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Bank Holding Companies and Data Processing

Remarks of George W . Mitchell

M e m b e r , Board of Governors of the Federal Reserve System

at the

Briefing #6381-01

Sponsored by

American Management Association

New York City, New York

December 6, 1971

Hank Hoi

Pomp an i es and Hat a 1'ro(:c:;:;i ng

Eleven months of experience with the 1970 Amendment.'; to
the Bank Holding Company Act have convinced mor>t observers that while
Congressional deliberations could produce neither a "clean" nor a
"dirty" laundry list of activities related to banking, Congressional
action did outfit the banking industry with what amounts to an attractive and varied addition t:o its wardrobe.

But it is a wardrobe addi-

tion, I. would hasten to add, on which there are important constraints
as to the circumstances and extent of its u s e .
The Congressional hearings and deliberations in 1969 and
1970 achieved a clearer identification of the needed constraints and
limitations imposed by the public interest on holding company activities than was apparent at the time.

Although the amendments in

final form w e r e , in some respects, inconsistently described in the
reports of the Congressional committees and although



historians and interpreters of Congressional intent will have numerous opportunities to dispute their application to particular



the Congressional intent on the major issues is clear.
The previously expressed legislative policy as to the
hostile consequences to the public interest of undue concentration,
anticoinpetitive affiliations, tie-in merchandising and the merging of
commercial and banking interests was reinforced in the amendments.
In these respects, the Congress left no doubt as to its concern nor
of its intent: that the Federal Reserve should not permit extension
of bank holding company activities that would jeopardize the. welfare
of users of banking, and financially related


On June 3 5 , .1971 , the Board of Governors announced an
amendment to its bank holding company regulation outlining the
kinds of data processing activities permissible for bank holding
companies under the 1970 Amendments to the Bank Holding Company A c t .
T h a t action was the culmination of Congressional and Board
judgments on the issues involved in permitting holding companies
to engage in this a c t i v i t y .
The bill originally passed by the House of Representatives would have expressly limited the kinds of data processing
services that bank holding companies could offer, on the basis of
section 4(c)(8) of the Holding Company A c t , to data processing
services that are incidental to banking services, such as the
preparation of p a y r o l l s , or that are necessary to make economical
use of equipment primarily acquired and used for the bank holding
company or its* bank subsidiaries..
Had the "negative laundry list" included in the HOuse bill
been a d o p t e d , the Congress would have decided that other data processing activitcs are not closely related to banking.

A provision of the

bill stated that those other activities are neither necessary, incid e n t a l , nor related to carrying on the business of banking or of
managing or controlling b a n k s , and are not in the public interest as
activities to be carried on by holding companies or subsidiaries


~ 3 The Senate dropped the negative laundry list.

With it

went any specific .limitations on the kinds of data processing activities that the Board might determine meet the test of the revised
section 4(c)(8).

That test is whether the activities are "so closely

related to banking or managing or controlling banks as to be a
proper incident thereto."

It i s , I b e l i e v e , a fair conclusion that the Congress delegated to the Board the authority to make the decision as to what
kinds of data processing activities are proper activities for bank
holding companies.

But I do not mean to suggest that Congress gave

the Board a free hand in this m a t t e r .
definite direction to the Board's

On the contrary, it gave


Congress specifically provided in section 4(c)(8) that
"In determining whether a particular activity is a proper incident to
banking or managing or controlling banks the Board shall consider

whether its performance by an affiliate of a holding company can
reasonably be expected to produce benefits to the public, such as
greater convenience, increased competition, or gains in efficiency,
that outweigh possible adverse effects, such as undue concentration
of r e s o u r c e s , decreased or unfair competition, conflicts or interests,
or unsound banking practices."
Further to protect against adverse consequences of
holding companies engaging in nonbanking activities, the Congress
included provisions in the 1970 legislation specifically directed
against the possibility of misuse of economic power of a b a n k .

- 4


Those amendments are commonly referred to as the antitying p r o v i s i o n s .

They express a specific statutory assurance

that a bank may not use its economic power to lessen competition
or engage in unfair competitive practices.

They arc intended to

affirm in statutory language the principles of fair competition.
In essence the anti-tying provisions prohibit a bank from
providing any credit, p r o p e r t y , or service for a customer on the
condition that he obtain from one of the bank's affiliates some
additional c r e d i t , p r o p e r t y , or service.

In its first implementation

of revised section 4(c)(8) of the A c t , the Board expanded the scope
of those provisions to include subsidiaries of holding companies
approved by the Board under that section.
C o n s e q u e n t l y , under the provisions of the statute and of
the Board's r e g u l a t i o n , there are three basic contraints on bank
holding companies' activities in data processing.

Such activities

m u s t not result in (1) unclue concentration of economic p o w e r ,
(2) decreased competition, or (3) unfair competition, unless such
adverse effect is outweighed by benefits to the public in the form
of greater convenience, lower c o s t s , and the like.

And section

225.4(c) of Regulation Y provides that a holding company's section
4(c)(8) subsidiary may not condition any credit, property, or services
upon the customer obtaining some additional credit, p r o p e r t y , or
servicc from the subsidiary or any other affiliate in the holding
company's subsidiary b a n k s .

Unlike the .situation before 197.1, there is no geographic
limitation on where a bank holding company may perform data processing
activities on the basis of section 4 (c.) (8) .

Before 1971, the only

substantive rule in the Board's regulation regarding bank holding
companies was that activities approved under section 4(c)(8) must be
closely related to the business of banking or managing or controlling
banks "as conducted by such bank holding company or its banking

This was an unsatisfactory rule both because

it m a d e the kinds of permissible activities vary among holding
companies and because it resulted in limiting the location at which
permissible activities could be performed to the market area of the
holding company's banking subsidiaries.
T h a t rule was condemned by the Senate Banking C o m m i t t e e .
In its Report on the 1970 legislation, the Committee observed


in e f f e c t , "the* business of banking" as used in former section 4(c)(8)
of the Act was interpreted' by the Board not to refer to the general
business of banking itself but instead to the business of the particular
banks within the particular bank holding company structure being

As the Committee concluded, the interpretation prevented

holding companies from offering new services to new customers a n d ,
in some instances, may have served to inhibit competition.

- 6


Implicit in the Senate Committee's views and in the provisions of revised section 4(c)(8) is authority for the Board to
remove geographic barriers to the performance by holding companies
of nonbanking a c t i v i t i e s .

In its original proposed implementation of

the revised section 4 ( c ) ( 8 ) , the Board noted that its proposal
did not limit the location af. which permissible activities might be
conducted to any State or other geographic a r e a .

It stated, h o w e v e r ,

that such limitations might be imposed by regulation, or by order in
particular c a s e s .

When the Board adopted its initial list of permis-

sible activities under section A (c)(8) in M a y , 1 9 7 1 , it did not
include geographic limitations by regulation.
In my view geographic limitations on holding company
activities pursuant to section 4(c)(8) generally are hostile to the
public interest because they sequester competitive forces instead
of releasing them.

Rather than attempting to confine a holding

company's activities to the market area of its banking subsidiaries,
a procompetitive policy would encourage a holding company to conduct
its nonbanking activities beyond the market area of the holding
company's b a n k s .

T h e farther away from that market those activities

are c o n d u c t e d , the more certain it is they w i l l add to the overall
competitive environment.
The activities determined by the Board to be closely related
to banking in its action announced in May relate essentially to typical
activities in the intermediation p r o c e s s — m o r t g a g e lending, operating
finance companies, factoring, servicing m o r t g a g e s , and the like.

- 7


Adoption by the Board in June of its regulation regarding
data processing activities was its first major action in the area of
services that are not an integral part of the intermediation process.
The significance of Lhis action was underscored by the Board conducting
a hearing on A p r i l 16 solely on the issues involved in deciding whether
to permit: holding companies 'to engage in data processing activities.
The Board had originally proposed to permit holding companies
to provide bookkeeping or data processing services for (1) the holding
company and its subsidiaries, (2) other financial institutions, and
(3) others so long as the. value of the services performed for those
other persons did not become a principal portion of the total value
of all data processing services performed.
After consideration of testimony at the hearing and the
written c o m m e n t s , the Board decided to abandon the proposed


tative description of permissible data processing services in favor
of a qualitative description.
Specifically, the Board determined that the following
activities are closely related to banking within the meaning of
section 4(c)(8):

(1) providing bookkeeping or data processing services

for the internal operations of the holding compamy and its subsidiaries and (2) storing and processing other b a n k i n g , financial, or
related economic d a t a , such as performing payroll, accounts receivable or p a y a b l e , or billing services.

- 8 -

The Board accompanied its amendment: with an interpretation
expressing, its intent.

The Board stated that the amendment is intended

to permit holding companies to p r o c e s s , by means of a computer or
o t h e r w i s e , data for others of the kinds hanks have p r o c e s s e d , by one
means or a n o t h e r , in conducting their internal operations and accommodating their customers.

It is not intended to permit holding com-

panies to engage in automated data processing activities by developing
programs either upon their own initiative or upon r e q u e s t , unless the
data involved are financially


The Board spelled out three activities that it regards as
incidental activities necessary to carry on the permissible data
processing activities:

(1) making excess computer time available to

anyone so long as the only involvement by the holding company system
is furnishing the facility and necessary operating personnel; (2) selling a byproduct of the development of a program for a permissible data

processing activity; and (3) furnishing any data processing service
upon request of a customer if such data processing service is not
otherwise reasonably available in the relevant market area.'
The amendment became effective July 1, 1 9 7 1 .

Since that

time, bank holding companies have been able to engage in data processing following compliance with procedures previously established by
the Board to assure that the balance of the public interest factors
the Board is required to consider in approving holding company activities or acquisitions on the basis of section 4 (c)(8) is favorable.

- 9 -

Under those procedures, a bank holding company may engage in
the specified types of data processing de novo 45 days after publishing
notice of its proposal in newspapers in the areas if expects to s e r v e ,
unless the company in informed by the Federal Reserve to the contrary^
within that time.

A holding company may acquire a going concern to

engage in the specified data" processing activities only upon publishing
notice and filing an application.

An acquisition requires a determina-

tion by the Board that consummation of the proposal'will be in the
public i n t e r e s t , giving consideration to the relevant factors specified
in section 4(c)(8) of the A c t ,

The differentiation between d ^ novo

entry and acquisition of a going concern is justified because of the
increase in competition by a new entrant into the m a r k e t .
During the course of the Board's consideration of holding
companies engaging in data processing, the Association of Data Processing Service Organizations

(ADAPSO) urged the. Board to adopt the

doctrine of maximum separation of banks from data processing.


argued that without that separation banks would have an unfair competitive advantage over independent data processing companies because
banks do not allocate the cost of performing data.processing services
for themselves fairly.

A l s o , the volume of internal work performed by

a holding company for its banks would enable it to offer services to
others at lower rates than the independent company, unless and until
that company had a volume equal to the bank's internal n e e d s .


recognized , h o w e v e r , that this pricing problem is not unique t.o holding
companies entering the data processing field.

It is inherent in all

large companies entering the field, which may for .some period of time
have excess machine and personne] capacities.

- 10 -

ADAPSO attempted to differentiate between industry and
bank participation in data processing on the grounds that banks have
the power to create credit and industry often has trouble obtaining

The suggestion was that this would mean that data processing

affiliates will be able to finance their operations easier than other
data processing companies because the bank w i l l extend them credit.
H o w e v e r , apparently ADAPSO failed to consider section 23A of the
Federal Reserve A c t .
Section 23A restricts in two ways the authority of a l l
Federally insured banks to lend financial assistance to affiliated

The first paragraph forbids a bank to risk more than

10 per cent of its capital and surplus in prescribed kinds of transactions relating to any one affiliate (including any "extension of
credit" to such affiliate) or more than 20 per cent in all such
affiliate-related transactions.

The second paragraph r e q u i r e s


loan or extension of credit to an affiliate to be fully collateralized
by prescribed types of securities.

C o n s e q u e n t l y , section 23A is

one of the major protections against bank holding companies engaging
in nonbanking activities in a manner contrary to the public interest.
The gist of the ADAPSO position was that banks have a
built-in clientele of customers that need data processing services.
The provisions of the regulation preventing a holding company nonbanking subsidiary from conditioning its services upon the customer
obtaining a service from an affiliated bank guards against this type
of p r o b l e m .

That protection should bo a d e q u a t e , if bank holding

companies .'ire prudent and exercise good business judgment.

• - n


By selling its data processing services for a fee separate
from any oilier s e r v i c e , a holding company can avoid criticism and
lessen the risk that the Hoard w i l l require modification of the
holding company's activities to assure that the balance of the public,
interest factors remains favorable to the company engaging in data

Other safeguards are available to holding companies seeking

to protect themselves against charges of unfair competition.


this l i n e , a holding company that proposes to establish a data
processing subsidiary might avoid the use of the name of its lead
bank in the title of the company.

A l t h o u g h in time potential cus-

tomers would associate the data processing subsidiary with the b a n k ,
the company could not be critiziced for taking advantage of the advertising value of the name of its lead b a n k .

The hoJ ding company might

also wish to consider establishing the subsidiary outside the market
area of the holding company's banking subsidiaries to help disassociate
the data processing services from its b a n k s .
Such factors as these are considered by the Federal Reserve
in evaluating holding company proposals to engage'in data processing
on the basis of section 4 ( c ) ( 8 ) — e i t h e r by de novo entry or through
acquisition of a going concern.

It is also necessary for the'Federal Reserve to
evaluate holding company proposals from the standpoint whether
the proposed data processing activities involve banking, financial,
or related economic, data within the meaning of the Hoard's regulation.

C l e a r l y , processing data relating to the production of
goods and services is not permissible.

Under the r e g u l a t i o n , holding

companies are also unable to develop data processing programs for
airplane traffic control or reservations, golf or other sport scores
or other s t a t i s t i c s , consumer surveys, and the like.
The kinds of data processing that are permissible under
the regulation d o e s , h o w e v e r , encompass all of the kinds of data
processing services in which the banking industry was engaged in 1969,
when Congress began its consideration of the the one-bank holding
company legislation.

In addition to the specific activities referred

to in the r e g u l a t i o n , those services include sales a n a l y s i s , inventory
a n a l y s i s , freight p a y m e n t , municipal tax billing, credit union
a c c o u n t i n g , and savings and mortgage loan bookkeeping.
This reflects the Board's conclusion that if a service is
a financial transaction processing service or a financial analytical
s e r v i c e , it is a service closely related to banking regardless of who
uses the service.

-13Thc role of data processing closest; to my interest: has to
do with improvements in the payments mechanism and the latitude
necessary for the banking industry to carry on the necessary
research and development.

Essentially, this is a matter of

providing a skill base compensurate to the challenge inherent
in a fully automated payment system.

Because banks may not engage

in data processing generally this fact could retard the development
of vital skills.

No one can say how large and how general a data

processing involvement is needed but 1 would be prepared to argue
that insofar as a given data processing activity can be related
to this very vital function of banking it is of necessity closely
related to b a n k i n g .

Commercin 1 Banks and Bank I [a hi i ng Companies
June 30, 1971 (subject to revision)


Banl us outside of a Hold ins; Company
Total. Deposits
Per con t
N 0.
Dcposi ts














°° - $500

45 7





A l 1

A] , BanksTotal Deposits
(bil1i ons)















8 1









° - $100

$ 1 0

L e S s






$ 1 0

Table II

Bank Hold in;; Companies and Their head Banks
June 30, 1971. (subject to revision)

Size of Holding Company
(Total deposits in'billions)


All Holding Companies
Total Deposits

Lead banks in
Heiding Companies
Total Denosits







$100 - $500




$60 - $100










Holding Companies
°ver $500

$10 - $60

s s than $10