Madame Chairwoman and Members of the Subcommittee:
For virtually all my adult life -- as student, as banker,
as teacher, most of all as a Treasury and Federal official --
I have been concerned with matters of banking regulation and supervision.
I have been among those regulated, today as a bank and insurance
company director. More often, I have been among those doing the
supervision. In between, I've sometimes been a sponsor and participant
in independent analyses and research-
Your responsibility today, and mine, is not to look back but to
look ahead into the twenty-first century. But as you might expect,
my experience over the past half century has confirmed the wisdom
of certain principles that have long provided the conceptual bass
for American bank regulation. As I see it, the essence of effective
reform is not to abandon those principles but to adapt them to
the circumstances of today and tomorrow. I welcome the invitation
to appear before you today to develop that point.
I recognize that the process of reform has been long, contentious
and tedious. It must be as frustrating to you as it is to me that
the agenda before you -- including notably Glass Steagall repeal,
the scope of bank holding company activities, and the locus of
supervising authority -- is hardly different from when I used
to appear regularly before this Committee as Chairman of the Federal
Reserve Board 15 or so years ago. Legislatively, we have been
stuck near dead center, frozen amid the interplay of particular
interests, each amply financed and represented. What has been
lacking is the will and capacity to cut through those competing
claims to reach a consensus demonstrably in the general interest.
What has not been frozen -- what can't be frozen -- is change
in the marketplace. As you well know, the combination of new technology
and an innovative spirit, each in ample supply and richly rewarded,
has greatly speeded that process. New ways of doing business,
within and around old institutions and regulations, is the order
of the day. In response, a few piecemeal adjustments have eventually
been made in law; more often regulatory authorities and the courts,
sometimes stretching established interpretations of law beyond
recognition, have tried to play catch up.
That market driven process, while following no coherent legislative
design, has had useful results. Markets and institution are in
fact more competitive and innovative, with more new products and
services, than if they had been frozen in time. But I don't think
anyone would argue the result is optimal, whether on grounds of
effective competition, fairness, or safety and soundness.
Now happily, there is a new opportunity for action. Market and
political forces seem now to be coalescing in a way consistent
with thoroughgoing rationalization and revamping of the legal
structure surrounding the whole financial services industry. Quite
obviously, this Subcommittee can play a key role in capitalizing
on that opportunity by clarifying the issues and cultivating consensus.
I do not intend in this brief statement to enter into all the
detail. I do not deprecate the importance of that work, which
is bound to occupy much of your attention in the weeks and months
ahead. But I want this morning to emphasize that not all "the
devils are in the details". What is fundamentally important
is some understanding of the basic legal and regulatory philosophy
that should drive the effort. without such an understanding, the
ability to reconcile or if necessary to override the competing
private interests will be limited, once again placing constructive
and comprehensive legislation beyond reach.
I will emphasize this morning just a few key elements that, taken
together, should provide much of the conceptual framework for
new legislation. In particular, I want to remind you of the continuing
importance to the financial system as a whole, and to the economy
generally, of certain core functions long associated with commercial
banking. Banks are creators of money and the main conduit for
monetary policy. They operate the payments system nationally and
globally. They can be mobilized to provide needed liquidity or
required to restrain credit in response to changing economic requirements.
For that reason commercial banks here and almost every where are
, on the one hand, relatively heavily regulated and supervised,
and on the other hand privileged in access to Federal financial
support. The point is the economy as a whole has a large stake
in the strength and stability of the banking system. That concern,
as you well know, gave rise to a substantial reform at the supervisory
framework a few years ago. Any new design for financial reform
must also recognize the implication.
Given that requirement, I believe new legislation must take account
of certain other realities:
The Need for Broad Legislation
The traditional distinctions among financial institutions, still
embedded in present law, are rapidly eroding . New technology,
global competitive pressures, and powerful business logic have
simply overpowered the idea that commercial banking, investment
banking, and investment management are distinct and separate lines
of business. In truth, the overlaps are large and growing. Many
large institutions feel a compelling need to engage in all or
most of those activities to remain competitive not only with their
domestic counterparts but internationally. Even relatively small
banks are pressured by competition to provide their customers
with access to brokerage, mutual funds, and increasingly insurance.
There is, as well, increasing recognition of the large investment
element in much of what is still labeled insurance. conversely,
insurance companies themselves, like many other financial institutions,
have felt the need to compete over a broad range of services and
to seek new marketing outlets.
I need not belabor the point because it is so widely recognized
Moreover, in one important area of overlap, that is between investment
and commercial banking, the institutional separation embodied
in the Glass-Steagall Act has been in practice largely abolished
by regulatory fiat, implicitly blessed by the Congress and explicitly
by the courts. But an ad hoc approach is hardly a satisfactory
way of proceeding.
The effort to adapt and reconstruct outmoded law by regulatory
liberalization has inevitably been incomplete, with a residue
of essentially arbitrary and dysfunctional distinctions among
particular institutions. As a result, some organizations are relatively
advantaged over others. Moreover, to my mind, there have been
elements of unhealthy competition among regulatory authorities
as they adapt novel or aggressive interpretations of law in ways
that leave the playing field uneven.
In the process, artificial incentives to engage in or to restrict
certain activities arise, at the expense of efficiency and effectiveness.
At best efficiency suffers competitive inequities. At worst, prudential
safeguards may inadvertently be weakened, neglected or applied
There are those, to be sure, who may be relaxed about that situation,
feeling they are, by design or otherwise, in a competitively privileged
position. But that is hardly an equitable result nor does it effectively
serve the broad public interest.
I referred earlier to one element in that public interest that
deserves special emphasis. Certain core commercial banking functions
-- as custodian of the payments system, as the conduit for money
creation and monetary policy, as residual suppliers of liquidity
-- are especially critical for the orderly functioning of the
financial and economic system. it is these functions that have
long justified more intensive Government regulation and supervision,
as well as the special support system embodied in deposit insurance
and Federal Reserve liquidity facilities. I know of no legislative
proposals under active consideration that do not rightly respect
the continuing need for such support to protect the stability
of the financial system.
At the same time, a strong banking system requires that commercial
banking institutions be able to participate in more rapidly growing
and profitable sectors of the financial services marketplace-
That is the powerful logic behind the need to expand the powers
of a bank holding company (or, as some would prefer terminological,
a "financial services holding company"). Commercial
banks can now engage competitively in fund management, and there
is, I believe, now wide agreement that they should be able to
affiliate with investment banks -- and that, reciprocally, those
financial businesses can acquire a bank affiliate. The time may
well have come to extend that same logic to the insurance business
in whole or in parts.
That much is common ground among most of the proposals for reform.
The challenge is to achieve that competitively desirable result
consistent with the safety and soundness of the banking system,
and with financial stability generally.
The Need for Capable and Coherent Oversight
Experience in one country after another over the past decade has
forcibly reminded us of one fact of financial life: the advances
in technology and the new and sophisticated techniques of risk
management have not ended the risk of financial crises. Markets
have a way of exaggerating moods of optimism and despair. Profitable
and attractive leveraging of capital in an equable economic environment
can quickly threaten bankruptcy when conditions worsen. The possibility
is real that particular failures will impact on others so that
the consequences are amplified through the markets -- so-called
systemic risk. Indeed, the risk may be increased by the closer
institutional and even global interdependencies today, reflected
in the daily movement of trillions of dollars.
We have learned first hand of the enormous financial and economic
consequences of crisis -- in the savings and loan failures of
the 1980's and banking strains of the early 1990's. The effects
of the sudden Mexican crisis in late 1994 are still felt in that
country and in other parts of Latin America. In Japan, the aftermath
of the financial bubble almost a decade ago is still restraining
I can think of no recent exception to the rule that faced with
crisis, and whatever the specifics of law, Government will de
facto step in to support and stabilize the banking system. But,
of course, it is better to head off the crisis, by effective regulation
and supervision, and to deal with points of strain before the
system as a whole is threatened. Essentially that is why the United
States, like other countries, has long regulated and supervised
commercial banking institutions and provided for them an official
'safety net" by means of deposit insurance and Federal Reserve
A key question that you must deal with in financial reform is how to maintain the necessary degree of protection for core barking functions in a world in which many banking organizations will be active in other areas of finance. Extending the degree of regulation appropriate for banks through the whole of the financial system is not attractive. Even less should we want to contemplate spreading Federal insurance or direct access to Federal Reserve credit to nonbanking functions. The challenge is to find a workable balance -- a means of credibly protecting the essential care, the money supply and the payments system, while minimizing intrusive regulation and the Government's
One approach with surface attraction is to isolate the essential
commercial banking functions from affiliated organizations by
the creation of strict "fire walls", at the extreme
prohibiting cross marketing, linked services, use of a common
name, and even geographic proximity. But that approach runs directly
across the logic of a bank or financial services holding company.
The point is not to run a group of isolated businesses but to
seek synergies in the provision and marketing of services. Moreover,
the reputation and commercial effectiveness of one part of the
organization cannot be insulated from its affiliate. The natural
tendency of management, faced with the possibility of failure
of one part of the organization, will be to bring the resources
of the whole to bear. Given the fungibility of money and the resourcefulness
of financial managers, no practical system of fire walls can be
fully successful in isolating a problem.
Clearly, some degree of separation of the care banking functions
can be maintained as it is at present. As a matter of policy,
official assistance can be directed to the banking affiliate rather
than to other parts of a holding company. But for that approach
to be effective, I believe there is a compelling need to continue
oversight by a single supervisory authority charged with assessing
the overall safety and soundness of the entire holding company.
I do not mean to suggest that the current arrangements need to
be replicated in all its aspects. The authority exercising oversight
need not have exclusive or primary jurisdiction over the various
affiliates. The SEC, the Comptroller, State banking and insurance
authorities, and others could be "functional" regulators,
providing consistency with their own legislative purposes and
responsibilities. But in the end, someone must be able to evaluate
any bank holding company as a whole, lest some parts become so
weak, or so large a drain on the whole, that the core banking
functions are jeopardized.
It will not surprise you when I suggest that, as a practical matter,
the appropriate agency for under-taking the oversight of a holding
company containing a bank within its structure is the Federal
Reserve. No other agency today has the same combination of resources
(including financial resources), of independence, of breadth of
responsibility and of experience. The only alternative to the
Fed as overseer, it seems to me, would be to start afresh with
a now umbrella organization, a difficult and uncertain task. And,
if that route were to be chosen, certainly the Federal Reserve
should have a large degree of influence in its governance and
in the implementation of its policies.
The Question-of Commerce and Banking
I emphasized at the start the need for new legislation to respect
the need for strong structural protection against conflicts of
interest in the provision of credit and undue concentration of
resources. In my judgment, permitting banks or bank holding companies
to extend their activities into commerce and industry -- contrary
to Anglo-Saxon traditions of finance -- would be directly contrary
to that need.
I am frankly puzzled as to why this question recurs each time
the Congress considers broad legislation. I understand, of course,
'that there have been a handful of large companies, some of which
already have substantial finance company or credit card arms,
who feel that ownership of a bank would enhance their market position
and permit greater financial leverage. Conversely, there may be
a few commercial or investment banks may have ambitions to expand
their activities into industry. But it has never been clear that
these interests are widespread, and the concept, for good reason,
has never commanded broad public or legislative support.
It is interesting how the rationale of the advocates has changed
over the years. A decade or so ago, the German (or Continental)
system, which has de facto permitted some substantial and controlling
ownership of large industrial firms by large banks, was cited
with admiration for its strength and stability. Few would make
that claim today in the face of the difficulties experienced by
some of the largest and proudest banking firms in German, France,
and elsewhere as a result of industrial holdings. it is an ironic
fact that, just as the proposal to relax our restrictions is pressed
by some, debate has emerged in Germany and elsewhere about the
wisdom of their approach, partly because of the implications for
corporate governance and for concentrations of economic influence.
I trust that those supporting banking and commerce combinations
are not contemplating replication of the Japanese kiretsu system.
In that system, large banks and trading companies have a network
of reciprocal stock holdings. individually those holdings are
relatively small, typically 5 percent or less of a company's capital
stock. In combination, however, those holdings are associated
with close and relatively favored trading and financial arrangements
within the group, with anti-competitive implications that have
frequently been a matter of concern for American companies wanting
to penetrate the Japanese market.
A few years ago, it was alleged banking equity was in such short supply that banks needed to draw upon stronger industrial firms to shore up their capital position. That argument never made much sense as an excuse for basic
structural change, implying as it did that American financial
markets are unable to allocate capital with reasonable efficiency.
The fact, of course, is the American capital market is the envy
of the world. It is New York and London -- not Frankfurt or Paris
or Tokyo -- that are the centers of innovation, of trading, of
capital raising in all shapes and sizes. American banks are as
well capitalized as at any time in memory. Far from being unable
to raise capital, many are buying back their own stock in the
market. All that has been achieved without relying on industrial
ownership or alliances. Surely, it is precisely the fact that
such alliances play a relatively little role in our banking and
financial markets which helps account for their adaptability and
I believe there is an instinctive -- and valid -disposition in
this country to avoid combinations of our largest banks and industrial
firms. This morning, I join with many others in advocating a broadening
of the powers of bank or financial holding companies. No doubt,
the result will encourage some further consolidation among financial
institutions. In 'those circumstances, it becomes even more important
to maintain the traditional distinction between banking and commerce.
We should want decisions on the allocation of credit, on the underwriting
of bonds, an the sale of stock to reflect unbiased financial judgments,
free of taint of serving the interests of a commercial affiliate.
We do now make some rules to limit and regulate transactions directly
among different parts of a holding company. But as a practical
matter, full insulation is impossible, and effective policing
of transactions with third parties is beyond reach. How likely
would it be, for instance, that a bank affiliated with a powerful
retail chain will eagerly lend to a local or regional competitor?
What about the one bank town, where the choices of smaller borrowers
are already at best limited? What about the temptations to lend
to or otherwise support a weak commercial affiliate?
I discussed earlier the compelling need for supervisory oversight
over an entire banking holding company. To do otherwise would
unnecessarily jeopardize the safety of the bank and place the
economy and the American taxpayer at added risk.
To go further and permit combinations of commerce and banking
would be to produce an insoluble dilemma for supervision. To forego
any oversight of important, and perhaps dominant, parts of the
holding company would create new risks for the bank, and thus
for the financial system and the taxpayer. But to extend regulation
and supervision into the non-financial world would imply an enormous
stretch of government oversight. The practical and policy implications
of either choice are simply not acceptable.
No doubt, you will hear arguments that these concerns are exaggerated
and they can be dealt with or ameliorated by compromise. There
are already combinations of finance companies -- some very large
-- and industrial firms. There are some limited "non-bank
banks" owned by commercial companies, a residue of earlier
attempts to square the circle. Surely, it will be said, that these
existing situations should, in an extension of the principle of
grandfathering, be accommodated in new legislation that liberalizes
the powers of bank holding companies.
Beware of the implications!
The Bank Holding Company Act today already permits what amounts
to incidental holdings of the stock of non-financial companies,
defined as less than 5 percent of the total capital stock and
absence of control. That leeway is not much used, precisely because
control is the issue; there is no strong incentive to own stock
if there is not a common business strategy and absence of strategic
influence. It is precisely when there is common business interest
and reciprocal influence that the conflicts and incentives for
A number of touted initiatives to combine commercial and financial
firms have fallen by the wayside in recent years. Other combinations
have become large and profitable without any need to perform core
commercial banking services. Those organizations can and should
be given a clear and perfectly equitable choice: continue without
a bank affiliate, or give up the industrial or commercial affiliation.
That is the same choice that should face any non-bank financial
firm: remain free to affiliate with an industrial firm or with
a bank, but not with both.
You know better than I that the idea of making limited exceptions
to a general rule breeds complications and inequities- By adopting
special "baskets" or other compromise approaches to
accommodate particular interests this year, you will be presented
in the years ahead with the argument that the compromises are
arbitrary and inequitable. An enlarged phalanx of lobbyists will
appear, dedicated to enlarging whatever room for maneuver has
been achieved. And the arguments will be more forceful because
there will then be established economic interests to defend and
I have argued this morning the logic and practical desirability
of finally eliminating Glass-Steagall restrictions, of generally
enlarging the powers of bank holding companies in the financial
area, and of providing effective supervisory oversight over bank
and financial holding companies.
All of that is important. And finally, after 15 years of recurrent
effort, the necessary intellectual consensus and will to act in
a comprehensive way seems to be coalescing. Failure by the Congress
to seize this opportunity to modernize the legislative framework
for banking and finance would be sad indeed.
But I also have to say none of that would be worth the risks and
costs of embarking on a new experiment - an experiment foreign
to our traditions and experience -- of relaxing prohibition on
combinations of banking and commerce. The Hippocratic injunction
to, above all else, do no harm has its application to banking
In my judgment, the Subcommittee Could make no greater contribution
to speeding constructive legislation than by making clear now,
at the very start of the legislative process, that the idea of
combining banking and commerce should remain "off the table,"
just as it has in the past. After all, your agenda is full, without
adding such an indigestible and foreign ingredient.