Barbara Bennett

Michael Keeley

English

Research Papers in Economics

FRBSF WEEKLY LETTER
March 18, 1988
Legislation to Expand Bank Powers
Several bills have been submitted to both
Houses of the Congress that would expand the
powers of banking orgClnizCltions or otherwise
reform the financial regulatory framework. In the
Senate there are three major bills: Proxmire-
Garn (51886), supported by the Administration
and the heads of the bank regulatory agencies;
Wirth-Graham (51891), which is essentially the
proposal that was recently put forth by Gerald
Corrigan, the president of the Federal Reserve
Bank of New York; and Cranston-O'Amato
(51905), which is much more sweeping in scope
than the other bills. On the House side, similar
bills have been introduced. However, Congress-
man St Germain, Chairman of the Banking Com-
mittee, is drafting a bill as well, which may
partly determine the direction the House will
follow.
This Letter discusses the similarities and dif-
ferences among the major Senate bills as of Feb-
ruary 15. The analysis focuses on the way each
bill addresses several important policy issues.
The first issue is the proper scope of a bank
holding company's activities, and which of those
activities are proper for the bank itself. The sec-
ond is whether a federally-insured bank can be
"insulated" from the risky activities of its affili-
ates. And the third is how to regulate and super-
vise banking organizations that have greatly
expanded powers.
Proper scope of activities
The major bills differ greatly on the types of new
activities that would be allowed. The Proxmire-
Garn bill is the most restrictive. It would expand
the securities powers of bank holding companies
by repealing the relevant sections of the Glass-
Steagall Act in several steps. However, the Prox-
mire-Garn bill does not explicitly authorize any
other new types of activities such as rea! estate
or insurance.
Under the bill, securities firms could own banks,
and would not be subject to Federal Reserve
capital regulation and monitoring of the consoli-
dated organization as long as 80 percent of the
organization's consolidated earnings and assets
were derived from securities activities and each
bank subsidiary were adequately capitalized.
Currently, many of the largest securities houses
are affiliated with insurance, real estate and
even commercial firms. Thus, the present ver-
sion of the bill would not allow these firms to
own banks without major divestitures.
The Wirth-Graham bill is less restrictive. It
would allow nonbank subsidiaries of bank hold-
ing companies to engage in any activities
deemed financial in nature by a newly created
regulatory oversight committee, although it
would prevent banks from affiliating with com-
mercial firms. It also would create a new type of
"financial holding company," which would not
own banksor be affiliated with commercial
firms, but which could have access to the large-
dollar electronic payments system through a
newly created National Electronic Payments
Corporation.
Since the Wirth-Graham bill would define banks
as any institution with federally insured deposits,
companies that owned "nonbank banks" no
longer could avoid bank holding company reg-
ulation. In addition, the bill would create "com-
mercial" holding companies in which financial
and commercial firms could be affiliated.
However, commercial firms that now own
institutions with insured deposits such as thrifts
and nonbank banks would have to divest them.
The Cranston-O'Amato bill is the most liberal of
the major bills. In addition to allowing banking
organizations to conduct all types of financial
activities, this bill would allow commercial firms
to own banks and vice versa.
These bills represent a range of opinion on how
broadly the powers of banking organizations
would be expanded - from essentially
securities powers only under Proxmire-Garn
versus all financial and even commercial powers
under Cranston-O'Amato. The key concern in
this debate is the likely effects of an expansion
of powers on the riskiness of the banking and
financial systems.
It is now well recognized that a fixed rate
deposit insurance system can provide strong
incentives for insured institutions to undertakeFRBSF
excessive risks. Currently, such opportunistic
behavior is limited by bank and bank holding
company regulation. The concern, then, is
whether the risks associated with the new
activities can be contained to prevent them from
spilling over to the insured bank and ultimately,
to the federal deposit insurance system.
Insulation
Each of the bills tries to insulate the insured
bank by placing new activities in legally sepa-
rate nonbank subsidiaries of bank holding com-
panies and by placing rather severe restrictions
on transactions between bank and nonbank affil-
iates. The idea is to try to limit the opportunities
for the bank to bailout the holding company or
sister affiliates with loans or asset purchases
funded with insured deposits.
The Proxmire bill would prohibit virtually all
credit transactions between a bank and its
securities affiliate, including indirect transactions
such as bank-issued standby letters of credit
backing securities underwritten by a securities
affiliate. The Cranston bill also would prohibit
direct and indirect credit transactions between a
bank and its securities affiliates. However, the
latter bill would allow transactions between a
bank and other types of affiliates up to the limits
of Rules 23A and 23B in current banking law.
(Rule 23A of the Federal Reserve Act limits a
bank's extensions of credit to a single affiliate to
ten percent of the bank's capital and limits the
credit to all affiliates combined to 20 percent of
capital. Rule 23B requires that permissible inter-
affiliate transactions be on terms and conditions
that are substantially the same as arm's-length
transactions with nonaffiliated firms.) The Wirth
bill, in contrast, would apply these limitations to
transactions between banks and all of their
affiliates.
Although the three bills differ regarding the strin-
gency of the restrictions they would place on
interaffiliate transactions, the approach itself has
several limitations. First, it is doubtful whether
the restrictions contained in any of these bills
could be enforced in times of financial stress.
The gains from using the bank to bailout failing
nonbank affiliates increase as the organization
approaches bankruptcy. Thus, far more stringent
restrictions than those contained in these bills
may be necessary to insulate banks fully.
Second,even if it were possible to insulate the
bank, perhaps by restricting all interaffiliate
transactions, doing so would preclude the organ-
ization from realizing important synergies
among separate subsidiaries. For example, banks
and securities companies may benefit from shar-
ing information, but unless the two can work out
a way to share the costs of acquiring that infor-
mation, they will have little incentive to do so,
even if they are subsidiaries of the same parent
organization.
Finally, restrictions on interaffiliate financial
flows also limit the extent to which the bank can
benefit from the diversification and reduced risk
of bankruptcy that might result from an
expanded range of activities. Moreover, apart
from bank capital regulation, there is no mecha-
nism for forcing a bank holding company to
provide support for a failing bank subsidiary.
Regulatory oversight
The major bills also differ significantly in their
provisions regarding supervision of the consoli-
dated firms, although all of the bills provide for
functional regulation of the various subsidiaries
of the holding company. The Proxmire bill
would leave intact the regulatory framework
established by the Bank Holding Company Act,
with the Federal Reserve as the primary regula-
tor of the holding company. The bill would give
the Fed explicit authority to regulate the holding
company's capital unless the company meets the
80 percent test mentioned above.
The Wirth bill also would leave the Federal
Reserve as the regulator of bank holding com-
panies, but in addition would give substantial
powers to a fifteen-member "super-agency"
composed of the various functional regulators.
This agency would oversee the functional reg-
ulation of the subsidiaries of bank, financial and
commercial holding companies, would have the
authority to set capital standards for financial
holding companies and could promulgate reg-
ulations defining permissible activities for bank
and financial holding companies.
In contrast, although the Cranston bill would
create a "super agency" called the National
Financial Services Committee, that agency's role
appears to be limited to an advisory one. More-
over, this bill would reduce the Fed's authority
to regulate the activities of nonbank affiliates of
insured banks.
Risk containment
Clearly, there are substantial differences among
these three bills regarding the permissible scope
of banking powers and the extent of regulation
and oversight of the consolidated firm. These
differences reflect divergent views on the bene-
fits of expanded powers and the costs associated
with the potential for increased risk taking.The Cranston-D'Amato bill allows the broadest
range of powers apparently on the assumption
that reliance on the holding company structure
and restrictions on interaffiliate transactions is an
inexpensive and effective way of insulating the
bank. It also apparently assumes that apart from
regulation and supervision of banks, little else is
needed to contain risk taking. For example, it
expressly prohibits capital regulation of consoli-
dated financial holding companies. However, it
permits bank regulators to require higher capital
in banks that are affiliated with nonbank firms
and gives bank regulators the power to require
holding companies to divest inadequately cap-
italized banks.
The Wirth-Graham bill takes a more middle-of-
the-road approach. It apparently assumes that
insulation cannot be made completely fireproof,
and instead, assigns a greater role to regulation
of the consolidated organization. Thus, it limits
the scope of powers and requires Federal
Reserve regulation of the capital adequacy of the
consolidated bank holding company.
Finally, the Proxmire-Garn bill seems the least
sanguine about insulating insured banks from
the risks associated with a broad range of new
activities and therefore takes the most cautious
approach. It requires the Federal Reserve to
monitor and ensure that the capital position of
the consolidated bank holding company is ade-
quate. Moreover, it allows expansion only into
securities activities, presumably because, unlike
many other activities, the benefits from such an
expansion are more obvious and the costs of
monitoring the market values and volatility of
securities activities are relatively low.
Opportunities vs. incentives
Limitations on the scope of activities as well as
restrictions on interaffiliate transactions can be
seen as attempts to limit opportunities for
increased risk taking with insured deposits.
However, the sponsors of these bills apparently
also recognize that limitations on opportunities
to undertake risk do not necessarily alter the
incentives to do so. Thus, these bills also
attempt, in various ways, to constrain the incen-
tives for a banking organization to shift risk to its
insured banks.
The Proxmire-Garn and the Cranston-D'Amato
bills contain capital "bear-down" provisions
that would allow regulators to force a holding
company to divest its inadequately-capitalized
bank subsidiaries. Such a provision, if enforced
on a market value basis regardless of the size of
the bank holding company, could be a very
powerful tool to limit risk taking.
As we have argued in previous Letters, banks
with stronger capital positions should be much
less inclined to use insured deposits to bailout
nonbank subsidiaries. And, even if they did, as
long as the bank had sufficient capital, the insur-
ance fund would not be at risk. Therefore, if
bank capital regulation could be strengthened,
there is considerably less risk in expanding
banking organizations' powers.
On the other hand, without enforcement of such
a provision, the incentives to find ways around
the holding company structure will remain and
could become particularly troublesome in times
of financial stress. Thus, without a r11arket value
closure or divestiture rule, an approach that calls
for a more modest range of new powers and
more active oversight of the consolidated organ-
ization as proposed in Proxmire-Garn or Wirth-
Graham may be appropriate.
Barbara Bennett and Michael Keeley
MONETARY POLICY OBJECTIVES FOR 1988
Federal Reserve Chairman Alan Greenspan presented a report to the Congress on the
Federal Reserve/s monetary policy objectives for 1988 on February 23. The report
includes a summary of the Federal Reserve's monetary policy plans along with a review
of economic and financial developments in 1987 and the economic outlook in 1988.
Single or multiple copies of the report can be obtained upon request from thePublic
Information Department, Federal Reserve Bank of San Francisco, p.o. Box 7702/ San
Francisco, CA 94120; phone (415) 974-2246.
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board.of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author.... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bankof San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.uo~6u!4S0m 4o~n U060JO OpOA0U
040PI !!omoH O!UJOJIIO) ouoz!J~ o~sol~
O)SI)UOJ~ UOS
JO ~uo8
aAJaSa~ IOJapa~
~uaw~Jodaa LpJOaSa~
BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
2/24/88
Change
from
2/17/88
Change from 2/25/87
Dollar PercenC
Loans, Leases and Investments1 2 203,558 - 57 - 1,001 - 0.4
Loans and Leases1 6 180,200 - 284 - 4,181 - 2.2
Commercial and Industrial 51,040 - 176 - 1,455 - 2.7
Real estate 70,752 - 67 4,329 6.5
Loans to Individuals 36,218 149 - 4,224 - 10.4
Leases 5,781 5 396 7.3
U.S. Treasury and Agency Securities2 16,295 217 2,994 22.5
Other Securities2 7,063 9 187 2.7
Total Deposits 200,309 - 3,721 - 668 - 0.3
Demand Deposits 47,209 - 3,670 - 1,999 - 4.0
Demand Deposits Adjusted3 43,253 12,105 9,864 29.5
OtherTransaction Balances4 19,906 - 231 1,130 6.0
Total Non-Transaction Balances6 133,194 181 200 0.1
MoneyMarketDeposit
Accounts-Total 43,201 - 326 - 2,345 - 5.1
Time Deposits in Amountsof
$100,000 ormore 30,614 547 - 1,115 - 3.5
Other Liabilities for Borrowed MoneyS 22,003 - 2,182 - 6,196 - 21.9
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency(-)
Borrowings
Netfree reserves (+)/Net borrowed(-)
Period ended
2/22/88
28
6
22
Period ended
2/8/88
98
9
90
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes U.5. governmentand depository institution deposits and cash items
4 ATS, NOW, Super NOWand savings accounts withtelephone transfers
S Includes borrowingvia FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately
7 Annualized percentchange

Legislation to expand bank powers

http://www.frbsf.org/publications/economics/letter/1988/el88-12.pdf

Legislation to expand bank powers

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics