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U.S. financial services in the global economy.

U.S. Financial Services in the Global Economy

Today, I've been asked to talk to you about what's happening in financial services, both in the U.S. and abroad. It's an exciting time. There are tremendous opportunities throughout the world for financial service companies. But, it's also a difficult time. Trade and regulatory policies, particularly in the U.S., have not yet adapted to the new global realities.

Some of what I will say today may sound familiar to you. As I read through remarks of your recent speakers. I was struck by some common themes--a stress on the reality of global markets, a call for improved U.S. competitiveness. Surprise! You'll get more of that from me today.

What may be less discussed are conditions unique to the financial services industry--for instance, the thrift bail-out, which will cost $166 billion over the next 10 years and $300 billion over the next 30. That's symptomatic of some fundamental questions about safety and soundness in U.S. financial markets:

* the role of deposit insurance,

* the need for specialized financial industries, and

* the structure of regulation.

Those questions are not going to go away. The possibility of bail-outs of the FDIC and the commercial banking industry is increasingly being raised--for example, in a Brookings Institution report last month and congressional testimony last week by Stanford economist Dan Brumbaugh, who predicted the thrift crisis. Concerns are surfacing in the insurance industry--Business Week just a few weeks ago had a cover story on this. Certainly, the securities industry has had its share of concerns since the crash of '87.

MACRO TRENDS

Now, before I get into issues of international competitiveness and safety and soundness, let me describe some of the positive trends going on that set the environment for financial services.

First, wealth is becoming more widely distributed around the world. Japan is already a mighty economic and financial power--and the world's largest creditor. Europe is well on its way to a unified internal market in 1992--a market larger than the U.S. in population and almost as large in GNP. The four Tigers of Korea, Taiwan, Singapore, and Hong Kong are being joined by Thailand, Malaysia, maybe Indonesia, and India. The Iron Curtain is rusting--the Soviet Union and Eastern Europe are experimenting with less state direction and more market mechanisms. China, whose path toward economic and political freedom ran into a storm at Tiananmen Square, will hopefully return to that course soon. If Latin America can shake free of the burden of debt, the market-oriented reforms that many Latin governments are now adopting may provide the basis for solid growth in the future.

The result? A truly global economy, with many sources of prosperity and economic power and greater interdependence.

Second, the globalization of financial markets will increase Technology keeps driving down the cost and pushing up the volume of international communications. Previously isolated markets are now linked, around the world, around the clock. Already $500 billion a day flows through the world's major foreign exchange markets. That's one-fifth the total value of world exports of goods in a whole year. No wonder financial flows, not trade flows, are driving exchange rates.

Third, financial markets will more and more guide economic policies. Everywhere savings are looking for profitable investment opportunities, without regard for national boundaries. Everywhere investment needs are seeking savings, regardless of national origin. If investors, domestic or foreign, find too much inflation or too many government restrictions in one country, they'll vote with their money and move it elsewhere. No country can afford to be an island. Each must compete both to attract foreign capital and to retain and mobilize its own.

Fourth, international trade in services--what the Economist magazine defined as "anything that you can't drop on your foot"--will become more important. Global exports of travel, transportation, education, professional services, banking, insurance, and other financial services last year were recorded at $560 billion--roughly equal to total world exports of food and fuels or of automobiles and electronics. Exports of financial services--commissions, advisory fees, premiums, and so forth--have especially high growth rates.

Aside note on services: Did you know that travel and tourism, American Express other major business, is the largest industry in the world in terms of employment? A study by Wharton Econometrics in 1989 showed that travel and tourism provided 100 million jobs worldwide--one out of every 16 workers. It's a $2 trillion industry in terms of sales.

Turning to the U.S., one can see the same trends of growing opportunities and blurring boundaries.

First, services generally, and financial services in particular, will loom larger in the U.S. economy. Services now equal 72% of U.S. GNP, up from 65% in 1980; financial services equal 17% of GNP, up from 15% in 1980. Those growth trends will continue.

Second, the U.S. still has a competitive trade advantage in services. This year it will probably export $17 billion more of services than it imports. Even that number understates the true surplus because statistics on services are so incomplete. Last summer the U.S. Commerce Department reported that new data collection methods had turned up about $30 billion in previously uncounted U.S. exports of education, tourism, and other services in 1988. And, there's more improvement to come. The bottom line is that services, and financial services in particular, are greatly helping the U.S. trade balance.

Third, geographic restrictions on commercial banks and thrifts in the U.S. are slowly disappearing. The regional banking compacts point that way. The thrift bail-out legislation may well accelerate the process by allowing any financial institution to buy any thrift anywhere. That means that soon there will be truly nationwide banks with greater efficiencies and increased consumer convenience.

Fourth, there will be further consolidation in financial services. The number of U.S. financial services companies is on a downward trend, driven by the move toward full interstate banking, mergers between troubled and healthier institutions, economies of scale, and the demands of international competition.

However, U.S. financial services are not going to become as concentrated as Japan's. With 158 commercial banks compared to 14,000 in the U.S., American entrepreneurial energies and the size and diversity of the U.S. create ample opportunities here for all sizes and types of financial institutions. Community banks and thrifts will still do well by meeting local needs. Regional banks, investment bank "boutiques," and mid-size securities or insurance companies will prosper by providing specialized financial services. Large diversified institutions will put the pieces together to offer customers a wide range of financial services around the world. Not all will succeed at every level. But, that's the kind of opportunity for diversity that the market wants to provide and that U.S. financial regulations should support: big and small, diversified and specialized, global and local.

Fifth, the foreign presence in U.S. financial service markets will grow. Already, nationally, 20% of all bank assets are held by foreign banks; in California, Japanese banks alone hold 25% of bank assets. Foreign firms are coming here for two reasons. One reason is globalization and the attractions of the U.S. market. Another, less positive reason is the U.S. need to import capital to finance our budget deficit and our investment needs. As long as that's true, foreign institutions will play a role in distributing imported capital.

Finally, consumer and business demand for financial services will continue to grow and change. New financial innovations will occur to meet these new demands. The financial futures and options pioneered in Chicago are one example. Another is the securitizing of bank assets--mortgage-backed securities, securities backed by auto loans or credit card receivables, etc. Hybrid securities with the features of both bonds and equities are still another. And, more innovations are on the way.

These trends affecting our industry have already brought us to where we are now. They'll define the world for financial services in the 1990s and beyond.

OBSTACLES TO PROGRESS

The trends I've described are market forces. But, market forces don't operate in a vacuum; they interact with, influence, and are influenced by public policies and government regulations. Unfortunately, regulations and policies are lagging behind the market. That creates problems.

Look at what we've got in the U.S.: The existing legal framework for financial services is an historical artifact. It reflects the conditions and realities of the 1930s, not the 1990s. Fundamental financial reform legislation to address ongoing changes has been frustrated by factional divisions in the industry and political procrastination in Congress. However, the market hasn't stood still. Stepping into the legislative vacuum, regulators, judges, and enterprising businesses have rewritten, revised, and reinterpreted existing statutes in an effort to facilitate adaptation, permit diversification, and respond to consumer demand. The result is a patchwork framework:

* Instead of financial institutions able to offer a full range of financial services, there are banks with some of the powers of security firms or insurance agents, but not all, and securities companies, insurance companies and agents, and others in similar straits. That limits consumer choice.

* Instead of true nationwide banking, there are regional bank compacts. That limits consumer and business flexibility.

* Instead of well-defined ways for commercial companies to be in financial services, non-bank banks are frozen in place. That limits new capital and new ideas.

* Instead of a level playing field, some industries are closely regulated, while others are not. That leads to incomplete competition and uneven regulatory supervision.

* Instead of a safe and sound financial system, there's one with built-in dangers and inadequacies. For example:

--inadequate geographical and product diversity;

--managements, once protected by a regulated environment, unable to respond well to new powers and new competition;

--inadequate capital, exacerbated by accounting practices that hide capital erosion;

--a deposit insurance system that allows insolvent institutions to gamble with insured deposits;

--piecemeal solutions that make the problem worse;

--delays that allow ultimate costs to grow.

The inadequacies I've just listed were the causes of the thrift crisis with its multibillion-dollar price tag. They're the potential causes of future troubles in other financial service industries.

Now, look at what's happening outside the U.S. There, public policy is doing a better job of keeping up with the market. The U.K. had its "big bang" of financial liberalization in 1987; Canada a "little bang." Japan has started a process of removing its regulatory barriers between banking, securities, and insurance. That will strengthen the already gigantic Japanese banks, securities companies, and insurance companies. Europe is moving toward a unified market by 1992. That will allow the already diversified universal banks of Germany, France, and the U.K. to expand across all of Europe.

What's missing internationally is an overall framework that will keep financial liberalization from pushing regulatory walls out to national or regional borders. That's where GATT comes in. To date, GATT--the General Agreement on Tariffs and Trade, the international body of rules governing trade--has only covered trade in goods, not trade in services. As a result, financial service companies that operate in international markets do so without internationally agreed upon rules and procedures. They face a tangle of market access barriers and discriminatory restrictions.

All this poses a major challenge to U.S. financial service companies and ultimately to U.S. consumers and businesses. The market is racing ahead. The U.S. is lagging behind, while other countries are moving to keep up.

Can U.S. companies compete in the global market? Certainly, we have great strengths:

* advanced technology and a record of innovation;

* lots of entrepreneurial experience in the world's most sophisticated and most competitive capital and financial markets;

* the support of an efficient payments system and a highly professional and competent central bank; and

* a history of successful competition overseas for many U.S. companies--among them. American Express and its subsidiary Shearson Lehman Hutton.

But, the private sector can't succeed unless the public sector provides the right environment. To achieve a world in which U.S. financial services companies can compete fully and fairly with each other and with foreign companies--a world in which consumers and businesses enjoy both a safe and sound financial system and the high-quality, low-cost financial services produced by competition--will require both financial reform in the U.S. and a strong GATT framework for open trade in financial services.

THREE FUTURES

What lies ahead? Let me describe three possible futures for U.S. financial services in this country and in the global market: Future #1 is what I would call "creeping incrementalism":

* a continuation of the piecemeal, loophole-driven erosion of regulations and the legislative stalemate that has characterized U.S. financial system reform;

* the increased presence of foreign firms in U.S. markets; and

* a shrinking presence of U.S. firms overseas.

That future is basically an extension of the status quo. Let me be clear about this. Creeping incrementalism has brought benefits: increased choice for consumers and business, higher earnings on their financial investments, greater efficiency, and greater international interdependence. But, it's also brought big costs as it inches along, like the thrift bail-out and reduced international competitiveness. Looking to the future, I see growing costs to this approach and fewer new benefits. More bail-outs, more troubled financial institutions, loss of competitive advantage to more efficient and diversified foreign companies--that's what may lie ahead in this future.

Perhaps the greatest risk from creeping incrementalism is that its growing costs will provoke a congressional or public reaction against financial reform. That brings me to Future #2 which I will label "back to the bunkers." By that I mean protectionism:

* reregulation at home into distinct financial service industries; and

* internationally, the creation of trade blocks.

In that future, Congress tries to return to the compartmented regulatory framework of the 1930s. Particular financial services are confined to particular types of companies and closely regulated in their activities. The thrift bail-out bill has essentially already done that to the savings and loans. Meanwhile, to counter increased foreign competition, Congress imposes restrictions on foreign ownership of U.S. financial service companies. In retaliation or because of their own protectionist fears, Europe and Japan limit the activities of U.S. financial service companies in their countries.

I don't think I have to spell out the costs of this kind of future. Yes, it might seem more secure, at least on paper. But, it would be a very fragile kind of security, vulnerable to market forces finding new ways around artificial barriers. The facts are clear, protectionism doesn't work. And, even if it worked, it would be at the cost of efficiency and innovation. But, just because this future would be ineffective and inefficient, don't think it won't occur. One should never underestimate the capacity of politicians to overreact when they're frustrated by the combination of obvious abuses and conflicting demands for protection.

Well, having presented two possible futures, one bad and one really bad, you no doubt expect me to present the third, good future, which saves the day. You're right. The third future that I see is a positive one of open markets and consumer choice in which all types of financial institutions can compete with adequate rules of consumer protection, fair play, and safety and soundness.

THE 1990s OFFENSE

What will it take to get there? In the U.S., the key initiative is modernizing financial regulations to provide U.S. financial service companies with a solid home base for international competition. At the international level, it's successful completion of the Uruguay round of the GATT.

Let me start with the antiquated structure of U.S. financial regulations. Here the solution is simple: adoption in the U.S. of a new legal and regulatory environment that:

(1) fits the reality of diversification by financial institutions, both functionally and geographically;

(2) provides effective and credible regulation;

(3) enhances the benefits of a free market system by expanding the choices available to users of financial services; and

(4) preserves and enhances the role of the U.S. markets and intermediaries in today's global market.

What would this framework look like? Obviously, different people could design it in different ways. But, let me offer one design with a very important feature--it's the product of the combined efforts of several different types of financial institutions.

Several years ago, in an effort to break the legislative deadlock, my company and a diverse group of banks, securities firms, thrifts, insurance, and finance companies combined in a coalition called the Financial Services Council or FSC. The FSC is itself proof that consensus can be reached out of seemingly irreconcilabe differences. This consensus helped produce a bill entitled the "Depository Institution Affiliation Act," introduced in the Senate as S. 530 and in the House of Representatives as H.R. 1992.

The key provision of this legislation would create a new federal financial charter alternative--one that would permit financial and non-financial companies to be part of the same holding company yet require different financial activities to be conducted in separately capitalized subsidiaries: for example, banking in one, securities in another, insurance in another. These separate financial activities would be regulated by appropriate state and federal officials along functional lines ("functional regulation"). Subsidiaries could work together to provide customers with a full range of services. Yet, reasonable safeguards, or firewalls, would insulate insured entities in order to protect federal deposit insurance, prevent self-dealing and consumer abuses, and assure fair competition and effective regulation. This would be a voluntary option; institutions that were happy with their present charters could retain them.

The FSC approach also offers a way to deal with an issue that is sure to be a top priority after the thrift bail-out: deposit insurance reform. Deposit insurance is still needed to protect the small depositor. But, we can't have a situation in which an insured institution is too big to fail. Confining deposit insurance to the liabilities of well-capitalized traditional depository institutions, with adequate safeguards against excessive risk, while allowing other, more risky activities to be carried out in separate, uninsured subsidiaries of a holding company, could be the best solution. This program for regulatory reform is doable; it's needed. I hope it's adopted soon.

Now, let me turn to the international dimension. Here, the most important initiative is reaching an international trade agreement that strengthens GATT and covers services--including financial services. As I said earlier, the U.S. already has great strengths in exporting financial and other services. Other countries are striving to catch up. The financial reforms I've outlined will help U.S. financial service companies keep up with the diversified financial institutions that foreign competitors are creating. But, a GATT agreement is also essential to keep foreign markets open to U.S. financial institutions and expand future access.

So far, the news has been encouraging. A major breakthrough was made at the start of the current Uruguay round of GATT negotiations in 1986 when services were included as one of the main topics. Since then, at the Montreal midterm review in December 1988 and during high-level talks in Geneva in April 1989, negotiators have affirmed their intention to forge an agreement to open trade in services. A draft text in likely by year-end on the basic principles of the services agreement:

(1) national treatment, i.e., that foreign firms will not be

discriminated against in national laws and policies;

(2) the right of foreign firms to establish operations in a

host country or to provide services cross-border;

(3) laws and regulatory

practices that are as

clear and fair in their

application to foreign

firms as they are to

domestic firms; and

(4) mechanisms for

reviewing compliance

with the agreement

and resolving

disputes.

The negotiations to apply these general principles to specific types of services, including financial services, began in earnest in January 1989. The Treasury Department is taking the lead in cooperation with the USTR to advance the U.S. position. So, I'm hopeful that a GATT agreement on services can and will be reached. But, we're not there yet: we won't get there unless there's progress on the rest of the GATT negotiating agenda. There's a lot at stake and a critical need for U.S. public and business support for successful GATT negotiations.

CONCLUSION

Let me conclude with this final thought. The global marketplace is a reality. Yet, too many Americans fail to recognize this truth. Instead, they have acquired the habit over the past four decades of assuming that the U.S. is number one; that American products are automatically the best in the world; that the U.S. market is the only one that really matters.

Thirty-five, 40 years ago, when those assumptions were true, our leaders had a much more global and forward-looking perspective. A statesman like George Marshall, in launching the Marshall Plan to rebuild Europe, articulated a fundamental truth: Without economic prosperity, there can be no lasting peace. A president like Dwight Eisenhower--whose birthday centennial was in 1989--recognized the interdependence of the world, acted as if the U.S. was no more than the first among equals, and worked to promote the free flow of goods, people, ideas, and capital among nations.

The interdependent, prosperous world that Marshall and Eisenhower sought to achieve is one we should strive for today. Like them, we should welcome and seek to realize the full potential of a global economy--because it's in our own best interest to do so.

We should not turn inward or shrink from foreign competition. Instead, we should work to make both our public policies and regulations and our private enterprises competitive in a global economy. We should maintain and expand our commitment to open trade. That's the road to peace and prosperity. That should be our legacy for the future.

Mr. Robinson is chairman and chief executive officer of American Express.
COPYRIGHT 1990 University of Memphis
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Robinson, James D., III
Publication:Business Perspectives
Date:Jun 22, 1990
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