The perils of commoditization have long prodded bankers to innovate, lest price become the sole determinant of success.
But what happens if innovation itself is regulated away as an option?
As the Obama administration seeks to mandate off-the-shelf, or "plain-vanilla" mortgage offerings, banks — already under pressure to distinguish themselves on the deposit and wealth management sides of their business — would face a potential commoditization of the lending business that could come on faster and stronger than anything competitive forces alone would have prompted.
Should Congress adopt the administration's proposal, industry representatives predict that small banks would be driven out of certain portions of the consumer lending market, unable to cope with the inevitable price squeeze. Major players, meanwhile, would go after volume to make up for lost margin, raising a new round of philosophical questions about whether companies already deemed too big to fail should be allowed to grow larger.
Under the Obama plan, banks would be required to offer standardized mortgage and other loan products before they could offer alternative products. Industry officials are alarmed for two reasons. For one, the exact definition of "plain vanilla" would be left to the proposed Consumer Financial Protection Agency — and it is unclear how it would do so.
They are also concerned that banks would shrink from offering alternative products — out of concern that they could be criticized by the new regulator — at exactly the time they would need to be creative in order to differentiate themselves.
The situation is not unfamiliar, but some say its scope would be broader than ever.
In the past two decades, the elimination of regulations and competitive barriers has forced banks to become accustomed to having some of their products and services treated like commodities, to which customers show little loyalty except on the basis of price. But under the proposal for the new agency, "you'd have that expand to areas that so far had been somewhat resistant to the trend to commoditize," said Wayne Abernathy, the American Bankers Association's executive vice president for policy and regulatory affairs.
Community bankers "are very much up in arms about it," he said, "and are really trying to convince their congressmen and senators that this will kill them."
But not everyone agrees that establishing the agency would send community bank-originated mortgages the way of community bank-issued credit cards.
"The banking model for the more traditional business of community banks is not based on exotic products. It's based on one, simple thing: a flat organizational structure so that the distance between the decision maker on a loan and the customer is very short," said Charles Calomiris, a finance professor at Columbia University. "That is the whole logic of why small banks still are in the lending business because loans already are commoditized."
Revolving credit agreements and term loans often are structured similarly from one institution to the next, and loan officers seem to uphold similar standards even for niche products like hotel loans, he said. On the consumer side, home equity lines of credit, which Calomiris called the "bread and butter of community banks," have been commoditized for years.
But rarely have standards for making loans been handed down directly from the federal government.
Alex Pollock, a resident fellow at the American Enterprise Institute for Public Policy Research in Washington, said the best comparison he could make to the proposed role for a consumer protection agency in mortgage lending comes from the deposit side of the business. Regulation Q, established in 1933 and phased out during the 1980s, put ceilings on the interest rates that banks could offer.
"You had the Federal Reserve telling all of the banks and all of the savings and loans what they could pay on deposits, and telling savers how much they could get on deposits, and that finally was judged by everybody not to be a good idea," Pollock said.
To what degree the consumer agency would be involved in designing mortgage loans that banks would be encouraged to offer remains to be seen. And even establishment of such an agency is not a sure thing.
"I would have said the CFPA was a foregone conclusion, given the problems we've had and how mad people are," said Doug Elliott, a Brookings Institution fellow and former investment banker, "but the industry seems to be doing a great job of at least slowing down" congressional approval.
And banks are motivated to lobby hard against its creation.
If the government does start designing mortgages or other consumer loan products, "commoditization of those products is virtually inevitable," Elliott said. "People will offer custom products that differ from those, but it's going to be an uphill battle. They're going to need to be answering a clear customer need in order to sell something that hasn't been blessed" by the government.
