Banks and Credit Unions
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Industry Overview
The US banking system includes about 8,000 commercial banks, 1,400 savings banks, and 10,000 credit unions, with combined annual revenue of more than $600 billion. Large commercial banks include Bank of America, JPMorgan Chase, Citibank, and Wachovia. Washington Mutual and Navy Federal Credit Union are among the largest savings banks and credit unions, respectively. The industry is concentrated, except in the credit union segment: the 50 largest banks hold more than 60 percent of the market. The credit union segment is highly fragmented: commercial banks account for about 80 percent of industry revenue; savings banks, 14 percent; and credit unions, 6 percent.
Competitive Landscape
Demand for banking services is closely tied to economic activity and the level of interest rates. The profitability of individual banks depends on marketing skills, efficient operations, and good risk management. Large economies of scale exist in some segments of the industry, which has encouraged industry consolidation. Smaller banks can compete successfully in segments where customer service or knowledge of the local market is more important. The industry is capital-intensive and highly automated: annual revenue per employee is close to $300,000.
Products, Operations & Technology
Major products are bank loans, account services, brokerage services, credit card and leasing services, trust management, and investment services. Bank loans provide 55 percent of industry revenue, account services provide 10 percent, the other major services each provide less than 5 percent. Following the Gramm-Leach-Bliley Act of 1999, some banks have used the financial services company structure to acquire large insurance or retail securities brokerage operations. Commercial banks, savings institutions, and credit unions provide many of the same products. However, commercial banks get a large percent of their revenue from services, while savings banks and credit unions get a majority of their revenue from loans.
Banks generate revenue mainly through interest income and service fees. Some banks also have significant revenue from investment activities. For commercial banks, interest income generates about 50 percent of revenue. The level of interest rates is important to banks because much of their revenue comes from the "spread" between the rate at which they can lend money and the rate they must pay to acquire money. When interest rates are high, the spread is usually high, increasing revenue. On the other hand, when interest rates are high, demand for loans usually decreases.
The biggest operating concerns for most banks are service and loan production (sales); funds acquisition (deposits and borrowed funds); risk management (the quality of loans and investments); interest rate management (correctly pricing loans, deposits, and services); liquidity management (timing differences in the maturity of loans and deposits); and transactions processing. Banks process and save information about a large number of daily transactions and produce a large number of reports.
Commercial banks and savings institutions often operate a network of branches. The average savings institution has 12 branches, and the average commercial bank has seven. Most credit unions operate a single location. Labor costs are the biggest single operating expense for banks. Heavy investment in computer technology in the past decade has allowed banks to cut labor costs and has encouraged bank mergers.
Computer systems are used extensively in banking because of the large number of transactions that are processed, like checking and credit card transactions, or interest credits, and because of internal and external demands for account information. Banks often use separate computer systems to run internal functions such as accounting; credit review; and customer relationship, cash, and investment management. Customer-operated functions like ATMs and Internet banking require additional sophisticated computer systems.
COMMERCIAL BANKS
On average, commercial banks receive about half of their revenue from commercial customers and half from consumers. A large portion of their revenue comes from fees for providing a wide range of services. Banks are one of the largest sources of real estate lending, including home mortgages, land commercial construction loans, and commercial mortgages. On average, a commercial bank loan portfolio consists 55 percent of real estate loans, 20 percent of commercial and industrial loans, and 12 percent of consumer loans (credit cards and auto loans).
The average size of commercial and industrial loans is less than $1 million. Commercial banks have fewer restrictions than savings institutions on the loans they can make and the securities they can invest in. Commercial banks have regulatory requirements from the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC.
SAVINGS INSTITUTIONS
Savings institutions include savings banks and savings and loan associations ("thrifts"). Typically larger than credit unions, their main purpose is to provide mortgage loans to home owners, funded by consumer deposits. Thrifts can offer a full line of consumer services but are barred from commercial banking. Under tight oversight, savings institutions are largely restricted to making residential mortgage loans and investing in US treasury securities or mortgage-backed securities.
A typical thrift loan portfolio consists almost 90 percent of mortgages and other real estate loans. To raise new funds, mortgages are often sold to the Federal National Mortgage Association (FNMA or "Fannie Mae") and the Federal Home Loan Mortgage Corporation (FHLMC or "Freddie Mac"), or are used as collateral for securities ("securitization") that the thrift issues. Even when mortgages are sold, the thrift generally retains the mortgage servicing (that is, making monthly collections, issuing reports, and dealing with delinquents). Savings institutions are regulated by the Federal Reserve or the Office of Thrift Supervision, and by the FDIC, which provides insurance through the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). Most thrifts belong to the private Federal Home Loan Bank system, which extends credit to its members.
CREDIT UNIONS
Credit Unions are tax-advantaged banking entities owned by their depositors. Most serve employee groups of midsized and large companies and are consequently small, with assets less than $50 million. Credit unions may also serve "affinity" groups or neighborhood associations. Credit unions generally have low expenses and officers often aren't paid. They specialize in making auto loans, small personal loans, home equity loans, and mortgage loans to their members, with payments frequently made through payroll deductions. Credit unions traditionally don't offer business accounts and business lending services, but some make small business loans.
Because direct investing of excess cash in financial instruments is impractical for small credit unions, many are members of federally-insured corporate credit unions ("wholesale corporates"), which pool the cash of their members. Corporate credit unions, in turn, are members of the US Central Credit Union. Typical investments of corporate credit unions are short-term US treasury securities; collateralized mortgage obligations (CMOs); and various types of asset-backed securities based on credit card, auto, and home equity loans. Credit unions may be chartered by the federal government or the states, and are regulated and insured by the National Credit Union Administration.