Market structure and regulation in the u s banking industry

Market Structure and Regulation in
the U.S. Banking Industry

Professor Wayne Carroll
Department of Economics
University of Wisconsin-Eau Claire

Slides available at www.uwec.edu/carrolwd


Roles of Banks in the Economy
 Facilitate borrowing and lending
 Facilitate payments
 Risk management



Issue financial assets that allow firms to share
risks
Provide guarantees and lines of credit


Role of Banks in Lending

Source: Available online at />

Financial Intermediaries
“Banks” include:
 Commercial banks
 Savings and loan associations (S&L’s)


Also sometimes called “thrifts” or “thrift
institutions”

 Credit unions


Financial Intermediaries
Assets at end of 2002 (in billions)


Ownership of Banks
 U.S. banks are privately owned – no banks

are owned by the government.
 In most cases a bank’s stock is held by a
large number of investors, so a bank has
many “owners.”
 It is relatively easy to establish a new bank in
the U.S.


Bank Market Structure
 There are a large number of banking firms in

the U.S., but the number is falling due to
mergers between banks.
 Thousands of U.S. banks are very small,
each having only a single office.
 Many banks today have multiple branches or

offices.
 A “bank holding company” is a firm that owns
one or more banking firms.


Size Distribution of U.S. Banks
 

Commercial Banks 
Number of 
 Asset Size
(as of June 30, 2006)

Institutions 

Offices 

Deposits 
(millions)

586

712

$7,661

$25 Million to $50 Million

1,098

1,701

$33,511

$50 Million to $100 Million

1,718

4,007

$105,754

$100 Million to $300 Million

2,427

10,338

$349,740

$300 Million to $500 Million

672

5,088

$211,495

$500 Million to $1 Billion

494

6,322

$265,540

$1 Billion to $3 Billion

275

6,856

$338,909

$3 Billion to $10 Billion

120

6,601

$427,340

Greater than $10 Billion

89

38,848

$3,580,817

7,479

80,473

$5,320,767

Less than $25 Million

TOTALS 

Source: www2.fdic.gov/sod/index.asp


Bank Market Structure: An Example
Wells Fargo & Company is a bank
holding company based in South Dakota
(with historic roots in Minnesota and
California). It includes:
 28 chartered bank companies
 a total of over 3,000 branches in 23
states


Some Wells Fargo branches


Wells Fargo’s Broad Scope

Source: www.wellsfargo.com/about/today1

20 Largest U.S. Banks
(as of June 30, 2006)
Rank

Institution Name  

State 
Headquartered

Number of 
Offices

Deposits 
(thousands)

1

Bank of America, NA

North Carolina

5,781

$563,906,844

2

JPMorgan Chase Bank, NA

Ohio

2,679

$434,752,000

3

Wachovia Bank, NA

North Carolina

3,136

$306,348,000

4

Wells Fargo Bank, NA

South Dakota

3,200

$298,672,000

5

Washington Mutual Bank

Nevada

2,167

$209,927,984

6

Citibank, NA

New York

267

$142,508,000

7

SunTrust Bank

Georgia

1,758

$117,956,301

8

U.S. Bank, NA

Ohio

2,525

$117,337,830

9

HSBC Bank USA, NA

Delaware

436

$75,588,320

10

World Savings Bank, FSB

California

286

$61,321,407

11

PNC Bank, NA

Pennsylvania

831

$58,134,805

12

Keybank, NA

Ohio

957

$57,327,323

13

Regions Bank

Alabama

1,397

$57,231,022

14

Merrill Lynch Bank USA

Utah

3

$52,331,967

15

Branch Banking and Trust Company

North Carolina

918

$51,246,133

16

Countrywide Bank, NA

Virginia

2

$50,657,812

17

ING Bank, fsb

Delaware

1

$46,440,495

18

Comerica Bank

Michigan

387

$43,081,270

19

Sovereign Bank

Pennsylvania

661

$40,829,851

20

The Bank of New York

New York

354

$40,014,000

Source: www2.fdic.gov/sod/index.asp


A Simple Bank Balance Sheet
Assets
 reserves
 "loans"
 securities
 bank

loans

Liabilities
 deposits
 borrowings
Bank capital
(equity)


Detailed Balance Sheet for the Banking Industry

Source: Mishkin, Economics of Money, Banking, and Financial Markets, 7 th edition

Two Important Ratios
 Capital/asset ratio – bank capital as a

percentage of bank assets.


The average capital/asset ratio for U.S. banks
was about 9% at the end of 2002.

 Reserve ratio – bank reserves as a

percentage of checkable deposits.


Information on U.S. Banks
 It is easy to get a lot of financial data on U.S.

banks.
 A great source:
www2.fdic.gov/idasp/index.asp


An Example: Data on Wells Fargo


What Can Go Wrong?
 “Bank failure” – the bank goes out of

business.





Bank depositors might lose some of their
funds.
Bank creditors might lose some of their
investment
Bank owners lose their capital.

 The bank suffers significant losses – the

government might have to help.


Reasons for Bank Regulation
Banks must be regulated because:
 a bank failure can be devastating to depositors.
 there’s a risk of systemic failure: the failure of
one bank can make it more likely that other
banks will fail.
 depositors can’t monitor how the bank invests
their funds, creating a moral hazard problem.
 government assistance to a bank can be very
costly.


Reasons for Bank Regulation
Banks are less stable than other businesses 
because:
 bank liabilities tend to be short-term – many

depositors could withdraw their funds with little
notice.
 bank assets tend to be longer-term – reserves
and other liquid assets are only a small share of
the total.
 the behavior of depositors depends on their
confidence that the bank is sound, and this
confidence can be easily shaken.


A Closer Look at Bank Failure
Two reasons for bank failure:
 The value of bank assets falls, so
assets Deposit outflow: A large number of depositors
withdraw their funds from the bank,
exhausting the bank’s cash (reserves) and
other liquid assets.
Therefore a bank is more likely to fail if it has
a low capital/asset ratio or a low reserve ratio.


A Closer Look at Bank Failure
Tradeoff between higher income and a lower
risk of failure:
 Holding other things constant, the bank’s net
income is higher if its capital/asset ratio and
reserve ratio are lower, since then it holds
relatively more interest-earning assets.
 If the bank’s capital/asset ratio and reserve

ratio are higher, it’s less likely that the bank
will fail (so it’s less likely that the stockholders
will lose their capital.)


A Closer Look at Bank Failure
If there were no government regulation of 
banks:
 each bank would choose a capital/asset ratio
and a reserve ratio to maximize the value of the
bank.
 depositors would want to deposit their money in
banks that are well managed, so banks would
have an incentive to choose capital/asset ratios
and reserve ratios that reduce the threat of bank
failure.
 “market discipline”


A Closer Look at Bank Failure
But if there were no government regulation of 
banks:
 banks would choose capital/asset ratios and
reserve ratios that are too low from society’s
standpoint.
 banks would take on too much risk, so there
would be too many bank failures, and the
government would have to spend too much
money to assist troubled banks.

An Example:
Continental Illinois Bank
 Continental Illinois Bank failed in 1984.
 The federal government paid billions of

dollars to keep Continental Illinois from
closing.
 This was the biggest bank “resolution” in U.S.
history.