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The Functions and Future of Retail Banking by Jerry L

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The Functions and Future of Retail Banking by Jerry L September 15, 1996 eCONOMIC COMMeNTORY Federal Reserve Bank of Cleveland The Functions and Future of Retail Banking by Jerry L. Jordan Ar the tum of the century, one of the • Origins of Banks largest employers in America was the Economies have always developed Societies have always developed U.S . Ice Trust, which cut, stored, and methods for providing financial serv­ -ways to provide financial services. delivered ice for people's "iceboxes." ices. Over time, the providers of these Although medieval goldsmiths may Today, that industry employs only a frac­ services have adapted to changes in seem worlds removed from today's tion of the workforce it once did. This technology and customer preferences. commercial banks, they have one happened not because people stopped Functions that today are identified with important trait in common: Both consuming cool fresh food, but because "banking" were performed by the succeeded as financial intermedi­ the refrigerator-a product born of new organizers of the Champagne Fairs in aries because they were able to pro­ technology-all but eliminated the need the twelfth and thirteenth centuries. vide the services their customers for ice blocks. In contrast, the Fisher They issued tokens to participating mer­ wanted using the best technology Company, which produced carriages and chants, with each token representing available at the time. In this look at buggies in the early years of the century, deposits of coin, plate, and bullion that the future of the retail banking is still in the business of making automo­ had been tested. The merchants used industry, Federal Reserve Bank of tive bodies. these tokens to net out their accounts Cleveland President Jerry Jordan before settling in the deposited gold. At explains that as technology and What does the future hold for the retail the same time, scriveners- clerks who deregulation transform the financial banking industry? That depends on wrote letters and contracts in an illiter­ marketplace, it will be critical to whether it continues to provide value to ate age-reduced transaction costs. understand the services that people its customers. The challenge for bank desire and explore banks' compara­ managers and supervisors is to under­ Most professors of money and banking tive advantages in supplying them. stand what customers want-to distin­ fondly describe how medieval gold­ guish between cutting ice and keeping smiths accepted gold for safekeeping, food cold. In my view, understanding and how the receipts they issued eventu­ the services that people demand and ally became money. The goldsmiths exploring banks' comparative advan­ assayed bullion samples, certified their tage in supplying them will be crucial in quality, and issued receipts that were determining the future of the retail easier to carry than metal. Thus, they banking industry. added value by producing verifiable information and reducing transaction By considering the value-adding activi­ costs. From here, it was but a short step ties of banks, I hope to provide a frame­ to making loans.1 work for evaluating profitable opportu­ nities and assessing competition from Institutions more recognizable as banks, other banks, money market funds, or such as the Casa de San Giorgio in 1407 even phone and computer software com­ and the Bank of Amsterdam in 1609, panies. I also examine how new methods arose on the continent.2 These firms pro­ of delivering financial services may vided safekeeping and security, assessed affect the role of the Federal Reserve in and certified quality, and enabled transfer regard to money, the payments system, and banking supervision. payments. Although fund transfers had to industry, such as "commercial banking" Second, commercial banks as legally be conducted at the bank, transaction or "insurance underwriting." However, defined today may disappear in the costs were relatively low compared to there is no guarantee that one type of future, but some organization will per­ carting gold through the streets.3 heavily taxed, heavily regulated industry form the functions they now provide: that has been granted a particular "char­ payments, pooling, and risk manage­ This brief history holds several lessons. ter" will survive-quite the opposite. ment on the liabilities side, and resource First, many of these functions still sur­ transfers and risk management on the vive, though modern banks' methods of Consider savings accounts, which trans­ assets side. Again, these particular com­ providing loans and a convenient means fer purchasing power from the present to binations may not be undertaken by a of payment are considerably different. the future. This saving function can also single entity, just as the functions of Second, the institutional form has be accomplished by investing in com­ making jewelry and accepting deposits changed dramatically-from guild to mon stock. Although these methods in­ no longer exist jointly. corporation. For example, banking and volve different risks, buying a put option goldsmithing are no longer combined.4 can remove an important element of risk In the future, firms may serve customers from holding stock.6 The functions pro­ by bundling certain frnancial services • The Functional Approach vided by savings accounts need not be that are currently provided separately, or to Financial Services provided by a depository institution. may even merge banking-like services There have been several government with non-banking services such as con­ attempts, particularly in the United Something similar bas happened with cert and sporting event tickets, vacation States since the 1930s, to separate mortgages. In years past, people pur­ planning, and so on. They may utilize "financial service" activities into distinct chased houses by using personal sav­ electronic delivery vehicles accessible industries. These industries can, and do, ings. Later, the funds came from mort­ via the Internet. Some activities that we exist separate! y in market economies, as gage loans using the savings of other regard today as inappropriate, difficult, long as they perform functions that peo­ families within the community. Now, or even illegal for banks will most likely ple value. Adopting afunctional per­ home purchases are financed by non­ change, and may do so sooner than we spective, therefore, permits a deeper bank loans funded by investors in the expect. In the end, firms that find ways look into the well of issues surrounding mortgage-backed securities market. to deliver the services that the public the future of banking. When firms adapt wants will prosper. to competitive forces, we should expect Characteristically, commercial banks them to alter their product mixes, deliv­ have funded themselves with liquid lia­ Already, the New Zealand government ery vehicles, and corporate structures to bilities and have made illiquid loans. appears open to the idea of eliminating fulfill their functional role.5 They do, however, provide various the distinction between corporations other services to their customers. Func­ chartered as commercial banks and those As frnan~ial intermediai.ies, banks per­ tionally, then, a "bank" is a combination incorporated for other business pur­ form six broad functions: 1) conducting of financial service activities. Legally, poses. Customers of public utilities, such exchange (clearing and settling claims), however, it is a corporation that receives as phone companies, may carry interest­ 2) funding large-scale enterprises (pool­ a batiking charter and is subject to the bearing balances and instruct these ing resources), 3) transferring purchas­ rules and regulations thereof. Typically, organizations to credit the accounts of ing power across time and distance, 4) these strictures prevent banks or their other merchants. Indeed, the government providing risk management (hedging, holding companies from offering some may even permit some non-bank busi­ diversification, and insurance), 5) moni­ services that are readily available in the nesses to maintain settlement accounts at toring borrower performance (mitigating marketplace because of concerns about the Reserve Bank of New Zealand. adverse incentives), and 6) providing safety and soundness. What, then, would be called a "bank"? information about the relative supply and demand for credit. This prompts two important observa­ • Money tions: First, the functional definition of Evolution of the financial services indus­ Commercial banks perform all of these "banking" is not synonymous with the try carries implications for money and functions, but so do other organizations. legal definition. Thus, a financial hold­ monetary policy. Just as we are chal­ Although people will continue to make ing company owning a frnance com­ lenged to rethink what a bank is, we will payments, save for the future, and insure pany, a venture capital firm, and a be challenged to rethink what money is. themselves, one ca.J.llot assume that the money market mutual fund has a fair existing corporate forms will survive claim to be called a bank under the func­ Money will, of course, remain the same (remember the goldsmiths). For eco­ tional approach. Conversely, a chartered from an economist's perspective-a nomic reasons, combinations of products bank that specializes in global custody medium commonly accepted in trade for may exist at a certain time within one arrangements or serves only as a clear­ goods and services. But in practical inghouse for credit cards is, functionally terms, if the set of firms engaged in speaking,
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