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For release on delivery
10 00 am EST
March 2, 1994

Testimony by
Alan Greenspan
Chairman, Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing, and Urban Affairs
United States Senate

March 2, 1994

Mr Chairman, I am pleased to appear today before the Senate Banking
Committee to give the views of the Federal Reserve Board on proposals to consolidate
the banking regulators into a single agency We have prepared a detailed analysis of
such proposals, which I have attached to my statement My remarks this morning will
highlight that analysis
The proposals to create one federal bank regulator have the clearly stated
objectives of reducing the government's costs of regulating and supervising banks, of
reducing bankers' costs and burdens from duphcative examination and overlapping
supervision, and in general making the supervisory process more efficient and more
accountable The Federal Reserve Board shares these goals, but disagrees with the
approach of one regulator for achieving these objectives However, the Board believes
that it is possible to achieve virtually all of these proposals' objectives without creating
the risks of one regulator that so trouble us
In reaching this conclusion, the Board tested various proposals against
the fundamental principle that the purpose of regulation is to enhance the capability of
the regulated entity to contribute effectively to the nation's long term economic growth
and stability We have concluded that for this to be accomplished four subsidiary
principles must be achieved

First, there should not be a single monolithic federal regulator


Second, every bank should have a choice of federal regulator


Third, there should be only one federal regulator for all of the
depository institutions in any single banking organization.


Fourth, the U S central bank should continue to have its essential
hands-on involvement in supervision and regulation

A consolidated single regulator would deprive our regulatory structure of
what the Board considers to be the current invaluable restraint on any one regulator
conducting inflexible, excessively rigid policies Laws on bank regulation and
supervision must be drawn very generally leaving the specifics to agency rulemaking.
This vests the agencies with a broad mandate and a not inconsiderable amount of
discretionary power Hence, a safety valve is vitally needed to avoid the exercise of
arbitrary actions A denial of, or severe limitation of, charter choice closes off a safety
valve inevitably leading to greater micromanagement of banks and a lessened market
for bank credit We must avoid a regulatory structure that inhibits economic growth
The present structure provides banks with a method—albeit one neither
easily accomplished nor often taken—of shifting their regulator, an effective test that
provides a limit on the arbitrary position or excessively rigid posture of any one
regulator The pressure of a potential loss of institutions has inhibited excessive
regulation and acted as a countervailing force to the bias of a regulatory agency to
The dual banking system and multiple federal regulators have facilitated
diversity, inventiveness, and flexibility in our banking system, so important to a market
economy subject to rapid change A single federal regulator would effectively end the
dual banking system it would become an empty shell if a state-chartered entity had no
choice of federal regulator or—reflecting a recent FDICIA provision—different asset

powers The dual banking system cannot survive consolidation at the federal level I,
as well as my colleagues on the Board, believe that would be a tragic loss
In addition to the effective loss of the dual banking system, the single
regulator contemplated in current proposals would be disconnected from broad
economic policy issues This is a problem because a regulator that does not have
macroeconomic responsibility for its actions is likely to inhibit prudent risk-taking by
banks, thus limiting economic growth and stability The central historic purpose of
banking is to take risks through the extension of loans to businesses and others.
Economic growth in our system could not occur without risk-taking by entrepreneurs
and small and large businesses Risk-taking requires financing Thus, either an
unwillingness or an inability of lenders to take risks would slow the expansion of our
nation's employment and income This fact creates a significant policy tradeoff in
banking regulation, especially because of the government guarantee of bank deposits
On the one hand, regulators are concerned about bank failures and their effects on the
economy, as well as their cost to the insurance fund On the other hand, banks need
to take risks to finance growth Tradeoffs are required, and a swing in either direction
can create both short- and long-term problems
Indeed, a single regulator with a narrow view of safety and soundness
and with no responsibility for the macroeconomic implications of its decisions would
inevitably have a long-term bias against risk-taking and innovation. It receives no

plaudits for contributing to economic growth through facilitating prudent risk-taking, but
it is severely criticized for too many bank failures The incentives are clear
The Federal Reserve's stabilization objectives cause us to seek to avoid
either excessive tightness or ease in our supervisory posture The former leads
inevitably to credit crunches, and the latter to credit policies that contribute, with a lag,
to bank losses and failures This is not to say, as some have advocated, that the Fed
itself should be the only regulator A single regulator Fed would be prone to arbitrary
and capricious behavior as would any other single bank regulator We would thus
oppose such an initiative, since as a single regulator we would inevitably drift to
increasing day-by-day control of banking institutions who would soon become less
innovative and competitive—a severe loss to the nation
Not only is it important that one of our regulators have macroeconomic
responsibility in order to carry out the regulatory function properly, but also our central
bank must continue to have hands-on involvement in supervision and regulation in
order effectively to carry out its macroeconomic responsibilities Joint responsibilities
make for better supervisory and monetary policy than would result from either a
supervisor divorced from economic responsibilities or a macroeconomic policymaker
with no involvement in the review of individual bank's operations Without the
hands-on experience of regulation and supervision, and the exposure to the operations
of banks and markets provided by such experience, the Federal Reserve's essential
knowledge base would atrophy Its deliberations would become increasingly academic

and the nation's central bank would soon resemble an ivory tower rather than an
institution necessarily involved with the day-to-day activities of our economic and
financial system It is our knowledgeable examiners and supervisors—knowledgeable
about banks, financial markets, and the payment systems that connect them—that
provide the expertise the Fed needs And the fact is that we simply could not retain
such staff if they were not actively involved in the process, reading reports or joining as
junior participants in a handful of examinations would not be sufficient
Some have argued that most foreign central banks are not involved in
bank supervision and regulation In fact, as described in more detail in the attachment,
central banks in all but one G-7 country (Canada), in most cases de jure but always de
facto, are closely involved with the supervision of banks in their countries and
internationally More broadly, the central bank has either total or shared responsibility
for bank supervision in three quarters of the nations in the OECD One example that is
frequently used by those that believe that central banks in foreign countries are not
involved in supervision is the Bundesbank The facts are quite the contrary the
Bundesbank has more supervisory staff than the German Federal Banking Supervisory
Office, reviews the auditors' reports before the Banking Supervisory Office receives
them, and has veto power over certain liquidity and capital regulations of that office In
all industrial countries, either central banks or finance ministries, or both, are involved
with supervision because nations have come to understand that bank supervision has
economic consequences that are important for stability and economic growth
Removing the Federal Reserve from supervision and regulation would
greatly reduce our ability to forestall financial crises and to manage a crisis once it
occurs In a crisis, the Fed could always flood the market with liquidity through open

market operations and discount window loans But while rapid liquidity creation is often
a necessary response to a crisis, supervision and regulation responsibilities give the
Fed insight and the authority to use less blunt and more precisely calibrated techniques
to manage such crises and, more importantly, to avoid them The use of such
techniques requires both the clout that comes with supervision and regulation and the
understanding of the linkages between supervision and regulation and macroeconomic
growth and stability

The Fed is required to play the key role when systemic breakdown
threatens The attachment to my statement provides some detail about Federal
Reserve involvement in financial crises over the last decade As you review it, I request
that you consider certain key questions

Could the Fed without supervisory responsibilities have successfully
managed the Mexican debt crisis of 1982, the 1985 collapse of Ohio and Maryland
privately insured thrifts, the stock market crash of 1987, or the Drexel failure of 1990?

Would the banking community have been persuaded to respond as they
did in each of these cases by a central bank with much more limited authorities to affect
events? Would the Fed have been able to play a role in persuading many of the banks
to complete the payments necessary to prevent payments gridlock without supervisory
knowledge and authority?

Finally, would a single bank regulator with no macroeconomic stabilization
responsibilities have given the proper weights to financial market stability and economic
growth? Without market expertise, would such a regulator have recognized early
enough many of the problems central to resolution of these crises?

In my judgment, the nsk that the answer to all of these questions is "no" is
too great to take
There are ways, short of the creation of a single agency, to address the
problems in the current regulatory structure and reduce the costs of regulations The
crux of the issue is duplicative examinations of banks. This problem could be
eliminated by a regulatory system that maintained two federal regulators, but provided
that in general only one of those regulators supervised all the depository institutions in
any banking organization

While there are many ways to achieve an improved regulatory structure,
one such approach supported by the Federal Reserve Board that could be
implemented with a relatively modest series of reforms would contain the following

Merge the OCC and the OTS This organization would become the
Federal Banking Commission


Remove the FDIC from examining healthy institutions


Put all independent national banks, all lead national banks that are
part of a holding company, and all thrifts under the purview of the
Federal Banking Commission, and put all independent state banks,
and all lead state banks in a holding company under the purview of
the Federal Reserve


Provide that the supervisor of the lead depository in a banking
organization also be the supervisor and regulator of all the

depository institutions in the organization regardless of the charter
class of those affiliates.


Finally, treat all U S activities of foreign banks as now, with
adjustments where necessary to reflect the changes in the
regulatory structure described above

The Board has not yet adopted a position on the supervision and
regulation of bank holding companies and their nonbank affiliates There are two broad
options, and a strong case can be made for each

Under the first option, all holding companies and their nonbank
affiliates could remain under the Fed's jurisdiction, continuing to
provide uniform rulemaking for competitive equity and a substantial
role for the Fed in shaping the financial structure, so useful for
stabilization and systemic risk purposes


Under the second option, the jurisdiction of virtually all holding
companies could be split between the Fed and the FBC on the
basis of the charter class of the lead bank However, for systemic
risk reasons, jurisdiction over the holding companies and nonbank
affiliates of a modest number of banking organizations that meet
certain criteria—such as large size and payment and foreign
activity—would be retained by the Fed, even if the lead bank of the
organization had a national charter organization

Under either option, the number of banking organizations subject to multiple regulators
would drop sharply

Whichever holding company option is selected, the general proposal
would have the Fed supervise and regulate state nonmembers, with these banks being
a significant addition to our existing regulatory load. This expansion of the Fed's
supervisory functions rests solely on the notion that in a two agency structure, it is
desirable to have supervision and regulation responsibility defined clearly by charter
class in order to preserve the dual banking system The Board makes no case that
responsibility for such banks— that account for almost one-quarter of bank assets—is
needed for financial stability and monetary policy purposes However, responsibility
over banks of various sizes and locations, as under our existing authorities, is required
if the Fed is to perform its functions effectively
The Board's approach would achieve essentially all of the benefits of one
consolidated regulator while incurring virtually none of its risks It eliminates duplicate
supervision of depositories in a single banking organization and greatly reduces
overlapping regulation It maintains the dual banking system and permits any bank to
change federal regulator by changing charter, thus ensuring a set of checks and
balances on the arbitrariness of a single regulator It maintains the healthy process of
dynamic tension in bank rulemaking It maintains the practical knowledge and skill, and
the influence and authority, of the central bank, so critical for crisis prevention, crisis
management, and monetary policy It maintains the valuable perspective the central
bank brings to supervision In short, the proposal would avoid an inflexible, single
regulator, preserve the dual banking system, assure that an economic perspective is
brought to supervision and regulation, and maintain a strong central bank