A Look at Banking Deregulation and its Effects on the U.S. Macroeconomy Kyle Myers June 17, 2004.

A Look at Banking A Look at Banking Deregulation and its Deregulation and its Effects on the U.S. Effects on the U.S.

MacroeconomyMacroeconomyKyle MyersKyle Myers

June 17, 2004June 17, 2004

ObjectivesObjectives Provide samples of common arguments Provide samples of common arguments

for and against Deregulationfor and against Deregulation Examine literature on Deregulation as it Examine literature on Deregulation as it

pertains to effect on the macroeconomy pertains to effect on the macroeconomy Attempt to quantify the relationship Attempt to quantify the relationship

between deregulation and the economybetween deregulation and the economy Weigh arguments for and against Weigh arguments for and against

regulationregulation Propose final recommendationsPropose final recommendations

Arguments Against Arguments Against DeregulationDeregulation

Smaller banks are more profitable Smaller banks are more profitable and efficientand efficient

Small business loans will declineSmall business loans will decline ““Too Big to Fail” StatusToo Big to Fail” Status

Arguments For Arguments For DeregulationDeregulation

Economies of ScaleEconomies of Scale Global CompetitionGlobal Competition Increased Diversification Increased Diversification Increases CompetitionIncreases Competition

Literature ReviewLiterature Review

Boyd & Graham (1991) – “Investigating the Boyd & Graham (1991) – “Investigating the Banking Consolidation Trend”Banking Consolidation Trend”

Offer arguments against economies of scale Offer arguments against economies of scale reasoning for consolidationreasoning for consolidation

Point out data that shows economies of scale reached Point out data that shows economies of scale reached when a banks total deposits equal $100 millionwhen a banks total deposits equal $100 million

3,000 banks in 1988 had deposits in that range3,000 banks in 1988 had deposits in that range Provide data showing that from 1972 to 1990 larger Provide data showing that from 1972 to 1990 larger

banks have:banks have:o Lower ROA (net income as a % of total assets)Lower ROA (net income as a % of total assets)o Lower ROE (net income as a % of equity capital)Lower ROE (net income as a % of equity capital)o Less Financial leverage (equity capital as a % of total assets)Less Financial leverage (equity capital as a % of total assets)……than smaller banks than smaller banks


Famulla (1999) – “Insights Into Accenture’s Famulla (1999) – “Insights Into Accenture’s Financial Services Consumer Index”Financial Services Consumer Index”

Contains data from 1995-98 showing measures of Contains data from 1995-98 showing measures of revenue and profit for different bank sizesrevenue and profit for different bank sizes

Shows that medium sized banks bring in more Shows that medium sized banks bring in more revenue per customer and earn larger profits per revenue per customer and earn larger profits per customer than larger banks.customer than larger banks.

Bank Size DefinitionsBank Size Definitions Super large banks (more than $80 billion in assets)Super large banks (more than $80 billion in assets) Large banks ($35 - $80 billion in assets) Large banks ($35 - $80 billion in assets) Medium banks ($10 - $35 billion in assets)Medium banks ($10 - $35 billion in assets) Small banks (less than $10 billion in assets)Small banks (less than $10 billion in assets)


Kwan (1997) – “Efficiency of U.S. Kwan (1997) – “Efficiency of U.S. Banking Systems”Banking Systems”

Contends that optimal size of large banks is Contends that optimal size of large banks is well below that of today's megabanks.well below that of today's megabanks.

Points out that “…that finding may be Points out that “…that finding may be obsolete given the dynamics of the banking obsolete given the dynamics of the banking industry. With significant regulatory changes, industry. With significant regulatory changes, rapid technological breakthroughs, and rapid technological breakthroughs, and constant product innovations, the right size constant product innovations, the right size for yesterday's environment may no longer for yesterday's environment may no longer be optimal today, much less for the future.”be optimal today, much less for the future.”


Evanoff and Örs (2002) – “Local Market Evanoff and Örs (2002) – “Local Market Consolidation and Bank Productive Consolidation and Bank Productive Efficiency”Efficiency”

Performed study that measures bank Performed study that measures bank efficiency before and after a merger efficiency before and after a merger takes place in a certain region.takes place in a certain region.

Finding was that efficiency increases Finding was that efficiency increases though not necessarily at the bank though not necessarily at the bank that was acquired.that was acquired.


Horwitz and Selgin (1987) Horwitz and Selgin (1987) – – “Interstate Banking: The Reform “Interstate Banking: The Reform That Won’t Go Away”That Won’t Go Away”

Predict that interstate mergers will Predict that interstate mergers will lead to diversification, inter-bank lead to diversification, inter-bank funds movement, and reduced bank funds movement, and reduced bank failures.failures.


Strahan (2002) Strahan (2002) – – “The Real Effects of “The Real Effects of U.S. Banking Deregulation”U.S. Banking Deregulation”

Attempts to tie the economic effects of Attempts to tie the economic effects of deregulation into the macroeconomy by deregulation into the macroeconomy by measuring state growth , entrepreneurial measuring state growth , entrepreneurial activity, and business cycle stability.activity, and business cycle stability.

Found positive effect on state growth rates Found positive effect on state growth rates and entrepreneurial activityand entrepreneurial activityo Growth rates went up .5%-1.0% from 1980-1992Growth rates went up .5%-1.0% from 1980-1992o Increase in corporation formation per capita of Increase in corporation formation per capita of

9.8% over same period9.8% over same period


Demirgüç-Kunt, Laeven, and Levine (2003) Demirgüç-Kunt, Laeven, and Levine (2003) “The Impact of Bank Regulations, “The Impact of Bank Regulations, Concentration, and Institutions on Bank Concentration, and Institutions on Bank Margins”Margins”

Review impact of deregulation on global Review impact of deregulation on global scalescale

Findings are that banking regulations Findings are that banking regulations effect bank incomes across globeeffect bank incomes across globe

Authors used net income as measure of Authors used net income as measure of bank success which is what I used in my bank success which is what I used in my statistical analysisstatistical analysis


Burger and Humphrey (1997) Burger and Humphrey (1997) ““Efficiency Efficiency of Financial Institutions: International of Financial Institutions: International Survey and Directions for Future Survey and Directions for Future Research Research ””

Found no significant cost savings, on Found no significant cost savings, on average, attributed to mergersaverage, attributed to mergers

Submit that when banks do become Submit that when banks do become more profitable after mergers it may be more profitable after mergers it may be due to product mix, as opposed to cost due to product mix, as opposed to cost efficienciesefficiencies


Yi-kan, Mason, and Higgins (2001) Yi-kan, Mason, and Higgins (2001) ““Does Does Bank Efficiency Change With the Bank Efficiency Change With the Business Cycle Business Cycle ””

Also support Gilbert’s (1997) arguments Also support Gilbert’s (1997) arguments that the entry of large banks into a local that the entry of large banks into a local area, positively effect those area bank’s area, positively effect those area bank’s efficiency; in other words competition is efficiency; in other words competition is good for efficiency.good for efficiency.

Find that the macroeconomy does have Find that the macroeconomy does have an effect on banking efficiency an effect on banking efficiency

CausalityCausality

In the early Twentieth Century, Joseph In the early Twentieth Century, Joseph Schumpeter argued that efficient financial Schumpeter argued that efficient financial systems promote innovations; hence, better systems promote innovations; hence, better finance leads to faster growth. finance leads to faster growth.

Joan Robinson (1952) believed that the Joan Robinson (1952) believed that the causality was reversed; economies with good causality was reversed; economies with good growth prospects develop institutions to growth prospects develop institutions to provide the funds necessary to support those provide the funds necessary to support those good prospects. good prospects.

In other words, the economy leads and In other words, the economy leads and finance follows. finance follows.

Tie To MacroeconomyTie To Macroeconomy

Did rate of GDP change after Did rate of GDP change after Deregulation?Deregulation?

Is there a relationship between GDP Is there a relationship between GDP and bank net income?and bank net income?

MethodologyMethodology

StrategyStrategyI.I. Establish way to measure Establish way to measure

relationship between banking relationship between banking industry profitibility and industry profitibility and MacroeconomyMacroeconomy

II.II. Use net income and GDP respectively Use net income and GDP respectively as a proxy for those relationshipsas a proxy for those relationships

III.III. Comparative analysis; regulation vs Comparative analysis; regulation vs deregulation eraderegulation era

FindingsFindings

High Correlation (.9478) between High Correlation (.9478) between Bank Net Income and GDPBank Net Income and GDP

Implies that there is a positive Implies that there is a positive relationship with respect to movement relationship with respect to movement between GDP and Bank Net Incomebetween GDP and Bank Net Income

Statistically Significant Difference Statistically Significant Difference between pre and post Deregulation between pre and post Deregulation Bank Average IncomeBank Average Income

Correlation ChartCorrelation Chart

Correlation Chart: Inflation Adjusted Bank Income vs GDP

-200

0

200

400

600

800

1000

1934

1941

1948

1955

1962

1969

1976

1983

1990

1997

Bank Income in billions

GDP Adjusted to 1934$

’87 Market crash

LimitsLimits

Limited by data on commercial Limited by data on commercial banks insured by FDIC only…may banks insured by FDIC only…may not be representative on entire not be representative on entire banking industrybanking industry

May be other factors effecting bank May be other factors effecting bank profitability that have nothing to do profitability that have nothing to do with Deregulation effortswith Deregulation efforts

ConclusionConclusion

Deregulation is good for the Deregulation is good for the economy, at least in the short runeconomy, at least in the short run

My Opinion:My Opinion: Many bank regulations Many bank regulations that were in effect protected private that were in effect protected private interest, not publicinterest, not public

RecommendationsRecommendations

Maintain current regulatory acts Maintain current regulatory acts regarding bankingregarding banking

Address “Too Big To Fail” concern Address “Too Big To Fail” concern through antitrust that is applicable through antitrust that is applicable to all industriesto all industries

Questions?Questions?

A Look at Banking Deregulation and its Effects on the U.S. Macroeconomy Kyle Myers June 17, 2004.

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