KQ Article

The specifics of the present regulatory situation in U.S. banking are certainly unique, but the industry’s history is rife with examples of bankers facing significant change in regulation. In each instance, bankers have found a way to successfully alter their strategy and continue to operate profitably. What follows are four examples.

The Deposit is Born
While state-chartered banks have been in place since 1781, national-chartered banks were created with the passage of the National Bank Act of 1864. One year later, the 1865 Revenue Act placed a 10% tax on the banknotes being printed and distributed at banks chartered by the states. One objective of the Revenue Act was to make state-charted banking prohibitively expensive in order to compel these bankers to convert their state charters to national charters.

Because the state-chartered bankers’ primary source of funds was banknotes, taxing them would increase costs and put them at a competitive disadvantage relative to national banks. State bankers responded swiftly. Instead of printing more banknotes and paying the tax, they began to aggressively accept deposits.

While this seems obvious today, deposits were at the time a relatively new way of doing business. By accepting deposits, the state banker adapted to the regulation, avoided the tax, and remained in business. Financial institutions found a way to thrive.

Investing through Adversity
Leap forward to just before the Great Depression to find another instance of heavy banking regulation. Historically, both state and national banks were prohibited from interstate banking and branching. While this kept competition at bay, an unintended consequence was to limit the benefits of geographic diversification gained from expanding branches a meaningful distance from the home office.

During this period, thousands of financial institutions were exposed to severe credit risk by holding largely agricultural and small business loans, making them vulnerable to the volatility of local markets. In an effort to overcome the credit risk created by the regulatory constraint, bankers sought to diversify their portfolios by opening investment affiliates.

These affiliates allowed bankers to engage in investment banking and, in the process, to diversify beyond the narrow lending opportunities of local markets. Financial institutions found a way to thrive.

Order of Withdraw
In the wake of the thousands of bank failures during the early 1920s, new regulation prohibited financial institutions from paying interest on checking accounts, and placed a limit on the interest rates bankers could pay for savings deposits.

The belief at the time was that competition for deposits was making banks more vulnerable to failure. For many years, due to extremely low market interest rates, this regulation did not pose a problem for the banker. However, by the late 1970s and into the 1980s, market interest rates climbed significantly. Depositors pulled their money out of commercial banks in favor of accounts that could earn market rates.

Initially, bankers responded by offering non-pecuniary incentives such as toasters, blankets, crystal goblets and the like to get depositors to remain at the bank. A more effective response, however, was the creation of a new type of account that was not subject to the regulation.

Bankers created negotiable order-of-withdraw accounts — basically, checking accounts that paid market interest rates but avoided the regulation because they were not technically checking accounts. This helped the banker attract the deposits that they had been losing to less-regulated competitors. Financial institutions found a way to thrive.

Finding Alternative Income
Banks and credit unions responded more broadly to the increased competition posed by money market mutual funds, foreign bankers, and finance companies in the 1980s and 1990s.

These non-bank financial institutions operated (and continue to operate) in a far less-regulated environment, which placed the banker at a competitive disadvantage. In the face of weak loan demand and increased competition, financial institutions searched for alternative income sources and found them in off-balance-sheet activity such as loan commitments, letters of credit and derivatives.

At a time of heightened new competition from less regulated competitors, these activities increased bank income and, in the process, profits. Financial institutions found a way to thrive.

Arguably, the history of few industries rivals the level of regulatory scrutiny and changed applied to U.S. banking. Yet, as the above examples illustrate, one constant has been the bankers’ persistent ability to survive and often prosper in the face of game-changing regulatory obstacles and complications.

Yes, today’s new regulation will provide challenge as your financial institution attempts to satisfy new requirements while finding your place in an increasingly competitive market. But as history clearly shows, successful adaptation to regulatory change is a hallmark characteristic of U.S. banks and credit unions.

Find your way to thrive.



_{© 2010 Jill Henderickson}

What did you think of this article? Share your thoughts by joining the discussion below.