What will happen: Banking at Y2K

Will there be problems in the New Year?

It is December 17, 1999. Two weeks prior to the New Year, and 15 percent of Americans are fearful for their bank deposits. They are afraid that they will be unable to access their cash because of the Y2K problem, even though virtually all banks are prepared for reliable operation in 2000.

With two weeks to go, these people decide to withdraw some cash to ensure they will be able to spend normally over the New Year weekend and after for up to a week - based on the average disposable income of in the U.S. ($18,963 in 1994), they typical household would need $364.67 to carry them for a week.

Although 15 percent of Americans are worried, less than that will be withdrawing money - some of these folks are married to one another, so let's assume the total percentage of households taking extra cash out of the bank in the last two weeks of 1999 is 11 percent, or 10,560,000 families and individuals.

The total demand for cash in the last part of December will be $3.9 billion, far less than the approximately $40 billion in extra cash printed by the Federal Reserve. Assuming these withdrawals are spread across the nation relatively evenly, no bank will be hard-pressed to keep up with demand. With 10,922 banks in the U.S. (in 1997, according to the Federal Deposit Insurance Corp.) and 72,992 branches, the average bank would need to keep only $352,583.00 on hand. The typical branch would need just $52,758.04 on hand to meet demand. The result: No bank runs.

The real question, though, is whether people had anything to worry about to begin with? Will there be problems in the New Year? Certainly, there will be some, but none that interfere with transactions on a large scale, and no one will "lose" their bank deposits. Banks will be able to trace their depositors assets backward in time if they encounter problems using recent paper receipts and data backups.

"More than 99 percent of the approximately 22,000 federally-insured depository institutions and credit unions have demonstrated to examining supervisors that they have completed preparations for the Year 2000, tested their mission-critical systems and put them into production." Federal Reserve Governor Roger Ferguson, Jr., told an audience at Georgetown University in Washington, D.C. on Sept. 28, 1999. In other words, banks have had to prove their readiness in order to continue to operate.

FDIC Chairwoman Donna Tanoue reports that 27 banks are still rated "less than satisfactory" by regulators; only seven ranked "unsatisfactory." "We're confident that bank and thrift customers and credit union members will be able to conduct business as usual before and after January 1" told Reuters in late September.

"To date, more than 9,000 financial institutions have tested the services they use with the Federal Reserve," Ferguson said. This is a critical link in the banking system, because it provides liquidity to institutions through overnight loans, as well as facilitating major transactions. "These represent all of our major customers in terms of transaction volume and dollar amount of the in terms processed through the Federal Reserve."

The Fed has backed up its readiness with a special center to provide additional cash to banks from Oct. 1, 199 through April 7, 1999.

The rational conclusion: fear will be misplaced. Fed Governor William McDonough said he would be confident heading into the New Year weekend with the $3.12 he had in his pocket over the Labor Day holiday.

Nevertheless, there will be some panic-driven withdrawals and transfers of money from overseas to U.S. institutions. The Federal Reserve, FDIC, and other federal agencies overseeing banking have asked banks to be prepared for gyrations in their deposits. Some banks, having received money from customers seeking safety, may find that they suddenly have too much money on hand, requiring increased deposits with the FDIC.

So, in the U.S., at least, the banking picture is very stable. Perhaps more so than usual, because of all the attention focused on Y2K.

Foreign banks, though, remain a cause of concern for Americans. There is very little information about many countries, but in countries doing extensive business with U.S. banks the situation is a little clearer. The Bank of Japan has conducted successful tests of its national transaction systems, as have central banks in Canada, the U.K., China and Germany, to name a few.

At a United Nations-sponsored meeting of Asian Y2K representatives in late September, 1999, contested criticisms of the region's Year 2000 readiness. Bruce McConnell, director of the U.N./World Bank-funded International Y2K Cooperation Center told the conference that negative assessments of Asia's readiness have been based on dated information. "Short-term infrastructure disruptions will be local and limited," McConnell said at the meeting. He added that, except for the health services industries in these countries, "preparations are well advanced."

Global 2000, an organization set up by banks and other financial companies, has met regularly throughout the year in locations around the world to drive industry preparedness. The International Monetary Fund will serve the same role as the Fed in the U.S., providing loans to central banks in need of cash to cover Y2K demand. The World Bank has delivered $35 billion in assistance to international banks to help them prepare for Y2K.

The concern in the U.S. rises from fears that U.S. banks doing business with foreign banks will suffer loses due to Y2K problems overseas. U.S. banks had more than $333 billion in foreign loans in 1997, according to the Fed and the Federal Financial Institutions Examination Council. The top five borrowers: U.K. ($33.5 billion, or 10 percent of the total), Japan ($19.2 billion, or six percent), Mexico ($17.2 billion, or approximately five percent), Germany ($16.953, or approximately five percent), and Brazil ($16.3 billion, or approximately 4.5 percent). Close behind are France, the Cayman Islands and Canada. All told, these major borrowers account for 44 percent of overseas lending by U.S. banks.

Particularly dangerous countries for finance, where money is loaned at high risk under all circumstances, are also at greater risk from Y2K. However, they will not likely "lose" money any more than an American bank - rather, as the recent Russian-Bank of New York controversy has shown, there is an opportunity for embezzlement around the New Year. Basically, bankers are equally honest all over the world, but there are bad apples aplenty, as in any industry.

Among the countries least prepared for Y2K are Russia, which had approximately $7.1 billion in U.S. loans in 1997, and Indonesia, with $5.1 billion. These do not constitute large exposure for U.S, banks relative to the rest of their loans. When the Asian economies collapsed in 1998, U.S. banks lost far more in the first quarter after the crisis began.

At the New Year, then, there will be some errors in accounts in the U.S. and overseas. But major transaction networks will operate largely intact, meaning that 99 percent of transactions will be conducted as safely as ever. The one percent in transactions that may fail will be rapidly dealt with - remember, there's a lot of money involved, especially for those who move quickly to solve these problems - and result in a total global loss in banking revenue of less than $1.5 billion over the entire month of January.

It's important to recognize that lost revenue is different than lost monies. With less revenue, banks will be less profitable, but only marginally so. U.S. banks turning a profit have steadily increased since 1985, the height of the S&L scandal. That year, 20 percent of banks lost money. By 1995, only four percent of banks were unprofitable, according to the U.S. Bureau of the Census. In the same time, the average return on assets generated by banks increased from approximately 0.1 percent to almost 1.25 percent. A hit on this profit rate, while painful in the short term, would pass. The profitability of banks swings as much as a half percent some years - the impact of Y2K will be far less than that.

On the whole, Y2K will be largely a non-event for banks, bank customers and investors in bank stocks. You heard it here.