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While always in a state of flux, the nation's banking system is now undergoing what is arguably the greatest transformation since the Great Depression. This change has taken three forms. First, banks have merged at an unprecedented pace during the last ten years. Second, banks and other financial companies have begun to offer their services over the Internet. And third, new legislation has opened up the doors to combining banking with other financial services.
Consolidation
While mergers have been going on for a long time, the pace increased significantly in the 1990s (see chart above). Some mergers took advantage of new laws allowing banks to expand within and across state lines. Other mergers were undertaken to cut costs, although the evidence suggests they failed to achieve that goal more often than not (Berger). Finally, some mergers probably occurred because the participants were afraid of being left behind in what seemed to be the wave of the future.
Merger activity has subsided more recently, and some experts believe the decline is more than just a temporary pause. Some large banking companies have already achieved nationwide coverage, reducing their incentive to acquire more banks. Furthermore, to the extent Internet banking catches on, banking organizations keen on expanding may not have to depend on mergers to get bigger. Finally, some experts argue that acquisitions of small banks will not rebound because the mid-size companies that accounted for most of the small bank acquisitions in the 1980s and 1990s have largely disappeared from the scene. Even if merger activity does not return to previous levels, however, the large number of mergers that have already occurred have changed the banking system in important ways.
One important effect of the recent merger wave has been an increase in the role of large banking organizations (see chart above). The biggest change has been in the importance of so-called megabanks, those that hold more than $100 billion of assets. At the end of 1999, there were eight of these giant companies. Together they accounted for over 30 percent of domestic bank deposits, four times as much as at the beginning of the decade. As the chart shows, most of that gain in deposit share has come at the expense of regional and super-regional banking organizations, those in the $ 10-100 billion range.
Another effect of the mergers has been a sharp increase in multi-state banking. Many of the mergers during the 1990s were between banking organizations operating in different states. Since 1993, in fact, these mergers have accounted for just over half of all deposits acquired in mergers. As a result, there has been a big shift in ownership of deposits from organizations based in the same market or the same state to organizations based in another state (see chart above). At the beginning of the decade, 20 percent of deposits were controlled by out-of-state banking organizations. By the end of the decade, that figure had surpassed 40 percent.
Internet banking
Another way banking is being transformed is through the growth of Internet banking. Whereas mergers have been going on for some time and may even have peaked, this change is just getting under way. At the end of 1999, about 3,500 banks and thrifts had web sites, representing a third of all banks and thrifts (see chart above). Of these institutions, however, only 1,100 had what are called transactional web sites. These are web sites through which customers can conduct business on-line-for example, verify account information, transfer funds, pay bills, or apply for loans. While the number of banks with transactional web sites is still small, it has grown rapidly over the last two years-a trend most experts expect to continue.
So far, large banks have made a much bigger commitment to online banking than small banks. Among national banks, for example, only 7 percent of banks under $100 million have transactional web sites, while all banks over $10 billion have them. Large banks also tend to offer a much wider array of services on their web sites than small banks. Among banks with transactional web sites, for example, a much higher percentage of large banks offer brokerage, fiduciary, and insurance services in addition to balance inquiry and funds transfer (Furst and others 2000, Sullivan). Some analysts argue that large banks will retain their lead over small banks due to large fixed costs of developing information management systems and creating brand recognition among consumers. Others argue that small banks are merely being cautious and will catch up with large banks by outsourcing their information management.
Banks have not been the only financial companies to offer their services through the Internet. In recent years, online brokerage companies have enjoyed rapid growth by allowing investors to buy and sell individual stocks on the Internet. Most of these companies also allow their online customers to shift funds among a wide variety of investment vehicles, including stock funds, bond funds, and money market mutual funds. Some nonbank financial companies have also begun offering mortgage credit over the Internet, although this service is still not nearly as popular as online brokerage.
Financial integration
The final often-cited change in the banking system is the least certain-the spread of diversified financial firms offering a wide array of services, such as insurance and securities underwriting in addition to traditional banking. Some movement in this direction occurred in the 1990s, as banks took advantage of loopholes in the laws restricting what they could do. But the trend toward financial integration could well accelerate due to legislation passed recently rolling back many of the restrictions. This law, the Gramm-Leach-Bliley Act of 1999 (GLBA), made two major changes. First, it allowed bank holding companies to merge with insurance and securities companies and cross-sell their products. Second, it allowed bank holding companies that did not merge with other firms to offer new financial services on their own-for example, underwriting securities, selling or underwriting insurance, and making equity investments in business firms.
During the first year of GLBA, the progress toward financial integration by large banking organizations was less than many analysts had expected (Atlas, Rehm). To be sure, most large banking organizations have elected to become financial holding companies (FHCs), as required to offer the new financial services. Among banking organizations over $10 billion in size, for example, two-thirds had converted to FHCs by February of this year (see table above). Surprisingly, however, these large banking organizations have used their new status to reorganize and simplify the nonbank activities they were already pursuing under various loopholes in the old law, rather than to acquire other financial companies. In particular, only a few large banking companies have acquired securities firms, and none have acquired large insurance companies. Indeed, among U.S.-based firms, the only large cross-industry merger has been between Citicorp and Travelers, which was agreed upon a year before GLBA in the hope that Congress would subsequently permit such combinations.
Despite this slow response, GLBA could still end up substantially broadening the array of financial services offered by large banking organizations. First, a number of special factors may have contributed to the lack of cross-industry mergers in the first year after enactment of the law, including the decline in bank stock prices during much of 2000 and the preoccupation of many banking organizations with the quality of their loan portfolios. Second, large banking organizations may have felt they could take their time shopping for merger partners in other industries because they were already pursuing the new activities in limited form due to loopholes in the old law (Meyer 2001).
While most of the attention has focused on large organizations, GLBA could also end up broadening the array of services offered by smaller banks. While lacking sufficient scale to underwrite securities and insurance, many small banks might want to take advantage of the new authority to sell insurance and purchase equity in smaller businesses. Small banks are already showing some interest in these new powers (see table above). As of mid-February of this year, 381 banking organizations under $1 billion in size had converted to FHCs. These organizations represent only a small fraction of all banking organizations under $1 billion in size. Nevertheless, the response by small banks was greater than many analysts expected and suggests that small banks might eventually exploit the new insurance agency and merchant banking powers in GLBA (Leuchter 2000a, Meyer 2001).
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