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The Process of Change in American Banking: Political Economy and the Public Purpose.

THE AMERICAN banking industry experienced turbulent times in the 1980s. These conditions were brought on, in part, by changes in the cost of funds; cross-intermediation from banks to mutual funds as investors sought higher yields; advances in technology and communications; the introduction of new derivative instruments; and adverse lending cycles in energy, foreign loans, agriculture, and real estate. The decade was ushered in with historically high inflation and interest rates, which led to negative interest rate spreads and insolvency in a large number of savings and loans. As the decade progressed, the savings and loan crisis grew due to inaction of the regulatory authorities and Congress, and due to regional economic problems. Only in 1989 did Congress finally address the savings and loan issue under President Bush's reform initiative. During this period, the largest number of commercial banks failed since the Depression, and the industry is still reeling from sectoral lending problems. Internationally, American banks made slow headway while Japanese banks vaulted to preeminence in size, accounting for the ten largest banks in the world. These events led Jeremy F. Taylor to analyze the process of change in banking and to search for solutions to the apparent gloomy industry outlook.

The book is divided into three parts. Part I examines the process of change. Taylor points out that banking changes almost always have a major impact on business activity. The recent technological changes and globalization are seen as increasing the volatility of financial markets and have led to greater global interdependence. Bankers have attempted to respond to these changes. However, in the author's opinion, there is a need for national leadership not forthcoming from Congress.

Taylor calls this the fifth major banking crisis. Historically, the first policy crisis was over the charter renewal of the First and Second National Banks. The second crisis was the failure of states to oversee banking activity from the demise of the Second Natinal Bank until the Civil War. The third crisis was the repeated liquidity crisis of banks that led to the formation of the Federal Reserve System. The fourth crisis was brought on by the Great Depression and led to the emergency banking reforms.

Part II addresses the problems of change in banking. The failure of the FSLIC is seen as symbolic of what could happen to banking with the erosion of profits, capital, loan quality and liquidity. The rapid expansion of lending by regional banks to the less-developed countries in the late 1970s and early 1980s was, in the author's view, simply unsound banking. Also, the recent rash of lending for leveraged buyouts and other highly leveraged transactions, reflected the deterioration of loan standards. Taylor indicates that this foreign lending was due, in part, to the need to seek new loan outlets not available in the United States because of geographic restrictions, and he blames LBO activity on the Glass-Steagal restrictions on investment banking.

Taylor believes that our banks need to be free from geographic limits in order to develop national or nationwide banks that are able to compete in world markets. For this to happen, the "localism" of state geographic restrictions needs to be eliminated and numerical competition dropped as a competitive criteria in approving mergers and acquisitions. The growth of Japanese banks in size and global power is seen as ultimately limiting our freedoms and subjecting the United States to externally induced financial crises.

In addition to the internal and external problems of the banking industry, the situation has further deteriorated due to Congressional failure to deal with the budget and trade deficit issues. Taylor expresses concern that the Treasury and Federal Reserve have suffered a loss of reality as exemplified by the proposed treatment of LDC debts, the adoption of risk-based capital standards and the proposed fines on daylight overdrafts.

In Part III Taylor offers his solution to the problems. The principal ingredient is a change in philosophy, going back to a Hamiltonian approach of responsible fiscal and monetary policy supported by a strong national banking system. This philosophy would eliminate the archaic dual banking system, geographic limits, and change the antitrust challenge to mergers and acquisitions. It would also lead to the establishment of a commission to recommend the best means of establishing a system of strong national institutions. Internally, Taylor sees a need for a new instrument allowing share drafts or direct participation in bank loans and increased securitization to permitting banks to compete more effectively with the yields paid on mutual funds.

Taylor takes a strong stand for a national policy aimed at strengthening U. S. banks in the arena of global competition. Others who have examined Japanese banking also advocate forcing Japan to open its domestic deposit base to foreign banking competition in order to tap Japan's high savings rates. Taylor does not address the capitalization issue. The high market capitalization rates for Japanese city banks have given them the financial strength to make inroads into foreign markets. This market capitalization is due to the difference between market value and book value of equities and real estate owned by the city banks. The capitalization of these banks appears to be four to five times better than U. S. banks.

Taylor'a advocacy of the elimination of the dual banking system will not sit well with some of his readers. The niche banking market of small local institutions cannot be case aside easily, and the checks and balances in entry and supervision between state and federal authorities appear to have been beneficial. The removal of geographic boundaries and the development of large international banking institutions are not necessarily incompatible with the dual system.

Taylor's interpretation of the process of change is thought-provoking. It will force the reader to re-examine national policy towards banking, and its future role in the global economy.

Jan W. Duggar University of Southwestern Louisiana
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Author:Duggar, Jan W.
Publication:Business Economics
Article Type:Book Review
Date:Oct 1, 1991
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