Diverse Experiences with Banking System Tale of Two Countries: Canadian and American Banking Systems J.D. Han King’s College, UWO

I. The American Story

1. Characteristics of U. S. Banking Industry 1) Dual Banking System Some banks are regulated by the state agency and others by the Federal agency Pre-1863 State Banking only 1863 National Banks (Act) emerging 1913 Federal Reserve System 1934 Federal Deposit Insurance Corporation

2) Multiple Regulatory Agencies: “Crazy Quilt System” The Office of the Comptroller of the Currency : in primary charge of “Charter” for national banks Fed :in secondary charge of national banks, and in sole charge of bank holding companies FDIC and State Banking Authorities : in charge of state banks with FDIC insurance State Banking Authorities : in sole charge of state banks without FDIC insurance

3) Fractured Banking Industry A Large # of Banks: 12,000 until the early 1990 Many Lacking “Scales of Economies -> only 325 banks have assets above $1 billion (’94) -> until recently, some states had “Unit Banking System”. -> Consolidation and Simplification: Key Issue of Presidential Reforms

2. Historical Background 1) Federal versus State Struggles for Hegemony -“The Wizard of Oz as a Monetary Allegory” by H. Rockoff Background: Depression in the 1890s Allegories: Dorothy: an Average conscientious true American Tornado Wicked Witch of the East- Eastern Business and Financial Interests Munchkins -Average Americans Scarecrow -Western Farmer Tin Woodman- Unemployed Industrial Workers Cowardly Lion -“William Jennings Bryan” Wicked Witch of the West - Grover Cleveland silver shoes: magic water that melt the witch: solution – watershed – inflation (through printing money) A Lesson: So much socio-political problems and regional interests were intertwined with Monetary policies (and banking practices): - The complexity of the current banking system of the U.S. is a on-goint legacy of the long tradition of these complicated political Struggles between regions, parties and interest groups.

2) Anti Trust Acts of 1920s to 1930s have shaped the U. S. Banking System McFadden Act of 1927: limits and prohibits inter-state banking and branching Glass-Steagall Act of 1933: Anti-Trust Act separating Banks and Commerce

* Apparent Rationale Underlying the Separation of Commercial and Investment Banking: Glass-Steagall Act In favor of Specialized Banking as opposed to Universal Banking If banks are engaged in securities business, there may occur Conflicts of Interests; Unfair Competition; Risk of Safety and Soundness; Concentration of Power; Unfair Stretch of Federal safety net

3) Turn Around 1.Evolution of Bank Holding Companies 2. Reigle-Neal Act of Interstate Banking and Branching Act (1994) : Opening up M & A for “Efficiency” in banking sectors 2.Gramm-Leach-Bliley Financial Modernization Act (1999) : Banks are allowed to form Financial Holding Companies across industries and even to carry out “merchant banking” or equity investments in non- financial firms.

* *Ground for Changes: Gramm- Leach-Bliley Act -Economics : Cost Savings : Risk Diversification -Legal Issues on Conflict of Interests can be resolved by “Mezzanine Finance” and “Lender Liability and Equitable Subordination”

* How American Banks Merge? The number of banks has been decreasing While mergers between banking groups have slowed, there has been a move towards diversification as the barriers between commercial and investment banking have finally broken down.

II. Canadian Story

1. Evolution of Canadian Financial System Tradition of “Four Pillar System” : Trust, Mortgage, Fiduciary Business Chartered Banks Insurance Securities Industry (Credit Unions) Full Service Banking Towards

2. Reforms in the Canadian Bank Act 1954 : Banks were allowed to go for household lending and to make mortgage loans insured by NHA 1967 : the 6% ceiling on the mortgage loans was removed 1980 : banks were allowed to have mortgage loan companies and venture capital companies.

1987 :banks were allowed to underwrite corporate securities : abolishing the Canadian equivalent of “Glass- Steagall Act” 1992 : banks were allowed to own trust companies : banks were permitted to offer a number of in- house activities, such as portfolio management, and investment counseling. : required reserves are to be phased out :Bill C Bill C-38 and Bill C-8

3. Current Characteristics A Small # of Banks Big Five Sisters dominate market Highly Regulated and Protected Inbound from International Competition Highly International Outbound

4. Other Apparent Differences between U. S. and Canada U.S. Big Increases in Mortgage Backed Securities <- S & L companies’ mismatch of maturity terms of Assets and Liabilities Big Surge of Money Market Mutual Funds <- way to get around `Regulation Q’ Canada Not Much No Big Surge

5. Changing Characteristics of Canadian Banking Industry Chart 9 of C. Freedman

III. Japanese Banking System Post WWII Japanese banks were reorganized by the U.S. Occupying Army Yet, they have been distinct from the U.S, banks Notably, Japanese banks have been allowed to hold equities and to participate in management of non-financial corporations

Japanese Banks are allowed to own Equities: Banks are lenders as well as owners

Pros: - Reduces bankruptcy costs for society (legal cost; disruption cost) - Sumitomo Bank revived Mazda in the 1970s - Reduces monitoring cost of Principal-Agent Problem (Sun Bae Kim, Banking and Commerce: The Japanese Case) - Makes banks share ‘Upside Returns’ and ‘Calculated Entrepreneurial Risk and Venture’

Cons: - Stock Market Crash leads to Loss of Bank Assets - Moral Hazards: “Too Big to go bankrupt” -

IV. European Banks Universal Banking offering a wide spectrum of services and products - as opposed to “Specialized Banking” Fully Merged