History of Banking Industry
Since the inception of the United States, citizens of this country have feared a strong central government.
Going along with this has been a similar fear of having too strong a central bank. Debates over this issue
date back to the 18th century and escalated to former President Andrew Jackson condemning the federal
bank all together. Despite the opposition a strong banking system in the U.S. has come about and this
paper will illustrate the development of this industry.
Forming of Banks and Governing Bodies
In 1864, the National Bank Act was passed finally establishing a national bank system and the chartering of
national banks (retrieved 1/28, http://www.fdic.gov/regulation/laws/important/index.html). In a little under
50 years, the Federal Reserve was established as the central banking system in the United States. Today
the Fed controls U.S. monetary policies, regulate state-chartered banks and their non-bank subsidiaries, and
foreign banking organizations. They also have been given the power to regulate the new “superbanks”
created by the Financial Service Act of 1999
(retrieved 1/28, http:www.fdic.gov/regulation/laws/important/index.html).
The Federal Deposit Insurance Corporation (FDIC) was also established temporarily in 1933 and
permanently in 1935 (retrieved 1/28, http://www.fdic.gov/regulation/laws/important/index.html). After the
chaos of the great depression congress established the FDIC so that the federal government could guarantee
some deposits. Today the FDIC guarantees all deposits up to $100,000 and regulates those banks not
covered by the Federal Reserve. No depositor has lost any insured money from a deposit since the FDIC’s
creation. Currently, there are over 8000 FDIC insured banks in the U.S. (retrieved 1/29,www.fdic.gov).
Another regulating body, the Office of the Comptroller of the Currency (OCC), has been in existence now
for over 100 years. This office, founded as a bureau of the U.S. Department of the Treasury, deals with
national and foreign banks. It charters, regulates and supervises all national banks, while also supervising
the federal branches and agencies of foreign banks. The OCC has maintained a mission of ensuring a
stable and competitive national banking system (1/30, http://www.occ.treas.gov/enforce/enforce.htm).
Other financial regulators include the Office of Thrift Supervision (OTS), the National Credit Union
Administration (NCUA) and the Securities and Exchange Commission. The OTS, like the OCC, was
appointed by the U.S. treasury to aid in regulating thrift institutions. NCUA was assigned the responsibility
of regulating credit unions as neither the OCC nor Fed wanted to. Finally, the Securities and Exchange
Commission takes responsibility in protecting investors and maintaining the integrity of the securities
markets. For more information on financial regulatory agencies please see appendix 1.
In 1927 the McFadden Act was passed by congress thus interstate banking was prohibited. The basis for
this decision was seemingly good as it was done to prevent bankers from “choosing inaccessible office sites
to deter customers from redeeming…circulating banknotes.” Most people at this time had no means of
travel allowing for better service from local banks. This law prevented outside competitors from restricting
banking for those with little travel capability. Many tried to avoid this law by forming “chain banks,”
several different banks owned by the same group of investors (Benefits of Branching Deregulation).
Going along with the McFadden Act, the Bank Holding Company Act also hindered interstate banking.
This bill prevented banks headquartered in one state from acquiring a bank in another state amongst other
things. A provision allowed for this bill to be ignored only if an individual state had laws contradicting it.
When this bill was passed in the 1950’s no state in the U.S. allowed interstate headquartering, making the
final provision irrelevant. It was not for 20 years until states started with legislation against these two bills
(Benefits of Branching Deregulation). More information is available for both of these bills and other
legislation in appendix 2.
Intrastate Banking Regulation
Along with restrictions on interstate banking, individual states had restrictions on intrastate banking.
Restrictions in this area lasted almost as long as interstate banking as only 12 states allowed complete
intrastate branching before 1970. Just as the McFadden Act stated, local and state legislation did not want
banks to be inaccessible, therefore limiting their branching ability. There was also fear that one bank
would gain too much power if allowed to expand across the state. Complete intrastate branching would
have made it possible for monopolistic power within an area as there was no competition coming from
other states (Benefits of Branching Deregulation).
Many other pieces of legislation existed in the past that limited U.S. financial institutions. The Glass-
Steagal Act of 1933 had major effects as it separated commercial banking from investment banking. This
was done as a direct result of the Stock Market crash of 1929. The enormous crash ruined the U.S.
economy and caused millions of people to go bankrupt. The ramifications of this bill are still felt as for
years other financial institutions could offer services that the banking industry could not. These investment
areas proved to be extremely profitable, often times more so than typical lending. Bills such as the Federal
Deposit Insurance act in 1950 and other legislation also gave financial regulators more authority (retrieved
1/28, http:www.fdic.gov/regulation/laws/important/index.html). Appendix 2 provides more information on
these regulatory bills and financial specifics on the market crash.
Deregulation of Banking Industry
In 1978 Maine became the first state to allow interstate banking. The law stipulated that other states’ banks
could expand into Maine, but only if that state allowed Maine banks to expand there. No other state
allowed interstate banking so this law was irrelevant, but not insignificant. Maine’s new law marked the
beginning of interstate deregulation and other states quickly followed. In fact, over the next 14 years all
but three states had deregulated and allowed interstate banking. Hawaii was the only state to not allow
interstate banking until the Riegle-Neal Act. This law, passed in 1997, allowed interstate banking in all 50
states. Bank Holding Companies could now expand or purchase banks in any state that they chose (The
Benefits of Branching Deregulation).
The Office of the Comptroller also aided bank deregulation by finding a clause in a bill over 100 years old.
In the National Bank Act the OCC found a provision allowing nationally chartered banks to branch freely.
The provision only allowed for branching in states were thrifts, financial institutions that hold deposits, did
not face branching restrictions. In the past this was irrelevant because of state laws, but in the early 1980’s
it had major impacts. The majority of expansion was seen in southern states where the National Bank Act’s
provision abided by several states legislation (The Benefits of Branching Deregulation).
The fifteen-year period from 1978 until 1993 was also one of intrastate deregulation. All states but Iowa
eliminated intrastate branching restriction in this period. Iowa, similarly to Hawaii, did not change this
until forced to under the Riegle-Neal Act. Intrastate branching was allowed first by merger and acquisition.
Later it was allowed by any means that a state branch chose (The Benefits of Branching Deregulation).
The Gramm-Leach Bliley Act of 1999 is the latest piece of banking deregulation. It repealed any
remaining provision of the Glass-Steagall act. Specifically, it allowed affiliations between banks and
insurance, and how this is regulated. The power of regulating this new combination was left to state
legislatures, but the new laws must be on an equal basis as those for normal insurance companies. The act
also allows financial holding companies to engage in merchant banking, investment banking, and for
national banks to underwrite municipal bonds. Cities, states or governments offer municipal bonds to
finance special operations or projects. Interest collected on these bonds is often tax-free (retrieved 1/28,
Reasons for Deregulation
There were several factors that led to legislatures removing banking regulations. One major reason was
that small, geographically restricted banks were doing poorly. These banks destabilized the banking
system by creating small, poorly diversified banks. The restrictions on these small banks also lead to more
vulnerability to bank runs and portfolio shocks. Bank runs occur when people feel that their bank
investments are poor and the bank may have to go out of business. Large numbers of people then pull their
money out of their savings, and the bank runs out of money to give to their customers. Banks keep only a
small percentage of their money in reserve and are in serious trouble when bank runs occur (The Benefits of
Increased awareness amongst customers of successful large banks were having also led to deregulation. In
the 1980’s there was a rash of bank and thrift failures amongst small banks. Larger banks did not
experience this as much and the public became increasingly aware of it. Customers began to desire
competition amongst banks so that they could have access to the best banking practices. Larger banks
often had lower funding cost and better lending opportunities than these smaller banks. Also, money
market mutual funds became available at larger banks. These very short securities often led to strong
returns and high demand. Customers desired the best possible services and the opportunity to make more
money inspired larger banks. Both of these desires led to increased pressure from consumers and large
banks alike, to end restrictions (Benefits of Bank Deregulation).
Finally, technology had a big impact on deregulation. In the late 1970’s the automated teller machine
(ATM) was invented and widespread in states. It was then possible to have ATM’s in areas outside
branching restrictions lessening the demand for actual banking tellers. Regulations became somewhat
obsolete as customers could access their bank from an ATM without violating branching restrictions
(Benefits of Bank Deregulation).
Effects of Banking Deregulation
The monopolistic environment that legislators feared when regulating the banking industry, actually
developed somewhat because of the restrictions. A national monopoly was not possible because of
expansion regulations, but these same restrictions allowed for local monopolies. Small banks were offered
little competition when heavily regulated and they felt little need for improvement because of it. When
deregulation occurred the first thing it did was weed out poor banks. As better banks could expand they
replaced ineffective ones and the bank industry’s evolution was allowed to move forward. Since
deregulation larger banks have been consistently able to have lower costs and offer higher lending rates
than smaller competition. This has led to a great deal of mergers and increased market share for large
financial institutions (The Benefits of Branching Deregulation). For more information on market share of
these and other financial industries please see appendix 3.
Compensation Has Increased Within Industry
Since major deregulation the compensation for banking managers and CEO’s has increased dramatically.
Before deregulation there was very little competition amongst banks and employees within those banks.
After deregulation this has changed and managers must now run their bank as efficiently as possible in
order to survive. The competition has increased by incredible amounts and those unable to adjust have
been left behind. However, those left in the industry have seen substantial pay increases.
Turnover has also increased amongst managers and CEO’s. The increased competition again causes for
higher demand for great management and chief executives. Those performing well are highly sought and
those not are moved out quickly (The Benefits of Branching Deregulation).
Deregulation Has Helped Individuals and States
After examining the effects of deregulation, statistical evidence shows that deregulation has helped
individuals and state economies. The increased competition has brought about more options for high
returning investments available to customers. Banks have also spent more time on the quality of their
investments because they are pressed by competition. This allows banks to provide better advice on
personal and company investments. All of this has lead to increased annual personal income since
deregulation occurred. Statistically significant evidence has also been found to show economic growth
nationally since deregulation (The Benefits of Bank Deregulation). More in-depth statistical information is
available in appendix 4.
National Monopoly Fears Have Been Lessened
After deregulation many in the U.S. feared that one or a few financial institutions would gain monopolistic
market power. This fear has been lessened by the competition that remains in the financial industry. If a
monopoly occurred we would see an increased concentration of a few companies and higher prices for
financial services, neither of which has occurred. Although some states have shown that profitability has
not decreased as much as cost this by no means classifies a monopoly. There is still incredible competition
amongst traditional firms and deregulation has made other financial institutions, competitors for customer
investments (The Benefits of Branching Deregulation). More information is available in appendix 5.
Global Deregulation Is Also Occurring
As the United States banking industry has become deregulated other countries are beginning to open up
their financial institutions as well. Singapore, for example, has uplifted their 40 percent cap on foreign
ownership of their local banks. Also, China has announced a plan to fully open up their enormous banking
industry to foreign competition in the next five years. All of this will lead to increased competition and a
difficult future for all financial institutions in the U.S (OhioLink Articles).
Globalization in the banking industry is a concept that wouldn't have seemed feasible even 15 years ago.
This was because of social factors as well as technology that didn't exist until now. Banks in recent years
have expanded their services and the markets they compete in. None of this would be possible if it wasn’t
for new technology that has become so common in the past decade. This includes the era of e-commerce
with banks moving quickly to offer all of their services online as well as banks that exist only online. With
the passage of the Financial Services Act of 1999 the industry will change in the next few years in drastic
Financial Services Act of 1999
The Financial Services Act of 1999 has far-reaching and major implications towards the movement of
globalization in the banking industry. This bill first and foremost allows mergers between different
sections of the industry that were previously not allowed (Mann, retrieved on 2/1/00). This allowed for
instance insurance companies to merge with banks. The Glass-Seagle act had prohibited banks from
entering securities market. This was because the nation in general feared banks from becoming too
powerful. They were afraid banks would win friends in politics and work against the good of the public.
Back in the 30's banks held an estimated 60% of U.S. financial assets, as opposed to today where they hold
less than 25% (Global Market Trends, 1/29/00). More information is available in appendix 6.
These regulations also hindered American companies in this day and age where billions of dollars travel
around the world electronically every day. The Financial Service Act of 1999 will allow banking to make
up for the past 60 years of tight regulation. Banks are expanding and moving into new markets each trying
to grab their piece of the pie. This has led to some banks to make the first step internationally through
foreign subsidiaries and joint venture companies.
Foreign Subsidiaries/Joint Ventures
Foreign subsidiaries are a popular method of expansion. A subsidiary is a foreign company owned by a
U.S. company but is still individually funded (retrieved 2/1/00, http://www.encyclopedia.com). A few
advantages to this are ability to get around foreign and U.S. tax laws and limited liability. Joint venture
companies are increasingly occurring as other countries allow increased foreign investment. U.S.
companies are jumping at this opportunity and buying stock in foreign financial service companies. U.S.
and foreign treaties are also aiding the movement of banking expansion into international markets (Global
Market Trends, 2/1/00).
World Trade Organization
The WTO was established in 1995, which was commonly said to succeed the General Agreement on
Tariffs and Trade (GATT). Actually, the WTO is much more than that because it is an organization, while
GATT was a mere agreement between nations. On December 12, 1997, the WTO completed an agreement
on trade in financial services. This agreement states that the member countries of the WTO pledged to
open up their financial service industries to more foreign competition. This agreement puts financial
services under WTO open trade rules, which means that countries that break their open market
commitments can face sanctions and/or retaliation. There have been seventy countries that have made
market opening commitments. With these combined commitments, more than an estimated 95% of the
world’s financial services activity is intertwined (retrieved 1/30, http://www.wto.org). This agreement will
provide great pressure for countries to eliminate or relax current restrictions on commercial presence of
foreign financial service suppliers.
The Euro is one of the most amazing accomplishments and examples of the international trend of banking.
The Euro arose from a group called the European Union. The Euro is the new currency of eleven European
nations. This has created more free trade agreements and financial integration in Europe. Today the
European Union represents over 380 million people and combines the economies of 15 countries (Noyer,
retrieved on 1/31/00). This Union accounts for almost 20% of the world G.D.P., which is very close to the
G.D.P. of the United States (Noyer, retrieved 1/31). The Euro is already the second most used currency in
the world behind the dollar. In 2002 the currencies of these eleven countries will be completely replaced
by the Euro and the change will be complete (Noyer, retrieved 1/31). This agreement will open up the
global financial services industry. Tapping into this new collective economy will be a major focus for U.S.
Foreign Banking in the United States
Foreign banking institutions already play an important part in the banking system in the United States. In
1996 foreign banking institutions held over $994 billion in assets, approximately 25% of the total
commercial banking assets in the United States (retrieved 1/29, http://nyfrb.org/pihome/fedpoint/fed
26.html). Banks in Europe and other parts of the world are also experiencing consolidation and growth in
their banking industries. Traditionally Japan has led the expansion into the U.S. but as of late this has
subsided do to the major Japanese recession. European countries now hold institutions that are the major
foreign competitors in the U.S. for financial services.
There are many alternatives to the financial services industry besides putting your money in a bank and
waiting for it to earn interest. One can put their money into other institutions that can provide a higher
return for your investment. There are also better ways that one can borrow money outside the scope of
conventional banking institutions. Some of these options are through brokerage and investment firms,
insurance companies or the credit union. These options are the ones we feel are most important in financial
services and we will be explaining them in this next section of our paper.
Brokerage and Investment Firms
The areas of investment and brokerage have become increasingly popular amongst consumers. During the
economies Bull Run since 1991 it has been more profitable to invest in the stock market than any other
financial area. The securities and brokerage market has become direct competition for traditional banks.
Firms such as Merrill Lynch and E-trade are not only major competition for all invested money, but also
are becoming competitive in traditional banking. E-trade has stated goals of becoming the complete online
bank, controlling all money held in deposits. Merrill Lynch has also announced this past week that they
will offer traditional banking features.
Banks and other competitors are striving to be a new superbank such as Citigroup has become. Citicorp,
who merged with Travelers Group, is currently leading the field in the consolidation of banking and
investments. Their goal is the same as other competitors, to become “one stop shopping” for financial
services. Competition in investments and traditional banking will continue to overlap into the future.
Since the 1960’s credit cards have been used as a method of deferred payment. Over these three decades
the industry has grown and become increasingly competitive. The charges for processing transactions and
high interest rates have made the industry incredibly profitable. Currently, banks and other financial
institutions are fighting for customers to use their credit cards. Companies such as Visa have formed
alliances with several banks to create credit and banking options. These banks and other credit companies
are now competing for not only standard credit use, but for online transactions as well.
American Express has developed a new card called “American Express Blue” which provides an online
“wallet”. This wallet allows customers to deposit money for use in online transactions. This new card and
wallet system offers 100 percent online fraud protection. Other financial service companies are attempting
to form their own version of this card in order to keep up with the lucrative online credit card enterprise.
Insurance today has become a way to preserve financial stability. It has become a safeguard against
accidents and a form of compensation for victims of different forms of misfortunes. Insurance’s impact on
the economy today is quite significant. With banks now being allowed to offer insurance to their
customers, the thousands of insurance companies are making concessions to compete. Insurance rates have
become increasingly competitive and several pieces of legislation have been passed to keep it that way.
Banks and insurance companies must follow the same guidelines in offering insurance packages.
There are many major competitors in the insurance industry today including foreign competitors. Using
assets as the method of measuring, Prudential is the leading life and health insurance company in the U.S.
today with Metropolitan coming in second. In the field of property/casualty insurance, State Farm Mutual
Automobile is in first place and The Allstate Corporation and Travelers Property is in second (retrieved on
1/30/99, http://www.hoover.com). Today, the U.S. insurance industry is still going strong, but the Japanese
is quickly becoming number one in the market. For more information on insurance companies see the
If one is in need of a loan and cannot afford bank interest rates, one can choose to join a credit union.
Credit unions can offer lower interest rates on loans then other financial institutions. People of the same
occupation or community join credit unions to borrow against each other. Each credit union has its own
regulations as to who can become a member. The money that is available for loan to members comes from
deposits the each member makes through sale of shares. There are more then 12,500 credit unions
throughout the U.S. today (retrieved on 2/1/00, http://www.ncua.gov/about/what.html).
For more information on insurance, investment and other firms please see appendix 3
Introduction to Technology
The Banking industry has been greatly influenced by technology in the past decade. The Internet,
specifically e-commerce has had both positive and negative effects on the industries.
The goal of e-commerce is to try and use technology to move the customer from a high cost channel to a
lower one, thus saving the bank a large amount of revenue. In the past decade transactions within branches
have not decreased a significant amount, although the number of U.S. banks have. This decrease in the
number of banks also comes, however, with an increase in the number of branches, ATM’s and call centers.
This illustrates location and availability of the branch still remains significant to the customer when
selecting a new bank.
Banks that use electric commerce must realize that they still need to address the problem of personalized
banking. Many banks are establishing relationships with firms such as Broadvision or Vignette for the soul
purpose of keeping up relations with customers. Using this new technology to customize their web sites to
customer needs will be essential for financial service companies to succeed in e-commerce.
Many banks are also developing partnerships with organizations that offer both financial and non-financial
products. A great example of this technique is the Microsoft Home Network, which advertises for bank
mortgages and moving services at the same site.
ATM conversion with the Internet
Another huge aspect of e-commerce is the possibility of ATM’s converging with the Internet. Many banks
are attempting to complement online banking through bringing the “real-time payments systems (ATM’s)
together with the real-time communications system (Internet)” (Lawlor, retrieved 1/27). In order to
complete this process three set goals are currently being striven for.
The first goal of corporations must be to develop some way of knowing that the customer requesting the
transaction is in fact who they say they are. This can be accomplished through smart cards that will use
encryption and a private security key. This will allow the computer system to distinguish between the
customer and a potential hacker.
Secondly, networks have to expand their transaction-processing pipe. Banks that are online should offer
more options to the customer when dealing with their accounts than a typical ATM. They also need to
enable the customer to work with larger amounts of their personal money. Currently, most ATM’s have
limits on daily transactions to protect security. This could be updated through security online. Companies
such as Concord’s MAC ATM are attempting to upgrade these and other problems with an ATM and
Finally, these networks should attempt to use this technology for credits as well as debits. Crediting
accounts on issues such as loans and stock sales over the Net can carry great potential. Many say that this
is the “final and defining step in the electronic bill presentment and payment industry” (Lawlor, retrieved
Banking and Brokerage Employment Problems
Today many MBA graduates are leaving the banking industry to venture into the enormous world of the
Internet. Many graduates are taking pay cuts and working longer hours for a large pay-off in the future.
Each of these graduates realizes the reality of their company soaring highly above average in a few years
time. This rush to the technology field has many in investment firms worried about the future. These
financial firms are attempting to make themselves more appealing to the eyes of the MBA students. Some
banking industry experts are calling this a fluke, and others are calling it the “new economy.” Whatever it
is called, this epidemic has helped the financial firms realize that sitting back and waiting for the “head of
the class” to come knocking may not be effective anymore.
Another fear for brokerage firms and banks is over job security in this industry. As more people move
accounts online, financial advisors and tellers become more obsolete. The industry is afraid that jobs in
these areas will no longer exist as customers can get similar advice online. Significant information on job
trends in this area is not yet available, as online banking/brokerage is fairly new.
As the U.S. economy has continued to grow over the last ten years, the speculation of the Federal Reserve
raising its interest rates has risen. The Fed has been attempting to prevent the economy from sweltering
since raising interest rates in August has hardly slowed down the economy (Wolk, retrieved 1/31). In
November they raised the rates once again and since then investors have been awaiting the next move.
With new reports showing short-term interest rates higher many believe that the Fed will have to tighten
credit (Wolk, retrieved 1/31). Although this is all speculation, the symptoms are showing a significant lean
towards the Fed to act in such a fashion. Regardless of the outcome the market will probably remain
unstable for weeks if not months into this year.
The primary worry in this matter is that if the Federal Reserve does decide to tighten credit, a large amount
of currency will be taken out of equities and placed into bonds. The rising interest makes bonds seem more
attractive to the investors. This could ultimately send the economy into recession and that is what the
The banking industry could be greatly affected by a recession in the economy. While in recession the
economy would become stagnate, thus causing consumers to panic and withdraw their investments from
these financial corporations. Inevitably this recession could damage the stable platform in which the
industry currently resides on.
More information on interest rates from 1991 until today are available in appendix 7.
Future Expectations of Financial Industry
Today and in the future, banks will be referred to as financial service companies. Deregulation has allowed
for banks to merge with other institutions and has erased the borders that kept them apart. All these
financial institutions will compete in the many different areas that have been discussed in this paper.
Typical savings and loan companies have already become obsolete and movement into other financial areas
is necessary. Banks will continue the trend set by CitiGroup, Merrill Lynch and others to become “one
stop” financial shopping.
Technology will also be a major emphasis amongst financial service companies as it provides a new outlet
to consumers all across the globe. How effective the Internet will be remains to be seen, but it is already
causing major changes. Those corporations that can make e-commerce succeed will be successful and
those that cannot will face major obstacles. The credit card industry alone will provide billions of dollars
in income through the Internet for financial companies and the competition in this area will again be fierce.
The financial industry has been reborn and companies will be forced to react through merger and
expansion. In the almost 25 years of major deregulation the number of financial institutions has decreased
by half and more of this can be expected in the future. There are over 8,000 banks today and no one knows
how long this number will last.
In this industry analysis, the past, present and future of the banking industry has been outlined. As we
approach the 225th anniversary of our country, our nations financial industry has never seen a time such as
this. The U.S. and other economies are growing and technology has changed how business is conducted.
The opportunities for this industry are amazing and the progress that will hopefully be made should
invigorate our country and others during this new millennium.