branch prohibition certainly has not been in the public interest. But at the same time, concentration of all banking business into big banks and the disappearance of unit banks has great dangers; we should not want that extreme either.

The optimum banking structure would seem to include the following features: The banking profession should develop such a high order of responsibility that supervisory arrangements could be reduced to much smaller scale. Rather than worry about who should be supervising banks, we should be looking forward to the time when the function is as nearly superfluous as possible. Secondly, banks should have greatly increased powers to branch, and chartering provisions should be liberalized. While the public cannot afford a rash of wildcat banking, the danger of that is far less serious than the danger of restricted competition in banking. Finally, a spirit of entrepreneurship in banking should assure the survival of efficient unit banks so that the banking giants cannot become competitively inactive or inefficient. The very smallest unit banks may disappear by attrition, but the efficient ones of reasonable size should be able to survive.

16. BRANCH BANKING,

MERGERS, AND

COMPETITION

By PAUL M. HORVITZ

THE structure of American banking in the years following passage of the National Banking Act was relatively simple-there were many banks, virtually all with national charters, and virtually none with branches. The 10 percent tax on issuance of bank notes by state banks, imposed in 1865, in effect taxed state banks out of existence. Branch banking was not an important issue in Congressional debate on the Act, and the Act itself does not specifically mention branch banking. There was, however, an implied outlawing of branch banking in the National Banking Act. Several clauses referred to "the place" where banking operations would be carried on, and where the "banking house" would be located. Comptrollers of the Currency interpreted the singular form of these words to mean that the intent of the lawmakers was to prohibit the establishment of branches by national banks.

The banking structure became more complicated as bankers found in the late 1880's that note issue was not essential and that a profitable banking business could be operated on the basis of deposits and discounts. This led to the resurgence in the strength of state banks, their number increasing from under 250 in 1868 to 6,650 in 1900. The development of the dual banking system also meant the reappearance of branch banking, as about half the states allowed state chartered banks to establish branches. Many conflicts arose at this time between national banks and state banks, between branch banks and unit banks, and between state and federal bank regulatory authorities.

The first two decades of the twentieth century witnessed a tremendous growth in the number of banks and banking offices in the United States. These were years of rapid industrial and agricultural ad

vance, accompanied by the development of the American West, and also a time of rising land and commodity prices. The number of banking offices more than tripled during this period, reaching a peak of over 31,000 in 1922. From 1915 to 1922 an average of over 500 new banks per year were chartered.

The 1920's and early 1930's were years of retrenchment for the banking system. By 1929 the number of banking offices was down to about 25,000, and by 1933 to about 17,000. Bank failures and mergers were common during the 1920's, and this trend was greatly aggravated in the period from 1930 to the bank holiday of 1933. During this three-year period, approximately 9,000 banks suspended operations and over 2,300 disappeared as a result of mergers.

The reorganization of the banking structure was virtually completed by the end of 1935. At that time there were about 15,000 banks and 3,000 branches in existence. While the number of bank failures dropped off sharply in the post-1933 years, the number of banks continued to decline slowly until 1945 due to mergers, while few new banks were chartered. The number of branches rose almost uninterruptedly throughout the whole period, but, even so, the number of banking offices fell by about 50 percent from 1922 to 1945.

These same trends have continued to the present time. We have had a gradual decline in the number of banks (a decline of about 800 since 1947), as mergers have outpaced new chartering activity, and an increase in the total number of banking offices due to expansion of branch banking (nearly 1,000 new branches per year since 1958).

The trends in banking structure have been aided by much of the banking legislation passed in the last 100 years. The McFadden Act and the Banking Act of 1933 liberalized the power of national banks to establish branches,' and several states passed legislation liberalizing their branch banking laws so that now some branching is allowed in 37 states. Nevertheless, we still have a dual banking system of state and federal charters and both unit and branch banks. The conflicts which existed in 1900 between different types of banks and regulatory authorities have not been resolved, and, in fact, have become more intense.

The conflict over branch banking exists not only between the Inde

1 It might be noted that even before Congress acted to grant national banks branching powers in 1927, the Comptroller of the Currency began in 1922 to grant permission to national banks to establish limited-power additional offices. The Attorney General supported the legality of this action.

pendent Bankers Association and branch bankers, but also between the IBA and some regulatory authorities,2 and between national and state banking authorities. The conflict over bank mergers is even more intense, with disagreements over merger policy among the Comptroller of the Currency, the Anti-Trust Division of the Justice Department, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation.

A major part of the problem concerns competition in banking. Economists have a strong predilection in favor of competition, but competition is not an end in itself. Competition is desirable because of what it leads to an efficient allocation of resources with produc tion carried on at minimum cost with minimum sustainable prices charged to consumers. Merely having a large number of competitors does not assure that these ends are being achieved. This is the nub of a large part of the problem of branch banking and banking competition. Opponents of branch banking focus on the number of banks and the concentration of banking power. Proponents of branch banking are more concerned with making the competitors really com. petitive.

It is not legitimate to look at the large number of banks in the United States and conclude that banking is a very competitive industry (or even that it is more competitive in this country than in Canada or England where the number of banks is much smaller). It is obvious that not all American banks compete with one another. There are many more-or-less separate and distinct banking markets, and it is important to stimulate competition in these separate banking markets. For the same reason, it is likewise not legitimate to measure banking competition in terms of the proportion of total bank ing assets held by the 100 or 200 largest banks in the country.

Unfortunately, encouraging competition in banking is not a simple matter. We cannot rely as completely on free market forces as we do in other industries because banking competition is tied up with problems of banking safety and banking factors. If an entrepreneur sees an opportunity to profitably manufacture steel, automobiles, or cigarettes, he is free to do so. The government would certainly do nothing to restrain a new firm from entering the steel, auto, or tobacco industries. The government would certainly do nothing to prevent a Pittsburgh-based steel manufacturer from establishing a 2 See, for example, the Wall Street Journal, May 2, 1963.

new plant on the west coast. This is not the case in the banking industry. Establishment of a new banking office (unit bank or branch) requires approval from regulatory authorities who will take into account in making a decision the effect on competition and several "banking factors"-the financial history and condition of the bank, capital adequacy, future earnings prospects, character of management, and the convenience and needs of the community involved.

The justification for limiting entry into the banking business lies in the need for a stable monetary system. Commercial banks are holders of a large fraction of community savings and means of payment. It is widely felt that banks must be shielded against the vigorous competition that characterizes some other industries in which failure is considered part of the game. In this view, the social costs of bank failures are considered to outweigh whatever inefficiency results from restricting bank entry.3 This means that if establishment of a new banking office will endanger the safety of an existing bank, the regulatory authorities may refuse to grant approval to the new office. Even evidence that the existing bank is inefficiently run may not help to gain approval.

This does not mean that regulatory authorities have been unaware of the desirability of increased competition. The President's Committee on Financial Institutions found that "the effect on competition, although it is only one of seven factors specified in the Bank Merger Act, is accorded substantial weight." Preston Delano, a former Comptroller of the Currency stated to a Congressional Committee that:

The availability of credit could be broadened and its cost to American business reduced if a feasible means could be devised for achieving effective banking competition in all communities and areas.5

Not only is it desirable to encourage more competition in certain banking markets, but it has been necessary in recent years to reshape somewhat the geographical structure of banking. The United States was probably inadequately served by banks around the end of World

3 Cf. Deane Carson and Paul Cootner, "The Structure of Competition in Commercial Banking in the United States," in Private Financial Institutions, Commission on Money and Credit (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1963).

4 Report of the Committee on Financial Institutions (Washington, D.C.: U.S. Government Printing Office, April, 1963), p. 48.

5 Monetary Policy and the Management of the Public Debt, Subcommittee on General Credit Control and Debt Management of the Joint Economic Committee, 82nd Cong., 1952, p. 928.