Deregulation and financial consolidation have led to the development of financial holding companies—allowing commercial banking, insurance, investment banking, and other financial activities to be conducted under the same corporate umbrella—and the Federal Reserve has been named supervisor of the consolidated enterprise. This Commentary explains the increasing importance of an umbrella supervisor amid the sea of regulatory agencies, and why the Fed may be the best natural choice, both practically and conceptually, to assume the role.Bank supervision ; Federal Reserve System

James B. Thomson

Joseph G. Haubrich

English

Research Papers in Economics

holding company—the Fed—would
examine a bank or thrift subsidiary of
the holding company only under exigent
circumstances, relying on the supervi-
sory judgment of the primary supervisor
to the greatest extent possible.
After GLBA was passed and the finan-
cial holding company was created, the
framework was set for the consolidation
of the financial services industry. How-
ever, GLBA did little in the way of 
regulatory consolidation. Even consoli-
dating the Office of Thrift Supervision
into the Office of the Comptroller of 
the Currency was not actively under 
consideration, despite both agencies
being housed within the U.S. Treasury
Department. Congress instead chose to
adopt a functional-regulator approach
for the new activities now allowed under
GLBA. For instance, the Securities and
Exchange Commission would regulate
investment banking subsidiaries of a
September 15, 2005
Federal Reserve Bank of Cleveland
Umbrella Supervision
by Joseph G. Haubrich and James B. Thomson
ISSN 0428-1276
Deregulation and financial consoli-
dation have led to the development of
financial holding companies—allow-
ing commercial banking, insurance,
investment banking, and other finan-
cial activities to be conducted under
the same corporate umbrella—and
the Federal Reserve has been named
supervisor of the consolidated enter-
prise. This Commentary explains the
increasing importance of an
umbrella supervisor amid the sea of
regulatory agencies, and why the Fed
may be the best natural choice, both
practically and conceptually, to
assume the role.
Seven Blind Mice, a children’s book
based on an old Indian parable, tells the
story of blind mice who visit an elephant.
The first six explore the part of the ele-
phant they happen upon first and each
declares that he has discovered either a
pillar, a snake, a cliff, a spear, a fan, or a
rope.  Only the seventh mouse, who
explores the whole of the animal,
deduces that it is an elephant. The lesson
of this parable for policymakers and
financial regulators is that only by
assessing the activities of a company as a
whole can its true risk be acknowledged.  
In 1933, the Glass-Steagall Act was
passed, shaping the evolution of the
United States’financial system through
a legislative blueprint that compartmen-
talized commercial banking, investment
banking, and insurance.  Not surpris-
ingly, separate agencies were created to
supervise these different areas, resulting
in a patchwork quilt of functional regu-
lators at both the federal and state 
governmental levels. 
In the past several years, however, the
lines between commercial banking and
other financial services have become
increasingly blurred. Deregulation, most
recently in the form of the Gramm-
Leach-Bliley Act of 1999 (GLBA), and
earlier in the form of the Reigle-Neal
Act of 1994, has lifted interstate branch-
ing restrictions and dismantled many 
of the statutory limits on financial con-
solidation that were the heart of Glass-
Steagall. This legal sea change, along
with technological innovations and
financial engineering, make increased
integration of financial markets and
more competition among financial firms
seem likely. However, consolidation
does not seem as imminent for the regu-
latory agencies that will supervise these
new and diverse financial services firms.
Instead, GLBA has created a new type of
bank holding company—the financial
holding company, where activities such
as merchant banking and insurance
underwriting, which previously were not
permissible for banking firms, are now
allowed—and named the Federal
Reserve, the seventh mouse if you will,
as umbrella supervisor. (Thrift holding
companies remain regulated by the
Office of Thrift Supervision and invest-
ment bank holding companies by the
Securities and Exchange Commission.)
■ Financial Holding 
Companies
There are several ways of conducting
different financial services in the same
organization: the universal bank as 
currently practiced in Germany, where
all financial services are done within the
bank; the bank subsidiary model, where
nonbanking activities are done in sepa-
rately chartered subsidiaries of the bank;
and the bank holding company model,
where nonbanking activities are done in
firms owned by a parent company that
also owns the bank. The United States
has used the bank holding company
form since the mid-1950s.
Prior to GLBA, bank holding companies
could own banks, thrifts, and other firms
engaged in activities deemed closely
related to banking by the Federal
Reserve Board. However, supervision of
banks and thrifts owned by a parent
holding company fell to the company’s
primary federal or state regulatory
agency—its functional regulator—and
supervision of nonbank subsidiaries of
bank holding companies and the consoli-
dated holding company fell to the Fed-
eral Reserve. Under this regulatory
model, the “umbrella supervisor” of thefinancial holding company, and the
appropriate state agency (insurance
commissioner or regulatory body in 
the state where the subsidiary is incor-
porated) would regulate insurance 
subsidiaries. Using these specialized
industry regulators echoed the approach
used to supervise banks and thrifts in
traditional bank holding companies. It
may not be a surprise, therefore, that the
Federal Reserve was chosen to be the
“umbrella supervisor” for the consoli-
dated financial holding company,
because Congress viewed this role as an
extension of the Federal Reserve’s role
as the regulator of bank holding compa-
nies. In fact, this sentiment is explicitly
stated in the Conference Report on the
Gramm-Leach Bliley Act released
November 1, 1999:
Reflected in the legislation is the
determination made by both Houses
to preserve the role of the Board of
Governors of the Federal Reserve
System… as the umbrella supervi-
sor for holding companies, but to
incorporate a system of functional
regulation designed to utilize the
strengths of the various Federal 
and State financial supervisors.1
Moreover, to minimize the regulatory
burden associated with this layered
approach to the supervision of financial
holding companies, the GLBA limits
the Federal Reserve’s ability to de facto
regulate functionally regulated sub-
sidiaries of financial holding companies.
■ Role of the Umbrella
Supervisor
The parable of the blind mice illumi-
nates how a functional regulator’s
assessment of a subsidiary may not
reflect the true risk in the context of the
entire company. The role of the
umbrella supervisor is to piece together
a consolidated picture of the financial
holding company’s risks—including
management’s ability to understand and
manage those risks. In other words, the
umbrella supervisor is charged with 
producing a comprehensive picture 
of an institution as the collection of its
parts, leaving the regulation and exami-
nation of each holding-company sub-
sidiary to its functional regulator. It is
not just the parts but how they fit
together that gives us the true profile 
of a financial holding company.
To further stress the importance of 
producing a comprehensive picture, 
consider the Butcher banks. The two
Butcher brothers, Jake and C.H., Jr.,
owned or controlled approximately 
40 depository institutions between them.
Through what was known as chain bank-
ing, the Butchers’holdings included
depository institutions in two of the 
Federal Deposit Insurance Corporation’s
(FDIC) jurisdictions and three Federal
Reserve Districts. Unlike a bank holding
company, this chain of commonly held 
institutions was not supervised on a 
consolidated basis. Depending on 
location, charter, and Federal Reserve 
membership status, examination of each 
separate chain-banking unit fell to one 
of the seven bank or thrift regulatory
agencies involved, making it difficult 
for any single examination agency to
detect systemwide problems. The lack 
of a comprehensive examination of their
entire empire allowed the Butcher banks
to hide asset-quality problems by shift-
ing problem loans from one bank to
another. Only after the FDIC conducted
simultaneous examinations of all the
major Butcher-affiliated banks were 
the problems detected, leading to the
closing of eight Butcher-affiliated banks
in 1983, with losses to the FDIC of
nearly $383 million.
In addition to the need for comprehen-
sive examinations, umbrella supervision
is also necessary because the legal sepa-
rateness afforded by the holding com-
pany structure is less and less an eco-
nomic reality. Senior management and
boards of directors are increasingly
adopting enterprisewide risk manage-
ment—aggregating risk at the corporate
level in order to effectively establish risk
limits and controls. New regulations,
such as the Basel II capital requirements
and Federal Reserve Board letter 
SR99-18, have further nudged banks
and their parent holding companies
toward organizing their risk-manage-
ment and economic capital allocation
plans according to lines of business, 
not legal entities. Hence, the need for
aggregated risk information, coupled
with economies of scale in information
storage, retrieval, and processing, have
reinforced the trend toward enterprise-
wide risk management by diversified
financial firms, including financial 
holding companies. Functional regula-
tors provide an important level of review
of risk-management systems at the legal
entity level, but they cannot, by design,
adequately assess the enterprise-wide,
risk-management efforts, particularly
when this function is housed in the 
parent company. This can only be done
effectively by a supervisor with the
authority to look at the consolidated
organization.
Finally, choosing the financial holding
company form as the model for consoli-
dation stems from a desire to insulate
bank and thrift subsidiaries from risks
posed by the new activities. By exten-
sion, Congress sought to limit the fed-
eral financial safety net to the insured
depository institution subsidiaries and
thereby protect the federal deposit
insurance funds (and by implication,
taxpayers) from the same risks. In
GLBA, Congress charged the umbrella
supervisor with protecting the insured
bank and thrift subsidiaries of financial
holding companies, as well as the
domestic and international payments
systems, from risks associated with 
the functionally regulated nonbank 
subsidiaries of holding companies.
Therefore, while the Federal Reserve is
to rely mostly on the functional regula-
tor for information on the condition of a
subsidiary of a nonbank financial hold-
ing company, as umbrella supervisor
the Fed has broad authority to examine
any holding company subsidiary that is
seen as a possible material risk to the
health of the insured banking (or thrift)
subsidiaries or to the payments system.
■ Umbrella Supervision and
the Fed
As with any supervisor of financial 
services firms, the umbrella supervisor
is required to be independent of partisan
politics and the congressional appropria-
tions process. Moreover, the umbrella
supervisor must have sufficient stature
in financial markets in order to attract
and retain qualified staff. It is unlikely
that a stand-alone agency, even in the
broad and deep financial markets of the
United States, would meet both of the
above conditions, for how would such
an entity be funded other than by con-
gressional appropriations? After all, by
design, the umbrella supervisor would
conduct few, if any, examinations, so
there would be no exam fees to rely on
and, unlike the Fed and the FDIC, there
would be no portfolio of government
securities from which earnings could be
used to support its operation. Hence, the
umbrella supervisory function would
need to be housed in an existing agency,
a new financial regulatory agency, or the
central bank. Why might the Federal Reserve be a
natural choice to be the umbrella super-
visor? The short answer—because 
Congress delegated the role to the Fed
in GLBA and it is a natural extension 
of the Fed’s role as regulator of bank
holding companies—is an unsatisfying
response, providing no explanation as
to why the central bank is a better
choice for this role than a federal bank
regulatory agency or even the SEC.
However, an economic case can be
made for housing the umbrella supervi-
sory function at the Fed. First, the Fed’s
responsibility to manage macropruden-
tial risks—including concerns for finan-
cial stability and the integrity of the
payments system—suggests that there
may be economies of scope between
central banking functions and umbrella
supervision. In other words, the types of
information the Fed needs to carry out
its mission include financial market and
financial firm information that an
umbrella supervisor would collect and
consolidate. In addition, the existence
of the Federal Reserve is not contingent
on its role as a functional supervisor.
Consequently, any conflicts of interest
between an agency’s role as a func-
tional supervisor and its role as
umbrella supervisor should be less at
the central bank. This, in turn, should
facilitate the cooperation between the
umbrella supervisory agency and func-
tional regulators so important to the
success of financial holding companies.
■ Recommended Readings
Ed Young. 1993. Seven Blind Mice,
New York, N.Y.: Philomel Books.
For a discussion of enterprise-wide risk
management in banking companies, see: 
Susan Schmidt Bies. 2004a. “Enterprise
Perspectives in Financial Institution
Supervision.” Remarks at the Univer-
sity of Connecticut School of Law,
Connecticut Law Review Symposium,
Hartford, Connecticut, October 21.
Susan Schmidt Bies. 2004b. “Using
Enterprise-Wide Risk Management to
Effectively Execute Business Strate-
gies.” Remarks at the Risk Management
Association and Consumer Bankers
Association Retail Risk Conference,
Chicago, Illinois, July 16.
Federal Reserve Board letter SR 99-18,
formally titled Assessing Capital 
Adequacy in Relation to Risk at Large
Banking Organizations and Others
with Complex Risk Profiles, instructs
banks to allocate capital on an eco-
nomic basis, that is, to assign capital to
business lines according to the risks
they pose to the company. Available at
<http://www.federalreserve.gov/board
docs/SRLETTERS/1999/SR9918.HT>.
For more details on the Butcher 
banks, see:  
Federal Deposit Insurance Corporation.
(FDIC) 1998. “Managing the Crisis:
The FDIC and RTC Experience:
Chronological Overview.” Available at
<http://www.fdic.gov/bank/historical/
managing/Chron/index.html> (accessed
01/04/05).  
For more on the pros and cons of 
regulatory consolidation, including
comparisons with other countries, see:
Charles A.E. Goodhart. 2000. “The
Organisational Structure of Banking
Supervision,” FSI Occasional Papers,
No. 1, November.
Charles A.E. Goodhart, and 
D. Schoenmaker. 1992. “Institutional
Separation between Supervisory and
Monetary Agencies,” Giorn. Econ., 
pp. 9–12, 353–439.
Alan Greenspan. 1994. “The Views of
the Board of Governors of the Federal
Reserve on the Consolidation of Bank
Supervision and Regulation.” Banking
Industry Regulatory Consolidation Hear-
ings before the Committee on Banking,
Housing, and Urban Affairs. U.S. Senate,
S. Hrg. 103–692, pp. 130–56.
Joseph G. Haubrich. 1996. “Combining
Bank Supervision and Monetary Policy,”
Federal Reserve Bank of Cleveland,
Economic Commentary (November).
Joao A. C. Santos. 1998. “Securities
Activities of Banking Conglomerates:
Should They Be Regulated?” Cato Jour-
nal 98, Spring/Summer, pp. 93–08.
United States General Accounting
Office. 2004. “Financial Regulation:
Industry Changes Prompt Need to
Reconsider U.S. Regulatory Structure.”
Report to the Chairman, Committee on
Banking, Housing, and Urban Affairs,
U.S. Senate, October. 
Footnotes
1. See http://banking.senate.gov/conf/
somfinal.htm.Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101
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Material may be reprinted if the source is
credited. Please send copies of reprinted
material to the editor.
Joseph G. Haubrich is a consultant and
economist at the Federal Reserve Bank of
Cleveland, and James B. Thomson is a vice
president and economist at the Bank.
The views expressed here are those of the
authors and not necessarily those of the 
Federal Reserve Bank of Cleveland, the Board
of Governors of the Federal Reserve System,
or its staff. 
Economic Commentary is published by the
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Umbrella supervision

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