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, 1978


Stu Eizenstat
Charlie Schultze *


Consolidation of Commercial Bank Regulatory
Functions into a Single Federal Banking Commission

The idea of consolidating bank regulatory functions
into a single Federal Banking Commission has the strong
endorsement of Senator Proxmire and the staff of the
Senate Banking Committee (although probably not a majority
of the Committee members) and the basic idea (not the
details of Senator Proxmire's specific proposal) has also
been endorsed in a report by the Senate Committee on
Governmental Affairs.
Under current law, commercial banks can be chartered
either nationally or by states.
National banks are
regulated in most respects by the Comptroller of the
Currency and must be members of the Federal Reserve
State banks may be members of the Federal Reserve
System, in which case the major Federal regulatory oversight
is in the Fed.
State nonmember banks that are insured are
regulated at the Federal level by the FDIC.
This crazy-quilt pattern grew up through historical
It has been cited by some as an example of the
need for reorganization and consolidation in the Federal
It has undoubtedly entailed some measure of
inefficiency in the regulatory process and may have
occasioned undesirable practices in markets served by
commercial banks.
Nevertheless, it has functioned since
the great depression to avert the kind of cumulative
financial crises that threaten overall economic stability.

-2Whether bank regulation would have been superior if
it had been lodged in a single agency is debatable.
a single Federal regulatory agency were to become "captive"
of the banking industry or some particular part of it, the
end result could be worse than the results of the existing
On the other hand, some pressures in the direction
of looser regulation or opportunities for banks to evade
restrictions might be avoided.
The basic arguments for consolidating the regulatory
function into a single commission are (a) that there is
inefficient overlapping of regulatory jurisdiction and,
at the same time, the possibility for activities needing
regulation to "slip between the cracks," and (b) that
banks can choose their regulator, while the regulators
can compete for clientele by accommodative regulation.
Moreover, during the first half of the 1970s a number of
questions arose about the safety and soundness of the
commercial banking system.



Are banks adequately capitalized to protect
their operations in event of losses?


Are banks making sound judgments about the risks
entailed in a rapidly growing volume of foreign


Is regulatory vigilance adequate to protect the
soundness of banks against insider abuses,
inappropriate takeovers, involvement in excessively
speculative real estate transactions (some of
them prompted by tax-preference provisions of the
tax code which were partially corrected in 1976
legislation and which your tax proposals will
further ameliorate?


Are merger and holding company regulations being
administered so as to prevent anti-competitive
developments ?

Supporters of consolidation allege that a single Federal
bank regulatory agency is needed to deal more adequately
with these problems.
The question arises as to what the Administration's
priorities should be in regard to financial regulatory
Several considerations are relevant:


The problems of safety and soundness of the
banking industry are not as critical as they
were several years ago.
Problems have been
shaken out, banks have come to recognize and
reduce certain risks, the regulatory environment
seems to have become more vigilant, and the
regulators are becoming better informed
concerning both real estate and foreign
A serious domestic or international
financial crisis would cause problems for some
banks but we have no reason to believe this
implies fundamental unsoundness in the banking
system, or that the problems would necessarily
be eased by having s single bank regulatory


Steps — such as S. 71, a bill to increase
certain powers of the regulators that was
introduced by Senator Proxmire in January
1977 and passed the Senate last August —
can be taken within the current organizational
fra m e w o rk .




The functioning of financial markets is changing.
New institutions and practices are evolving (for
example, the growing role of credit unions and
electronic funds transfer mechanisms) and it
is important to consider what regulatory
issues are posed by these developments.


There are substantive issues pertaining to
financial regulation which are under consideration
by the regulators or within the Administration
which address some significant current issues.
(For example, the Federal Reserve is now reviewing
issues relating to bank holding companies and
there is an interagency task force studying the
question of interest rate ceilings.)

Although these considerations reduce the immediate pressure
for reorganization of the banking regulatory agencies, we
can expect a continuing interest in our position on the
need for such a reorganization.
It is therefore important
to recognize that a major reorganization effort would
entail serious difficulties:



Separation of regulatory powers from the monetary
policy powers of the Federal Reserve would
require very careful design.
Chairman Miller
should certainly be given time to assess this
Reduction of the Federal Reserve's
regulatory powers has been strongly resisted
by the Federal Reserve in the past.


The regulatory agencies are clearly jealous of
their powers and also have constituencies.
the political problems would be very substantial. \
Very significant opposition would arise from some
banking groups, most state banking supervisors,
and Congressmen with connections to the banking


Steps toward regulatory consolidation would very
likely be accompanied in the Congress by an
increase in detailed regulation that substitutes
for market competition — exactly the opposite
direction from the thrust of your other regulatory
reform initiatives.

For these reasons, we do not believe the Administration
should at this time propose or support a major reorganization
of bank regulatory agencies.
But there are improvements
that we can make.
An informal coordinating committee now
exists among the regulators to deal with the setting of
interest rate ceilings and, from time to time, this or
other ad hoc committees have considered and attempted to
coordinate regulatory policies in other areas.
establishment by law of a Financial Institutions
Examination Council has recently been proposed in the
House and a similar bill is pending in the Senate.
This |
Council would promote uniformity of bank examination
procedures and standards.
It could be the forum within
which regulatory policies to protect the safety and
soundness of financial institutions would be reviewed
and developed as necessary.
This is a very desirable
step which the Administration has endorsed.
The existence
of a Financial Institutions Examination Council may be
able to solve those legitimate problems that result
from "lowest-common-denominator" regulation.
establishment is a logical next step in an incremental
improvement of financial regulation.

We have discussed the contents of this memo with
Treasury and OMB, and both agencies are in general
agreement with our appraisal.
We all recommend that the
Administration continue vigorously to support legislation
to establish a Council.
The issue is whether we should initiate a formal "study"
of the banking consolidation issue at this time.
Treasury and OMB oppose such a study, and believe that
support for the Examination Council would be a positive
response to Senator Proxmire's proposal and would indicate
our concern with overlapping functions and regulations.
In pressing for legislation to establish the Council, it
can be emphasized that the Administration considers your
transportation reform initiative and your Executive Order
on Improving Government Regulations also to be high priority
efforts in regulatory reform for 1978. At the same time,
however, Senator Proxmire can be assured that questions of
financial regulation would be reviewed carefully as we develop
our regulatory reform and reorganization priorities for 1979.
Stu*s view is that the consolidation question raises
legitimate substantive issues and that there is substantial
pressure from Senator Proxmire at least to "study" his
allegation that the present regulatory structure has created
inefficiencies and weakened the banking system.
Stu has no
opposition to such a study but in view of the reluctance
of the three relevant agencies to initiate this study, Stu
would concur with the recommendation of CEA, OMB and Treasury
that no study be undertaken at this time.

Approve (Inter-agency recommendation)
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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102