FTC Staff Comment to the Hon. Paul D. Schauer Concerning Colorado H.B. 1142 to Permit Branch Banking in Colorado

V890026
Federal Trade Commission
Denver Regional Office
Suite 2900
1405 Curtis Street
Denver, Colorado 80202-2393
(303) 844-2271
February 	10, 	1989
The 	Honorable 	Paul 	D. 	Schauer
House 	of 	Representatives
State 	Capitol
200 	East 	Colfax Avenue
Denver, 	Colorado 	80203
Dear Mr. 	Schauer:
COMMISSION AUTHORIZEO
The 	staff 	of 	the 	Federal 	Trade 	Commission 	is 	pleased 	to
submit 	this 	letter 	in 	response 	to 	your 	request 	for 	comments 	on
the 	implications 	for 	consumer welfare 	of House 	Bill 	1142, 	a 	bill
to 	permit 	branch banking 	in 	Colorado 	after 	a 	phase-in 	period
which 	ends 	on 	December 	31, 	1992. 	1 	We 	believe 	that 	H.B. 	1142, 	if
enacted, 	is 	likely 	to 	provide 	some 	benefits 	to 	consumers. 	We
also 	believe 	that 	the 	legislation would 	not 	prevent 	small 	banks
from 	competing 	effectively and 	would 	not 	increase 	the 	risk 	of
bank 	failure.
Interest 	and 	Experience 	of 	the
Federal 	Trade 	Commission Staff
The 	staff 	of 	the 	Federal 	Trade 	Commission 	-- 	upon 	request 	by
federal, 	state, 	and 	local 	governmental 	bodies 	-- 	comments 	on
regulatory 	proposals 	that may 	affect 	competition, 	consumers, 	or
the 	efficiency 	of 	the 	economy. 	Under 	section 	Sea) (2) 	of 	the
Federal 	Trade 	Commission Act, 	15 	U.S.C. 	section 	4S(a) (2), 	the
Commission 	does 	not 	have 	any 	authority 	to 	prevent 	unfair methods
of 	competition 	or unfair 	acts 	or 	practices 	by. banks.
Accordingly, 	the 	Commission 	and 	its 	staff 	have 	undertaken 	no
enforcement-related 	investigation 	of 	the 	banking 	industry.
Although 	the 	Commission 	staff 	is 	familiar 	with 	competition 	and
consumer welfare 	issues 	in 	other 	nonbanking 	markets, 	and 	that
experience may 	be 	of 	some value 	by 	analogy, 	it 	is 	recognized 	that
other pUblic 	interest 	considerations 	outside 	the 	Commission's
expertise 	may 	appropriately 	be 	considered 	in 	enacting 	banking
1 	These 	comments 	are 	the 	views 	of 	the 	staff 	of 	the 	Bureau
of 	Economics 	and 	the 	Denver Regional 	Office 	of 	the 	Federal 	Trade
Commission. 	They 	are 	not 	necessarily 	the 	views 	of 	the 	Commission
or of 	any 	individual 	Commissioner. 	Please 	contact Janice 	Charter
of 	the 	Denver Regional 	Office 	at 	844-2271 	if 	you 	have 	any 	questions.

The 	Honorable 	Paul 	D. 	Schauer
legislation. 	We 	are 	not 	suggesting, 	for 	example, 	that 	audit 	and
other 	regulatory 	safeguards 	should be 	relaxed 	in 	any 	fashion.
The 	comments 	below 	are 	based 	for 	the 	most 	part 	on 	articles 	and
materials 	prepared 	by 	individuals 	not 	affiliated 	with 	the
Commission 	staff.
Description 	of H.B. 	1142
The 	bill 	would 	amend 	the 	"Colorado 	Banking 	Code 	of 	1957,"
Colorado Revised 	Statutes 	§ 	11-6-101 	(1987 	Repl. 	Vol.) 	to 	permit
unrestricted 	branch 	banking 	after 	a 	four-year 	transition 	period
during 	which 	certain 	geographical 	and 	numerical 	restrictions
would 	be 	in 	effect.
Consumers 	are 	likely 	to 	benefit 	from 	the 	removal
of 	restrictions 	on 	branch 	banking
A number 	of 	studies, 	some 	of which 	are 	summarized 	below,
suggest 	that 	the 	performance 	of 	banks, 	in 	terms 	of 	consumer
prices 	and 	services', 	is 	better 	in 	states 	that 	permit branching
than 	in 	states 	that 	do 	not 	(referred 	to 	below as 	unit-banking
states). 	Some 	indications 	of 	improved 	performance 	are 	lower
loan 	interest 	rates 	and 	checking 	service 	charges, 	higher deposit
interest 	rates, 	greater 	availability 	of 	loans 	(higher 	loan-to-
asset 	ratios), 	and 	reduced 	personnel 	expenses.
One 	study 	found 	that 	unit 	banks, 	or 	banks with 	a 	single
location, 	earned 	17.5 	to 	23 	percent higher 	rates 	of 	return 	in
unit-banking 	states 	than 	in 	branching 	states, 	which 	the 	author
attributed 	to 	the 	ability 	of 	banks 	in unit-banking 	states 	to
assess 	higher 	service 	charges 	and 	loan 	interest 	rates. 	2 	A study
that 	examined 	the 	differences 	in 	performance 	of 	unit 	banks 	in
unit-banking 	states, 	restricted-branching 	states, 	and
unrestricted-branching 	states 	found 	that 	unit 	banks 	in
unrestricted-branching 	states 	paid higher 	interest 	rates 	on
deposits 	and 	earned 	lower 	rates 	of 	return 	on 	assets 	than 	unit
banks 	in 	unit-banking 	states. 	Unit 	banks 	in 	limited-branching
states 	also 	earned 	a 	lower 	rate 	of 	return 	on 	assets, 	charged
lower 	interest 	rates 	on 	loans, 	charged 	lower 	service 	fees 	on
demand 	deposits, 	and 	paid 	higher 	interest 	rates 	on 	deposits 	than
unit 	banks 	in 	unit 	banking 	states. 	3 	Thus, 	these 	studies
2 	Flannery, 	Mark J., 	"The 	Social 	Costs 	of 	Unit 	Banking
Restrictions," 	Journal 	of 	Monetary 	Economics, 	March 	1984, 	pp.
237-249.
3 	Savage, 	Donald T., 	and 	Rhoades, 	Stephen A., 	"The 	Effect
of 	Branch 	Banking 	on 	Pricing, 	Profits, 	and 	Efficiency 	of 	Unit
Banks," 	Proceedings 	of 	a 	Conference 	on 	Bank 	Structure 	and
2

The Honorable 	Paul 	D. 	Schauer
suggest 	that 	banks 	in 	states 	that 	do 	not 	permit 	branch 	banking
assess 	higher 	service 	fees, 	charge 	higher 	interest 	rates 	on
loans, 	and 	pay 	lower 	interest 	rates 	on deposits 	than 	banks 	in
states 	that 	allow more 	competition.
California 	has 	had 	statewide 	branching 	since 	1909. 	A report
of 	the 	Governor's 	Banking Study Committee 	on 	the 	Future 	of
Banking 	in 	California 	discussed 	the 	impact 	of 	branch 	banking 	on
California 	consumers:
The 	dominant 	position 	of 	the 	branch 	banking 	system 	in 	the
State 	has 	led 	to 	a 	rapid 	proliferation 	of 	total 	banking
offices, 	even 	while 	the 	number 	of 	unit 	banks 	in 	the 	State
was 	declining 	for 	a 	time. 	It 	is 	the 	opinion 	of 	this
Committee 	that 	competitive 	pressures 	which 	exist 	in 	ten
major 	markets 	have 	worked 	their way 	through 	to 	most
California 	communities 	of whatever 	size 	and 	to 	the 	benefit
of 	most 	California 	borrowers. 	4
other 	studies, 	while 	not 	specifically directed 	at 	the 	branch
banking 	issue, 	have 	looked 	at 	the 	effect 	of 	increased 	competition
on 	bank 	performance. 	One 	of 	these 	compared 	the 	pre-entry 	and
post-entry performance 	of 	banks 	in 	one-, 	two-, 	and 	three-bank
markets 	in Texas 	and Oklahoma. 	Before 	entry, 	the 	banks 	studied
had 	lower 	than 	average 	ratios 	of 	loans 	to 	assets 	and 	time
deposits 	to 	total 	deposits. 	A low 	loan-to-asset 	ratio 	may
indicate 	that 	a 	bank has 	not 	been 	aggressive 	in meeting 	the
credit 	needs 	of 	its 	community, 	preferring 	instead 	to 	put 	more 	of
its 	funds 	into 	investments 	such 	as 	government 	securities. 	A bank
with 	a 	low 	ratio 	of 	time 	deposits 	to 	total 	deposits 	is 	paying 	out
less 	overall 	to 	its 	depositors 	than 	other banks, 	indicating 	that
more 	of 	its 	deposits 	are 	held 	in 	accounts 	that 	pay 	either 	no
interest 	or 	lower 	rates 	of 	interest. 	After 	competitive 	entry,
both 	ratios 	rose 	to 	average 	levels, 	indicating 	an 	increased
emphasis 	on 	business 	and 	consumer 	loans, 	as 	opposed 	to
investments. 	Interest 	paid 	on 	deposits 	also 	went 	up, 	an
additional 	benefit 	to 	consumers. 	5
Competition, 	Chicago: 	Federal 	Reserve 	Bank 	of 	Chicago, 	1979, 	pp.
187-196.
4 	Governor 	of 	the 	State 	of 	California, 	Report 	of 	the
Governor's 	Banking 	Study 	Committee 	on 	the 	Future 	of 	Banking 	in
California, 	January 	1965, 	p. 	70.
5 	Fraser, 	Donald R., 	and 	Rose, 	Peter 	S., 	"Bank 	Entry 	and
Bank 	Performance," 	Journal 	of 	Finance, 	March 	1972, 	pp. 	65-78.
This 	is 	not 	meant 	to 	suggest 	that 	all 	Oklahoma 	and 	Texas 	banks 	in
one-, 	two-, 	and 	three-bank markets 	had 	lower 	than 	average 	ratios
3

The 	Honorable 	Paul 	D. 	Schauer
We 	also 	believe 	that 	both 	individual 	and 	business 	consumers
are 	likely 	to 	benefit 	from 	the 	increased 	convenience 	offered by
branch banking. 	Currently, 	consumers 	must 	select 	a 	new 	bank when
they 	move 	from 	one 	community 	to 	another. 	Removing 	these
restrictions 	would 	allow many 	bank customers 	who move 	merely 	to
transfer 	their 	records 	to 	another branch 	in 	their 	new 	community.
Branch banking may 	also 	allow 	firms 	or 	organizations 	with
operations 	in many 	communities 	to 	simplify 	their 	banking
relationships 	and 	reduce 	cash management 	costs. 	Currently,
firms, 	especially 	chain 	stores, 	may 	find 	it 	necessary 	to 	open 	an
account 	at 	a 	different 	bank 	for 	each 	community 	in which 	they
operate. 	The 	absence 	of a 	single 	bank may 	impose 	significant
cash management 	expenses 	on 	these 	firms, 	a 	burden 	that 	would 	be
relieved 	by 	branch 	banking. 	6
The 	possible 	effect 	of 	branch 	banking
on 	the 	likelihood 	of 	bank 	failure
One 	of 	the 	most 	frequently 	cited 	criticisms 	of 	unrestricted
branch 	banking 	is 	that 	it will 	destroy 	small 	community 	banks. 	A
bank 	failure 	may 	impose 	significant 	costs 	on 	consumers. 	Long
established 	banking 	relationships 	are 	interrupted, 	and 	some
uninsured 	deposits 	may 	be 	lost. 	From a 	consumer 	standpoint,
therefore, 	it 	is 	important 	to 	examine 	whether 	branch 	banking 	is
'likely 	to 	lead 	to 	bank 	failure.
Loans 	constitute 	the 	majority 	of 	assets 	on 	the 	balance 	sheet
of 	almost 	all 	banks. 	For 	both 	economic 	and 	legal 	reasons, 	a 	bank
lends 	mostly 	to 	businesses 	and 	individuals 	located 	in 	communities
of 	loans 	to 	assets 	and 	time 	deposits 	to 	total 	deposits, 	only 	that
for 	banks 	with 	low 	ratios, 	competition 	caused 	those 	ratios 	to
rise. 	Although 	the 	competition 	that 	occurred 	did 	not 	come 	from
branch 	banking, 	the 	effects 	of 	greater 	competition 	are
illustrative. 	Similar 	results 	were 	reported 	in 	Chandross, 	Robert
H., 	liThe 	Impact 	of 	New 	Bank Entry 	on 	unit 	Banks 	in 	One 	Bank
Towns,1I 	Journal 	of 	Bank Research, 	Autumn 	1971, 	pp. 	22-30, 	and
McCall, 	Alan 	S., 	and 	Peterson, 	Manfred 	0., 	liThe 	Impact 	of 	De 	Novo
Commercial 	Bank Entry," 	Compendium 	of 	Issues 	Relating 	to
Branching 	by 	Financial 	Institutions, 	Washington, 	D.C.: 	U.S.
Senate 	Subcommittee 	on 	Financial 	Institutions 	of 	the 	Committee 	on
Banking, 	Housing, 	and 	Urban 	Affairs, 	October 	1976, 	pp. 	499-521.
6 	Becker, 	Michael, 	Horwitz, 	Steve, 	and 	O'Quinn, 	Robert,
"Interstate 	Banking: 	Toward 	a 	Competitive 	Financial 	System,"
citizens 	for 	a 	Sound 	Economy 	Issue 	Alert, 	No. 	18, 	September 	16,
1987, 	pp. 	7-8.
4

The 	Honorable 	Paul 	D. 	Schauer
where 	it maintains 	offices. 	Thus, 	where 	local 	economies 	are 	not
well 	diversified, 	restrictions 	against 	branch 	banking 	leave 	banks
vulnerable 	to 	failure 	from 	local 	economic 	downturns. 	This 	could
be 	particularly 	important 	in 	a 	state 	like 	Colorado, 	where 	local
economies 	may 	be 	heavily dependent 	on 	single 	industries 	such 	as
skiing, 	farming, 	or 	tourism.
various 	studies 	show that 	since 	1933, 	bank 	failure 	rates 	have
been 	lower 	in 	states 	which 	permit 	unrestricted 	branching 	than 	in
states 	that 	do 	not. 	One 	study 	found 	that 	"evidence 	from 	as 	far
back as 	the 	1920s 	and 	1930s 	suggests 	that 	failure 	rates 	were
lower 	among multi-office 	organizations 	than 	unit 	banks." 	7 	A
1980 	Treasury 	Department 	study 	concluded:
Broader 	intrastate 	branching 	authority may 	reduce 	the
threat 	of bank 	failures 	and 	increase 	the 	continuity 	and
quality 	of 	service 	to 	local 	communities. 	8
The Treasury 	study 	confirmed 	similar 	findings 	of 	the 	u.S. 	Senate
Subcommittee 	on 	Financial 	Institutions. 	9 	This 	evidence
indicates 	that 	Colorado banks 	may 	be 	less 	rather 	than 	more
susceptible 	to 	economic 	disturbances 	if 	branching 	is 	allowed. 	We
have 	found 	no 	evidence that 	branching 	contributes 	to 	an 	increase
in 	the 	rate 	of 	bank 	failure.
We 	do 	not 	mean 	to 	suggest 	that 	the 	profits 	of 	banks
experiencing 	competitive 	pressures 	from 	the 	removal 	of 	branching
restrictions 	would 	remain 	at 	their 	previous 	levels. 	If 	branching
results 	in 	an 	increase 	in 	the 	number 	of 	banks 	in 	a 	local 	market,
the 	profits 	of 	incumbent 	banks 	would 	probably decline. 	This
would 	not 	necessarily 	result 	in 	bank 	failure, 	however, 	if 	the
incumbent 	banks were 	previously 	experiencing 	above 	average
profits. 	As 	mentioned 	above, 	a 	number 	of 	studies 	point 	to 	the
existence 	of 	above 	average 	profits 	in 	areas 	where 	there 	is
little 	competition. 	One 	such 	study 	looked 	at 	the 	effect 	of 	entry
7 	Eisenbeis, 	Robert 	A., 	"Interstate 	Banking's 	Impact 	upon
Financial 	System Risk," 	Economic 	Review, 	Atlanta: 	Federal 	Reserve
Bank 	of 	Atlanta, 	March 	1985.
8 	US, 	Department 	of 	the 	Treasury, 	Geographic 	Restrictions
on 	Commercial 	Banking 	in 	the 	United 	States: 	The 	Report 	of 	the
President, 	January 	1981.
9 	Gilbert, 	Gary 	C., 	"Branch 	Banking 	and 	the 	Safety 	and
Soundness 	of 	Commercial 	Banks," 	Compendium 	of 	Issues 	Relating 	to
Branching 	by 	Financial 	Institutions, 	Washington, 	D.C.: 	U.S.
Senate 	Subcommittee 	on 	Financial 	Institutions 	of 	the 	Committee 	on
Banking, 	Housing, 	and 	Urban Affairs, 	October 	1976.
5

The 	Honorable 	Paul 	D. 	Schauer
in 	98 	previously 	one-bank towns. 	The 	study 	found 	that 	for
three 	years 	before 	entry, 	banks 	earned 	significantly 	above
average 	profits. 	In 	the 	three 	years 	following 	entry, 	bank
earnings 	fell 	significantl o' 	but 	not 	below 	the 	average 	for
banks 	in 	the 	same 	state. 	1
the
all
It 	is 	possible, 	however, 	that 	the 	removal 	of 	branching
restrictions 	might 	reduce 	the 	returns 	of 	less-efficient 	banks
below 	a 	"normal" 	rate. 	While 	these 	banks 	may 	still 	earn
positive 	profits, 	the 	returns 	would 	be 	lower 	than 	those 	attained
in 	other 	industries. 	These 	banks 	might 	then 	be 	absorbed 	by 	more
efficient 	banks, 	including 	new 	entrants. 	Acquiring 	a 	currently
operating bank with 	an 	established 	asset- base 	is 	typically more
efficient 	for 	an 	entrant 	than 	de 	novo 	entry. 	Alternatively,
banks may 	respond 	to 	increased 	competition 	by 	improving 	their
performance 	through 	changes 	in 	the 	quality 	of 	their 	products,
e.g., 	by 	offering more 	personalized 	service. 	This 	behavior may
explain 	the 	inability 	of New 	York 	city banks 	to 	achieve 	any
significant degree 	of 	penetration 	in 	upstate 	New 	York markets
after 	the 	removal 	of 	branch 	banking 	restrictions 	in 	1970. 	In
analyzing 	the 	New 	York 	experience, 	one 	commentator has 	stated:
[T]here 	is 	virtually no 	evidence 	that 	small 	banking
organizations 	cannot 	compete 	effectively 	head-to-head 	with
larger banks .•. [T]he 	attempt 	by New York banks 	to 	move 	in
upstate 	communities 	provides 	but 	one 	recent 	example 	where
local 	banks were 	able 	to 	perform very 	well 	against 	larger
competitors. 	These 	local 	bankers 	showed 	formidable
strengths 	in 	their 	ability 	to 	serve 	their 	communities 	where
they 	were 	encouraged 	to 	do 	so 	[by 	statewide 	branching].
The 	interest 	that 	they 	paid 	on deposits 	rose, 	the 	interest
charged 	on 	loans 	fell, 	and 	the 	perks 	that 	the 	local 	bankers
were 	able 	to 	take 	for 	themselves 	were 	reduced. 	But 	profit
margins 	in many 	cases were 	not 	significantly 	affected, 	once
these 	local 	bankers 	began 	to 	compete. 	11
10 	Chandross, 	Robert 	H., 	"The 	Impact 	of 	New 	Bank 	Entry 	on
unit 	Banks 	in 	One 	Bank Towns," 	Journal 	of 	Bank 	Research, 	Autumn
1971, 	pp. 	22-30.
11 	Interstate 	Banking: 	How much, 	How 	fast?, 	The 	Heritage
Lectures 	45, 	March 	23, 	1985, 	p. 	7. 	See 	also, 	Frank 	B. 	King,
"Upstate New 	York: 	Tough Market 	for 	City 	Banks," 	Economic 	Review,
Atlanta: 	Federal 	Reserve 	Bank 	of 	Atlanta, 	June-July 	1985, 	pp. 	30-
34.
6

The Honorable 	Paul 	D. 	Schauer
Conclusion
We 	believe 	that 	an 	easing 	of 	restrictions 	on 	branch banking 	is
likely 	to 	benefit 	consumers 	in terms 	of greater 	convenience,
higher 	interest 	rates 	on deposits 	and 	lower 	interest 	rates 	on
loans. 	We 	also 	believe 	that 	a 	loosening 	of 	branch 	banking
restrictions 	would 	not 	render 	small 	banks 	unable 	to 	compete, 	nor
will 	it 	increase 	the 	risk of 	bank 	failure.
Please 	get 	back 	in 	touch 	if 	you 	have 	any 	questions 	concerning
this 	letter, 	or 	if we 	can be 	of 	assistance 	in 	any 	other way.
Sincerely,
a~'/ 	~./	~ 	, 	,
C 	.
Claude 	C. 	Wild 	III
Director
Denver Regional 	Office
7