Mr. Chairman and Members of the Committee!
I am delighted you have afforded me the opportunity
to testify this morning on H.R. 10 and related bills.
The Committee is dealing with issues that
have long been debated among you. The time for action is now,
this year. In fact, legislation is overdue.
It is also true that legislation should not
come at any cost. I will not disguise my concern that there are
provisions in the proposed bills that would be far too high a
price to pay for legislation. Specifically, that is the case with
proposals that would open the door to banking and commercial conglomerates
and expose the economy to new risks and the Federal Government
to added costs.
In the interest of full disclosure, I should
remind you that I am a director of a major commercial bank now
and prospectively heavily engaged in investment banking. I am
also a director of a large insurance company as well as two commercial
firms. I have recently managed a small investment banking firm,
and in the distant past, I once directed planning for a major
commercial bank. During most of my professional life, however,
I have been in Government with responsibility, directly and indirectly,
for supervising and regulating banks.
Perhaps it is needless for me to add that
I am not representing any of those particular interests today.
Rather I want to draw on my experience from a variety of vantage
points to concentrate on a few questions crucial to maintaining
a strong, competitive financial system for the United States.
You have also suggested I focus my remarks on several key issues. Consequently, I will not take much time to press once again the general case for the Congress, at long last, to provide a coherent legislative framework suited to today's competitive and technological realities in the market for financial services.
What is at issue is fair and vigorous competition.
But that is not all. We must not lose sight of the continuing
need for a safe and sound banking system -- a system strong enough
to maintain stability and independent enough to assure dispersed
and unbiased sources of credit.
As you are aware, there has been substantial adaptation to change, with blurring of distinctions among financial institutions. But that adaptation has proceeded by fits and starts, dependent in large part on new interpretations of old laws by regulators. For lack of consensus on new legislation, Congress and the courts have accepted rather benignly those decisions even when they have altered almost beyond recognition previously settled regulatory approaches.
The Glass Steagall separation of commercial
and investment banking is now almost gone, and overlaps between
banking and insurance are becoming common.
There can't be any doubt that accommodation
and adaptation has been desirable and necessary. But the ad
hoc approach has had uneven results. Every new ruling
has a way of exposing fresh inequities and creating new uncertainties.
In the absence of clear and up-to-date Congressional mandates,
there is seemingly endless squabbling in the courts. Unfortunately,
in some instances, important safeguards are being weakened, and
the playing field is uneven.
Nor can there be any doubt about another practical
consequence of piecemeal regulatory relaxation. Some sectors
of the financial service industry and particular institutions
find themselves in an increasingly advantageous position competitively.
Perhaps understandably, they have been losing enthusiasm for broad
reforms. Why, they ask themselves, should they forgo present advantage
and potential future benefits that may accrue from agency rivalries
or court decision-making.
I trust that this Committee, with its unique
oversight and legislative responsibility will reject those inherently
divisive interests. The opportunity is here to provide clear and
decisive leadership that reflects not parochial pleading but the
A key part of that interest, in the United
States or elsewhere, has been to protect the nation's banking
and financial system from systemic breakdown -- the kind of banking
crisis that would gravely impair the growth and stability of the
economy as a whole as well as place a heavy burden on the system
of deposit insurance. Experience over the past 10 or 15 years
in most industrialized countries has demonstrated just how costly
banking crises can be in both economic and budgetary terms. As
a result, efforts have been and are being made in international
forums as well as within individual countries to reform and adapt
regulatory structures. Important steps have been taken to assure
adequate capital, to assess better new risks, and to facilitate
necessary international cooperation. The Director of the IMF
has recently added his authoritative voice to those of other observers
suggesting weaknesses in the banking structure of developing and
emerging economies present the prime threat to their growth and
I emphasize all of that because I believe
it essential that, in considering the appropriate regulatory structure
for finance, you take care of the need to protect the stability
of the system and to provide appropriate regulatory oversight.
In the end, whatever the particulars of law, the Federal Government
will not escape ultimate responsibility and cost when a banking
The main areas that you have asked me to address this morning -- the separation of commerce and banking, the proper approach toward holding company regulation, and the role for fire walls and other regulatory safeguards -- bear directly on that fundamental issue.
Commerce and Banking
The long tradition of American banking --
following the Anglo-Saxon pattern -- has been to maintain a separation
of "banking" and "commerce". That tradition
has been incorporated legislatively in the Bank Holding Company
Act. Even when there has been no explicitly prohibitory legislation,
as there is not in the U.K. and some other countries, the practice
de facto has been to maintain a broad distinction
between the providers of money and credit -- the banking system
-- and the ultimate users of credit -- the commercial and industrial
In Germany, and to a lesser degree in some
other Continental European countries, such linkages have been
more common, although not general practice. In Japan the major
banks have long maintained cross-holdings of equity with groups
of commercial and industrial customers, rather typically forming
"keiretsus" implying especially close ties of cooperation.
Some banking systems in developing or emerging economies also
have banking and commercial ties.
What immediately stands out from all this
experience is that it is countries in the Anglo-Saxon tradition
that have the most competitive, innovative, and flexible banking
systems. It is their capital markets that are the envy of the
world. No country can begin to match our system in the variety
of large and small banks and other financial institutions, in
the provision of risk capital in support of small and emerging
ventures, and in providing narrow margins between borrowing and
Moreover, our banks today are more profitable
than in many years; with relatively strong capital positions,
they increasingly are in a position to retire their stock. Should
they need more capital, they have ready access to the markets
on attractive terms.
In contrast, there is plenty of recent experience
in other parts of the world to suggest the potential problems
with banking/commerce links are not just theoretical. For instance
the drastic decline in the value of Japanese stocks has aggravated
pressures on bank capital, helping to retard economic recovery.
The successive and very costly official rescues of France's largest
bank have been greatly complicated by their ventures into commerce,
including American movie making. Similarly, a few years ago one
of Spain's largest banks with aggressive management pushing toward
substantial industrial ties faced failure.
In Germany, significant severe and unexpected
losses in industrial affiliates of banks could be handled without
substantial systemic damage primarily because of the exceptional
capital strength and the underlying profitability of its major
banks. But I do not think that today many observers look to Germany
or Japan for a model of an effective, innovative banking system.
Quite the contrary. And it is an ironic fact that, just as some
here would let down the bars on banks owning industrial firms
or industrial firms owning banks, doubts have arisen in both those
countries about the wisdom of such linkages.
One need not look abroad for illustrations
of the dangers. Right here in the United States, it was not so
long ago that savings and loan associations were provided authority
under some state laws, and to a degree under Federal law, to make
what were antiseptically labeled as "direct investments"
-- in other words to take controlling interest in non-financial
businesses. We had academic authorities, some sponsored by the
industry, writing of the theoretical benefits of "diversification"
into new businesses -- even as much of the activity took the form
of real estate development, surely among the riskiest of commercial
There were other important factors in the
savings and loan debacle, importantly including imprudent and
inadequately supervised commercial lending. But it is clear the
non-financial businesses greatly contributed to the more than
$100 billion dollar cost of stabilizing the industry. In the wake
of the crisis, legislative and regulatory rules were tightened.
But how much better to have foreseen the predictable problems.
And how discouraging to see the proposals today for banks to
undertake real estate development.
The main thrust of the legislation before
you is to permit and to encourage a broadening of the powers of
bank and so-called financial services holding companies. Organizations
with commercial bank affiliates would be permitted broadly to
enter into other areas of finance -- investment banking, money
management, and insurance. Reciprocally, other financial firms
would be able to acquire banks or otherwise compete directly in
banking. That process has already, as you well know, gone very
far under the impetus of technology and with the support of the
regulators and the courts. But much remains to be done to even
the playing field, to remove outmoded restrictions, and importantly
to assure competent and suitably comprehensive supervision.
While a great many smaller and specialized
financial institutions will remain, one highly likely result will
be greater consolidation of the financial services industry. The
clear corollary, it seems to me, is to reinforce, not weaken the
importance of maintaining the traditional separation of banking
This country has always had a strong aversion
to massive concentrations of economic power. Pragmatically, we
like lending decisions and the sale of bonds and stock to reflect
independent and widely dispersed financial judgments, without
the bias, conflicts of interest, and opportunities for self-dealing
inherent in the business interests of affiliated companies.
As nearly as I can tell, there is no groundswell
of political support for changing our traditional approach. Consumer
groups, retired people, unions, small business and community organizations,
are not to my knowledge supportive -- quite to the contrary.
My sense is that most larger banks and other financial institutions
are themselves doubtful of the merits of broadly combining banking
There are, indeed, some insurance companies
and a handful of investment banks that have ties to commercial
firms and "non-bank banks". You have heard from a number
of them that they would like to extend their operations more broadly
into commercial banking. Some industrial firms would like direct
access to the payments system, bypassing their existing banks
and establishing an essentially captive source of credit for their
customers. Banks and bank holding companies are typically much
more highly leveraged financially than commercial firms, another
perceived advantage of bank affiliation. But is any of that a
sufficient reason for overturning a tradition that has served
us well, of diminishing the role and strength of independent banks,
of placing greater burdens on the system of deposit insurance?
I think not.
No one is proposing that those financial firms with commercial ties lose any option they now have. This is not a "grandfathering" situation. In the context of the bills before you, investment banks and insurance companies will continue to be able to own commercial or industrial companies, and vice versa. Investment banks and insurance companies will be able to buy commercial banks. What they could not do is associate with both a commercial bank and a commercial firm -- and none of their competitors could either.
I know the force of these arguments is rather
widely appreciated. Yet there is an urge to compromise, to try
to somehow reconcile all the claims. I suggest to you that is
just not possible. The proposals for various baskets involve
highly arbitrary distinctions that cannot logically and practically
be maintained. What is the logic for instance, of a basket that
would permit a large bank to affiliate with large commercial firms,
aggravating concentration and conflicts of interest, while a large
firm could not be affiliated with a small bank? What is the relevant
measure of size -- capital, revenue, employees, or something else
and would not the appropriate measure vary industry by industry?
What happens when the size of a commercial affiliate increases
or the bank shrinks? Are affiliated commercial firms to be prohibited
from growing or merging with another? What is the practical difference
between the hundredth largest company and the hundred first, or
the thousandth and the thousand first, and won't those rankings
constantly change? If a bank can buy a commercial firm, shouldn't
a commercial firm be able to buy or start a bank to handle its
business, even it the net result is to weaken the system as a
Surely, various compromises could be devised
that so restrict bank/commerce combinations that the dangers of
affiliation are de minimum. That may be the case
with H.R. 10. But there simply can't be any doubt that, once
the foot is in the door, the pressures to ease the necessarily
arbitrary limits, lubricated by ever larger political contributions,
will grow stronger. The fissures in the dike will erode, new
compromises will be struck, and the risks and concentrations will
I realize, at the margin, elements of administrative
judgment will be required in implementing legislation separating
banking and commerce. At what point, for instance, is the provision
of computer services or management consulting sufficiently "closely
related" to finance to permit its affiliation with a bank?
But we have lived with those kinds of distinctions for years,
and Congress can provide fresh guidance.
Moreover, regulators can be asked to make
distinctions between controlling and non-controlling holdings
of industrial or commercial firms. Congress should also set out
the extent to which equity acquired in the ordinary course of
underwriting and merchant banking activities might be permitted
for a limited period. Present law already provides some scope
for such activities and permits non-controlling holdings
That, it seems to me, is the key point. We can permit incidental and non-controlling equity holdings in the ordinary course of business. What we want to avoid is banking and industrial firms coming under common control, with all that implies for concentration of resources, biased lending decisions, and new risks for the stability of the banking system.
Holding Company Regulation
Rather comprehensive supervision and regulation
of banking and financial institutions is commonplace around the
world; it is the essential corollary of the official support provided
in the face of threats to the stability of a banking system.
Nor can there be any doubt that, whatever their ideological predispositions,
major banks do benefit from and rely upon the presence of a Federal
safety net in time of strain. To some extent, that has become
the expectation of other regulated financial institutions as well.
Those facts have important implications for
financial regulation. A business organization will be managed
as a cohesive whole. They may be centralized or decentralized
in operation, but one part is necessarily affected by the fortunes
of another. And it is, of course, precisely the search for "synergies"
in marketing, in production, and in joint use of shared resources
that is the driving force for business combinations.
The clear implication is that, if the banking
system is to be officially protected and supported, then the regulators
and supervisors need to be concerned about the well being of the
business organization as a whole. As a practical matter, it is
neither desirable nor feasible that such regulatory oversight
be extended into the commercial and industrial world. That is
itself a powerful reason -- conclusive in my mind -- to avoid
the bank/commerce affiliation.
The situation is different with respect to
financial institutions which are already subject to official regulation,
by states if not by Federal agencies. There are scores of such
regulators within and among states; there are more than half
a dozen at the Federal level with significant responsibility for
enforcing prudential safeguards.
Obviously that diversity presents complications
in regulating and supervising institutions ranging over many areas,
functionally and geographically. But the number of regulators
also reflects continuing realities. A variety of significant objectives
are served and different agencies have different priorities and
areas of competence. Moreover, the American style of government
abhors unnecessary concentration of authority.
Recognizing the force of those considerations,
I know of no support for the idea there be a single monolithic
regulator of bank or financial services holding companies, as
simple and logical an approach that in the abstract may seem to
The presumption of most of the proposed legislation
is that something like the current regulatory apparatus will remain:
the banking agencies will regulate and examine banks; the SEC
will write the rules for disclosure and investor protection, the
states will regulate insurance activities, including sales practices.
All that amounts to functional regulation, and it is broadly appropriate
and practical as far as it goes.
But disparate functional regulation is not
by itself enough. The overriding and distinctively Federal interest
in safety and soundness requires that some authority, armed with
adequate authority, be charged with broad oversight and surveillance
over the entire holding company. Otherwise, the clearly protected
and supervised part of the holding company -- the commercial bank
-- will be "blindsided" and potentially overwhelmed
by crises originating outside the bank itself. That is what happened
when "direct investment" destroyed so many savings and
loan associations in this country. Similarly the woes of financial
and commercial affiliates have disrupted and damaged a number
of European and Japanese banks.
Conceptually, one might perceive of an approach
toward this problem by authorizing and convening a sort of council
of regulators, meeting regularly to exchange information and coordinate
approaches. But practical experience within the banking area --
which should be easier -- strongly suggests that approach is neither
efficient nor consistently workable. At the least there would
need to be a strong lead agency with clear responsibility for
enforcing coordination among agencies with disparate priorities,
traditions and competence.
The more effective approach would be to designate
one agency for oversight responsibility insofar as prudential
considerations are relevant. Functional regulation for a
variety of purposes could and should continue. Individual state
and Federal agencies, equipped with appropriate legal authority
and competence, would implement their particular mandates. The
primary assignment of the oversight agency would be to work with
those agencies to assure itself that their approaches are reasonably
consistent and adequate to protect the safety and soundness of
the whole. Moreover, experience has demonstrated that with even
closer and more intense competition across traditional lines,
there is a compelling need to seek "functional equivalence"
in regulatory approaches in some areas.
By nature of their responsibility and interest, only the Treasury or the Federal Reserve would appear logical candidates for the oversight function. It will not surprise you for me to suggest that between the two, by virtue of its experience, its resources (financial and otherwise) and its relative freedom from client and political pressures, the Federal Reserve would be the logical choice.
One approach toward minimizing the need for
supervision of an entire financial services holding company would
be to erect so-called "firewalls" between a commercial
banks -- the institution we most want to protect because of its
core functions of money creation and operation of the payments
system -- and its affiliates. Indeed, some common sense restrictions
on financing of affiliates by commercial banks and other kinds
of self dealing have long been part of law and regulation and
are retained in H.R. 10.
At the same time, it is an illusion to think
firewalls can themselves meet the need. That would require restrictions
on lending and or other financing transactions with third parties,
prohibitions on cross marketing and linked services, and even
limits on the use of common names and symbols. Such strong firewalls
would run right across the grain of what businesses want to achieve
when they combine. Few managers would want to be truly passive
owners of another business. They will naturally want to bring
to bear the resources of the entire organization, including the
bank affiliate, when any important part is financially threatened.
In sum, given the fungibility of money and
the resourcefulness of financial managers, no practical system
of firewalls can be fully effective in insulating a bank from
the difficulties of its affiliates without, at the same time,
strangling the business operations. Indeed, what we are seeing
in practice is a tendency to ease or remove existing restrictions
on inter-affiliate transactions and management interlocks.
In sum, Mr. Chairman and members of the Committee, the need for new legislation to define and direct the world of financial services is clear. Probably more than ever before, industry participants are prepared for reform and key elements of a consensus have developed.
In encouraging and nurturing that consensus,
it remains crucially important that we not neglect the costly
lessons of the past, that we not abandon a legislative and regulatory
philosophy that has served this nation well, and that we guard
against financial crises and systemic breakdown. In the end,
as you well recognize, the object cannot be to satisfy every particular
interest or respond to individual wish lists. Encouraging combinations
of banking and commerce or dispensing with effective and coherent
oversight of consolidated bank and financial holding companies
cannot be sensible public policy.
If at the end of the day -- more accurately
before the end of this Congressional session -- you are not satisfied
that the broad public interest in strong, diverse, and independently
managed banks and financial institutions will be protected and
enhanced or that the risk to the economy and the future taxpayer
will be reduced rather than increased, then the implication is
clear: better no legislation at all.
But there is no good reason to anticipate
that conclusion. It is your Committee that carries the main responsibility
for steering the needed effort in the right direction. I urge
you to do just that.