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Is this when banks become glass boxes and retail spaces?

The early eighties saw dramatic changes in the banking regulatory environment. These changes fundamentally re-oriented the rules and competition within the banking system. Two bills started the process, which would continue throughout the eighties and into the nineties. As one would expect, they emerged out of a deepening crisis.

DIDMCA in 1980 and Garn-St Germain in 1982 responded to the high-interest rate environment that had exposed and exacerbated competitive disadvantages at the community bank and S&L level that stemmed from the existing regulatory framework. The legislative answer, in the form of DIDMCA and Garn-St. Germain shifted bank’s focus to financial products and opened the competition across state lines. The result was a shift in mind-set. Banks became two things. First, they became retail institutions designed to sell increasingly complicated financial services. Second, they also took on the ability to hold and manage increasingly risky assets. Both got them into trouble, but the shift to a retail mind-set is what changed the architecture of the bank.

Banks had been institutions defined by their place and designed to hold your money in a limited and regulated set of products. Banking institutions had been more like farms than those we regard today. Their business was tied to the fact that they were a physical part of the region. The McFadden Act of 1927 and the Douglas Amendment to the Bank Holding Company Act of 1956 intentionally obstructed the development of national banks. Their financial services were regulated, and they competed for customers based on the fact that they were close. These banks, coddled by a stable regulatory structure, remained largely unchallenged by competing institutions and cultivated the architecture of safety.

The high interest-rate environment of the early eighties strained the regional banks and forced legislators to respond. Banking regulations had put community banks and S&Ls at a competitive disadvantage. Interest rates were regulated and had not kept pace with the high interest-rate environment ushered in by Volcker’s Federal Reserve. As a result, they were losing deposits, and the banking system was in turmoil.

The DIDMCA focused on establishing equality among financial services institutions, so it would level the competitive field. It removed interest rate caps on deposits for community banks by phasing out Regulation Q, so they could compete with money market funds and provide market rates. Thrifts were allowed to enter the consumer loan and credit card business. The bill provided a consistent framework for reserve requirements that would be managed by the Federal Reserve as an instrument of monetary policy. It also raised the FDIC insurance levels to $100k, which William Isaac later claimed, with Fernand St Germain, was a mistake. Banks started on a trajectory from being a place to keep your money to a place for accessing money-services on the open market.

The crisis did not abate. The economy was in a major recession. Paul Volcker had raised interest rates to unimaginable levels. The thrift industry was in crisis, and congress came to the rescue in two ways. First, it accelerated the deregulation of banks and S&Ls, so they could improve their business. Second, it interceded with insolvent banks through direct funding and opening the possibility of non-regional and interstate acquisitions of banks.

The deregulation of the banking industry introduced a tectonic shift in banking. Banks would grow into financial supermarkets of services. Services, such as interest rates, which had been regulated, became competitive and subject to active management. These new abilities would enable banks to become aggressive producers and managers of capital. This was evident in many respects. The bill accelerated the abolition of remaining Regulation Q differentials between banks and thrifts, which governed maximum allowable rates on deposit accounts. S&Ls and savings banks gained the power to invest up to 5% of their assets in commercial loans. Up to 30% of an S&L’s assets could be invested in consumer loans, and they also could invest in state and local government bonds. In a high interest rate environment, this accrued to their benefit by making their deposits more competitive, improving the returns on their deposits, and perhaps improving net interest margins. Garn-St Germain also de-regulated real-estate loans, removing statutory restriction on real estate loans for national banks, and preempted state regulation that would adversely affect the activities of a national bank.

Garn-St Germain convened a spectrum of solutions for failing institutions. The Federal Savings and Loan insurance Corporation (FSLIC) introduced the concept of net worth certificates. These would be purchased by the FSLIC, counted as regulatory capital, and provide for the ongoing operation of the bank as a solvent entity. The legislation authorized the FDIC to bless interstate banking acquisitions of closed savings or commercial banks with assets over $500m, and similar powers were granted to the FSLIC. Both the McFadden Act of 1927 and the Douglas Amendment to the Bank Holding Company Act of 1956 had been designed to obstruct the development of an interstate banking system by devolving regulatory responsibility to the states, leaving no consistent national regulatory fabric. The FDIC’s new powers were a direct challenge to 50+ years of banking practices that defined banks and financial services in terms of place, not product. The Competitive Equality Banking Act of 1987 would later make these changes permanent and pervasive. DIDMCA and Garn-St Germain shifted banks’ focus to products, and place, though still important, was no longer integral of the bank’s identity. Later regulation, such as CEBA, would compound and expand these changes.

The rising metaphor for banking became the retail store. The architecture of safety was for institutions that were rooted in the region and frozen in the regulatory structures that came out of the market crash and depression. The emphasis was safety, the product mix was simple and regulated, and banks looked more like traditional, quasi-state institutions. The changes in the early eighties forced banks to expand the financial services they provided and provide them just like retail stores. These were new, highly variable, and very competitive. It’s not for nothing that Garn-St. Germain included the initial Truth in Lending provisions. The new services at the local bank level required marketing support and additional education. A teller didn’t have to give their client a toaster to stand out. With Regulation Q retired, they could offer a more competitive interest rate. These dynamics are more typically associated with consumer goods, and the architecture changed to suit them, promote them, and grow the business. Retail banking begins, and with it, glass boxes and retail spaces find themselves occupied by the former tenants of the traditional and staid – banks.

Out of region and out of state competitors begin to spring up. They’ve acquired failed banks or otherwise joined the market. The new branches are designed to sell financial services and projected into new markets. They’re designed to be retail stores for financial services. Banks find that they can quickly open “new doors,” as they might say in the retail industry, and these doors are the source of new deposits and sale of loans, accounts, et al.

One question that emerges is, if the front end of banks begins to shift into retail and change its relationships with its customers, how does the back end change? How do banks change their relationship to the supply of money? The legacy of the local bank had been deposits funded by a local depositor base and lent to the local depositor base according to strict capital requirements. What happens as the community banks and S&Ls gain direct exposure to the capital markets? One answer is Liar’s Poker.