ABSTRACT
Commercial bank investment in information technology (IT) equipment has grown rapidly, from $104 million in 1960 to more than $10 billion in 1994. These investments in “hard” technologies (computer hardware, software, telecommunications equipment, etc.) have been accompanied by increases in "soft" technologies, for example, complex financial innovations that were infeasible on a large scale without IT hardware. These developments, together with deregulation, are creating new competitors, new financial markets and instruments, and a new role for commercial banks as providers of financial services.
This study documents how changes in information technology have affected the role of banks in financial markets and have influenced changes in the structure and performance of the U.S. banking industry. The analysis also covers new, fast-growing financial innovations linked to IT investment e.g., asset securitization and derivatives.
IT’s effect on the banking industry has been positive. Increased competition has caused banks to lose traditional customers, but IT enabled the banks to offer new products, expand into nontraditional areas, operate more efficiently, and minimize risk. The aggregate economy is better off because of a more efficient financial industry and because of the increased quality and value of banking services.
IT has been central to the evolution of the market for securitized instruments. Mortgagebacked securities have experienced phenomenal growth over the past 25 years. Forty percent of mortgages outstanding are securitized today compared with less than 1 percent in 1960. Banks have benefitted from this market because securitization reduces the risk associated with holding long-term, fixed-rate mortgages. The market for derivatives (i.e., futures, options, swaps) has also been growing rapidly, at an average annual rate of over 30 percent since 1983. Banks earned $6.5 billion (13 percent of net income) from derivatives trading in 1995 and the derivatives market promises to be an even larger source of income for banks in the future.
The banking industry will continue to consolidate over the next five to ten years. There were 9,941 banks in 1995, compared with the peak of 14,483 in 1984. Consolidation will be driven by interstate banking deregulation and by the inability of less IT-intensive banks to keep pace with innovative banks. Competition from nonbanks and even technology vendors will continue to force banks to venture into nontraditional markets.
Regulators were slow to recognize how rapidly financial markets were changing because of IT and competition, but are now actively developing ways to monitor financial innovations (especially derivatives) and reduce the likelihood of an adverse impact on the overall health and stability of the U.S. banking industry and global financial markets.