THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 304

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PA R T I I I

Financial Institutions
The growth of the bank holding companies in the United States has been dramatic over the past three decades. Today bank holding companies own almost all
large banks, and more than 90% of all commercial bank deposits are held in banks
owned by holding companies.
Another financial innovation that avoided the
restrictions on branching is the automated teller machine (ATM). Banks realized
that if they did not own or rent the ATM, but instead let it be owned by someone
else and paid for each transaction with a fee, the ATM would probably not be considered a branch of the bank and thus would not be subject to branching regulations. This is exactly what the regulatory agencies and courts in most states in the
United States concluded. Because they enable banks to widen their markets, a
number of these shared facilities (such as Cirrus and NYCE) have been established
nationwide. Furthermore, even when an ATM is owned by a bank, states typically
have special provisions that allow wider establishment of ATMs than is permissible for traditional brick and mortar branches.
As we saw earlier in the chapter, avoiding regulation was not the only reason
for the development of the ATM. The advent of cheaper computer and telecommunications technology enabled banks to provide ATMs at low cost, making them
a profitable innovation. This example further illustrates that technological factors
often combine with incentives such as the desire to avoid restrictive regulations
like branching restrictions to produce financial innovations.

AUTOMATED TELLER MACHINES

COM PE T IT I ON ACROSS AL L FO U R P I LLA RS
Another important feature of the structure of the banking industry in Canada
until recently was the separation of the banking and other financial services
industries such as securities, insurance, and real estate. Regulations enforced
the separation of institutions according to their core financial service, and only
four distinct types of financial services were identified: banking, brokerage,
trusts, and insurance. This approach to regulation by institution (versus regulation by function) has been known as the four-pillar approach. The separation

of the four pillars prohibited chartered banks from engaging in insurance and
real estate activities. In turn, it prevented investment banks and insurance companies from engaging in commercial banking activities and thus protected banks
from competition.

Convergence

In recent years, however, financial markets have opened up and Canada s traditional four-pillar system has changed. Despite the prohibitions in the legislation,
the pursuit of profits and financial innovation stimulated both banks and other
financial institutions to bypass the intent of the legislation and encroach on each
other s traditional territory. For example, credit unions long offered insurance to
their members and brokerage firms engaged in the traditional banking business of
issuing deposit instruments with the development of money market mutual funds
and cash management accounts.
Not surprisingly, the regulatory barriers between banking and other financial
services markets have been coming down in response to these forces. Before the
1950s, for example, legislation allowed chartered banks to make loans for commercial purposes only and prohibited them from making residential mortgage
loans. It was only after the 1967 revision of the Bank Act that banks were allowed
to make conventional residential mortgage loans, thereby directly competing with
trust and mortgage loan companies, and credit unions and caisses populaires.