Ebook Bank Risk and the Declining Franchise Value of the Banking Systems in the United States and Japan
A major development in industrialized countries over the past decade has been the growing modernization, deregulation and integration of financial markets. This in turn has produced increased competition among the suppliers of financial services. Although this increase in competition has resulted in increased efficiency in the allocation of financial resources, it has also brought concerns about a decline in the franchise value of the banking industry i.e., the value of the business that distinguishes banks from other financial intermediaries.
This paper deals with the recent evolution of the franchise value of banks in the United States and Japan. The problems of banks in the United States are well known. Twice in the last five years, provisions for bad loans have more than wiped out the aggregate net income of American wholesale banks, and they have been forced to pay dividends out of capital. In addition, after an extended period of maintaining a high return on equity, Japanese banks have also recently been experiencing downward pressure on earnings and on capital. This paper argues that the franchise value of wholesale banking in the United States and Japan has declined, increasing the incentives for risk taking by banks. Specifically, the paper maintains that the decline in franchise value has led to increased risk taking on the part of wholesale banks in the United States and to a decline in earnings at Japanese wholesale banks.
In contrast with the conventional view that identifies the franchise value of banking as arising from informational advantages over other lenders, this paper argues that banks are unique because they are the cheapest source of "good funds" i.e., cash or items whose delivery always constitutes settlement of a claim for cash in the economy. This uniqueness is derived from the special nature of the banking system which can mobilize good funds more easily than competing financial institutions. As such, the franchise value of banking originates in the provision of liquid assets and payments services to banks' customers. The higher the demand for those services, the higher the value of the banking franchise. A central argument in this paper is that, following the liberalization of financial markets and the increased efficiency in the payments systems, corporations in the United States and Japan reduced their demand for bank liquidity. This in turn led to a decline in the franchise value of wholesale banks in those two countries.
The proper identification of the franchise value of banking has important policy implications. In recent years, concerns about the profitability of wholesale banks in the United States and Japan has led authorities in those countries to consider expanding the range of activities undertaken by banks. In the United States, for example, the Treasury's proposal for reform of the banking system aims at removing restrictions on securities activities by depository institutions and at loosening restrictions on interstate banking. Similarly, in Japan, debate is under way over a proposal to broaden the securities powers of banks. An important implication of the analysis in this paper is that bank reform envisioned in current proposals may not be able to solve the fundamental problems of wholesale banks. This is because broader powers are unlikely to offset the declining franchise value attributable to a reduction in corporate demand for bank liquidity.
The rest of this paper is organized as follows: Section II presents the conventional view regarding the nature of the franchise value of banks, discusses its shortcomings and suggests an alternative view. This section also discusses the factors that have induced banks to undertake risky activities, emphasizing the linkages between risk taking and the franchise value of a bank. Section III presents a brief overview of banking systems in Japan and the United States. Section IV analyses the franchise value for wholesale banks in the United States and Japan and explores the relationship between the decline in this value and the increase in bank risk. Section V analyzes the franchise value for American and Japanese regional banks. Section VI evaluates the potential effectiveness of proposed reforms in solving the problems faced by major banks in the United States and Japan. Finally, Section VII contains the paper's conclusions.
Contents
Summary
I. Introduction
II. The Nature of the Franchise Value of Banks and its Effect on Bank Risk
- 1. The conventional view on the franchise value of banks
2. An alternative view on the franchise value of banks
3. Linkages between risk and the franchise value of banks
III. An Overview of the Banking Systems in the United States and Japan
IV. Franchise Value in Wholesale Banking and Bank Risk in the United States and Japan
- 1. The franchise value of wholesale banks in the United States
2. The franchise value of Japanese wholesale banks
V. Franchise Value in Regional Banking
- 1. U.S. regional banks
2. Japanese regional banks
VI. Regulation and the Franchise Value of Banks
VII. Conclusion
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