Full text of Statements and Speeches of K. A. Randall : Remarks at a Panel on "At What Point Does Competition Among Financial Institutions Become Destructive?" Georgetown University Savings and Loan Forum, Washington, D.C.

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Remarks by K. A. Randall, Director, Federal
Deposit Insurance Corporation, as a member ofa
panel on ”At What Point Does Competition Among
Financial Institutions Become Destructive?” at
the afternoon session, Georgetown University
Savings and Loan Forum, Hall of Nations, Edmund
A. Walsh Memorial Building, Washington, D. C.,
December 4, 1964.

When we examine the question,

”At What Point Does

Competition Among Financial Institutions Become Destructive,”
we should first set the stage.
another question:
by destruction?

We should ask ourselves

What is competition, and what is meant
And we should consider the unique

circumstances surrounding the banking and other related
finaneial industr ies.
What precisely do we mean by destructive competition?
Are we actually asking what excesses, what aberrations in
the system can lead to "destruction” or tp failure?
We are here today not to come up with world-shaking and
definitive answers to the questions posed to us, but to
suggest some provocative and possibly fruitful lines of
thought.
We might consider the possibility that competition of
itself is never destructive under our existing economic
system, but rather the built-in purifier which has kept the




2
system viable, strong, and relatively lean and hungry.

Ours

is not a monolithic system, in which one central authority,
not necessarily responsible to majority desires, makes
decisions.

The managed economy all too often in history has

deliberately stultified competitive efforts to introduce new
products, new ideas, new techniques, as being harmful to
existing structures.

The inflexible, unresponsive and

uncompetitive economies of such states have always existed,
and exist now.

Historically they produce often inefficient

systems administered by large and inflexible bureaucracies
operating at the expense of both the prosperity and happiness
of the masses.
Our system has rather been characterized by judgments
of the market place —

what people will or will not accept.

The result has been, on the whole, to create a society with
greater mobility, greater wealth, and a more complete use of
the available resources —

not to mention a spur to a greater

development of new resources.
It might be suggested that competition serves to keep
the system alive.

At the same time it serves as the

mechanism whereby decisions are rendered, as to what is to
receive the available resources, and what is to cease to
soak up resources, because they are unwanted, unneeded, or



3
superceded.

As an example, consider the automobile.

The

competitive environment of the Western World allowed the
car to flourish.
pay for them.

People wanted them, and were willing to

There was therefore a profit to be made in

building cars, and many manufacturers vied for that profit.
In competing for the market, they improved the product.
New industries were created, and new wealth generated.
were some losses —

There

buggy makers, for example, went out of

business.
Perhaps we are willing to concede that competition, of
itself, benefits our system.

But what of the proposition

that competition, or any form of it, can be harmful?
we say destructive, do we mean of an industry
business —

of an individual?

When

of a single

Do we mean a reshaping of the

economy as a whole?
Consider again the development of the car.
competitive effects were destructive —
But were they, to the public as a whole?

Its

to buggy makers.
Were they, to the

economy as a whole?
Perhaps we can refine our concept a bit, and say that
while competition of itself may not be destructive, excesses
within a competitive framework can be and often have been
destructive to individual institutions, and harmful to




-■41-

industries and the general economy alike.
Before turning to considerations of ways in which
competitive excesses can prove harmful to the financial
community and the economy, let us first consider the unique
posture that banking and related industries find themselves
in, due to thier special nature.
The structure of the financial systems, and more
specifically of the commercial and mutual savings banking
systems and the savings and loan association system, require
certain limitations upon competition, found only in a few
other industries, but not to such a marked degree.

Any

discussion of competition within or between these three
systems must consider these limitations.
Commercial banking is fundamentally different from
ordinary manufacturing and mercantile businesses, in that its
powers permit acceptance of demand deposits, operation of
checking accounts, and lending against fractional reserves.
In short, the commercial banking system has the power to
create a money supply.

Justice Harlan in the Philadelphia

National case pointed out that for these reasons considerations
other than pure competition are relevant in fixing banking
within the traditional American free enterprise system.




5
Commercial bankers are entrusted with funds belonging
to individuals and corporations, in the form of demand and
savings deposits.

Unlike investors these people and firms

do not regard these funds as being risk capital, nor do
they consider them subject to loss.

Where demand deposits

are involved, they do not expect any return except service.
Where savings funds are concerned, they expect an earnings
increment, but they forego any possible increment of capital
itself.
The depositor-creditor relationship existing between
customers and commercial and mutual savings banks is a unique
one.

In theory and law, funds placed in savings and loan

associations are true investments, conferring ownership or
a portion of ownership in the institution upon the investor.
In reality, however, the public, and legislative authorities,
look upon the relationship as being quite similar to that
governing bank savings activities.

While the technique and

the legal status of savings and loan-investor relationships
differ from that of banking, the public does not draw the
distinction, with the result that in many ways savings and
loans are subjected to the same competitive restrictions as
banks.




6
Competition, therefore, cannot be allowed or imposed
upon the banking system in the manner permitted other industries.
Successful banking is not only the interest of stockholders,
managerial talent, or employees, but most vitally the concern
of the community served and the depositors in a financial
institution.

As a result, the maximization of profits plays

only a small part in banking philosophy.
Applying these considerations, we can examine at least
five ways in which competition is regulated, for banks and
for savings and loan associations, to a greater degree than
for other businesses.

Among these are limitations on entry

into the business and establishment of branches; the
superimposition of diversified and careful supervision on
both state and federal levels; restrictions on the types of
business which may be carried out, eliminating from the
financial industry much of the right to diversify, so much
beloved these days by business; some control over, the amount
which may be paid to acquire funds, and control over the
charges which may be levied for use of those funds, and
finally the basic philosophy which seeks as far as possible
to prevent failure of financial institutions.
The concept of limited entry plays a key role in banking.
This was not always so.




The American banking system has gone

- 7 through three basic phases.

The first was exemplified by

the first and second Banks of the United States, with national
charters and state charters granted solely by act of Congress
or state legislatures.

The second step was a reaction to

this relatively monopolistic practice, so subject to abuses
of privilege.

New York in 1838 enacted a

free

banking

law, permitting entry into banking by anyone who desired it,
under certain specified conditions.

This philosophy spread

throughout the nation, and, as you all know, led to some
grave excesses.
The third step led to controlled entry, on a basis that
charters would be granted to any group, provided certain
statutory criteria were fulfilled and provided state and/or
national authorities could be persuaded.

As of this time,

’’need" became a major criterion.
Thus, for the first time, it had to be demonstrated
that a need actually existed —

although there were, and still

are, conflicting opinions as to what constitutes need.
An additional factor in this push for limited entry was
in the desire to preserve control over financial institutions
as far as was possible in the local area.

Rather than a

system of large national financial institutions, this nation




— 6 ~

has preferred a structural system which assures local control
and ownership of its financial structure as far as possible,
consistent with profitable operation and satisfaction of all
legitimate credit needs.
The basic thesis behind the over-all entry restriction,
therefore,

is that a need must be demonstrated,

controls and local service must be emphasized,

that loc^o.
and tnat the

operation should be profitable enough to assure its continued
existance, even if in many instances this means setting up
a small monopoly,

v

as it does in hundreds of small towns ana

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Xt would be helpful if we could devise a xOrmuJ.<d wni.^.
■culd control the entry of new units,
chartered institutions,

branch or originally

into the banking business.

If some

formula could be devised whereby it would be held that X
number of banks, Y number of savings and loan associations,
and Z number of credit unions were the proper balance for
each 10,000 of population,
simplified.

our problems would be greatly

Unfortunately, no statistical tools exist to

make such formulations accurate,
tools are desirable.
of convenience,
population,




nor am I sure that such

We must still turn to factors of need,

of the dispersion,

for these decisions.

or compaction,

of the

Another part of this drive for limited competition
between banks and other financial institutions lies in the
careful and detailed supervision by state and federal
regulatory bodies.

Its restrictiveness is well known to

all of you, and in our limited time here we cannot consider
the many ramifications of bank,supervision and their impact
on competition.

We are all aware of the efforts of

supervisors to maintain standards in loan activity,
portfolios,

licmidity,

capital ratios,

investment

and management

capability.
But perhaps I might offer another thought for
consideration.

The supervisory structure, with its diversity,

and its split between state and federal authority,

is in

itself a different form of competition for the financial
industry.

If -financial institutions in this country are

forbidden some competitive advantages offered to most businesses
perhaps the diversity existing in the present supervisory
structure acts as a replacement for the diversity sacrificed.
The interaction of ideas, philosophies,
and regulations,
authorities,

and operating rules

the myriad approaches by state and federal

acts as a cross-pollinization which in part at

least substitutes for the circumscribed situation of the
financial industry itself.




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isolate banks
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savings

shocks possib le in economic

area s outside of the very enpp ialized concer ns of the financial
institutions.
State and Federal laws control rather tightly the
charges which banks may levy and the cost they may incur xoi
funds.

Federal regulations matched by some states, restrict

the amounts which may be paid for time and savings deposits,
and there is an absolute prohibition against the payment of
interest on demand deposits.

While savings and loan

associations do not face any such direct prohibitions,

its

supervisory bodies have not been afraid to use all possible
powers of persuasion to hold rates down when considered
desirable.
Additionally,

there are laws on the books of all the

states setting forth limits on what may be charged for loans




These so-called 'usury
of profits -—

absolut e maximization

laws prever

id savings

and have
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e restrictions are part ana p;

last limitation —

Is

¡el ox th<

the limitation against the competitive

right of banking institutions to fail.
free enterprise system,

a "right”.

This is, under our

Any business can in

competition reap the benefits of success,
suffer the consequences of failure.

or as a corollary

Not so banking.

Banks

do fail, b u t 'it is despite all efforts of the system to keep
them alive.

Above all, everything in the system is structured

as far as possible to assure that ownership or reserves
bear the loss, not the depositors.
become dangerous when they erode
account funds.

Competitive excesses

into depositor or share

The very creation of the Federal Deposit

Insurance Corporation v/as designed to preserve the nation's
money supply as evidenced by depositor holdings.

A parallel

protection was given share accounts on the creation of
Federal Savings and Loan Insurance Corporation.
Competition itself can be said to be the essential
feature of our economic system.




Competition'within.the

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is severely limi.ted .
ium system
p t lipt excesses do exist.
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It is necessary for

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iese

esses iare.
We d<3 not have the time for

O V®eful consider

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the areas in which excesses can be found, nor to analyse
what might constitute destructive excesses.
these:

They may be

limitations on destruction of economic units;

constriction of economic output; misallocations of resources
Perhaps competition can be held to be destructive when
it splits up a market among units which are too small to
t

efficiently utilize the available resources,
real service to the public.

and to offer

If too many institutions are

formed in an attempt to compete for a market of fixed size
and predictable and limited growth, then service by these
units may be hampered by cutting the pie into non-economic
slices.

For example,

3 million bank,

an area may be able to support a

and that bank may be able to render real

and efficient servjce to its community.

Yet two banks with

footings of $1.5 million would find that too much is being
allocated to expenses, that earnings are hard to come by,
and that the small size made it impossible for the banks




.3 -

o render real and effective service to the- community.

In

;uch a situation competitive pressures could actually lessen
;he effectiveness of the banking structure.

This situation

general
jould actually stultify the economy in gene:
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and reduce

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nnot draw a

uneconomic.

For New York

higher than for a small
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tfown

a 0X

1c «lo division of markets into possibly non-economic

segments can be a competifive problem of larfre iiriporta n c e .
This is a broad area but it is worthy of serious study.
In a simple r vein, ho w e v e r , perhaps we can indicate
some areas where excesses occur,
always be maintained.

and in which vigilance must

I might suggest that many of what we

call excesses in competition stem not from any basic flaws
within the system, but from flaws within those people who
manage the system.

In other words, many of the excesses we

encounter are man-made,

characterized all too often either

by a too-eager desire to surpass all competitors,
willingness to gamble on the future.

or from a

We can cite several

examples.
Competition in seeking funds for investment purposes has
at times been destructive not only of individual institutions
but almost of the system as a whole.




The best known example

that is the excessive payments made during the 1920's
>r demand deposit funds.

We have seen some banxs destroyed

his vear when their managers sought funds ior investment

4- U -i

through payment of bounties for certificates of deposit,
the full legal limit o± aiiowauie interest.

over

ine ucuigeis> UCiC

are two-fold:

not only does this action attract the least

stable type ,Uor\,1-P

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>ney , but in order to'meet the cost

loans hai/e to be m a d e .
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these

8ever*il of chei bank

which failed this, year did so precisely because managers
made risky loans for high rates of interest, only to see the
loans turn bad and wipe out capital.
A.second danger, closely allied to the first,

i
lies in

lending activity outside the institution's area or its zone
of competence.

The bank that goes out of its area, where it

is qualified to make credit judgments and to supervise its
loans, opens the door to loss.
Too many banks seek, for competitive reasons,
fields in which they do not have any competence.

to enter
There are

times when such expansion into new fields can be supported,
but only if the institution secures competence in the field.
Too many man a g e r s , especially in boom times, make loans
on inflated values, or assess values not on current standards
but on anticipation.




Projections of the future are of value,

re times when we must
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his is not yet a danger to the nation as
this

The number o± banking n limX4 4L

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each

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Pxces ses in branching and in ch tering of new

have, however, developed in som e areas.

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in the f 11

job of risk capital.

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units have been opened because of
that. an area will in time need

bps

Many

f i Xi fo nU JvL pW
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nking service

The paramount criterion for entry is supposed to be

need,

and that supposes current need, not future expect ions.
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In oyenei
a i& y, competit ion is a he a 1th;y method for assur ing
at our banking system will cont inue t o serve the public
th as little cost as possil)le.

«•Lb>' assures that banking and

o m e r x inanela1 systems will fill the credit and thrift needs
o: the public.

It assures also that financial systems w i l

extend their services when the public needs them.
Excesses creep into the system when managers allow a
desire for size to overwhelm their own good judgment.

Excesses

creep in when managers start to "bank on the future.

The

financial system is not a risk-oriented business;




and gambling