Productivity in Banking

Numerous articles have reported increased productivity in the economy over the past decade as a result of computers and artificial intelligence. However, the articles have generally overlooked the fact that productivity in commercial banking began increasing two decades ago. The Economic Letter of the Federal Reserve Bank of San Francisco credits the early rise in banks' productivity to deregulation and increased competition. Why did banks become more efficient? They had to.

By the early 1980s, commercial banks had lost the protection of rate ceilings that they could pay on their deposits. Even though the caps protected them from rate competition, many banks had already chipped away at the interest caps by offering toasters and extra services at no cost. Unfortunately, these "free" services were not free to the banks and required more personnel. Regulators removed the last of the interest rate ceilings on deposits in 1992. Legislators began to remove restrictions on interstate and intrastate branching. As a result, some banks began to enjoy the benefits of "economies of scale." However, others did not relish the increased competition and merged or failed. Bank failures rose sharply from 1982 to 1989. (In contrast, as noted in the August issue of Spotlight, there were only five bank failures last year.) At the same time, legislators allowed the surviving commercial banks to enter financial areas that had previously been reserved for other financial institutions. The Gramm-Leach-Bliley Act of 1999 opened most financial services to competition.

The pressure of competition and a taste for survival motivated banks to increase the productivity of their labor force by acquiring sophisticated equipment to provide banking services and by training and reorganizing their employees. A common measure of labor efficiency is "the volume of its product or services produced for each hour of labor input." Thus, the measure reflects the combined efficiency of machinery and workforce. From 1983 through 1999, output per labor hour grew at a compound average rate of 2.8 percent, compared with an annual compound growth rate of just 0.7 percent in the previous ten years.