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Federal Reserve Bank of Cleveland
possess advantages such as entry
restrictions, deposit insurance, and
access to the FRB's discount window, they would have a competitive
advantage over other suppliers of
financial services unless reciprocal
entry is allowed. Those who favor
relaxing Glass-Steagall contend
that banks also bear some unique
costs, such as paying insurance
premiums and maintaining reserves that do not pay interest.?
If we adopt a deregulation measure
such as the' Treasury advocates,
allowing banks to engage in businesses previously prohibited while
barring nonbank firms from operating a bank, would banks be granted a
competitive advantage? Perhaps the
FRB's implementation of the BHCA
can provide insight on these issues.
To date, the FRB has authorized 15
"permissible" nonbanking activities
for BHCs. Each new activity is evaluated in terms of whether, when
coupled with a bank's credit-granting
powers, a bank would have a competitive advantage over other producers
in that industry. In such a case, the
FRB either disallows or restricts the
bank's involvement in the nonbanking activity. Restrictions on the nonbanking activities, in effect, neutralize the potential for credit abuse.
In considering a relaxation of
Glass-Steagall's barriers, we
should also identify and quantify
what economic effects might predictably occur if the securities
and commercial banking businesses were recombined. Would an
increase in the number of potential
competitors significantly affect the
prices of banking and securities
products or services, other things
being equal? Could we realize signifi9. See statement by Paul A. Volcker, p. 6, testimony of September 13, 1983.

cant cost savings by co-producing
security and commercial banking
products? And, if banks are allowed
to offer new products but only on
restrictive terms, we should evaluate
whether, and to what degree, such
restrictions would have on negating
any "synergies" of co-production.
A principal objective of banking
regulation is the safety and soundness of banks. If we allow banks into
other business activities, we must
face the question of what new risks
would be incurred. Investment
bankers can incur substantial losses
if markets fluctuate adversely, or
simply if the marketability of the
issue were poorly judged. On the
other hand, securities discount brokering involves virtually no market
risk. If banks were permitted to take
on such risks, then is it possible to
isolate banking activities from the
risks associated with nonbanking
activities? Those who advocate a
deregulation proposal in which a
BHC's nonbanking activities are
conducted in separate subsidiaries
and regulated principally by market
forces assume that the BHC can be
financially structured so that potential parent-company problems cannot
be transmitted to affiliate banks.l"
Some individuals have expressed
doubt about this assumption.l!
Recent research, which shows that a
BHC operates as an integrated firm,
provides a basis for these reservations. Deregulation proposals, therefore, that attempt to separate a
BHC's banking and nonbanking

activities would probably achieve
limited success.
The question of solvency
If banks are special, given that
their activities are highly interdependent, then the government should
provide the public with a "safety
net" to ensure the liquidity of the
banking system. Currently, this
safety net consists of deposit insurance and the Federal Reserve Bank
as a lender of last resort. But, if the
banking business were completely
deregulated, could we expect to be
cushioned from the harmful effects
of a failed bank or group of banks?
How would financial deregulation
affect the public's trust in this safety
net in financial crisis?
If Glass-Steagall were reformed,
the role of deposit insurance in the
financial system also must be examined. As legislatively mandated by
Garn-St Germain, the deposit insurance agencies submitted reports to
Congress recommending methods
of injecting more market discipline
into the deposit insurance system.
Reform of the deposit insurance sysFederal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

tem would enable further financial
deregulation. But without such
reform, even if banks were given
additional product powers, it is likely
that the regulatory agencies would
restrict the risks that banks incur.
Conclusion
Garn-St Germain and the Monetary Control Act unquestionably
represent major steps in deregulating
the banking system and in loosening
the restraints imposed by GlassSteagall and the BHCA. Yet, Congress should reappraise existing
financial legislation, including the
extent to which banking and commerce should mix. If the competition
for deposits continues to circumvent
Glass-Steagall's barriers, Congress
ought to consider seriously the
merits of imposing a moratorium on
encroachments by banks and nonbanks into each other's areas. Without a moratorium, it is likely that the
financial services industry would be
restructured in the future, more to
avoid legislative restrictions than
to respond to market incentives.
BULK RATE
U.S. Postage Paid
Cleveland, OH
Permit No. 385

10. See Robert]. Lawrence and Samuel H. Talley,
"An Alternative Approach to Regulating Bank
Holding Companies," in Proceedings of a Conference on Bank Structure and Competition, Federal
Reserve Bank of Chicago, April 27-28, 1978,pp. 1-10.
11. See Robert A. Eisenbeis, "How Should Bank
Holding Companies Be Regulated?" Economic
Review, Federal Reserve Bank of Atlanta, January 3,
1983,pp. 42-7.

Address Correction Requested: Please send corrected mailing label to the Federal
Reserve Bank of Cleveland, Research Department, P.O. Box 6387, Cleveland, OH 4410l.

December 5, 1983

Economic Commentary

ISSN 0428-1276

Banking and Commerce:
To Mix or Not to Mix?
by Thomas M. Buynak
n the late 1970s, commercial banks and thrifts
experienced an unprece-- __
dented diversion of their
funds to less regulated institutions.
Partly in reaction to this massive
outflow of depositories' funds, the
U.S. Congress passed two separate,
fairly comprehensive deregulatory
measures-the
Depository Institutions Deregulation and Monetary
Control Act of 1980 and the GarnSt Germain Depository Institutions
Act of 1982.1 Because of these two
acts, banks and thrift institutions
can more freely pay whatever interest rates they choose in order to
attract deposit funds.
Financial concerns such as Merrill Lynch and insurance firms,
retailers, and money market funds
are competing more and more with
banks. Their most recent incursion
into the banking business involves
acquisitions of "nonbank banks"entities that function as banks but
escape the legal definition of banks
under the Bank Holding Company
Act of 1956 (BHCA), as amended.
The BHCA defines a bank as an
institution that both accepts
demand deposits and engages in
commercial lending. If an institution engages in only one of these
activities, it is not classified as a
bank for purposes of the BHCA. In
1. In 1982, Congress also passed the Export
Trading Act, which authorizes limited bank
involvement in financing and developing export
trading companies.

response to this competition, banks
are doing more than accepting deposits and extending loans. Increasingly, banks are seeking a larger
presence in securities, real estate,
and insurance businesses.
Concern about exploitation of the
BHCA's definition of a bank
recently prompted the Federal
Reserve Board to update its definitions of a commercial loan and a
demand deposit. A commercial loan
now includes the purchase of commercial paper, certificates of deposit, federal funds, and bankers'
acceptances; the definition of a
demand deposit has been amended
to include negotiable order of withdrawal (NOW) accounts. In
response to these nonbank bank
acquisitions, the Office of the
Comptroller of the Currency
(OCC), the regulator of national
banks, imposed a temporary
moratorium on nonbank bank
acquisitions involving de novo
national charters. Other broader
moratorium proposals, including
one by the Federal Reserve Board,
are pending before Congress. Such
moratoriums would allow Congress
more time to investigate proposals
for restructuring the financial services industry.
Economist Thomas Buynak analyzes bank structure and consumer issues for the Federal Reserve
Bank of Cleveland.
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Congress is considering a financial deregulation bill, sponsored by
the Treasury Department, which
has sought to expand banks' product powers since 1981. At issue in
this bill is the degree to which
banks should engage in other businesses, including real estate, securities, and insurance and the
degree to which these businesses
should be involved in banking.
This Economic Commentary explores the implications of mixing
banking and commerce and poses
questions about the effects of this
trend on banks, nonbank institutions, and the banking system as a
whole. It also focuses on the GlassSteagall Act, its roots in the Depression, and its role in the current
tension between a regulated financial environment and the "level
playing field" that the GamSt Germain and Monetary Control
acts attempt to establish.
Ensuring safety and
soundness of banks
During the financial turmoil of
the 1930s, it seemed that excessive
competition and risk-taking by
banks contributed to the collapse
of the banking system. Congress
responded by passing major legislative reforms affecting the banking
and securities businesses. The
Banking Act of 1933, popularly
known as the Glass-Steagall Act,
separated commercial banking
from the securities business, limited rates paid on deposits (Regulation Q), and authorized federal
deposit insurance. All three measures were viewed as essential to
restoring the public's confidence in
banks and to assuring the safety
and soundness of banks in the future. The Bank Holding Company
Act of 1956, as amended in 1970,

imposed additional limits on banking. This act, among other things,
set controls for the formation
and expansion of bank holding
companies (BHCs), required the
divestment of a BHC's nonbanking
activities, and confined a BHC's
activities to the business of banking.2 One exception permitted bank
holding companies certain "closely
related" nonbanking activities,
subject to approval by the Federal
Reserve Board (FRB). In 1970, the
act was amended to eliminate the
exemption of the one-bank holding
company-i.e., a holding company
that owned only one bank, thus
completing product restrictions
on banks.
Glass-Steagall and
recent relaxing trends
The drafters of Glass-Steagall apparently contemplated a system of
specialized financial institutions,
as the act sets limits on the extent
to which securities and commercial
banking activities may mix. Today,
these boundaries are becoming less
clear as banks and securities firms
enter markets traditionally forbidden to the other.
The Glass-Steagall Act stipulates
that commercial banks may underwrite general obligation bonds but
not municipal revenue bonds and,
through their trust departments,
may purchase and sell stock and
securities. Specifically excluded,
however, is the underwriting and
dealing of corporate long-term debt
and stocks. The act also has historically prevented securities firms
from encroaching on markets
served by commercial banks. Glass2. A significant provision of the 1956 known
act,
as the Douglas Amendment, effectively prohibited interstate banking by requiring a host state
specifically to authorize the entry of out-of-state
banking organizations.

Steagall also prohibits affiliations
and personal or management interlocks between securities firms and
commercial banks.
Increasingly, however, regulatory agencies are loosening product
restrictions on their constituent
institutions. The FRB recently
added discount brokering activities
and securities credit lending to its
list of permissible nonbanking activities. In reaching this decision,
however, the FRB specifically proscribed full-line brokering and the
dealing and underwriting of longterm corporate debt or equities.
The FRB also is considering a proposal that would relax its procedures for adding new nonbanking
activities for BHCs.3
The OCC and the Federal Deposit Insurance Corporation (FDIC),
the regulator of state-chartered
nonmember banks, also are easing
traditional product restrictions
on their constituent institutions.
The OCC recently authorized a
national bank, via a bank subsidiary, to offer investment advisory
services." In the past, banks have
offered such services through their
trust departments; this authorization makes them available to the
general public. Two even more farreaching proposals are now being
considered by the FDIC. One would
permit FDIC-regulated banks, via
bank subsidiaries, to underwrite
3. Proposed Revision of Regulation Y, "Bank
Holding Companies and Change in Bank Control," June 3,1983.
4. The OCC approved an application by American National Bank of Austin, Texas, to provide
investment advice through an operating
subsidiary.

5. Proposed

rule by the FDIC, May 9,1983;
see
Federal Register, vol. 48,no. 96(May 17, 983).
1
pp. 22,155-64.
Under the FDIC plan, a bank would underwrite corporate securities in a separate

corporate securities.' In another
proposal, the FDIC solicited comment on whether, and to what degree, controls or limits should 'be
placed on the non banking activities
of FDIC-insured banks.f Under
consideration are real estate, thirdparty data processing, travel agency activities, and insurance brokerage and underwriting.
The Treasury's proposal
The Treasury Department favors reform of Glass-Steagall and
since 1981 has been advocating, on
behalf of the Reagan administration, fewer restrictions on banks'
product decisions. The Treasury's
latest proposal would permit
banks, through bank holding companies, to enter or expand insurance, real-estate brokering, limited
real-estate investment and development, and thrift ownership. Also, a
BHC would be authorized to underwrite government revenue bonds
and certain industrial development
bonds and to advise, sponsor, and
manage investment companies. Further, BHCs could engage in any
activity that the Federal Reserve
would determine to be of "financial
nature or closely related to banking." Finally, this proposal would
redefine the term bank as an institution that has or is eligible for
FDIC insurance, or an institution
that both accepts deposits that can
be withdrawn by check (or othersubsidiary-that
could not, in name, be identified with the bank itself. One of three prescribed
approaches would have to be followed to minimize the risks' undertaken by the bank. Limits
on the bank's credit extensions would cover
companies for which it underwrites securities
and customers who purchase its underwritten
securities.
6. Advance notice of proposed rulemaking by the
FDIC, August 30,1983; Federal Register,
see
vol. 48,no. 177
(September 12,1983), 40,
pp.

900-02.

wise accessed by third-party payment) and that engages in com merciallending.
Before approving other nonbank
activities, the FRB would evaluate the proposed business activity
to ensure that the impartiality of
a bank's credit extensions was
not adversely affected. The FRB
would also ensure that these activities would not jeopardize the safety
and the soundness of a BHC's
banking affiliates.
The FRB generally supports the
current Treasury proposal. While
favoring additional financial deregulation, the FRB has opposed proposals that fail to take into account
the special role that banks play in
the economy-that
is, serving as
operators of the payments system,
as important suppliers of credit,
and as depository institutions for
most of the public's liquid savings?
Also, banks are the channels
through which monetary policy
is implemented. It is the FRB's
position that the current Treasury
deregulation proposal distinguishes
sufficiently between banks and
other financial and nonfinancial
producers.
Commerce and finance
Glass-Steagall opponents argue
that depositories are not significantly different from other providers of financial services, such as
securities brokers, investment
bankers, and insurance companies.
Each offers products or services
that complement or are substitutable for one another. Proponents of
deregulation hold that any barriers
preventing financial firms from
7. See statement by Paul A. Volcker, before
Committee on Banking, Housing and Urban
Affairs, U.S. Senate, April 26,1983; also tessee
timony of September 13,1983.

entering each other's businesses
should be dismantled, enabling all
financial suppliers to compete on a
"level playing field."8
Those who oppose GlassSteagall's repeal argue that banks
should be distinguished from other
financial and nonfinancial providers and that the government,
through the regulatory agencies,
should assure their safety and
soundness. Since financial markets
are highly integrated, the government should assure the solvency
of the banking system as a whole.
According to this line of thought,
regulations imposed on banks
would exceed those levied on other
suppliers of financial services,
although banks must offer competitive products to survive.
Evaluating the merits of these
two views involves a re-examination of the purposes of financial
regulatory policy. Questions must
be asked that focus specifically on
the extent to which banking and
securities activities should mix. Do
other regulations exist to protect
individuals or corporations from
potentially abusive tie-in credit
arrangements? Would investors be
adequately protected without the
stipulations of Glass-Steagall?
Would current antitrust laws
guard against concentrations of
economic power?
Glass-Steagall's relaxation might
have a more profound effect on the
concentration of financial resources
if banks, securities firms, and other
financial suppliers did not compete
fairly in a deregulated financial
environment. Glass-Steagall proponents allege that because banks
8_ See, for example, E_ Gerald Corrigan, "Are
Banks Special?" in 1982 Annual Report, Federal
Reserve Bank of Minneapolis.

Congress is considering a financial deregulation bill, sponsored by
the Treasury Department, which
has sought to expand banks' product powers since 1981. At issue in
this bill is the degree to which
banks should engage in other businesses, including real estate, securities, and insurance and the
degree to which these businesses
should be involved in banking.
This Economic Commentary explores the implications of mixing
banking and commerce and poses
questions about the effects of this
trend on banks, nonbank institutions, and the banking system as a
whole. It also focuses on the GlassSteagall Act, its roots in the Depression, and its role in the current
tension between a regulated financial environment and the "level
playing field" that the GamSt Germain and Monetary Control
acts attempt to establish.
Ensuring safety and
soundness of banks
During the financial turmoil of
the 1930s, it seemed that excessive
competition and risk-taking by
banks contributed to the collapse
of the banking system. Congress
responded by passing major legislative reforms affecting the banking
and securities businesses. The
Banking Act of 1933, popularly
known as the Glass-Steagall Act,
separated commercial banking
from the securities business, limited rates paid on deposits (Regulation Q), and authorized federal
deposit insurance. All three measures were viewed as essential to
restoring the public's confidence in
banks and to assuring the safety
and soundness of banks in the future. The Bank Holding Company
Act of 1956, as amended in 1970,

imposed additional limits on banking. This act, among other things,
set controls for the formation
and expansion of bank holding
companies (BHCs), required the
divestment of a BHC's nonbanking
activities, and confined a BHC's
activities to the business of banking.2 One exception permitted bank
holding companies certain "closely
related" nonbanking activities,
subject to approval by the Federal
Reserve Board (FRB). In 1970, the
act was amended to eliminate the
exemption of the one-bank holding
company-i.e., a holding company
that owned only one bank, thus
completing product restrictions
on banks.
Glass-Steagall and
recent relaxing trends
The drafters of Glass-Steagall apparently contemplated a system of
specialized financial institutions,
as the act sets limits on the extent
to which securities and commercial
banking activities may mix. Today,
these boundaries are becoming less
clear as banks and securities firms
enter markets traditionally forbidden to the other.
The Glass-Steagall Act stipulates
that commercial banks may underwrite general obligation bonds but
not municipal revenue bonds and,
through their trust departments,
may purchase and sell stock and
securities. Specifically excluded,
however, is the underwriting and
dealing of corporate long-term debt
and stocks. The act also has historically prevented securities firms
from encroaching on markets
served by commercial banks. Glass2. A significant provision of the 1956 known
act,
as the Douglas Amendment, effectively prohibited interstate banking by requiring a host state
specifically to authorize the entry of out-of-state
banking organizations.

Steagall also prohibits affiliations
and personal or management interlocks between securities firms and
commercial banks.
Increasingly, however, regulatory agencies are loosening product
restrictions on their constituent
institutions. The FRB recently
added discount brokering activities
and securities credit lending to its
list of permissible nonbanking activities. In reaching this decision,
however, the FRB specifically proscribed full-line brokering and the
dealing and underwriting of longterm corporate debt or equities.
The FRB also is considering a proposal that would relax its procedures for adding new nonbanking
activities for BHCs.3
The OCC and the Federal Deposit Insurance Corporation (FDIC),
the regulator of state-chartered
nonmember banks, also are easing
traditional product restrictions
on their constituent institutions.
The OCC recently authorized a
national bank, via a bank subsidiary, to offer investment advisory
services." In the past, banks have
offered such services through their
trust departments; this authorization makes them available to the
general public. Two even more farreaching proposals are now being
considered by the FDIC. One would
permit FDIC-regulated banks, via
bank subsidiaries, to underwrite
3. Proposed Revision of Regulation Y, "Bank
Holding Companies and Change in Bank Control," June 3,1983.
4. The OCC approved an application by American National Bank of Austin, Texas, to provide
investment advice through an operating
subsidiary.

5. Proposed

rule by the FDIC, May 9,1983;
see
Federal Register, vol. 48,no. 96(May 17, 983).
1
pp. 22,155-64.
Under the FDIC plan, a bank would underwrite corporate securities in a separate

corporate securities.' In another
proposal, the FDIC solicited comment on whether, and to what degree, controls or limits should 'be
placed on the non banking activities
of FDIC-insured banks.f Under
consideration are real estate, thirdparty data processing, travel agency activities, and insurance brokerage and underwriting.
The Treasury's proposal
The Treasury Department favors reform of Glass-Steagall and
since 1981 has been advocating, on
behalf of the Reagan administration, fewer restrictions on banks'
product decisions. The Treasury's
latest proposal would permit
banks, through bank holding companies, to enter or expand insurance, real-estate brokering, limited
real-estate investment and development, and thrift ownership. Also, a
BHC would be authorized to underwrite government revenue bonds
and certain industrial development
bonds and to advise, sponsor, and
manage investment companies. Further, BHCs could engage in any
activity that the Federal Reserve
would determine to be of "financial
nature or closely related to banking." Finally, this proposal would
redefine the term bank as an institution that has or is eligible for
FDIC insurance, or an institution
that both accepts deposits that can
be withdrawn by check (or othersubsidiary-that
could not, in name, be identified with the bank itself. One of three prescribed
approaches would have to be followed to minimize the risks' undertaken by the bank. Limits
on the bank's credit extensions would cover
companies for which it underwrites securities
and customers who purchase its underwritten
securities.
6. Advance notice of proposed rulemaking by the
FDIC, August 30,1983; Federal Register,
see
vol. 48,no. 177
(September 12,1983), 40,
pp.

900-02.

wise accessed by third-party payment) and that engages in com merciallending.
Before approving other nonbank
activities, the FRB would evaluate the proposed business activity
to ensure that the impartiality of
a bank's credit extensions was
not adversely affected. The FRB
would also ensure that these activities would not jeopardize the safety
and the soundness of a BHC's
banking affiliates.
The FRB generally supports the
current Treasury proposal. While
favoring additional financial deregulation, the FRB has opposed proposals that fail to take into account
the special role that banks play in
the economy-that
is, serving as
operators of the payments system,
as important suppliers of credit,
and as depository institutions for
most of the public's liquid savings?
Also, banks are the channels
through which monetary policy
is implemented. It is the FRB's
position that the current Treasury
deregulation proposal distinguishes
sufficiently between banks and
other financial and nonfinancial
producers.
Commerce and finance
Glass-Steagall opponents argue
that depositories are not significantly different from other providers of financial services, such as
securities brokers, investment
bankers, and insurance companies.
Each offers products or services
that complement or are substitutable for one another. Proponents of
deregulation hold that any barriers
preventing financial firms from
7. See statement by Paul A. Volcker, before
Committee on Banking, Housing and Urban
Affairs, U.S. Senate, April 26,1983; also tessee
timony of September 13,1983.

entering each other's businesses
should be dismantled, enabling all
financial suppliers to compete on a
"level playing field."8
Those who oppose GlassSteagall's repeal argue that banks
should be distinguished from other
financial and nonfinancial providers and that the government,
through the regulatory agencies,
should assure their safety and
soundness. Since financial markets
are highly integrated, the government should assure the solvency
of the banking system as a whole.
According to this line of thought,
regulations imposed on banks
would exceed those levied on other
suppliers of financial services,
although banks must offer competitive products to survive.
Evaluating the merits of these
two views involves a re-examination of the purposes of financial
regulatory policy. Questions must
be asked that focus specifically on
the extent to which banking and
securities activities should mix. Do
other regulations exist to protect
individuals or corporations from
potentially abusive tie-in credit
arrangements? Would investors be
adequately protected without the
stipulations of Glass-Steagall?
Would current antitrust laws
guard against concentrations of
economic power?
Glass-Steagall's relaxation might
have a more profound effect on the
concentration of financial resources
if banks, securities firms, and other
financial suppliers did not compete
fairly in a deregulated financial
environment. Glass-Steagall proponents allege that because banks
8_ See, for example, E_ Gerald Corrigan, "Are
Banks Special?" in 1982 Annual Report, Federal
Reserve Bank of Minneapolis.

Congress is considering a financial deregulation bill, sponsored by
the Treasury Department, which
has sought to expand banks' product powers since 1981. At issue in
this bill is the degree to which
banks should engage in other businesses, including real estate, securities, and insurance and the
degree to which these businesses
should be involved in banking.
This Economic Commentary explores the implications of mixing
banking and commerce and poses
questions about the effects of this
trend on banks, nonbank institutions, and the banking system as a
whole. It also focuses on the GlassSteagall Act, its roots in the Depression, and its role in the current
tension between a regulated financial environment and the "level
playing field" that the GamSt Germain and Monetary Control
acts attempt to establish.
Ensuring safety and
soundness of banks
During the financial turmoil of
the 1930s, it seemed that excessive
competition and risk-taking by
banks contributed to the collapse
of the banking system. Congress
responded by passing major legislative reforms affecting the banking
and securities businesses. The
Banking Act of 1933, popularly
known as the Glass-Steagall Act,
separated commercial banking
from the securities business, limited rates paid on deposits (Regulation Q), and authorized federal
deposit insurance. All three measures were viewed as essential to
restoring the public's confidence in
banks and to assuring the safety
and soundness of banks in the future. The Bank Holding Company
Act of 1956, as amended in 1970,

imposed additional limits on banking. This act, among other things,
set controls for the formation
and expansion of bank holding
companies (BHCs), required the
divestment of a BHC's nonbanking
activities, and confined a BHC's
activities to the business of banking.2 One exception permitted bank
holding companies certain "closely
related" nonbanking activities,
subject to approval by the Federal
Reserve Board (FRB). In 1970, the
act was amended to eliminate the
exemption of the one-bank holding
company-i.e., a holding company
that owned only one bank, thus
completing product restrictions
on banks.
Glass-Steagall and
recent relaxing trends
The drafters of Glass-Steagall apparently contemplated a system of
specialized financial institutions,
as the act sets limits on the extent
to which securities and commercial
banking activities may mix. Today,
these boundaries are becoming less
clear as banks and securities firms
enter markets traditionally forbidden to the other.
The Glass-Steagall Act stipulates
that commercial banks may underwrite general obligation bonds but
not municipal revenue bonds and,
through their trust departments,
may purchase and sell stock and
securities. Specifically excluded,
however, is the underwriting and
dealing of corporate long-term debt
and stocks. The act also has historically prevented securities firms
from encroaching on markets
served by commercial banks. Glass2. A significant provision of the 1956 known
act,
as the Douglas Amendment, effectively prohibited interstate banking by requiring a host state
specifically to authorize the entry of out-of-state
banking organizations.

Steagall also prohibits affiliations
and personal or management interlocks between securities firms and
commercial banks.
Increasingly, however, regulatory agencies are loosening product
restrictions on their constituent
institutions. The FRB recently
added discount brokering activities
and securities credit lending to its
list of permissible nonbanking activities. In reaching this decision,
however, the FRB specifically proscribed full-line brokering and the
dealing and underwriting of longterm corporate debt or equities.
The FRB also is considering a proposal that would relax its procedures for adding new nonbanking
activities for BHCs.3
The OCC and the Federal Deposit Insurance Corporation (FDIC),
the regulator of state-chartered
nonmember banks, also are easing
traditional product restrictions
on their constituent institutions.
The OCC recently authorized a
national bank, via a bank subsidiary, to offer investment advisory
services." In the past, banks have
offered such services through their
trust departments; this authorization makes them available to the
general public. Two even more farreaching proposals are now being
considered by the FDIC. One would
permit FDIC-regulated banks, via
bank subsidiaries, to underwrite
3. Proposed Revision of Regulation Y, "Bank
Holding Companies and Change in Bank Control," June 3,1983.
4. The OCC approved an application by American National Bank of Austin, Texas, to provide
investment advice through an operating
subsidiary.

5. Proposed

rule by the FDIC, May 9,1983;
see
Federal Register, vol. 48,no. 96(May 17, 983).
1
pp. 22,155-64.
Under the FDIC plan, a bank would underwrite corporate securities in a separate

corporate securities.' In another
proposal, the FDIC solicited comment on whether, and to what degree, controls or limits should 'be
placed on the non banking activities
of FDIC-insured banks.f Under
consideration are real estate, thirdparty data processing, travel agency activities, and insurance brokerage and underwriting.
The Treasury's proposal
The Treasury Department favors reform of Glass-Steagall and
since 1981 has been advocating, on
behalf of the Reagan administration, fewer restrictions on banks'
product decisions. The Treasury's
latest proposal would permit
banks, through bank holding companies, to enter or expand insurance, real-estate brokering, limited
real-estate investment and development, and thrift ownership. Also, a
BHC would be authorized to underwrite government revenue bonds
and certain industrial development
bonds and to advise, sponsor, and
manage investment companies. Further, BHCs could engage in any
activity that the Federal Reserve
would determine to be of "financial
nature or closely related to banking." Finally, this proposal would
redefine the term bank as an institution that has or is eligible for
FDIC insurance, or an institution
that both accepts deposits that can
be withdrawn by check (or othersubsidiary-that
could not, in name, be identified with the bank itself. One of three prescribed
approaches would have to be followed to minimize the risks' undertaken by the bank. Limits
on the bank's credit extensions would cover
companies for which it underwrites securities
and customers who purchase its underwritten
securities.
6. Advance notice of proposed rulemaking by the
FDIC, August 30,1983; Federal Register,
see
vol. 48,no. 177
(September 12,1983), 40,
pp.

900-02.

wise accessed by third-party payment) and that engages in com merciallending.
Before approving other nonbank
activities, the FRB would evaluate the proposed business activity
to ensure that the impartiality of
a bank's credit extensions was
not adversely affected. The FRB
would also ensure that these activities would not jeopardize the safety
and the soundness of a BHC's
banking affiliates.
The FRB generally supports the
current Treasury proposal. While
favoring additional financial deregulation, the FRB has opposed proposals that fail to take into account
the special role that banks play in
the economy-that
is, serving as
operators of the payments system,
as important suppliers of credit,
and as depository institutions for
most of the public's liquid savings?
Also, banks are the channels
through which monetary policy
is implemented. It is the FRB's
position that the current Treasury
deregulation proposal distinguishes
sufficiently between banks and
other financial and nonfinancial
producers.
Commerce and finance
Glass-Steagall opponents argue
that depositories are not significantly different from other providers of financial services, such as
securities brokers, investment
bankers, and insurance companies.
Each offers products or services
that complement or are substitutable for one another. Proponents of
deregulation hold that any barriers
preventing financial firms from
7. See statement by Paul A. Volcker, before
Committee on Banking, Housing and Urban
Affairs, U.S. Senate, April 26,1983; also tessee
timony of September 13,1983.

entering each other's businesses
should be dismantled, enabling all
financial suppliers to compete on a
"level playing field."8
Those who oppose GlassSteagall's repeal argue that banks
should be distinguished from other
financial and nonfinancial providers and that the government,
through the regulatory agencies,
should assure their safety and
soundness. Since financial markets
are highly integrated, the government should assure the solvency
of the banking system as a whole.
According to this line of thought,
regulations imposed on banks
would exceed those levied on other
suppliers of financial services,
although banks must offer competitive products to survive.
Evaluating the merits of these
two views involves a re-examination of the purposes of financial
regulatory policy. Questions must
be asked that focus specifically on
the extent to which banking and
securities activities should mix. Do
other regulations exist to protect
individuals or corporations from
potentially abusive tie-in credit
arrangements? Would investors be
adequately protected without the
stipulations of Glass-Steagall?
Would current antitrust laws
guard against concentrations of
economic power?
Glass-Steagall's relaxation might
have a more profound effect on the
concentration of financial resources
if banks, securities firms, and other
financial suppliers did not compete
fairly in a deregulated financial
environment. Glass-Steagall proponents allege that because banks
8_ See, for example, E_ Gerald Corrigan, "Are
Banks Special?" in 1982 Annual Report, Federal
Reserve Bank of Minneapolis.

Federal Reserve Bank of Cleveland
possess advantages such as entry
restrictions, deposit insurance, and
access to the FRB's discount window, they would have a competitive
advantage over other suppliers of
financial services unless reciprocal
entry is allowed. Those who favor
relaxing Glass-Steagall contend
that banks also bear some unique
costs, such as paying insurance
premiums and maintaining reserves that do not pay interest.?
If we adopt a deregulation measure
such as the' Treasury advocates,
allowing banks to engage in businesses previously prohibited while
barring nonbank firms from operating a bank, would banks be granted a
competitive advantage? Perhaps the
FRB's implementation of the BHCA
can provide insight on these issues.
To date, the FRB has authorized 15
"permissible" nonbanking activities
for BHCs. Each new activity is evaluated in terms of whether, when
coupled with a bank's credit-granting
powers, a bank would have a competitive advantage over other producers
in that industry. In such a case, the
FRB either disallows or restricts the
bank's involvement in the nonbanking activity. Restrictions on the nonbanking activities, in effect, neutralize the potential for credit abuse.
In considering a relaxation of
Glass-Steagall's barriers, we
should also identify and quantify
what economic effects might predictably occur if the securities
and commercial banking businesses were recombined. Would an
increase in the number of potential
competitors significantly affect the
prices of banking and securities
products or services, other things
being equal? Could we realize signifi9. See statement by Paul A. Volcker, p. 6, testimony of September 13, 1983.

cant cost savings by co-producing
security and commercial banking
products? And, if banks are allowed
to offer new products but only on
restrictive terms, we should evaluate
whether, and to what degree, such
restrictions would have on negating
any "synergies" of co-production.
A principal objective of banking
regulation is the safety and soundness of banks. If we allow banks into
other business activities, we must
face the question of what new risks
would be incurred. Investment
bankers can incur substantial losses
if markets fluctuate adversely, or
simply if the marketability of the
issue were poorly judged. On the
other hand, securities discount brokering involves virtually no market
risk. If banks were permitted to take
on such risks, then is it possible to
isolate banking activities from the
risks associated with nonbanking
activities? Those who advocate a
deregulation proposal in which a
BHC's nonbanking activities are
conducted in separate subsidiaries
and regulated principally by market
forces assume that the BHC can be
financially structured so that potential parent-company problems cannot
be transmitted to affiliate banks.l"
Some individuals have expressed
doubt about this assumption.l!
Recent research, which shows that a
BHC operates as an integrated firm,
provides a basis for these reservations. Deregulation proposals, therefore, that attempt to separate a
BHC's banking and nonbanking

activities would probably achieve
limited success.
The question of solvency
If banks are special, given that
their activities are highly interdependent, then the government should
provide the public with a "safety
net" to ensure the liquidity of the
banking system. Currently, this
safety net consists of deposit insurance and the Federal Reserve Bank
as a lender of last resort. But, if the
banking business were completely
deregulated, could we expect to be
cushioned from the harmful effects
of a failed bank or group of banks?
How would financial deregulation
affect the public's trust in this safety
net in financial crisis?
If Glass-Steagall were reformed,
the role of deposit insurance in the
financial system also must be examined. As legislatively mandated by
Garn-St Germain, the deposit insurance agencies submitted reports to
Congress recommending methods
of injecting more market discipline
into the deposit insurance system.
Reform of the deposit insurance sysFederal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

tem would enable further financial
deregulation. But without such
reform, even if banks were given
additional product powers, it is likely
that the regulatory agencies would
restrict the risks that banks incur.
Conclusion
Garn-St Germain and the Monetary Control Act unquestionably
represent major steps in deregulating
the banking system and in loosening
the restraints imposed by GlassSteagall and the BHCA. Yet, Congress should reappraise existing
financial legislation, including the
extent to which banking and commerce should mix. If the competition
for deposits continues to circumvent
Glass-Steagall's barriers, Congress
ought to consider seriously the
merits of imposing a moratorium on
encroachments by banks and nonbanks into each other's areas. Without a moratorium, it is likely that the
financial services industry would be
restructured in the future, more to
avoid legislative restrictions than
to respond to market incentives.
BULK RATE
U.S. Postage Paid
Cleveland, OH
Permit No. 385

10. See Robert]. Lawrence and Samuel H. Talley,
"An Alternative Approach to Regulating Bank
Holding Companies," in Proceedings of a Conference on Bank Structure and Competition, Federal
Reserve Bank of Chicago, April 27-28, 1978,pp. 1-10.
11. See Robert A. Eisenbeis, "How Should Bank
Holding Companies Be Regulated?" Economic
Review, Federal Reserve Bank of Atlanta, January 3,
1983,pp. 42-7.

Address Correction Requested: Please send corrected mailing label to the Federal
Reserve Bank of Cleveland, Research Department, P.O. Box 6387, Cleveland, OH 4410l.

December 5, 1983

Economic Commentary

ISSN 0428-1276

Banking and Commerce:
To Mix or Not to Mix?
by Thomas M. Buynak
n the late 1970s, commercial banks and thrifts
experienced an unprece-- __
dented diversion of their
funds to less regulated institutions.
Partly in reaction to this massive
outflow of depositories' funds, the
U.S. Congress passed two separate,
fairly comprehensive deregulatory
measures-the
Depository Institutions Deregulation and Monetary
Control Act of 1980 and the GarnSt Germain Depository Institutions
Act of 1982.1 Because of these two
acts, banks and thrift institutions
can more freely pay whatever interest rates they choose in order to
attract deposit funds.
Financial concerns such as Merrill Lynch and insurance firms,
retailers, and money market funds
are competing more and more with
banks. Their most recent incursion
into the banking business involves
acquisitions of "nonbank banks"entities that function as banks but
escape the legal definition of banks
under the Bank Holding Company
Act of 1956 (BHCA), as amended.
The BHCA defines a bank as an
institution that both accepts
demand deposits and engages in
commercial lending. If an institution engages in only one of these
activities, it is not classified as a
bank for purposes of the BHCA. In
1. In 1982, Congress also passed the Export
Trading Act, which authorizes limited bank
involvement in financing and developing export
trading companies.

response to this competition, banks
are doing more than accepting deposits and extending loans. Increasingly, banks are seeking a larger
presence in securities, real estate,
and insurance businesses.
Concern about exploitation of the
BHCA's definition of a bank
recently prompted the Federal
Reserve Board to update its definitions of a commercial loan and a
demand deposit. A commercial loan
now includes the purchase of commercial paper, certificates of deposit, federal funds, and bankers'
acceptances; the definition of a
demand deposit has been amended
to include negotiable order of withdrawal (NOW) accounts. In
response to these nonbank bank
acquisitions, the Office of the
Comptroller of the Currency
(OCC), the regulator of national
banks, imposed a temporary
moratorium on nonbank bank
acquisitions involving de novo
national charters. Other broader
moratorium proposals, including
one by the Federal Reserve Board,
are pending before Congress. Such
moratoriums would allow Congress
more time to investigate proposals
for restructuring the financial services industry.
Economist Thomas Buynak analyzes bank structure and consumer issues for the Federal Reserve
Bank of Cleveland.
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Federal Reserve Bank of Cleveland
possess advantages such as entry
restrictions, deposit insurance, and
access to the FRB's discount window, they would have a competitive
advantage over other suppliers of
financial services unless reciprocal
entry is allowed. Those who favor
relaxing Glass-Steagall contend
that banks also bear some unique
costs, such as paying insurance
premiums and maintaining reserves that do not pay interest.?
If we adopt a deregulation measure
such as the' Treasury advocates,
allowing banks to engage in businesses previously prohibited while
barring nonbank firms from operating a bank, would banks be granted a
competitive advantage? Perhaps the
FRB's implementation of the BHCA
can provide insight on these issues.
To date, the FRB has authorized 15
"permissible" nonbanking activities
for BHCs. Each new activity is evaluated in terms of whether, when
coupled with a bank's credit-granting
powers, a bank would have a competitive advantage over other producers
in that industry. In such a case, the
FRB either disallows or restricts the
bank's involvement in the nonbanking activity. Restrictions on the nonbanking activities, in effect, neutralize the potential for credit abuse.
In considering a relaxation of
Glass-Steagall's barriers, we
should also identify and quantify
what economic effects might predictably occur if the securities
and commercial banking businesses were recombined. Would an
increase in the number of potential
competitors significantly affect the
prices of banking and securities
products or services, other things
being equal? Could we realize signifi9. See statement by Paul A. Volcker, p. 6, testimony of September 13, 1983.

cant cost savings by co-producing
security and commercial banking
products? And, if banks are allowed
to offer new products but only on
restrictive terms, we should evaluate
whether, and to what degree, such
restrictions would have on negating
any "synergies" of co-production.
A principal objective of banking
regulation is the safety and soundness of banks. If we allow banks into
other business activities, we must
face the question of what new risks
would be incurred. Investment
bankers can incur substantial losses
if markets fluctuate adversely, or
simply if the marketability of the
issue were poorly judged. On the
other hand, securities discount brokering involves virtually no market
risk. If banks were permitted to take
on such risks, then is it possible to
isolate banking activities from the
risks associated with nonbanking
activities? Those who advocate a
deregulation proposal in which a
BHC's nonbanking activities are
conducted in separate subsidiaries
and regulated principally by market
forces assume that the BHC can be
financially structured so that potential parent-company problems cannot
be transmitted to affiliate banks.l"
Some individuals have expressed
doubt about this assumption.l!
Recent research, which shows that a
BHC operates as an integrated firm,
provides a basis for these reservations. Deregulation proposals, therefore, that attempt to separate a
BHC's banking and nonbanking

activities would probably achieve
limited success.
The question of solvency
If banks are special, given that
their activities are highly interdependent, then the government should
provide the public with a "safety
net" to ensure the liquidity of the
banking system. Currently, this
safety net consists of deposit insurance and the Federal Reserve Bank
as a lender of last resort. But, if the
banking business were completely
deregulated, could we expect to be
cushioned from the harmful effects
of a failed bank or group of banks?
How would financial deregulation
affect the public's trust in this safety
net in financial crisis?
If Glass-Steagall were reformed,
the role of deposit insurance in the
financial system also must be examined. As legislatively mandated by
Garn-St Germain, the deposit insurance agencies submitted reports to
Congress recommending methods
of injecting more market discipline
into the deposit insurance system.
Reform of the deposit insurance sysFederal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

tem would enable further financial
deregulation. But without such
reform, even if banks were given
additional product powers, it is likely
that the regulatory agencies would
restrict the risks that banks incur.
Conclusion
Garn-St Germain and the Monetary Control Act unquestionably
represent major steps in deregulating
the banking system and in loosening
the restraints imposed by GlassSteagall and the BHCA. Yet, Congress should reappraise existing
financial legislation, including the
extent to which banking and commerce should mix. If the competition
for deposits continues to circumvent
Glass-Steagall's barriers, Congress
ought to consider seriously the
merits of imposing a moratorium on
encroachments by banks and nonbanks into each other's areas. Without a moratorium, it is likely that the
financial services industry would be
restructured in the future, more to
avoid legislative restrictions than
to respond to market incentives.
BULK RATE
U.S. Postage Paid
Cleveland, OH
Permit No. 385

10. See Robert]. Lawrence and Samuel H. Talley,
"An Alternative Approach to Regulating Bank
Holding Companies," in Proceedings of a Conference on Bank Structure and Competition, Federal
Reserve Bank of Chicago, April 27-28, 1978,pp. 1-10.
11. See Robert A. Eisenbeis, "How Should Bank
Holding Companies Be Regulated?" Economic
Review, Federal Reserve Bank of Atlanta, January 3,
1983,pp. 42-7.

Address Correction Requested: Please send corrected mailing label to the Federal
Reserve Bank of Cleveland, Research Department, P.O. Box 6387, Cleveland, OH 4410l.

December 5, 1983

Economic Commentary

ISSN 0428-1276

Banking and Commerce:
To Mix or Not to Mix?
by Thomas M. Buynak
n the late 1970s, commercial banks and thrifts
experienced an unprece-- __
dented diversion of their
funds to less regulated institutions.
Partly in reaction to this massive
outflow of depositories' funds, the
U.S. Congress passed two separate,
fairly comprehensive deregulatory
measures-the
Depository Institutions Deregulation and Monetary
Control Act of 1980 and the GarnSt Germain Depository Institutions
Act of 1982.1 Because of these two
acts, banks and thrift institutions
can more freely pay whatever interest rates they choose in order to
attract deposit funds.
Financial concerns such as Merrill Lynch and insurance firms,
retailers, and money market funds
are competing more and more with
banks. Their most recent incursion
into the banking business involves
acquisitions of "nonbank banks"entities that function as banks but
escape the legal definition of banks
under the Bank Holding Company
Act of 1956 (BHCA), as amended.
The BHCA defines a bank as an
institution that both accepts
demand deposits and engages in
commercial lending. If an institution engages in only one of these
activities, it is not classified as a
bank for purposes of the BHCA. In
1. In 1982, Congress also passed the Export
Trading Act, which authorizes limited bank
involvement in financing and developing export
trading companies.

response to this competition, banks
are doing more than accepting deposits and extending loans. Increasingly, banks are seeking a larger
presence in securities, real estate,
and insurance businesses.
Concern about exploitation of the
BHCA's definition of a bank
recently prompted the Federal
Reserve Board to update its definitions of a commercial loan and a
demand deposit. A commercial loan
now includes the purchase of commercial paper, certificates of deposit, federal funds, and bankers'
acceptances; the definition of a
demand deposit has been amended
to include negotiable order of withdrawal (NOW) accounts. In
response to these nonbank bank
acquisitions, the Office of the
Comptroller of the Currency
(OCC), the regulator of national
banks, imposed a temporary
moratorium on nonbank bank
acquisitions involving de novo
national charters. Other broader
moratorium proposals, including
one by the Federal Reserve Board,
are pending before Congress. Such
moratoriums would allow Congress
more time to investigate proposals
for restructuring the financial services industry.
Economist Thomas Buynak analyzes bank structure and consumer issues for the Federal Reserve
Bank of Cleveland.
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.