Financial Update (October-December 1999)
Guynn Poses Serious Questions to Bankers
oday's stellar economy and prosperous banking industry may be leaving a daunting legacy what Federal Reserve Bank of Atlanta President and CEO Jack Guynn refers to as "the institutionalization of unrealistic expectations." In an address to the Community Bankers of Georgia, Guynn predicted that when ordinary times return when great times give way to merely good times bankers will have to rethink their approach to business as they face future changes that will be even more radical than the ones the financial industry has experienced in the past 20 years. Guynn argued that an individual bank's ultimate viability will be determined by how it answers five closely related questions.
Does the bank have the intellectual capital needed to compete?
Two factors financial technology and delivery technology have turned financial products into commodities and increased competition for deposits. Because these technologies have become so common that no modern financial institution can hope to operate with long-term success without both, a more fundamental concern will be hiring and retaining the brainpower needed to stay up and running, Guynn said.
Does the bank have a competitive delivery system?
It is no longer enough for a bank to tailor its delivery system to a customer's changing needs, he said. Banks must also make sure that delivery systems increase output per worker while lowering costs for businesses and prices for consumers. While banks have improved delivery system productivity by investing in ATM networks, credit scoring software and telephone systems, the industry now faces an entirely different delivery system the Internet.
Where will the bank's funding base come from?
The declining rate of growth in deposits is being driven largely by demographics, Guynn said. As baby boomers age, fewer new customers are coming into the banking fold. Also, as policymakers realized that Social Security and other pay-as-you go programs must account for a declining base of workers, tax policies have increasingly encouraged individuals to invest through IRAs, Keoghs and 401(k)s. These developments have set off a huge shift in savings toward the mutual fund industry and away from banks and thrifts.
How will the bank establish its loan pricing?
The United States is overbanked, and it has been for many years, according to Guynn. Now, with deregulation and the Internet, not only are there too many banks chasing too few customers, but every bank has many more ways to market itself. Geographical boundaries have become meaningless, and there are many more nonbanks in the lending-banking business.
All these developments, said Guynn, have increased the aggregate supply of funds available for lending, and when supply exceeds demand, prices fall. Banks have become price takers, as lending seems to have less to do with profitability or the risk presented by an applicant and more to do with an excess supply of funds and holding on to customers.
These developments will increasingly leave banks to slug it out at lower prices with their nonbank competitors in an effort to reach riskier customers further down the credit ladder, he continued.
Can the bank afford to keep its loans on its books?
As costs of funds increase and loan yields fall, it is becoming obvious that banks can no longer afford to store loans on their balance sheets. Too many loans simply don't or won't make economic sense at the interest rates they carry, Guynn said. For this reason, banks are seeing more and more "de-leveraging" in consumer and business lending, whereby banks pare their credit portfolios by securitizing assets or syndicating loans to intermediaries better able to profit from the activity. The profit for banks is thus not in carrying credit risk to maturity but in originating, packaging, selling and servicing that credit risk, for a fee, for third-party investors.
In closing, Guynn said that before banks can respond favorably to these questions, they must recognize that converging forces have made traditional lending less profitable; that lending competition from banks and nonbanks is only going to intensify; and that prices, or at least margins, are only going to go down. And, most important, banks must understand that as radical as these changes have been, they are just the beginning.
For the full text of Guynn's speech, click here.