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  • The Rise and Fall of the Check

    It doesn't seem that long ago when writing checks was a daily practice. But look at where checks rate now: That's from Matt Phillips of Quartz . Phillips has an interesting piece about the decline of checks. Checks became very popular in the post World War Two boom, according to Phillips, and their rise prompted some interesting innovation in the banking industry, like magnetic ink character-recognition code. The arrival of MICR, which became the industry standard in 1967, helped drive check-processing times below two days during the 1970s, according to a Fed report (pdf). Those improvements in processing times made checks a more viable option for a range of household payments. The number of checks written surged to nearly 33 billion by the end of 1979. That year, checks made up roughly 86% of all non-cash payments, according to a separate report (pdf). But the check’s days as king of the cash alternatives were numbered. While the number of check payments continued to rise into the mid 1990s—they peaked at an estimated 49.5 billion in 1995—checks began to lose significant market share to alternative forms of payment like debit and credit cards and direct, electronic, automatic clearinghouse payments (ACH). The trend toward electronic payments only gathered pace, and by 2003, the Fed estimated (pdf) that other forms of payment had overtaken checks in usage. And by 2006, checks accounted for barely one-third (pdf) of non-cash payments in the US. Consumer preferences seem to be a key driver of the trend. According to the Fed, debit cards and credit cards are by far consumers’ favorite way to make payments. Some 43% of the consumers surveyed by the Fed said debit was their preferred method of payment. Another 22% preferred using credit cards. A solid 30% preferred cash. Checks? Only 3% of the people who took part in the Fed study preferred using checks. (Check preference was highly correlated with older consumers.) Read How America fell out of love with writing checks here .
  • Banks Increasing Lending, But Not Necessarily Risk

    It has taken some time to restart borrowing, and lending, after the Great Recession, but consumers are taking on more debt. For three straight quarters, total consumer debt has risen, note at Liberty Street Economics. But is this the result of banks now being less risk averse? According to some recent work by the New York Fed 's Basit Zafar , Max Livingston , and Wilbert van der Klaaw , that does not seem to be the case. From Liberty Street Economics : To assess the demand for credit and measure how much of that demand was met, we classify our respondents into four groups. In February 2014, 40 percent of respondents reported not applying for any type of credit over the past twelve months because they didn’t need it (satisfied consumers); 40 percent of respondents reported applying for some type of credit and being approved (accepted applicants); 13 percent reported applying for some type of credit and being rejected (rejected applicants); and 8 percent reported not applying for credit despite needing it because they believed they would not be approved. This last group represents latent demand for credit; we refer to them as discouraged consumers. The leftmost two bars in the chart below show that the distribution of respondents in February 2014 looked quite similar to that in May 2013 (the results of which we discussed in a previous post ): we see a slight increase in satisfied consumers from May to February and a slight decrease in accepted applicants. Note that the SCE is a rotating panel, so the respondents in the two surveys will be different; however, we use weights to ensure that the statistics reported in this post remain representative of the population of U.S. household heads. The picture, however, varies radically when split by credit score. The chart above shows that individuals with lower credit scores (those with credit scores below 680) were more likely to report that they were rejected, and much more likely to report that they were discouraged, than their more creditworthy counterparts. In February, 22 percent of respondents in the low-credit-score group were discouraged, versus 3 percent in the middle-credit-score group, and zero percent in the high-credit-score group (those with scores of above 760). Furthermore, the chart shows that credit experiences got markedly worse for the low-credit-score group in February 2014 compared with May 2013: 57 percent of this group reported either being denied credit or being too discouraged to apply in February this year, versus 47 percent in May of last year. This result contrasts with the experiences of their more creditworthy counterparts, which were largely unchanged since May 2013. These patterns suggest that although banks may be increasing their lending activity, they are not necessarily taking on more risk, as the risky population has not seen an improvement in its ability to obtain credit. Read Rising Household Debt: Increasing Demand or Increasing Supply? here .
  • Former Regulator on Really, Really, Really Big Bank Heists

    In the Ted Talk below, William Black teaches us that robbing banks does not tend to bring the robbers a lot of money. Unless the people who are robbing the banks are inside the banks. And we don't mean the tellers. Black is a former bank regulator. And he estimates that the bank "robbers" he's worried about made off with about 11 trillion dollars.
  • The Economist Special Report: Shadow Banking

    The new issue of The Economist features a special report on the state of shadow banking. It appears shadow banking activities are on the rise, largely because, as the report notes, "orthodox banks are on the back foot, battered by losses incurred during the financial crisis and beset by heavier regulation, higher capital requirements, endless legal troubles and swingeing fines." Stanley Pignal , finance correspondent at The Economist, talks about shadow banking with Ed McBride , finance editor, and their findings for the special report: Read more from the report here .
  • Ben Bernanke on Innovative Responses to Financial Crisis

    Ben Bernanke closed out a daylong discussion at the Brookings Institution titled Liquidity and the Role of the Lender of Last Resort. In his address, Bernanke talked about how the Fed--with him at the helm--responded to "unforeseen challenges" during the global financial crisis. Bernanke notes that the Fed had to be innovative because of limited legal powers.
  • Liberty Street Economics: Cost Benefits of Big Banks

    There has been a lot of discussion about the potential problems with very large banks, and about policy efforts to minimize the risk of those "too big to fail." But one thing that policy makers have to consider when thinking about breaking up big banks are the costs associated. Conventional wisdom suggests that bigger banks have cost benefits. New York Fed researchers Anna Kovner , James Vickery , and Lily Zhou have been testing that conventional wisdom. For the most part, they find that the larger the bank, the more cost advantages. While they do note some caveats about their findings, they argue out that "limiting the size of banking firms could still be an appropriate policy goal, but only if the benefits of doing so exceed the attendant reductions in scale efficiencies." Here is an excerpt from their latest paper: Large Bank Holding Companies Have Lower Noninterest Expense Ratios Our analysis focuses on U.S. bank holding companies over the period 2001 to 2012. We find a negative relationship between bank size and noninterest expense ratios, robust to the expense measure or set of controls used. Quantitatively, a 10 percent increase in assets is associated with a 0.3-0.6 percent decline in noninterest expense scaled by income or assets. In dollar terms, our estimates imply that for a BHC of average size, an additional $1 billion in assets reduces noninterest expense by $1 to $2 million per year, relative to a base case where operating cost ratios are unrelated to size. No Flattening of the Relationship between Size and Cost Even for the Largest BHCs These results hold across the size distribution of banking firms and over different parts of our sample period. As shown in the chart below of the efficiency ratio and bank size, which is based on our statistical estimates, we find no evidence that these lower operating costs flatten out above some particular size threshold. This is in contrast to the early academic literature on scale economies, which suggested that these economies taper off above a relatively low size threshold. If anything, the estimated slope steepens, although the statistical uncertainty associated with the estimate becomes larger due to the small sample size. Read Do Big Banks Have Lower Operating Costs? here .
  • Marketplace: Remembering the Biggest Consumer Bank Failure in US History--Washington Mutual

    Five years ago a major financial institution failed. No, not that one. Washington Mutual, was one of the largest consumer banks in the country. But it went under just 6 days before Congress set up the Troubled Assets Relief Program (TARP), which they went on to protect other institutions like WaMu that had overextended themselves in the credit bubble years. Kai Ryssdal and his Marketplace producers have not forgotten WaMu. They invited Kirsten Grind onto the air yesterday. Grind has written the book on the WaMu collapse. And the book is titled, The Lost Bank: The story of Washington Mutual and the Biggest Bank Failure in American History .
  • A Potential Model for Putting the International back in International Banks

    The international bank, as we knew it before 2008, seems to have gone away. Instead, it has been replaced by banks that Dirk Schoenmaker refers to as multinational banks, "under which the national subsidiaries are supervised separately." Schoenmaker--Dean of the Duisenberg School of Finance and Professor of Finance, Banking and Insurance at the VU University Amsterdam, and author of Governance of International Banking --thinks this may be temporary, and he believes that international banking will again be international. Writing at Vox , he outlines the model he expects: The solution is a supranational approach for supervision and resolution. The bottom line is to arrange an appropriate fiscal backstop through burden sharing (see also, Goodhart and Schoenmaker 2009). The Banking Union in Europe is moving into that direction with proposals for a European Resolution Board, backed up by the European Stability Mechanism. The Banking Union will save the international banking model for the Eurozone. Figure 2 shows the improvement in resolution. The starting point is that a recapitalisation is efficient when the benefits (in the form of financial stability) exceed the costs. The solid diagonal in Figure 2 represents the line where benefits (B) and costs (C) are equal. The left dashed line measures the home country benefits.1 Basically, the home country only considers their local share of the benefits, ignoring the cross-border impact of averting bank failure. In the diagram area A – where there is no bank recapitalisation since the costs outweigh the benefit – there is an efficient outcome. Area B – where there is a recapitalisation – is, similarly, efficient. Area C, however, involves inefficiency. This is where the recapitalisation would be socially efficient considering spillovers but the costs for one nation exceed the one-nation benefit. Put simply, the home country will not do the recapitalisation. In the supranational approach (all benefits in the home country and the rest of Europe are incorporated by the supranational body), area C, which indicates the area of inefficiency, is smaller under the supranational line than under the home country line. Read Is there a future for international banks here .
  • Impact of China's Rules Changes on Lending Rates

    China made some significant reforms to its financial system at the end of last week. The biggest change was eliminating a lower limit on interest rates. Banks in China now have more leeway to set their own lending rates. The Wall Street Journal 's Michael Casey says that the move should make banks more competitive, even though most lending rates have been above the state-set floor already. But, he adds, there is a lot of additional liberalization of the financial system that can still be done. Casey discusses the potential impact of liberalizing China banking on the global market in this Moneybeat interview with Paul Vigna.
  • Banks and Startups

    When John Mullins went to business school, he didn't hear his professors or fellow students talk about entrepreneurship. And he went to Stanford, in the heard of Silicon Valley. Now Mullins teaches at the London Business School, and he spends a lot of his time looking into successful entrepreneurship. In this interview with the Wall Street Journal , Mullins discusses the challenges of getting financing for startups. He says banks are of little help--at least at the early stages.
  • Interest Rate Liberalization Key to China Becoming a High-Income Country

    For China to become a high-income country, policy makers have to make some significant changes. Pingfan Hong , Chief of the Global Economic Monitoring Unit of the United Nations Department of Economic and Social Affairs, says those changes must begin with financial reform. And top on his list is liberalizing interest rates. From Project Syndicate : In many ways, China is breaking the mold. Despite severe financial repression, it has experienced extremely high savings and investment, owing mainly to Chinese households’ strong propensity to save and massive government-driven investment, particularly by local governments. The adverse effects of financial repression in China are reflected primarily in its economic imbalances. Low interest rates on deposits encourage savers, especially households, to invest in fixed assets, rather than keep their money in banks. This leads to overcapacity in some sectors – reflected in China’s growing real-estate bubble, for example – and underinvestment in others. More important, financial repression is contributing to a widening disparity between state-owned enterprises (SOEs) and small and medium-size enterprises (SMEs), with the former enjoying artificially low interest rates from commercial banks and the latter forced to pay extremely high interest rates in the shadow-banking system (or unable to access external financing at all). Interest-rate liberalization – together with other financial reforms – would help to improve the efficiency of capital allocation and to optimize the economic structure. It might also be a prerequisite for China to deepen its financial markets, particularly the bond market, laying a solid foundation for floating the renminbi’s exchange rate and opening China’s capital and financial accounts further – a precondition for the renminbi’s eventual adoption as an international reserve currency. Read China's Interest Rate Challenge here .
  • Not All Capital is Good Capital: Why Regulators Need to Look at Equity When Evaluating Banks

    Sometimes financial institutions go under even though it looks like they have plenty of capital, and we all wonder how it happened. Wharton School professor of finance Richard Herring says that is because we are looking at the wrong numbers. We should be looking at equity, and he believes new regulatory frameworks proposed at Basel III are a step in the right direction. But he fears that some policymakers are eager to return to the old definitions of capital and liquidity. He speaks about the best ways to measure financial stability in this interview with Knowledge@Wharton Steve Sherretta :
  • The Impact of Risk Averse Bankers on Inflation

    In their latest World Economic Outlook , IMF analysts pointed out that inflation "has become less responsive to cyclical conditions." This prompted Simon Wren-Lewis to consider valid explanations. At his Mainly Macro blog, he puts forward one that has to do with banks, risk, and sacrificing long term strategy because of short term fears: The story I want to tell involves firms’ pricing behaviour, and the role of more risk averse banks. Suppose a firm sees demand for its output fall. Its profits are lower, but it calculates that it can reduce that decline in profits by cutting its price, if that price cut increases demand. There are two risks involved in doing this. First, the price cut might raise demand by much less than expected, with the consequence that profits fall further still. Once the firm realises this it can always put prices back up again, but in the short run profits will decline. Second, it may take time for the price cut to feed through into higher demand: those buying competing products may not immediately realise that they should switch. So although profits might rise eventually, they could fall in the short run. So in both cases, there is a risk that profits in the short run might suffer as a result of the price cut. In normal times firms would be prepared to take those risks, either because the risks are symmetric (maybe demand will increase by more than expected), or because they represent an investment with a positive eventual payoff (as customers switch products). Critically, even if the short run might actually bring losses rather than profits, the firm’s bank will cover the losses because it is taking a long term view. However, since the financial crisis, the firm may have noticed that the behaviour of its bank has changed. It refused the business down the road any credit, even though by all accounts its difficulties were clearly temporary. Although the firm would like to cut prices in the expectation that this will eventually raise profits, if the price cutting idea does not work out and the bank plays tough that could mean bankruptcy. The idea is that the aftermath of the financial crisis, by raising the risk of bankruptcy associated with short term losses, has lead to greater price rigidity. In addition, there are two related effects that could actually lead to higher inflation in the short run. First, the firm does not like the fact that it can no longer depend on the bank to cover any short term losses. Who knows what might happen. So although a price increase might reduce profits if sustained (as customers gradually switch), in the short run profits will rise, and that allows the firm to pay off those debts which would otherwise keep its owners awake at night. This is the firm as a precautionary saver. Second, firms might be keeping prices low not because of existing competition, but because of the threat that a new start-up might emerge and steal some of its business. The one silver lining of the financial crisis for existing firms is that new start-ups are much less likely to get any money from the bank, so this diminished threat of new entry allows the firm to safely increase its profit margins. Read the full post here .
  • Global Ethics Corner: 'When Banks Fail, Who Should Pay?'

    Here's a useful conversation starter from the Carnegie Council 's Global Ethics Corner . It sets up the key questions over the IMF, EU, and European Central Bank bailout of Cyprus. While Cyprus as a nation is rather singular, the issues raised by the terms of the bailout are relevant across Europe moving forward:
  • Can Investors Spot the Next Cyprus?

    While we continue to watch events in Cyprus , MarketWatch 's Jim Je l ter looks at countries that might be "the next Cyprus." To be more specific, Jeiter notes other countries where the overall economy is highly dependent on the banking sector. Switzerland and the UK, for example, are two countries that are, as Jelter puts it, "most exposed to the ups and downs of their banks":
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