10.5 Banking Industry Profitability and Structure #Notebook

Banking Industry Profitability and Structure

When interest rates rose enough to cause disintermediation, to cause funds to flow out of banks to higher-yielding investments, banks are likely to compete with each other for funds and deposits. 

Securitization has hurt banks by giving rise to numerous small lenders that basically sell every loan they originate.

In 1933, at the nadir of the Great Depression, commercial and investment banking activities, strictly separated by legislation, Glass-Steagall. 

The banking crisis of the 1980s has caused some reforms, including greatly easing restrictions on branch banking and investment activities.

Due to the deregulation, banks began to merge in large numbers (consolidation), and participating in nonbanking financial activities, like insurance (conglomeration).

Due to the demise of Glass-Steagall, conglomerate banks can now more easily tap economies of scope, consolidation and conglomeration have left the nation with fewer but larger and more profitable banks to supply numerous products or services. 

Consolidation has allowed banks to diversify their risks geographically and to tap economies of scale, due to the high initial costs of employing the latest and greatest computer and telecommunications technologies.

Complex banking organizations or large, complex financial institutions point to the costs of the new regime. These institutions are too big, complex, and politically potent to regulate effectively.

However, they are also taking on higher levels of risk. A combination of consolidation, conglomeration, and concentration helped to trigger a systemic financial crisis acute enough to negatively affect the national and world economies.

Those big banks control the vast bulk of the industry’s assets and rapidly gaining market share. Nevertheless, U.S. banking is still far less concentrated than the banking sectors of most other countries. 

In Canada, the commercial bank Herfindahl index hovers around 1,600, and in Colombia and Chile, the biggest five banks make more than 60% of all loans. The Herfindahl index is calculated by summing the squares of the market shares of each bank.

However, bank entry is fairly easy, so new banks will form to compete with them, the Herfindahl index may be ultimately back in line. Consultants like Dan Hudson of NuBank.com help new banks to form and begin operations.

The U.S. banking industry is increasingly international in scope. Foreign banks can enter the U.S. market relatively easily. Foreign banks can buy U.S. banks or simply establish branches in the United States. 

The internationalization of banking means that U.S. banks can operate in other countries, and also a way to diversify assets. 

In continental Europe, like Germany and Switzerland, so-called universal banks that offer commercial and investment banking services and insurance prevail. 

Great Britain and its commonwealth members, full-blown financial conglomerates are less common for now, but most banks engage in both commercial and investment banking activities. 

Increasingly, the world’s financial system is becoming one, make it more efficient, but also raises fears of financial catastrophe.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.