by James M. Rockett *
Banking is, and during the past 25 years of my legal practice has
been, a highly regulated industry. I recall sitting in the Board
of Directors room of United California Bank and listening to a senior
executive proclaim the end of the world because an amendment of
Regulation Q was being debated which would allow interest on demand
deposit accounts, an unthinkable concept. In those days, banks and
bankers relished regulation because competition was in a very narrow
band and the customer was a hostage of the inefficiencies created
by governmental oversight. Now as we approach the Millennium we
hear revolutionary thoughts of deregulation. HR 10 is debated with
every imaginable interest group fighting to preserve its special
position in the current regulated hierarchy. Politicians line up
to choose sides (and incidentally solicit campaign contributions)
in a debate that will possibly affect the future delivery of financial
services in the United States. But rather than focus on the numerous
issues of HR 10, I propose instead to review the philosophical underpinnings
for banking powers and consolidation.
In actuality, the revolution in banking has been more subtle than
we at first glance realize. In fact, through the forces of the marketplace,
changes have evolved making the role of politicians increasingly
irrelevant. Viewed over the past two decades, expansion of banking
powers has been dramatic: Banks offer securities in their branches
and sell insurance on their premises; they have sweep accounts for
corporate customers (thus circumventing the remaining limitations
of Reg. Q); bank products are offered over the Internet to customers
without geographic limitation. And changes such as these have taken
place without any significant statutory revisions. Yet the pall
of regulation continues to inhibit banking opportunities which would
benefit customers, shareholders and communities.
Similarly, consolidation has become a defining force in banking.
Suddenly even the largest institutions are being sold and merged
at a prodigious rate. Small community banks and regional institutions
seem to be a dying breed. The rush to bigness appears to have no
bounds. The zeitgeist commands size and little thought is given
to the consequences as mergers create bureaucratic behemoths.
The market forces behind expanded banking powers and consolidation
could be no more dramatically demonstrated than when, in a breathtaking
moment last year, Citibank and Travelers announced a merger creating
a giant financial services company that appeared to defy current
law. And, within minutes after that announcement NationsBank acquired
Bank of America to become the largest retail banking franchise in
the world. At the same time, some of the country's largest insurance
carriers and industrial companies have entered the world of banking
through the side door by acquiring thrift charters from the Office
of Thrift Supervision.
These charters have evolved to include most if not all of the characteristics
of a commercial bank, and the companies entering banking through
this route are theoretically prohibited from commercial banking.
Other companies are availing themselves of even greater freedom
by chartering state-regulated, FDIC-insured, deposit-taking institutions
called industrial loan companies in states like Utah, Nevada and
Arizona. Yet, no comprehensive (or comprehensible) scheme exists
to rationalize the incongruencies of these actions and the underlying
rationale for existing law. Regulators continue to beat up on the
obvious and easiest targets, while our regulated financial institutions
struggle to be competitive in the face of restrictions dating back
The topic at hand is the current regulatory scheme and whether
and to what extent banks should enjoy greater freedom from regulation.
As a Federalist, I am and will always be skeptical of governmental
intrusion on the free market. I have yet to meet a regulation, no
matter how well intended, that provides the ultimate benefits promised.
Yet the pragmatist in me recognizes that because it provides deposit
insurance, the government will play a role in controlling banks
and the real question must be how to balance regulation with competition.
And in establishing that balance, we must consider whether there
are necessary limits on powers that would allow banks to compete
effectively while not adversely affecting the parallel protections
intended to protect the public through regulation. For instance,
should industrial companies be precluded from owning commercial
banks and, if so, why? Or, should banks be denied the authority
to underwrite securities, or offer insurance for sale in branches
or become an Internet service provider? If any of these powers should
be denied, what is the basis for such a determination?
We also need to consider the impact of consolidation on all of
the constituencies of banks, their shareholders, customers, employees
and communities. Is the rush to size consistent with the best interests
of any or all of these constituencies? Certainly, shareholders in
the short term seem to be in favor of combinations. But customers
and communities appear to be both short term and long term losers.
In my experience in bank mergers, very little thought, other than
nodding recognition, is given to the needs of the customers and
the communities served by the combining institutions. It is hard
to believe that, in planning a merger, bankers do not first evaluate
the customer base and focus on fulfilling the needs of that constituency
as a primary priority; and yet, time and again this is the least
considered element of a merger. As importantly, the communities
served by the target institution often are alienated and the resultant
animus can take years to mend.
As we think about consolidation, the world of community banking
is one which appears to be imperiled. The history of banking in
the U.S. has been one in which there has been a diffusion of banks.
Until recently, branch banking has been rare and unit bank states
had a separate bank in every town. Community banking has been the
backbone of our country's banking system. Consolidation would appear
to be the end of the road for what is perceived to be a very inefficient
structure. And yet, like the mythical Phoenix, community banks re-assert
themselves as de novo institutions throughout the country. Is there
a future for community banks? Can they survive consolidation? Will
the giant institutions (not to mention the strengthened regional
banks) render community banks incapable of true competition? How
can independent banks survive in an era of increased technology?
The betting seems to be that small banks have no future for these
and other reasons.
Where would you place your bet?
My own thoughts are these: As to powers I submit that there is
very little justification for restricting the financial services
products that should be permitted to banks. Banks have a powerful
distribution network and, if they can conveniently meet customer
needs, those products should be available through banks. The Depression-era
justifications for restrictions have no relevance today and, I submit,
had no relevance then. That said, I have very severe reservations
that banks, once handed a new sack of toys in the form of enhanced
powers, would execute profitable business plans measurably adding
to shareholder value or meaningfully changing the currently available
product mix. In fact, the evidence is that grandiose business plans
by bankers inevitably fail, not because the ideas are unsound but
because the talent to execute such plans has been lacking and institutional
focus becomes diffused.
Currently I watch Citigroup with a mixture of curiosity and skepticism.
Thus far there is little indication that the sum of the parts is
any greater than the value of each entity on a stand alone basis.
And, there is empirical evidence that such a plan will ultimately
fail. For example, one only has to examine the efforts of Sears
Roebuck in the 1980s to see that grouping a series of apparently
related financial services products under one flag is not a panacea.
In that instance, Sears began with its retail stores, an incredible
consumer-based platform from which to offer its products. It then
brought together Allstate Insurance, Dean Whitter brokerage, Discover
Card and added Sears Savings Bank, a one-stop consumer emporium
of financial products. Yet, in the final analysis, consumers failed
to respond and the parts became more valuable as stand alone entities.
Granted Citi has an even greater platform from which to approach
customers. But, can Citigroup manage to cross-sell its various units
at a time when most banks find it difficult to cross-sell their
own related products? I submit that until this happens, old fashion
commercial banking will continue into the Twenty-First Century regardless
of the outcome of the financial powers debate. Moreover, it will
be response to the market place that will cause the evolution of
new products and services, not the granting of greater powers.
As to consolidation of banking, I also am skeptical. Certainly
there is economic evidence that our current diffused model of banking
contains excess capacity. Economics will inevitably force consolidation
in such circumstances. But, the idea that bigger is better has never
proved to be true in banking. Ultimately the cost of bloated bureaucracies
in our large institutions, with related customer dissatisfaction,
results in inefficiencies that more than offset the gains in apparent
delivery power. For this reason, I continue to believe that independent
banking will not disappear in the next Millennium. Perhaps the smallest
institutions will not be able to compete effectively, but there
is a great deal of room for community based institutions that can
execute a well defined, carefully focused business plan. The issue
of technology, in my view, actually works to the benefit of small
institutions. First, the research and development costs of sophisticated
systems falls primarily on the largest institutions. Once they perfect
the technology and gain customer satisfaction, follow-on technology
is available in the marketplace at extremely competitive costs through
third party vendors. This process has largely solved the technology
gap of small institutions. Moreover, the availability of banking
through the Internet minimizes the advantages of size and promotes
competition based on pricing and products. Well-managed independent
banks will be able to compete successfully on the internet and will
prosper through a close relationship to their communities combined
with personal service and the deployment of well considered technology.
* Mr. Rockett is a partner in San Francisco CA office of McCutchen,
Doyle, Brown & Enersen LLP <firstname.lastname@example.org>.
This article is taken from his remarks before the Financial Institutions
Practice Group's conference, Banking in the New Millennium, on June
4, 1999 in St. Louis, Missouri.