Starting in the late 1970s, the changed economic environment along with advances in technology, financial innovations, and globalization resulted in increased competition to U. S. banks by thrifts, nondepository financial institutions, foreign banks, and the capital markets. Higher and more variable interest rates, and the accompanying increased yield sensitivity of depositors and borrowers, contributed to the development of money market mutual funds as alternatives to bank deposits and the growth of finance companies and commercial paper as substitutes for bank loans.The increase in external competition brought a swift response from both banks and their regulators.

Banks responded to the challenge by expanding in ways that they could, also taking advantage of improvements in technology and applied finance. They expanded their roles as intermediaries through off-balance-sheet activities such as securitization, back-up lines of credit and derivatives, and, in the process, substituted fee income for some of the interest income lost through competition with other financial intermediaries.In addition, banks sought expanded powers to help them compete, including being able to cross state borders, set their own deposit rates and account types, and–by the late-1980s–expand into securities underwriting activities. Regulators responded to the new environment by reducing the regulatory burden on banks and allowing them to compete on a more level playing field with nonbanking firms. That is, the new market realities required a reorientation in emphasis from protecting banks from competition to giving banks the opportunity to compete not only with other banks but with nonbank competitors as well.By allowing banks to enter other states, set their own prices, and engage in other than traditional banking activities, the orientation of regulators evolved toward protecting the safety net while allowing banks to deliver financial services to the public efficiently, profitably, and with sufficient capital to be protected against unforeseen events. (Governor Laurence H. Meyer At the Ohio Bankers Day Convention, Columbus, Ohio November 21, 1996 www.

federalreserve. gov/boarddocs/speeches) As the material above shows, after late 1970s, the competition for banking industry have increased.This was due to the improvement on technology, financial innovation, globalization and deregulation.

Banks not only have domestic competition but also global competition. Thus banks have to restructure and improved their services. Banks appear to have responded to these regulatory changes in a significant way- consolidation. ‘The number of commercial banks has decreased by the thousands, reaching around 8,000 in 1999 from over 11,000 a decade earlier, and most of the banks exiting have been small. ( Astrida A Demand estimation and Consumer Welfare in the Banking Industry //www. fic. wharton.

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upenn. edu)’Much of the consolidation is a direct outgrowth of the removal of geographic restrictions on bank branching, which is interstate expansion. However, this does not mean the end for small banks. When large banking organizations enter a new local market by acquisition, the existing small banks that are efficient can still compete successfully and maintain their market shares and profitability. As the consolidation, the market concentration increased and so does the economies of scale.

Large banks’ power expanded, including the move into nontraditional activities to offset the competition for their traditional products.In addition, banks applied new technology such as used ATM (cash machine), more recently, like telephone banking,electronically transfer and internet banking. Other fundamental changes are occurring in the industry as banks diversify their services to become more competitive. Many banks now offer their customers financial planning and asset management services, as well as brokerage and insurance services, often through a subsidiary or third party. Others are beginning to provide investment banking services that help companies and governments raise money through the issuance of stocks and bonds, also usually through a subsidiary.

As the graph above shows, even though the competition for banking industry is increasing, the number of insured commercial banks in the US still was going up. One reason for this is the number of banks decrease but the banks remained in the industry were able to set up more branches as they were more powerful and can use their economies of scale. For instance, large banks can set up more branches easily as they are richer. UK banking Let us look at the UK banking industry, in the past 10 years, it have been very difficult for the main UK banks because of the intense competition from new entrants.Barriers to entry are relatively low. For example, in the credit card market, many UK financial institutions including building societies and insurance companies have issued cards. In the deposit market, banks have been under intense pressure from building societies again, and more recently, supermarkets such as Sainsbury and insurance companies like the Prudential.

‘UK banks are far more profitable than their European counterparts. Indeed with rate of return on capital employed of 23. 2 percent, they have been more profitable than most of British industry (Merrill Lynch datastream the student’s economy in foucus 1999/2000)’In theory, the UK banking industry should be perfectly competitive industry thus the banks should not be able to earn such high profits under those intense competition.

First of all, the banking products are fairly homogeneous. Secondly, the large number of new entrants show that barriers to entry are low. Thirdly, there is a larger number of firms in the industry, none of which is large enough to use power over the market. There is also perfect knowledge in the market.

Many banking products are on the newspaper and TV, giving advice about the best offers around.All these are the conditions for perfect competition. However, we have to focus on customers behavior. Banks have considerable power of customer inertia. It is very unlikely for a person to change their bank account. Even though those customers know they can get a better deal elsewhere but, despite of this, they would like to stay with their bank. The result is that banks can pay considerably lower rates of interest than the best in the market and charge higher interest rates on loans such as mortgages. They also know that many customers do not shop around when buying a new financial product.

People just go to their bank for advice which then leads to a sale. In this case, for instance, banks would provide relative higher interest account for students, even though banks would make a loss on these accounts. But if those students keep their accounts after they start work, banks know that the accounts are going to be used for the whole lives of those students. There are possibly two reasons why bank customers show such inertia.

First, it takes time and effort to change accounts. Many people’s accounts are linked with direct debit for such as gas bill or phone bill.It is trouble to cancel them then link them with the new account. Second, and more important, many bank customers do not understand the products being offered by competing firms in the market. They often believe that there must be hidden drawbacks to a product which gives them, say, a lower interest rate on their mortgage.

So although there is plenty of information available in the market, consumers find it difficult to follow. In this case, banking industry is not really perfectly competitive. This is quite an important characteristic for this industry.Current state and future prospects Nowadays, banks come in a wide range of sizes, from large global banks to regional and community banks. Global banks are involved in international lending and foreign currency trading, in addition to the more typical banking services. Regional banks have numerous branches and automated teller machine (ATM) locations throughout a domestic area that provide banking services to individuals. As the environment of economies the competition from domestic and global will be strong, however, the demand for banking services will also be extreme.Efficiency and the use of information system and new technology will become more and more important for banking.

Conclusion In conclusion, banks offer a full range of services for individuals, businesses, and governments. But the products are homogeneous. The biggest difficulty for banking industry is the intense competition. Consolidation and innovation are the main trend in its development since late 1970s. Even though the industry seems be perfect competitive, due to customers inertia and behavior, it is not really perfect competitive.