Why does the US have a weak mutual savings banks sector? Daniel R. WADHWANI March 2011 World Savings Banks Institute - aisbl – European Savings Banks Group – aisbl Rue Marie-Thérèse, 11 ￭ B-1000 Bruxelles ￭ Tel: + 32 2 211 11 11 ￭ Fax: + 32 2 211 11 99 E-mail: first [email protected] ￭ Website: www.savings-banks.com WHY DOES THE US HAVE A WEAK MUTUAL SAVINGS BANK SECTOR? Prof. R. Daniel Wadhwani, Assistant Professor, University of the Pacific R. Daniel Wadhwani, Assistant Professor of Management and Fletcher Jones Professor of Entrepreneurship at the University of the Pacific, received his B.A. from Yale University and his Ph.D. from the University of Pennsylvania before studying on a Newcomen Fellowship in Business History at Harvard Business School. He was a lecturer on the faculty of the Harvard Business School prior to joining the University of the Pacific in 2006. He has conducted extensive primary source research on the history of savings banks in the United States and is currently completing a book on the role of savings banks in the development of the market for personal finance in America. He has also examined the development of savings banks from a comparative-historical perspective. Over the last three decades, mutual savings banks have experienced a precipitous decline in their role in the American financial system. Dozens of savings banks have failed and hundreds have chosen to convert from their traditional “mutual” form into joint-stock institutions that are akin to commercial banks. The 82 mutual savings banks that remain in existence today account for less than 1% of the assets of the American banking system (OTS 2010: 9-10). Their position was not always this weak. At their height in the late 19th century, mutual savings banks accounted for over a quarter of the assets in the American banking system and financed infrastructure and housing development that was crucial to the growth of the industrial economy (Welfling 1968). For most of the 19th century mutual savings banks were the fastest growing financial institution in the US and generally had a reputation as conservative but well-managed institutions (Kroos Hermann and Martin Blyn 1971). 59 Why, then, have mutual savings banks become so marginal in the American banking system? What caused their precipitous decline? While it is common to attribute the decline of mutual savings banks in the United States to the period of bank deregulation beginning in the 1980s, the inability of American savings banks to compete in a deregulated environment has deeper historical roots. Savings banks in some other parts of the world – Spain and Germany, for instance – have successfully competed in the deregulated bank environment that has developed in the last three decades. To understand why American savings banks were unable to compete like their Spanish and German counterparts we need to understand the historical development of savings banks in the United States and their relatively weak capabilities. Their decline holds lessons for savings bank managers in other parts of the world today. Part of the decline of savings banks, as we shall see, was attributable to federal regulation, and especially to deposit insurance. By insuring commercial bank and savings and loan deposits as well as savings bank accounts, federal deposit insurance wiped out mutual savings banks’ most significant advantage in the eyes of depositors: their reputation for safety. But deposit insurance only accounts for part of the story. Mutual savings banks in the United States also remained regional rather than national institutions, failed to aggressively innovate their products and services when given the opportunity or presented the need to do so, and refused to cooperate as a group to engage in meaningful collective action. It was these historical weaknesses in the capabilities of mutual savings banks – as much as the regulatory environment – that led to the eventual decline of the institution when deregulation no longer protected its market from competitors. The paper is organised as a chronological account of the development and decline of mutual savings banks in the United States, focusing in particular on the weaknesses that would lead to their eventual demise in the late 20th century. Part I examines the origins and growth of savings banks in the United States. Part II considers the emergence of competitors in the market for personal savings, including commercial banks, S&Ls, and other intermediaries. Part III examines why savings banks failed to innovate and diversify their services in response to the competitive threats that emerged in the late 19th century. In part IV, I examine the lack of effort at collective action among savings banks in the United States; though they formed an association, it provided a very limited array of services when compared to similar savings bank associations around the world. 60 Part V examines the regulatory environment both before and after the New Deal and shows how it both protected savings banks from competitors while eliminating the key source of the savings banks’ competitive advantage. The sixth section examines the crisis of the last quarter of the 20th century. I conclude by considering some of the implications of the American experience for the managers of savings banks in other parts of the world today. Figure 1: Mutual Savings Banks’ Share of Assets of Selected Financial Intermediaries 30% 25% 20% 15% 10% 5% 0% 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2009 Sources: FDIC, White, “Were Banks Special Intermediaries.” Notes: Intermediaries include savings banks, commercial banks, and savings & loans. 1. Origins and Early Growth, 1810s-1870s The financial system in the United States during the 19th century was comprised of an array of institutions, each designed to provide a specific and often quite limited bundle of services. Its cornerstone was the commercial banks that state legislatures chartered to maintain a money supply and extend short-term commercial credit. Prior to the National Banking Act of 1863, commercial banks were regulated by the states; after 1863, some also came to be regulated by the federal government. 61 While commercial banks were extremely important for conducting business, they were only rarely used by individuals of modest means who wished to set aside small sums for future needs. The needs of small savers were met by a variety of other financial institutions, of which the most important were the mutual savings banks. The first savings banks in the United States were established during the 1810s in Philadelphia, Boston, New York and Baltimore, based on the model of the British Trustee Savings Banks. These savings banks accepted small-denomination savings deposits from the general public, which they were charged with investing in prescribed “safe” asset classes, usually government debt and high-grade mortgage loans. However, since mutual savings banks were state rather than nationally chartered institutions, the rules governing their investment practices varied from state to state (Olmstead 1976; Wadhwani 2006). From the outset, these institutions had been intended primarily to enable persons of modest means to save a portion of their present income to meet future needs. They furnished, as the founders of the Bank for Savings in New York explained in 1819, a “secure place of deposit” for “all who wish to lay up a fund for sickness, for the wants of a family, or for old age” (Manning 1917: 125). Savings banks were state chartered institutions that were prohibited from branching, and so remained “unit banks” targeted at serving savers in the local community (Welfling, 1968; Wadhwani, 2002). Though these early savings banks were based on a seemingly simple business model, it is easy to underestimate their innovative accomplishments. Prior to their establishment, no formal intermediaries existed that served the mass market for personal finance, and most “ordinary households” saved, borrowed and insured through direct personal transactions with people they knew. Over their first half-century, savings banks proved the viability and profitability of serving the mass market for personal finance. Much of their success lay in the credibility and trust they had developed among the general public, a growing portion of which entrusted their savings to the institutions (Wadhwani 2002). A critical element of the development of this credibility was the innovative corporate governance structure of mutual savings banks, which (like their British counterparts) were established as trusteeships on behalf of depositors, without a conflicting class of joint-stock shareholders (Wadhwani, forthcoming). 62 Throughout the 19th century savings banks grew extremely rapidly, buoyed by the rise of the urban, wage economy in which ordinary Americans found ways to manage their income and save for periods of old age, sickness and unemployment. With few competitors in this urban environment, mutual savings banks became the fastest growing financial intermediary in the United States between the 1820s and the 1870s. Between 1820 and 1910, the number of mutual savings banks in the country rose from 10 to 637, while their deposits soared from USD 1 million to USD 1 billion (Lintner 1948, Welfling 1968). In fact, in the 1870s, mutual savings banks controlled nearly a quarter of the assets of financial intermediaries in the United States – a moment that in retrospect represented the high water mark in their share of the American banking market. The rapid aggregate growth of savings banks in mid-19th-century America, however, masked one significant weakness. Throughout their history, mutual savings banks remained a regional institution rather than a national one. Mutual savings banks were chartered in only 19 states, primarily in New England and the Mid-Atlantic. In fact, historically more than 95% of savings deposits in mutual savings banks were accounted for by only nine states: Connecticut, Massachusetts, Maine, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Washington (FDIC 1997, Lintner 1948).