A Staff Report from the Straight Dope Science Advisory Board

Why are banks opening so many branch offices?

July 17, 2007

Dear Straight Dope:

What's with all the banks opening on every corner? I've even seen a bus converted to a mobile bank. Is there really a need for all those branch banks in the era of the Internet or is this some kind of scam?

SDStaff Gfactor replies:

Gnome 1: Hey, what's phase two?!
Gnome 2: Phase one: we collect underpants.
Gnome 1: Ya, ya, ya. But what about phase two?
[Silence]
Gnome 2: Well, phase three is profit. Get it?
—South Park, episode 30 (1998)

A scam? Well, they're real banks, or more accurately, they're real offices of financial services companies, many of which are banks. While banks and quasi-banks are certainly opening lots of branches these days, for reasons we'll explore, the fact is that they've been on a branch-opening frenzy for quite a while.

Why? It's a little complicated, but basically it comes down to profit. In the nineteenth century, commercial banks didn't need branch offices because they had little use for the nickel-and-dime transactions of the consumers that branches serve. Instead they sought commercial accounts. According to Peter Rose, in The Changing Structure of American Banking (1987), National City Bank of New York was the first commercial bank to open a consumer credit department – in 1928. Before that, consumer banking was the business of credit unions, savings and loans, mutual savings banks, insurance companies, mortgage bankers, and finance companies.

Commercial accounts are still a big part of what banks do, but large corporations nowadays have lots of nonbank options for meeting their financial needs. Since the 1950s, the real growth for banks has been in consumer accounts, fueled by the expansion of the American middle class. "Confronted with unprecedented opportunities for profitable installment and real estate lending and a ready source of loanable funds from family savings accounts, U.S. commercial banks for the first time in their history offered aggressive competition to nonbank thrift institutions and finance companies for consumer accounts," Rose writes. Banks had a competitive advantage because they could offer services that thrifts couldn't (checking accounts and later credit cards, for example). It was banks' desire to muscle in on the consumer banking market that led to the original surge in branches after World War II.

But that was more than fifty years ago. Why are there more bank branches around today than ever before?

In Money and Capital Markets (2003), Rose outlines several trends affecting financial institutions that contribute to the phenomenon. First, cost pressures are increasing. It's a lot cheaper to open a branch, or buy one, than to start a bank from scratch.

That brings up an important point. While we're seeing more bank offices these days, we aren't seeing more banks – quite the contrary. That's because of another trend Rose mentions: consolidation. As you can see on the graph below, there are actually fewer banks today than there were twenty years ago. The number of banks peaked in 1984 (14,496) and gradually dropped to around half that amount (7,527) by 2005. That's partly due to regulatory changes during that period that made it easier to open branch banks.

The U.S. has a long history of regulating branch banking. In 1864, the National Bank Act created the office of the Comptroller of the Currency, who soon decided national banks weren't allowed to have branches. In 1927, the McFadden Act and subsequent amendments permitted national banks to open branches within a state, subject to the same state branch-banking regulations as state-chartered banks, which was a victory of sorts; but it also prohibited interstate branches, which was a loss. Another problem for banks was that the states, which now controlled intrastate branch banking, tended to sharply limit branches. Creative bankers who wanted to open branches came up with the idea of creating bank holding companies to own banks in multiple states. The Bank Holding Company Act (1956) thwarted that plan – out-of-state bank holding companies were prohibited from controlling banks in a state without express permission from state regulators.

In the 1980s, banks began to lose their competitive edge over nonbank financial services companies. Legal changes empowered nonbank thrift institutions such as savings banks and savings and loan associations to offer services previously restricted to banks. These competitors posed a serious challenge to bank dominance because many of them weren't subject to the territorial limits imposed on banks. Banks began to pressure state regulators to relax branching restrictions, and by the late 1980s some states were doing so. Banks opened branches in other states wherever it was legal to do so, and also expanded by merging with other banks or buying failed savings-and-loans after the S&L crisis. In 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act opened the branching floodgates by making it possible for a bank holding company to acquire banks in every state – even if state law prohibited it.

As Rose points out, regulatory changes only partly explain the growth of branch banking. Another factor is shifting population: "Many of the nation's largest banks have followed their customers to distant markets through branching and mergers to protect their sources of funds and their earnings and gradually spread across the nation." Similarly, Mark Carlson and Kris Mitchener note in a 2005 working paper: "growth in branching is attributable largely to shifts in the relationships of banks with each other, technological progress, and population/economic growth rather than changes in regulation specifically concerning branching[.]"

Finally, Rose talks about convergence – the distinction between banks and other financial services providers is eroding, and competition between them is increasing. Due to competitive pressure from nonbanks, banks today offer more financial products than ever before. To market these products effectively, they need a visible retail presence. As Matt Valley put it in a 2003 article:

Banks want to sell a full line of investment products – from mortgages to mutual funds – and that requires a personal touch, says Bruce Ficke, CEO of account management for Jones Lang LaSalle, which represents Bank of America in its massive expansion program. "These branches are viewed as their link to the customer."

Rose points out that commercial banks (which traditionally have made their money on loans) are combining with investment banks (which help businesses raise money in the capital markets) to become universal banks. "In 1999 with the passage of the Gramm-Leach-Bliley Act, leading banks in the United States began to move toward universal banking more aggressively, establishing financial holding companies (FHCs), combining banking, securities, insurance, and other affiliates under one corporate umbrella. Nineteen of the 20 largest U.S. banks now belong to an FHC."

This diversification in banking services applies equally to many bank competitors, including mutual funds, pension funds, insurance companies, finance companies, savings and loan associations, savings banks, credit unions, and money market funds. All of these entities are entering the same financial services markets as banks. So while the number of banks is declining, the number of entities that look like banks and market themselves like banks is increasing, and with it the number of branch offices – in fact, branches are multiplying faster than people. According to Richard Newman of NorthJersey.com, between 2000 and 2005 the number of bank branches in the U.S. expanded 7.6 percent while the population increased 5.3 percent. The trend is particularly noticeable in gentrifying urban areas such as Brooklyn and parts of Chicago that historically have been neglected by the financial services industry and are just now catching up. Still, look at that graph again – the uptick in branches began in the 1950s, and growth has been pretty steady since. While the day will surely come when the market is saturated, the trend hasn't shown signs of flattening out yet.

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Staff Reports are written by the Straight Dope Science Advisory Board, Cecil's online auxiliary. Though the SDSAB does its best, these columns are edited by Ed Zotti, not Cecil, so accuracywise you'd better keep your fingers crossed.

References

Carlson, Mark A. and Mitchener, Kris James, "Branch Banking, Bank Competition, and Financial Stability" (April 2005). FEDS Working Paper No. 2005-20: http://ssrn.com/abstract=725021

Ely. Bert, "Savings and Loan Crisis," The Concise Encyclopedia of Economics: http://www.econlib.org/Library/Enc/SavingsandLoanCrisis.html

FDIC website: http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=20

Federal Reserve Bank of San Francisco, "Bank Diversification, Economic Diversification?" FRBSF Economic Letter, May 12, 2006: http://www.frbsf.org/publications/economics/letter/2006/el2006-10.html

Harrigan, Susan, "Lots of branches, fewer trunks," Newsday.com: http://www.newsday.com/business/ny-bzbank0515,0,2606239.story

Jayaratne, Jith & Strahan, Philip, "The Benefits of Branching Deregulation," Regulation 22(1) (1999): http://www.cato.org/pubs/regulation/regv22n1/branching.pdf#search=%22more%20bank%20branches%20deregulation%22

Klebaner, Benjamin, Commercial Banking in the United States: A History (1973)

Knox, John, A History of Banking in the United States (1908)

Koltveit, Jim, "So many banks, so little profit. Is the industry 'overbanked'?" Bank Notes, June 2005: http://www.rsmmcgladrey.com/publica...overbanked.html

Kroszner, Randall, "The Effect of Removing Geographic Restrictions on Banking in the United States: Lessons for Europe," speech given April 6, 2006: http://www.federalreserve.gov/boarddocs/Speeches/2006/20060406/default.htm#fs6

Matasar, Ann & Heiney, Joseph, The Impact of Geographic Deregulation on the American Banking Industry (2002)

Milkove, Daniel, "Deregulation Will Not Eliminate Rural Banks," Rural Conditions and Trends 9(3) (1999): http://www.ers.usda.gov/publications/RCAT/rcat93/rcat93i.pdf

Newman, Richard, "Banks grow faster than population," Northjersey.com, February 11, 2007: http://www.northjersey.com/page.php?qstr=eXJpcnk3ZjczN2Y3dnFlZUVFeXkzJmZnYmVsN2Y3dnFlZUVFeXk3MDc0MDQ2JnlyaXJ5N2Y3MTdmN3ZxZWVFRXl5Mg==

Rose, Peter, Banking Across State Lines (1997)

Rose, Peter, The Changing Structure of American Banking (1987)

Rose, Peter, Money and Capital Markets (2003)

Schmidt, Jason & Wirtz, Ronald, "In Banking, Less Can Equal More," Fedgazette, November 2004: http://minneapolisfed.org/pubs/fedgaz/04-11/cover.cfm

Strahan, Philip, "The Real Effects of U.S. Banking Deregulation," The Wharton Financial Institutions Center, 2002: http://fic.wharton.upenn.edu/fic/papers/02/0239.pdf#search=%22state%20banking%20deregulation%20expansion%22

Valley, Matt, "It's a Bidding War," Real Estate Investor, August 1, 2003: http://nreionline.com/strategies/corporate/real_estate_bidding_war/

Wirtz, Ronald, "Too much of a good thing?" Fedgazette, November 2004: http://minneapolisfed.org/pubs/fedgaz/04-11/good.cfm

Wright, Robert, Origins of Commercial Banking in America, 1750-1800 (2001)

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