Federal Deposit Insurance Corporation
American Bankers Association
October 5, 1996
Banking rests on public confidence and public
confidence rests on the soundness of the two insurance funds
managed by the Federal Deposit Insurance Corporation.
Legislation that the President signed Monday night will make
both of our funds sound, benefitting everyone. I want to
commend the American Bankers Association, the Independent
Bankers Association of America, America's Community
Bankers, and the other banking trade groups that worked to
find a constructive solution to a problem created by no
financial institution operating today, but from whose ill effects
everyone would have suffered. Deposit insurance is one of the
few certainties in an uncertain financial world. We can now all
look to the future with greater assurance, and focus on the
competitiveness and other issues that deserve and require our
I am here today to talk about the state of the banking
industry: where it is and where it is going. There are several
measures that we could use to assess the condition of the
banking industry and its direction in the future. Market share
and profitability are two popular gauges. Both of these
measures reveal important trends, but neither alone can
summarize banking's condition today or its future tomorrow.
The banking industry's declining market share relative
to other financial intermediaries has led to grim assessments
about the industry's future. At the end of 1995, commercial
banks held 24 percent of the total assets held by financial
intermediaries, compared to 34 percent in 1980. This relative
decline in market share merits our attention, but for three
reasons, the picture is more complex than a single statistic
suggests. First, financial markets have grown ever more
sophisticated, new types of institutions, such as mutual funds
and pension funds, have grown to meet evolving financial
needs. Second, in absolute terms, the banking industry has not
shrunk, it has grown, but much more slowly than many of its
competitors. The industry has experienced about a
one-and-a-half percent compounded annual growth rate over
the past 10 years. By contrast, credit unions have experienced
annual growth of about five percent, and mutual funds about
19 percent. Third, traditional market share measures, which
are based on asset holdings, generally do not reflect the
growing importance of bank income from off balance sheet
products and services. The rise in the noninterest income
share of bank earnings indicates less reliance on traditional
lending activities. It also indicates that banks, too, are
innovating and adapting to a changing marketplace.
Let's now look at profitability.
Banking has achieved record profitability in recent
years -- and has attracted the attention of old and new
investors. The industry's return on assets (ROA) has exceeded
one percent every year since 1992. In the time since the FDIC
was created in 1933, banking has never before achieved this
level of profitability. Moreover, if the commercial banking
industry maintains the earnings strength it displayed during
the first half of 1996, it will earn more than $50 billion in one
year -- an annual record. These strong earnings are
widespread in the industry, with 70 percent of banks reporting
ROAs above one percent in the second quarter of this year.
Standing alone, however, profitability, too, gives us an
incomplete assessment of banking's condition and its
To achieve a more complete assessment, this morning I
will examine three other factors for the industry as a whole --
capital, asset quality and management -- and I will indicate
what they may mean for the industry's future.
Banking enjoys a pool of capital that is deep and wide.
As of the end of the second quarter, the industry's equity
capital represented 8.3 percent of total industry assets, the
highest level registered since 1941. High capital levels are
widespread in the industry: as of mid-year, 98.5 percent of all
commercial banks were ranked as well capitalized under the
FDIC's risk-based deposit insurance system.
Second, asset quality.
Banking's extraordinary turnaround from the most
recent national recession and its record profitability has been
supported both by improvements in the quality of existing
loans, and by income from new lending. Since reaching an
all-time high of more than $83 billion in 1991, banks'
inventories of troubled loans have declined by almost
two-thirds, to $30 billion at mid-year 1996. The sharp drop-off
in troubled loans has allowed banks to increase their reserve
coverage ratios while reducing their loss provisions. As of
June 30, banks had a record $1.77 in reserves for each dollar of
noncurrent loans, up from only 73 cents at the end of 1991.
In the early 1990s, loan growth rebounded, helping
banks to boost their net interest income even as net interest
margins gradually narrowed from the historic highs reached in
the early 1990s. In 1995, banks had 26 percent more net
interest income than in 1991.
There has been a structural change in the composition
of the industry's loan portfolio, however, that has implications
for credit quality in the future. In recent years, consumer loan
growth has outstripped increases in other types of loans, which
changes the nature of the industry's credit risks. Ten years
ago, two-thirds of the portfolio consisted of loans to business,
while one-third consisted of loans to consumers -- such as home
mortgages and credit card loans. Now the balance is nearing
even, with business loans representing 56 percent of the
portfolio and consumer loans representing 44 percent.
Despite the inherent diversification in consumer
lending, concerns have arisen regarding the quality of credit
card loans. The amount of credit lines that banks have
provided through credit cards has more than doubled in four
years, increasing from $730 billion in 1992 to almost $1.6
trillion today. Of that amount, $350 billion in credit card
lending is outstanding.
We are closely monitoring the performance of credit
card and other consumer loan portfolios at individual
institutions, largely because of the rise in net charge offs in
credit card loans and the significant increase in personal
bankruptcies in the past several years. For commercial banks,
the annualized net charge-off rate on credit card loans hit 4.48
percent in the second quarter of this year, its highest level since
the fourth quarter of 1992. And, for the first time, annual
personal bankruptcy filings are expected to exceed one million
during this year. Some consumers in recent years have even
gone straight from being current on credit card loans to
personal bankruptcy without passing through delinquency.
These reasons -- and others -- make credit card lending
a matter of concern.
Finally, let's turn to an assessment of management -- the
hardest of the three elements to quantify in analyzing the state
of the banking industry.
The market, as well as bank supervisors, assesses the
quality of management, and bank management has clearly won
a vote of confidence in the market. Bank stock prices have
increased sharply, beginning in 1990. The improvement in
bank stock prices is reflected in rising price/earnings multiples
even as bank earnings have continued to increase. The stock
market has traditionally discounted bank earnings when
compared to other industries. Salomon Brothers notes,
however, that in 1991, the average bank price/earnings ratio
was 46.3 percent of the Standard and Poor's 500, but the
average climbed back to 71.2 percent in 1995, which may be
another signal that the market is having greater confidence in
Let's look at another factor in assessing management.
There is some evidence that banks are becoming more
efficient -- in part, by leveraging technology. For example,
analysis of Call Report data shows that the industry has
become more productive by being able to increase its size
without adding new employees. Ten years ago, on average the
industry managed $2.5 million in assets for each employee,
after adjusting for inflation. As of June 30, commercial banks
were managing nearly $3 million in assets for every employee,
excluding the banks that specialize in credit card loans.
Technology enables banks to be more efficient and effective.
While it is clear that larger banks are taking advantage of
technology, it is not clear that many smaller banks have
accepted the benefits technology can bring.
There is more to management, however, than creating
organizational efficiencies. Management must also prepare for
the future and seek to shape events, rather than simply react to
them. In this regard, the continuing consolidation of the
banking industry is likely to test whether bank management
can sustain the industry's performance. The number of banks,
as well as thrift institutions, has been shrinking for the past 10
years, with mergers being the main cause. Last year, for the
first time in modern times, the number of commercial banks
fell below 10,000 -- while at mid-year the number of thrifts fell
below 2,000 for the first time since 1937.
In addition, the number of acquisitions of very large
companies is increasing. Since 1990, twenty-four acquisitions
of companies larger than $10 billion have been announced --
including 13 in 1995 and 1996. Of the 100 largest bank holding
companies in existence in 1990, thirty-nine have been acquired
or closed -- including 22 of the largest 50. While forty-two
banking organizations controlled 25 percent of all domestic
deposits in 1984, by March, 1996, only 13 banking
organizations controlled 25 percent of domestic deposits.
Managing the larger institutions that result from
consolidation may be a more difficult proposition.
We should remember, too, that there are almost 6,500
community banks today -- two thirds of all U.S. banks. There
has been some shrinkage in their numbers, also, but based on
past experience community banks will continue to fill market
niches that other, larger institutions may not be serving. In
addition, the recent increases in new charters suggest investors
see those opportunities, as well. For all banks, however, it is
improbable that the banking industry's extraordinary record
of profitability since 1992 can continue unabated in the
foreseeable future. The question mark is whether there has
been sufficient industrywide attention to strong internal
controls and sound approaches to risk management to offset
What is the state of the banking industry today?
In summary, strong returns over the past several years
have positioned the industry well to compete in an evolving
environment shaped by technology, changing demographics,
and a widening marketplace. The fact that increasing
profitability has been accomplished while competition has
increased and market share has decreased only underscores
Where is the industry going in the future? The answer
will depend on a number of factors.
One, banks will have to maintain credit quality in the
face of greater competition -- and that means banks will have
to be better at identifying, pricing and managing risks than
their competitors -- even if it means sacrificing market share.
Two, future profitability will also depend upon
expansion of profits from less traditional off balance sheet
business. Further diversification of revenue sources will help
banks absorb rising credit losses when the economy is less
favorable. The prospects for banks would be brighter if you
are allowed to function effectively in the marketplace to offer
credit and investment opportunities more broadly to serve the
needs of the U.S. economy and the needs of all Americans.
That is a legislative issue that deserves the immediate attention
of the new Congress.
Three, in the long term the real test for bank
management is how it addresses the interconnectedness of a
worldwide marketplace and the growing risks that a highly
competitive financial system presents -- and that is not easy to
While regulation has a role to play in the future of
banking, we regulators should not get in the way of market
discipline more than necessary in meeting our statutory and
prudential obligations. Balancing risks and rewards will not
be easy for banks in the rapidly changing financial
environment. In the final analysis, successfully maintaining
the balance is up to bank management and boards of directors
-- and not up to regulators. Regulators can set the parameters
of behavior, but we cannot determine the results.
There is no way to measure quantitatively whether the
management of America's banks is equal to the challenges
ahead, but if the past is any guide to the future, bank
performance in recent years gives us reason for cautious