Do We Really Need Banks Anymore?

By Bernard Baumohl

As Congress haggles over a plan to rejuvenate the banking system, a central question is going unasked: Does the U.S. economy even need banks?

To many Americans, the idea of a bankless society may seem inconceivable. Not only have banks provided everything from Christmas clubs to car loans, but they have acted as hubs of the community as well. Yet today consumers and businesses can conduct virtually all their banking needs, from opening up a government-guaranteed checking account to getting a mortgage, without ever having to set foot in an actual bank. Now some or all of these services are offered by insurance companies, brokerage firms and such finance companies as Ford Motor Credit and Westinghouse Credit, often at more attractive rates than banks can offer. "Banking's preserve has been invaded. There is simply nothing unique about banking any longer," notes University of California, Berkeley, economics professor James Pierce in his new book, The Future of Banking.

Want an auto loan? Simply go to your car dealer, who can provide a loan from one of the financing arms of the big automakers. Want a home mortgage? Call an insurance company or even a Wall Street securities firm. More and more Americans are doing just that. At the end of 1990, banks held a mere 16% of the $3 trillion in residential mortgages outstanding, and less than half of all auto loans.

Savers don't need banks any more than borrowers do. Those who want to open a checking account and earn healthy income on their deposits can do so through a cash-management or money-market account with a brokerage firm. Some people shy away from such accounts because they aren't protected by the Federal Deposit Insurance Corp., but they now have reason to reconsider. One Wall Street company, Prudential Securities, has an "insured income account," including checking privileges, that comes with the FDIC's $100,000 guarantee. (To get the government protection, the parent company, Prudential Insurance, bought a finance company covered by the FDIC.)

The business community has an even greater variety of nonbank choices to meets its financing needs. Blue-chip companies now turn elsewhere to borrow most of their money. Firms can raise short-term cash at lower rates by selling commercial paper; for longer-term money, they can issue bonds. Even small and medium-size firms, a vital source of business for banks, have many borrowing sources. The financing arms of General Electric, General Motors and Ford, which offer loans to businesses, are among the 10 largest financial institutions in the U.S.

Another class of private creditors that has encroached on the turf of banks is asset-based lenders like Congress Financial, in New York City. These firms, which lend money to companies based largely on the value of the borrower's collateral, have tripled their loans outstanding to more than $100 billion over the past five years. Even the junk-bond market has bounced back as a source of funds for U.S. companies.

Foreign lenders have also expanded their reach in the U.S. market. By having access to cheaper funds overseas and avoiding some of the regulations that bind U.S. institutions, foreign banks can package loans at hard-to-beat interest rates. The result: they made 30% of all loans to American companies last year, up from 18% a decade ago. All this competition has taken its toll on the U.S. banking industry, which now holds only a 30% share of business loans.

Banks still offer a few things almost exclusively, like automatic teller machines. But even there, American Express offers a network of ATMs, as do several other companies.

Have the U.S. banks thus become obsolete? The answer is that they still have a role to play, but a far smaller one, since they are no longer the only game in town. Beset with an overhang of poor-quality loans from the 1980s and new challenges in all the bread-and-butter businesses, banks have lost their financial edge -- and then some. "The nonbank companies have smelled blood in the banking system, and they have moved in to gain market share," says Edward Yardeni, chief economist for the Wall Street firm C.J. Lawrence. "To survive, the banks are going to have to restructure, repair their balance sheets and drop in number closer to 5,000 by the end of the decade." The banks that remain, the strong and progressive ones, will be the better for it.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Steve Hart

[TMFONT 1 d #666666 d {Source: The Boston Co. Economic Advisors}]CAPTION: GOING ELSEWHERE

In the U.S., commercial banks have a declining share of total loans outstanding: