The Decline of Traditional Banking: Implications for Financial Stability and Regulatory Policy

[...]This article has two objectives: to examine theforces responsible for the declining role of traditionalbanking in the United States as well as in other countries,and to explore the implications of this decline and banks’responses to it for financial stability and regulatory policy.A key policy issue is whether the decline of bankingthreatens to make the financial system more fragile. Ifnothing else, the prospect of a mass exodus from thebanking industry (possibly via increased failures) couldcause instability in the financial system. Of greater concernis that declining profitability could tip the incentivesof bank managers toward assuming greater risk inan effort to maintain former profit levels. For example,banks might make loans to less creditworthy borrowers orengage in nontraditional financial activities that promisehigher returns but carry greater risk. A new activity thathas generated particular concern recently is the expandingrole of banks as dealers in derivatives products. Thereis a fear that in seeking new sources of revenue in derivatives,banks may be taking risks that could ultimatelyundermine their solvency and possibly the stability of thebanking system.[...]