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This column was originally published on RealMoney on Aug. 15 at 1:00 p.m. EDT. It's being republished as a bonus for readers.

The banks have been losing ground, relatively, since shortly after the

Federal Reserve

began its campaign last summer to move in relentless baby steps from an accommodative to a neutral stance.

They had served as a place to hide during the market meltdown of 2000 to 2003, escaped more or less unscathed from the recession the meltdown engendered and then held their own in the market rebound that ensued in 2003.

Underperformance by the banks during a phase of monetary tightening shouldn't be a surprise, given the historical record and the logic that short-term interest rates are both the Fed's policy target and a critical part of the banks' cost structure.

But the relative performance deficit, so far, is quite modest when you consider how flat the yield curve has become and how much higher short-term rates may yet have to go before the Fed perceives its stance to be no longer accommodative.

Maybe this relative resilience is a form of recognition that banking companies are much better managed than they once were.

This is the result of more stringent prudential regulatory supervision, deeper mandated capital cushions and more highly developed risk-management systems. Or perhaps it's a function of the banking sector's rich dividend yields in a yield-starved environment.

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But it may also be due to the market's perception that banking companies are no longer quite the sitting ducks they once were for the effects of tight monetary policy. Bank balance sheets characteristically showed short-term deposit liabilities and borrowings, many of which were highly sensitive to the level of short-term interest rates.

Many of these funded bank assets, such as intermediate-term loans and investments, embodied credit exposures that tended to deteriorate as the economy slowed in response to Fed tightening. With relatively sticky assets acquired in happier times, and with their asset-liability duration mismatches, banks saw both their liquidity and their solvency come under stress when the Fed turned unfriendly.

Banks Endure Fed Tightening

Source: Standard & Poor's, Philadelphia Stock Exchange

In its attempts to control the economy, the Fed placed its thumbs directly on the banking sector's windpipe. By throttling the banks, the primary source of credit for most businesses and households in the economy, the monetary authorities were able to effect a slowdown in economic activity, which often turned into a downturn that then resulted in the Fed releasing its chokehold. With such a record, it isn't a surprise that many investors rotate out of the banks when a monetary tightening is in progress.

But with 250 basis points of snugging already in place and more apparently to come, the banks haven't done too badly, so far, relative to the broad market. One possible reason (with ominous overtones) is raised in the most recent annual report of the Bank for International Settlements.

It notes that structural changes in the financial system have resulted in a shift of risk-bearing from financial institutions and markets to the household sector.

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BIS recognizes that "households are the ultimate bearers of all risks by virtue of being the ultimate stakeholders in all economic enterprises," but it argues that the overall level of financial risk is not independent of the financial structure.

Credit and interest rate risk may once have accumulated in financial institutions. But today, thanks to securitization, variable-rate mortgages and loans, market-linked life insurance products and the shift from defined benefit to defined contribution pensions, the household sector is more directly exposed to market risks than had been the case in the days when the structure of finance was one of narrower intermediation.

If we change the structure, perhaps we change the characteristic response pattern. Why is it, after all, that the banks came through the market meltdown and subsequent recession with so little injury? Perhaps it was that the Fed was quick to ease in response to the crisis. Maybe it was that the problem was centered in equities rather than in mortgages, bonds or business loans. But maybe, more generally, the banking sector -- the "structure of finance" -- has changed in ways that shift the bearing of risk away from itself on to the capital markets and through them to the "ultimate bearers," the household sector.

As the Fed marches on in its tightening campaign and as the yield curve becomes ever flatter, it is worth wondering just how changes in the structure of financing of economic activity might affect such activity going forward. In the days of Regulation Q (a 1930s-era restriction that prevented banks for competing for funds), the Fed could induce disintermediation almost surgically, with the result that it had fairly precise control over economic cyclicality. But today, with risk-bearing spread so far and wide as a result of the changed structure of finance, it is not clear that the Fed, bedeviled by conundrums, has even a shadow of the control it once had.

Yield Curve
How will it respond to new structure?

Source: Bloomberg

With risk-bearing now more widely distributed, the structure of finance has shown itself to be more stable, at least so far and at least "in the small." It has yet to be demonstrated that this will also be true "in the large," when, for example, the risk-bearing capacity of the household sector, the ultimate bearer of risk, is reached. After all, interest rate risk doesn't disappear even if, say, variable-rate mortgages mitigate that risk for banks.

I don't know what will happen if or when the yield curve inverts in the new structure of finance. It seems logical, though, that if the structure has been less sensitive to Fed tightening than it once used to be, it may also be less responsive to Fed easing.

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Jim Griffin is economic consultant and portfolio adviser to ING Investment Management and its Hartford-based unit, ING Aeltus, which manages institutional investment accounts and acts as adviser to the ING Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he appreciates your feedback;

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