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THE
COMPETITIVE
OUTLOOK
IN
___ BANKING

REMARKS BY

John J. Balles
PRESIDENT
FEDERAL RESERVE BANK
OF SAN FRANCISCO

Annual Intermountain
Banking Sem inar
Utah State University
Logan, Utah
Novem ber 9, 1972







John J. Balles

T h e m anagem ent of the A m erican B ank­
ers A ssociation undertook an opinion survey
at its recent Dallas convention to ascertain
what business problem s are upperm ost in the
m in d s o f b a n k e rs . P re s id e n t E u g e n e H .
Adam s reports that the m ost often-m entioned
problem was the com petitive clim ate facing
th e b a n k in g in d u stry . M o re sp e c ific a lly ,
bankers are concerned about the structure of
the banking industry, com petition between
large and small banks, com petition between
banks and thrift institutions, and the im plica­
tions of the H unt C om m ission’s recom m en­
dations.
Y our program com m ittee obviously is at­
tuned to these problem s, since they have
designated the com petitive outlook for b an k ­
ing a m ajor subject for this sem inar. They
may not have been so wise in inviting me to
handle the subject, since this is a tall order,




and I don’t pretend to have all of the an­
swers. N evertheless, I welcome the o pportu­
nity to share my thoughts on this m ost im­
portant topic with you. H opefully, this will
stim ulate further discussion and considera­
tion on your part.
Profound forces for change are at w ork in
our financial system. T oday I would like to
review with you the nature and im plications
of some of the key developm ents th at are
bound to alter existing com petitive relation­
ships within banking, and betw een com m er­
cial banks and their principal nonbank com ­
petitors:
. . . The vital thrust within the com m ercial
banking system itself for innovation;
. . . The drive by other financial institu­
tions increasingly to share the func­
tio n s an d m a rk e ts o f c o m m e rc ia l
banks;
. . . The technological revolution occurring
in the paym ents system;
. . . The emerging change in social values
which is likely to im pact on financial
institutions.
T aken individually, the existence of these
trends is not unknown to any of us. But as
I began to think about the interrelations and
the com bined im pact of them on the com peti­
tive outlook for banking, it seemed to me
that m any of us have underestim ated the
degree of synergism at work. H ence my be­
lief that they constitute a profound change
when viewed as a package.
Thrust for Banking Innovation
First, as to the vigorous thrust tow ard
greater innovation within the com m ercial
banking industry itself, several leading exam ­
ples are worth reviewing.
N ew Financial Instrum ents — N ondeposit
Funds. One innovation represents a response
to m ovem ents in general credit conditions in
the economy. A case in point is the develop­
ment of new or modified financial instru-




ments during the past decade; witness the
massive recourse taken by com m ercial banks
in the nation to nondeposit funds in 1969
and early in 1970. This was a result of the
im pact of intensive borrow ing dem ands in a
situation in which bank access to deposit
funds was lim ited by R egulation Q. Thus,
in spite of a net loss of $4 billion in deposits
in 1969, banks were able to extend credit by
about $16 billion— $12 billion through loans
and investments on their own books and $4
billion through sales of loans to affiliates. This
was m ade possible largely by tapping some
$20 billion in funds from non-deposit sources,
including E urodollars and sales of com m er­
cial paper by bank affiliates. A t present, in­
creasing use is being m ade by bank holding
com panies of notes and debentures as a
source of funds.
The G row th o f B ank H olding Com panies.
A second type of innovation centers on the
proliferation of bank affiliates through the
creation and active use of bank holding com ­
panies. P art of this m ovem ent was generated
by the search for ways of cushioning the im­
pact of tight money, to which allusion was
just m ade; part, by the search for ways to
escape the geographic lim itations on branch­
ing imposed by some states; and part, by the
search for new and profitable ways to offer
services to the public th at com m ercial banks
are not perm itted to provide directly.
The num ber of bank holding com panies is
likely to grow, particularly in states where
sharp restraints exist over branching. The
reason for this stems from econom ic advan­
tages of the holding com pany form of organ­
ization, as dem onstrated by its success in
those states where it has had an extended
period of operation, and from the greater
range of services, closely related to banking,
that holding com panies can offer. The inevi­
table result will be to bring about a signifi­
cant change in banking structure and com ­
petition.




C olorado furnishes a good illustration. A t
the end of last year, the seven m ultiple-bank
holding com panies operating in that state
held 47 banks with $2,727 million in de­
posits, representing some 54 percent of all
C olorado bank deposits. This was up from
roughly 23 percent five years before and
from less than 7 percent at the end of 1962.
A ltogether, there were 58 holding companies
headquartered in C olorado on D ecem ber 31,
1971. A lready, in that state, overtures have
been m ade for mergers of holding com panies
to gain even further advantages. M oreover,
I understand that two requests have been
placed before the C olorado Bankers Associa­
tion seeking broad banking legislation, and
increasing num bers of bankers are becoming
restive for change in the existing geographical
restraint.
O ther N ew Services. Com m ercial banks
have also pioneered in the w idespread pro­
vision of new services both to business, in
the form of corporate cash m anagem ent ser­
vices and other m atters, and to consumers.
A prim e exam ple of the latter is bank credit
cards. C ontrary to some beliefs, credit cards
are not in the direct line of evolution tow ard
a paper-less financial system; indeed, they
generate even m ore paper than before in the
provision of paym ents convenience to the
public. In so doing, however, they helped
precipitate the introduction of technology
that will be giving a further boost to bank
com petition.
E xpanding International Business. Finally
we should note the vast expansion in inter­
national services and overseas banking activ­
ity of some of the nation’s leading banks.
Induced largely by a desire to follow their
custom ers abroad in an era of developm ent
of m ajor m ultinational com panies, this trend
not only has been profitable but also has
given a c o m p e titiv e edge to th o se b a n k s
which have engaged in expanded interna­
tional activity.




The Drive by Nonbank Institutions—
Implications o f the H unt Commission
Late last year, the President’s Com mission
on Financial Structure and Regulation issued
its report and recom m endations. This group,
m ore com m only known as the H u n t C om m is­
sion, proposed sweeping changes in the pow ­
ers, functions, and regulation of banks and
com peting financial institutions. T o a consid­
erable extent, the recom m endations are said
to be aim ed at providing m ore com petition
am ong the nation’s financial institutions, and
less regulation of them , to the extent con­
sistent with safety; and at providing equal
ground rules for various classes of com peti­
tors. One of the m ajor proposals is to offer
commercial bank-type powers to thrift insti­
tutions (m utual savings banks, savings and
loan associations, and credit unions) if they
also assum e approxim ately the sam e regula­
tory and tax burdens as com m ercial banks.
Thus far, the banking industry has not
taken a position on the H unt Com mission
recom m endations, probably because the in­
dustry faces a dilem m a regarding them . If
adopted pretty much in toto (w hich appears
highly unlikely), the recom m endations would
entail m ajor changes in com petitive relation­
ships affecting banks. On the other hand, if
adopted only in part through piecem eal leg­
islation at the Federal or state level (which
appears m ore likely), the results m ay be even
more profound for com m ercial banking. W hy
do I say this? Because the ability of the here­
tofore specialized thrift institutions to com ­
pete against banks would likely be increased
if their lending and fund-raising powers were
broadened and m ade m ore com parable to
those of com m ercial banks but if their tax
burdens, reserve requirem ents and regulatory
structure were not.
Suppose, for exam ple, th at savings and
loan associations in various states succeeded
in getting consum er loan powers and the
authority to offer checking accounts to indi-




offices. A “limited facility” is subject to the
branching regulations, but differs from a
branch by having specific restrictions placed
upon it as to personnel, physical size, capital
in v e s tm e n t, a n d / o r fu n c tio n s p e rm itte d .
However, the only practical such constraint
is simply “w hat the m arket will b ear,” ac­
cording to Federal H om e L oan Bank Board
D irector T hom as Clarke. Such facilities are
envisioned as a particularly powerful vehicle
for penetrating low-density rural areas.
“Satellite” offices, on the other hand, are
provisionally approved entities th at offer full
service within restraints of other sorts. F or
instance, they m ust be located within five
miles of an existing S&L office, and are lim ­
ited in num ber. N o more than five satellites
can be established in total, and also no m ore
than two can be installed in any one year.
One type of “satellite,” the “counter in a
store,” will be confined to retail establish­
ments and m ay not occupy m ore than 500
square feet, with a m axim um of four teller
stations. A t these offices, custom ers may
deposit their paychecks, m ake m ortgage pay­
ments, or obtain cash — right in the store
where they have com e to shop.
The second type of “satellite” is the “fully
autom ated” facility, an electronic device op­
erated by a special card given to custom ers.
These m achines may be located in a wide
range of places such as in retail stores, shop­
ping center malls, office buildings, or trans­
portation depots. O pen 24 hours a day, 7
days a week, 365 days a year, such facilities
will receive deposits and accom m odate cash
withdrawals.
The characteristic shared by each of these
three new types of offices is that they will
enable an S&L to pinpoint and accom m odate
small, local m arkets in both rural and urban
areas at a fraction of the cost involved in the
establishm ent of a full-scale branch. As F ed ­
e ra l H o m e L o a n B an k B o a rd D ire c to r
Thom as C larke has claimed, “ An S&L can




now be just as convenient— even m ore con­
venient— than a com m ercial bank, and so
there is no longer any reason to settle for
com m ercial bank passbook savings rates.”
The key to the great prom ise of the auto­
m ated facility in particular is its “kinship
with the new breed of electronic and data
processing technology which will transform
financial transactions in this country . . . to
an electronic funds transfer system .” “Such
a system ,” he notes, “is absolutely inevita­
ble.” Consequently, the FH L B B is urging
the savings and loan industry to “begin lay­
ing the groundw ork for conversion to an
electronic funds transfer system at the oppor­
tune m om ent. This m eans developing pres­
ent third-party paym ent authority to its full
capacity.”
Let me now turn to the subject of com ­
puter technology and the paym ents system,
as it affects the com petitive outlook for b ank­
ing.
The Im pact o f C o m p u ter Technology
Until the advent of the com puter, the
banking business was little affected by tech­
nological change, but these changes are now
occurring with the prospective im pact “ on
the figurative order of a m egaton bom b,” to
use the words of G overnor G eorge W. M itch­
ell of the Federal Reserve Board. T he tech­
nology for a com pletely integrated and auto­
matic paym ents system is know n, is being
developed, and is becom ing operational. O b ­
viously, this has m ajor implications in the
com petitive outlook for banking.
First Steps: Regulation J and R C P C ’s.
This month, for exam ple, with the im ple­
m entation of the revisions in F ederal R e­
serve Regulations D and J, you will feel the
effects of one step of the sweeping changes
which are to take place. As you know, the
new R egulation J has the twin objectives of
helping to expedite and rationalize the checkcollection process while at the sam e tim e




viduals and non-business entities. Also sup­
pose that they were not required to m aintain
the sam e reserves against checking accounts
as m em ber banks m ust do, but at the same
time were perm itted to continue benefitting
from preferential Federal tax treatm ent. In
that case, their ability to provide services at
a d v a n ta g e o u s ra te s v is-a -v is c o m m e rc ia l
banks would be increased, since the ability of
any interm ediary to com pete for deposits re­
flects the return it can earn on its assets.
Hence, to the extent that differing reserve
requirem ents, regulatory limitations, and tax
burdens influence asset mix and earnings,
the ability of the various types of institution
to com pete for deposits will also vary.
Thus, if thrift institutions are to be pro­
vided with broader lending, investment, and
deposit powers (including checking accounts)
that are m ore akin to those enjoyed by com ­
mercial banks, it will be vital, in the interest
of com petitive equality, that they assume in
com m ensurate degree the sam e burdens as
com m ercial banks — i.e., reserve require­
ments, ceilings (if any) on interest rates pay­
able on deposits, regulatory constraints, and
tax treatm ent.
Changes N ow Taking Place—
Thrift Institutions
But while the debate on the H unt C om ­
mission report goes on, a num ber of changes
in the powers and functions of thrift institu­
tions are even now taking place, and it is
to these that I wish to call your attention.
Regulatory A ctions o f the F H L B B . The
first developm ent which I would like to em ­
phasize involves the num erous regulatory
changes im plem ented over the last year or so
by the Federal H om e Loan Bank Board,
which were designed to strengthen the posi­
tion of savings and loan associations.
1.
B roadened Lending A uthority. These
ch a n g e s n o t o n ly e m b ra c e s u b s ta n tia lly
broadened lending powers in the field of real




estate financing, but also perm it savings and
loan associations to m ake loans for m ajor
home appliances and built-in equipm ent (up
to 5 percent of assets, as authorized by the
H U D A ct of 1 9 6 8 ). Included in the latter
group are loans for the financing of wall-towall carpeting, central air conditioning, food
freezers, lawn sprinkler systems, w ater sys­
tems, and installed w orkshop equipm ent—
items that com prise a large portion of consum er-durables financing.
2. T hird-P arty Paym ents. Still other regu­
lations, adopted in 1971, authorize savings
and loan associations to m ake non-negotiable
transfers from savings accounts to third-party
payees for a wide range of transactions m ore
or less related to housing and hom e occu­
pancy. They cannot, however, arrange such
paym ents for food, clothing and autom obiles.
(Similarly, although not subject to the
FH LB B regulations, m utual savings banks
and credit unions in a num ber of states are
now offering, or are seeking to obtain author­
ity to offer, a wide range of third-party
paym ents services— including checking ac­
counts. )
3. C apital Structures. T hrough yet an­
other regulatory action the Federal H om e
Loan Bank Board has proposed approval for
savings and loan associations to issue subor­
dinated debentures, and has lifted the m ora­
torium on conversions from m utual to stock
associations, in order to provide increased
flexibility in the raising of funds.
4. B r a n c h i n g R e g u l a t i o n s . F i n a l l y ,
branching regulations have been adopted
that will give savings and loan associations
a num ber of new possibilities to serve the
public. These are w orth reviewing in greater
detail in view of the com petitive im plications
for com m ercial banks.
L im ited Facilities and Satellite Offices. The
new regulations will perm it the establishm ent
by savings and loan associations of so-called
“ limited facilities” and “ satellite” (or “m ini”)




reducing Federal Reserve Float. The simul­
taneous lowering of reserve requirem ents
under the new R egulation D is intended to
minimize the transitional im pact on m em ber
banks.
A nother significant developm ent in F ed ­
eral Reserve activities affecting the paym ents
mechanism over the past year has been in
the area of Regional Check Processing C en­
ters. E ach Federal Reserve Bank has either
proposed, planned, or im plem ented one or
m ore “R C P C ’s” in its District. A t the F ed ­
eral Reserve Bank of San Francisco, we ex­
pect to have R C P C ’s operational at each of
our five offices by early 1973.
As you know, the basic function of an
R C P C is to p ro v id e th e m a n p o w e r an d
equipm ent, geared to later deposit deadlines,
at locations where large concentrations of
check volumes can be expeditiously pro­
cessed and collected. O ur goal is to furnish
the earliest practical availability of funds to
our depositors and ultim ately to the public.
Furtherm ore the Federal Reserve System is
beginning to look ahead to the next steps in
improving the paym ents m echanism .
SCO PE. A ncillary changes in the pay­
ments system, which are in the early process
of developm ent or in the im plem entation
stage, include the m uch-publicized SC O PE
project in California, initially conceived and
prom oted by ten m ajor banks in the state.
T h e sy stem p ro v id e s fo r p re -a u th o riz e d
paperless entries to effect paym ents in lieu
of checks. The nerve center of this project
lies in two autom ated clearing houses, locat­
ed in the San Francisco and Los Angeles
offices of the Federal Reserve Bank of San
Francisco. F or the bank custom er, the sys­
tem involves both credit entries to his check­
ing account in the form of payroll depositing,
and debit entries in the form of regularly re­
curring paym ents of such items as utility
bills, mortgage loans, and insurance. Now
in the process of being im plem ented by some




145 banks which account for 90 percent of
the banking business in C alifornia, SC O PEtype projects are under active consideration
by banks in some 20 or m ore other areas in
the nation. Significantly, the possibility of
participation in such program s by d epart­
ments and agencies of the F ederal G overn­
ment is being carefully studied.
The A tlanta Project. O ther significant de­
velopm ents in the electronic funds transfer
area include the A tlanta paym ents project,
which, in addition to the autom atic deposit
of payrolls and a pre-authorized, paperless
system for paying bills, has proposed to offer
“ bill-checks.” These bill-checks will use
m achine-processable docum ents on which
the payor endorses a bill and stipulates the
am ount and date on which his bank is to
debit his account and effect paym ent to the
creditor or the vendor-payee.
C om puter Term inals in R etail Stores. G o­
ing beyond these projects is the point-of-sale
com puter term inal in retail stores, activated
by a consum er’s card, and providing a direct
hookup with a b ank’s com puter and authori­
zation term inals. Indeed, as envisioned by a
num ber of observers, w hat these arrange­
ments eventually will entail is a system of
com puterized te le c o m m u n ic a tio n s linking
hom e and business with the m arket, includ­
ing vendors and those institutions which ad­
minister the paym ents m echanism . These in­
stitutions — com m ercial banks and possibly
other financial and non-financial institutions
— will be grouped into a series of local sys­
tems, with access to a central data bank con­
taining a variety of inform ation on custom ers.
The local systems will be linked into regional
centers which in turn will be linked to an
integrated national system of com puterized
telecom m unications.
Implications fo r Banks of
Electronic Payments System
In assessing the implications of an elec-




tronic paym ents system for the com petitive
outlook in banking, the first and basic con­
sideration to you as bankers m ust be the
great opportunity it will afford for expanding
the scope and variety of your services. There
is little doubt that banks (o r their com peti­
tors) will be in a position to accom m odate a
very wide range of bill-paying and accountkeeping functions of consum ers, businesses,
and governm ents alike.
Larger B anks and Fewer B anking Offices.
A t the sam e time, the era of less-checks and
instant com m unications between businesses,
consum ers, vendors and bank com puters is
likely to witness at least some tendency to­
wards the concentration of business in large
or regional banks. The reason is that such
banks will be able to serve custom ers that
are not in close geographical proxim ity to
them , and hence will offer m ore com petition
to small local banks.
Consequently, the developm ent of an elec­
tronic paym ents system m ay be a force w ork­
ing tow ard a decline in the num ber of small
banks and of branch offices. A n electronic
transfer system reduces the need for the bank
custom er to visit his bank office, either in the
capacity of a depositor or borrow er. If the
custom er can bank through his telephone and
have his bills paid and funds deposited auto­
matically, proxim ity to a bank office per se
will become less relevant. By the same token,
an electronic paym ents system is certain to
break down geographical barriers, and in the
process render obsolete many existing legal
barriers to com petition such as branch re­
striction and home-office protection laws.
Changing R ole for C orrespondent Banks.
W hat, then, of the correspondent banker?
Clearly, a very im portant function of the cor­
respondent today— clearing checks and other
cash items— will greatly diminish in im por­
tance. Yet, the new and varied services that
are likely to develop in connection with an
electronic paym ents system could result in




new correspondent ties in the way of special­
ized services. Consequently, one key to the
survival of the small bank m ay depend upon
its ability— perhaps through pooled facilities
and leasing arrangem ents— to w ork out with
its city correspondent the m eans of partici­
pating in the new services and m arkets of­
fered by an electronic system, w ithout inde­
pendently having to undertake the costly
investm ent involved in the necessary hard­
w are and personnel.
C om petition from N on-B anks. The elec­
tronic funds transfer system is also likely to
impinge upon com m ercial banks as com peti­
tive nonbank financial institutions enter the
third-party-paym ent field and utilize the latest
technological developm ents in the process.
It is the view of some observers th at nonbank
firms increasingly will attem pt to m ove into
the paym ents system, which has long been
the nearly exclusive dom ain of com m ercial
banks. These potential entrants include not
only savings and loan associations and m u­
tual savings banks but also data processing
firms, specialized service bureaus, large re­
tail firms, and possibly some elem ents in the
com m unications industry itself. N ot over­
looking the advantages of m odern technology
in their own operations, they will deny to the
banking industry the luxury of doing business
just the way it was done before.
Changing Social Values
Finally, there is another fundam ental force
for change which is increasingly evident in
our body politic and which has an im portant
bearing on the com petitive outlook for b ank­
ing. I caution you against underestim ating
the potential im pact of it. F o r better or
worse, some groups in society are raising
questions as to the appropriate balance be­
tween social ends and means. M ore specif­
ically, questions are being raised regarding
the consistency of traditional econom ic goals
— high and rising levels of income, output




and consum ption — and considerations re­
garding environm ental and ecological bal­
ance.
Effect on F in a n c ia l Institutions. This
growing concern has im portant implications
for the nation’s financial institutions as well
as for economic policy. As exam ples I would
cite the growing support for construction
m oratoria in some areas, and the increasing
antagonism tow ards developm ent.
This is, of course, a m atter of concern both
to financial institutions and to policym akers
simply because econom ic growth — which
means m ore jobs and m ore incom e— is re­
lated to the pattern of real-resource alloca­
tion. which is affected by the p attern of finan­
cial flows. The latter, in turn, is influenced
by the structure of financial institutions and
the rules under which they operate.
The outcom e of the growing debate is not
certain. However, it would appear that, p a rt­
ly under the im pact of the environm ental
m ovements, a stabilization— and even de­
cline— in hom ebuilding and other forms of
construction already is occurring in some
areas. If environm ental concerns becom e
more pervasive, then types of activity which
involve a heavy throughput of m aterials
(such as construction) will be viewed with
progressively less favor. If so, this clearly
has im plications for the likely course of ac­
tion by heretofore specialized thrift institu­
tions which have been prim arily engaged in
financing these types of activity. M ore spe­
cifically, pressures on their part for diversifi­
cation into other fields— including several
fields dom inated by or reserved to com m er­
cial banks— can be expected to increase.
N eed for Flexibility. It is partly for this
reason— the fact that the social priorities of
the future may well differ from those of to­
day— that the increased flexibility in opera­
tions envisioned for banks and their nonbank
com petitors by the H unt Com m ission would
appear to some observers to have consider-




able merit. In their view, such a system
would be preferable to the present one, which
induces thrift institutions to specialize in
real estate lending and which offers less free­
dom of action to com m ercial banks. In any
event, it is clear th at m aintenance of the
status quo is not one of the options open to
com m ercial banks.
Summary and Conclusion
With these rem arks, I have attem pted to
identify the nature and the im plications of
some of the m ajor forces in the com petitive
outlook for banking. Stem m ing from inno­
vations within the banking industry itself,
from the drive by thrift institutions for banktype powers, from the technological revolu­
tion in the paym ents system, and from chang­
ing values in our society, these forces for
change are certain to exert an increasingly
powerful influence upon the com petitive en­
vironm ent in which you, as banks, are going
to live.
M ore specifically, the changes now in the
air suggest an increasing reliance by banks
on non-deposit sources of funds; a growing
im portance of bank holding com panies, both
in banking and in “closely-related” fields; a
continued proliferation of new and im agina­
tive services by banks to business, consum ers,
and governm ental bodies; a further growth
in im portance of international banking; a m a­
jor drive by thrift institutions (m utual savings
banks, savings and loan associations, and
credit unions) in directions th at have the po­
tential of sharing increasingly in the functions
and m arkets of com m ercial banks; a m ajor
revolution in the paym ents m echanism of the
country and in the role of banks in th at m ech­
anism, with an inevitable im pact on the func­
tions of correspondent banks; and changing
social values which m ay have an im portant
effect on banks and other financial institu­
tions. I urge th at you be prepared to cope
with these changes w hen they come.




A fam ous econom ist and form er banker,
the late Joseph Schum peter, once described
the capitalist system as one characterized by
“ a perennial gale of creative destruction.”
The assessm ent m ay seem a little severe to
those seeking solace, but certainly changes
are in the air, and m ost assuredly, they are
not just of a seasonal nature.