A reexamination of the uniqueness of banks

Banks appear to be uniquely able to make loans and sell CDs to fund those loans. Since bank CDs carry the same nominal rate of interest as similar debt issued by firms of equal risk, several authors have questioned why banks can compete despite the disadvantage of having reserve requirements assessed against their CDs. These authors have suggested that the information content of bank loans makes borrowers willing to pay the higher cost of bank loans, and that the information provided by bank loans is unique, thus preventing other intermediaries from selling CDs not subject to reserve requirements and making loans at rates below rates offered by banks. This paper questions the assumptions behind such information content models by showing that the principal form of alternative financing, commercial paper, has issuing costs comparable to the reserve tax on CDs, so reserve requirements do not automatically place banks at a disadvantage. Also examined is the short-term borrowing behavior of firms with commercial paper ratings and rated long-term debt and finds that the market for debt is segmented by risk, with banks making loans primarily to riskier companies. Thus companies with access to lower cost funds do not appear willing to pay higher rates for the information content of bank loans. The paper presents an alternative theory for the uniqueness of bank loans which is based on the effect of access to the discount window in lowering the cost of CDs to banks. The reserve tax is shown to be the cost of a put option with the Discount Window of the Federal Reserve. Potential non-bank intermediaries cannot duplicate this put option. The value of access to the discount window in lowering CD costs is demonstrated by a test which shows that, after controlling for bank size, Fed member banks in 1980 were able to rely more heavily on large, money market CDs than non-member banks. This evidence is consistent with the idea that the costs of large CDs were lower for Fed member banks