an increase in debt capacity
would imply a decrease in the riskiness of the
firm with leverage held constant. The model was
estimated using both industry average data and
data from specific firms. Stover found that BHC
diversification outside of banking increased the
organization's value. His analysis of companies
found that fire and casualty insurance, investment
banking, land development and savings and loan
companies should be included in a portfolio
along with banking organizations because they
increase its debt capacity and, by implication,
lower its risk given constant leverage.
John Boyd, Gerald Hanweck, and Pipat Pithyachariyakul (1980) point out an important problem with using industry data when analyzing
risk. Their study uses data on existing BHC
subsidiaries. They found that the risk is almost
always underestimated when one uses industry
data rather than data for individual companies.
They also found that the correlations of returns
can even change signs when one uses individual
company data rather than industry data. Their
results suggest that we should not read too
much into analysis using industrywide data.
The effect of one-bank holding company formations (and the impact of the 1970 amendments to the Bank Holding Company Act) on
bank stock returns is examined by Robert
Eisenbeis, Robert Harris and Josef Lakonishok
(1982). Prior to the 1970 amendments, a onebank holding company could engage in any
activity except investment banking. Thus, the
stock market's reaction to holding company
formation during the sample period w o u l d
reflect the market's opinion of the value of
diversification. The researchers found that the
stock market valued the potential for one-bank
holding companies to provide for geographic
diversification, but they found little evidence
that the stock market valued product diversification.
14



The effect on the stock price of nonbank
organizations acquiring so-called " n o n b a n k
banks" is examined by Jeffery Born, Robert
Eisenbeis and Robert Harris (1983). Presumably,
if banking is less risky than nonbank activities,
then acquiring nonbank banks should lower a
nonbank organization's risk. That study found
positive, but statistically insignificant, returns
to the shares of nonbank organizations.
These studies of stock market returns provide
some information on change in the firms' value.
The results, however, are ambiguous concerning
the perceived change in risk of an acquiring
firm. Stock prices can increase even if the
combined organization is more risky, provided
the firm's expected returns also increase. Conversely, stock prices can fall for the acquirer
even if the combined organization is less risky,
provided the combined organization's expected
returns are lower.
Studies that examine earnings data often find
that banking is one of the riskiest activities and
that banks' risk exposure would be reduced if
they diversified. These studies use the best
available data, but they must be interpreted with
caution. Boyd, Hanweck and Pithyachariyakul
demonstrate the problems with using industry
data and the studies that used data from
individual companies relied on small samples.
Studies that looked at stock market returns have
found no evidence to demonstrate that banks
will become either more or less risky.

Evidence on Risk:
Analysis of Earnings
Table 1 provides a detailed look at the variability
of returns from the Corporate Source Book of
I n c o m e similar to those examined by Heggestad. 26 Heggestad's data covered the 19531967 period, prior to passage of the 1970
amendments to the BHC Act. He examined the
variability of both the ratio of average profits to
capital and the ratio of net income to total
assets. Given what has subsequently proved to
be a significant difference in the capitalization
of BHC subsidiaries compared to independent
firms and the widespread use of double leverage
by holding companies, only the variability of
net income to assets from nonbanking activities
is examined in Table I. 2 7 The 1970-1980 data
allow a comparison with those of Heggestad of
any differences that may have occurred over a
M A Y 1984, E C O N O M I C

REVIEW

T a b l e 1. Coefficients of Variation and Determination for Selected Banking Activities (1970-1980)
Coefficient
Variation

Coefficient
Determination

Banking
Mutual Savings Banks
Banks and Trusts Except Mutual Savings Banks

0.173503
0.296098
0.211527

0.622278
-0.43451
1

Credit Agencies Other than Banks
Savings and Loans
Personal Credit Agencies
Business Credit Agencies
Other Credit Agencies and Finance Companies Not Allocable

0.229455
0.337307
0.326252
0.253581
0.146301

-0.26771
-0.20784
-0.49144
0.586265
-0.05962

Security and Commodity Brokers, Dealers, etc.
Security Brokers, Dealers, etc.
Commodity Brokers, Dealers, etc.

0.350792
0.406553
0.213660

-0.16108
-0.17821
0.431596

Insurance
Life Insurance
Mutual Insurance
Other Insurance Companies

0.183474
0.100957
0.487323
0.427181

0.167736
-0.163621
0.095143
0.202264

Insurance Agents, Brokers, Service

0.118640

0.487375

Real Estate
Real Estate Operators, Lessors of Buildings
Lessors of Mining, Oil, e t c
Lessors of RR Property, Other Property Not Allocable
Condominium Management, Co-op Housing Associations
Subdividers and Developers
Other Real Estate

0.216494
0.200242
0.434163
0.124316
0.542500
0.306568
0.184351

0.605346
0.645042
0.370005
-0.36543
0.928662
0.560607
0.310724

0.259857
0.247479
0.609843
0.627969
0.156598
' 0.385963
0.106876

0./92789
0.599360
0.421816
0.808927
0.686523
-0.24442
0.456074

0.198433

0.621591

Holding and Other Investment Companies
Regulated Investment Companies
Real Estate Investment Trusts
Small Business Investment Companies
Other Holding and Investment Companies Except BHCs
General Merchandise Stores
Food Stores
Bank Holding Companies

The coefficient of variation is a measure of risk of the activity by itself. The coefficient of determination is a measure ot the correlation of
earnings of the firms with banking.

period of rapid change in the banking industry.
These expanded tabulations also permit a preliminary examination of securities, insurance
and related activities now being considered as
possible permissible activities for bank holding
companies.
Several observations are worth noting. First,
if the coefficient of variation is used as a risk
measure t h e n we c o n c l u d e that banking
FEDERAL RESERVE B A N K O F A T L A N T A




(whether looking only at banks or at bank
holding companies) is neither the most nor
least risky activity. Second, conclusions about
risk are influenced by the period under investigation. For example, using these same measures,
Heggestad found that "lessors of railroad property" were among the riskiest firms investigated,
while the present results suggest they are
among the least risky. Third, many of the
15

activities presently under consideration, such
as securities, insurance, and certain real estate
activities are more risky than banking. On the
other hand, these activities appear somewhat
less risky than other activities (such as consumer
and commercial finance, operating small business investment corporations, and owning S&Ls),
already permissible to banking organizations,
which have not necessarily caused substantial
problems. Examination of the coefficients of
determination, however, reveals that several
activities that appear more risky than banking
(S&Ls, personal credit agencies, security brokerages and dealers, life insurance, and general
merchandise) have returns that are negatively
correlated with those of banking. This would
suggest that such activities would be riskreducing and imply the potential for beneficial
diversification.
As Heggestad noted, we must exercise care in
interpreting these data. They look only at cyclical
variability of returns without weighing any synergies that may accrue; the fact that bank holding
companies (not controlling for size) seem to
have a smaller coefficient of variation than commercial banks alone suggests that such synergies may exist, possibly because certain riskreducing activities have been authorized. Nor do
the data imply anything about the riskiness of
specific acquisitions. Finally, no attention is paid
to cash flows. Rather, those data raise more
questions than they answer concerning, for example, the stability of such measures over time.
Also, the importance of negative correlation among
banking and various nonbanking activities
deserves further investigation.

Evidence on Risk:
B o n d Market Reactions
What about the return on bonds of firms that
have recently acquired a financial services firm?
Can it provide additional information on the
riskiness of different financial services? The
bond markets, in determining the price of a
company's bonds, consider the factors that can
influence its riskiness. Thus, the market will
provide information on the expected effect of
management on the riskiness of the new combination.28 If the bond markets expect the new firm
to be more risky, after considering all factors
including management, then the price of the
firm's bonds will fall. If the new firm is expected
to be less risky, prices will rise.29
16




Unfortuanately most of the cases where one
firm entered a new aspect of the financial services
industry did not involve banking organization
acquisitions. Therefore, most of the acquiring
organizations we looked at are nonbankfinancial
firms and nonfinancial firms. This analysis should
shed some light on which combinations of services
in the financial services industry are the most
risky and whether the financial services industry
is less risky than some nonfinancial industries.
For this study we used the monthly returns on
the bonds of 11 companies. 30 W e separated the
sample into four groups based on the characteristics
of the acquiring and acquired firms. The composition of the four groups and the merger dates are
given in Table 2.

"The threat that activity deregulation
will destabilize the financial system is
minimal given the rest of the safety
and soundness system, especially
deposit insurance and discount-window
access"

The returns on a company's bonds normally
fluctuate, so we needed some method to distinguish abnormally large fluctuations due to a
merger from random fluctuations. W e utilized
the comparison period returns approach that
Stephen Brown and Jerold Warner (1980) used
in analyzing changes in stock returns.31 This method
compares fluctuations in returns duringa control
period with their fluctuations at the time of
acquisitions. If the fluctuations are significantly
larger at the time of acquisition than during the
comparison period, the acquisition is assumed to
have had a significant effect on bond prices. The
control period extends from six months prior to
the acquisition to t w o months prior and from one
month after to six months after. The abnormal
returns are measured overthe month before and
month of the acquisition.
Some of the abnormal bond returns in Table 3
are quantitatively large, but all are statistically
insignificant. Neither were the abnormal returns
of the individual acquiring firms significant. The
MAY 1984, E C O N O M I C

REVIEW

T a b l e 2. List of Firms in Bond Study by Characteristics of Acquired and Acquiring Company

Acquiring
Company

Group

Acquired
Company

Announcement
Date

Bond
Rating

1 /8/82
10/8/81
1/2/81
9/22/82

Baa
Aa
Aa
Aaa

N/A
Aaa

Nonfinancial
firms acquiring
financial
firms

American Can
Sears, Roebuck & Co.
Dana Corp.
Xerox

Associated Madison
Co.
Dean Witter Reynolds
General Ohio S&L Corp.
Crum & Foster

Banks acquiring
discount
brokers

United Jersey Banks
Bank America

Richard Blackman & Co.
Charles Schwab & Co.

9/29/82
11 / 2 5 / 8 1

Financial firm
acquiring another
financial firm

American General

Credithrift Financial
Inc.

9/21/81

Financial firms
acquiring a
nonbank bank

Household International
Aetna Life & Casualty
Walter E Heller Intl. Corp
National Steel Corp.

T a b l e 3. Mean Abnormal Bond Returns of Firms
Acquiring a New Financial Activity

Group
Nonfinancial firm acquiring
a financial firm

Annualized Return
(t-statistic)

-.00202

(-104)
Banks acquiring a discount
broker
Financial firm acquiring
another financial firm
Financial firm acquiring
a nonbank bank

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




-.19737
-.70289
.25844
(.24117)
-.19089
(-.48717)

Valley National Bank
Samuel Montagu & Co.
American National Bank
& Trust
United Financial Corp.

7/13/81
7/23/82

Aa
Aaa

7/14/72
3/7/79

N/A
Aa

large size of some of the abnormal returns
appears to reflect volatility in long-term rates
during this period. The insignificance of the
abnormal returns suggests that bondholders did
not perceive the acquisitions to have a significant
effect on the acquiring firm's risk position.

Conclusion
Bank activity regulation is part of a larger
system designed to protect the stability of the
U.S. financial system. The threat that activity
deregulation will destabilize the financial system
is minimal given the rest of the safety and
soundness system, especially deposit insurance
and discount-window access. The problem with
activity deregulation is that the government now
bears much of the risk of bank failure. Thus, the
government will bear additional risk to the extent
that deregulation increases the riskiness of banks.
We cannot avoid all risks, however, by maintaining
existing activity regulation. Banks are regulated
to protect the financial system. Regulation may
17

allow important bank functions to be assumed
by institutions whose safety is less protected. If
this happens, we would defeat the very purpose
of regulating and protecting banks.
One alternative to regulating activities is to
reform the safety and soundness system so that
the private sector, and not the government,
bears the risks of new ventures. Each of the three
reforms under consideration have important problems that must be resolved. The first reform we
considered would allow the new activities to be
performed in BHC nonbank subsidiaries, and
then use regulations to insulate the banking
subsidiaries from their nonbank affiliates. Unfortunately, the health of the banking subsidiaries
necessarily will depend on the health of their
nonbank affiliates so long as the BHC uses its
control over subsidiaries to maximize synergies
and profits.
Another possible reform w o u l d charge riskbased premiums for government deposit insurance.
The problem is that the FDIC says it cannot link
premiums closely to risk for traditional banks,
and the task is certain to be more difficult as the
range of covered activities expands. A third
possible reform w o u l d be to transfer more of the
risk of bank failure to the private sector. This may
have some merit, but first we must consider what
to do about dealing with bank runs and about
allowing very large banks to fail.

'See Rose (1984) for an overview of the rationale for bank activity
regulation.
'For example, banks lost substantial consumer deposits to the money
market funds when bank deposit rates were limited by Regulation Q.
•"For example, an affiliate of National City Bank sold Peruvian bonds
without notifying the public that its agents had reported that Peru was a
bad credit risk. The value of these bonds fell from 96'/2 with a spread of
5.03 points when issued in 1927 to 7 in February 1933. See Kennedy
(1 973), especially Chapter 5, tor a discussion of the unethical behavior.
"The Supreme Court commenting on the reasons for the passage of GlassSteagall in I.C.I vs. Camp decision, 91 S. C t 1091 (1971).
J
Benston (1982), for example, argues that the primary purpose behind the
legislation was to restrict competition.
•Kennedy notes that the overwhelming majority of small banks were small,
rural and located in unit banking states
'Sanford argues that commercial banks are charged a lower risk premium
than other firms because regulation reduces their risk
"Some restrictions on bank holding company affiliates were passed in the
1933 Banking Act, but these restriction were weak. They only limited BHC
affiliation with an investment banking firm and limited BHCs ability to
vote the shares of any Federal Reserve member banks
"Senate Banking Committee s 1970 report.
,0
The Bank Holding Company Act of 1956, as amended, defines a bank
as an institution that accepts demand deposits and makes commercial
loans. A nonbank bank is an insured and regulated commercial bank,
but it does not offer either demand deposits or commercial loans. It
does not therefore, meet the legal definition of a bank for the purposes
of the Bank Holding Company A c t
" S e e Eisenbeis (1984) for a further discussion of the issues raised by
nonbank banks.

18




Since the decision to maintain existing regulations and the decision to reduce activity regulation both carry risks, one possible interim
measure would be to allow banking organizations
to offer additional financial services that are
unlikely to increase their risk significantly. W e
explored this possibility by looking at the evidence
on the effect of deregulation on risk. The evidence,
based on historical earnings data, suggests that
banking organizations' risk would have been
lower in the 1970s had they been passive owners
of some activities, but it w o u l d have increased
for other activities.
This evidence is incomplete, however, because
management can have a significant effect on risk.
Cautious bank managers can make a risky activity
relatively safe, but aggressive or inept managers
can make a safe activity become risky. An analysis
of bond market reactions to the acquisition of
financial firms suggests that the bond market
doubts that these acquisitions significantly change
the risk exposure of the acquiring firm. This
evidence also is incomplete, however, because
examples of banks acquiring firms performing
prohibited activities are, by definition, unavailable.

— Larry D. Wall
and Robert A. Eisenbeis
The authors
assistance

wish to thank Felicia bellows

and Rebel Cole

lor their

research

' ' S e e also Karekan and Wallace (1978).
'••Ignoring for the moment the concentration of financial power and conflict
ot interest problems.
'"Chase and Waage (1983) also argue that banking subsidiaries can be
protected from the problems of their nonbank affiliates
" S e e Walen (1982a, b), Rose (1978) and Murray (1978).
'"See Wall (1 984a) for a review of the FDIC report and Wall (1984b) for
further discussion of the problems with a risk based insurance premium
scheme run by the government.
" T h e first failure to be handled with the modified purchase and assumption
method that exposes depositors to risk was the failure of Seminole State
Bank. See Murray and Paltrow (1 984).
'"Private deposit insurance will not stop bank runs unless the solvency and
liquidity of the private insurer are guaranteed by someone with unquestionable solvency and liquidity. See Leff and Park (1977) for
discussion of the collapse of the Mississippi savings and loan insurance
fund.
9
' Wall (1984b) discusses the potential for overcoming the problem by
requiring banks to issue additional subordinated debt. Subordinated
debt holders can redeem their claims only when the debt matures and
they are therefore unable to participate in bank runs He also points out,
however, that the amount of subordinated debt that can be issued in the
short run (and perhaps in the long run) will be limited due to practical
problems
'"Mayer (1975) and Longstreth (1983) both discuss reasons why the
government may not want to let large organizations fail.
2
' See Wall (1 984b) for a further discussion of the issues involved in shifting
the risk of loss to the private sector.
" E v e n if depositors private insurers or other parties are nominally at risk,
the government can prevent a bank from failing if it wishes The Federal

M A Y 1984, E C O N O M I C R E V I E W

Reserve can k e e p an illiquid bank open by providing loans to the b a n k but
this will result in a subsidy by the government to the extent the rates on
the loans are below those the market w o u l d charge the bank.
' J T h i s c o n c e r n is obviously relevant to the agencies, however, w h e n they
modify current s t a n d a r d s
"•This suggestion w o u l d effectively extend current restrictions on BHC
expansion to BHC expansion into new activities.
" T h e activities of one-bank holding c o m p a n i e s were not restricted prior to
the passage of the 1 9 7 0 a m e n d m e n t s to the Bank Holding C o m p a n y Act
except for the Glass-Steagall restrictions on investment banking.
•"•Source: Internal Revenue Service, various years 1970-1980.
•"See for example, the studies reviewed in T h e B a n k H o l d i n g C o m p a n y
M o v e m e n t t o 1 9 7 8 : A C o m p e n d i u m , A study by the staff of the Board of
Governors of the Federal Reserve System, Washington, D C„ 1978.
" T h e effect of m a n a g e m e n t on risk could also be examined by looking at
the earnings of the c o m b i n e d firms after the acquisition. This is not d o n e
in this study because the mergers being analyzed have taken place since

1979, w h i c h is t o o recently to have p r o d u c e d e n o u g h information on
earnings.
" T h e u n a m b i g u o u s effect of risk on bond prices contrasts with the
ambiguous effect of risk on stock prices. If an increase in the risk of a
stock is more than offset by an increase in e x p e c t e d return, t h e n the price
of a stock will g o up, and vice versa for a decrease in risk. In contrast, the
maximum return on bonds is fixed, so bondholders concentrate on risk
and can ignore c h a n g e s in e x p e c t e d returns.
J0
An initial list of c o m p a n i e s was obtained from Rosenblum and Siegel,
Information Access Corporation, Trade and Industry Index (DIALOG
O N L I N E FILE 148) and Born, Eisenbeis and Harris. The list was then
pared d o w n to t h o s e acquisitions involving a new entry or dramatic
increase in current position of the acquiring firm in some aspect of t h e
financial services industry. The firms actually used are those in the
r e d u c e d sample w i t h publicly traded bonds that w e r e listed in Moody's
Bond Guide.
•"Masulis and Woolridge also use this method to examine b o n d r e t u r n s

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Eisenbeis, Robert A, Robert S. Harris and Josef Lakonishok, "Benefits of
Bank Diversification: The Evidence from Shareholder Returns," University of North Carolina School of Business Administration, (forthcoming J o u r n a l o f Finance). October 1982.
Federal Deposit Insurance Corporation. D e p o s i t I n s u r a n c e in a C h a n g i n g
E n v i r o n m e n t A Study S u b m i t t e d to Congress by the Federal Deposit
Insurance Corporation, Washington, D. C. (April 1983).
Flannery, Mark J. " D e p o s i t Insurance Creates a N e e d for Bank Regulation,"
B u s i n e s s Review, Federal Reserve Bank of Philadelphia (JanuaryFebruary 1982), pp. 17-27.
Hayes III, Samuel L " C o m m e r c i a l Banking Inroads into Investment Banking," E c o n o m i c Review, Federal Reserve Bank of Atlanta. 8 9 (May
1984).
Heggestad, Arnold A "Riskiness of Investments in N o n b a n k Activities by
Bank Holding Companies.' J o u r n a l o f E c o n o m i c s a n d B u s i n e s s , 27
(Spring 1975), 2 1 9 - 2 2 3 .
Jessee, Michael A and Steven A Seelig. B a n k H o l d i n g C o m p a n i e s a n d
t h e P u b l i c I n t e r e s t : A n E c o n o m i c Analysis. (D. C. Heath and
Company, Lexington, Massachusetts) 1977.
Johnson, Rodney D., a n d David R. Meinster. " B a n k Holding Companies:
Diversification Opportunities in N o n b a n k Activities." 1 E a s t e r n Econ o m i c J o u r n a l (October 1974), pp. 1453-1465.
Kane, E d m u n d J. "Role of Government in Thrift Industries' Net Worth
Crisis," in F i n a n c i a l S e r v i c e s : T h e C h a n g i n g I n s t i t u t i o n s a n d
G o v e r n m e n t Policy e d i t e d by George Benston, Prentice Hall, Englewood/Crest, 1983.
Kane, Edmund J G a t h e r i n g C r i s i s in F e d e r a l D e p o s i t I n s u r a n c e :
O r i g i n s , E v a l u a t i o n a n d P o s s i b l e Reforms, Book in progress, 1984.
Kareken, J o h n H., and Neil Wallace, "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," J o u r n a l of B u s i n e s s (July
1978), pp. 4 1 3 - 4 3 8 .
Kennedy, Susan E s t a b r o o k T h e B a n k i n g Crisis o f 1 9 3 3 , University Press
of Kentucky, Lexington, Kentucky) 1973.

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Leff, Gary and J a m e s W. Park "The Mississippi Deposit Insurance Crisis,"
B a n k e r s M a g a z i n e , 160 ( S u m m e r 1977), pp. 74-80.
Longstreth, Bevis. " I n Search of a Safety Net for the Financial Services
Industry," B a n k e r s M a g a z i n e , 166 (July-August, 1983), pp. 27-34.
Masulis, Ronald W. "The Effects of Capital Structure Change on Security
Prices: A Study of Exchange Offers," J o u r n a l of F i n a n c i a l E c o n o m i c s
8 (1980) pp. 139-178.
Mayer, Thomas. " S h o u l d Large Banks Be Allowed to Fail?" J o u r n a l o f
F i n a n c i a l a n d Q u a n t i t a t i v e Analysis, 10 ( N o v e m b e r 1975), pp. 6 0 3 610.
Meinster, David R., and Rodney D. Johnson. " B ä h k Holding C o m p a n y
Diversification and the Risk of Capital I m p a i r m e n t " T h e Bell J o u r n a l
o f E c o n o m i c s , 10 (Autumn 1979), pp. 6 8 3 - 6 9 4 .
Murray, William. "Bank Holding Company Centralization Policies," prepared
for the Association of Registered Bank Holding Companies, Golembe
Associates, Inc., February 1978.
Rose, J o h n T. " B a n k Holding Companies as Operational Single Entities," in
the B a n k H o l d i n g C o m p a n y M o v e m e n t t o 1 9 7 8 : A C o m p e n d i u m ,
Washington: Board of Governors of the Federal Reserve System
1978a, pp. 69-93.
Rose, John T. "The Effect of t h e Bank Holding C o m p a n y M o v e m e n t on
Bank Safety and Soundness," in T h e B a n k H o l d i n g C o m p a n y
M o v e m e n t t o 1 9 7 8 : A C o m p e n d i u m , Washington: Board of Governors of the Federal Reserve System, S e p t e m b e r 1978b, pp. 137-184.
Rose, John T. " G o v e r n m e n t Restrictions on Bank Activities: Rationale for
Regulation and Possibilities for Deregulation," (forthcoming I s s u e s in
B a n k Regulation), J a n u a r y 1984.
Stover, Roger D. "A Reexamination of Bank Holding C o m p a n y Acquisitions,"
J o u r n a l of B a n k Research, 13 (Summer 1982) pp. 101-108.
Sanford, Charles S. Jr. " S h o u l d the Glass-Steagall Act be Repealed? T w o
Views: Pro," A m e r i c a n Banker, (March 8, 1984) pp. 4, 7, 9, 12-14.
U. S Congress. Conference Report (to accompany H. R. 6778), Bank Holding
C o m p a n y Act A m e n d m e n t s , House Report 1747. 91 Cong. 2 Sess.
Washington: Government Printing Office, 1970.
U. S. Congress. Senate Committee on Banking and Currency. Bank H o l d i n g
C o m p a n y Act A m e n d m e n t s of 1970. Senate Report 1 0 8 4 . 9 1 Cong. 2
Sess. Washington: Government Printing Office, 1970.
U. S. Congress. Committee on Banking and Currency. Bank Holding
Company Act of 1955. Senate Report 6 0 9 . 8 4 Cong. 1 S e s s Washington:
Government Printing Office, 1955.
Upshaw, William F. "Federal Regulation of Bank Holding C o m p a n i e s — I , "
M o n t h l y Review, Federal Reserve B a n k of Richmond, (October 1968),
pp. 2-5.
Wall, Larry D. "Deposit Insurance Reform: The Insuring Agencies' Proposals," E c o n o m i c Review, Federal Reserve Bank of A t l a n t a 89,
(January 1984a), pp. 43-57.
Wall, Larry D. "The Future of Deposit Insurance: An Analysis of the Insuring
Agencies' Proposals," E c o n o m i c Review, Federal Reserve Bank of
A t l a n t a 8 9 (March 1984b), pp. 26-39.
Whalen, Gary. " M u l t i b a n k Holding C o m p a n y Organizational Structure and
Performance," Working Paper8201, Federal Reserve Bank of Cleveland,
March 1 9 8 2 a
Whalen, Gary, "Operational Policies of Multibank Holding Companies,"
E c o n o m i c Review, Federal Reserve B a n k o f Cleveland,(Winter 1981 1982b) pp. 20-31.
Woolridge, J. Randall. " D i v i d e n d C h a n g e s and Security Prices," J o u r n a l of
F i n a n c e 3 8 (1983) pp. 1 6 0 7 - 1 6 1 5 .

19

Beyond the deregulation that has already taken
place in financial services are foreshadowings
of continued market change and proposals for
further legislative deregulation. Further moves of
banks into insurance and securities activities at
home and abroad and further incursions of
nonbank firms into traditional preserves of depository institutions seem certain. There will be
pressure to give these moves and other potential
changes legal blessing.
Beyond the initial flush of
success of interest rate deregulation, what problems may
Financial-industry deregulation will stimulate
arise to haunt us in this new
greater
competition that can benefit America's
world? One of the principal
consumers, but for some critics it raises the spectre
concerns voiced by some important participants has been
of concentrated economic power.
its impact on the public's
access to competitive markets
and to prices that reflect the
economic value of the resources that they use.
The extent to which that concern proves to be
valid will depend on how the new competition
permitted by crumbling market barriers evolves
over time.
The optimal long-range resolution of the shortrun transition problem is approached by competition and new entry provided by erasing product
limits. Applicant of antitrust policy and philosophy,
grounded in existing legislation, should eradicate
any lingering problems. However, new antitrust
legislation dealing with cross-industry mergers
might help prevent abuses or conflicts, as well as
clarify some present ambiguous legal and economic
issues.

Bank Product
Deregulation:
Some Antitrust Tradeoffs

20




M A Y 1984, E C O N O M I C

REVIEW

I. H Y P O T H E T I C A L S C E N A R I O S O F
MARKET E V O L U T I O N
Product deregulation could produce several
alternative results:
A. The Fully Competitive Scenario. The ideal
competitive solution would produce an environment where barriers to entry erode as Congress
removes remaining Glass-Steagall constraints,
and technology permits all businesses to take full
advantage of new opportunities. More firms,
bank and nonbank alike, compete with one
another head-on in broadened product markets.
Technology will reduce dramatically the cost of
producing and delivering these new services.
Consumers will benefit fully from the new technology through lower prices and higher quality
financial service at retail. If small banks and thrifts
lack the necessary capital and expertise to "go it
alone," they can share in the new electronic
systems or buy or rent essential components
without restrictions. Since competition for small
institutions' respondent accounts will be intense,
the necessary technological and human inputs
will be available to the country bank from big city
firms or correspondents for the full cluster of new
financial services.
Small or specialized institutions can compensate for any cost or pricing disadvantage through
special consumer services gleaned from firsthand knowledge of the local market Empirical
studies indicate the small seller can flourish
despite new competition from bank leaders. 1
Whether new rivalry comes from other banks or
nonbanks, the theoretical implications for competition are similar. If competitors are numerous
and varied in size and focus, sellers are unlikely
to develop a collusive oligopoly. Other financial
institutions will stand ready to take business
away from would-be collusive oligopolists if
prices get out of line. Market power will not
persist permanently when attempts by would-be
monopolists to raise price cause consumers to
shift their business to existing competitors in the
broadened product market. If that fails to keep
market participants in line, then new entry from
all the other kinds of financial institutions now
able to compete with banks will surely do so.
Suppose that dominant commercial banks in a
market are pricing short-term loans in a noncompetitive way. Customers will increasingly
turn to the commercial paper markets to get
short-term financing of equivalent maturity, price
and quality. 2 A sufficient rise in the price of bank
FEDERAL RESERVE B A N K O F A T L A N T A




loans will induce these customers to shift their
allegiance from bank to nonbank sellers of virtually identical loan services. At the same time,
given Carn-St Germain, locally limited customers
can go to a local savings and loan for business
loans and the related business and transactions
accounts services that they require. Hence, any
noncompetitive supplier will find itself thwarted
by customers w h o can easily switch in response
to noncompetitive price increase.
In Diagram 1, we can visualize competition
through markets at many stages of the financial
"productive process" rangingfrom initial"selleK'
(the Federal Reserve Banks and Board) to ultimate
consumer (the business and household user at
retail several levels downstream).
W e can think of competition as proceeding in
many layers, from sellers of basic raw materials or
clearing services upstream to banks, businesses
and consumers downstream. Given deregulation
plus new technology, there can be new entry all
down the line. Nonbanks such as AT&T, will soon
be able to compete for clearing business with the
Fed banks. In markets downstream, a variety of
correspondent banks and nonbank sellers will
compete for small bank business. Interaction of
still greater numbers of sellers is possibleat retail,
all offering a cluster of financial services in
regional or broader markets. Merrill Lynch, American Express and Sears compete with Citicorp.
The joint benefits of technology and bank and
nonbank entry accrue to each user at each level
of production, from wholesale (clearing) to interbank (correspondent services) to retail (consumer and business buyers). Because none of
the profits gained from scale efficiencies of the
new technology get trapped at any stage of the
productive process through monopoly power,
the final consumer at retail gleans fully the
benefits of deregulation. 3 Market forces will
have triumphed. There is little for antitrust to do
given such a scenario, except perhaps to monitor
development in an unobtrusive way.

B. The " Lingering Pockets of Monopoly" Scenario.
Market solutions may take time. Not all thrift
institutions can easily gear up to full competition
for business loans (or deposits) where any lingering
pockets of monopoly persist 4 Deregulation may
impact unevenly from the deposit side according
to customer sophistication or knowledge of deposit options. Banks may more rapidly raise rates
paid on deposits to larger depositors with large
minimum balances and collateral business. Some,
21

D i a g r a m 1.
Levels of Financial Services C o m p e t i t i o n

but not all, of the difference in treatment of
deposit accounts may reflect the different administrative cost or services bartered in return for
low-cost deposits. A lack of full information
about customer pricing may result in noncompetitive pricing. 5 Not all prime-based bank
business loan customers are aware of belowprime market-based loan pricing. If bank customers
can be clearly and permanently segmented into
groups over which the bank can exercise some
degree of monopoly power, price discrimination
would be possible and attractive where the
groups display different elasticities of demand. 6
W i t h imperfect markets, it may be important to
identify the problem and seek a practical remedy.

C The Concentration of Resources Scenario.

Another alternative scenario suggests than the
present wave of large bank and financial conglomerate mergers eventually may give rise to
different, but potentially more significant, competitive difficulties. Beyond some critical "triggering point" in a merger wave, the efficiencies of
22




large-scale production of banking services may
be outweighed by possible market harm to
groups of customers. At this critical point, the
nature of competition is changed because a
community of interest or common understanding
develops between the remaining rivals.7 The
public fear of concentration of financial power is
based in part upon the presumed economic
clout wielded by the large and powerful.
The "deep-pockets" theory assumes that organizations with greater resources and staying power
can intimidate rivals or develop anticompetitive
strategies that can stick. Buyers may trust the
greater reliability of a Schwab discount brokerage
house allied with the Bank of America more than
one standing alone, especially when the former
is accompanied by extensive media hype or advertising. Or, buyers may think they stand a
better chance of securing loans if they try to
patronize other departments of the bank, whether
or not such beliefs are well grounded.
Banks may erect a "Chinese wall" between
different departments, and especially between
M A Y 1984, E C O N O M I C

REVIEW

parent bank and affiliate. But skeptics may fear
conflict of interest between trust officer and loan
officer, or that bank loan officers may make lower
interest rate loans to long-term customers of
other bank departments. The Justice Department's
early Minneapolis price fixing cases found
agreement between banks to charge belowprime rates to certain respondent bank customers
seeking bank acquisition financing. 8 Fears are
stated also in terms of political power, and the
power to influence legislation, yielding results
that cannot always be measured in strictly economic
terms. 9

II. T H E Q U E S T I O N S
Based on how these scenarios evolve, we can
pose the following questions:
A. Are fears of undue concentration following
mergers between large financial institutions
exaggerated or real? If the fears materialize,
can antitrust actions solve the public policy
problems, given the present legal and economic
underpinnings for enforcement?
B. May conflicts of interest, or alternatively,
tying of scarce bank to nonbank services by
the financial "supermarket" present problems?
Again, what can the Antitrust Division do to
resolve conflicts?
C May all customers expect to share equally—
and p r o m p t l y — t h e benefits of deregulation
and product market mixing? Will operations
people (now schooled in the MBA tradition to
target customer groups selectively) segment
market pricing according to the price-sensitivity of customer demand? After all, customers
with the greatest clout, w h o buy most from
the financial "super-market," can threaten
most effectively to leave the bank for other
financial institutions if prices get out of line.
Given the fact that preferred treatment to
such customers may be the proper strategy for
maximizing profits, what steps might the antitrust authorities wish to take to remedy pricing
or allocation inequities?
One problem istodetermine how the issues
should be identified in economic terms. The
classical microeconomic approach is implicit
in modern antitrust analysis, which seeks to
optimize economic efficiency and overall welfare. As long as producers gain more from a
particular practice than consumers lose, say
from tying or price discrimination, the conditions
FEDERAL RESERVE B A N K O F A T L A N T A




for welfare maximization are satisfied. Any
questions of income distribution, whose wealth
is maximized, or whether producers gain at
the expense of consumers, are left to macroeconomics, or for a political response, such as
subsidies or direct grants.

III. P O S S I B L E S O L U T I O N S
A. U n d u e Concentration Questions. Market solutions are always to be preferred, particularly in
a period of rapid technological change. To the
extent that market failures occur, there may be
no one best solution to any potential problem.
Our first line of defense against undue concentration is the antitrust laws, and the starting point
for analysis must be the new Department of
Justice Merger Guidelines. 10 They give powerful
weight to economic theory in deciding which
cases to litigate and how to litigate them. Judges
will decide cases on the basis of economic
theory and evidence to a much greater degree
than earlier. Masses of data developing information on nonbank as well as bank behavior will

The "deep-pockets" theory assumes
that organizations with greater
resources and staying power can
intimidate rivals or develop
anticompetitive strategies that
can stick.
be brought into evidence. To gauge product markets, judges may have to evaluate surveys to
determine whether consumers may switch their
purchases, given any hypothetical future increase
in price by would-be monopolists.
1. The Horizontal Product Merger. Under the
best of circumstances, it is difficult for the
Justice Department to win antitrust cases
based on hypothetical consumer behavior.
Empirical difficulties of designing a reliable
market survey and developing data within a
realistic time frame for trial purposes are great
Defendants may argue that consumers won't
know whether they will switch or not until
they find themselves face to face with the
reality of monopoly power. Moreover, when
the prospect becomes a switch to another
institutional supplier, say from banks to thrifts,
23

or from both to money market mutuals, some
consumers will be perplexed as to how to
respond. They may be unfamiliar with the
alternate supplier or the benefit it can offer
until pushed to the wall by bad service or high
prices.
Economists can unanimously welcome the
introduction of more sophisticated economic
criteria as represented by the new Merger
Guidelines. But that recognition puts a special
burden on the antitrust authorities and especially on economists within the Antitrust
Division. 11 The new complexities of product
market definition in post-Carn-St Germain
markets increase the costs of effective antitrust enforcement At the same time, economists may worry about the public policy
effects of moving away from the banking
"cluster of services" market definitions that
simplify legal analysis.12 These problems are
compounded if the Antitrust Division is given
sole responsibility for competitive analysis
and enforcement as recommended by the
Bush Task Force Given broader markets through
deregulation, however, the probabilities of
competitive harm from all b u t t h e most significant mergers decrease.
The combination of more complex analysis
and the economic gains brought by a broader
market base should reduce the number of
cases initiated, but the financial community
would be ill advised to consider this as an
indication that"anythinggoes." The Division's
recent actions on the LTV-Republic merger
makes clear that its continuing presence is
real.13
2. Product Extension Mergers. A market extension merger is one in which a bank seeks to
expand into geographic markets other than its
own but often adjacent A product extension
merger is expansion into a product market
often closely related to its own. Analysis is
similar in both cases and can proceed in
several ways.
Suppose Citicorp decides to buy Household Finance. The Antitrust Division can analyze the merger's effects by computing Herfindahl indices in all the markets in which the
t w o firms may now directly compete. As in any
horizontal case, economists may delineate
the geographic and product markets according
to consumer future buying intentions in the
event that prices charged by the new merged
company get out of line. The Division may




seek to litigate in markets where substantial
overlap occurs or to require spinoffs as part of
a legal settlement
Unfortunately, the reliability of good banking
data, supplied in the past by a cooperative
Federal Reserve, is not paralleled in the finance
company sphere where spotty and often inconsistent data are collected by 50 state
supervisory authorities. The market share data
of other competing banks or finance companies
and other suppliers of the same services must
be secured from reluctant firms, made consistent, and factored into the market universe.
Another alternative is to go the potential competition route. Given the Department's record
of Supreme Court losses in such cases, that
alternative may not be appealing. W i t h many
more potential entrants in most markets, the
likelihood of injury to the public on the basis of
eliminating a potential competitor will decline
significantly. Compared with earlier efforts, the
Justice Department will have less need for and
likelihood of winning. 14
An exciting concept in the new world of
i n t e r p r o d u c t c o m p e t i t i o n is spatial analysis
which attempts to look at many dimensions of
c o m p e t i t i o n simultaneously. This c o n c e p t
assumes that markets are not clearly separated,
but that clusters of suppliers and customers

"The reliability of g o o d banking d a t a
supplied in t h e past by a cooperative
Federal Reserve, is not paralleled in
t h e finance company sphere where
spotty and often inconsistent data are
c o l l e c t e d by 5 0 state supervisory
authorities."
compete at cluster borders where transactions
costs of switching to new suppliers are lower
than at the market center. 15 At the border,
consumer transactions costs of purchase in
alternative clusters become equalized. Suppliers
must react and prices must respond competitively in both clusters, hence the " t r u e " market
expands. In this manner, just as service areas
blend into broader local markets, so the local
market may mesh into broader statewide,
regional, or even national combined productgeographic markets. The new computer technology speeds this process by reducing transactions costs and disseminating product information.
24 M A Y 1 9 8 4 , E C O N O M I C

REVIEW

While intellectually satisfying, this theory
mathematically embraces the concept of product and geographic markets in intertwined
multi-dimensional space. Hence, on a practical
level it is unsuitable for easy empirical resolution
or court use.16
A related and somewhat easier approach to
product extension mergers would be the tentative measurement of markets as a group of
concentric circle-like shapes. In a highly concentrated statewide branching state, say Oregon
or Washington, the state represents an area in
which banks can operate and transfer funds
from within the branching organization. An EFT
network may transfer funds or make short-term
consumer loans for card holders over a broader
multi-state region. The local market constrained
in size by convenience to depositors or small
retail businesses, will represent another smaller
market within the broader circumference. In
product extension mergers it also may be
appropriate to consider ringed areas of possible
impact and to single out for analysis specific
markets where damage to classes of consumers
most likely will o c c u r — b a n k and thrift, or bank
and nonbank.
The Federal Reserve Board, in assesssing
mergers of large financial organizations, has
often measured both statewide and local market

"Multi-market linkages between the
same organizations do not necessarily
diminish competition in markets where
rivalry already is intense."

concentration. However, except perhaps in correspondent banking markets, the state often
does not represent the market area
In states of high concentration, and generally
poor bank economic performance, the state
was sometimes viewed as a cluster of interconnected local markets in which monopoly
power was exercised. This theory too has a
counterpart for product extension mergers
where substitution possibilities are close. One
advantage of the " l i n k e d oligopoly" theory was
that attorneys wishing to preserve the broadest
range of potential horizontal and market extension antitrust possibilities could have their
FEDERAL RESERVE B A N K O F A T L A N T A




cake and eat it too. Markets could either be
local, hence, suited for the run-of-the-mill small
bank horizontal market litigation. Or, they might
be viewed as concentrated clusters of interlinked
local (or product) markets.
However, multi-market linkages between the
same organizations do not necessarily diminish
competition in markets where rivalry already is
intense, as proven empirically by David D.
Whitehead and Jan Luytjes (1983). Indeed,
multi-market meetings may enhance the initial
interfirm rivalry. 17 M o d e r n game theory may
help us understand which mergers may strengthen competition in the new world of highly
interlinked product as well as geographic markets, and which may reduce or alter competition
and behaviorial relationships in complex and
difficult to predict ways. In either case, present
performance in a market must enter into analysis
as a proxy for initial group interdependence. 1 8

B. Tying and Conflict of Interest Questions. It
seems unlikely that the present Antitrust Division
will often litigate tying or conflict of interest
questions. The Division has gone on record as
believing there are few circumstances where
tying (or other vertical restraints on trade) are
likely to reduce economic efficiency. 19
A " t i e " means that a customer's purchase of
one product is conditioned on the purchase of
another product. A bank cannot tie such nonbank services as mortgage banking to banking
services such as loans in the absence of some
" leverage." The buyer will simply switch to another
seller w h o does not attach strings to the purchase. Even in times of tight money, banks are
unlikely to possess leverage over many bank
loan customers w h o have other bank or nonbank
financing options. But even if banks have leverage
or market power over customers, independent
competing suppliers of the " t i e d " products will
not be hurt competitively unless "foreclosed"
from the opportunity of selling the tied product.
That implies both high concentration in the tied
nonbank product and lack of easy e n t r y — a lack
of competition in both tied and tying markets.
Since nonbank financial organizations such as
finance companies, mortgage bankers and discount brokers tend to be less regulated than
banks, with generally easier entry, the conditions
conducive to a successful tie rarely exist. It is not
surprising thatthejustice Department has initiated
few tying cases in financial markets over the
years.
25

"Unfair advantage" questions often focus on
financing opportunities, such as a bank's superior
ability to attract low-cost funds in the form of
price regulated deposits. But that opportunity, if
it ever existed, is shrinking as deposit rates
become deregulated. The important consideration
for pricing purposes is the marginal cost of funds,
such as the large denomination CDs that banks
must sell at market rates. Under the Bank Holding
Company Act, the holding company cannot lend
more than a small percentage of its assets to
affiliates. If the acquired nonbank firm itself
enjoys a lower financing price as an affiliate of the
new bank holding company parent, that reduction
may reflect administrative or marketing efficiency,
or lower actual or perceived investor risk.
Tying was an issue in the recent Bank of
America/Schwab acquisition, in which the nation's
second largest bank acquired the nation's largest
discount brokerage house. The merger, approved
by the Federal Reserve Board, has been appealed.
The Supreme Court voted to consider the issues

Conflict-of-interest p r o b l e m s appear
unlikely "since it is improbable that
unsound loans will be made to discount
brokerage customers to facilitate
securities purchases."
formally upon request of the Securities Industry
Association. A Supreme Court decision will be
welcome, for it may settle difficult issues of law,
including Class-Steagall Act interpretation. But
because of easy entry into brokerage, careful
analysis of the microeconomic issues reveals no
real tying opportunity in that case.
Nor is "conflict of interest" a likely problem,
since it is improbable that unsound loans will be
made to discount brokerage customers to facilitate securities purchases. Bank trust departments will not accept unsound securities to help
the brokerage subsidiary; Schwab will merely
execute orders, not take market positions. The
Bank of America may influence consumers' preferences through effective packaging of prestige
associated with its many brand names and multiproduct offerings. But is that necessarily contrary
to public interest? Consumers may benefit through
extensive advertising of discount brokerage services, with the result that full line brokers have to
lower prices or improve service quality.
26



C User Group Equity Questions. It may well be

that new competition will provide needed solutions in the world of interproduct competition and
deregulation. Then we will not have to worry
about esoteric measurements of equity welfare
and consumer marginal utility. Even so, there is
room for a continued antitrust role even if all it
accomplishes is monitoring and deterrence. It is
not enough simply to look at how many cases the
Justice Department w o n vs. how many it lost in
the period since 1961 when antitrust first began
to be applied to financial markets. A better test
would be the number of anticompetitive actions
such as discrimination, price fixing or market
division which did not take place because of
antitrust deterrents. To that the response w o u l d
be of course, how much damage the antitrust
presence also did through unsolicited meddling,
or dampening of normal profit and investment
incentives. In either case, the problem to consider
now is whether that deterrence function may in
the future fail because of distorted private beliefs
about the antitrust authorities' ability and readiness
to do their legal job.

IV. C O N G R E S S I O N A L A N D
REGULATORY S O L U T I O N S
While all the economic and legal issues
surrounding antitrust sort themselves out,
other solutions come to mind. One would be
to retain or even expand Federal Reserve
authority to judge independently any major
bank or nonbank acquisitions under its present
bank holding company authority. Historically,
the Federal Reserve Board has been more independent politically than many other branches of
government It also has a large staff of highly
qualified financial economists, along with great
data-gathering and econometric capabilities. To
expect the Antitrust Division to understand and
solve all financial competition matters in unitary
isolation seems, in my view, to ask the impossible as
well as to risk cyclical shifts in emphasis.
The Federal Reserve's help has been invaluable
to banking antitrust enforcers, often to the distress
of private parties involved. Any Board decisions
are subject to Justice Department analysis and
intervention through comments or active participation in regulatory proceedings, to assure a
broader economic and legal frame of reference.
Court review (up to and including the Supreme
Court) will continue also in contested cases. The
M A Y 1984, E C O N O M I C

REVIEW

latter, too, assures full public airing and consideration of all the issues, both legal and economic.
A final alternative is for Congress to tighten the
antitrust laws and improve litigating speed. Former
Assistant Attorney General John Shennefield
(1979) advocated legislation designed to eliminate
very large corporate mergers through acquisition
of leading market positions. 22 More recently, an
eminent scholar in this financial antitrust field,
Stephen Rhoades, suggested legislation to
limit large acquisitions. Rhoades discussed
cogently the political and social as well as
economic bases for accumulating and deploy
ing power. 23 The Congress, in my view, would do
well to consider these questions further for the

social as well as economic payoff. Assuming the
legislative route is desirable, the question is
whether the Congress should act before or after
relatively unencumbered free market forces have
had the opportunity to sift themselves out fully.
If our goal is to address the antitrust question
without having to resort to divestiture, with all
the potentially painful consequences of unscrambling, then Congress perhaps should
look at these questions sooner rather than
later.

— Elinor H. Solomon*
"Elinor H. Solomon is professor of economics, George Washington University.

NOTES

' See Alan S McCall." Economies of Scale, Operating Efficiencies and the
Organizational Structure of Commercial Banks," J o u r n a l of B a n k
Research, (Summer 1980), pp. 95-100; Paul F. Metzker, "Future Payments
System Technology: Can Small Financial InstitutionsCompete?" Federal
Reserve B a n k of Atlanta, E c o n o m i c R e v i e w (November 1982), pp 5867.
2
Evelyn M. Hurley. "The Commercial Paper Market Since the MidSeventies," F e d e r a l Reserve B u l l e t i n (June 1982) pp. 3 2 7 - 3 3 4 .
J
Benefits may flow freely downstream if, for example, arrangements or
joint ventures by sellers at one level who offer, say, processing or credit
card services (#3), do not contain clauses w h i c h specify prices of
services at retail (#5) or discriminate against any institutional buyers at
the next level (#4).
4
The New England experience is described by Constance Dunham,
" M u t u a l Savings Banks: Are They Now or Will They Ever Be Commercial
Banks?" N e w E n g l a n d E c o n o m i c R e v i e w , ( M a y / J u n e 1982) pp.51-68.
' S t e v e n Salop. "The Noisy Monopolist: Imperfect Information, Price
Dispersion and Price Discrimination," Review of E c o n o m i c S t u d i e s
XLIV (October 1977), pp. 393-406.
"Bernard Schull, "Commercial Banks as Multiple-Product Price-Discriminating Firms, B a n k i n g a n d M o n e t a r y Studies, pp. 351-363, P. Carson,
editor 1966. Michael A Goldberg, "The Pricing of Prime Rate," J o u r n a l o f
B a n k i n g a n d F i n a n c e 6 (1982), pp. 277-96. Marcelle Arak, A S.
Englander, and E.M.P. Tang, "Credit Cycles and the Pricing of the Prime
Rate," Federal Reserve Bank of New York, Q u a r t e r l y Review, (Summer
1983), p. 8 and pp. 1 2-28.
' D o n a l d Savage and Elinor Solomon, " B r a n c h Banking: The Competitive
Issues," J o u r n a l of B a n k Research, 11 (Summer 1980), pp. 110-121.
" U n i t e d S t a t e s vs. N o r t h w e s t e r n N a t i o n a l B a n k of M i n n e a p o l i s , et.
al., 1964 Trade Cases # 7 1 , 0 2 0 (D. Minn. 1964); U n i t e d S t a t e s vs. T h e
First N a t i o n a l B a n k of St. Paul, et. a l , 1964 Trade Cases # 7 1 , 0 2 1 (D.
Minn. 1964) and U n i t e d S t a t e s vs. T h e D u l u t h C l e a r i n g h o u s e Ass o c i a t i o n , et. al, 1964 Trade Cases # 7 1 , 0 2 2 (D. Minn. 1964) (consent
decrees).
" S t e p h e n A. Rhoades, P o w e r , E m p i r e B u i l d i n g a n d M e r g e r s ( L e x i n g t o n
Books: Lexington, Mass, 1983). Corwin Edwards, "Conglomerate Bigness
as a Source of Power," in G e o r g e Stigler(ed.) B u s i n e s s C o n c e n t r a t i o n
a n d Price Policy (Princeton: Princeton University Press, 1955), pp. 331359. The Zaibatsu breakup experience in postwar Japan is instructive
also. See Eleanor Hadley, A n t i t r u s t in J a p a n (Princeton, 1970).
,0
U. S. D e p a r t m e n t o f J u s t i c e M e r g e r G u i d e l i n e s ( J u n e 14,1982), reprinted
in T r a d e R e g u l a t i o n R e p o r t (Commerce Clearing House) pp. 4 5 0 0 - 0 5 .
" O n e problem may be that mergers in small or isolated geographic
markets, w h e r e n o n b a n k entry is unattractive because of poor growth
prospects, b e c o m e the easiest to litigate a n d win. This prospect of
lopsided emphasis poses a d a n g e r for effective antitrust enforcement
across the board.

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




,2

F o r a s t a t e m e n t of issues and tradeoffs see Robert A Eisenbeis,
"Regulatory Agencies' A p p r o a c h e s to the Line of Commerce,'" Federal
Reserve Bank of A t l a n t a E c o n o m i c R e v i e w (April 1982), pp. 20-28.
13
See T h e Wall S t r e e t J o u r n a l , February 16, 1984, 3. Assistant Attorney
Paul McGrath said t h e more recent U. S Steel Corp. bid for National Steel
Corp. increased his c o n c e r n s about the LTV-Republic merger, which
w o u l d excessively increase c o n c e n t r a t i o n in three product lines.
" F o r example, U n i t e d S t a t e s vs. C o n n e c t i c u t N a t i o n a l Bank, 4 1 8 U. S.
6 5 6 (1973). U n i t e d S t a t e s vs. First N a t i o n a l S t a t e B a n c o r p o r a t i o n ,
4 9 9 F. Supp. 7 9 3 (D. N. J. 1980).
,5
T h e literature is extensive. See, for example, B. Benson, "Spatial Microeconomics: Implications for the Relationship Between Concentration
and Ownership in Bank Performance," in P r o c e e d i n g s o f a C o n f e r e n c e
o n B a n k S t r u c t u r e a n d C o m p e t i t i o n (1980), Federal Reserve Bank of
Chicago, pp. 60-85.
'"However, Markovitz s u g g e s t s that legal rules may be developed to
handle specific situations in his"gravitational" spatial analysis Richard S.
Markovitz, "Predicting the Competitive Impact of Horizontal Mergers in a
Monopolistically Competitive World: A Non-Market O r i e n t e d Proposal,"
56 T e x a s Law Review (March 1978). "Shading" of market shares by the
Antitrust Division to account for such close competition outside the
primary market often reflected this view.
" S e e David D. W h i t e h e a d and Jan Luytjes, " C a n Interstate Banking
Increase Competitive Market Performance? An Empirical T e s t " Econ o m i c Review, Federal Reserve Bank of A t l a n t a (January 1984), pp. 4' " L i k e l i h o o d of a " linked oligopoly" developing w a s e n h a n c e d in o n e c o u r t
case by suggestions of close personal contracts b e t w e e n leading
bankers, who enjoyed discussions of c o m m o n banking strategies Merger
in that litigated case was viewed as a way of eliminating the maverick
local banker who did not think and act in the way of the group, t h u s
upsetting to achievement of c o m m o n goals. Rivalry was not great to
begin with, whether or not collusion in a strictly legal S h e r m a n Act s e n s e
was present. The final twist to this story was that the maverick banker
decided not to g o through with the merger following the ultimate
Supreme Court victory after t h r e e years of litigation, and has thrived well
and independently ever since.
'»For example, William F. Baxter,"Vertical P r a c t i c e s — H a l f Slave, Half Free,"
A n t i t r u s t Law J o u r n a l , o p , c i t , pp. 743-754. F. M. Scherer, however,
points out the technical difficulties of the n e w theory and its imperfect
state of development, at that s a m e Antitrust Institute, pp. 687-707.
20
John H. Shenefield, Testimony before the Senate C o m m i t t e e on the
21

Judiciary C o n c e r n i n g Conglomerate Mergers, (March 1979).
See Rhoades, op, cit., footnote 10 above.

27

Consumer Demand for Product Deregulation
research reports. Some are based on proprietary
Changing consumer demand already has
studies conducted by private research firms.
prompted considerable deregulation of the
Some are new. After reviewing the empirical
retail financial services industry. In the inflationdata that were available for public use, the
ary environment of the late 1970s and early
Federal Reserve Bank of Atlanta commissioned a
1980s, many consumers, demanding a better
nationwide mail panel survey through National
return on their money than depository instituFamily Opinion (NFO) to fill in the gaps. Of the
tions could legally pay, shifted their funds to
5,000 households surveyed, 3,410 usable surnewly created "checkable" mone^market funds.
veys were returned. The sample represents a
It was this evidence of heightened consumer
national distribution. The publicly available
demand for transactionable high-interest-rate
and proprietary data were assembled here with
accounts that led ultimately to the deregulation
the Reserve Bank's new survey data in order to
of interest-rate ceilings for depository institutions.
provide a comprehensive picture of consumers'
Today, industry spokesmen claim that conreaction to broad financial product offerings.
sumer demand is the driving force behind the
All of the surveys indicate that many conmovement toward product deregulation. Consumers favor the idea of one-stop financial
sumers demand one-stop financial service conservice convenience. The evidence that convenience, they say, and that demand cannot be
sumer demand is the driving force behind
denied.
product deregulation is less concrete. Just over
What evidence exists to support these claims?
a quarter of U.S. households want to secure
This article will address that point. It is based
most of their services from a single firm. Furtheron empirical data generated by consumer surmore, affluent consumers, who use the greatest
veys conducted in 1982, 1983 and 1984. Some
variety of financial servicof the data have come
es, generally are reluctant
from publicly available
Many consumers favor the concept of

one-stop c o n v e n i e n c e in securing financial services, surveys indicate. Yet research has turned up
less evidence that consumer demand is the force driving bankproduct deregulation.

28




M A Y 1984, E C O N O M I C

REVIEW

to consolidate their services. Because of customer loyalty and the desire to obtain a number of
different investment perspectives, most U. S.
households currently prefer to continue obtaining banking services from banks, insurance from
insurance companies, and brokerage services
from brokerage firms. Some, however, w o u l d
like to have all these businesses located in a
single place.

The Use of Multiple
Financial Service Providers
A financial service provider may be a depository institution (commercial bank, savings bank,
savings and loan association or credit union) or
a nondepository financial service firm such as
an insurance company or brokerage house.
Most U.S. households today deal with t w o or
more financial service providers.
A study conducted in 1982 by Electronic
Banking Inc (EBI) of Atlanta counted the number
of financial service providers used by consumers
and classified them as Bank Only, Bank + 1
Bank + 2 and Bank + 3 or more. Under this
classification scheme, "bank" is a generic term
referring to any type of depository institution,
while the + 1 , + 2 and + 3 designations refer to
additional consumer/financial institution relationships, regardless of whether those relationships are with depository institutions or nondepository financial service firms. 1
Data from the EBI study reveal that less than
2 percent of the responding households surveyed
deal with only one financial institution. Thirtynine percent deal with a "bank" and one other
provider. Forty-two percent deal with a "bank"
and t w o other providers. At the other extreme,
only 17 percent dealt with three or more
financial service providers in addition to a
"bank".
The EBI data also indicate that the number of
financial service providers a household uses is
directly related to income. Households in the
$10,000-$20,000 income range are one-andone-half times as likely on average to deal with
a " b a n k " and only one other firm. In contrast,
the likelihood of high-income ($50,000 or
over) households dealing with a " b a n k " and
three other types of providers is twice the
norm. 2
A nationwide consumer survey conducted and
published by Payment Systems Inc. (PSI) of
FEDERAL RESERVE B A N K O F A T L A N T A




T a b l e 1 . Percentage of U.S. Households Using
Selected Types of Financial Service
Providers

Provider

Percent Using

Commercial Banks
Life Insurance Companies
Savings & Loan Associations
Credit Unions
Brokerage Firms

86.8
62.1
50.3
38.9
15.0

Source: P a y m e n t S y s t e m s , P e r s p e c t i v e s ' 8 3 : A S p e c i a l R e p o r t .
V o l u m e 2, Payment Systems Ina, Tampa, Fla.

Tampa in 1983, provides evidence that the use of
multiple providers is a reflection of the financial
services industry segmentation brought about
by rate and product regulation. 3 Until N O W
accounts were authorized nationwide in 1980,
commercial banks were virtually the only institutions authorized to offer transaction accounts.
Because of Regulation Q, savings and loan
associations paid higher rates on savings than did
commercial banks. Life insurance has been available primarily from life insurance companies.
The average consumer historically has dealt
with three different types of financial service
providers to meet these three basic financial
service needs and get the best possible return on
their savings. Table 1 shows that most U.S.
households have done this, and, despite recent
interest rate deregulation, few have changed
their ways.

Demand for One-Stop Convenience
At least half of the population, it seems,
would like to do things differently. In a survey
conducted in March of this year, the Federal
Reserve Bank of Atlanta asked consumers,
" H o w desirable would it be to get all financial
services at one location?" Nearly 50 percent of
the respondents indicated it would be somewhat or very desirable. Back in November
1982, Electronic Banking Inc asked consumers,
" I f it were possible to obtain nearly all financial
services such as checking, savings, loans, insurance, investments and tax planning from
one provider, would you be inclined to consolidate your services?"3 Nearly 50 percent of the
29

T a b l e 2. Attitudes Toward Desirabiity of One-Place Financial Service
Convenience and Willingness t o Consolidate Services
Willing to Consolidate

Attitudes Toward Desirability

Percent

Percent
Not at all desirable...

1 6 -

30
Somewhat undesirable...
Neither desirable nor
undesirable...

20

26-,

Very desirable...

24—1

50

2804

Source: Federal Reserve Bank of Atlanta

respondents answered yes or said that they
already do so. (Table 2 shows the responses to
the two questions in greater detail.) In addition,
Synergistics Research Corporation asked consumers last August, " I f you could obtain most
of your financial services from one financial
services provider, would you consider this to
b e . . . an improvement?" Fifty-nine percent of
the respondents to this survey said it would be
very much or somewhat of an i m p r o v e m e n t
(See related articles.)
The sample selection critieria for the three
surveys differed slightly. The questions were
worded differently, and the surveys were conducted at three different times. Nevertheless,
the responses to the three questions were not
significantly different. About half of all U.S.
households favor one-stop financial service
convenience. Another 15 to 20 percent have
no strong feelings for or against the idea. The
remainder of households find consolidation
undesirable for one reason or another.

Types of One-Stop Financial
Service Convenience Preferred
Financial service providers are considering
three general approaches to providing consumer
financial services. O n e is the single firm app r o a c h — a financial services firm or institution
offering all types of services under its o w n
30



36

Don't k n o w . . .

14

Yes

50

14-

Somewhat d e s i r a b l e . . .

Total number of respondents

No...

1092

Total
Source: Electronic Banking Inc.

name. Many financial institutions urging product
deregulation w o u l d like to be able to d o this.
Second is the financial service center concept
in which different financial services, like insurance, real estate, and brokerage, are available
from different firms in one location. Sears is
one organization taking this approach. Although
all the providers in a Sears Financial Service
Center are subsidiaries of the retailer, they
retain their original names and may be thought
of as separate entities by the consumer.
Finally, there is the financial services boutique.
The boutique approach connotes specialization,
by providing a limited number of products and
services or by targeting a specific market segment, such as affluent consumers.
Among the 70 percent of all consumers w h o
are not opposed to the concept of one-stop
financial services, few seem to want financial
service boutiques. Only 7 percent of those
surveyed preferred this type of provider.
O n the other hand, the sample is split fairly
evenly between those w h o prefer to get most
of their services from a single firm and those
w h o prefer financial service centers or financial
boutiques. (See Table 3.) Indeed, only 28
percent of all respondents to the Fed survey
prefer dealing with just one firm. This preference
seems to be strongest among individuals in the
50-64 age group. Younger individuals appear
to respond more favorably to financial service
centers.
M A Y 1984, E C O N O M I C

REVIEW

T a b l e 3. Type of One-Stop Provider Preferred
(respondents who do not find one-place services undesirable)
Age Groups

%

3 4 and
Under

%

35-49

50-64

65 and
Above

%

%

%

Single firm

40

34

4

44

37

Financial Service Center

31

36

29

29

32

7

8

6

7

9

23

23

Financial Service Boutique
No Preference
Total
Total number of respondents

22

25

20

100

100

100

100

100

2398

518

654

770

456

Source: Federal Reserve Bank of Atlanta

Depository Institutions Preferred
Regardless of the preference for single-firm
providers or financial service centers, depository
institutions top the list of institutions preferred.
Among the respondents w h o favor the single
firm approach, 93 percent say they w o u l d like
for that single firm to be a depository institution.
This was virtually identical to the response to a
similar question asked in the EBI study. Of
those Fed survey respondents w h o say they
prefer a single firm, 51 percent w o u l d like to
get most or all of their financial services from a
commercial bank, 26 percent prefer an S&L,
and 16 percent prefer a credit union. (Table 4)
Depository institutions also are desired strongly
by the 31 percent of respondents who prefer
the financial service center approach. Seventy
percent of the respondents prefering a financial
service center want to find an S&L there, while
66 percent want to find a commercial bank.
Forty-one percent say they w o u l d want a credit
union represented in the center. These consumers may be more thrift institution-oriented
than those w h o prefer a single firm.
The data do not suggest that deregulation to
permit one-stop financial service convenience
would change the relative competitive positions
of the different types of depository institutions.
An analysis of the preferences suggests that
household market shares of the three major
types of depository institutions' would decline if
FEDERAL RESERVE B A N K O F A T L A N T A




T a b l e 4 Type of Institutions Preferred
(respondents preferring single
financial institution)
Percent
Commercial Bank

51

Savings & Loan Association

26

Credit Union

16

Full-Line Brokerage Firm

4

Discount Brokerage Firm

*

Insurance Company

*

Others

3
100

Total number of respondents

924

* Less t h a n 0.5 percent
Source: Federal Reserve Bank of Atlanta

one-stop financial service convenience were
available. However, one-stop convenience would
have no substantial effect on the share of total
relationships claimed by each type of institution.
Section One in Table 5 highlights the difference between the percentage of households
31

T a b l e 5. Depository Institution Market Shares

Section One: Current Distribution of Market

Commercial Bank
Savings & Loan
Credit Union
Totals

Household
Market Share

Relationships Per
100 Households
(number)

Relationship
Market Share

87
50
39

87
50
39

49

176*

176

100

28
22

"Multiple relationships possible. Total exceeds 100%

Section Two: Data Available From Consumer Research
Group:
Respondents
Number
%
One-Stop Undesirable
Prefer Single Firm
Prefer Fin. Svs. Center

1012
955
734

Distribution:
% Using or Would Use
Bank
S&L

Totals

50
26
70

87
51
67

38
37
28
2601

CU.
39
16
41

100

Section Three: Calculation Results
cell percentages = group percent of total X distribution for group
One-Stop
Undesirable

Single Firm
Preferred

Fin. Svs. Center
Preferred

Total

34
19
15

19
10
6

19
20
12

71
49
33

%

Commercial Bank
Savings & Loan
Credit Union

%

%

%

Section Four Estimated Distribution of Market Share in One-Stop Environment
Market Share
%

100 Households
(number)

Market Share
%

71
49
33

71
49
33

47
32
21

153*

153

100

Commercial Bank
Savings & Loan
Credit
Totals
' M u l t i p l e relationships possible. Total exceeds 100%

32




M A Y 1984, E C O N O M I C

REVIEW

that use a depository institution and the percentage of each household's total number of depository institution relationships. It is based on
data from PSI. This study found that 87 percent
of all households that deal with a depository
institution use one or more services at a commercial bank. However, as Section One of
Table 5 shows, the data might also be interpreted
to mean that, on average, each household has
some kind of service relationship with 1.76
depository institutions. Thus, each 100 households have approximately 176 relationships
and 87 of those relationships are with commercial banks. In short, commercial banks
have an 87 percent market share when the
market is expressed as the total number of
households maintaining a financial relationship
with a given type of financial institutions. Banks
have a 49 percent share when the market is
expressed as the number of financial relationships between households and depository institutions.
The next step in the analysis was to recalculate
the percentages of consumers w h o w o u l d use
the three types of depository institutions. This
was necessary because some respondents to
the Fed survey provided too little information
about the type of institution they would use if
one-stop convenience were available to estimate
their behavior in such an environment. W e
disregarded these responses.
Respondents
who stated they consider one-stop convenience
undesirable were not eliminated. Instead, we
assumed that their behavior would not change,
and they w o u l d continue to use the three types
of depository institutions in the same proportions
as reported by PSI. The recalculated percentages
are shown in Section Two of Table 5.
Section Three of Table 5 shows the market
share of households that each type of institution
would control within each of the three user
groups. The consumers' preference distributions
for the depository institutions were multiplied
by the percentage of households that each
group represents to obtain these estimates of
market share.
Section Four of Table 5 parallels Section
One. It shows household shares and total
relationship shares of each type of institution
in a one-stop convenience environment As
noted above, household market share for each
type of depository institution would be lower
than the current market share because some
consumers currently using multiple depository
FEDERAL RESERVE B A N K O F A T L A N T A




institutions would consolidate their financial
services with one of the three types. The
differences between the current and projected
relationship market shares is small. Although
some consumers would consolidate their financial services at one type of depository institution
or another, their choice of institutions would
vary and most consumers w o u l d continue to
use multiple depository institutions. The consumers tendency to stick with the tried and
true is also a major theme in the related article
contributed by SRI International.

The Relationship Between Income
and Financial Service Usage
Thus far, we have focused on consumers as a
single group; however, not all consumers have
the same financial service needs. Affluent households generally are more active financially than
those of more moderate means. Table 6 provides
evidence of this. It shows, for example, that
households with annual incomes in excess of
$60,000 are twice as likely to use transactionable
investment accounts and IRAs and three times
as likely to use the services of full-line and discount brokerage firms.
The Atlanta Fed survey covered a larger
number of financial services than the PSI study.
In the Atlanta Fed survey, consumers w h o were
not opposed to the concept of one-stop financial
services and w h o specified a favored provider
were asked what services they probably w o u l d
obtain from a single firm, financial service
center or financial service boutique. The responses confirmed the positive relationship
between income and the use of large numbers
of services. Of the 19 services studied (see
Table 7), t h e likelihood of using one (passbook
savings) decreases as income goes up. Obviously
the reason is the lower return associated with
these accounts. For five services—checking,
life insurance, property and casualty insurance,
real estate brokerage and tax p r e p a r a t i o n income was not related to likelihood of use.
The likelihood of a consumer's using the remaining 13 services was directly related to income.

The Relationship Between Income
and Service Consolidation
The Fed survey found no statistically significant evidence that households earning $35,000
33

T a b l e 6 . Percentage of U.S. Households Using Selected Types of Financial Services
Income (in thousands)
Total
Transaction Services
Regular Checking Accounts
Now Accounts

Under
$25

$25$40

$40$60

Over
$60

61.7%
41.7*

71.2%
-31.8

66.1%
31.2

71.2%
25.0

64.1%
31.2

(466)
35.8

(125)
30.4

(202)
37.6

(98)
41.8

(18)
33.3

Transactionable Investment Services
M M D A / S u p e r N O W Accounts
Money Market Mutual Funds

22.3
16.2

17.7
10.4

19.2
14.8

27.2
22.3*

45.5*
34.8*

Brokerage Services
Full-Service Brokerage
Discount Brokerage

12.7
3.5

5.9
1.4

10.6
2.3

23.8
8.3*

31.8*
9.1*

Individual Life Insurance
Term
Whole Life
Universal Life

31.4
43.9
6.9

25.0
34.9
4.5

30.8
49.5
9.2

45.1*
52.9
8.3

35.0
50.0
6.1

Individual Retirement Accounts (IRAs)

22.7

10.8

20.9

40.8*

54.5*

1,199

424

426

206

66

Share Draft Accounts**

Total Number of respondents

• P e r c e n t a g e is significantly higher t h a n the percentage s h o w n for all U.S. households (Total) w h e n t e s t e d at t h e 9 5 % c o n f i d e n c e level.
- " A s k e d only of credit union members. Bases on w h i c h percentages are calculated are s h o w n in ( )s.
Source: Payment Systems Perspectives '83: A Special Report, Vol. 2, Payment System, Ine, Tampa, F l a

or more a year are less likely than the population
as a whole to consider one-stop financial service
convenience desirable. Two other studies, however, suggest that affluent consumers are less
likely than middle or lower income consumers
to consolidate with a single firm. In other
words, affluent consumers prefer to obtain
their financial services from a wide array of
suppliers. EBI's report notes:
Overall, while there is a large segment of the
sample w h o would consider consolidating
their financial services into one institution
. . . this segment of the population is heavily
weighted with young, low to middle income
consumers w h o are not currently using a
diversified group of financial service providers.
In short, the upscale s e g m e n t . . . is the least
likely to be attracted by consolidation. 4
In addition, PSI's Affluent Market Research
Program, which surveyed over 1,500 households
having annual incomes of $50,000 or more or
net worths or $200,000 or above, found that
34



"virtually none of the respondents indicated
any tendency to consolidate their accounts."

Consumer Demand for Services from
Non-Traditional Vendors
If those consumers whose financial lives are
most active and most complex are unwilling or
unlikely to consolidate their financial services,
does consumer demand for product deregulation
exist? Empirical evidence suggests it does. The
extent of that demand appears to be limited,
however.
One measure of consumers' demand for
product deregulation is the degree to which
they are willing to obtain financial services
from nontraditional vendors. Evidence of this
willingness is mixed. For example, when EBI
asked consumers how likely they would be to
purchase life, health or property insurance
through a bank, approximately 47 percent said
M A Y 1984, E C O N O M I C

REVIEW

T a b l e 7. Types of Financial Services Likely to be Used at One-Stop Provider of Choice
Income in Thousands
Total

Under
$10

$10.0$17.5

$17.5—
$24.9

$25.0—
$34.9

$35 &
Above

Checking
Passbook Savings
Certificates of Deposit
Money Markety F u n d s / A c c t s
Credit Cards
Lines of Credit
Consumer Loans
Mortgages
Second Mortgages
Life Insurance
P&C Insurance
Real Estate Brokerage
Tax Preparation Ser.
Tax and Investment
Planning and Advice
Stock & Bond Brokerage
Managed Investment Funds
IRA/Keogh Accounts
Estate Planning
Settlement & Trusts
Asset Management Accts.

87
70
53
44
60
33
33
43
14
28
36
18
33
27

80*
70
42*
27*
39*
22*
20*
23*
7*
27
30*
13*
28*
13*

89
74
48
38
58
28
31
39
10
28
38
16
35
19*

86
77
52
43
64
34
37
46
13
34
38
18
35
24

89
70
57
48
64
35
37
52
16
27
35
20
32
30

87
63
64
58
72
42
39
52
22
26
39
21
37
42

24
17
44
21

8*
8*
21*
14*

15*
12*
34*
16*

19
10
45
16

27
22
52
23

43
30
63
33

11

5*

7*

6

12

21

Total number of respondents

1,864

294

365

472

363

370

Source. Federal Reserve Bank of Atlanta Survey

they would be somewhat or very likely to do
so.5 However, when PSI asked commercial
bank customers if they w o u l d purchase life
insurance from any depository financial institution they dealt with, only 17 percent ^aid
they definitely or probably would. 6 That is a
large variation, some of which may be accounted
for by the different wording of the questions
and the broader spectrum of insurance products
covered in the question asked by EBI. The EBI
report also notes that some of the respondents
"qualified their positive reactions with such
disclaimers as I'm willing to check into the
service," " i t depends on the service," or it
depends on the price of the service." 7
The two studies were more in concert on the
question of purchasing brokerage services from a
commercial bank. In both studies, over a third
of the respondents indicated they would do
this. However, both also provided caveats. EBI
again noted that many of the positive responses
FEDERAL RESERVE B A N K O F A T L A N T A




were qualified by statements like, " I ' m willing
to check it out," or " w h e n I have money
available to invest" 8 PSI cautioned readers,
saying, "These figures represent only the consumer's predisposition to use a service." Therefore, it should not be assumed that the potential
for discount brokerage offered by depository
institutions is currently anywhere near 35-40
percent of affluent households." 9
In another approach to determining consumer
demand for financial product deregulation, a
factor analysis was performed using responses
to the Atlanta Fed survey concerning services
likely to be used at a one-stop financial service
location. Factor analysis is a statistical technique
used to reduce a large number of measurem e n t s — in this case, the likelihood of using
each of 19 services—to a smaller set by determining which seem to go together and measure
the same factor. The four factors produced by
35

T a b l e 8 . Factor Analysis Results
Services

Factor
Factor One

Stock & Bond Brokerage
Asset Management Account
Tax and Investment Planning/Advice
M a n a g e d Investment Funds
Money Market Funds/Accounts
Estate Planning, Settlement & Trust
IRA/Keogh Accounts
Certificates of Deposit

Factor Two

Mortgage Loans
Consumer Loans
S e c o n d Mortgages
Lines of Credit
Credit Cards
Real Estate Brokerage

Factor Three

Checking
Passbook Savings
Certificates of Deposit
Money Market Funds/Accounts
Credit Cards
IRA/Keogh Account

Factor Four

Life Insurance
Property & Casualty Insurance
Tax Preparation
Real Estate Brokerage
Tax and Investment Planning/Advice

this analysis and the services they comprise are
shown in Table 8.
Factor One is a set of services that w o u l d be
used by a distinct segment of the population
that can be described as packag^oriented
investors. The "package" orientation is suggested
by the demand for asset management accounts,
which generally combine transaction and investment services in a single account All of the
services that make up this factor may currently
be obtained from a full-line brokerage firm.
Many are also available from larger commercial
banks. Under current regulations, however,
banks cannot offer investment advice. Thus,
existing regulations prevent any financial service provider from directly filling all the needs
of these customers.
Factor Two is a combination of services that
suggests a segment of the population best
described as borrowers. In this combination,
mortgages and second mortgages have high
factor scores, suggesting that real estate investments are an important part of this segment's
financial lives. Thus, it is not surprising to find
36




that real estate brokerage services constitute
one of this segment's financial service needs.
Once again, however, regulations that restrict
banks' real estate activities obstruct this segment
from obtaining all the services it would like at
one location.
The services that make up Factor Three can
be met by full-service depository institutions
today. Lacking a better term, these customers
might be called traditionalists. They seemingly
would be content with the status quo or w o u l d
prefer not to secure "banking' and other financial
services at the same place.
Factor Four is more difficult to interpret. This
combination of services desired at a single
location seems to reflect the needs of a security
conscious, help-seeking group of people. They
seem to want the services of independent
professionals as well as those of insurance and
real estate firms. One can only speculate why
real estate brokerage would be one of their
important financial service needs. Perhaps they
are high-equity homeowners, or individuals
w h o pay cash for primary or secondary homes,
making sizable downpayments to minimize
their mortgage payments. It is reasonable to
believe that people with such a conservative
financial orientation would consider it important
to get professional help and advice when
buying or selling real estate.
Factor analysis provides no indication of the
number of responses each factor represents.
Thus, while the analysis may provide evidence
of some consumer demand for deregulation,
the extent of that demand cannot be determined.

CONCLUSION
Some, but far from all, consumers expect to
gain from product deregulation. Fifty percent
of those responding to the Atlanta Fed survey
considered it desirable to obtain all their financial
services at one location. Twenty-eight percent
would like to obtain most of their services from
one firm. Both of these facts appear to indicate
considerable demand for product deregulation.
Yet a factor analysis of the Fed's survey data
suggests that some individuals in that 28 percent may define "most" as those services they
can already obtain from full-service depository
financial institutions. In short, the data are not
conclusive but leave the impression that the
M A Y 1984, E C O N O M I C

REVIEW

general population's current demand for additional product deregulation is not extremely
strong. Educating consumers concerning these
offerings and allowing them to become accustomed to obtaining these services from a
single location might remove some resistance.
But some firms may not believe the effort
worthwhile in terms of training a staff and
otherwise preparing to offer all these services.
This survey of empirical evidence also leads
to the conclusion that consumer demand for
product deregulation is unlike the demand for
interest-rate deregulation. The demand to earn
higher interest rates was a compelling enough
force to make consumers redirect their funds
to the new types of institutions offering moneys
market rates. W i t h product deregulation, however, there is a gap between what consumers

say they will do when broader product choices
are offered and what they say they will do
w h e n they consider using non-traditional
vendors. It is doubtful that convenience alone
will cause large numbers of consumers to
consolidate their services if financial products
are deregulated in the future. More likely,
financial service firms in a deregulated environment will have to prove their ability to provide
services outside of their traditional purview
effectively and at a competitive price before
consumers will make a change.

—Veronica Bennett*
'Veronica Bennett heads V. Bennett Asssociates
Payments Systems, Inc.

and is director ot research

for

Special thanks to Allen K. DeCotiis and John /. DeMarco of Payment Systems, Inc.,
Maria Martin and Leslie Langan Altick ol SRI International and Debbie Stern oi
Synergistics
Research.

A f f l u e n t C o n s u m e r s ' D e m a n d for
Financial Products and Services
Affuent consumers (defined as those with annual
incomes of $50,000 or more and/or with net worth of
$200,000 or more) represent an attractive market to
many financial service providers A nationwide survey of
affluent consumers conducted by Payment Systems
Inc. (PSI) in 1983 revealed, however, that this market is
not homogeneous in terms of product usage and that
such customers in general show little propensity to
change their present ways of handling financial affairs.
In making their financial decisions affluent consumers
appear to make conscious tradeoffs between costs
and benefts, risks and returns The majority say they
shop for convenience rather than low cost for services
such as checking. They also shop around to find the
financial institution offering the highest return. All
agree that quality financial planning and investment
advice can be costly. Finally, while 53 percent prefer
guaranteed returns on their savings 82 percent prefer
to put some of their assets into non-guaranteed
investments to get a higher rate of return.
Affluent consumers say they want personal attention
from their financial service providers Seventy percent
feel it is important that the officers of their financial
institutions know them personally; 78 percent agree
they would stay with a account executive with w h o m
they had established a good working relationship,
even if the account executive changes firms; and 60
percent prefer tellers to automated teller machines
(ATMs) for routine financial transactions
A majority of affluent consumers use eight financial
and investment products or services First, of course,
is the checking account; 90 percent of the respondents
use one or more such a c c o u n t s It should be noted,
however, that the PSI survey definition of a "checking"
account includes NOW and Super NOW a c c o u n t s

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




The second most widely used product is life insurance with 87 percent holding one or more life insurance
policies Nevertheless there appears to be little potential to sell new insurance products t o this group. None
of the respondents lacking life insurance coverage at
the time of the survey indicated that they planned to
obtain it in the next 12 m o n t h s Only 1 percent of the
life insurance users intended to increase their use of
this financial product And 2 percent said they intended
to discontinue policies Affluent consumers who value
insurance protection obviously have already met their
needs and some will probably get out of this investment
vehicle gradually as they grow older and their life
circumstances change.
The remaining six products and services used by a
majority of affluent consumers are:
• Money market accounts or funds - used by 79
percent;
• Retirement accounts - used by 7 5 percent;
• Brokerage services - used by 7 0 percent;
• Passbook savings accounts - used by 65 percent;
• Tax preparation services - used by 6 0 percent; and
• Premium credit and travel and e n t e r t a i n m e n t
cards - used by 59 percent.
Knowing the percentage of affluent consumers
who use each particular service provides no insight
into specific combinations of services used by different
groups. PSI performed a factor analysis of the survey
data and found considerable diversity in the combinations of services used. The six clusters of services
that the analysis identified are shown in the accompanying table. The names assigned to the clusters are
PSI's interpretation of the kinds of affluent consumers
that use each group.

37

The absence of a particular product or service from
the lists of services used by each segment in the table
does not imply that none of the individuals use that
service. Some may and some may not; however,
usage is not consistent enough to make the unlisted
product or service useful in identifying the segment's
financial affairs For example, while one may reasonably assume that individuals in the Entrepeneur segment have transactions accounts, they do not gravitate
toward any one type of transaction a c c o u n t Some
may use checking (including NOWs and Super NOWs);
some may use asset management accounts; some
may use checkable money market funds; and some
may be cash o r i e n t e d
In light of the variety of services affluent consumers
use, it is not surprising to find that they deal with a
number of different financial firms Six types of providers
are used by a majority of the respondents:
• Commercial banks - used by 8 7 percent;
• National full-line brokerage firms - used by 74
percent
• Insurance companies - used by 73 percent
• Independent professionals (attorneys CPAs, etc)
- used by 72 percent
• Savings and loans or savings banks - used by 68
percent; and
• Travel and entertainment card companies - used
by 63 percent.
In addition, about a third of the affluent consumers
deal with direct-mail investment firms and credit
unions, while 20-27 percent deal with bank trust
departments, major retail chains, specialized brokerage
firms and discount brokerage firms
With all their experience in dealing with different
financial service providers affluent consumers should

be able to identify the type of provider they would
prefer if they wanted one-place convenience and
could get all types of financial sen/ices from a single
firm. The survey, however, shows a dichotomy exists
between what affluent consumers say they want and
what they say they would do.
Two attitude questions tested the respondents'
desire to consolidate their financial dealings with a
single firm. On each question, 70 percent consistently agreed that they would like to consolidate.
However, when asked to place themselves in a hypothetical situation where all providers could offer all
services legally and to assume that the cost quality
and features were the same regardless of provider,
virtually none of the respondents indicated any tendency
to consolidate their a c c o u n t s Affluent consumers say
that, in a deregulated e n v i r o n m e n t they will still
obtain insurance from insurance companies discount
brokerage services from discount brokerage firms;
credit cards from credit card companies or banks; tax,
accounting and advisory services from independent
professionals transactions savings retirement accounts
and loans from commercial banks and savings institutions; and other investments from national full-line
brokerage firms
In short, while affluent consumers find the concept
of product deregulation attractive, the availability of
one-stop financial service convenience appears unlikely, by itself, to encourage them to change their
patterns They say it would be nice to be able to
consolidate all their financial dealings; b u t before
they will make a change, affluent consumers will have
to be shown that a single provider can meet all their
needs effectively and provide some advantage to
them.

C o n s u m e r P r e f e r e n c e s in t h e N e w
Financial Services Industry
It is clear to financial services vendors that the
industry has changed because of deregulation, but
the effect of deregulation on consumers is less clear.
Research conducted by SRI International's Consumer
Financial Decisions (CFD) Program indicated that
deregulation has produced little change in the way
many households handle their financial affairs Two
factors causing consumers' inertia are their fear of
change and their unmet needs for information and
advice.
As a result of deregulation, consumers are deluged
with advertising by financial services vendors The
volume of advertising will likely increase dramatically
over the next few y e a r s Households are bombarded
with descriptions of the new financial products and
vendors available to them. One reaction to these new
options is typified by the CFD focus group respondent
who eagerly anticipated the day he could buy a few
shares of stock as he walked through the checkout
line at his neighborhood grocery store A more common
reaction, however, is for households t o attempt t o

38



maintain the status quo, in fact to insist that nothing
has changed. In a recent CFD survey, more than half
of the U.S. households questioned stated that they
are unlikely to try a new financial product unless
someone they know recommends it. Thus, it is unsurprising that in the face of change, consumers continue
to prefer traditional financial relationships
The logic behind their convictions is sometimes
surprising. For example, although less than one-fifth
of the households surveyed use a stockbroker regularly,
half say they would be comfortable dealing with a
stockbroker in a brokerage office. Most households
use banks regularly, but less than one-third say they
would be comfortable with a broker in a retail store. To
consumers, brokers belong in brokerage offices not
in banks or department stores.
Clearly, consumers have not yet developed preferences for nontraditional vendors. As the table
below indicates, more than three-fourths of those
surveyed say that, if all vendors offered financial
services at competitive prices, they would prefer to

M A Y 1984, E C O N O M I C

REVIEW

use banks. Yet, households do accept the idea of
nontraditional vendors in theory. For example, more
than half of the households surveyed believe that
insurance companies could offer both insurance and
checking, and more than a third believe department
stores could.
The gap between consumers' willingness to consider
nontraditional vendors in theory and their willingness
to use them may be largely due to their inability to get
information and advice for decision-making. In the
deregulated environment households need information
and advice. Half of those surveyed consider being
able to obtain information and advice regarding financial decisions highly important. One-fourth consider it
critical. Because they often are unwilling to pay for
information or advice, however, most households fail
to receive the assistance they need. One-third of the
households surveyed say they do not know how to
choose financial products and services. More than
half say they never get information about differences
in financial products, and two-thirds say they never
get advice on which financial products are best for
them.
The need for information and advice represents a
clear strategic opportunity for new v e n d o r s or those
willing to change, since this need is one that is not
being met by existing relationships. Although households tend to maintain traditional relationships because
of their confusion, they appear willing t o establish
new relationships to get the information and advice
they need Half of the households surveyed, for example

say they would use a financial center (that is a
financial "supermarket") for information, and close to
half would do so for advice. Because bundling information with all but the simplest of financial products
increases a product's perceived value, vendors that
regard information and advice as a marketing necessity
(rather than a profit-generating product) in mass
markets will be a step ahead in the new financial
services industry.
As the boundaries between traditional financial
industries continue to dissolve, vendors must also
concern themselves with developing or maintaining
distinct images Consumers will continue to be attracted
by particular institutional attributes such as safety
and competitive prices. But their willingness to trade
off one against the other will vary with their psychographic profiles, financial n e e d s and current life
stages. Image attributes such as competence and
courtesy will be helpful in maintaining customer relationships—less so in establishing them. Still other attributes
such as vendor size, are often irrelevant to t h e
consumer.
The ideal image is insufficient to motivate confused
consumers to modify their behavior. Promoting institutional differences or product features to consumers
who insist nothing has changed wastes scarce marketing resources Vendors that choose instead to inform
and direct the mass-market consumer will benefit
now through cross-selling opportunities and in the
future thróugh households' increased ability to differentiate products and institutions.

Relationship Management:
A C o n s u m e r Perspective
Consumer financial relationship management has
emerged as the dominant retail financial strategy in
the 1 9 8 0 s Success or failure in relationship management will depend on a sen/ice provider's ability to
integrate multiple services To achieve integrated,
mutiple-service relationships financial service providers
will offer a wide variety of deregulated products and
services that establish an initial account with a customer, and then encourage a total relationship including
checking, savings, investing, insuring, and financial
planning.
One of the key pressures now acting on the environment of financial services is competition for the pool
of household assets. The consumer financial market
is highly fragmented in the distribution of these assets
Even though the average consumer is using about
eight services the average client relationship amounts
to two services per client. Through effective use of
relationship programs and multiple service offerings,
providers can increase their business and decrease
the cost of acquiring clients.
The attractiveness of relationship management programs from the provider standpoint is obvious. Synergistics Research Corporation (SRC) of Atlanta assessed

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




consumer reactions to such programs last August by
surveying 5 0 0 consumers across the country. The
data can be projected to the 74 percent of U.S.
households with incomes or liquid financial assets
(excluding the primary home) of $15,000 or more.
Respondents were asked: "If you could obtain most
of your financial services from one financial services
provider, would you consider this to be very much of
an improvement somewhat of an improvement, not
too much of an improvement or no improvement at
all?" Data suggest t h a t while consumers are less
enamored of this concept than providers it appeals at
least somewhat to the majority of those surveyed, as
shown below:
Very much of an improvement
20%
Somewhat of an improvement
39%
Unsure
6%
Not too much of an improvement
15%
Not at all an improvement
20%
Marketing t o the affluent is one of the segmentation
strategies most often cited by financial services providers Many providers see relationship management
as an approach to improving their affluent-market

39

position. Survey data, however, show that the single
provider concept is not as appealing to incomeaffluent or asset-affluent consumers as to o t h e r s For
example, only half the consumers with household
incomes of $50,000 or more feel that the concept
represents at least somewhat of an improvement,
compared to 62 percent of those with household
incomes b e l o w the $50,000 level. Similarly, the single
provider concept appeals to 48 percent of households
with $ 1 0 0 , 0 0 0 or more in liquid assets, versus 64
percent of those with lower assets
Consumer financial relationships are now highly
fragmented—especially within the upscale or affluent
customer s e g m e n t While these consumers use more
services, they also maintain relationships with more
nonbank providers Also they tend to rely on specialists
such as accountants and attorneys for financial information and advice. The net result is that it may be
difficult for financial firms to encourage a consolidated
relationship among members of this market segment.
Relationship management, by definition, decreases
or eliminates the number of specialists that consumers
rely on for their financial needs. It also should reduce
the amount of comparison shopping done for financial
products or providers Survey data confirm that relationship prospects are not oriented toward specialists or
comparison shopping to the same extent as are nonprospects
Nearly two-thirds (63 percent) of consumers who
feel that the single provider concept represents a
substantial improvement strongly agree with the statem e n t "I would rather deal with one generalist for all
types of financial services than with several specialists"
In comparison, only one-third of non-prospects strongly
agree with the same statement Relationship prospects
are also more likely than non-prospects to agree that,
"It takes too much time to comparison shop for

financial services" (56 percent vs. 32 percent). Therefore it appears that prospects are convenience-driven
to some degree.
One strategy for promoting relationship management
being highly touted is to offer some form of financial
planning sen/ices as a key element in the total relationship. From a practical standpoint, however, many
providers are skeptical about their ability to deliver
financial planning in a cost-effective manner. Nevertheless SRC's research shows that consumers' reactions
to the single provider concept are highly correlated
with their stated willingness to pay for financial advice
on savings and investments
Almost three-quarters (74 percent) of conumers
w h o say they are "willing to pay a reasonable fee for
good advice about savings and investments" are
attracted to the single provider concept, compared to
only 4 4 percent of those who say they are not willing
to pay a reasonable fee. Of course, we must take care
in intepreting the term "reasonable fee." "Reasonble"
as defined by providers is rarely the same as "reasonable" as defined by c o n s u m e r s According to SRC's
research, only 2 percent of the consumers surveyed
have paid even $ 5 0 0 for financial planning during the
past two years.
Given the volatility of the current e n v i r o n m e n t —
with new p r o d u c t s new providers and uncertainty
about interest rates—it is not surprising that consumers
want and need financial information and advice. Consumer demand for relationship programs seems to be
real, as measured in this and several other SRC
research studies It may well be that financial planning of
some form will provide the impetus and incentive
around which a relationship program can be built.
Consumers surely will need an incentive to overcome
the inertia complexity, or awkwardness involved in
changing their financial relationships.

NOTES

'Telephone conversation with J. Brittain, Bnttain Associates, A t l a n t a Ga..
April 8, 1984.
'Electronic Banking Inc, F i n a n c i a l Service Usage a n d P r o d u c t Strategies:
A N a t i o n a l C o n s u m e r Survey, (Atlanta December, 1982) Appendix B..
Table 1, Page 1.
•Payments Systems Inc, P a y m e n t s S y s t e m s P e r s p e c t i v e s ' 8 3 : A S p e c i a l
R e p o r t (Atlanta: July 1983).
••Electronic Banking Inc, Appendix A
"Ibid., p. 25.

40



"Payment Systems Inc., P a y m e n t S y s t e m s P e r s p e c t i v e s ' 8 3 : A S p e c i a l
R e p o r t Payment Systems Inc. (Atlanta G a : July, 1983) Vol. 1, p 68.
Electronic Banking I n c F i n a n c i a l Service U s a g e and P r o d u c t Strategies:
A N a t i o n a l C o n s u m e r Survey, Electronic Banking Inc. (Atlanta G a :
December, 1982) p. 26.
"Ibid., p. 27.
"Payment Systems Inc., P a y m e n t S y s t e m s P e r s p e c t i v e s ' 8 3 : A S p e c i a l
R e p o r t Payment Systems Inc. (Atlanta G a : July, 1983) Vol. 1, p. 73.

M A Y 1984, E C O N O M I C

REVIEW

How are corporate banking services likely to
evolve if securities activities restrictions are removed? This article will utilize criteria that an
expansion-minded bank (or other organization)
would use in considering whether to enter currently prohibited businesses.
Banks' potential investment management and
credit and financing services are significantly
limited at present by the Glass-Steagall Act.
Removal of that law's limits on managing comingled funds would allow banks to offer services
that businesses desire. These services also would
involve extensions of banks' present services
and skills.
However, removing corporate underwriting
restrictions w o u l d not significantly increase the
benefits perceived by large corporations. They
would most likely fear puttingall financingeggs in
one basket. Smaller corporations would be more
likely to benefit from banks' entry. Banks now
offering municipal underwriting and extensive
government security trading almost certainly
would expand to offer various types of debt
placement and debt underwriting, but they are
unlikely to enter into full-scale national debt
and equity underwriting significantly.

Business and Bank
Reactions to
New Securities Powers
If Congress frees banks to compete in the securities business,
the institutions will face hard
decisions on what activities to
undertake. Here's a look at the
challenges expansion-minded
banks might face in marketing
these new services.

Background
The legal framework for today's financial services business was established primarily in the
1920s and 1930s. The McFadden Act (1927)
imposed geographical restrictions on commercial banks. (The Douglas A m e n d m e n t to the
Bank Holding Company Act extended geographical restrictions to bank holding companies in
1956.) The Glass-Steagall Act (1933) divided
the financial services business into segments. In particular, commercial banks
were prohibited from both investment
banking and investment-related financial services (underwriting,
brokerage, mutual funds,
and so forth).




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While communications, transportation, computers, and other technology have changed greatly
over the past 50 years, the line-of-business segmentation persists. However, the actual distinctions between commercial banks and other
financial institutions have become blurred, especially over the last 15 years.
One reason for the blurring has been the
creation of the bank holding company able to
engage in a variety of financial services other
than commercial banking. Thus, major banks
now offer a variety of financial services under
their holding company structure. Some do so on
an interstate basis. Yet t w o corporate financial
services remain clearly prohibited to banks today—securities underwriting and mutual fund
management.

Economic Framework
In considering the corporate services that
depository institutions w o u l d enter if the GlassSteagall regulatory prohibitions were removed,
five factors offer a systematic framework for
evaluating the overall attractiveness of currently
prohibited business lines: profitability, crossproduct scale economies, synergy, competitive
advantages or disadvantages, and business similarities or dissimilarities.
These five factors are not mutually exclusive.
In fact, the last four can be viewed as important
attributes of profitability. Yet they are relevant
because they are congruent with the way a
merger-acquisition group or new product development group would analyze and evaluate
buying or developing new businesses. Thus, this
analysis will attempt to simulate in capsule form
banks' decision processes if legal-regulatory changes
make such decisions possible.
1. Profitability. The ultimate reason for entering
a new business is a belief that it offers attractive
long-run profit opportunities. " A t t r a c t i v e "
means a return on investment that more than
compensates for the costs of investment and
the risk borne. Hence, the basis for profitability
decisions is attractive return-risk situations
relative to other opportunities available to
commercial banks and other depository institutions. The risk dimension is crucial since the
financial service business is undergoing rapid
change in products, structure, and competition,
with the associated increase in business risk
that accompanies such change.
42



2. Scale Economies. The design, development,
production, and distribution of financial services are characterized by scale economies.
Here "scale economies" refer to situations
where fixed costs are substantial and variable
costs are low, so that average cost per unit falls
with increased volume. If scale economies are
extensive, they can produce a market structure
characterized by only a few large service
providers, possibly only one. Securities underwriting is a clear example of a business with
scale economies. Electronic distribution networks and computer-based processing are
others that are pertinent to the emerging use
of computer-communication technology to
produce and distribute financial services.
In terms of new businesses that banks are
likely to enter, the issue is not simply scale
economies per se but rather cross-product
scale economies. Cross-product scale economies represent a particular kind of synergy.
Nevertheless, scale economies are so important in the emerging use of electronic-based
financial services that this type of synergy
merits special attention.
3. Synergy. The term synergy is overused in
mergers to refer to situations where t w o businesses can be run more profitably together
than as separate entities. Product synergy is
used here to refer to cross-product interdependences that allow cost savings when t w o
or more products are offered by a single
enterprise relative to the same level of product
offerings by separate enterprises. These savings
also are called economies of scope. Often
these will be marketing or management synergies—for example, the ability to have a
calling officer sell several services to the same
client
4. Business Similarities/Dissimilarities. This
category covers similarities and differences
between current businesses in which banks are
engaged—areas such as management skills,
organizational structure, compensation structure,
skill requirements, geographical location, and
technologies.

5. Competitive Advantage/Disadvantage. The

terms competitive advantage and competitive
disadvantage are used here to refer to anything
that distinguishes banking from other financial
service companies with which banks would
have to compete.
M A Y 1984, E C O N O M I C

REVIEW

Classification of Corporate Services
The financial services used by corporations
can be placed in three broad categories—investment-management, credit-financing and cash
management.
I n v e s t m e n t m a n a g e m e n t services include
pension fund management and other trusteebased management for corporations or their
beneficiaries. The central issue is the ability to
expand current asset management services to
include comingled funds or mutual funds.
Credit-financing involves provision of credit or
financing. 1 Today, the only domestic business
financing provided by banks is some form of
lending. The central line-of-business issue is the
expansion of financingservicesto include underwriting for corporate debt or equity and a variety
of underwriting-related financing assistance.
C a s h management is a catch-all term for the
variety of transaction and information-based products provided corporations. Given the Federal
Reserve's recent decision to allow Citicorp to
offer a variety of computer-based services and
even the incidental sale of computer hardware
and time-sharing, there are few line-of-business
restrictions covering cash management products
and services. The only significant regulatory restrictions are geographical (McFadden and Douglas),
namely, restrictions on the ability to establish deposit-taking offices across state lines.
Since line-of-business restrictions are insignificant for corporate cash management services,
we will disregard these bank services except as
they involve placement of commercial paper in
the consideration of financing-underwriting.

Investment Management and Mutual Funds
In managing pension funds and other investment management services including personal
trusts, banks cannot create and manage internal
mutual funds into which client funds are placed.
Moreover, different clients' funds cannot be
comingled if invested in corporate securities, i.e.,
managed as a single set of funds with pro rata
assignment of investment returns. Commingled
funds are viewed as a de facto mutual fund and,
thus, as the offering of a security by the bank. 2
The inability to comingle funds or to achieve
investment objectives via selection from a set of
internal mutual funds is a significant competitive
handicap. Commingled funds are less expensive in
both administrative costs and transaction-trading
FEDERAL RESERVE B A N K O F A T L A N T A




costs, since roughly the same effort is required to
manage one large pooled fund as to manage
each company's separate fund. Thus, with deregulation, any bank offering pension fund management and other trustee-managed funds could
offer comingled funds or internal mutual funds.
Exhibit 1 summarizes the pros and cons of this
product addition for the offering bank. It shows
virtually all benefits and no disadvantages.
Since there are significant economies of scale
in a well-automated commingled management
service, there could be a net reduction in the
number of service providers. Or, more likely, it
could mean that a consortium of banks could
form with centralized fund management and
decentralized marketing and administration but
with lower fees. Thus, the corporations seeking
professional asset management also would be
better off it these restrictions were removed.
Asset management clearly would become more
competitive.

Retail Synergy: Mutual Funds
Once mutual funds are created internally, it is
logical in a deregulated environment to offer
them also to the public. Therefore, it is reasonable
to expect that banks now offering pension fund
management and other trustee managed investments will enter mutual fund management, although many banks' offerings w o u l d logically be
managed passively as index-type funds.
Once banks could offer mutual funds, these
undoubtedly would be bundled into"cash management accounts" like that pioneered by Merrill
Lynch (with the assistance of Bank One). These
accounts could offer: (1) an automatic sweep
into a mutual fund, especially an ordinary moneymarket fund or tax-exempt money-market fund,
(2) automatic transfer between funds without
any transaction cost, (3) the use of equity in
mutual funds and other securities as collateral for
an automatic loan, and possibly (4) a credit line.
These accounts would be offered to consumers
and businesses alike.
While only a few banks with large trust departments would enter the mutual fund management
business, most would offer mutual funds as part
of their cash management accounts or security
brokerage business. They could serve as agents
for the funds of either other banks or nonbanks.
Thus, virtually all banks would be likely to offer
mutual funds to their clients.
43

E x h i b i t 1. A Summary of the Pros and Cons Associated with Mutual-Fund-Like Services
STRENGTHS

WEAKNESSES

PROFITABILITY

It is much less costly to manage pooled
funds as a single commingled account
than to manage many separate accounts
especially for smaller companies.

Over time, banks offering lower service
delivery costs could attract more business
but not see revenue and income growth
comparable to their growth in managed
assets.

SYNERGY

Major banks are the primary source of
back-office processing for most of the
mutual fund management companies.

CRITERION

Funds are the best way to offer "passive
assets management' designed to match
security market indices. Hence, banks
would become more competitive in one
of the most rapidly growing areas of fund
management, especially in extending
this service to small accounts of smaller
companies.
SCALE ECONOMIES

The crux of commingling is to obtain the
benefits of aggregation and reduce the
costs of many f u n d s for n different
companies to roughly 1/n-th the
aggregate cost of n separate a c c o u n t s

BUSINESS
SIMILARITIES

1. Very similar to managing large pension
funds and other trustee-oriented
investment management services.

Fees (as well as costs) are much less for
"passive asset management".

2. Banks already provide back-office
processing, shareholder a c c o u n t i n g
and i n v e s t m e n t research t o many
mutual funds.
COMPETITIVE
ADVANTAGES
AND DISADVANTAGES
VERSUS NONBANK
COMPETITORS

Major trust departments are much larger
than most mutual fund m a n a g e m e n t
companies in terms of both assets
managed and professional staff.

Financing Services and Securities
Underwriting
At present, banks provide companies credit
and short-term financing but not significant longterm debt or equity except in special situations.
Thus, major companies issue commercial paper
or borrow short-term from banks, and then rely
primarily on other financial intermediaries to
purchase or help them issue long-term debt and
equity. Over time, a borrowing firm's underwriter
not only will have provided underwriting of debt
and equity; it also will have developed services
44




Some mutual fund management
organizations may cease to use banks
for support services if they are perceived
as direct competition.

sufficient to allow it to assume a preeminent role
in advising on most aspects of corporate financing.

The Argument for Corporate Underwriting
The arguments for expanding bank creditfinancing services include profitability, synergy
with current financing, and the competitive advantage of offering a company "one-stop financing." Along with these advantages of corporate underwriting, Exhibit 2 lists the negatives,
namely: (1) potential customer perception of
conflict-of-interest between equity underwriting
M A Y 1984, E C O N O M I C

REVIEW

E x h i b i t 2. A Summary of the Pros and Cons Associated with Underwriting
CRITERION

STRENGTHS

WEAKNESSES

PROFITABILITY

High sales margin, return on assets

Volatile, business-cycle and interest-rate
dependent revenue; high systemic risk

SYNERGY

Client base is same as for commercial
loans and credit; contacts within
businesses are senior financial officers;
"relationship" natures of banking and
underwriting are similar and involve similar
knowledge-skill sets.

Many companies do not want to obtain
long-term underwriting from the same
firms that provide them credit and/or
short-term financing.

SCALE ECONOMIES

There are cross-product cost sharing
opportunities in image advertising,
marketing and back-office operations.

Established firms with skilled personnel,
investment in model technology, lack of
securities marketing fuction are a
significant entry barrier to new entrants.

BUSINESS
SIMILARITIES

1. Both commercial lending and
underwriting are financial sen/ices.

1. Both commercial lending and
underwriting involve business-cycle
and interest-rate risk

2. Knowledge of financing and financial
markets is a key to both businesses.

2. Employee compensation is primarily
via direct salary and perquisite in
banking rather than bonuses,
commission, or profit sharing.

There are many organizational,
operational and technical similarities to
municipal underwriting.

Municipal underwriting is usually won on
a competitive bid basis rather than the
relationship-service-planning basis
upon w h i c h most c o r p o r a t e underwriters are selected.

COMPETITIVE
ADVANTAGES

Banks with large calling organizations
are often the first source of financing for
many companies.
COMPETITIVE
DISAVANTAGES

Banks are in regular contact with
corporate financial officers.

Banks lack the brokerage-based retail
distribution required for large-scale
national underwritings.

Banks could logically place commercial
paper since they have information on
companies with investable funds, and
their balance reporting services are a
natural communications link

Current bank market-making is limited to
municipals and government securities
rather than corporate debt and equity.
Most banks lack the syndication and
distribution structures of the investment
banks and brokerage firms.
Only the most senior officers in
commercial banks receive compensation
commensurate with that provided
professionals in major investment banking
firms; top salaries in most banks are for
management rather than professional
skills although some banks are now using
commissions and other incentive
structures in security trading, leasing,
and consulting but this usually occurs in
holding company units outside of the
commercial lending area.

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




45

and being a provider of short-term credit, (2)
competitive disadvantages involved in going up
against a partnership-oriented organization with
high compensation for the talent required to
design and price underwritings, and (3) the need
for a distribution capability that would require
activities such as full-service brokerage and security market-making.
While underwriting is often viewed as a logical
and attractive business, especially the apparent
synergy from offering one-stop financing to companies, a close examination of the strengths and
weaknesses raises questions about how eagerly
banks would enter into corporate underwriting if
they received complete securities powers.
The synergy of one-stop financing appears
questionable. First, major companies already
deal with many banks for credit so that the value
of having one of several credit banks provide
underwriting seems unlikely to increase administrative efficiency. Second, relying on the same
organization for short-term credit and most longterm financing including its underwriting could
be viewed as risky because of disadvantages of a
company being dependent on a single vendor
for two of its most critical needs—short-term
credit and access to the capital markets. Third,
and most important, most companies would be
acutely aware of the conflict of interest between
the role of credit granter and short-term lender
and the role of underwriter of both equity and
bonds.
Corporate financial officers clearly would worry
that, in times of financial duress, a bank concerned
with the safety of its short-term loans could force
an equity offering or long-term debt offering at an
inopportune time. Because companies use shortterm financing as the primary means for controlling
the timing of long-term financing, most would
prefer to have one vendor for short-term debt
and another for underwriting both long-term
d e b t a n d equity, ratherthan relyingon"one-stop
financing."
Since major companies now deal with several
banks and most would not want their major
credit banks to be their equity underwriters, it
seems that the common assumption regarding
the marketing value of a bank's ability to offer
one-step financing is dubious for the major
companies that comprise most of the underwriting market.
The foregoing has focused on the issue of
marketing synergy because some form of synergy
46



is usually cited as the primary argument for bank
entry. However, other reasons against significant
bank entry into underwriting are also strong.

Profitability and Organizational Structure
Most investment bankers that act as major
underwriters are organized as partnerships. The
underwriting business is highly covariant with
the business cycle and the level of interest rates.
Hence, there is significant year-to-year variation
in both revenue and income. For this reason,
firms find it difficult to pay consistently high
compensation even though the business requires
talented professionals. A significant portion of
pay is given as bonuses rather than base salary,
with the bonus reflecting the year's revenue and
income. Thus, compensation is variable and
much of the firm's risk (uncertainly in revenue
and income) is shifted to the professional emp l o y e e s — b o t h partners and non-partner professionals. In addition, the partnership form means
that while the most senior professional employees
receive compensation via their partnership shares,
they also bear equity risk.
Banks, especially the major banks, cannot
easily emulate either the high level of compensation or the employee risk-sharing inherent in
bonus and partnership income. First, banker
salaries are generally much lowerthan the averge
compensation paid underwriting professionals.
Moreover, most banks today pay high salaries
only to senior management rather than nonmanager personnel providing professional services.
Second, if banks were to pay salaries comparable
to the compensation in underwriting but without
relying significantly on bonus and partnership
income, the net effect would be a large salary
base and, therefore, a volatile, highly seasonal
profit contribution. Moreover, once higher employee compensation requirements are recognized,
the actual profitability of underwriting to banks is
likely to be much less than the apparent profitability.
In addition, compensation predominantly as
salary would mean a high fixed cost that would
make underwriting income risky and, thus, less
attractive on a risk-adjusted basis than average
income would suggest Finally, banks have only
limited ability to tolerate volatile, uncertain income streams because of their highly leveraged
financial structure and narrow margins on lending.
In sum, it seems quite doubtful that banks are
MAY 1984, E C O N O M I C

REVIEW

organizationally able to engage in broad-scale
corporate underwriting on a significant scale.3
Besides the problems involved in assisting
companies with planning long-term financing,
other requirements of the business also could
prove troublesome for banks. One is the need for
a distribution network. Both market-making and
full-service brokerage also involve high compensation and highly variable, business-cycle covariant
income. Brokers, for instance, typically receive
commissions as their primary source of income.
Again, commission income is a device for shifting
risk to employees in the presence of volatile
revenue. But commission income is again a form
of compensation alien to the rank-based salary
ladders of most major banks.

Bank Underwriting: Synthesis
I n summary, it seems clear that full-scale national
underwriting is not an easy, synergistic business expansion for banks as they are currently
organized. The usually assumed marketing synergy
from being able to offer one-stop credit-financing
would be of limited value to major companies
and may even be rejected as risky and flawed by
latent conflict-of-interest problems. Once the
necessity of compensating skilled professionals
generously is recognized, the apparently high
average profitability becomes questionable. Moreover, the volatile, underwriting revenue pattern
means that underwriting income is risky, especially if an organization cannot shift risk to
employees by relying extensively on bonuses
and partnership equity. Finally, the organizational
structure of banks and the need to obtain or
create market-making and security distribution
capabilities constitute further obstacles to bank
entry.
These obstacles are formidable. Thus, it seems
that few major banks, probably at most five or six,
could rationally hope to become full-scale national
underwriters. Given the clear risks associated
with trying and failing, few major banks would be
likely even to attempt aggressive direct entry
into full-scale national underwriting even if there
were no line-of-business restrictions.
Rather than encouraging direct entry, complete
securities line-of-business deregulation most likely
would produce gradual expansion of major banks
now engaged in municipal debt underwriting
and U.S. and municipal-government securities
trading into aspects of underwriting. Below are
plausible types of underwritingactivity for banks.
FEDERAL RESERVE B A N K O F A T L A N T A




1. C o m m e r c i a l Paper Placement. More banks
apparently w o u l d become commercial paper
underwriters and dealers. A few banks (for ex
ample, Bankers Trust Company and Manufacturers Hanover Trust Company) already
engage in this activity. In effect, major banks
would seek to reestablish their role as shortterm borrowing-lending intermediaries between
major corporations, a business that has shifted
to four investment bankers 4 as the primary
intermediaries in dealer-placed commercial
paper.

2. Regional and Middle-Market Underwriting.
Banks now in municipal underwriting may expand into limited underwriting for regional and
middle-market companies, especially those
not listed on major exchanges. M u c h of this
underwriting would be debt rather than equity
and much would be privately placed rather
than through public offerings. But the ability
to engage in public underwritings would allow
banks to fill out their line of services.
3. Industry Focused Underwriting. Some banks
may specialize by industry—for example, electric
utilities and other regulated companies obligated
to obtain competitive bids.
4. Debt Underwriting. Some banks might seek
to expand their financing for major companies
by expanding existing debt-underwriting skills
into long-term debt placement and underwriting
for high-quality companies, but avoiding equity
underwriting.

5. Underwriting Syndicate Participation. Be-

sides direct underwriting and debt placement,
banks that expand into brokerage or acquire
brokerage firms w o u l d participate in underwriting syndications. They w o u l d act not as a
principal but as one of the many participating
firms involved in the distribution network
created for large underwritings.

Conclusions
Corporate banking services can be placed in
three broad categories—investment management,
credit-financing, and cash management. Aside
from commercial paper placement (which some
banks are now entering), corporate cash management services are not curtailed by line-of-business restrictions but only geographical restrictions.
In contrast, investment management and creditfinancing services are limited significantly by
current line-of-business restrictions.
47

Internal mutual funds and other kinds of commingled fund management, currently prohibited
to banks, represent a straightforward business
extension of current pension fund and other
corporate investment management services.
Once banks offer internal mutual funds for their
trusteemanaged funds, it is also a straightforward
business expansion for them to offer mutual
funds to the public and to incorporate them in
retail cash management accounts patterned on
those pioneered by Merrill Lynch and now offered
by other brokerage firms, banks and thrifts.
Bank entry into corporate underwriting involves
much greater uncertainty in terms of both form
and scope. Expanding into underwriting to provide more comprehensive credit-financing appears superficially to provide marketing synergy.
But closer analysis suggests that major companies
probably will want credit and short-term financing
from a source other than their equity and longterm debt underwriters.
Virtually all other factors appear negative also.
Thus, few if any banks are likely to become fullscale, full-service national underwriters. If all

' C r e d i t is used as a generic term for any agreement, both contractual and
non-contractual, to loan funds up to a specified maximum level. The
standard forms are credit line (non-contractual commitment to lend at a
formula rate such as a prime for a term up to a year), c r e d i t a g r e e m e n t
(contractual commitment to lend for a term up to a year), revolving credit
a g r e e m e n t (contractual agreement to lend for periods in excess of a year
under a variety of rate agreements and possibly with a time-varying upper
limit).
' The issue of commingling trust assets has been the subject of litigation. The
Investment Company Institute challenged Citibank's offering of a commingled

48



line-of-business restrictions were eliminated, bank
entry into underwriting would be limited to
banks already in municipal underwriting or government security market-making and would be
focused on smaller regional companies and other
specialized services. In addition, those few banks
that choose to offer full-service retail brokerage
seem more likely to participate as part of
underwriting distribution systems rather than
as the lead underwriter.
Conversely, investment banks specializing in
corporate underwriting are unlikely to enter fullscale commercial banking in terms of direct
credit and short-term financing for corporation
although they w o u l d continue to place commercial paper.

— Bernell K. Stone*

•Berne// K. Stone is the Mills B. Lane Protessor or Hanking and Finance.
Institute ol Technology.

Georgia

fund service in 1969. The courts agreed that there was an implicit security
offering and a violation of Glass-Steagall.
•An argument to counter the issues of salary form would be to create
underwriting as a separate holding company unit so that it could emulate
the organizational form of the major underwriting organizations This
device would clearly enable a different salary structure, salary level and
organization. B u t if it is operated as a separate holding company unit, the
market synergy, cross-product cost savings and other arguments for
bank underwriting are invalid.
"These are Goldman Sachs, AG. Becker. First Boston and Merrill Lynch.

M A Y 1984, E C O N O M I C R E V I E W

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




49

Investment Banking:
Commercial Banks' Inroads
The evolving competition between securities
firms and commercial banks has come into
increasingly sharp focus in recent years. This
article examines some of the historical antecedents and contemporary market forces at
work in both the retail and wholesale sectors of
the securities business which bear on its interface
with commercial banks. This examination leads

Commercial banks and securities firms have invaded
each others' turf more and more often in recent years.
These incursions strain product limits of the GlassSteagall Act from both sides.

50



MAY 1984, E C O N O M I C REVIEW

to some suggestions about possible direction
and speed of future competitive change in these
market sectors.

Historical Evolution
Since 1933, the traditional role of U.S. commercial banks has been reasonably clear; the
niches occupied by various groups of securities
firms during this period have been less well
understood. Some observers see the securities
business as a relatively homogeneous activity;
others see it as a disparate series of independent,
easy-entry" lines of commerce." Neither of these
stereotypes mirrors reality. Instead, competitive
factors have divided the business more practically
into "retail" investor services and "wholesale"
services to corporate, municipal and institutional
customers.
Securities firms and deposit-taking commercial banks have undergone separate mutations
in response to broader developments in financial
services, but the historic routes and influences
that have brought them to their current positions
have much in common. The post-World War II
U.S. commercial and investment banking structure
grew out of legislation and regulatory interpretation
in the 1930s. The Securities Act of 1933, the socalled Glass-Steagall Act, threw up a Chinese
Wall between deposit-taking and securities-dealing firms and thus created an industry structure
that is mirrored only in Japan, among industrialized countries.
This structural dichotomy survived for several
post-war decades without major challenge, perhaps in part because the United States was
enjoying an unprecedented era of secular growth
accompanied by relatively high savings, nominal
inflation and low interest rates. Each group of
financial intermediaries was comfortable, protected, and able to prosper within its assigned
niche in the industry structure.
The McFadden Act and the Douglas Amendment protected and nurtured local and regional
banks and curbed the money center banks'
market shares in domestic lending and depositseeking. But these large banks diversified and
grew by following corporate customers into the
largely unregulated international arena Likewise,
insurance companies were major beneficiaries
of the post-war institutionalization of savings,
and thrifts prospered by fueling the growth in
home ownership with fixed-rate, long-term mortgages.
FEDERAL RESERVE B A N K O F A T L A N T A




O n the other side of Glass-Steagall's Chinese
Wall, an ever-expanding base of individual stock
ownership and overall market trading volume
promoted growth and consolidation within the
retail securities sector. Increasing corporate and
municipal underwriting volume also yielded attractive profits to the wholesale investment banking sector. Growth in institutional investor demand, which first came into focus in the early
1960s, created yet another dimension for postwar securities industry growth. Over time, that
dimension has come to be associated and identified more closely with the wholesale investment
banking function.
Meanwhile, beginning in the 1960s, changes
in the domestic and world economy conspired
to upset the equilbrium in this financial services
structure. Several important factors that particularly affected competition between commercial
and investment banks were the rise of the Euromarkets, the increasing sophistication of both
institutional investors and corporations, and the
acceleration of inflation and interest rates in the
1970s, with a consequent realignment of securities values and investor preferences.

"The McFadden Act and the Douglas
Amendment protected and nurtured
local and regional banks and curbed
the money center banks' market shares
in domestic lending and
deposit-seeking."

Originally minimized in the mid-1960s as a
minor and temporary phenomenon, the Euromarkets' evolution into a large and permanent
"supra-national" market has created an arena
outside the jurisdiction of Glass-Steagall where
participation is open to diverse financial institutions willing and able to assume the attendant
risks. This market, abetted by the advances in—and application of—electronics technology, has
spearheaded the rapid evolution toward a global
market in money. Linkage of the various national
capital markets with the Euro-markets and accompanying aggressive arbitrage on rates and
terms have established money as a truly fungible
commodity, whose movement across national
and currency frontiers is increasingly difficult to
control. 1 It has thus become more and more
51

compelling for U.S. financial service organizations
to accommodate this global market.
In the United States, the inexorable institutionalization of savings had, by the beginning
of the 1980s, raised the institutional sector share
of the New York Stock Exchange equity wealth to
35.4 percent (from 17.2 percent in 1960) and its
1982 share of equity market trading to 83.8
percent (from 24.3 percent in I960). 2 Money
market funds have grown from nothing in the
early 1970s to more than $1 75 billion at the end
of 1983. This institutionalization has loosened
the commercial banks' link to the individual
saver and focused much of the securities industry's attention on the large portfolio manager.
Corporations also developed and expanded
their internal financial engineering capabilities
over this period. The growth of the commercial
paper market to a mid-1983 annual rate of
$123.7 billion (versus $4 billion in 1960) 3 reflects
large companies' willingness to substitute these
less expensive but potentially more volatile shortterm funds for traditional commercial bank lines
of credit. This development also has diminished
an important, moderate-risk revenue stream for
the commercial banks and forced them into
other, often more risky funds deployments as
well as more costly retail lending avenues. After
the oil shocks of 1974 and 1979, this redeployment was evidenced by the much greater volumes
of foreign, cross-border loans.
Of the forces that increased the pressure on the
financial services industry status quo during the
1970s, accelerating inflation and rising interest
rates were among the most pervasive. For many
years, savings patterns had been fairly stable.
Most individual savings were channeled to commercial banks, thrifts and insurance companies
in exchange for a modest interest return.
Although earlier flare-ups in interest rates had
failed to disrupt this deposit pattern seriously,
inflation and interest rate jumps after the first oil
price hike in 1973 appear to have precipitated a
structural change in retail savings.
On one side of the Glass-Steagall wall, mandated rate differentials were causing commercial
banks and other deposit-gathering institutions to
lose deposits to money market funds and other
intermediaries capable of adjusting more rapidly
to changes in prevailing interest rates. Institutions
such as thrifts, holding fixed rate instruments
with greatly diminished value, suffered from
badly mismatched maturity funding sources on
52



the liability side of their balance sheets. As retail
deposits deserted them for substantially better
returns elsewhere, their options were to turn to
the higher-cost wholesale markets for replacement funds or else sell their assets at substantial
losses from their original value. Unlike the commercial banks, they had few alternative strategies
for survival until passage of the Cam Act in 1982.
O n the securities side of the Glass-Steagall
wall, higher inflation and interest rates also created
serious dislocations. The consequent downward
revaluation in the market prices of securities
created disaffection among retail and institutional
investors and disrupted the markets for new
issues of securities as well as for secondary
market trading. Concurrently, inflation substantially increased securities firms' operating costs,
especially since t h e i r o v e r h e a d is heavily
weighted with the "people" costs and electronics
support systems deemed necessary to stay competitive. 4
Break with the Status Quo. These developments have impelled various financial service
institutions to seek out n e w — a n d hopefully
more promising—business niches. O n the deposit-accepting side, various legislative and regulatory changes initiated at the behest of industry
lobbyists have facilitated this development. Deregulation of the interest payments permitted on
deposits (Regulation Q), for instance, has helped

"Of the forces that increased t h e
pressure on t h e financial services
industry status q u o during the 1970s,
accelerating inflation and rising interest
rates w e r e among t h e most pervasive."

spur an intensive competition for retail deposits.
While these deposits are more expensive than
they were prior to the deregulatory measures,
they are seen as a stabilizing counterbalance to
the banks' and thrifts' mismatched asset maturity
structures.
To help attract those deposits and to spread
the overhead of the infrastructure and marketing
costs, banks and like institutions have sought
both to broaden their retail product offerings
and to explore alternatives for delivering them,
including radically different electronic distribution
M A Y 1984, E C O N O M I C

REVIEW

systems. There also has been a more concerted
search, particularly by commercial banks, for
additional products and services to strengthen
relationships with traditional corporate customers.
In building new ties to both the retail saverand
the corporate customer, commercial banks and a
variety of other nonbank institutions have moved
to break through the Glass-Steagall wall to get
into new areas of the securities business. They
have noted the growth in securities trading
volume and the industry's greatly enhanced
revenue stream.
Securities firms focusing on individual investors,
however, have not themselves been comfortable
with their o w n situation. They recognize that a
large part of their profit derives from their role as
banker for their customers and that their own
historic "deposit base" (free credit balances),
like that of the traditional deposit-taking institutions, has come under attack from the money
market funds and other higher-yielding instruments. They have responded in part by creating
their own in-house savings vehicles to hold those
deposits and by creating an even wider variety of
products and services both to retain customers
and to spread their overhead across a wider base.
A consequence of that deposit-protecting and
product diversification strategy has been for
securities firms to emulate competing financial
intermediaries on the deposit-taking side of the

"In building new ties to both the retail
saver and the corporate customer,
commercial banks and a variety of
nonbank institutions have moved to
break through the Glass-Steagall wall
to get into new areas of the securities
business"
Glass-Steagall wall. They have initiated moves to
break through that wall into the territory of the
commercial banks, thrifts and insurance companies by offering de facto checking and savings
accounts, consumer loans, home mortgages and
various insurance products.
These retail brokerage firms also have sought
to combat accelerating overhead and squeezed
margins by attempting to integrate backward
into the "manufacture" of their financial products.
They have created special " t h i n k tank" groups to
devise new marketable instruments such as unit
FEDERAL RESERVE B A N K O F A T L A N T A




trust, tax-advantaged investments and various
"stripped" securities. It also has propelled them
into a more active competition for leadership in
new corporate underwritings, thus obtaining securities that are typically attractive products for
their retail (and institutional) clientele and whose
management and underwriting fees add incremental revenue to the selling commissions they
traditionally have received.
Both retail securities firms and commercial
banks have noted that wholesale investment
firms were not hurt seriously by any of the major
international or national money market developments in which their institutional and corporate
customers were active during the 1970s and
early 1980s. 5 To be sure, the banks often were
prodded into making massive incremental investments of people and money to accommodate
structural changes in their institutional and corporate markets. But they found ways to cushion
their revenues even when the volume of underwritings declined cyclically. 6 The activities and
employment within these firms increased dramatically during the 1970s, 7 and profitability
held up much better than was true for the retail
brokerage firms.8 Notably, one of the wholesalers'
diversifying moves was into the lucrative highnet-worth sector of the retail brokerage business—
primarily because it was a profitable exploitation
of their in-place research and trading activities
rather than as a way of ensuring distribution for
their underwritings.
These competitive "migratory" moves are noteworthy. Some of them appear to be in defiance
of the spirit, if not the letter, of the 1933 act
Challenges to the long-held interpretation of the
limits on business activity imposed by the act
surfaced only as a result of economic and competitive forces in a more fragile and volatile
environment Industry competitors began to discover that, like the Wizard of Oz, the GlassSteagall wall was much more formidable in
appearance than in reality. Once tested by restive
competitors with inventive legal counsel in an
environment generally sympathetic to deregulation, gaps opened up that allowed competitors
to cross through the wall in both directions.
It is still too early to predict with confidence
the durability or success of many of these competitive moves. Nonetheless, we can learn something about their dynamics by looking at specific
market segments. To do that, let us search for
likely longer-term competitive patterns in t w o
segments of the securities business.
53

Retail D i s c o u n t B r o k e r a g e
An industrial organization view of the retail
securities sector would depict a number of traditional, full-service brokers in the center, with
individual savers on the one hand and the
various capital users on the other. Primary and
secondary transactions in traditional stocks and
bonds have declined in importance as new
products, many of them devised by the firms
themselves, have grown in variety and volume.
A number of new firms have entered this
business in recent years, including wholesale
securities firms seeking to skim the cream through
appeals to wealthy customers and discount brokers
aiming at the price-sensitive, independent investor. Discount brokers emerged after securities
commission rates were deregulated on May 1,
1975. In the immediate aftermath, rates on
institution-sized transactions fell by almost 50
percent, whereas rates on trades under 200
share actually rose by almost 10 percent. 9 During
the first couple of years of the negotiated commission era, the retail discounters made little
progress, perhaps in part because of inertia on
the part of individual investors. The discounters'
market share began to grow materially after
1977, however, and by the beginning of 1984
fully 14 percent of the retail trades on the N e w
York Stock Exchange were handled by discount
brokers. 10
Commercial banks and thrifts moved into
discount brokerage beginning in 1982. 11 Many
leading money center banks have acquired or
affiliated with established discount brokerage
operations. 12 Other banks have set up their own
operations but clear the trades through a conventional securities firm. 13 In some instances,
commercial banks and thrifts have even invited
brokerage firms to set up booths on their banking
floors, much as Dean Witter is doing within the
retail stores of parent Sears, Roebuck.
The number of commercial banks and thrifts
offering brokerage services has grown from virtually none in 1981 to an estimated 1,500 at the
end of 1983. 14 One market observer has predicted
that, with the growing participation of the commercial banks, discounters' share of the retail
securities market could grow much larger within
the next several years.15
W i t h the effective neutralization of the GlassSteagall legal barrier that had prevented banks
from offering brokerage services, the question
remains whether economies of scale or other
54



barriers will inhibit the commercial banks, thrifts
and others from maintaininga sustained presence
in the retail brokerage business. 16 In an earlier
study, Irwin Friend and Marshall Blume suggested that economies of scale are relatively
modest in the brokerage business. Certainly
these new bank entrants, whose overhead costs
are largely covered by other service activities,
appear to enjoy a current price advantage over
full-service brokerage firms. That could change
as the full-service brokers cut costs and spread
their remaining overhead across an ever-broadeningarrayof products and services. It could also
be altered if commercial bank entrants move
from discount transactions into a more fullservice configuration. While trade reports indicate
several banks have abandoned brokerage operations because of disappointing profits, the
primary motivation for a number of others may
be different. If this activity generates incremental retail deposits and other attractive
retail "cross-selling" opportunities, it may become a permanent fixture in the banks' product
line regardless of its profitability.

W h o l e s a l e Services
In contrast to the fluidity of the retail sector,
the wholesale securities sector, catering as it
does to corporate, municipal and institutional
clienteles, is resisting intrusion more effectively.
That appears to be the case from the viewpoint
of either an aspiring retail securities firm tryingto
integrate backward into product"manufacture,"

"The number of commercial banks and
thrifts offering brokerage services has
grown from virtually none in 1981 to
an estimated 1,500 at the end of
1983."

or a non-traditional intermediary attempting to
penetrate the wholesale business.
Competitive patterns in the wholesale sector
appear to differ materially from those in the retail
sector. A variety of investment banking intermediaries are competing for the business of
increasingly sophisticated capitakaising corporate
clients on the one hand, and a group of "savers"
M A Y 1984, E C O N O M I C

REVIEW

T a b l e 1 . Dollar Revenue Concentration: Combined Negotiated and Competitive Securities
(all $ figures are in millions)
1970

1971

1972

1973

1974

1975

1976

1977

1980

1981

1982

32
53
80

30
50
77

32
56
79

36
62
89

47
68
89

42
66
88

42
64
88

42
67
92

41
63
86

39
60
84

45
64
87

139

141

92

48

140

198

194

153

748

920

1,704

44
67
97

31
51
75

29
51
77

30
53
80

49
72
93

41
65
89

39
62
89

46
67
92

44
68
88

41
65
87

43
67
90

109

268

263

134

86

211

181

159

346

350

289

33
55
80

27
47
73

27
47
76

33
53
79

44
63
87

39
61
87

36
58
84

41
64
91

42
62
88

41
60
84

45
65
88

253

408

355

182

227

409

375

312

1,053

1,220

1,948

Debt
Top 4%
Top 8%
Top 1 5%
TOTAL UNIVERSES
Equity
Top 4%
Top 8%
Top 1 5%
TOTAL UNIVERSE $
Debt & Equity
Top 4 %
Top 8 %
Top 1 5%
TOTAL UNIVERSE $

Source: Securities and Exchange Commission Data (1970-1977) released to author/Securities Industry Association (1980-1982) as provided by
NYSE adjusted for ' Universe of top 2 5 firms. Data for 1978 and 1979 were not available from the NYSE.

heavily dominated by sophisticated institutions
investors on the other hand. The growing competences of the traditional corporate clients and
the heavily reinforced staffs of the wholesale
securities firms 17 have accelerated the pace of
" n e w product" and service innovation. Increasingly, the character of innovation has drawn on
the secondary market intelligence generated by
the wholesalers' trading floors. A n u m b e r o f firms
have even moved part of their corporate finance
groups down to those trading floors to provide
better what their corporate clients identify (and
pay for) as "value-added" services.
Some wholesalers entered the institutional
markets seriously in the early 1970s as a defensive
move to service their corporate clients better.
Others that already had substantial positions in
trading used this as a lever to obtain new corporate business. The institutional investors, for
their part, have escalated the quid pro quo for
their business, so that to be an investment
banking participant in the institutional services
(and therefore the corporate) sector requires a
FEDERAL RESERVE B A N K O F A T L A N T A




large commitment of capital and human resources. For some wholesalers the serious commitment to trading was originally a means to an
end, but in some instances that activity has
become so large that it rivals the firms' corporate
finance activities. 18
Retail securities firms' efforts to integrate backward into this wholesale sector have been modestly successful at best The top eight wholesale firms' grip on various parts of the business
has, if anything, grown stronger in recent years.
This is true in the underwriting of corporate
securities, whether one looks at a volume of
corporate securities managed 19 or revenues from
corporate underwriting activities (see attached
exhibit). The same also holds true for municipal
finance, 20 for perceived trading competence
among institutional clients 21 and for the lucrative
merger and acquisition counseling business. 22
Several new or potential entrants to the securities market have emerged. They include
foreign banks, with their merchant banking skills
developed and refined in traditionally integrated
55

commercial and investment banking home market settings and in the Euro-markets. 23 They also
include a variety of businesses that recently have
purchased securities firms with some representation in the wholesale market. Among these are
insurance companies (like Prudential), merchandising companies (like Sears), and financial services companies (like American Express). In
addition, more and more money center and
regional commercial banks have shown interest
in parts of the wholesale market which they
believe are not closed to them by the GlassSteagall Act. 24
These potential entrants believe they have the
regulatory license to compete in a wide range of
activities. For the commercial banks, some of the
more important include Euro-market foreign exchange hedging, underwriting, lending and trading;
U.S. government bond underwriting and trading;
interest rate futures; general obligation, municipal underwriting and trading; mortgage-backed
securities trading; real estate financing; taxable
and nontaxable private placements; mergers
and acquisitions; venture capital and leveraged
buyouts; financial counseling; leasing and portfolio management.
Viewed from a national market perspective,
the commercial banking group enjoys major
positions in Euro-financing, 25 leasing,26 and portfolio management. 27 Until now, they have been
excluded from underwriting corporate securities28
and severely restricted by Glass-Steagall's prohibition on revenue bond financing, which in
recent years has constituted approximately t h r e e
quarters of municipal underwriting volume. 2 9
In the areas of taxable private placements and
mergers and acquisition counseling, no legal
barriers prevent overt commercial bank competition with securities firms, and yet the results
have been d i s a p p o i n t i n g from banks' perspective. Their penetration in private placements
has been quite modest, although growing, 30 and
their share of mergers and acquisitions assistance
at the national level thus far has been nominal. 31
In venture capital, neither commercial banks nor
the cadre of leading securities firms have had
much impact thus far, although commercial banks
have been increasingly active in leveraged buyouts and both groups profess a major interest in
venture capital for the future. 32
Commercial banks have had a similar record at
the regional level. Several regional banks have
established "investment banking" or"corporate
56




finance" departments, 33 usually well-separated
from commercial lending activities. They offer a
variety of services, including private placements,
mergers and acquisitions, financial consulting,
venture capital, leveraged buyouts, valuations
and appraisals, various types of asset-based financing and international financing accommodations. Full-time personnel and revenues tend
to be modest; these departments typically have
had limited success in mobilizingthe sponsoring
banks' resources and m o m e n t u m on behalf of
these investment banking activities.
In sum, despite efforts to penetrate the wholesale securities markets, the commercial banks'
overall record thus far has been unimpressive. In
view of their professed interest in wholesale
corporate finance, what are the prospects for the
future?
Aside from the regulatory constraints discussed
above, future progress for many commercial
banks may hinge in part on their ability to sell
corporate customers on the banks' professional
capabilities in providing investment banking services.
It also will hinge on banks' ability to convince
themselves that they have those capabilities.

"Corporate underwriting leadership
increasingly d e p e n d s on quick and
deep access to institutional investors
that can be assured only by a
continuous presence in the secondary
markets."

Two important aspects of the wholesale investment banking business seem clear: (1) activities
within this sector tend to be interdependent and
(2) the successful players in this market have
made an important accommodation to t h e " c u l ture" of investment banking, with its attendant
risk and reward structure and high level of
personal commitment.
The Interdependent Parts. Many of the key
activities in wholesale investment banking are
not isolated "lines of commerce" in the classic
economic sense but rather"joint product" activities
that are, to one degree or another, actually
interdependent. A leadership position in the
annual underwriting" league tables," for instance, is
M A Y 1984, E C O N O M I C

REVIEW

treated by investment bankers as tangible evidence of their market presence and overall
corporate finance skill, and is used as a selling
tool to convince current and potential corporate
clients of their acumen in such areas as financial
counseling, private placements and, very lucratively, mergers and acquisitions.
Corporate underwriting leadership increasingly
depends on quick and deep access to institutional
investors, an access that can be assured only by a
continuous presence in the secondary markets.
That ongoing market activity, in turn, depends
not only on the commitment of people and
capital; it also depends on " p r o d u c t " that provides the excuse for securities salesmen to maintain daily contact with institutional portfolio
traders and elicit a steady flow of transactions.
Wall Street's response to the introduction of
Rule 415 " s h e l f registrations demonstrates that
investment bankers understand this interlocking
system and act accordingly. W h e n the Securities
and Exchange Commission first began " s h e l f
registrations on a trial basis in March 1982, it
expressed hope that the introduction of de facto
competitive bidding on these offerings would
not only yield savings to corporate issuers but

" D e s p i t e efforts to penetrate the
w h o l e s a l e securities markets, the
commercial banks' overall record thus
far has been unimpressive."

also would boost competition by opening the
market to a broader array of competing underwriters. 34
While corporate issuers have realized significant savings,35 the leading wholesale firms' responses have further concentrated, not broadened,
the group of competing intermediaries.
These traditional underwriting leaders, as noted,
have continued to consider high standings in the
annual underwriting"leaguetables" important in
soliciting business in other areas. In addition,
because they are continually under pressure to
generate adequate volumes of marketable products to feed their institutional trading and
distribution networks, the " s h e l f registrations,
FEDERAL RESERVE B A N K O F A T L A N T A




representing well-known credits, are often attractive acquisitions.
Perhaps most important, the traditional underwriting leaders have continued to hold onto their
ties with certain corporate clients. They act as
though the loss of a client's " s h e l f offering to
another investment bank could pose a threat to
that relationship, with its prospects for other
profitable pieces of business.
Thus, in most instances, these traditional leading
wholesale investment banking firms have stepped
in and aggressively (and often successfully) bid
for their clients' 415 offerings. Having won the
bid, these underwriting firms often have omitted
or sharply curtailed the size of the distribution
syndicates, thus further concentrating the new
issue business. Investment banks' behavior in
connection with " s h e l f registrations helps clarify
the interlocking nature of the corporate (wholesale) services business as well as the competitive
response that leading securities firms could be
expected to make to a new group attempting to
enter this market.
Commercial banks, which in theory could be
serious competitors in the corporate market, are
blocked from a more effective challenge, in part
because they lack access to some key components in the interlocking portfolio of products
and services. They are legally barred not only
from corporate underwriting and trading but also
from the big volume industrial revenue bond
business. This, in turn, has denied them access to
other key components of the product and service
"system." The commercial banks cannot aspire
to the visibility and stature of a leadership position
in corporate underwriting. They cannot benefit
from the interaction with corporations that would
follow from day-to-day trading in their securities.
Absence from the corporate and revenue bond
trading markets also can hamper them in providing the latest pricing intelligence to these
corporations when new financing strategies are
being formulated.
It is not surprising, therefore, that the investment banks have been tenaciously fighting any
change in the prohibition on revenue bond
underwriting by commercial banks. It probably is
not fear of inroads into the profitable revenue
bond market that galvanizes investment banks,
but rather the spectre of commercial banks
gaining greater m o m e n t u m in secondary market
trading and then arguing with credibility for
authority to apply that acumen to the U.S.
corporate securities markets.
57

competence that could wrest important feebased corporate business from the current wholesale investment banking leaders.
The Bankers' Mindset. While some commercial
bankers believe that the only thing standing
between them and the wholesale investment
banking business is Glass-Steagall, it is much less
certain that commercial banks as a group could
penetrate this market rapidly if these regulatory
barriers fell. Even putting aside the massive
counterattack that leading investment banks
could be expected to launch, the traditional
"mindset" of commercial banks' management
could inhibit successful penetration of investment banking.
W h i l e t h e investment banks talk confidently of
their ability to continue fielding the most competent resources in each of their business sectors,
they may well fear the trading power that commercial banks might muster. From an initial
strategy of "buying" leadership in high volume
corporate underwritings such as " s h e l f registrations, and by aggressive trading and principal
positioning in the "commodity" end of the secondary markets with the help of their huge capitalizations, commercial banks (and certain other
non-traditional entrants) subsequently could move
into greater value-added products. Like Salomon
Brothers, they might parlay that trading initiative
into a credible, broad-based corporate finance
Field interviews suggest that commercial banks
have found it difficult to link the competence
and skills of their investment banking groups
with their much larger core of lending officers.
Some lending officers' reluctance to become
familiar with investment banking product and
service possibilities and to promote them to
corporate customers may indicate a "mindset"
that resists change and fears encroachment by
investment banking specialists onto their traditional business "turf."
Envy and resentment at the elite status usually
accorded a bank's investment banking personnel
also may play a part in some lending officers'
unenthusiastic response. These "corporate finance" professionals often are relatively young,
deal in what is seen as a more glamorous mix of
problems, and have access to the corporate
customer group's highest management levels.
Lending officers, by contrast, often interact with
staff further down the organizational hierarchy.
The investment banking staff members usually
are paid substantially more than other bank
58




officers, given comparable age, time-in-grade
and experience. The managements of some
leading money center banks believe they already
have crossed the psychological barrier to sharply
higher compensation levels for their corporate
finance and securities trading professionals. 36
Yet at most banks there has been insufficient
experience to predict how well mainstream
personnel will react to compensation levels of a
half million dollars or more for fast-track corporate
finance professionals still in their 30s!
Similarly, commercial bank and other nontraditional entrants into investment banking must
be prepared to absorb the vicissitudes of the
securities block positioning and trading business.
As mentioned earlier, a substantial presence in
the institutional trading area has become a sine
qua non among serious competitors for corporate
service business. Inventory levels have risen
dramatically in recent years37 in the face of
increasingly volatile securities markets. While
hedging strategies have sought to dampen capital
risks considerably, players must be prepared to
absorb large, unexpected swings in securities
inventory values.
O n the positive side, commercial banks can
point to gains in trading skills and the assimilation
of a supportive culture through participation in
several arenas, including the domestic market
for U.S. government securities, the Euro-markets,
the ongoing management of the banks' liability

"Changing economic and demographic
patterns have broken the longstanding
status quo that prevailed in the postWorld War II financial services industry."

structure, and the emerging secondary markets
for commercial, industrial and foreign loans.
More than a dozen U.S. money center banks 38
are recognized dealers in government securities.
These markets are so large and liquid that they
often serve as the benchmark from which securities in other markets are priced, either directly
or indirectly. Thus, banks actively participating in
these markets have been able to hone their
trading skills and related management systems in
anticipation of later access to the corporate
securities markets.

M A Y 1984, E C O N O M I C

REVIEW

Euro-markets have offered commercial banks
another arena in which to gain securities market
experience, and some of the large U.S. multinational banks have become important participants there. While underwriting syndicates have
been active in that market since the 1960s,
secondary markets in Euro-securities are a relatively recent phenomenon. Nevertheless, several
U.S. money center banks have already captured
significant positions in these markets. Some U.S.
commercial banks have developed impressive
worldwide financial networks with which to
exploit the evolving global market for money.
As commercial banks and other deposit-taking
institutions have moved from primary dependency
on savings and demand deposits toward greater
reliance on the "wholesale" money markets,
they have been propelled into an active trading
mode. The constant money-raising efforts of
banks' treasury operations and the increasing
use of forward hedges and other sophisticated
risk-management techniques to accommodate
the gap between asset and liability maturities
have fostered skills that find ready application in
investment banking.
Similarly, on the asset side of their balance
sheets, many commercial banks are moving
toward a "transaction" as opposed to a "yield"
management philosophy, in which each asset is
priced as though it were a candidate for resale. As
regulatory pressures have mounted on commercial banks to improve their capital bases
relative to loans outstanding, one goal has been
to increase the velocity of asset turnover through
the temporary or permanent sale of their domestic loans 39 to correspondent bank, and
institutional or foreign investors willing to take a
slightly smaller spread. Thus, the selling bank is

able to reduce its asset base, improve its loan-todeposit ratio and enhance the return on those
assets. It also can foster a transaction orientation
among lending officers that supports the development of a trading culture.

Conclusions
Changing economic and demographic patterns
have broken the longstanding status quo that
prevailed in the post-World War II financial
services industry. Each part of that industry has
reacted differently to these changes, reflecting
competitive dynamics specific to a particular
niche. This pattern is mirrored in the intrusion of
commercial banks into the securities business.
Entry into discount brokerage has been quite
rapid because there appear to be few barriers.
Penetration of the wholesale investment banking
business has been slower and more difficult
Regulatory barriers limit banks' ability to offer
the trading and underwriting services necessary
if an institution is to compete successfully in the
wholesale securities business. The securities industry has recognized this and has moved in
both the markets and the courts to limit banks'
entry. Even removing regulatory barriers would
not assure banks of rapid success, however.
Despite the experience and success some banks
have gained in permitted securities activities,
they must learn to manage differences between
commercial and investment banking cultures in
order to penetrate the wholesale securities market

— Samuel L Hayes III
'Samuel L Hayes III is the lacob H. Schili Proiessor
Graduate School of Business. Harvard University.

ol Investment

Hanking,

NOTES
'See, lor instance, Theodore Leavitt, The Globalization of Markets,
Harvard B u s i n e s s Review, (May-June 1983), p. 92.
' N e w York S t o c k E x c h a n g e Fact Book-1969, p. 48.
New York S t o c k E x c h a n g e Fact Book-1983, p. 8
Federal Reserve Bulletin. (January 19o1), p. 192. Federal Reserve
Statistical Release dated December 30, 1983.
4
See, for instance. Staff Report o n t h e Securities Industry in 1 9 7 9
published by the Securities and Exchange Commission.
3
lbid.
'Samuel L. Hayes, III, A. Michael Spence and David Van Praag Marks.
C o m p e t i t i o n in t h e I n v e s t m e n t B a n k i n g Industry Cambridge: Harvard
University Press. 1983) p. 44
'Samuel L. Hayes, III 1 he Transformation of Investment Banking,
Harvard B u s i n e s s Review (January-February 1979) p. 1a3.

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




See various staff reports of the Securities and Exchange Commission
based upon Focus data supplied by the New York Stock Exchange.
"Staff Report o n t h e Securities Industry in 1979, published by the
Securities and Exchange Commission, p 4 /
"William B. Hummer Bankers March on Discount Brokerage, Bankers
M o n t h l y M a g a z i n e (January 15, 1984) p. '¿7
'Chemical Bank made an earlier aboriive attempt to enter the brokerage
business in trie 1970 s
' For instance in January 1983 Bank of America acquired Charles Schwab
& Company and Chase Manhattan acquired Rose & Company
' 'Pershing & Company, a division of Donaldson. Lufkin & Jenrette. provides
trading and clearing services to banks as do a number of other securities
firms.

59

'•'Hummer, in work cited, p. 26. O t h e r estimates range considerably higher
t h a n this number.
' ' H u m m e r , in the work cited, p. 2 6
'"Irwin Friend and Marshall Blume. Competitive Commissions on the
New York Stock Exchange. T h e J o u r n a l of F i n a n c e , (September 1 973),
p. 795.
" S a m u e l L. Hayes, III. The Transtormation of Investment Banking,
H a r v a r d B u s i n e s s Review (January-February 1979), p. 153.
" N e w Y o r k S t o c k E x c h a n g e Fact B o o k - 1 9 8 3 .
'A. L. Adams, " S a l o m o n s Number One, I n v e s t m e n t Dealers' D i g e s t
(January 17, 1984i p. 8
' " M u n i c i p a l S e c u r i t i e s M a r k e t s - 1 9 8 3 published by the PublicSecurities
Association, (February 29, 1984)
" ' See results of G r e e n w i c h Research surveys, as reported in various issues
of the Wall S t r e e t L e t t e r (published by I n s t i t u t i o n s Investor).
" " 1 9 8 3 Mergers and Acquisitions Tombstone Talley, C o r p o r a t e Fin a n c i n g W e e k , (January 30, 1984), a publication of I n s t i t u t i o n a l
Investor.
•^Dwight B. Crane and Samuel L. Hayes, III. The New Competition in World
Banking, H a r v a r d B u s i n e s s Review (July-August 1982) pp. 88-94
" A l m o s t all of the money c e n t e r banks have at least a corporate finance
group. The U n i t e d S t a t e s C o m m e r c i a l B a n k C o r p o r a t e F i n a n c e
D i r e c t o r y - 1 9 8 3 , compiled by officials at Northwestern National Bank of
Minneapolis, lists corporate finance groups for nine New York City banks,
thirteen regional money center banks and eight other regional b a n k s
" " T h e International S w e e p s t a k e s I n s t i t u t i o n a l Investor. (September
1983), p. 213.
' " T h e American Association of Equipment Lessors reports that, using
either equipment cost of $ 3 2 billion or total receivables outstanding of
i>62 billion, commercial banks presently hold approximately 28% of the
outstandings, c o m p a r e d to 3 4 % for independent leasing companies and
13% for captive finance companies.
•"Federal Deposit Insurance Corporation, "Trust Assets ol Insured Commercial Banks-1 9 / 7 . Washington, D. C., F o r b e s (April 17, 1978.)

60



" Bankers Trust, however, has recently e n g i n e e r e d a private placement of
a Rule 4 1 5 "shelf registration securities and is being challenged in the
courts by the Securities Industry Association tor undertaking a de facto
corporate underwriting.
M u n i c i p a l S e c u r i t i e s M a r k e t s - 1 9 8 3 , published by the PublicSecurities
Association, (February 29, 1984).
Jii
See, tor instance, C o r p o r a t e F i n a n c i n g W e e k . Vol. IX, No. 5 (February 7.
1983). In reporting on the t o p 15 leading intermediaries in private
placements it notes that " B a n k of America, the only bank on the 1981 list,
d i d n t m a k e it in 1982 No banks made it in the 1982 r a n k i n g s but
Bankers Trust c a m e the closest, finishing 16th.
•""1983 Mergers and Acquisitions Tombstone Tally. C o r p o r a t e F i n a n c i n g
W e e k (January 30. 1984), a publication ot I n s t i t u t i o n a l I n v e s t o r .
•'See, tor instance, M Blumstein, " M o r g a n Stanley Fights tor No 1, N e w
Y o r k Times, (April 1, 1984).
' United States C o m m e r c i a l Bank Corporate Finance Directory-1983.
in the work cited.
J
"See. tor instance, hearings, betore the Securities and Exchange Commission on Rule 41 5, Jan 28-July 2, 1982.
•"See. for instance, M. W. M a r r a n d G . R. Thompson, Shelf Registration and
the Utility Industry, Virginia Polytechnic Institute and State University.
Blacksburg, Virginia, (June 30, 1983).
JO
G. Hector "Bankers Trust Takes on Wall Street, F o r t u n e 109 (January 9,
1984) pp. 105-107.
-"See Staff R e p o r t o n t h e S e c u r i t i e s I n d u s t r y in 1 9 7 9 , other years,
Securities and Exchange Commission.
•"•The "Recognized Dealers include Bank ot America, Bankers Trust,
Chase Manhattan, Chemical. Citicorp, Continental Illinois, Crocker National,
First Interstate. Fust Chicago, Harris Trust. Morgan Guaranty, Northern
Trust, Manufacturers Hanover and Bank ot Boston.
" T h e r e have also been reports of the creation of an informal secondary
market for LDC loans, particularly in the case of Mexico. See Gary Hector,
"The Banks Latest Game: Loan Swapping, F o r t u n e . ( D e c e m b e r 12,
1983), p. I l l

M A Y 1984, E C O N O M I C

REVIEW

Conclusion
This Review has analyzed the consequences of
expanding the array of financial products commercial banks may offer. The important questions
are the impact of product deregulation on the
safety and soundness of the banking system and
on the concentration of financial power. The
material here indicates there is little to fear from
deregulating the financial products banks may
offer. Indeed, there may be benefits for bank
customers.

Safety and Soundness
This issue analyzed the potential risks to banks
both of adding activities and of failing to add
activities. The appropriate concern when considering the potential risk of allowing an additional
activity is not the activity alone, but how the
activity contributes to total risk exposure of the
bank. A review of the relevant literature suggests
that some new financial activities actually have
the potential to decrease the risk exposure of
banks. The literature also shows that acquisitions
of financial firms do not necessarily change the
acquiring firm's risk.
Management of the new activities determines
whether potential risks become actual. Banks
may already take substantial risks on their loans,
securities, futures and options dealings, maturity
matches and many other types of activities. U.S.
banks engage abroad in many ventures forbidden
at home. The evidence shows that U.S. banks
have generally—not always—managed these risks
competently. There is little reason to expect that
managements will mismanage new domestic
risks. New activities can be managed in a manner
that will stabilize or even diminish risk to the
individual bank and to the financial system.
Providing incentives to limit risk is a crucial
consideration. Today's deposit insurance and
discount w i n d o w arrangements actually provide
incentives for risk by reducing the exposure of
both depositors and shareholders. Adjusting these
environmental factors to shift the risk on to the
private sector would impose useful market discipline. These issues are already being widely
discussed, so we have not focused on them here.
FEDERAL RESERVE B A N K O F A T L A N T A




61

Failure to deregulate carries its own risk. Firms
offering insurance, investment banking and real
estate services are already invading the traditional
financial service markets of banks, while banks
are constrained from offering these traditional
products. If less regulated firms are able to attract
significant amounts of bank liabilities to lessregulated sectors, the financial system's safety
and soundness will be reduced. Ensuring both
i n t e r m e d i a t i o n and payments is important.
Although nondepository contenders pose little
threat to either of these systems in the short run,
in the longer run, larger shifts of deposits and
payments activity into less regulated sectors could
weaken the safety of the financial and payments
systems. Allowing banks to compete more broadly
might delay or prevent that prospect

Concentration and Competition
Proposals to broaden banks' permitted activities
also have raised concerns about concentration
of economic resources and competition. Overall,
however, concentration, tie-in requirements and
conflicts of interest apparently would be reduced,
not encouraged,by the relaxation of product restraints on banks. Many competitors from several
industries would be vying for financial services
business. New entrances are generally more
innovative and market-sensitive.This w o u l d increase the number of alternatives available, encouraging competition, and decreasing economic
concentration.
Fears that cross-industry mergers will concentrate political and social power still trouble some
regulators and economists. Policymakers lack
hands-on experience with the potential structural
changes resulting from broad financial deregulation and are not entirely sanguine about its
ultimate effects on financial power. Laws limiting
the size of cross-industry mergers would limit
any natural tendencies toward concentration, if
they exist. Size limits for merging firms would
have to be considered carefully to ensure that
they gave no advantages to firms that are already
large and that they did not unduly limit firms'
ability to increase efficiency by capturing economies of scale and scope.
Current laws, regulations and market factors
serve to limit significant increases in concentration.
The evidence suggests that concern about conflicts of interest and tie-ins are largely unwarranted.
Users of financial services would be able to spurn
62




financial organizations that d e m a n d e d unreasonable tie-ins because deregulation should
actually increase, not reduce, the number of
alternative suppliers of financial services.

Customer Benefits
Surveys indicate that users of financial services
desire broader product offerings from financial
institutions. The public apparently believes it
would benefit from some removal of activity
limits. This expected benefit must be balanced
against broader concerns about safety and concentration, of course. W e surveyed household
customers on their reactions to broader powers.
Households generally responded positively. Those
in the lower-and middle-income groups affirmed
a stronger preference for making a wide array of
product offerings available at single institutions.
High-income consumers place a premium on
receiving financial advice and information from a
broader range of suppliers. Some households
expressed strong preference for a commercial
bank as their full-service provider. Asked what
services they w o u l d like to see added to banks'
present capacities, consumers indicated a preference for insurance, and stock and real estate
brokerage services.
An analysis of probable business reactions to
broader bank activities indicated that they would
like to see an increased range of bank products,
including management of comingled funds and,
for some smaller firms, securities underwriting
and retail distribution. Larger firms do not consider securities underwriting by banks to be
particularly necessary. Judging from the evidence,
current limits on banks' securities and underwriting business apparently have little impact on
these businesses.

Lessons from the
Securities Industry
Banks' current activities in the securities industry exemplify at least three things about
product limitations: First, product limits may
increase risk-taking as well as reduce i t Limits on
banks' underwriting and trading activities, for
example, may limit banks' ability to offer the
narrow range of permitted securities services
profitably. Second, product limitations may reduce banks' ability to serve customers. Securities
M A Y 1984, E C O N O M I C

REVIEW

,

|

limitations apparently make it difficult for banks
to provide the full services necessary to establish
ongoing relationships with wholesale customers.
Finally, removal of product limits need not mean
that banks will increase substantially their share of
new markets. For example, banks have fared
poorly in securities activities for cultural reasons,
in addition to regulatory restrictions.

Summing Up
Skeptics express concern that further deregulation could increase banks' and the financial
systems' risk, spawn conflicts of interest or allow
a dangerous concentration of financial power.
This Review, however, has shown little threat that
the banking system w o u l d be undermined by
permitting banks to diversity into a broader

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




range of activities. Most bankers have shown
themselves to be competent and they will remain
competent if regulatory prohibitions are relaxed.
Capable managers can conduct potentially risky
ventures safely, just as irresponsible ones can
make "safe" activities hazardous. Reform of deposit insurance and the discount window,currently being debated, would help discourage
bankers from taking inappropriate business gambles.
On balance, customers w o u l d benefit from an
expansion of the products commercial banks are
permitted to market. Customers for financial
services would be likely to benefit from stimulated competition if banks were allowed to
diversify into such areas as securities brokerage,
insurance and real estate. Further, some customers expect to benefit from being able to buy
more financial services from the same institution.

63

flip

;

:

WWTVT*i

i r l i " ! ! " !

FINANCE

$ millions
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings <5c Time

ANN.

MAR
1983

FEB
1984

MAR
1984

CHG.

1,333,868 1,326,657 1,240,595
302,556 299,371 291,377
88,815
87,544
72,737
356,733 352,739 304,431
622,999 619,272 603,360
50,194
49,687
48,480
5,249
5,120
4,584
44,962
44,492
43,471
151,756
35,799
11,416
39,730
68,513
5,749
494
5,137
15,798
3,741
1,031
3,222
8,305
922

138,502
34,446
9,685
33,342
64,198
5,058
372
4,303

+ 8
+ 4
+22
+17
+ 3
+ 4
+15
+ 3

Savings & Loans**
Total Deposits
NOW
Savings
Time

+11
+ 5

Savings & Loans
Total Deposits
NOW
Savings
Time

Mortgages Outstanding

643,174
19,092
174,626
453,085
FEB
487,561
29,513

637,308
18,669
173,594
448,738
JAN
483,845
27,524

579,199
16,053
174,957
391,195
FEB
472,529
17,512

N.A.
N.A.
N.A.
N.A.
FEB
68,776
4.631

N.A.
N.A.
N.A.
N.A
JAN
68,616
4,344

N.A.
N.A.
N.A.
N.A.
FEB
67,477
3,088

5,304
154
906
4,292
FEB
3,945
235

5,280
150
896
4,278
JAN
3,894
253

4,592
136
756
3,786
FEB
3,715
78

54,615
2,165
14,974
37,943
JAN
40,612
2,917

51,160
1,881
15,416
34,259
FEB
39,923
2,307

+ 11
+ 19
- 0
+ 16
+ 3
+69

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time

153,046
36,148
11,645
40,340
69,155
5,816
515
5,200

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time

15,922
3,770
1,047
3,264
8,416
928
91
810

797

14,740
3,516
3,516
2,816
7,986
855
71
729

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savii||5 & Time

54,443
13,063
4,850
19,007
18,733
2,525
238
2,144

53,777
12,941
4,764
18,685
18,609
2,498
248
2,121

47,796
12,487
4,116
14,954
17,190
2,285
198
1,804

+14
+ 5
+18
+27
+ 9
+11
+20
+19

Mortgages Outstanding
M ortgage_Con}nHtments_

55,140
2,210
15,102
38,003
FEB
40,599
3,098

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings^^im^^^^^^^^

22,504
22,201
6,940
6,739
1,523
1,493
5,090
4,964
10,168
10,044
1,219
1,201
79
74
^ l j e ^ ^ 1,150

19,564
6,178
1,275
4,304
8,714
962
39
861

+15
Savings & Loans
+12
Total Deposits
+19
NOW
+18
Savings
+17
Time
+27
+103
Mortgages Outstanding
+35 ^ ^
Mortgage C o m m i t m e n t s

N.A.
N.A.
N.A.
N.A.
FEB
8,389
485

N.A.
N.A.
N.A.
N.A.
JAN
8,342
415

N.A.
N.A.
N.A.
N.A.
FEB
8,813
209

9,241
211
2,378
6,758
FEB
8,353
523

9,150
210
2,370
6,669
JAN
8,325
514

8,681
179
2,174
6,402
FEB
7,690
309

+ 6
+ 18
+f

2,590
106
491
1,938
FEB
2,078
63

2,503
101
484
1,964
JAN
2,037
62

2,525
69
485
1,999
FEB
2,049
32

+ 3|
+54
1
- 3

wmtmmkmmm

88

+ 20

+21

Mortgages Outstanding
Mortgage C o m m i t in ents
+ 7
-70

+ 16

+ 5
+ 9

+ 28
+ 11

Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings äc Time

25,577
5,706
1,530
5,497
13,427
206
24
199

25,572
5,777
1,499
5,451
13,335
203
23
197

24,201
5,835
1,295
4,495
13,077
163
13
154

+~6
- 2
+18
+22
+ 3
+26
+85
+29

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time

12,012
2,396
843
2,499
6,610

11,923
2,419
841
2,480
6,506

11,147
2,322
757
2,027
6,302

+ 8

*

!

!

+ 3

+ 11

+23
+ 5

Savings & Loans**
Total Deposits
NOW
Savings
Time
Mortgages Outstanding
Mortgage C o m m i t m e n t s
Savings & Loans**
Total Deposits
NOW
Savings
Time

Savings & Loans**
Total Deposits
NOW
Savings
Time
Mortgages Outstanding
Mortgage C o m m i t m e n t s
Savings 3c Loans**
Total Deposits
NOW
Savings
Time
Mortgages Outstanding

+16
+ 13
+20
+ 13
+ 6
+201

+ 1

+1
+69

+1
+97

Savings & Loans**
+ 7
21,049
22,588
22,485
Commercial Bank Deposits
6,858
6,817
6,878
Total Deposits
+ 4
4,108
4,182
4,273
Demand
173
183
176
NOW
+ 4
4,182
4,108
4,273
NOW
1,511
1,337
1,351
Savings
+35
1,367
1,788
1,852
Savings
5,200
5,350
5,392
Time
+ 5
4,746
4,928
4,983
Time
FEB
JAN
FEB
+ 8
10,929
11,714
11,801
Credit Union Deposits
5,287
5,412
5,406
Mortgages Outstanding
+ 24
51
61
63
Share D r a f t s
153
183
227
Mortgage C o m m i t m e n t s
+ 17
755
872
886
Savings & T i m e
All deposit data are e x t r a c t e d from the Federal Reserve Keport oi transaction n c c o u n i b , umvi
v*
.
and are reported for the average of the week ending the 1st Wednesday of the month. This data, reported by institutions with
over $15 million in deposits as of December 31, 1979, represents 95% of deposits in the six s t a t e a r e a . T h e m a j o r d . f f e r e n c e s be
this report and the "call report" are size, the t r e a t m e n t of interbank deposits, and the t r e a t m e n t of float. The data g e n e r a t e d ti >,
the Report of Transaction Accounts is for banks over $15 million in deposits as of December 31, 1979. The total deposit data ge ;
from the Report of Transaction Accounts eliminates interbank deposits by reporting the net of deposits due to and due trom o
depository institutions. The Report of Transaction Accounts s u b t r a c t s cash items in process of collection from demand deposits,
the call report docs not. Savings and loan mortgage data are from the Federal H o m e Loan Bank Board Selected Balance Sheet D
T h e Southeast data represent the total of the six states. Subcategories were chosen on a selective basis and do not add to total.
* = f e w e r than four institutioas reporting.

** = S&L deposits subject to revisions due to reporting changes.
N.A. = not available at this time.


M A Y 1984. E C O N O M I C R E V I E W ,

CONSTRUCTION
ANN

%

FEB
1984

JAN
1984

FEB
1983

Nonresidential Building Permits - è Mil.
53,121
Total Nonresidential
Industrial Bldgs.
5,648
Offices
13,243
Stores
7,480
Hospitals
2,099
Schools
848

52,264
5,592
13,024
7,187
2,065
857

44,869
4,999
11,867
5,228
1,580
781

+
+
+
+
+
+

Nonresidential Building Permits - $ Mil.
8,343
Total Nonresidential
686
Industrial Bldgs.
Offices
2,029
Stores
1,443
Hospitals
469
Schools
162

8,271
676
2,036
1,376
470
152

6,487
677
1,430
968
345
105

+
+
+
+

Nonresidential Building P e r m i t s - $ Mil.
562
Total Nonresidential
39
Industrial Bldgs.
66
Offices
109
Stores
Hospitals
5
9
Schools

543
35
62
102
5
9

371
46
72
61
30
5

15
8
+ 79
- 83
+ 80

Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multi-family units
Total Building P e r m i t s
Value - $ Mil.

Nonresidential Building P e r m i t s - $ Mil.
4,161
Total Nonresidential
Industrial Bldgs.
363
Offices
965
Stores
798
Hospitals
290
Schools
63

4,133
360
969
777
297
57

3,307
380
708
519
178
21

26
4
+ 36
+ 54
+ 63
+200

Residential Building P e r m i t s
Value - $ Mil.
Residential P e r m i t s - Thous.
Single-family units
Multi-family units
Total Building Permits
Value - $ Mil.

Nonresidential Building P e r m i t s - $ Mil.
1,396
Total Nonresidential
Industrial Bldgs.
177
Offices
451
Stores
184
Hospitals
36
Schools
31

1,384
175
464
159
35
28

980
134
227
84
25
13

+ 42
+ 32
+ 99
+119
+ 44
+ 138

Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multi-family units
Total Building P e r m i t s
Value - $ Mil.

1,153
33
375
133
95
50

1,164
33
370
130
97
49

1,066
63
309
165
62
52

+
+
+
-

8
48
21
19
53
4

Residential Building P e r m i t s
Value - S Mil.
Residential Permits - Thous.
Single-family units
Multi-family units
Total Building Permits
Value - $ Mil.

Nonresidential Building Permits - $ Mil.
Total Nonresidential
206
10
Industrial Bldgs.
Offices
23
S tores
48
Hospitals
19
Schools
4

195
10
22
40
19
4

161
13
14
39
6
5

+ 28
- 23
+ 64
+ 23
+217
- 20

Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multi-family units
Total Building Permits
Value - $ Mil.

Nonresidential Building P e r m i t s - $ Mil.
T o t a l Nonresidential
865
Industrial Bldgs.
64
Offices
149
Stores
171
Hospitals
24
Schools
5

852
63
149
168
17
5

602
41
100
100
44
9

+
+
+
+
-

Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multi-family units
Total Building Permits
Value - $ Mil.

12-month Cumulative Rate

T o t a l Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools

FEB
1984

CHG
18
13
12
43
33
9

Residential Building P e r m i t s
Value - $ Mil.
Residential P e r m i t s - Thous.
Single-family units
Multi-family units
Total Building P e r m i t s
Value - $ Mil.

29
1
42
49
+ 36
+ 54

Residential Building Permits
Value - S Mil.
Residential Permits - Thous.
Single-family units
Multi-family units
Total Building Permits
Value - $ Mil.

+ 51
-

+
-

44
56
49
71
45
44

JAN
1984

FEB
1983

70,984

69,204

42,812

+ 66

918.1
730.4

900.7
716.0

584.3
480.4

+ 57
+ 52

124,104

121,468

87,681

+ 42

13,358

12,934

7,529

+

77

188.8
170.8

184.7
165.2

121.6
91.1

+

55

21,627

21,132

14,016

+

54

454

440

260

+

75

8.1
8.5

8.0
8.1

5.5
4.3

+
+

47
98

1,015

983

631

+

61

7,766

7,578

4,350

101.7
94.1

99.8
92.1

62.6
53.0

11,927

11,711

7,658

+ 56

2,540

2,436

1,501

+

69

43.1
26.1

41.9
25.0

29.0
14.9

+

49

3,936

3,820

2,481

+

59

1,157

1,098

708

+

63

16.9
18.3

16.6
17.1

12.1
9.5

+
+

40
93

2,310

2,262

1,774

+

30

328

317

193

+ 70

4.9
5.2

4.7
5.1

3.8
2.2

+ 29
+ 136

534

511

354

+ 51

1,113

1,065

517

+ 115

14.1
18.6

13.7
17.8

8.6
7.2

+ 64
+ 158

1,905

1,845

1,118

+ 70

NOTES:
Data supplied by the U. S. Bureau of the Census, Housing Units Authorized By Building Permits and Public C o n t r a c t s , C - 4 0 .
Nonresidential d a t a excludes the cost of construction for publicly owned buildings. The southeast data represent the total of
the six states. The annual percent change calculation is based on the most recent month over prior year. Publication of F. W.
Dodge construction c o n t r a c t s has been discontinued.
F E D E R A L RESERVE B A N K O F A T L A N T A 65




ANN
%
CHG

+ 87

+ 79
+

+

62
78

+ 75

GENERAL
LATEST C U R R .
DATA PERIOD
Personal Income
($bil. - SAAR)
Taxable Sales - $bil.
Plane Pass. Arr. 000's
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
SOUTHEAST
Personal Income
($bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. A r r . 000's
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
ALABAMA
Personal Income
($bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. 000's
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.

ANN.

PREV.
PERIOD

YEAR
AGO

2,709.1
N.A.
N.A.
8,675.5

2,584.7
N.A.
N.A.
8,665.0

+ 7

MAR

2,775.1
N.A.
N.A.
8,509.7

MAR
JAN

307.3
206.5

306.6
185.4

293.4
178.7

+ 5
+ 16

3Q

CHG.

- 2

FEB
MAR

332.1
N.A.
4,167.9
1,428.0

326.7
N.A.
4,169.6
1,404.0

310.0
N.A.
4,207.2
1,380.0

JAN

N.A.
32.7

N.A.
27.8

N.A.
28.0

+ 17

3Q
DEC
FEB
MAR

36.8
30.2
103.2
51.0

36.2
29.6
99.9
49.0

34.2
28.4
90.6
52.0

+ 8
+ 6
+ 14
- 2

JAN

N.A.
4.4

N.A.
3.7

N.A.
3.7

+ 19

124.9
76.1
2,218.9
49.0
MAR
165.6
8.8

121.9
74.8
2,189.8
49.0
JAN
165.0
7.3

115.1
67.9
2,253.8
62.0
MAR
159.0
7.5

+ 9
+ 12
- 2
-21

59.3
43.2
1,443.1
N.A.
FEB
309.3
5.0

58.2
41.1
1,469.0
N.A.
DEC
307.3
4.6

54.4
40.6
1,455.8
N.A.
FEB
295.1
4.7

+ 9
+ 6
- 1

45.3
N.A.
241.3
1,240.0

45.9
N.A.
244.3
1,220.0

44.9
N.A.
260.6
1,180.0

+ 1

N.A.
4.9

N.A.
4.2

N.A.
4.4

21.1
N.A.
29.3
88.0

20.8
N.A.
30.0
86.0

19.8
N.A.
25.2
86.0

+ 16
+ 2

N.A.
2.2

N.A.
1.9

N.A.
1.8

+22

44.7
41.9
132.1
N.A.

43.7
39.0
136.6
N.A.

41.6
38.2
121.2
N.A.

+ 7
+ 9
+ 9

N.A.
7.4

N.A.
6.1

N.A.
5.9

+25

3Q

Personal Income
($bil. - SAAR)
3Q
Taxable Sales - $ bil. MAR
Plane Pass. Arr. 000's FEB
Petroleum Prod, (thous.) MAR
Consumer Price Index - Miami
Nov. 1977 = 100
Kilowatt Hours - mils. JAN
GEORGIA
Personal Income
($bil. - SAAR)
3Q
Taxable Sales - $ bil.
4Q
Plane Pass. Arr. 000's FEB
Petroleum Prod, (thous.)
Consumer Price Index - Atlanta
1967 = 100
Kilowatt Hours - mils. JAN
LOUISIANA
Personal Income
($bil. - SAAR)
3Q
Taxable Sales - $ bil.
FEB
Plane Pass. Arr. 000's
Petroleum Prod, (thous.) MAR
Consumer Price Index
1967 = 100
Kilowatt Hours - mils. JAN
MISSISSIPPI
Personal Income
($bil. - SAAR)
3Q
Taxable Sales - $ bil.
Plane Pass. Arr. 000's FEB
Petroleum Prod, (thous.) MAR
Consumer Price Index
1967 = 100
Kilowatt Hours - mils. JAN
TENNESSEE
Personal Income
($bil. - SAAR)
3Q
Taxable Sales - $ bil. MAR
FEB
Plane Pass. Arr. 000's
Petroleum Prod, (thous.) MAR
Consumer Price Index
1967 = 100
Kilowatt Hours - mils. JAN

+ 7
- 1
+ 3

+ 4
+ 17

+ 5
+ 6

- 7
+ 5
+ 11
+ 7

MAR
1984

FEB (R)
1984

MAR
1983

Agriculture
Prices Rec'd by F a r m e r s
Index (1977=100)
146
Broiler P l a c e m e n t s (thous.) 84,498
Calf Prices ($ per cwt.)
65.00
Broiler Prices (« per lb.)
37.8
Soybean Prices ($ per bu.)
7.65
Broiler Feed Cost ($ p t r ton) 242

144
80,879
63.90
37.4
7.29
243

134
84,834
68.40
25.4
5.82
210

Agriculture
Prices Rec'd by F a r m e r s
Index (1977=100)
139
Broiler Placements (thous.) 32,345
Calf Prices ($ per cwt.)
60.6
Broiler Prices (® per lb.)
36.9
Soybean Prices ($ per bu.)
7.75
Broiler Feed Cost ($ per ton) 228

134
31,217
60.3
36.7
7.40
235

119
32,526
65.0
24.8
6.00
200

+ 17
- 1
- 7
+49
+ 29
+14

Agriculture
Farm Cash Receipts - $ mil.
(Dates: J A N , JAN)
144
Broiler P l a c e m e n t s (thous.) 11,010
Calf Prices ($ per cwt.)
60.3
Broiler Prices (<S per lb.)
36.5
Soybean Prices ($ per bu.)
7.75
Broiler Feed Cost ($ per ton) 270

10,596
59.0
35.5
7.47
275

148
10,718
63.6
24.0
5.99
215

- 3
+ 3
- 5
+52
+ 29
+26

Agriculture
Farm Cash Receipts - S mil.
(Dates: J A N , JAN)
389
Broiler P l a c e m e n t s (thous.)
1,977
Calf Prices (S per cwt.)
66.8
Broiler Prices (<t per lb.)
37.0
Soybean Prices ($ per bu.)
7.75
Broiler Feed Cost ($ ptr ton) 255

1,827
63.1
36.0
7.47
260

543
1,983
69.4
24.0
5.99
215

-28
- 0
- 4
+54
+29
+ 19

Agriculture
Farm Cash Receipts - $ mil.
(Dates: J A N , JAN)
218 Broiler P l a c e m e n t s (thous.) 12,912
12,694
Calf Prices ($ per cwt.)
57.1
58.4
Broiler Prices (® per lb.)
36.5
36.5
Soybean Prices ($ per bu.)
7.81
7.61
Broiler Feed Cost ($ per ton) 205
215

216
13,223
61.5
24.5
5.90
195

+ 1
- 2
- 5
+49
+32
+ 5

191
N.A.
65.9
26.0
6.18
250

+ 2

251
6,603
65.5
26.5
5.97
169

-30
- 2
-10
+46
+30
+ 11

179
N.A.
63.4
24.0
5.91
191

- 8

-

Agriculture
Farm Cash Receipts - $ mil.
(Dates: J A N , JAN)
194
Broiler P l a c e m e n t s (thous.)
N.A.
Calf Prices ($ per cwt.)
60.5
Broiler Prices (<t per lb.)
38.5
Soybean Prices ($ per bu.)
7.83
Broiler Feed Cost ($ per ton) 285

N.A.
62.2
38.0
7.44
295

Agriculture
Farm Cash Receipts - $ mil.
(Dates: J A N , JAN)
176
Broiler P l a c e m e n t s (thous.)
6,446
Calf Prices ($ per cwt.)
59.0
Broiler Prices (<f per lb.)
38.8
Soybean Prices ($ per bu.)
7.77
Broiler Feed Cost ($ p t r ton) 187

6,101
61.7
39.0
7.52
191

Agriculture
Farm Cash Receipts - $ mil.
(Dates: J A N , JAN)
165
Broiler P l a c e m e n t s (thous.)
N.A.
Calf Prices ($ per cwt.)
58.1
Broiler Prices (<£ per lb.)
36.0
Soybean Prices ($ per bu.)
7.56
Broiler Feed Cost ($ per ton) 215

N.A.
58.6
36.5
6.95
220

-

-

-

+ 9
- 0
- 5
+49
+31
+ 15

• •

- 8
+48
+ 27
+14

- 8
+50
+ 28
+ 13

Notes:

Personal Income data supplied by U. S. Department of C o m m e r c e . Taxable Sales are reported as a 12-month cumulative t o t a l . Plane
Passenger Arrivals are collected from 26 airports. Petroleum Production data supplied by U. S. Bureau of Mines. Consumer Price
Index data supplied by Bureau of Labor Statistics. Agriculture data supplied by U. S. D e p a r t m e n t of Agriculture. Farm Cash
Receipts data are reported as cumulative for the calendar year through the month shown. Broiler placements are an average weekly
r a t e . The Southeast data represent the total of the six s t a t e s . N.A. = not available. The annual percent change calculation is based
on most recent data over prior year. R = revised.

66


MAY 1984, E C O N O M I C REVIEW

EMPLOYMENT
ANN.

FEB
1984

JAN
1984

FEB
1983

Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. W'kly. Hours
Mfg. Avg. VV'kly. Earn. - $

111,368
101,961
9,407
7.8
N.A.
N.A.
41.7
370

111,025
101,270
9,755
8.0
N.A.
N.A.
40.5
368

109,647
97,265
12,382
10.4
N.A.
N.A.
38.8
340

+ 2
+ 5
-24

Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg.
'Vg- ' W k l y ^ a r r u - $ ^

14,535
13,314

14,507
13,167
1,339

14,068
12,436
1,632

+ 3
+ 7
-25

N.A.
N.A.
40.8
324

N.A.
N.A.
39.7
300

1,756
1,531
224

1,755
1,516
238

1,742
1,454

N.A.
N.A.
40.8
319

N.A.
N.A.
39.8
320

N.A.
N.A.
39.8
298

4,991
4,685
306
6.0
N.A.
N.A.
41.7
313

4,984
4,617
367
7.0
N.A.
N.A.
41.6
312

4,682
4,238
444
9.3
N.A.
N.A.
40.0
290

2,683
2,507
176
5.9
N.A.
N.A.
40.9
303

2,657
2,481
176
N.A.
N.A.
40.8
301

2,637
2,406
231
8.4
N.A.
N.A.
40.3
285

1,890
1,705
185
9.7
N.A.
N.A.
41.7

1,888
1,688
200
10.2
N.A.
N.A.
41.5

1,833
1,610
223
12.3
N.A.
N.A.
39.4

+ 3

1,021
910
Ill
9.9
N.A.
N.A.
40.7
281

1,023
910
113
10.2
N.A.
N.A.
40.5
280

1,056
900
156
13.6
N.A.
N.A.
39.1
258

- 3

2,194
1,976
218
8.7
N.A.
N.A.
40.8
311

2,200
1,955
245
9.7
N.A.
N.A.
40.6
310

2,118
1,828
290
12.6
N.A.
N.A.
39.6
292

A I A R A

ÏMA

Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Misc.
« t g . Avg.
Avg. W k l y E a r n - $ ^
FLORIDA
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - 96 SA
Insured TJnemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wklv. Hours
Mfg. Avg. Wkly. Earn. - $
>R H B
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
i

1,220

7.9
N.A.
N.A.
41.1
325

12.2

;

frmm

Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg.
ISSIPPI
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
NESSKE
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $

ü

8.6

12.8

6.2

11.0

288
16.0

FEB
1984

CHG.

+ 7
+ 9

+ 4
+ 1

+ 5
-22

+ 3
+ 7
+ 7
+11

-31

+ 4
+ 2

+ 4

+ 1
+ 6

+ 6

-17

+ 6
+11

+ 1

+ 4
+ 4
-25
-30
+ 3
+ 6

JAN
1984

FEB
1983

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.

91,033
19,308
3,753
20,430
15,972
20,040
5,518
4 972

90,572
19,169
3,771
20,586
15,719
19,795
5,514
4^76

o í , old
18,077
3,376
19,870
15,988
19,065
5,340
4,896

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. C o m . <5c Pub. U u l .

11,852
2,232
684
2,860
2,187
2,390
684
688

11,784
2,225
676
2,861
2,162
2,366
683
684

11,276
2,096
595
2,676
2,179
2,273
646
671

Nonfarm E m p l o y m e n t - thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. C o m . & Pub. Util.

1,330
345
60
274
287
218
60
72

1,324
345
60
274
286
216
60
70

1,286
327
53
261
291
214
59
69

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. C o m . & Pub. Util.

4,084
493
291
1,104
649

4,059
493

1,006

302
229

1,102
640
995
301
229

3,816
451
243
1,013
647
947
276
230

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., 6c Real Est.
Trans. Com. & Pub. U u l .

2,320
522
116
558
440
403
123
150

2,306
520
111
557
438
400
123
150

2,197
493
97
518
440
378
118
145

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. C o m . & Pub. Util.

1,563
176
113
368
320
309
83
114

1,556
175
113
370
315
307
83
114

1,546
180
109
354
318
301
81
109

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. C o m . & Pub. Util.

796
209
32
164
184
126
34
38

793
210
32
164
181
125
34
38

769
193
33
158
183
123
33
38

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.

1,759
487
72
392
307
328
82
85

1,746
482
60
394
302
323
82
83

1,662
452
60
372
300
310
79
80

|

288

ANN.
%

CHG.
+ 4
+ 7

+ 11

+ 3
- 0

+ 5
+ 3

+ 2

+ 15
+ 7

+ 0

+ 5

+ 6

+ 3
+ 6

+ 13
+ 5

- 1
+ 2
+ 2

+ 4

m
+ 7

+ 9

+ 20

+ 9

+ 0
+ 6

+ 9

- 0

m

+ 6
+ 6
+ 20
+ 8
0

+ 7
+ 4
+ 3

m
+ 1

- 2

+ 4
+ 4

+ 1

+ 3

+ 2

+ 5

m

+ 6
+ 8
+2
+ 5
+ 2
+ 6
+4
+6

Notes: All labor f o r c e data are from Bureau of Labor Statistics reports supplied by s t a t e agencies.
Only the unemployment rate data are seasonally adjusted.
The Southeast data represent the total of the six s t a t e s .
The annual percent change calculation is based on the most recent data over prior year.
FEDERAL RESERVE B A N K O F ATLANTA




67

Federal Reserve Bank of Atlanta
P.O. Box 1731
Atlanta, Georgia 30301
Address Correction Requested




Bulk Rate
U.S. Postage

PAID

Atlanta, Ga.
Permit 292