Shackles off for a banking melee

AT LAST, the US has achieved interstate banking. The legacy of the Great Depression, which had shackled US banks to home markets and hindered their growth worldwide, has finally been lifted. The US Congress passed legislation last week that removed the last vestiges of border blockades that prevented banks from branching across state lines.

In effect, Congress has said let the merger mania begin. There is virtual consensus that the legislation will allow both the big US banks and their foreign rivals in America - British banks among them - to grow much bigger.

For more than a decade, successive US administrations have attempted to lift outmoded branching restrictions that had reduced the size and scope of US banks in international markets. As the big US money centre banks dropped, one by one, from the list of the world's top 20 institutions, cries for national reform would erupt. European and Japanese banks, bouyed by strong national positions, were seen as swamping US banks in international commerce. The Reagan Administration made a strong bid in the early 1980s to change the law but lost.

Reforms foundered in the aftermath of the US savings and loan crisis and the spate of bad real estate loans that provided ammunition for the naysayers in Congress. Deposit runs reminiscent of the 1930s and taxpayer bills climbing over dollars 200bn were powerful reminders to the anti-reform movement. Critics argued successfully that it would be foolish to give banking institutions more powers when they were misusing those they already had. Better to have an over- banked US market comprised of thousands of controlled mom and pop institutions, some incapable of completing even rudimentary foreign exchange transactions, than to let the big banks take over. Or so the critics argued.

Meanwhile, stronger US institutions found ways to circumvent branching laws by forming holding companies and opening separate subsidiaries in each state in which they intended to operate. This allowed banks in tightly knit regions to resolve the most glaring problems - but not all of them.

For example, under current law a customer of a bank branch in Connecticut cannot make a deposit at the same bank's New York branches. As a result, banks were forced to operate large, duplicative bureaucracies in each state, which cut into operating profits.

The new interstate banking law will eliminate these restrictions and also open up the field, giving more impetus to the consolidation in US banking that has already begun. The smaller state-protected banks, which had initially fought the bill, were placated somewhat by late amendments to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. These made it virtually impossible over the next several years for big banks to open branches in other states without first buying a bank there.

Congress was finally prompted to act on the reforms - and the Clinton Administration to make them a top legislative priority - by a big-bank lobbying blitz led by NationsBank of Charlotte, North Carolina - owner of Panmure Gordon, the London stockbroker. Hugh McColl, the chief excecutive of NationsBank, sat at President Clinton's side when his favourite Arkansas University Razorbacks won the US national collegiate basketball championships.

Access such as this was one of the necessary elements in the legislative victory. Mr McColl and others now confidently predict that big regional banks like his will greatly expand their markets, meeting big money centre banks like Citibank head-on in a national contest for dominance that will result eventually in a few huge US banks.

In other words, US banks will return to the world's top 20 list. However, without disputing the coming wave of mergers, financial specialists question whether banks in general will ever regain their former powerful status.

The rise of a largely unregulated parallel banking system - finance companies, money market mutual funds, mortgage companies and others - has already cut significantly into the traditional deposit- taking business of banks.

In 1980, outstanding assets of domestic US finance companies amounted to dollars 242.8bn, or 15.8 per cent of the assets of domesticially chartered commercial banks at dollars 1,534bn. By mid-1992, the finance companies' assets had risen to 26.1 per cent of the banking assets, which stood at dollars 3,003bn.

In response to the competition, banks began taking on more risk in their search for profits, as witnessed by the movement into a vast array of derivative products. Now there is fierce debate in the US over deposit insurance safety nets and whether they should be extended to banks that engage in such risky investments.

Successful banks have also begin to suggest that the less nimble players should be allowed to fail - without penalising the rest. The point of all this being that the modern US banking saga is only beginning.