FYI: An Update on Emerging Issues in Banking

The Evolving Role of Commercial Banks in U.S. Credit Markets

March 25, 2004

Note: This is the first of a series of papers comprising the FDIC's Future of Banking 

Study.

Banking is often thought of as among the most traditional of industries. Because of this 

conventional wisdom, innovation in financial services is sometimes thought to originate 

in areas other than commercial banks.1 Long term financial sector trends would appear 

to support this view. As new technologies and new practices have expanded the 

volume of U.S. credit market debt relative to GDP since 1980, the share of that debt 

held by commercial banks has clearly declined. However, a careful analysis of U.S. 

financial sector data shows that banks' share of the financial services market has not 

shrunk to the extent that is commonly asserted. Moreover, banks have assumed 

leading roles in providing some of the newer types of financial services products, such 

as credit card securitizations and mortgage banking services. Today's issue of FYI 

summarizes an in-depth analysis of these trends that was published today under the 

FDIC's ongoing study of The Future of Banking.

Recent historical trends clearly show cross-currents in the importance of financial 

services in the economy and the share of that activity financed directly by banks. During 

the 1980s, the total indebtedness of U.S. households, government and nonfinancial 

businesses rose from just over 1.3 times annual GDP to nearly 1.9 times the size of the 

economy. Meanwhile, the share of these borrowings directly funded by commercial 

banks fell, from a peak of 30 percent in 1974 to a low of 20 percent in 1993 .

Banks' smaller share of the credit-market pie reflects a dramatic shift in the way loans 

to households and businesses are being financed. Specifically, asset securitization (the 

pooling of loans and their funding by the issue of securities) has allowed loans that 

used to be funded by traditional intermediaries, including banks, to be funded in 

securities markets. 

Somewhat surprisingly, we find that commercial banks continue to play a significant 

role in directly funding loans to non-financial businesses. Indeed, the share of businesssector debt held directly on commercial bank balance sheets has remained relatively 

stable (at around 30 percent) for the past five decades. However, there has been a 

notable shift in how banks make commercial loans, moving away from shorter-term 

unsecured loans and towards loans secured by business real estate. This shift partly 

reflects increased competition from other sources of credit, including the commercial 

paper market, finance companies, and asset securitization. The shift also reflects the 

continuing comparative advantage of banks in commercial real estate lending, a form of 

lending that is, in some cases, less well-suited to the standardization necessary for 

asset-backed securitization.

With respect to the funding of household debt, commercial banks and, to a greater 

extent, savings institutions have lost market share to the securitization process for 

home mortgages and other forms of consumer credit. However, the increasing 

commoditization of consumer and mortgage lending—that is, the standardization, 

unbundling, and repackaging of payments and risks associated with credit flows—

makes the actual holding of household debt a less accurate measure of the provision of 

financial services than it may previously have been. Commercial banks provide 
significant services in originating, servicing, and enhancing the liquidity and quality of 

credit that is ultimately funded elsewhere. Hence, market-share measures based on 

balance-sheet data are likely to understate the importance of banks to a greater extent 

than even a decade ago. 

A better measure of market share in the financial services sector may be the net 

income of banks versus other types of financial institutions. Focusing on income-based 

measures of market share, we find no evidence of a secular decline in the importance 

of commercial banking. Analysis of publicly-traded financial firms shows that 

commercial banks and savings institutions accounted for 44 percent of total financial 

sector earnings between 1992 and 2002, a level comparable to their share before the 

banking sector problems of the 1980s. A growing source of earnings for banks during 

the last two decades has been noninterest income, including fees from both traditional 

banking activities and new activities such as securities underwriting. Noninterest 

income rose from 18 percent of bank net operating revenue in 1980 to 42 percent in 

2003, helping push total banking industry profits to record levels.

The bottom line of today's FDIC report on The Future of Banking is that, despite the 

challenges of measuring market share in an evolving financial services industry, 

common perceptions of the decline of the banking sector have tended to be somewhat 

exaggerated. While innovation has led to new and more efficient ways to provide credit 

market financing outside the banking balance sheet, banks remain integral not only in 

terms of funding these loans but also as active participants in the newer types of 

financial market activities. 

1 See, for example, "Banking Is Necessary -- Banks Are Not," Fortune, May 11, 1998. 

pp. 84-86.

About FYI

FYI is an electronic bulletin summarizing current information about the trends that are 

driving change in the banking industry, plus links to the wide array of other FDIC 

publications and data tools. 

Disclaimer

The views expressed in FYI are those of the authors and do not necessarily reflect 

official positions of the Federal Deposit Insurance Corporation. Some of the information 

used in the preparation of this publication was obtained from publicly available sources 

that are considered reliable. However, the use of this information does not constitute an 

endorsement of its accuracy by the Federal Deposit Insurance Corporation.

Last Updated 04/01/2004