A Simple Cure for Weak-Bank Disease

What does it take to run a successful business? Brains, profit, a little humility--as anyone can see who looks at the dunce caps and the gold-star winners in banking.

Citicorp, America’s largest bank, announced Tuesday that it lost $457 million in 1991. And though the bank won’t admit it, worse may be yet to come. As more of its loans on commercial real estate and risky corporate transactions go sour, it’s certain that Citicorp will have to raise massive amounts of new capital--$4 billion to $7 billion by some estimates on Wall Street--severely diluting the value of the current shares.

Elsewhere, more than 1,300 U.S. banks were unprofitable last year, mostly because of bad real estate loans. Nor is weak-bank disease an American phenomenon. The big banks of Japan, pictured only a few years ago as Godzilla towering over global finance, are on the verge of meltdown because of massive bad loans, most of which they have yet to formally recognize and reserve for.

Now, let’s put that in perspective. More than 10,700 U.S. banks, or 89% of the nationwide total, earned a profit last year--although in too many cases it was only a slim profit.

But J. P. Morgan & Co., the fourth-largest U.S. bank and the worldwide holding company of Morgan Guaranty Trust, set an example by smartly conserving capital, cutting expenses and increasing profits.

And banks much smaller than Morgan also succeeded. “Banks in the Middle West present a different and healthy picture,” says analyst Raphael Soifer of the Brown Bros., Harriman & Co. investment firm.

Indeed, a look at the results for banks in the Big 10 states show many small banks and some large ones--such as Banc One of Columbus, Ohio, NBD of Detroit, Norwest Bancorp of Minneapolis and Northern Trust of Chicago--with decent profits and low ratios of dumb loans.

The Midwest’s secret may well be humility. The region has gone through more than a decade of sober economic times, in manufacturing and agriculture, and its banks have had to remember that banking is inherently a cautious business--that lending money is easy, collecting is the real trick--and that each loan and investment has to show a profit.

Those are lessons that Citicorp, the Japanese banks and hundreds of others forgot as they found reasons to make loans on uncompleted office buildings and corporate takeover schemes.

The U.S. Congress too seems to have forgotten that banks must make a profit. In bank reform legislation designed to shore up the Federal Deposit Insurance Corp., Congress added higher insurance costs onto healthy banks, but refused to broaden regulations and allow banks to enter other businesses, such as insurance. The perhaps understandable fear was that banks would make colossal and costly errors as did savings and loan associations a decade ago.

But one result is that the banking industry is shrinking. Most banks are unable to profitably make loans, says Michael Morrow of Morrow Group, an Austin, Tex., bank consultant. Therefore they are less than eager to accept deposits--one reason you’re offered such an unattractive rate on certificates of deposit.

Morrow explains the equation: Banks’ prime lending rate--for their most credit-worthy clients--has come down to 6.5%, which is 3% more than the rate at which banks can borrow funds from the Federal Reserve, and roughly 2.5% more than they pay on deposits these days. But with bank operating expenses running close to 2%, and being increased by a hike in their costs for deposit insurance and holding reserves against losses, there’s not much prospect for profit in making loans.

So banks hold back on loans--frustrating the economy’s recovery from recession--and invest their deposits in Treasury securities or in mortgage securities. With interest rates falling, banks are doing a lot of home mortgage refinancing these days--and collecting fees for same.

But they don’t need a lot of deposits to conduct such business, so they’re not eager to give you a CD. They’d rather sell you a mutual fund and earn a commission. That’s one reason bank savings deposits have been flowing into the stock market via the mutual funds.

The upshot is that long-term trends that have seen traditional banks fade in U.S. financial life will continue. According to the Federal Reserve Board, banks accounted for more than half the loans and deposits in the U.S. financial system in 1950; now they’re closer to 30% and falling.

But that doesn’t mean smart banking organizations will fade. Morgan & Co., with more than $100 billion in assets, is one of the world’s premier financial institutions--earning fees for advising clients and arranging financing. But it has only 30% of its assets in loans. It’s not profitable for the bank to risk its own capital, explains George Rowe, president of Morgan’s California division--nor do the bank’s clients desire it. “It may be far better to raise money for our clients in the money markets or in Europe or Japan,” explains Rowe. “It’s not our capital that’s needed, but our brains.”

You could say the same for any bank, and indeed for any business--and the smart ones are waking up to that fact.