Types and classes of commercial banks

Because commercial banks are so important to America's financial system, let's look at the various types and classes of commercial banks in the United States (Table 1-1 and Box 1-1). The birth of a bank begins with a chapter obtained at either the national or the state level. Chapter for national banks are granted by the Office of the Comptroller of the Currency (OCC), while those for state banks are granted by state governments, including the District of Columbia. Although a state bank has the option of joining the Federal Reserve System (“the Fed”), a national bank does not. A Fed-member bank must be insured by the Federal Deposit.

The legal definition of a bank and the nonbank bank

The 1970 amendment to the Bank Holding Company Act of 1956 defines a commercial bank as an institution that “(1) accept[s] deposits that the depositor has a legal right to withdraw on demand and (2) engages in the business of making commercial loans.” In the 1980s, prior to the passage of the Competitive Equality Banking Act of 1987, organizations were chartered that engaged in one of these activities but not both. They were called nonbank banks or limited-service banks; those that did not make commercial loans were also known as consumer banks. By using this loophole, these organizations avoided being regulated by the Federal Reserve as bank holding companies (BHCs). Companies such as Merrill Lynch, Sears, Shearson/American Express, E. F. Hutton, Gulf &Western, Prudential-Bache, Household International, Parker Pen, and J. C. Penney jumped on the nonbank-bank bandwagon.

To attempt to level the playing field in the FSI, the Competitive Equality Banking Act of 1987 banned further establishment of nonbank banks. Although the 160 or so existing nonbank banks were grandfathered, their activities were restricted such that they could not cross-market products and services with their parent companies, and after 1988 they were limited to annual growth of 7 percent. Bona fide trust companies and consumer banks were exempted from these restrictions, and because of the thrift crisis, nonbank banks were not excluded from bidding on failed S&Ls with assets of $500 million or more.

Insurance Corporation (FDIC). Before the crises in deposit insurance (both state and federal), a state chapter could be obtained without FDIC insurance; today such an occurrence would be highly unlikely but legally possible. As a result, de facto chartering power for state banks is effectively controlled by the FDIC.

Organizational form, business orientation, and geographic reach represent three additional ways for classifying banks. The dominant organizational form in commercial banking is the bank holding company (BHC), an organization that owns one or more banks. With money- and capital-market instruments (e.g., commercial paper and corporate bonds) crowding banks out of the wholesale market, the business focus of commercial banking has turned more toward small businesses consumers, and nontraditional banking products such as investment banking, mutual funds, and insurance. Although technology has permitted even the smallest banks to have a wide geographic reach, most banks operate in limited geographic areas defined by towns, counties, states, or regions. In contrast, multinational banks have worldwide reach. Although pawnshops have been around for centuries, consumer advocacy groups, like the Consumer Federation of America, have recently brought attention to these businesses as “shadow banks.” In addition to pawnshops, which numbered about 10,000 in the United States in 1994

(the number doubled since 1986), some 5,000 check-cashing stores and 7,500 rent-to-own stores are included in the category of shadow banks. They provide high-cost financial services to the less affluent members of society. Although one in five Americans has no relationship with a bank, some consumers prefer to have it that way. Others simply have no alternative but to deal with shadow banks, which provide money transfers, high-rate mortgages, and rent-to-own items such as televisions and furniture. Shadow banks are easily identified by their neon and chrome storefronts, in sharp contrast to the glass and steel facades of the modern commercial bank.

To blunt criticism from consumer-advocacy groups and politicians, some commercial banks began offering “lifeline banking” in the early 1980s. Defined as a limited package of retail banking services offered at a relatively low fixed monthly cost, lifeline banking has been offered to low-income depositors and senior citizens. Lifeline banking has evolved to “basic banking” (the term preferred by bankers), and this type of account or service is generally available to all depositors.