P2 banking and financial market

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It also does not look as though community banks will disappear. When New York

State liberalized branching laws in 1962, there were fears that community banks

upstate would be driven from the market by the big New York City banks. Not only

did this not happen, but some of the big boys found that the small banks were able

to run rings around them in the local markets. Similarly, California, which has had

unrestricted statewide branching for a long time, continues to have a thriving number

of community banks.

Economists see some important benefits of bank consolidation and nationwide

banking. The elimination of geographic restrictions on banking will increase competition

and drive inefficient banks out of business, thus raising the efficiency of the

banking sector. The move to larger banking organizations also means that there will

be some increase in efficiency because they can take advantage of economies of scale

and scope. The increased diversification of banks’ loan portfolios may lower the probability

of a banking crisis in the future. In the 1980s and early 1990s, bank failures

were often concentrated in states with weak economies. For example, after the decline

in oil prices in 1986, all the major commercial banks in Texas, which had been very

profitable, now found themselves in trouble. At that time, banks in New England were

doing fine. However, when the 1990–1991 recession hit New England hard, New

England banks started failing. With nationwide banking, a bank could make loans in

both New England and Texas and would thus be less likely to fail, because when loans

go sour in one location, they would likely be doing well in the other. Thus nationwide

banking is seen as a major step toward creating a banking system that is less

prone to banking crises.

Two concerns remain about the effects of bank consolidation—that it may lead to

a reduction in lending to small businesses and that banks rushing to expand into new

geographic markets may take increased risks leading to bank failures. The jury is still

out on these concerns, but most economists see the benefits of bank consolidation

and nationwide banking as outweighing the costs.

Separation of the Banking and Other Financial Service Industries

Another important feature of the structure of the banking industry in the United

States until recently was the separation of the banking and other financial services

industries—such as securities, insurance, and real estate—mandated by the Glass-

Steagall Act of 1933. As pointed out earlier in the chapter, Glass-Steagall allowed

commercial banks to sell new offerings of government securities but prohibited them

from underwriting corporate securities or from engaging in brokerage activities. It