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Financial supermarkets in the United States: The remarkable transformation of the financial system

International Monetary Fund. External Relations Dept.
Published Date:
March 1984
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What they are, how they evolved, and what they imply for policy

Charles Collyns and Yusuke Horiguchi

The last several years have seen a remarkable transformation of the financial structure of the United States. Until recently, commercial banks, thrift institutions, and other financial intermediaries played well-defined roles, each offering its customers a limited and specialized array of financial services. Today, these distinctions have to a large extent evaporated, and there are many financial institutions that are able to meet the bulk of the traditional financial needs of consumers in one place; for this reason, they are sometimes referred to as financial supermarkets. By taking advantage of recent advances in banking technology, these financial supermarkets have greatly enhanced the convenience and reduced the costs of financial transactions. In addition, against the background of a rapid liberalization of the regulatory structure, they have been able to offer savers many new financial instruments available in small denominations and bearing interest at rates close to market levels. The resulting financial system is highly competitive and quick to respond to shifting market opportunities, in sharp contrast to the relatively rigid and segmented system from which it emerged.

Early regulation

The roots of the extensive regulatory structure that underlay the previous system may be traced to the financial collapse of the Great Depression. The severity of this collapse was attributed in large part to the unsound banking practices of the time. Fierce competition had led banks to bid up rates of interest to depositors and to seek high-yielding but risky investments. When many of these investments began to fail, a general loss of confidence led depositors in vulnerable banks to attempt to convert deposits to currency. As banks scrambled for liquidity, the crisis spread through the system, while the Federal Reserve failed to ensure the adequacy of bank reserves.

In response to these events, the framework of the financial system was substantially restructured to enhance its underlying stability. Price competition among commercial banks was limited by the Banking Act of 1933, which prohibited interest payments on demand deposits and authorized the Federal Reserve to set ceilings on interest paid on time and savings deposits by member banks of the Federal Reserve System (see glossary). The financial system was effectively segmented by the Glass-Steagall Act, which required banking operations to be clearly separated from activities in the securities market, and the Homeowners Loan Act, which placed restrictions on the loan portfolios of thrift institutions. Revisions of the Federal Reserve Act clarified the responsibilities of the Federal Reserve as the lender of last resort and established closer supervision of banking activities; in addition, insurance of deposits at bank and thrift institutions was established to bolster the confidence of small savers in the security of their deposits. Interstate banking had already been prohibited by the McFadden Act of 1927, while anti-usury laws in some states placed ceilings on interest rates charged on mortgage and other loans.

During the 1950s and 1960s, the financial system performed satisfactorily within this framework, providing a secure flow of funds from saver to borrower. This system was highly compartmentalized, by function as well as by geographic area. Commercial banks channeled funds from depositors needing a ready form of payment and safe store of value to borrowers in the commercial, government, and household sectors; thrift institutions deployed deposits from small savers for use primarily in mortgage lending; security firms and investment banks provided more sophisticated financial services and intermediated between large investors and corporate and government borrowers. The regulatory system remained largely unaltered, except that interest rate ceilings were extended to apply to all commercial banks and to thrift institutions and the diversification of the services offered by banks and their affiliates was restricted by the Bank Company Holding Act of 1956.

Inflation and deregulation

A buildup in inflationary pressures during the late 1960s began to place strains on this system and these intensified with the sharp increase in rates of inflation in the 1970s. Market rates of interest tended to rise in tandem with inflation, often outstripping adjustments in interest ceilings and making the opportunity cost of holding noninterest-bearing reserves an increasing burden. Nondepository institutions, which were not bound by interest rate ceilings, then obtained a substantial competitive advantage and were able to attract business away from commercial banks and thrifts. Money market mutual funds, for example, could issue deposit-like instruments (called shares) that bore market rates of interest and offered a high degree of liquidity. Foreign banks, which were not subject to Federal Reserve regulation and had access to external funding, gained an increasing share of the lending market. Meanwhile, well-established companies often found they could obtain access to funds at a lower cost by selling commercial paper directly to the market rather than by borrowing from a commercial bank.

In response, many commercial banks left the Federal Reserve System in order to avoid the cost of reserve requirements. At the same time, depository institutions sought to bypass regulatory restrictions on interest rates by issuing new types of instruments. One such innovation was the repurchase agreement, under which a bank sold government securities to a customer subject to an agreement for repurchase by the bank at a fixed time and price. Since repurchase agreements were subject neither to interest rate ceilings nor to reserve requirements, banks could thus offer competitive rates to large customers. Another development was that state-chartered thrift institutions in the states of Massachusetts and New Hampshire found a legal means to offer limited interest on checkable accounts; these were called negotiable order of withdrawal (NOW) accounts and competed directly with noninterest-bearing demand deposits.

Throughout the 1970s, there were piecemeal efforts at deregulation aimed at allowing banks and thrift institutions greater flexibility to compete for funds. In 1973, ceilings on interest rates on time deposits of $100,000 or more were completely removed. The authority to offer NOW accounts was gradually extended to all thrift institutions (federally chartered as well as state-chartered) in the New England states, while liquidity for thrift savings deposits was increased by the authorization of automatic or telephone transfers to checking accounts and of direct deposit and withdrawal at automatic teller machines. In the late 1970s, banks and thrifts were authorized to issue 6-month money market certificates and 30-month small-saver certificates; interest ceilings on these certificates were linked to the market yields available on government securities of equivalent maturities. At the same time, U.S. branches of foreign banks were brought within the regulatory framework applied to domestic banks.

Pressure for further change

Despite these reforms, considerable pressure had built up by the end of the 1970s for a more fundamental restructuring of the financial system. Much of this pressure stemmed from the inefficiencies that had resulted from the clash of interest ceilings and high inflation. The efforts banks and thrifts had made to bypass interest ceilings and compete for deposits through the provision of free customer services rather than through interest rates were a major source of inefficiency. Meanwhile, ceilings on loan rates and a shortage of funds had led to credit rationing in the mortgage markets of many states.

The increasingly precarious financial situation of the savings and loans was a second cause for concern. The measures taken to increase the ability of these institutions to compete for funds had not been accompanied by a corresponding relaxation of restrictions on their investment portfolios or liberalization of the rates that they could charge for mortgages. The combination of this asymmetric deregulation with escalating inflation had led to a serious profit squeeze on savings and loans as the cost of their short-term liabilities rose faster than the average return on their primary type of asset, the long-term fixed-rate mortgage.

A third factor behind support for regulatory reform was the growing sentiment that the existing financial system might be inappropriate to macroeconomic policy objectives. The low rate of personal saving experienced in the United States relative to other countries was ascribed, in part, to the poor rewards from holding assets in bank and thrift accounts. At the same time, the Federal Reserve faced increasing difficulty in conducting monetary policy, as its control over money and credit was reduced by dwindling membership in the Federal Reserve System and by the growing importance of new forms of liquidity not subject to reserve requirements.

The political weight of these factors was increased by a shift in the prevailing climate of opinion. Greater emphasis came to be given to the advantages flowing from free market competition as the adverse effects of regulatory rigidities became more evident. It was also felt that the effort to ensure stability of the financial system through interest-rate regulation may have underestimated the stabilizing benefits of deposit insurance and more effective bank supervision. As early as 1971, the President’s Commission on Financial Structure and Regulation (the Hunt Commission) had strongly recommended a major liberalization of the financial system. While only a few of the Commission’s proposals had been enacted by the late 1970s, the views underlying their recommendations had become widely accepted.

The Depository Institution Deregulation and Monetary Control Act of 1980 followed close to the spirit of the Commission’s report. It sought “to enhance the efficiency of financial markets, promote competitive balance among depository institutions, and facilitate the implementation of monetary policy.” It was an omnibus act that covered a wide range of regulatory reforms, which included:

(1) The imposition of uniform reserve requirements on transactions balances at all depository institutions, including non-member banks and thrifts, to be phased in over an eight-year period from September 1980.

(2) The progressive phasing out of interest-rate ceilings over a six-year period and the extension of authority to offer NOW accounts to all depository institutions nationwide from January 1981.

(3) The relaxation of restrictions on the investments of federally chartered thrift institutions to permit such institutions to extend consumer, corporate, and business loans and also to offer credit card services.

(4) The preemption of state-imposed usury ceilings on mortgage, business, and agricultural lending.

Following this Act, the deregulation of interest rates progressed rapidly, and interest rate ceilings have now been eliminated on all deposits except for accounts less than $2,500 maturing within 31 days. Further legislation (the Garn-St. Germain Depository Institutions Act of 1982) authorized a new type of account, the money market deposit account, to help depository institutions compete with money market mutual funds. These accounts offer both liquidity and market-related rates of return (see glossary).

The financial services revolution

The rapid pace of innovation in the financial system over the last decade, the so-called financial services revolution, has led to a situation in which a wide range of institutions vie with each other in offering the customer a great variety of financial products. In contrast to the past, one institution may now supply most, if not all, of its clients’ financial requirements. So, for example, a customer may have a checking account and a savings account, borrow to purchase a house or for other purposes, maintain a credit card, and buy and sell stocks and government securities—all in one institution. Thus, such a financial supermarket offers its customers the traditional virtues of the supermarket grocery—namely, diversity of product and the convenience of one-stop shopping.

Financial institutions, in turn, benefit from increasing their product range, as the overall riskiness of their operations is reduced and their costs are lowered through economies of scale. The overall riskiness of the institution’s operations is reduced by diversifying its investment portfolio and its sources of funds. Economies of scale are achieved by aggressive marketing of the expanded product range to attract more business from each customer. The scope for lowering the transactions costs of straightforward banking operations is increased by the dramatic technological innovations of recent years. Applications of new technology include the adoption of electronic fund transfer and information retrieval systems, the introduction of automatic teller machines, and the extension of credit and debit card services.

Over the past 20 years, commercial banks have been fairly successful in defending their dominant position at the liquid end of the financial market; more than half of the short-term assets that comprise M-3 were held in deposits with commercial banks in July 1983 (Table 1). However, there has been a substantial shift in the composition of deposits with commercial banks. While the relative shares of demand and savings deposits have declined steadily, there has been rapid growth in accounts bearing higher rates of interest—in particular, time deposits and, during the last two years or so, NOW accounts, Super-NOW accounts, and money market deposit accounts.

Table 1Commercial bank deposits, 1960–83(In percent of M-3)
Demand deposits362825191410
Other checkable deposits114
Money market accounts9
Savings deposits18191514106
Small-denomination time deposits3512121413
Large-denomination time deposits and repurchase agreements45121312
Source: U.S. Federal Reserve Board.Note: Details may not add to totals due to rounding.

Indicates zero.

Including NOW and Super-NOW accounts.

Source: U.S. Federal Reserve Board.Note: Details may not add to totals due to rounding.

Indicates zero.

Including NOW and Super-NOW accounts.

In addition to their deposit-taking functions, commercial banks now offer an increasing variety of customer services. On the lending side, credit may be obtained through a bank in a number of ways: through direct loans to cover particular expenditures, such as commercial credit, mortgage financing, and credit for purchase of consumer durables; through prearranged overdraft facilities; and through the use of a credit card. Other nonbanking but closely related financial services, such as discount brokerage, credit-related life insurance, and the issue of traveler’s checks, are also offered by many banks, often through a contractor or affiliate. The permissible range of such activities is regulated by the Federal Reserve Board under the 1970 amendment to the Bank Holding Company Act.

During the 1960s and 1970s, a rising proportion of short-term financial assets was held with thrift institutions, although in the last three years their market share has, in fact, slipped (Table 2). As with commercial banks, there has been a shift away from the traditional type of account—in this case, the savings deposit—toward the small-denomination time deposit and, more recently, the money market deposit account. Thrifts now offer almost as wide a product range to the saver as the commercial bank does. They are also able to provide a broader range of lending facilities to customers than had been the case earlier; credit is available for consumer purchase as well as mortgage finance and may also be obtained via an overdraft facility or credit card.

Table 2Thrift deposits, 1960–83(In percent of M-3)
Checkable deposits11
Money market accounts6
Savings deposits32352520127
Small-denomination time deposits1110162316
Large-denomination time deposits and repurchase agreements134
Source: U.S. Federal Reserve Board.

Indicates zero.

Includes NOW and Super-NOW accounts, share draft balances, and demand deposits.

Source: U.S. Federal Reserve Board.

Indicates zero.

Includes NOW and Super-NOW accounts, share draft balances, and demand deposits.

In recent years, money market mutual funds have been the depository institutions’ most successful rivals in attracting liquid funds. Holdings of their shares were negligible in 1978 but had risen to 10 percent of M-3 by November 1982, although this proportion has subsequently declined somewhat following the introduction of federally insured money market deposit accounts and Super-NOWs (Table 3). In response, mutual funds are diversifying the range of customer services and investor opportunities they provide, developing high yield and tax-free security investments with similar degrees of liquidity as their money market funds.

Table 3Other financial Instruments, 1960–831(In percent of M-3)
Savings bonds15118643
Short-term treasury securities1399589
Commercial paper226455
Shares in money market mutual funds47
Eurodollar deposits3134
Individual retirement accounts413
Source: U.S. Federal Reserve Board.Note: Details may not add to totals due to rounding.

Indicates zero

With the exception of shares in money market mutual funds and overnight Eurodollar deposits, these investments are not included in M-3.

Both overnight and term.

Held at banks, thrifts, and mutual funds.

Source: U.S. Federal Reserve Board.Note: Details may not add to totals due to rounding.

Indicates zero

With the exception of shares in money market mutual funds and overnight Eurodollar deposits, these investments are not included in M-3.

Both overnight and term.

Held at banks, thrifts, and mutual funds.

A concurrent development has been the formation of financial conglomerates, which combine many individual financial institutions, often including a bank, thrift, or mutual fund. The restrictions of the Glass-Steagall Act and subsequent legislation can be sidestepped provided that the deposit-taking institution involved in the conglomerate does not itself make commercial loans. Conglomerates are able to offer the consumer a package of brokerage and banking services and may take full advantage of the greater scale and geographical spread that their nonbanking connections make possible. Typically, the package would provide a customer with cash management facilities for ready transfer between stock, bond, and money market investments, together with the liquidity provided by a credit or debit card and access to a checkable account. Transactions needs may be met through a “sweep account,” an arrangement by which funds are moved automatically as required between transactions balances and investment accounts. The conglomerate may also offer a wide range of other specialized services, such as insurance brokerage, real estate and tax shelter sales, and financial advice.


A bank is defined for regulatory purposes as an institution that accepts demand deposits and makes commercial loans. In December 1983, the Federal Reserve acted to broaden the legal definition of a bank by classifying NOW accounts as demand deposits and by including the purchase of commercial paper, certificates of deposit, and bankers’ acceptances in the definition of commercial lending.

The Federal Reserve System is the central bank of the United States created by the Federal Reserve Act of 1913. It regulates the money supply by influencing reserve availability to member banks, provides the central clearing mechanism, and carries out other regulatory and operational functions. The System consists of the Board of Governors, 12 Federal Reserve Banks, their 25 branches, and the national and state banks that are members of the System.

M-1 consists of currency, traveler’s checks, demand deposits, and other checkable deposits (including NOW and Super-NOW accounts, credit union share draft accounts, and demand deposits at thrift institutions). M-2 consists of M-l plus overnight repurchase agreements and Eurodollars, money market mutual fund balances (general purpose and broker/dealer), money market deposit accounts, saving accounts, and small time deposits. M-3 consists of M-2 plus large time deposits, term repurchase agreements, and institution-only money market mutual fund balances.

Money market deposit accounts are accounts available at banks and thrifts that are federally insured, have no fixed maturity, and require only a $2,500 average minimum balance to qualify for the payment of unregulated interest rates. Depositors are limited to six transfers per month (three of them by check) but may make unlimited withdrawals in person. These accounts are defined as nontransactions balances for reserve requirement purposes.

Money market mutual funds are companies that issue deposit-like instruments (called shares) to small savers and invest solely in short-term credit instruments. Customers earn market-related interest rates on their accounts and can write checks (usually with the minimum amount of $250) against their share holdings.

Negotiable order of withdrawal (NOW) accounts are interest-bearing checking accounts. Ordinary NOW accounts bear interest at a fixed rate (5 1/4 percent in December 1983). Super-NOW accounts are NOW accounts with more than $2,500 average balance, whose interest rates are unregulated. Super-NOW accounts are available only to individuals, governmental units, and certain nonprofit organizations.

Thrift institutions include savings and loan associations, credit unions, and mutual savings banks. A savings and loan association uses the savings of its members in large part to finance long-term mortgage loans. A credit union is a mutual thrift institution that uses its funds primarily to make personal loans to members. A mutual savings bank is a banking organization effectively owned by its depositors, whose funds are invested in mortgages and high-grade securities.

Thus, commercial banks, thrifts, mutual funds, and financial conglomerates are evolving into institutions that seek to meet most, if not all, of a consumer’s needs for financial services in one place. It seems likely that, in such an emerging business environment, the financial institutions that do not follow such a path would only survive by meeting very particular needs for their clients. There would still be a niche for financial “boutiques” offering highly specialized brokerage, insurance, foreign exchange, advisory, and other services; similarly, “community” banks and thrifts could continue to prosper by providing personal service for localized geographic areas or consumer groups.

Problems for policy

Rapid institutional change inevitably raises policy problems, and recent financial innovations have proven no exception to this rule. For example, the conduct of monetary policy has been made more difficult by increased uncertainty about the interpretation of the monetary aggregates, M-1 in particular. This problem reflects the proliferation of accounts that can be used for both transactions and savings purposes; these include NOW and Super-NOW accounts, money market deposit accounts, money market mutual funds, and sweep accounts. Reflecting these difficulties, the Federal Reserve has been giving principal weight to broader monetary aggregates (M-2 and M-3) as guides for monetary policy since October 1982. However, although these broader aggregates may appear to be more reliable guides for policy at this time, they are less easy to control than M-l. Direct control over M-2 and M-3 is limited because many of their components are not subject to reserve requirements. In addition, the rapid growth of the proportion of these aggregates that bears interest at unregulated rates has reduced the Federal Reserve’s control over them via its influence on market rates of interest.

The advent of supermarket banking has also raised concerns for the stability of individual financial institutions. In particular, doubt has been cast on the viability of those institutions that are unable to compete successfully with the new financial giants. While the process of deregulation enhances the potential opportunities for commercial banks and thrifts, many of these may lack the scale, geographic spread, or entrepreneurial talent to adapt successfully to the new environment. Such institutions would be swallowed by competitors or become insolvent. In assessing such changes, it is important to bear in mind that the proper functioning of the market inevitably involves success and failure in order to allow for fluidity and change. In addition, it should be emphasized that the defenses against local bank failures sparking a general financial crisis are more secure today than they were at the time of the Great Depression. The financial system is stabilized by the protection offered to the small saver by deposit insurance and by the Federal Reserve’s commitment to ensure the adequacy of overall bank liquidity.

The challenge facing the financial policymaker today is to strike the appropriate balance between removing unnecessary and inequitable restraints on the market and yet ensuring the safety and soundness of the financial system and safeguarding the efficacy of monetary policy. In this context, various legislative proposals are now being considered that follow the general trend of removing barriers to market forces and restoring the competitive position of banks and thrift institutions relative to nonbanks. Proposals include the further relaxation of restrictions on bank acquisition and mergers and on interstate banking; such legislation would increase the opportunities to take advantage of economies of scale and would reduce the various inequities and anomalies that have resulted from attempts to exploit the various loopholes in existing laws. Also under consideration are the removal of restrictions on the payment of interest on demand deposits and the payment of interest on reserve balances held by depository institutions with the Federal Reserve System. Such actions would reduce incentives toward the development of transaction-type accounts outside the depository system, and thus reinforce the ability of the Federal Reserve to carry out monetary policy efficiently.

International Money and Credit: The Policy Roles

Edited by George M. υon Furstenberg

This book provides readers with comprehensive and critical assessments of the recent past, as well as indications of the future evolution, of the international monetary system. It contains the 12 papers and 19 commentaries written for a Fund conference held in March 1983.

In the first chapter, Thomas Willett assesses international financial developments over the past 15 years and the ways international coordination and control have changed. Jacob Frenkel then shows that although international liquidity is influenced much more by national policy decisions than premeditated international arrangements, reserve and exchange objectives remain important in formulation of national monetary policies. Willem Buiter and Jonathan Eaton probe this interdependence more deeply by asking how a country’s status as reserve issuer or acquirer, or as international borrower or lender, influences its policies on inflation and the intertemporal distribution of consumption, and vice versa.

Stanley Fischer elucidates reserve control by examining the feasibility of a world central bank and seigniorage from a theoretical perspective and noting practical difficulties. Max Corden identifies further difficulties in obtaining adjustment through reserve creation and management within any system not incorporating strict conditions enforceable on particular countries.

Peter Kenen, on the other hand, expresses the view that several incentives to international good behavior could be created or strengthened by using SDRs imaginatively. David Lomax investigates the degree to which SDRs, European currency units (ECUs), and other composite currencies can become acceptable substitutes for national-currency claims in private markets.

After examining the past, Paul De Grauwe draws some conclusions about how much international monetary cooperation can be expected during the 1980s. While he calls for measures to reduce the extreme variability of exchange rates, De Grauwe sees little scope for international reserve control schemes.

Nevertheless, something new was coming into view at the conference. International Money and Credit is indicative of the kind of rethinking of the international agenda under way at leading universities, banks, and official institutions. It should be useful to academicians, advanced students, government officials, and others seeking authoritative expositions of developments in international finance, as well as professional analyses of the consequent changes in policy roles.

Pp. xii+596

Price: $28.50 (cloth)

$15.00 (paper)

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Box A-841, Washington, D.C. 20431 U.S.A.

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