Big is not so bad.

Author:Miller, C.E.
Position:Presence of large banks in Indiana - Includes ranking of bank holding companies and banks - Industry Overview

The crop of new bank names sprouting in Indiana includes a bunch of competitive and well-managed banks.

The banking landscape across Indiana changed dramatically in 1992. Roughly half of the market statewide is now controlled by out-of-state bank corporations, including NBD, Banc One, National City, Society, Norwest, First of America and Huntington. This leaves the remaining market share to the approximately 270 banks still in Hoosier hands.

What are the ramifications for Hoosiers? How did things get this way? While some in Indiana have found the situation alarming, there are reasons why the influx of out-of-state bank corporations may not be such a bad thing. Indeed, the crop of new bank names sprouting in Indiana includes a bunch of competitive and well-managed banks.

Even so, those running banks with names relatively new to Indiana understand why some customers may have misgivings. "Change can lead to uncertainty for customers," says Michael Hammes, Society National Bank, Indiana's northern regional president. "Banking is a confidence-level business. When they see a name change, they don't know what that means for them until they experience it." Hammes and his colleagues believe customers' experiences have been positive.

Banking was a fairly simple business until the '70s. A bank took in deposits and made loans--primarily business loans, with a few consumer loans, mainly on cars. The deposits didn't cost banks much, nothing was paid on demand deposits (checking accounts) and little was paid on savings accounts.

Government regulated how much banks could pay on savings deposits, and the mandated rate was very low. Then banks calculated costs, added a reasonable profit margin, and set the loan interest rate. Banks made money on the "spread." A simple business. Since the cost of money was the same for every bank, and overhead costs per depositor were comparable, loan rates varied little from bank to bank. Competition in this environment was largely a matter of perception.

Between 1975 and 1985, it all changed.

Non-bank competition for deposits and loans became the problem for the banking industry. Often a bank couldn't come close to the car-loan deals offered by GMAC or Ford Credit. Finance companies pecked away at other parts of the consumer-loan business, financing everything from TVs to sewing machines.

The financing arms of companies such as GE took away business from the commercial-loan department, as did commercial finance companies that handled equipment purchases and leasing. According to the Federal Reserve, banks' share of the short-term credit market fell from about 75 percent in 1975 to roughly 50 percent by 1990.

Probably nothing impacted the banking industry more than the competition for bank deposits from the brokerage houses' money-market funds. As a percentage of all bank liabilities, the Fed reports savings deposits fell from about 40 percent to about 15 percent by 1990, and demand deposits from 20 percent to 10 percent.

Banks were left with two courses of action: attract new depositors or lobby with state and federal governments to deregulate the unwieldy banking industry, allowing a more level playing field with other financial services players.

In order to attract new depositors, banks focused on service and opened more and more bank branches. During the '80s, about 16,500 branches opened nationwide. The growth of electronic branches, or automatic teller machines, was even more dramatic. In 1970, Bank One introduced the plastic-card ATM. By 1978, there were perhaps 2,400 machines in the United States. Now there are nearly 100,000.

The ability to use plastic at ATMs and in stores as debit cards (another convenient bank service) forced banks to greatly increase computer capacity and improve information systems. TABULAR DATA OMITTED Banks had to automate quickly or lose customers.

Acquiring data-processing facilities has been expensive for many banks. The cost of new branches and the need for increased computer capacity in order to be competitive have been leading contributors to the growth of bank overhead.

Bank deregulation happened in two ways in the early '80s. Congress passed legislation allowing banks to offer market interest rates on deposits. The other part of the deregulation trend was allowing out-of-state bank holding companies to acquire in-state banks.

Meanwhile, other forces put pressure on the industry. Because banks were now offering higher rates for deposits, the cost of the raw material for loans was going up. Higher rates on deposits forced banks to look at higher-yielding loans: credit cards and other types of consumer credit, and commercial real estate. The Fed reports that from the late '70s to 1990, real-estate loans became the biggest part of a bank's loan portfolio, at 40 percent, surpassing commercial loans at 33 percent.

But there's a reason why these loans yield more: They are riskier. As the years wore on, recessions caused problems with consumer loans. The substantial sums available for real-estate developers allowed overbuilding in some parts of the country and in some segments of the market, especially office buildings. As a result, defaults were inevitable. Loan charge-offs went up 35 percent during the '80s.

To make a complicated story short, rising costs and declining customer base brought about overcapacity. There were too many banks, too few customers to go around, and too few accounts to adequately cover overhead expenses. Banks faced the choice of increasing the spread to cover costs and risk losing customers; keeping the spread as it was and lowering profits, or worse...

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