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The Fate of the Banking Industry

Top of the Ninth

September 1, 1993


The Fate of the Banking Industry

Earlier this year, we published an essay titled "Banking's Middle Ground: Balancing Excessive Regulation and Taxpayer Risk." Several points were made in that essay: We cautioned against relying excessively on regulation and supervision to maintain a safe and sound banking system; we advocated enhanced market discipline of banks; and we urged continued attention to antitrust issues as consolidation proceeds in banking. The bottom line, as suggested by the title, was that there were a number of legitimate objectives that must be balanced in formulating banking policy if the public were to be well served in the years ahead.

Throughout the year, we repeatedly have heard calls for action to help banks. Allegedly, banks are overregulated and cannot compete effectively with other providers of financial services. Proponents of deregulation typically advocate removal of or relief from interstate expansion restrictions, expansion of the range of activities in which banks may engage, and relief from capital regulation and from Community Reinvestment Act requirements.

Individually or collectively, these calls for action may have considerable merit, but in our judgment they should not be implemented solely because of concerns about the fate of the banking industry. The welfare of the banking industry per se should not be an objective of public policy. Imagine how the development of the automobile and airline industries would have been retarded had we been willing to devote substantial resources to protecting and preserving the railroads. And would the public interest have been well served by such a policy?

In this spirit, the following letter, provided by a colleague here at the bank, is instructive.

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To: President Andrew Jackson*

The canal system of this country is being threatened by the spread of a new form of transportation known as "railroads." The federal government must preserve the canals for the following reasons:

  • One. If canal boats are supplanted by "railroads" serious unemployment will result. Captains, cooks, drivers, hostlers, repairmen and lock tenders will be left without means of livelihood, not to mention the numerous farmers now employed in growing hay for horses.

  • Two. Boat builders would suffer and tow-line, whip and harness makers would be left destitute.

  • Three. Canal boats are absolutely essential to the defence [sic] of the United States. In the event of the expected trouble with England, the Erie Canal would be the only means by which we could ever move the supplies so vital to waging modern war.

For the above-mentioned reasons the government should create an Interstate Commerce Commission to protect the American people from the evils of "railroads" and to preserve the canals for posterity.

As you may well know, Mr. President, "railroad" carriages are pulled at the enormous speed of 15 miles per hour by "engines" which, in addition to endangering life and limb of passengers, roar and snort their way through the countryside, setting fire to crops, scaring the livestock and frightening women and children. The Almighty certainly never intended that people should travel at such breakneck speed.

Martin Van Buren
Governor of New York
January 31, 1829

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Let me be clear. We are not comparing banks to the canals of the 1820s. But, as argued in our earlier essay, it is far more appropriate to ask if customers, broadly defined, of financial services firms would be significantly better off were various restrictions to be lifted from banks than to focus on the benefit of such action to banks. Unfortunately, it is not easy to gauge the effects on customers. To be sure, it is virtually certain that bank customers will gain as a result of deregulation, since under the current regime bankers are precluded by regulation from taking advantage of some opportunities, and thereby of meeting some consumer demand. But the quantitative significance of remaining restrictions may be small. After all, customers already have a wide range of options when seeking financial services, and the fact that bankers feel they are at a competitive disadvantage implies that many non-bank providers have been successful.

The magnitude of these gains to customers is a critical issue. If the gains are sizable, then the case for deregulation is necessarily strengthened because these gains may compare favorably to the taxpayers' costs of potential increases in bank risk-taking. If, on the other hand, they are negligible, then all that remains is just another of the perennial examples of an industry that pleads its case on marginal merit.

*Editor's note: A reference is made in this column to a letter allegedly penned by Martin Van Buren to President Andrew Jackson. It was critical of railroad growth. We later learned that others, like us, had attributed such a letter to Van Buren, but that biographical experts have never found the letter and suspect that it may not exist.