I make forecasts of the future of banking with caution. One need only
recall the many eulogies that experts had written for banks during the
early 1990s to justify this humility. Of course, skepticism about the
future of banks did not appear unjustified. Bank failures had increased
to levels not seen since the Great Depression, and oft-cited data revealed
a long-term decline in banks' share of assets held by financial institutions.
But economists with the Federal Reserve Bank of Minneapolis, among others,
found that the death of banking was greatly exaggerated. They concluded
that after correcting for both the mismeasurement of foreign bank loans
and the exclusion of off-balance sheet activities, any evidence of a substantial
decline in commercial banks' share of intermediate assets vanishes.
The record profitability of banks in the Ninth Federal Reserve
District and the nation as a whole over the last several years has
made claims of demise appear even more off base. The valuations
put on banks across the country by the stock market, and as revealed
through acquisition prices, suggest that banks have significant
Nonetheless, I think a reasonable case can be made that the long-term
future of banking is not particularly bright, if we think of banks
as we have traditionally known them. As we observe them today, traditional
institutions are in for a struggle.
There are essentially two reasons for my view of the future of
banking. First, the unique franchise of banking has eroded and will
continue to do so. Changes in technology, together with advances
in the theory of finance, are partially responsible for this. Second,
two important characteristics that set banks apartdirect participation
in the payments system and safety net coveragemay not persist
in their current form.
Changes in technology
Technological progress in the fields of information processing
and asset valuation/risk measurement have brought down the cost
of credit quality evaluation such that capital markets can now finance
an increasing variety of previously illiquid loans. Securitization
of assets, beginning with consumer loans, moving to commercial real
estate, and now creeping to small business loans, has increased
liquidity. New technologies, such as credit scoring, may be an important
factor behind the further spread of securitization. In any event,
it is clear that commercial loans are taking on securitylike attributes.
As a result, demands for credit are being met by a wide, and expanding,
range of institutions engaged in origination and/or portfolio investment.
Similar technological initiatives also allow nonbanks to provide
increasingly close substitutes for bank liabilities. Among other
things, this implies that banks, relying on traditional funding
sources, will have to pay up for such deposits or watch a core funding
Payment systems and the safety net
Most of the new payment instruments and systems one can envision
will still settle with bank balances, but this fact may become less
important over time in terms of what it says about customer services,
relationships and revenue. A software firm, for example, may provide
more of the value-added and take a greater share of the revenue
from new forms of electronic payment than the bank that settles
As for the safety net, as a matter of public policy Congress should
rein in federal insurance of bank deposits and encourage more market
discipline of banks. There are a number of respectable proposals
to reform deposit insurance, including the Federal Reserve Bank
of Minneapolis' proposal that would make banks subject to increased
market forces by requiring uninsured depositors at the nation's
largest banks to bear losses upon failure.
My contacts with community bankers suggest a great reluctance
to support any change to deposit insurance, including our limited
plan, in the belief that modifications will reduce the competitive
position of community banks. While this is not the forum to debate
deposit insurance reform, it is important to understand that our
plan actually levels the playing field for small banks. Banking
law that we want to reform effectively allows 100 percent coverage
of uninsured depositors at the largest banks. In contrast, the FDIC
has increasingly imposed losses on the uninsured at community banks
Wide Range of Options
This perhaps sobering view of the future of banking is positive,
nevertheless, for bank customers. This is because the changing nature
of the financial services industry allows it to meet the demands
of customers, large and small, at competitive terms and conditions.
Moreover, this assessment need not augur poorly for bank employees.
These employees provide valuable servicesevaluation and management
of risk, clearance and settlement of payments, administration of
loans, investment of funds, and so forth. Demand for these skills
and services will persist.
The harder question to answer concerns the organizational form
in which these skills and services will be deployed over the long
run. Certainly, community banks meet a significant demand, and banks
that look very much like the community bank of today will remain.
But it is easy to imagine new breeds of banking institutions. Some
banks may become similar to their nonbank competitors and focus
on the origination and sale of loans. Others may concentrate on
business and financial consulting with specific types of borrowers,
such as farmers, with which they already have credibility. Even
the bank which keeps its traditional form may have to serve a niche
clientele, such as those with lower credit quality or in unusual
and specialized businesses, due to increased competition in and
commoditization of standard banking products.
My view, in short, is that banks as we know them are facing a rough
competitive ride. Technological progress, and the ability of all
sorts of institutions to capitalize on such progress, contributes
to this. Moreover, I question the extent to which the special role
of banks in payments will continue to translate into a special relationship
with customers. The safety net, unquestionably of considerable value
to banking, is in a sense a double-edged sword and, in any event,
is in need of judicious reform. Interesting, perhaps exciting, times