Thrift Involvement in Commercial and Industrial Lending

Federal Reserve Bulletin, Dec, 1998 by Steven J. Pilloff, Robin A. Prager

The rapid pace of mergers and acquisitions among financial institutions in recent years has heightened the need to understand competition in banking markets. Questions often arise as to the most appropriate ways to measure competition. One particular issue that has received attention from the bank regulators and antitrust officials who analyze the competitive effects of proposed bank mergers is the weight that should be given to thrift institutions as actual or potential competitors of commercial banks in the provision of financial services. The question arises because, historically, the menu of financial services offered by thrift institutions has been more limited than that offered by commercial banks.

Thrift institutions (savings and loan associations and savings banks) are financial intermediaries that raise funds primarily through time and savings deposits and invest principally in residential mortgages and consumer loans. Their focus on consumer accounts and loans, as opposed to business accounts and loans, is largely attributable to historical factors. Thrift institutions arose in the early nineteenth century to satisfy an unmet demand for small savings accounts and home mortgages in an era when commercial banks had little interest in these lines of business.

Savings and loan associations (originally called building and loan societies) were established to enable wage earners to obtain funds to build or purchase homes. Their balance sheets consisted primarily of residential mortgages on the asset side and savings shares on the liability side. Savings banks were established to encourage savings by poorer members of the working class. Their liabilities consisted mainly of savings deposits, and their assets were somewhat more diversified than those of savings and loan associations, including consumer loans in addition to residential mortgages. Subsequent regulations, at both the state and federal levels, limited the types of deposit accounts that thrifts were permitted to offer and the extent to which they were allowed to invest in non-mortgage assets. The relaxation of federal restrictions (particularly those affecting commercial and industrial lending) starting in the early 1980s has led to greater portfolio diversification by many thrift institutions; however, few thrifts have taken full advantage of their expanded powers.(1)

The limited range of financial services typically offered by thrift institutions compared with commercial banks raises a challenging question for those responsible for assessing the competitive effects of proposed bank mergers and acquisitions.(2) Should thrifts and commercial banks be treated as equal competitors in local banking markets, or should the role of thrifts be discounted because of their less extensive involvement in the provision of commercial and industrial (C&I) loans and other business services?(3) Although the degree of actual competition provided by thrifts in the area of C&I lending may he modest, their role as potential competitors could be important. A thrift institution that is actively involved in residential mortgage and consumer lending in a local market could, at least in theory, quickly shift resources into commercial lending if it determines that the risk-adjusted profits to be derived from commercial lending exceed those associated with more traditional thrift activities. Likewise, a thrift that is involved in commercial lending to a very limited extent could increase its involvement in response to profitable lending opportunities. In practice, however, the specialized expertise needed to engage in C&I lending and the perceived need to offer a broad menu of financial services to commercial banking customers may inhibit thrifts from aggressively pursuing commercial lending opportunities.

This article assesses the role played by thrift institutions as competitors of commercial banks in the provision of commercial and industrial loans by examining variations in bank and thrift involvement in C&I lending both over time and across institutions and markets having different characteristics. Two aspects of involvement are examined. "Participation" is examined by looking at the proportions of commercial banks and thrifts that have some of their assets in C&I loans, as well as the proportions whose C&I loan-to-asset ratios are above 1 percent and above 5 percent. And "extent of involvement" is examined by looking at the average ratios of C&I loans to assets for banks and thrifts that engage in C&I lending. Also examined are the ways in which the change between 1991 and 1997 in an institution's involvement in C&I lending is related to certain institutional characteristics.

PATTERNS OF C&I LENDING ACTIVITY

To examine patterns of commercial and industrial lending, we looked at variations in lending activity over the period 1991 through 1997 and at the relationship between 1997 lending activity and such variables as institution size, ownership status, and get)graphic location.(4) The initial sample consisted or commercial banks and thrift institutions that filed either a midyear Report of Condition and Income (Call Report) or a midyear Thrift Financial Report. With certain exceptions, an institution that filed a report was included in the sample if its total assets were reported to be greater than zero and an amount was reported for total loans. Institutions that held more than 25 percent of their assets in credit card loans were excluded because institutions that are heavily involved in such lending often specialize in that activity and do not provide, and therefore do not compete for, many of the retail banking products and services typically provided by commercial banks. (The Federal Reserve typically excludes credit card banks from its analysis of the competitive effects of proposed bank mergers.) Data are as of June 30 of each year.