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For release on delivery 9:30 a.m., • r E.D.T. October 5, 1987 Testimony by Alan Greenspan Chairman, Board of Governors of the Federal Reserve System before the Subcommittee on Telecommunications and Finance Committee on Energy and Commerce United States House of Representatives October 5, 1987 Mr. Chairman and members of the Committee, I welcome this opportunity to appear Telecommunications and financial services framework that want the Finance industry applies to express my and focusing before with appreciation Subcommittee explore an to banking the attention important to the the emphasis and structure on the securities to you on of the regulatory activities. for calling this I hearing of the Congress and this Committee on issue of the basic rules that should apply to the in a speech that you made recently in San financial services industries. Mr. Chairman, Francisco, you expressed increasing unease that the financial system has evolved beyond the terms of our laws and is functioning without effective legislative guidelines. must be at the center, You said that not the sidelines, "Congress of the development of the policy for structuring our financial industry." I view. It difficult new would is like essential decisions circumstances considerable to express that my strong Congress come agreement to that must be made to update of technology frustration that and grips our competition. Congress has not with acted with that the laws to the We all and feel I very much welcome the pledge made by both the House of Representatives and the earlier Senate this expansion, a in the year to review not Competitive to Equality extend our banking and the Banking moratorium financial Act adopted on banking laws and to make -2- decisions on the need for financial restructuring legislation before the moratorium expires. Before turning to the questions of financial structure, I believe it is important to reflect on our starting point. We have the strongest, most competitive and innovative capital market in the world. Our improvements to competitive capital environment strength. is assure world market job its preserve role marketplace. structure this to industry has in Banking and its a and make substantially is a vital despite shown strengths a part of difficult extraordinary more this economic resilience and It has carried a special burden in the transition to a less inflationary economic climate as some of the major sectors it has financed — real estate — transition, down in have been experiencing the prices. agriculture, rate of The banking developing seriously and countries, adversely energy, affected by the in some cases not only a relative inflation, industry but actual is coming sharp through and slow- declines this in experience wiser and stronger. While depressed, profitability regional strengthened banks have been themselves in the interstate banking arrangements. development of a levels broad interstate profitable remain and years through banking framework. full interstate banking, it transition period banks have regional In the future, I anticipate the have adopted a many strongly last three arrangements evolve into a national after for and system as regional Already 10 states 13 states have provided 8 additional states for permit -3- interstate trend, acquisition especially of when troubled fully banks. developed, This will constructive result in better service to customers and a strengthened banking system. Securities change. variety The of explosion markets global marketplace securities in also complex is new now are adjusting to involving 24-hour reality. There a products and services trading has posing and putting a new emphasis on capital adequacy. attention has focused on a deterioration substantial in a been new an risks And, here at home in ethical standards and the possible need to take corrective action. All of these focus on how our Francisco concerns financial speech pointed competition, of rates fields versa. and traditionally All of structure to international interest some has fifty thought reflect what of I believe Your a new improved. these issues, products, organization as and banking searching Your San including deregulation expansion vice a very much for banking, while at the same time have amounted a regulatory statement is a widespread services into and frozen within ago. to can be of nonbanking these developments been years many led new securitized more competitive environment banking have and to structure those feeling fashioned of many that our others existing structure is too rigid, limiting efficient service to the users of financial services, hampering competition unfair and anomalous results. in a way that produces Senator Proxmire's consideration of a proposal to repeal the Glass-Steagall Act is another example of this serious reevaluation of our financial laws. -4- Among all these changes there is one development that I believe is of particular importance and is now a permanent of the financial environment. feature This is the erosion of the role of banks as intermediaries in the credit granting process as a result of major developments technology. in processing and telecommunications These changes have taken the form of improvements in productivity permitting of data transactions, the the efficient linking of processing geographically and a substantial reduction of costs. whose function it is to substitute ultimate result of careful has provided have been borrower. This credit bank and — intermediation intermediation, diversification of lenders more secure investments than would possible ultimate borrower. and a core element through direct markets credit for the credit of traditional analysis separate These, in turn, have had a marked impact on the traditional role of banks the of large volumes loans from a the risk, otherwise lender to an In this process, the value added by the bank of its comparative advantage, is its superior information about the creditworthiness of the borrower. Now capacity market make and result own evaluation that and almost analysis complex is on-line data telecommunication information its execute extensive trading the bases, facilities instantaneously, of basic products diversification than they were ten years ago. of to hedge provided risk — computation provide credit and allowing the lender to creditworthiness, strategies powerful and to develop and risk. The against by are banks less — credit competitive These fundamental changes will have -5- a permanent effect institutions and on will the expand competitiveness the competitive of depository advantage of the market for securitized assets. The due to impact of these technological innovation simultaneous development. changes come has affected many at of the changes a has The time in relative been full when accelerated force market sectors to which institutions have made significant competitiveness of the forces by technological have and regulatory banking financial commitments. already significant administrative adversely a large number of the growing cost advantage of avoiding the depository intermediary, another Thus, institution in terms of both a reduction in costs, widened as a result of the market downgrading of many banks. As changes, paper we one important have market as seen a a example of remarkable substitute for the expansion direct banks to the most creditworthy borrowers. has more than doubled — rising consequences from of of the short-term these commercial lending by Since 1980, this market $31 billion at the end of types of that year to $78 billion at mid-year 1987. The lending kind of securitization proceeded apace mortgages to automobile loans. in the exceeded has same mortgage where involving mortgage has more debt. recently other everything from Expansion has been most mortgage pass-through $600 billion at mid-year 1987 or about residential security market of many The concept been extended of home dramatic securities one-third of all the to other pass-through claims on the -6- household sector, notably automobile receivables, which stood at about development of this market loans and credit card $15 billion at mid-year. which substitutes securities The for bank loans is now reaching down below the top industrial and commercial firms to have a broader not been extension of segment able their to of the economy. participate own natural As you fully markets in because know, banks servicing this of regulatory now prevalent restrictions. These same technological throughout the world. forces are To remain viable in this highly competitive and innovative environment, financial institutions are seeking to have the broadest range of products available to meet the changing needs of provide their customers. traditional Thus, banking financing, and banking banks that are under we have services, firms, such including regulatory seen short-term American constraints broadly in securities markets overseas. as investment at home, in these overseas markets for bridge Japanese participate As an aside, I would note that the successful and substantial participation firms and firms debt of U.S. banking securities certainly raises important questions about the need for the restrictions on lenders doing the same thing at home. It is considerations of the kind I have outlined above that have led the British and Governments to adopt previously segmented financial service or in their financial systems to allow banking and other firms propose to substantial provide single world financial market. integrated changes Canadian services in the -7- As I have our segmented stressed, financial we do need to make structure to make some changes it more effective, both domestically and internationally, to this in a moment. to competitively and I will turn One thing I do not think we need to do is follow a deliberate policy of allowing our financial to become larger for the specific purpose of meeting institutions international competition. One argument that is put forward for this proposition is the fact that of the top 25 banks in the world in 1986, sixteen were Japanese and only two were based here, in contrast with 1981 when were four Japanese. were American including the top two, while ten At the same time, we must ask ourselves whether these changes in the relative ranking of Japanese firms can be explained largely by Japan's rather highly concentrated banking system, appreciated currency, savings. its its trade surpluses, and very high domestic It is no surprise that in these circumstances Japanese institutions would be growing rapidly, particularly in terms of dollars. But there is no evidence that extraordinary necessary for successful international competition. countries other international than our marketplace own Many banks in successfully the smaller than those of their American counterparts. Clearly, many American size have that in significantly institutions assets is are financial with compete size reached the that necessary for effective participation in international markets. is -8- On the important which other hand, ingredient does Reserve require has uniform based in the a begun supervisors both system I would deal more effort, in for measuring competitive adequacy progress is banking agreement on a focused being an Federal with to achieve as environment The cooperation capital Considerable adequacy attention. at home and overseas, standard. capital international great an rate on a risk- made toward an agreement, which I hope will be completed by the end of this year. An agreement of this kind will both strengthen the banking worldwide and assure greater equity in the system competitive environment. I would like should go about the problems performance. to turn restructuring that I Mr. think now the we Chairman, to financial all you consideration agree have system are suggested of how we to deal with hampering its the fundamental test for determining the kind and scope of the required changes is what we will need to do interest. You point removal some or of out all securities firms we have questions, including: from securities safety and securities interest markets; serve that of and in the (a) how of, better the our barriers can (b) how and of can of separating we confidence we resources? banking insured ensure To the in, prevent economic considering a number of insulate can public (c) how concentration we nation's process to ask ourselves activities; soundness and to important deposits continued banking conflicts these considerations I would add the corollary that our basic and and of important objective -9- must be to promote customers large competition. points that As and small part of in this environment analysis, that I would efficiently, and in which (b) maintains monetary the the add two other (a) we system to promotes but are also of vital concern to the economy as a whole: a importance services to Reserve have of particular a efficient Federal must are a system which provides policy integrity of can function the nation's payment system. There is, I believe, wide agreement on these goals. We accept of banking and as basic to our thinking that any combination other within firms should take place an organizational structure which separates the bank in such a manner as to assure that only the bank has the benefit of the support of the federal safety net which includes deposit insurance and access to Federal Reserve lending. There are various ways in which this separation could be accomplished. The three main proposals that have been put before the Congress involve the following ideas: (1) Require that enterprise take place company. This holding all nonbanking in the activities subsidiary company could of be an of a banking overall holding subject to the same regulatory framework that we have now for holding companies. This proposal, put forward by the President of the Federal Reserve Bank of New York, should not suggests that extend beyond the powers of bank holding securities and companies insurance activities and that traditional holding company regulation is appropriate in this context. -10- (2) regulation In should contrast, be applied others suggest to of each the that functional different kinds of activities owned by a holding company parent, but there should be little if any regulatory authority over the parent enterprise. recently (3) Finally, suggestions have been made, put in forward appropriate to an FDIC expand staff paper, nonbanking including that activities it those would of be banking institutions within the subsidiary of banks themselves without any regulation at all at the holding company level. While we have yet to come to definitive conclusions about these that implementation the most financial options, effective or commercial our experience insulation activities of a thus bank is achieved far suggests from affiliated through a holding company structure, though we welcome debate on other alternatives. We also agree that attention must be given to the range of relationships between a bank and its affiliated to assure that confidence in banks conflicts of interest are avoided. such issues as is not compromised need premises; and that (a) the need for limitations on loans by a bank to for adequate separation (c) restrictions information, (d) the (e) rules intercorporate on entities In addition, we are addressing affiliated enterprises or to customers of affiliated (b) the whole scope on of of the directors, flow permissible provision of of joint services, need for public disclosure of affiliate relationships. enterprises; officers and confidential marketing, and (f) the -11- As a result of this review we at the Board hope to be in a position changes to that advise we see financial system expect to have the Congress are needed to We insulation, soundness, prevention on of the on how maintenance conflicts of assure best of all these competitors that recommendations proceeds financial with its system are will similarly be interest, consideration and that our situated. valuable of to the to the We on unavailable hope Congress will and and restructuring recommendations achieve safety avoidance of conferring competitive benefits that are to the continues to serve our public policy goals. recommendations to implement the bank-affiliate on urgently best that specific so on how that as it of our enable the American financial system to remain competitive, serving the needs of customers here and abroad without compromising the strength or stability of our financial markets. Board of Governors of the Federal Reserve System Washington, D.C. 20551 OmClAL •L'SJNBS f»tn»irf K* Prrr*» Uw VS09 POSTAGE AND FIES PAIO Bo*rd d Cowiwi of tha Mrr*l l « m Syurrr *Z2 First Class
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