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March 8, 1976 To: Chairman, Council of Economic Advisers From: Chairman, Board of Governors of the Federal Reserve System A F Subject:- The Financial Reform.Act of 1976 As you know, this legislation is pending before the House Banking Committee, and the hearings on the legislation are scheduled to conclude on March 18. It is anticipated that the Committee will move promptly to mark up the bill, and the markup could commence as early as March 23. Chairman Reuss has publicly stated his intention to move this bill not only through the Committee but also through the House before the mid-April Easter recess. It is not at all certain that this ambitious scheduling can be met, but it is our present judgment that the bill will be voted on by House Banking before this recess. Hill sources indicate that if the House passes a Financial Reform Act, this legislation will be brought to conference with the Financial Institutions Act which passed the Senate during the first session of the 94th Congress. I find the legislation as it is presently drafted an 'exceedingly troublesome piece of legislation. It is my judgment that if this legislation passes in its present form, it could well frustrate the conduct of monetary policy and do serious injury to our nation's economy. I am primarily concerned about Title I of the bill, which proposes the establishment of a Federal Banking Commission. Under the bill, this Federal Banking Commission would assume the bank regulation and other banking supervisory functions presently lodged with the Board of Governors of the Federal Reserve System or with the Comptroller of the Currency. It is the Board's considered judgment that the Federal Reserve, as the nation's central bank, must be closely involved in the process of bank regulation and supervision. There is a vital interaction between monetary policy and bank supervision that the drafters of the legislative proposal obviously didn't consider. The interaction is so strong that actions by this new Federal Banking Commission, either deliberately or inadvertently, could frustrate monetary policy and destroy the effectiveness of the Federal Reserve. -2- r For examplej rigid bank examination standards by the new Commission will help determine bank lending policies. A monetary policy by the Federal Reserve designed to promote active lending policies on the part of our n a t i o n 1s banks could thus be frustrated by actions currently taken or previously taken by the Federal Banking Commission. Conversely, a~ policy of monetary restraint could be frustrated by past or prospective Commission action to ease bank lending standards. Again, the new C o m m i s s i o n ^ policies regarding the adequacy of bank capital could disrupt the conduct of monetary policy. If the Commission sets rigid bank capital standards, such action could weaken monetary policy aiming to finance a satisfactory economic expansion. Conversely, loose standards could frustrate a monetary policy looking towards economic restraint. Thirdly, the transfer of our regulatory and supervisory function to the new Commission will make far more difficult the operation of our discount window. Through the bank regulatory and supervisory function, the Federal Reserve has built up a considerable body of knowledge concerning the individual banks which come to the discount window for temporary assistance. In time, this knowledge will be lost. Finally, our experience as a regulator has convinced us that the behavior of monetary aggregates is directly affected by regulatory decisions--such as the recent decision of the Board which authorized passbook accounts for business firms. In conclusion, I urge that you and the Administration oppose this Title of the bill and that this opposition be conveyed to the Committee in testimony and in other ways prior to the markup of the legislation.