Fragility in the Banking World

Abstract

We are experiencing several general processes of change in the banking world:

• 1. Concentration in banking is leading to a reduction in the number of independent banks.

  • a. In Europe this process started much earlier and is now largely completed in the individual countries. Examples include the Netherlands, but also the UK, France, Germany, etc. Recent developments in Spain reflect this trend.

  • b. In the U.S. the situation is still fundamentally different as a result of legislation in the 1920s and 1930s, especially the ban on interstate branch banking. In recent years we have seen a partial lifting of this restriction to resolve the crisis in the savings and loan sector. Many S&Ls have been acquired by banks in other states. Also, there have been several mergers among both regional banks (NationsBank, Banc One) and money center banks (Chemical Bank). It now seems likely that Congress will finally lift the ban on interstate banking. This is welcome and long overdue. It will lead to many more mergers and acquisitions in the U.S. (However: Citibank is now less interested in making extensive use of this increased freedom than in the past!) Iwelcome this consolidation in U.S. banking. It will strengthen the banking industry and reduce its excessive fragmentation and fragility.

  • c. International,cross-border. On the one hand we have seen several cross-border mergers and acquisitions or alliances. One of the biggest was the acquisition of Midland Bank by Hong Kong and Shanghai Bank. On the other hand, many efforts have failed. Examples include Netherlands-Belgium, AMRO-Générale de Banque, and ING-BBL. Concentration in banking is still largely a domestic activity, even in the EU. Acquisitions of U.S. banks by non-U.S. banks have in most cases been not very successful.

• 2. A second process is the blurring of the separation between commercial banks and investment banks or securities firms. This development has never been much of an issue in continental Europe, where banks traditionally perform both functions. They do this, in my opinion, in a satisfactory way which has not led to fragility of the banking system. In the U.S., however, this was and is a hot issue. The same for Japan. The Glass-Steagall Act of 1933 still stands, and the U.S. Congress still insists on this separation. I think that times have changed and that abolition of Glass-Steagall is long overdue. In fact, part of this separation has already disappeared as a result of the liberal interpretation of this law by the Federal Reserve. It has allowed a growing number of commercial banks to act as underwriter of bonds and—to a lesser extent—of (equity) shares. I welcome this development. If implemented properly it will remove elements of unfair competition against U.S. commercial banks and it will strengthen the position of these banks, not only against investment banks but also against foreign banks. In a time of growing disintermediation (industrial companies borrow less from banks and raise funds directly from investors through securities issues in the capital markets) the position of commercial banks in the U.S. would otherwise become unnecessarily restricted and fragile.

• 3. A third trend is the growing importance of non-banks as providers of loans to industry. In the U.S. and elsewhere finance companies play a growing role, especially in leasing and other asset-based lending. A large and successful case is General Electric Credit Corporation (GECC). As such this development is acceptable and an aspect of free competition. The only critical note I want to raise is that the authorities should provide a fair and “level” playing field. If a situation would arise where non-banks are free to do as they like because they are basically non-regulated whereas banks are constrained to perform the same activities because of rules set by their bank regulators, then there is reason for concern.

• 4. Finally the hotly debated issue of bancassurance: mergers, acquisitions, or alliances between banks and insurance companies, respective de novo activities of banks in insurance products, and vice versa. I take a relaxed and rather positive attitude towards this blurring of the borderlines between different financial industries. I simply note, however, that the U.S. Congress (and the Federal Reserve) continue to be strongly against bancassurance, and I expect no change in the foreseeable future. In Europe the situation is different. Both domestically and cross-border there is a movement towards bancassurance in the EU. The Netherlands is a clear case in point for both national mergers (Nationale-Nederlanden Insurance and NMB Bank/Postbank into ING Group) and cross-border mergers (AMEV and AG into Fortis). Provided that the problem of supervision of banks and insurance companies can be solved in a satisfactory way, I do not see why this trend would increase the fragility of the financial system.