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Retail Banks Should Exploit Comparative Advantages: Regulators Should Encourage Innovation

Retail banks must find innovative ways to exploit their comparative advantages, and regulators should encourage these innovations, says Federal Reserve Bank of Cleveland President Jerry Jordan. As technology and deregulation transform the financial marketplace, banks must adapt to competitive forces by changing their product mixes, delivery vehicles, and corporate structures.

Writing in the Bank’s Economic Commentary, Jordan explains that banks are not the only entities that can provide financial services. However, by combining certain products and services, banks have been able to provide them more efficiently, effectively and cheaply than if they were handled separately.

Commercial banks, for example, fund themselves with liquid liabilities, like savings accounts, and make illiquid loans. Of course, this transfer of purchasing power from the present to the future can also be accomplished by nonbank methods like purchasing common stock. But banks can use information from their deposits to better price and monitor their loans. This is the kind of advantage which Jordan says banks must exploit to compete.

Jordan also says that as the financial marketplace evolves, so must financial regulations and regulators. Regulations, he believes, should focus on financial functions, and provide a level playing field between banks and other providers of financial services. Regulators must concentrate more on adding value to financial services by helping firms provide services safely and efficiently, and less on playing financial cop.

The evolution of the financial services industry also carries implications for the payments system and for monetary policy. Jordan says, for example, that in the future electronic Federal Reserve notes may compete with electronic travelers checks for transactions balances. New payment technologies, like many other changes in financial services, should be regarded as innovations that enhance productivity and welfare just as surely as do many other new products. Jordan says the challenge faced by the Fed is to ensure that operating practices and monetary policies can be adapted to maintain financial stability and control the price level.

Jordan says that the question for the future is "What is the cheapest way to integrate and deliver banking functions?" In the end, firms that find ways to deliver the services that the public wants will be the firms that prosper.

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