Banks

The idea of a bank is something that someone grows to know early in their life, they may go with their parents to cash a check when young or even go to set up their first account while in grammar school. So to ask the question if banks are dying, or on the other hand have grown to be unnecessary in this day and age is something that might seem a little scary to some. When considering if banks are actually dying you must first consider what caused them to lose their market share.

In an attempt to stabilize the banking system, the federal government first set up the Federal Reserve System as a lender of last resort to provide liquidity to the banks during banking panics. Another way in which the federal government sought to maintain banking stability was to limit competition through anticompetitive regulations such as the Banking Act of 1933, which authorized Regulation Q. “Regulation Q was intended to maintain banks’ profitability by limiting competition for funds among banks and guaranteeing a reasonable spread between interest rates on loans and interest rates paid to depositors” (Feldman and Lueck). The only thing that was wrong with Regulation Q, was when interest rates would rise above the ceiling rate savers would seek out alternative investments which provided them with a better return, as a result the financial system introduced money market mutual funds. “Money market mutual funds gave small and medium-sized depositors an opportunity to earn market rates of return with low transactions costs” (Feldman and Lueck). Along with attracting away savers form banks money market mutual funds also gave borrowers with a new source of funds. “Large, well-established firms could raise short-term funds in the commercial paper market” (Feldman and Lueck), this alternative that borrowers now had created new competition between commercial and investment banks.

With the increased competition that banks faced due to the limitations placed upon the by Regulation Q, banks had to development new financial instruments to circumvent the interest regulations. One of these developments introduced was the negotiable certificate of deposit which was used to compete with commercial paper. Negotiable CDs circumvent the limitations of normal CDs (which were relatively illiquid since the panelized depositors for early withdrawal) by having the ability to be sold to someone else even though they cannot be redeemed prior to maturity. “When they were introduced negotiable CDs of at least $100,000 were exempt form Regulation Q” (Feldman and Lueck), so the interest rates they offered had no ceiling and were able to compete with those offered by commercial paper. Another innovation came about when a Massachusetts mutual savings bank created a substitute for checking accounts that was not governed by Regulation Q. This alternative was called a negotiable order withdrawal account which is basically a combination of a checking account and demand deposit; this was done by the use of withdrawal slips that could be signed over to someone else. Since it was not a demand deposit interest could be paid on it. These innovations along with others such as repurchase agreements, overnight Eurodollars, and automated transfer system accounts allow banks to stay