While Congress labors with legislation that would remove most of the six-decade-old barriers between commercial and investment banking, the blurring of differences between these two industries continues. And nowhere is this erosion more evident than in the entry of banks into the booming mutual fund industry, a move that started in the late 1980s and has accelerated in the 1990s. More than 2,000 U.S. commercial banks—about one fifth of the industry—now sell mutual funds to their customers. This total includes about 170 Eighth District banks, or roughly 15 percent of the District total.

Mutual Funds' Rising Popularity

Mutual funds' growing popularity over the last decade has come at the expense of other financial intermediaries, especially commercial banks, whose low rate offerings on certificates of deposit (CDs) and other traditional products drove savers willing to trade some risk for reward into the stock and bond markets, often for the first time. This substitution phenomenon, frequently referred to as disintermediation, explains a significant portion of the tremendous growth in mutual fund assets in the 1990s.

Other factors have been important too, however. Corporate America's move from defined benefit plans—or the traditional corporate pension—to defined contribution plans, like 401(k) plans, has forced many to take control over the management of their retirement assets, which are increasingly comprised of mutual funds. New innovations in mutual funds, like check-writing privileges, have also been important to mutual fund growth.

Banks and Mutual Funds

Banks entering the mutual fund business generally fall into one of two camps. The first consists of banks that are taking the offensive with mutual funds, believing that fee income from the sale and, in some cases, management of them will add significantly to the bottom line at a time when profits from traditional lines of business are being competed away. The second group of banks is taking a more defensive posture in response to real or perceived disintermediation, believing that offering mutual funds to their customers is necessary to keep them.

Bank involvement in the mutual fund business ranges from very little to very significant. The vast majority of banks sell third-party funds, that is, funds that are managed and distributed by an independent and unaffiliated mutual fund or other securities firm, like Fidelity or Vanguard. Banks broker third-party funds to their retail customers either through an authorized securities brokerage subsidiary or a networking arrangement with an outside service provider that sells funds on bank premises.

About 120 U.S. banks have chosen to become much more actively involved in the mutual fund business by managing and advising their own proprietary funds. Although the Glass-Steagall Act prohibits banking organizations from underwriting and distributing mutual fund shares, they are permitted to conduct most activities related to mutual funds, including managing mutual fund assets and selling shares of their own and outside funds to their customers.1

Recent Trends in Bank Mutual Fund Sales

Banks of all sizes sell mutual funds to their retail and trust customers, though large banks are more likely to sell funds than smaller banks. In the District, for example, just 6.9 percent of banks with average assets of less than $100 million sell mutual funds, compared with 78.3 percent of banks with average assets of more than $1 billion. These 18 large institutions accounted for more than two-thirds of the $588.4 million in gross mutual funds sales at District banks in the second quarter of 1995.2

Sales of money market mutual funds (MMMFs) dominate third-party and proprietary bank mutual fund sales at the District and national levels. MMMF sales accounted for 76 percent of total sales in the second quarter of 1995 in the District and 95 percent at all U.S. banks. District banks sold $77.47 million in equity funds and $48.49 million in fixed income funds in the second quarter, accounting for 13.2 percent and 8.2 percent of total sales, respectively.

MMMF dominance in bank mutual fund sales likely reflects several factors: consumer preference for liquidity; consumer familiarity with MMMFs, which are very similar to the money market deposit accounts (MMDAs) offered by banks since 1982; and the strong likelihood that a sizable proportion of buyers are first-time investors who view long-term funds (equity and fixed income) as too risky.

Despite the preponderance of MMMF sales in total bank mutual fund sales, about two-fifths of the District banks that sell mutual funds do not sell MMMFs. In the second quarter of 1995, about 55 percent of District bank mutual fund sellers sold MMMFs, compared with 89 percent that sold long-term funds. Just under half of all District bank sellers sold both short- and long-term funds in the second quarter, compared with just over 30 percent one year ago.

Proprietary Mutual Funds

The select group of U.S. banking organizations that have chosen to offer and manage their own funds includes nine bank holding companies headquartered in the District (see table). Not surprisingly, these institutions are among the area's largest. Four of the nine—Boatmen's Bancshares, Mercantile Bancorp, National Commerce Bancorp and Mark Twain Bancshares—manage all of the major types of mutual fund portfolios: money market, fixed income, municipal debt and equity. Another District banking organization, Trans Financial Inc., of Bowling Green, Ky., recently announced that it would manage a full complement of funds consisting of six portfolios, pending Securities and Exchange Commission (SEC) approval.3

To date, bank fund managers have been only moderately successful in generating sales, particularly sales of relatively lucrative long-term funds. Sales of proprietary mutual funds and annuities accounted for just 7.3 percent of total mutual fund and annuity sales at District banks in the second quarter of 1995. The proportion for all U.S. banks was a whopping 83 percent, a figure that analysts believe is mostly comprised of MMMF sales, since the bulk of bank mutual fund assets are still in MMMF portfolios.

Although they do not constitute major players yet, banks are making their presence felt in the mutual fund industry. According to Lipper Analytical Services, banks' share of total mutual fund assets doubled in the last six years, from 7 percent in 1989 to 15 percent in mid-1995. More important, the composition of bank-managed funds is changing. In 1989, long-term fund assets comprised just 16.3 percent of total bank mutual fund assets; by mid-1995, that share had increased to 42.4 percent. In terms of performance, bank managed, long-term mutual funds are generally holding their own against nonbank funds, though they typically trail most nonbank fund types. According to Lipper, for the period ending June 30, 1995, bank-managed general equity funds posted a five-year annualized total return of 10.95 percent, compared with 11.11 percent for nonbank funds. Over the same period, the annualized five-year total return for bank-managed, taxable fixed-income funds averaged 8.27 percent, compared with a 9.08 percent total return for nonbank funds.4 Despite the comparable returns, most analysts believe that banks need to outperform their nonbank rivals if they are to increase their market share against the large mutual fund companies.

The Bottom Line

Although sales figures and market share numbers are useful guides for assessing how successful banks have been in the mutual fund business, the real test is the effect on the bottom line. To date, income from mutual fund and annuity sales has accounted for just a fraction of noninterest income at selling banks. In the District, for example, mutual fund and annuity income averaged 1.64 percent of noninterest income in the second quarter of 1995, with just 20 percent of mutual fund sellers reporting mutual fund income shares of more than 5 percent. Moreover, no comprehensive information about the costs of starting and administering mutual fund sales programs, whether third-party or proprietary, exists. Without cost data, it is impossible to gauge whether bank mutual fund programs are making a net contribution to the bottom line or whether the resources spent on mutual fund programs would be better deployed elsewhere. In the end, these are the most important measures of success.

Table 1

District Banks that Manage Proprietary Mutual Funds

Ranked by Assets under Management

Organization	Location	Total Fund Assets at 6/30/95 (US $ millions)	Total Number of Portfolios	Money Market	Fixed Income	Muni	Equity
Boatmen's Bancshares Inc.	St. Louis, MO	$4,738.5	31
Mercantile Bancorp Inc.	St. Louis, MO	1,820.8	27
First Tennessee National Corp.	Memphis, TN	475.0	7
National Commerce Bancorp	Memphis, TN	328.7	7
Mark Twain Bancshares Inc.	Ladue, MO	250.7	4
Magna Group	St. Louis, MO	79.3	2
Commonwealth Bancshares Inc.	Shelbyville, KY	74.4	1
Union Planter's Corp.	Memphis, TN	36.1	1
Trans Financial Inc.1	Bowling Green, KY	N/A	6

¹ Pending SEC approval

SOURCES: Lipper Analytical Services; American Banker

[back to text]

Thomas A. Pollmann provided research assistance.

Endnotes

1. See Clark (1995) for more detailed analysis of the Act's history and recent efforts to repeal it. Also see Clark (1993) for more detail on banks' permitted mutual fund activities. [back to text]
2. Banks report gross sales of mutual funds and annuities—rather than the industry standard of net sales, which are sales less redemptions—on the balance sheet and income statements (call reports) they file quarterly with their primary regulators. The reporting of gross sales tends to overstate banks' share of the mutual fund business because some funds, especially MMMFs, experience frequent sales and redemptions because of their use as a cash management tool. [back to text]
3. See Plasencia (1995). [back to text]
4. See Kimelman (1995). The five-year return for bank proprietary funds includes 77 bank funds that have existed for at least five years. [back to text]

References

Clark, Michelle A. "Banks and Investment Funds: No Longer Mutually Exclusive," The Regional Economist (October 1993), pp. 5-9.

_______. "Commercial and Investment Banking: Should This Divorce Be Saved?" The Regional Economist (April 1995), pp. 5-9.

Kimelman, John. "Bank Mutual Funds Pass Test of Five-Year Performance," American Banker (August 4, 1995).

Lipper Analytical Services, Inc. "Lipper Bank-Related Fund Analysis," Second Quarter 1995.

Plasencia, William. "Kentucky's Trans Financial Bank Starting a Mutual Fund Family," American Banker (August 11, 1995).