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FRB CHICAGO NONTRADITIONAL BANKING ACTIVITIES: A REGULA TORY PERSPECTIVE Silas Keehn President Federal Reserve Bank of Chicago Vanderbilt University April 8, 1987 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Bank loans as a percent of total borrowings by nonf arm nonfinancial business Percent 50 40 30 20 10 60 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 62 64 66 68 70 72 74 76 78 80 82 84 86 Bank loans as a percent of total borrowings by nonfinancial corporate business Percent 40 30 20 10 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 60 62 64 66 68 70 72 74 76 78 80 82 84 86 Commercial paper vs. C&I loans at large banks Billion $ 275 250 225 C&l loons 200 175 150 125 100 75 Commericol paper 50 25 0 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 75 76 77 78 79 80 81 82 83 84 85 C&I loans at large banks as a percent of total bank C&I loans Percent 70 65 60 55 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 75 76 77 78 79 80 81 82 83 84 85 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Early commercial banks and trust companies • 1927 - underwrote 37% of all new bond issues • 1930 - underwrote 60% of all new bond issues https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Commercial banking legislation • 1933 - Glass-Steagall Act • 1956 - Bank Holding Company Act • 1970 - Amendments to the Bank Holding Company Act https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Positioning of firms in the 1970s • J. P. Morgan • Merrill Lynch • Sears Major developments in the 1970s https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • International orientation • Overseas investment banking • Competition for deposit services • Deregulation of securities industry Eurodollar market https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • Regulation Q ceilings • Limitations on capital outflows • Favorable treatment of foreign deposits https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Deregulation of securities industry • Eliminated inefficient brokers • Increased competition • Created a more competitive securities industry https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Acquisitions in the early 1980s • Prudential acquires Bache • American Express acquires Shearson • Sears acquires Dean Witter • BankAmerica acquires Schwab https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Deregulation of the 1980s • Phase-out of Regulation Q • Reduction in reserve requirements • Expanded powers of thrifts • Bank holding companies gain new powers https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Banks listing in the Yellovv Pages ► Banks Also see Financial services Investment firms Stock brokers Insurance companies Credit unions Savings & loans Retailers Noninterest income as a percent of total income at large banks Percent 12 10.1 10.2 1983 1984 10 8 6 4 2 0 1981 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1982 Domestic investment banking activities of 10 largest U.S. banks Value Number of Deals ($ billions) 5.94 115 Tax-exempt bonds 22.50 2,471 Private placements 13.16 713 Mergers & Acquisitions https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Investment banking activities of U.S. banks overseas Eurobonds Citicorp BankAmerica Chase Manhattan Manufacturers Hanover J. P. Morgan & Co. Chemical NY Corp. Security Pacific Corp. Bankers Trust Co. X X X X X X X X X X X X X X X X X X X 9 10 First lnterst_ate Bancorp. First Chicago Eurocommercial paper International Equities X X X X X X X 7 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Loan sales • Unbundling • Originating and servicing loans • Funding loans https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Turning mortgages into securities Financial institutions make mortgage loans S&L Mortgages are bundled and sold as securities MORTGAGE- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Major types of loan-backed securities • Pass-through securities • Collateralized securities • Pay-through securities Federal agency pass-throughs as a percent of residential mortgages Percent 35 30 25 20 15 10 5 0 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 80 81 82 83 84 85 86 est. Securitized consumer credit Billion$ 20 Auto loans 15 10 5 Credit card loans oLl_ 0 _ l _ : _ __ __L_ 1985 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis _ . . l _ ~ ~ ~ - _ L_ 1986 _L 1987, projected Commercial letter of credit https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1a . Importer orders goods 2. Exporter ships goods to importer Exporter l Importer ......l .. .. .. ...... .......... 1b. Letter of credit ........ ....... .... .... ·--......... ...-··........ ....- ~-••••·· 3. ExP,orter sends draft and documents --- 4 . Bank accepts drafts and pays exporter face value less discount Bank (Drawee> -- 5. Ban k forwards doc uments ~ 6. Importer pays bank https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Credit-related OBS activities • Loan commitments • Standby letters of credit • Note issuance facilities • Asset sales with recourse Standby letter of credit https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Accoaa,t Party Beneficiary ◄ Bank (Issues SLOC) Note issuance facilities • Medium-term arrangement between borrower and underwriter • Borrower issues short-term paper • Underwriter commits to purchase notes or provide standby credit • Underwriter keeps notes or places them with investors https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Hedging-related OBS activities • Options • Futures and forward contracts • Swaps Example of interest rate swap https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10.5,: Swap Swap Counterparty ◄ 6-month LIBOR Counterparty C&I loans, standby letters of credit and loan commitments at money center banks Percent of assets 45 40 35 1978 30 1985 25 20 15 10 5 0 C&I loans https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis C&I loan commitments SLOCs Share of the OBS market by bank size, 1985 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Over $25 billion 717. Types of OBS activity by bank size, 1985 Percent share 100 .5-5$8 <.5$8 90 80 > 5$8 70 60 50 40 30 20 10 0 .J...-..1.--~ - - Trade~ https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ~ Finance ~ I - - Hedging ~ Composition of regulatory taxes on domestic loans 1980-1985 Burden of reserve requirements Burden of deposit insurance premiums Burden of capital requirements Total ( - - - - - - - - - - - - - - - - - basis points - - - - - - - - - - - - - - - ) 1980 44 4 13 61 1985 holding tax structure and interest rates constant at the 1 980 levels 22 8 21 51 1985 holding interest rates constant at the 1 980 levels 22 8 15 45 1985 actual 11 8 7 26 1985 assuming 1987 tax structure 11 8 20 39 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The changing composition of regulatory taxes Burden of reserve requirements Burden of deposit insurance premiums Burden of capital requirements ( - - - - - - - - - - - - - - - - percent - - - - - - - - - - - - ) 1980 72 7 21 1985 holding tax structure and interest rates constant at the 1 980 levels 43 16 41 1985 holding interest rates constant at the 1980 levels 49 17 33 1985 actual 42 31 27 1985 assuming 1987 tax structure 28 20 51 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Factors in issuance of guarantees • High regulatory taxes • Bank soundness https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Factors in loan sales • Originating and servicing loans • Diversification • Regulatory taxes https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Nonbank financial firms and OBS activities • GM, Ford, and Chrysler • Computer companies • Property and casualty insurers Financial guarantees by property / casualty insurers Millions 3000 S 0 Ratio https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 2 Ratio 0 '9-------.------.----r------r----r-----.-----.---r-------r---,------r 74 75 76 77 78 79 80 81 82 83 84 85 Futures and options contracts on financial instruments Millions 60 50 40 30 20 10 0L..-~-----y--------.---------r------,----~-----.-----.-- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 77 78 79 80 81 82 83 84 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Catalysts for financial innovation • Technology • Competition