Mr. Chairman, my name is Bill Sones, and I am president and CEO
of State Bank & Trust Company, Brookhaven, Mississippi. I
am pleased to appear before you today on behalf of the Independent
Bankers Association of America (IBAA), the only national trade
association that exclusively represents the interests of our nation's
We appreciate this opportunity to testify on proposed legislation
to reform the nation's banking laws.
Mr. Chairman, let me first express my personal appreciation to
you, and the appreciation of community bankers, for your strong
leadership in the last Congress on issues vitally important to
our industry. We especially want to thank you for your sensitivity
to the concerns of rural areas and the majority of states which
will never be the headquarters of financial conglomerates or economic
and commercial conglomerates should the Baker Bill pass.
To better appreciate our perspective, here are some facts about
our association and our members. IBAA represents some 5,500 independent
community banks nationwide that hold nearly $375 billion in insured
deposits, $445 billion in assets, and more than $240 billion in
loans for consumers, small businesses and farms in the communities
they serve. IBAA members also employ more than 200,000 people
in their communities.
The State Bank & Trust Company has $115 million in assets
and 57 employees. We are located in Brookhaven Mississippi, which
has a population of 11,000 people. There are some 15 different
financial institutions in our market area. My bank is locallyowned,
locallyoperated. Our policies are set locally, and that's
what sets it apart from many other financial institutions in my
Diversified Financial System
Community banks often are the very key to the survival and economic
well being of many local communities. We specialize in doing business
in our towns and cities and reinvest our deposits in our communities
in the form of local loans. Mutual fund companies, securities
companies, and insurance companies, among other financial institutions
operating in our communities, cannot say this.
We serve our communities because, as a small locally owned and
operated businesses, our communities are our market. Large, geographically
diverse companies have multiple markets and are not dependent
on any particular geographic market for their prosperity or survival.
In addition, the Congress has not required non-insured entities
to serve their communities as the CRA does for insured financial
institutions. And the CRA rules for large insured financial institutions,
especially for those that operate interstate branches, do not
require that each branch serve its community in the manner, and
to the extent, that community bank offices are required to serve
Community banks are also essential to maintaining diversity in
the banking industry. This diversity enables the industry to meet
the financial needs of all customers, with community banks serving
small businesses, farmers, ranchers and consumers.
Financial Services Restructuring
The issue before this Committee is the need for financial services
restructuring, and the implications that such legislation will
have on financial institutions, corporations, and consumers. In
your bill, H.R. 10, financial services restructuring can be defined
as providing broad affiliations between financial firms, securities
firms, insurance companies and banks. In Congresswoman Roukema's
bill, H.R. 268, and in Congressman Baker's bill, H.R. 669, financial
services restructuring would allow, respectively, either restricted
or non restricted affiliations among commercial/industrial companies
We have the strongest and most diversified financial structure
in the world. The Japanese model, which so enamored the Bush Administration,
has grave deficiencies, and the German universal bank model is
under critical review.
In our judgment, last year's regulatory actions by the Federal
Reserve and the OCC raise serious questions about the need for
legislation. And as members of this Committee are aware, previous
banking legislation authorizing nationwide branching becomes fully
effective on June 1, and this means that the historic merger and
consolidation wave sweeping the banking industry will continue.
Many observers of the banking industry have concluded that when
this merger wave ends, our country's banking structure will be
characterized by far fewer banks and probably will
be a bar bell banking structure characterized by some 1520
very large banks with thousands of remaining community banks.
The ranks of regional banks will be dramatically slimmed.
The issue before this Committee is whether this merger and acquisition
wave should also encompass not only the securities industry and
the insurance industry, but also commercial and industrial companies
as well. We very much appreciate your leadership role Mr. Chairman
in opposition to proposals that significantly undermined the walls
separating banking and commerce. We urge this Committee to heed
the concerns of consumer groups, labor, small business and agriculture
in regards to these proposals which are proving to be enormously
controversial in the U.S. Senate.
In its Section 20 action of last year, the Federal Reserve set
new ground rules that will permit bank holding companies to acquire
larger securities and insurance firms.
In turn the Comptroller's operating subsidiary rule, if carried to its logical conclusion, may permit national banks to acquire securities firms.
We feel it is a legitimate question to ask whether it would be
prudent to accelerate the pace of change dramatically by passing
additional legislation. In an interview in the American Banker
on January 31, 1997, the highly regarded Wall Street lawyer Rodgin
Cohen of Sullivan and Cromwell stated inter alia: "I think
perhaps this year we may see banks acquire regional brokerage
firms. The Federal Reserve has made these transactions feasible
now, and some of them sit well. . . . If you had legislation letting
the insurance industry and the banking industry consolidate, it
could totally change the map." This statement has proved
to be prophetic, as witnessed by the recent announcement of the
acquisition of Alex Brown & Co. by Bankers Trust.
These hearings are a vital step in the exploration of the consequences
and unintended consequences of legislative proposals that could
restructure and concentrate our financial and economic system.
Banking and Commerce
Each of the financial restructuring bills introduced so far, by
Chairman Leach, by Chairwoman Roukema and Ranking Subcommittee
Member Vento, and by Chairman D'Amato and Congressman Baker, permit
the common ownership of banks, securities firms and insurance
underwriters. While we seriously question the need for such expanded
powers, as outlined above, if Congress elects to proceed down
this course, we believe they must do so carefully and with appropriate
firewalls protecting the bank. However, banking and commerce should
not be allowed to mix.
These three bills treat banking and commerce affiliations differently.
Congressman Baker's bill would allow unrestricted affiliations
between banks and commercial/industrial companies. Congresswoman
Roukema's bill creates a 25 percent "basket" for nonfinancial
activities, meaning major banks could buy major commercial firms.
Chairman Leach's bill does not allow any affiliations between
commercial firms and insured banks.
Former Federal Reserve Chairman Paul Volcker has testified that
mixing banking and commerce could distort lending decisions, be
anticompetitive and threaten the safety and soundness of
the banking system. And Federal Reserve Governor Meyer, speaking
for the Board, stated on January 24 that "the Board would
prefer to proceed with the expansion in financial services and
defer any discussion of commercial activities." This
is very wise advice.
Since the passage of the RiegleNeal Interstate Banking and
Branching Act of 1994 there has been an unprecedented consolidation
in the banking industry. It is expected that this consolidation
will increase later this year when interstate branching takes
effect. Major securities and insurance firms have already indicated
their desire to own banks. And large banks have made known their
desire to get into the securities and insurance businesses. Thus,
there will be significant additional consolidation across the
entire Financial Services Industry will occur if legislation is
enacted. Allowing the common ownership of banks and commercial
firms would also increase economic consolidation and add other
negatives. In turn, the Federal Reserve Board's Section 20 actions
are driving the securities industry to consolidate in order to
increase their size, and thus limit their acquirability by commercial
banks. The merger of Dean Witter with Morgan Stanley is an example
of this consolidation. In addition, the Section 20 actions have
started the wave of affiliations that will occur between banks
and securities firms. The recent announcement of the acquisition
of Alex Brown & Co. by Bankers Trust is but the first of many
We believe any affiliations between depository institutions and
commercial firms would cause severe safety and soundness concerns
for the Federal safety net, and have a significant negative impact
on our economic system, and, over time, destroy the impartial
allocation of credit.
Congress prohibited the common ownership of banks and commercial
firms because of the potential for conflicts of interest when
banking and nonbanking firms affiliate. Maintaining the
wall between banking and commerce is critical to the free enterprise
system. Our system relies on banks to allocate credit to its most
productive uses. Separating banking and commerce insures that
credit is allocated impartially and without conflicts of interest.
Breaching that wall, even a partial breach using a "basket"
approach, raises the risk that credit decisions will be based
on the business strategies of the bank's corporate parent and
not on economic merit. Commercial bank ownership of commercial
firms and/or commercial firm ownership of banks would undermine
the impartial allocation of credit one of the foundation
blocks of our fine financial system.
The affiliation of commercial banks and commercial firms would
raise safety and soundness concerns because there is no practical
way to insulate a bank from the affiliate it owns or that owns
it. Firewalls do not work in times of stress, and one only has
to look back a few years to Continental Illinois and its First
Options affiliate to see this illustrated. Although firewalls
were in place at a time when First Options suffered major losses,
Continental Illinois National Bank stepped in and violated the
firewalls by improperly loaning money to First Options to prop
it up. Although the loan was quickly up streamed to the holding
company, and the bank suffered no loss, what occurred shows how
useless firewalls are. Federal Reserve Board Chairman Greenspan
testified before Congress that it is not wise to put too much
faith on firewalls, because "under stress, they tend to melt."
This would place additional stress on the safety net provided
by the Federal Deposit Insurance System.
Allowing the mixing of banking and commerce would result in economic
concentration. Concentration would hurt consumers, small businesses,
farmers and ranchers by making it more difficult, and more expensive,
for them to obtain credit. Banks with less than $300 million in
assets, holding less than 20% of U.S. deposits, account for close
to 50% of small business loans under $250,000. Consolidation that
is wrongly structured would drive out smaller players to the detriment
of the ongoing financing of small business and agriculture.
These crossindustry combinations will benefit the Northeast
and New York City to the detriment of other sections of the country.
The restructuring proposals would benefit regional interests and
not national interests.
In addition, access to the payment system must be limited to FDIC-insured
institutions. Various entities that are interested in breaching
the banking and commerce wall have stated that one of their objectives
in doing so is to gain access to the payment system. Limitations
on access are critical in order to limit risks to the payment
system. FDIC-insured institutions are the only entities that are
subject to examination and regulation in a manner that gives the
Federal Reserve Board sufficient control to manage risk in the
system. Chairman D'Amato is questioning whether access to the
payment system should be opened to all players.
The "Basket" Approach
The basket approach has been offered as an alternative to full
scale banking and commerce. However, it suffers from all of the
deficits that exist with regard to banking and commerce. In addition,
the concept has additional flaws.
There are a number of basket options that have been put forward.
For example, Congresswoman Roukema's test would allow 25% of the
"business" of the holding company to be in commercial/industrial
activities. The Treasury Department is working on a proposal that
reportedly would base the test on "revenues." Whatever
test is used, there is a fatal flaw. If the commercial/industrial
company's "business" or "revenue" grows faster
than the "business" or "revenue" of the rest
of the entity, eventually, the limit will be reached. It is virtually
impossible to control growth in a commercial/industrial company.
For example, the production line cannot be shut down, because
the under-served customers would be lost forever, and existing
and new customers would be very hesitant to purchase seeds from
the company because they would be unsure of the continued availability
of product. So the only remedies left are divestiture or breaching
the cap. The former would be unacceptable to the business entity,
the latter would make a mockery of the limitation.
In addition, the basket approach brings virtually no practical
limitations with it. Under this scenario, with no size restrictions,
Citicorp could buy ITT, Federal Express, or Microsoft. Chase could
acquire USAirways, Reynolds Metals or ConEdison. If Citi first
merged with Merrill Lynch, AIG and GE Capital, it could purchase
Sears, Boeing, Coca Cola, or any other company outside the top
15. Think of the impact these combinations could have on the national
economy, or the economies of whole regions of the country.
It has been reported that the Treasury Department has been floating
a 25% revenue basket. To address the concentration of assets concerns,
they will prohibit the 1,000 largest U.S. commercial firms from
affiliating with a bank. Under the Treasury proposal, a bank would
be allowed to affiliate with an industrial firm as long as the
non-financial revenues of the combined company do not exceed 25%
of its total revenue.
Simply put, to fall under this 25% "merger cap," an
industrial company would have to affiliate with a bank at least
three times its size (three quarters of total revenue from the
bank, versus one quarter from the industrial company).
If the largest 1,000 commercial firms are taken out of play, this
would prevent a Citi-Microsoft affiliation. However, it still
would permit the creation of substantial banking-commercial/industrial
combinations. The 1,001st largest U.S. corporation is Amphenol
Corporation, which had revenues last year of roughly $800 million.
So even if you exempt the largest 1,000 commercial firms, you
are still talking about very large companies. Some of the other
companies that would still be in play include Getty Petroleum,
Riceland Foods, Greyhound Lines, U.S. Can, Houghton Mifflin, Control
Data, America Online, and Starbucks. These are not small companies.
To put this in better perspective, Mr. Chairman, under this scenario,
Norwest could acquire Bandag, Inc., Casey's General Stores, Lee
Enterprises and Interstate Power Company in the state of Iowa,
with total revenues of about $2.2 billion per year. In Minnesota,
Chase could acquire eleven Minnesota companies including Apogee
Enterprises, St. Jude Medical, American Crystal Sugar, and Buffets,
Think of what impact these combinations would have on the economies
of the states of Iowa and Minnesota. And this is a small sample
of what could happen cross the country, even when you take the
largest 1,000 commercial firms out of play.
Relationship of Basket to Financial Affiliations
The securities and insurance industries have argued that a basket
is necessary to allow a full two-way street. They claim that without
a basket, they would have to divest permissible commercial affiliations
in order to affiliate with a bank. At the outset, the IBAA notes
that a full two-way street is available without the need for any
divestiture. If no basket is permitted, a bank could affiliate
only with insurance and securities firms that do not have commercial
affiliations. Likewise, only insurance and securities firms without
commercial affiliations could affiliate with banks. The decision
of whether or not a securities or insurance firm has commercial
affiliations is a business decision of that firm. There is nothing
that would inherently give such a firm the right to affiliate
with both commercial firms and banks. Because of the federal safety
net, banks ownership and activities have always been restricted.
The banking industry because of the safety net, is not and cannot
be fully market driven
Under H.R. 10, merchant banking activities and passive equity
investments of insurance firms would not have to be divested in
order for such firm to affiliate with a bank. The bill recognizes
that passive investments do not constitute the same risks as do
active investments. Therefore, most commercial "affiliations"
of securities and insurance firms would not have to be divested.
According to the Securities Industry Association (SIA), only eight
of its over 700 members are owned by commercial firms. Although
to our knowledge data is not yet available on SIA's membership's
ownership of commercial firms, it is believed to be relatively
small. Therefore, we do not believe that this is a significant
issue for the securities industry. We are unaware of comparable
data with regard to the insurance industry.
IBAA believes that the burden should fall on those entities asking
for a change in the status quo to justify the need for the change.
Neither the securities industry nor the insurance industry has
put forth any facts that would indicate that there is any volume
of affiliations with commercial firms, outside of the investment
banking and passive investment banking area, that would justify
a basket. Congress should not even consider a "basket"
approach until such time as a factual case can be made that there
is a substantial segment of the market which would be adversely
affected without the change.
International Experience with Banking and Commerce
The mixing of banking and commerce has not been successful in
other countries where it has been tried. Former Federal Reserve
Chairman Paul Volcker pointed out that New York and London are
the financial capitals of the world, and the mixing of banking
and commerce does not occur in the United States or the United
Kingdom. Chairman Leach, in your testimony before the Subcommittee
on Capital Markets of the House Banking Committee on March 12,
1997, you noted that in Japan, significant losses have occurred
as a result of the relationship between banks and commercial firms.
In Germany, industrial conflicts have created such problems as
to have begun a debate aimed at changing the German universal
bank to a bank closer to the American model. In Spain and Mexico,
bank/commercial investments have proved expensive to the public
Treasuries. Martin Mayer, in a March 28, 1997, Wall Street
Journal article, noted that in France, Spain, Sweden and Finland,
the universal bank led to failed banks, money losing non-financial
subsidiaries, and government bail-outs.
The IBAA believes that the evidence is clear: The mixing of banking
and commerce has not been successful in the international marketplace.
Consumers and Small Businesses
We also would like to remind the Committee that concentrated markets
are neither consumer nor small business friendly. It is important
for Congress to insure that consumers, small businesses, farmers,
and ranchers do not pay the price of economic concentration. Past
experience suggests that they will. For example, the four largest
banks in California control over 60 percent of the state's bank
deposits (and over 80 percent of the local banking markets are
considered highly concentrated under Justice Department merger
guidelines). A 1992 study showed that California banks pay interest
on deposits that are significantly lower than both the national
average and the average paid in outofstate metropolitan
areas. For interest charged on loans, the converse is trueCalifornia
banks charged higher rates than the national average and the average
rates charged in outofstate metropolitan areas. For
users of the financial system, concentration means less competition
and higher prices.
Consumers are not the only losers in a concentrated market. Small
businesses come up big losers as well. Many larger banks simply
do not find it economical to make small business and consumer
loans. Richard Thomas of First Chicago Corporation told the House
Government Operations Committee a few years ago that:
In a large bank, it would be difficult to make money on a loan
of less than half a million dollars. I suspect the number might
be $25,000 for a much smaller bank with a much smaller overhead.
Indeed, as noted above, banks with less than $300 million in assets,
holding less than 20% of U.S. deposits, account for close to 50%
of small business loans under $250,000. Consolidation that is
wrongly structured would drive out smaller players to the detriment
of the ongoing financing of small business and American agriculture.
Proponents of concentration will argue that this will create more
opportunities for community banks to fill the niche deserted by
the bankingindustrial complexes. But the plain facts are
that the community banking industry simply does not have the capacity
and resources to fill the void. Although some local banks may
prosper temporarily, many communities will suffer, and in the
long run so will the local banks. There were approximately 360
sales of banks under $1 billion in 1996. The number of new banks
chartered was less than half this number.
As an example, a few years ago when North Carolina National Bank
(now NationsBank) took over a number of failed banks in Texas,
it became one of the largest agriculture lenders in the State.
When it decided to abandon the agricultural lending field because
the new bank personnel did not have the expertise or the experience
to evaluate ag loans, this benefited a few local banks. However,
it devastated the agricultural community because farmers and ranchers
were scrambling to find alternative sources of credit during a
critical time in the production cycle, and the community banks
did not have the resources to meet all of the agricultural credit
needs. This had a significant adverse impact on the recovery of
the Texas economy, and is a perfect example of the negative impact
massive economic concentration can have on an economy.
Safety and Soundness
Breaching the banking and commerce wall also undermines bank supervision by threatening the safety and soundness of our financial system. There is no practical way to separate a bank from its affiliates, either operationally or in the public's perception. Former Fed Chairman Volcker warned of this danger repeatedly and testified before the Senate Banking Committee that "problems in one part of the system will inevitably be transmitted to other parts."
Federal Reserve Board Chairman Alan Greenspan echoed those concerns
in testimony before the House Banking Committee as we indicated
Competition in the Marketplace
I am confused when advocates of sweeping consolidation characterize
the IBAA as anticompetitive. How is competition furthered
by allowing the largest banks, securities firms and insurance
firms to buy one another, then only to be bought by a major industrial
firm? The IBAA understands competition in the marketplace to mean
more, not fewer competitors. The number of banks and thrifts peaked
at 18,033 at the end of 1985. At the end of 1996, there were only
11,452 banks and thrifts and since the those numbers include the
component part of holding companies, the number of independent
banks is considerably less. With interstate branching happening
in all but two states this June, the consolidation trend will
continue. And the securities industry is consolidating with itself
and with banks right now. Enactment of this legislation will only
serve to hasten consolidation, and thus lessen competition.
Under all of the bills, a new form of holding company called a
Financial Services Holding Company could own or affiliate with
companies engaged in a much broader range of activities than is
permitted for bank holding companies under current law, including
ownership of or affiliations with securities firms.
In the last Congress IBAA supported the original Leach proposal
on GlassSteagall reform in part because it contained significant
firewalls to separate the deposits insured by FDIC insurance from
the noninsured securities affiliate. Our later withdrawal
of that support was based on elements that were added to the bill,
such as permitting affiliations with insurance underwriters, that
made the entire bill unacceptable. Mr. Chairman, your bill incorporates
these firewall protections. The other bills have significantly
lower firewalls protecting the insured bank.
Still, we are skeptical about firewalls in general, as we have
discussed, and question whether the protections in any of the
bills are sufficient to protect 1) the safety and soundness of
the banking system, 2) the legitimate competitive interests of
all banks, and not just the large financial institutions that
can take advantage of what the bills offer, and 3) the potential
conflicts of interest that could arise because of the affiliation
of such diverse entities.
Crossselling of services is very important in companies
with multiple arms. Banks, subject to the Bank Holding Company
Act, can only engage in activities closely related to banking.
By contrast, if diversified firms owned banks, they would be free
to combine banking with a wide variety of financial or other services.
Former FDIC Chairman William Seidman testified before the Senate
Banking Committee that the nonbank bank loophole, which
breaches the wall between banking and commerce, "is highly
inequitable and detrimental. Allowed to grow, nonbank banks can
weaken the real banks by competing in an unfair contest in the
Insurance underwriting brings increased risks with it. Although
insurance companies are financial companies, they also engage
in commercial activities. Insurance companies engage in financial
services that are the same or similar to those offered by commercial
and investment banks, along with the underwriting of insurance.
They also engage in commercial activities; for example, some are
direct investors in and developers of real estate. Yet insurance
companies are not Federallyregulated.
This Committee should be very careful about allowing affiliations
between an insured bank and a company that is not only exempt
from Federal regulation, but also can engage in a wide range of
financial services and in commercial activities including real
estate speculation that proved fatal to many Federallyinsured
institutions. This Committee should be most careful, indeed, in
putting financial entities together in a common structure with
different regulatory structures, particularly in light of concerns
a number of highly respected observers, including Fed Chairman
Alan Greenspan, have raised about the efficacy of firewalls.
Retail Insurance Sales
It should be pointed out that the concerns we have expressed relate
to insurance underwriting and not to insurance sales. Retail insurance
powers do not contain any safety and soundness threat to insured
banks. Bankemployed and affiliated sales people are licensed
by the state with the same license that independent agents must
have. Banks currently are required by law to disclose that annuities
are not insured by the FDIC or guaranteed by the bank. IBAA has
always supported the expansion of opportunities for community
banks to sell insurance products.
The insurance industry has taken the position that if financial
affiliations occur, they must occur in the context of rules that
would roll back existing national bank retail insurance
sales powers. The powers of national banks to sell insurance have
been part of the National Bank Act since 1916. The Supreme Court,
in a unanimous decision handed down in 1996, upheld the validity
of the power of national banks to sell insurance from an office
in a place of less than 5,000. It also upheld the proposition
that a State cannot prevent or significantly interfere with a
national bank's ability to sell insurance.
Mr. Chairman, attempting to restrict a national bank's ability
to sell insurance has no place in any financial restructuring
legislation. These bills are all described by there authors as
"financial modernization" legislation that will allow
banks to effectively compete as we enter the new century. Yet
the actions that these bills would take will help only large banks
-- those large enough to acquire non-bank financial firms, or
large enough to be attractive acquisitions for non-bank financial
firms. If retail insurance powers, which are a critical component
of the community bank's ability to compete in the financial marketplace
is restricted, you will have served a competitive double whammy
to community banks. You will have given big banks additional competitive
opportunities, while restricting our existing opportunities.
Mr. Chairman, any legislation that is enacted to change our financial
system must not contain regressive changes in national bank insurance
sales powers. The only insurance sales power that should be modified
is to lift the place of 5,000 restriction from national banks.
Mr. Chairman, under your proposal, The Federal Reserve Board would
be the "umbrella" regulator that oversees the entire
financial services holding company. However, under Congresswoman
Roukema's and Congressman Baker's bills, financial services holding
companies would not be subject to the banklike regulation
that currently applies to the capital and activities of bank holding
In addition, all of the bills would apply, in general, other requirements
including affiliate transaction restrictions such as Sections
23A and 23B of the Federal Reserve Act, a prohibition on credit
extensions to nonfinancial affiliates, a requirement that
subsidiary banks be well capitalized, and a divestiture requirement
applicable to banks within any financial services holding company
that fails to satisfy certain safety and soundness standards.
Congresswoman Roukema's bill would apply the "holding company
risk assessment provisions" to financial services holding
companies. Essentially, this is a scheme of functional regulation
-- the holding company would not be regulated as a bank holding
company, and each subsidiary of the holding company would be regulated
by its primary regulator, if it has one. The holding company would
be subject to some supervisory requirements regarding the protection
of the safety and soundness of the bank.
IBAA believes that the safety and soundness of the bank cannot
be protected without Federal Reserve Board supervision of the
holding company in the manner that now occurs under the Bank Holding
Company Act. The holding company can be characterized as the brain
and nerve center of such an entity. One regulator should have
oversight over this brain center since the failure of such an
integrated structure could carry with it systemic risk to the
financial system and the economy. Our recent financial history
makes very clear that the largest financial entities in our nation
will not be allowed to fail. The Federal Reserve is best equipped
to carry forward this sensitive mission and has a proven track
record of insulation from the political process. This becomes
particularly important since many expert witnesses question whether
Laurence H. Meyer, a member of the Board of Governors of the Federal
Reserve System, in a recent speech before the Southwestern Graduate
School of Banking, identified two important principles of bank
Two special characteristics of banking are critical to understanding
why banks are regulated. First, banks have access to a government
safety net through deposit insurance, the discount window, and
payment system guarantees.
The second characteristic of banking is that banks especially large ones are capable of being the conduits of systemic risk and crisis in financial markets. A breakdown of the payments system or other contagion effect that hampers the ability of banks to intermediate credit flows could have serious consequences for the economy. The challenge is to maintain sufficient regulation to protect taxpayers, avoid unnecessary extensions of the safety net, and mitigate moral hazard incentives without undermining the competitiveness of the banking industry and its ability to take risk.
Our readingbetweenthelines interpretation is
that very large financial entities whose failure would present
a systemic risk for the financial system will always be regulated
because they will never be allowed to fail. The issue of whether
the FDIC or the U.S. taxpayers directly would pay for the rescue
is a separate issue.
Wholesale Financial Institutions
Last summer, Chairman Leach proposed to include wholesale financial
institutions, or "woofies" in H.R. 2520, the banking
restructuring bill. At that time, IBAA came out strongly against
woofies and they were not part of the banking bill that passed
in the final hours of the 104th Congress.
The creation of woofies opens up the potential for new, specialized
charters that could be superior to a banking charter because they
could be exempt from banking regulations. And very important from
a public policy standpoint, since woofies can also be owned by
bank holding companies, wholesale deposits could be moved from
the insured bank to the uninsured woofie, which could narrow
the deposit insurance fund base and lead to a destabilization
of the deposit insurance funds. We also have payment system concerns.
The woofie issue is highly contentious and should not be made
part of this bill.
Under H.R. 10, the federal thrift charter would be eliminated,
and thrifts would be required to convert to a state or national
bank, or a state savings bank. Thus, the BIF and the SAIF could
be merged under the terms established in last year's banking bill.
H.R. 10 contains what has become known as the "charter down"
option whereby the existing national bank charter would be the
model for a common charter for all national financial institutions.
IBAA has expressed concerns in the past about "chartering
up," or granting all financial institutions the authority
to engage in greater powers with which they have little or no
expertise, including real estate investment and other powers that
contributed to the thrift crisis in the 1980s.
IBAA believes that a limited "Charter Up" option should
be the standard. Retail financial powers are the lifeblood of
community banks. We must be able to compete with non-bank financial
firms in the retail area in order to retain our customers and
remain competitive. If a securities/insurance company, such as
Merrill Lynch, that already offers a full range of investment
services (i.e, insurance products, consumer loans, insured brokered
deposits, etc.) were to affiliate with a unitary thrift, that
provides a full range of retail deposit products, the lure of
"one stop shopping" would be the straw that broke the
community banking industry's back. In order to maintain our customer
base, community banks need to be able to offer the same range
of products and services to compete.
H.R. 10 would grandfather existing unitary thrifts that are affiliated
with commercial entities. The thrift would have to maintain compliance
with the QTL test and with the current Thrift asset limitations..
While recognizing that Congress seldom requires divestiture, we
are nonetheless concerned about allowing the unitaries with commercial
affiliations to continue to operate.
The unitary thrift holding company loophole breaches the separation
of banking and commerce. Under current law, unitary thrift holding
companies are not prohibited from affiliating with commercial
firms. This loophole should be closed or, at the very minimum,
not expanded further.
Thank you, Mr. Chairman, for this opportunity to testify before
the Committee. We appreciate your voice of relative moderation
and sensitivity for the complex issues before this Committee.
IBAA believes that Congress must proceed prudently and cautiously
because the future structure of our financial system and thus
our economy hangs in the balance. Our present system is the envy
of the world. The system's enormous diversity insures proconsumer
competition for financial products and services and the availability
of financing for business and agricultural units of all sizes.
The banking and securities industry is in the midst of a historic
consolidation wave partially driven by the 1994 RiegleNeal
bill which mandates full interstate branching in June of this
year and by the Federal Reserve's Section 20 regulatory actions.
Legislation and regulatory actions over the last three years guarantee
additional massive consolidation in the months and years ahead.
Very large financial organizations spanning the banking, securities
and insurance industries may logically emerge from the Federal
Reserve's Section 20 action and the Comptroller's operating subsidiary
Such financial conglomerates will test the mettle of our financial
regulators and, unfortunately, the FDIC and the American taxpayer
should they fail.
The IBAA is puzzled about Congressional and regulatory support
for sweeping legislative proposals that would accelerate and expand
this consolidation to commercial firms. Legislation encouraging
the common ownership of the largest banking, insurance, securities
and commercial firms in the United States is neither procompetitive
nor "modern." Rather, it harks back to the financial
and industrial cartels that characterized the United States in
the early years of this century and the German and Japanese economic
systems before their slide into fascism.
Legislation that encourages the massive consolidation of economic
and financial power in fewer and fewer hands and in fewer and
fewer cities is not progrowth, proconsumer, or prodemocracy.
If the congressional leadership decides to move such radical financial
restructuring legislation, and we hope that they do not, the following
principles would mitigate against some of the damage:
(1) Banking and commerce should not be mixed because this destroys
the impartial allocation of credit, the fundamental foundation
block of our financial system. An incremental approach via a commercial
firm ownership basket would still impair the impartial allocation
(2) There must be an umbrella regulator of the resulting diversified
firm and the only federal regulator equipped for this job is the
(3) The FDIC must be protected from being raided should a financial
conglomerate collapse. No credible regulator claims that firewalls
work in times of crisis. Noncomplex depository institutions
should not be left holding the bag in the event of the collapse
of a financial conglomerate presenting a systemic risk to our
financial system and economy.
(4) There should be provisions for liquidity for institutions
serving local markets and communities. Community banks should
be able to access all available financial vehicles, including
the Federal Home Loan Bank System, as alternative funding sources.
Main Street America communities should not be sacrificed to the
avarice of Wall Street. Financial conglomerates with national
reach that are largely exempt from CRA and other consumer compliance
laws cannot be allowed to ravage the funding base of depository
institutions serving community needs.
(5) The level of regulation should be commensurate with the systemic
risk institutions present to the financial system and the economy.
Consumer protection regulation, in turn, should be even handed
and either lifted for all or applied to all since it represents
a competitive cost.
(6) Access to the payments system should only be via FDICinsured
depository institutions to limit risks to the payments system.
Legislation should not authorize the establishment of a new charter
for investment bank holding companies able to access the Federal
Reserve System's payments services or take uninsured deposits.
(7) Any financial restructuring should include new retail powers
for banks, includingwithin the parameters of safety
and soundnessunrestricted insurance agency powers
and the power to sell mutual funds and other financial products
and services, including annuities; and the authority to underwrite
taxdeferred investments such as an annuity CD.