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Blessings of Liberty

Friday, March 1, 1996

In the early 1980s, the Texas banking industry seemed like a sure winner. The oil industry was booming. The state's population was growing rapidly as workers came in search of Sun-Belt prosperity. Major Texas-based manufacturing and retail enterprises burgeoned. Not surprisingly, some of the fastest-growing U.S. banks were located in bustling Houston and Dallas.

But then the bottom fell out of gas prices -- and the banking industry. By 1990, the state's largest banks no longer existed, resulting in billions of dollars in bad loans and leaving bank customers confused and angry. Suddenly, the dominant players in the state's banking industry were those that hailed from faraway places like North Carolina and Ohio.

It was not pleasant to be a bank customer in Texas back then. If you were a depositor in a bank that collapsed, you may have gotten all or part of your money back from the FDIC -- but you lost other things, such as convenience and a sense of security. If you owned a small business and badly needed a loan to expand, the picture looked even bleaker. Failing banks aren't likely to lend you money or cut you slack when you need it most.

Other states have seen downturns in their dominant industries without suffering the double- whammy of bank failures. The difference is government regulation. Until recently, Texas imposed strict geographical and size restrictions on its banks. Statewide branching was prohibited. These regulatory barriers kept Texas banks tethered to particular cities or regions, protecting them from competition and giving them little incentive to embrace innovation and serve consumers better. Lacking the diversification necessary to weather the oil glut of the 1980s, the state's banks either went under, saw the value of their equity drop, or were bought by stronger banks from more competitive, less regulated markets.

One such market was Charlotte, North Carolina, home to NationsBank and First Union, two of the nation's 10 largest banks. At first glance, the idea that Charlotte would be one of America's leading financial centers seems absurd. With one-fifth the population of Houston, Charlotte has no obvious advantages in commercial influence or financial acumen. Yet Charlotte has become the banking capital of the Southeast. And NationsBank has become the largest bank in Texas.

A major reason for the ascension of North Carolina banks to the upper tier of the industry is, once again, regulation. The state has some of the least restrictive bank regulations in the country. The state legislature authorized statewide branching in 1814; at the beginning of this century, the state began to charter banks and allowed them to sell insurance and other financial services. In the following decades, banks in the largest cities established branches across the state and began selling such products as annuities, commercial insurance, and securities.

By the 1980s, a bank customer in North Carolina enjoyed many benefits unavailable to his peers in Texas. He could transact business with the same bank virtually anywhere in the state, which accelerated routine tasks such as clearing checks, depositing funds, and seeking balance information. He could purchase more services at lower cost than in Texas, because statewide banks can spread fixed administrative expenses over more branches and customers and can hire more experienced bankers. He was much more likely to have access to national ATM networks and bank credit cards with low interest rates. Most importantly, he had security. With a diversified loan portfolio and depositor base, his bank was less dependent on the economic health of dominant local industries.

The benefits of competition in banking have become increasingly clear. In 1960, the year that NCNB (NationsBank's predecessor) was created from the merger of two small banks, North Carolina was one of 16 states with statewide branching. Over the next 20 years, there were only 17 bank failures in those states, compared with 45 failures in the states that allowed limited regional branching and 66 failures in the states that prohibited branching altogether.

During the 1980s, a combination of economic turmoil and bad policy decisions created even more banking risk. In the first four years of the decade, more than 500 savings-and-loans and almost 200 commercial banks failed. Then things got worse. In 1988 alone, 200 banks and 233 savings-and-loans closed or were liquidated. Most failures occurred in highly regulated states.

By 1990, most states had figured out what North Carolina already knew: Competition is better than protection. Only three states continued to prohibit branching, while 33 allowed it statewide. Furthermore, Texas and other states dropped their longtime aversion to interstate banking and allowed banks in nearby states to acquire failing institutions.

For banks in North Carolina (as well as in Ohio, New York, and California) that were bred in fiercely competitive statewide markets, even this limited form of interstate banking represented a golden opportunity. NCNB went into Florida in 1981, South Carolina, Virginia, and Maryland in 1986, and Texas in 1988. A subsequent merger with C&S/Sovran in Virginia created NationsBank, which continued to enter new markets in the Southeast, most recently consolidating its position in Georgia by acquiring Bank South.

Charlotte's other big bank, First Union, has also pursued numerous acquisitions in the new era of interstate banking. Most recently, it purchased First Fidelity Bancorp, making it the largest bank in New Jersey and sixth largest in the U.S.

The First Fidelity deal illustrates why competition and interstate banking have much to offer consumers. As with statewide branching, interstate banking makes it easier for customers to do routine things. Travelers to another state can often bank at their own institution, which is usually cheaper and easier. Checks clear faster and are accepted at more businesses. Firms with operations in various states can work with a familiar institution rather than learning new rules and developing new relationships every time they expand. And according to economist Steven Horwitz of St. Lawrence University, both business and residential borrowers find it easier to get credit. "Banks in states with more liberal branching laws use a greater proportion of their resources for loans than do banks in states that limit branching," he says.

For Garden State customers, the differences will be immediately noticeable, say banking analysts. "First Union, Nationsbank, and Wachovia [another major N.C. bank] offer customer service that is clearly superior" to the New Jersey norm, says Anthony Davis of Dean Witter Reynolds. Many New Jersey banks still close at 3 p.m., and few offer customers automated systems for checking balances or conducting transactions by telephone. With the arrival of First Union, New Jersey's mutual-fund investors can also enjoy one-stop shopping at their local bank.

Of course, bigger is not necessarily better. It is competition, not size per se, that has allowed banks in less regulated markets to serve their customers better. Although North Carolina has fewer separate banking institutions per capita than most states, its competitive climate allows plenty of mid-sized and small banks to continue to battle successfully with large banks for market share across the state.

"I think community banking will always have a future because a number of people want to be known by name," says Bill Graham, the former banking commissioner of North Carolina. By identifying niche markets and improving customer service, home-grown banks in such states as Texas and Florida have thrived even as out-of-state banks have moved in. Post Oak Bank in Houston, for example, specializes in private banking and trust services for middle- and upper- income professionals. "We felt the five big banks would be very dominant in the mass retail market," says chairman Kent Anderson, "but we felt opportunities existed to work the personal- services business."

Actually, the best way to keep community banking healthy may well be to push for even more deregulation. Sidney Bostian, former chairman and CEO of Investors Savings Bank, the second-largest thrift in Virginia, says that community banks are hurt most by costly state and federal regulatory burdens and by high taxes and fees, because larger competitors can spread such costs over a greater number of workers and customers. "While consolidation is a desirable outcome in our banking system," Bostian says, "policymakers should take care not to create artificial incentives for bank mergers."

In 1994, Congress extended interstate banking across the U.S. to speed the development of interstate branching, which means even more convenience for consumers. Paul Calem, senior economist at the Federal Reserve Bank of Philadelphia, argues that interstate branching would also "enhance competition in banking, benefiting consumers through more favorable interest rates and fees."

But some people never learn. Despite the benefits of banking freedom, Texas and a few other states may opt out of interstate branching, as the federal law allows. For the most part, though, bank customers everywhere are starting to enjoy the benefits of competition that states like North Carolina have long produced. And improbable Charlotte, not Dallas or Houston, is likely to remain the financial powerhouse of the South.

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