A Big Brawl in Banking

By Charles P. Alexander

Deregulation sparks competition that could reshape the financial industry

In the realm of finance, 1983 may be remembered as the year that competition rumbled through the banking industry and rattled its foundations. To be sure, bankers have long vied with one another to offer customers the shiniest toasters or softest Teddy bears, but they have not had to compete where it counts: in the interest they pay for their basic savings and checking deposits. That situation is now changing. In a move to ease restrictions that had been in force since the Great Depression, federal regulators last month freed banks and savings and loan associations to pay whatever interest they wish on so-called money-market savings accounts of $2,500 or more. Last week the rules were loosened further to allow financial institutions to pay unlimited interest on checking accounts of at least $2,500. That spurred the creation of the Super NOW, a higher-interest version of the old NOW accounts, which had a 5 1/4% limit.

Fighting to attract customers to these new accounts, S and Ls and banks are offering a bewildering array of double-digit interest rates, bonuses and prizes. The competition may threaten the survival of hundreds of small institutions that cannot afford to match the come-ons of their rivals. Says Robert Lackovic, executive vice president president of the San Francisco-based 1st Nationwide Savings: "It's going to be a real dogfight. The one thing regulation did was to produce a system in which the consumer knew he could walk in anywhere and get the same product. That era is over."

The scramble began with the introduction of the money-market accounts on Dec. 14. Congress authorized these savings plans to help banks and S and Ls recover a part of the $231 billion that had been diverted to money-market funds operated by mutual-fund management companies and brokerage houses. The new money-market savings accounts offer high interest, allow unlimited withdrawals and even permit depositors to write up to three checks a month. Moreover, the deposits are federally insured, unlike the shares in a money-market mutual fund.

To entice customers, banks and S and Ls have offered introductory--and temporary--interest rates far higher than the 8 1/4% now being paid by the typical money-market fund. In the Atlanta area, the banks practically went berserk, guaranteeing rates of 20% or more for the first month. The First DeKalb Bank there, which dangled 25% interest and an E.T. doll, took in $7 million the first day, an amount that increased the bank's total deposits by 17%. Elsewhere, rates have been more realistic, generally ranging from 9% to 11%. But money has hardly been the only lure. Besides paying 10% interest, the Union Warren Savings Bank in Boston has handed out 4,700 16-piece dinnerware sets (retail value: $65) to customers opening money-market accounts.

The Federal Reserve Board reported last week that by Dec. 22 some $52 billion, much more than expected, had flowed into money-market deposits. Reserve Board officials estimate, however, that only one-sixth of the cash came from money-market funds or other sources outside the banks. The rest of the money was transferred from lower-interest bank deposits like passbook accounts. Thus the banks are simply paying higher interest for money that they already had. Some institutions are having much greater success than others at attracting new customers. San Francisco's Bank of America, which has offered 11 1/4% on money-market accounts plus a $100 bonus for deposits of $20,000 or more, reported that fully 50% of the first $4 billion it attracted was "new money" from outside the bank.

While touting the money-market account, most banks are cooler toward the Super NOW authorized last week, and many institutions have not offered it yet. Because the Super NOW allows unlimited check writing, it will be more expensive to operate than the money-market account. Moreover, bankers fear that the Super NOW will draw in little new money. Instead, it could attract much of the $340 billion in existing checking accounts that pay interest of 5 1/4% or less. To discourage customers from switching to the Super NOW, many banks are slapping stiff fees on the new account. The Wachovia Bank & Trust Co. in Winston-Salem, N.C., offers 7 1/4% interest on the Super NOW, but also levies a $2-per-month service charge and a 200-per-check fee. Admits John Ramsey, the bank's retail marketing manager: "Customers will probably have to keep more than $5,000 [in the Super NOW] to be better off than they were with their original NOW accounts." New York's Chemical Bank, which wa paying only 6 3/4% on Super NOWs last week, levies a 200-per-check fee on all balances below $20,000 and an additional $6-per-month service charge on account; of less than $10,000.

Unlike most commercial banks many savings and loan associations are hailing the Super NOW. Because they have relatively few checking accounts, they expect the Super NOW to bring in mostly new money and are paying high rates Chicago's St. Paul Federal Savings & Loan is offering 11%. New York City's Dry Dock Savings Bank is paying 8.6% on $5,000 deposits and 11.3% on $25,000 accounts, with no fees unless the customer writes more than 30 checks a month. Says Dry Dock Chairman Robert Steele: "We're new to the checking-account business, and we hope to make a major inroad against commercial banks."

Customer response to the Super NOW was subdued last week, compared with the rush into money-market deposits in December. Many people are now befuddled about which new account to choose and where to open it. The returns offered may change from week to week as interest rates throughout the economy fluctuate, and few institutions have given any clues in their advertising about how they will determine what to pay. In general, Super NOWs are expected to yield at least 1% less on average than money-market accounts. One reason: federal regulations require that banks put aside 12% of their checking-account funds, including Super NOW money, as reserves that cannot be used to make loans. As a result, banks and S and Ls will earn less and thus pay less on Super NOW accounts than they will on money-market deposits.

The new accounts are not a total windfall for consumers. People will earn more on their deposits, but they will also pay more for loans than they otherwise would have. At the moment, the recession is putting downward pressure on interest rates, especially for business loans. But cautious bankers, worried about the interest they will have to pay on money-market deposits, are keeping consumer-loan rates at onerous levels. The national average rate on auto loans from banks is 16%, down only 1 1/2 points from a year ago, despite a 4-point drop in the rate at which banks can borrow from one another.

Deregulation could be devastating to many financial institutions if competition prevents them from keeping loan rates high enough to cover the steep costs of their new accounts. Big money-center banks should fare well because they get the bulk of of their deposits from businesses, which are not eligible for the Super NOW accounts, rather than consumers. But smaller, regional banks rely heavily on consumer deposits and are thus more vulnerable to rate-raising competition for money-market accounts. Banking Analyst Jonathan Gray of the Sanford C. Bernstein investment firm predicts that regional banks will face earnings declines of 10% to 20% or more this year. Gray also believes that as many as 25% of the 15,300 banks in the U.S. may eventually have to merge with stronger competitors or go out of business altogether. Consolidation will no doubt continue in the ailing savings and loan industry, where the number of firms has shrunk from 4,240 to 3,620 in the past two years.

The money-market mutual funds, which are responsible for provoking deregulation in the first place, are sure to suffer. After years of torrid growth, the funds' assets have declined from $231 billion to $207 billion since the debut of the new bank accounts. Several funds are trying new strategies to keep their customers. Boston's Fidelity Group is offering federally insured money-market accounts through an arrangement with Chicago's Continental Illinois bank. Continental holds the accounts, but Fidelity handles communications with the customers and collects a fee from the bank. Another mutual-fund company, New York's Dreyfus Corp., bought its own bank last month: Lincoln State Bank in New Jersey.

Besides shaking up the banking industry, deregulation will make it tougher for the Federal Reserve Board to fine-tune the U.S. economy by controlling the money supply. Traditionally, the Reserve Board has focused on M1, a measure that includes checking accounts and currency and thus represents the amount of funds that Americans have readily available to spend. But with the advent of Super NOW checking accounts, which go into M1, that measure becomes more nebulous. No one knows what portion of the funds in Super NOW accounts will be spending money and how much will constitute savings. The Reserve Board has announced that partly because of the uncertain impact of the new accounts, it will temporarily abandon its targets for M1 growth. This alarms many economists who feel that the Reserve Board may unwittingly allow inflation to speed up again.

Ultimately, deregulation could bring on the most sweeping financial upheaval in half a century. It will change the way money is saved, borrowed, spent and even defined. It will reshape the banking industry as some competitors prosper in the new environment and others falter. Before the fallout settles, some bankers may look back nostalgically to those lazy days when the Government told them what to do.

--By Charles P. Alexander. Reported by William R. Doerner/San Francisco and Sara White/Boston

With reporting by William R. Doerner, Sara White This file is automatically generated by a robot program, so viewer discretion is required.