The State and the Transformation of British and American Commercial Banking, 1945-2008

Abstract

In the aftermath of WW2, British and American commercial banks’ activities were heavily restricted. Governments, regulatory agencies, and central banks used controls on assets and liabilities to direct credit to their preferred ends and maintain financial stability. It was broadly accepted that the public interest, as defined by the authorities, was of greater importance than the interests of bank shareholders. From the mid-1950s, large banks proved increasingly uneasy with their regulators’ definition of the public interest and the ensuing severe restrictions imposed on them. It was in seeking to escape these restrictions that banks transformed their balance sheet management practices in the 1960s, starting with the largest American banks. These banks attempted to escape controls on competition for deposits (which were designed to constrain asset growth and allocation) by borrowing in money markets at home and abroad. British banks did the same, though less successfully, through subsidiaries. Balance sheet management, previously a relatively passive activity managed disjointly by various parts of the bank, became a distinct practice aiming first to control the volumes of cash inflows and outflows at head office, then to manage the volume and rates of bank assets and liabilities concurrently and continuously. Aspects of balance sheet management which had previously been largely separate were brought together through new divisions and committees. By the mid-1970s in large American commercial banks, and the mid-1980s in British commercial banks, liquidity risk and interest rate risk were managed jointly to maximise profits. A new field of expertise, Asset and Liability Management (ALM), had emerged. The authorities in both countries largely abandoned their attempts to control bank balance sheet in the 1970s. The view that banks were regular businesses which ought to be regulated as such became increasingly common, first in banks, then among legislators and regulators. As a consequence, the banks’ responsibilities were narrowed to the provision of a broad range of services at a price set competitively, and the authorities only set the price at which they could acquire reserves. Banks were allowed to compete freely and take more risks. It had previously been considered in the public interest to control banking competition; now competition increasingly became synonymous with the public interest. Over the following decades, this new freedom, combined with the optimizing logic of ALM and the influence of even more loosely regulated non-bank competitors, led to a second round of transformations in bank balance sheets, including a large increase in real estate exposure and a proliferation in subsidiaries, ending in catastrophe in 2007-2008.