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FOR RELEASE ON DELIVERY
Thursday, February 13, 1975
1:30 P.M., E.S.T.




THE FEDERAL RESERVE AND THE BANK HOLDING COMPANY
Remarks of
GEORGE W. MITCHELL
Vice Chairman
Board of Governors
of the
Federal Reserve System

at the
Florida Atlantic Executive Program
"The Bank Holding Company - Development and Potential"
Conducted by the College of Business and Public Administration
and the
Division of Continuing Education
In Cooperation With
Florida Association of Registered Bank Holding Companies
Boca Raton, Florida
February 13 - 14, 1975

THE FEDERAL RESERVE AND THE BANK HOLDING COMPANY
It is widely recognized today that the bank holding company
has become a significant factor in the evolution of the American banking
system*

Its contribution has been through the enhancement of the

capacity of many American banks to extend their service areas both
geographically and through a broadened range of financial activities
and conveniences.

The Bank Holding Company Act offers banking a number

of entrepreneurial incentives and corporate opportunities.

Some are

available for the first time in banking history.
Certain critics of bank holding companies believe the tindeniable corporate advantages given such companies are disproportionate
to the limited public benefits growing out of the expansion of authorized
activities.

And an even more serious criticism is that lead banks and

other banking units in holding company families are exposed to credit
and liquidity risks as a result of their affiliation with holding company
non-bank subsidiaries such as finance companies, mortgage banking,
leasing companies and the like.

The extent to which these apprehensions

are justified cannot be known for certainty at this time.

The financial

history of our time when it is written will show whether banking pru­
dence and wise regulatory policies and judgments were exercised today.
Deprived of historical perspective, I believe we should con­
sider the essential role of banks and bank holding companies in light
of their ability to fulfill two functions:

first, to provide secure

depository institutions for a community's money and savings with adequate
service and compensation to depositors and, second, to act as intermediary




-2 vehicles channeling funds needed to meet the community's credit needs.
To a degree, greater effectiveness in one of these functions may be at
the expense of less effectiveness in the other.
Forty years ago «hen public confidence in financial institu­
tions was indeed fragile, a Chicago banker advertised his institution
as 100 per cent sound.

He assured depositors that their money would

be backed up, dollar for dollar, by cash and short-term government
securities.

For this claim he was known as "100-per-cent Nichols."

While his competitors, holding a mere fourth of their assets in govern­
ments, derided his institution as a non-bank-safe-deposit-vault operation,
he certainly had an accurate appraisal of the pervading public wariness
of banks and banking.
It has taken several decades and numerous changes in govern­
ment support and supervision of financial institutions to rebuild
confidence in the banking system which had been so seriously undermined
by the bank holiday and the events preceding it.

For a time, that re­

building process went on at the sacrifice of the full potential flow
of bank credit for the community and a considerable smothering of
competition among financial organizations.

For example, it was not

until about 15 years ago that the banking system's holding of government
securities began to reflect the fact that depositor confidence had been
re-established and that their funds could be more actively used to
service the private credit needs of individuals and businesses in their
service areas.




-3
Today, the banking system serves a broader spectrum of the
U.S. economy than it did 10, 20 or 40 years ago.

The most conspicuous

single user of bank credit today is the non-financial business community,
including agriculture.

Commercial, industrial and agricultural loans

amount to about 26 per cent of the banking system's net assets (total
assets less cash and due-from banks).
Governments— Federal, State and local— are banking's second
largest category of credit customers.

Investment in Treasury and agency

securities amounts to about 11 per cent.

State and local securities

account for 13 per cent; the total is comparable to that for businesses.
Banking's third largest category of customers is made up of
consumers.

Loans to individuals amount to 14 per cent of net assets

and if residential mortgages are included, the bulk of which are on
one-to-four-family dwellings, consumers' share of bank credit rises to
24 per cent.
In thus accounting for the use of three-fourths of bank credit
we have gone about as far as our statistical classification permits.
Another 6 per cent in loans can be allocated to financial institutions
and an additional 6 per cent to mortgages other than residential (churches,
hospitals, and other community facilities as well as business facilities)
but further specification involves classification uncertainties and
relatively insignificant uses of bank credit.
The diversification in the use of bank credit has become a
major characteristic of our banking system.




The trend toward such

-4

diversification is continuing and I believe that it makes for more
responsive financial services and adds to the economy's capability.
The past year has posed difficult problems for the nation's financial
institutions, but in general these problems have been those of their
customers for many of whom banks are lenders of last resort.
I see no inherent reason why the greater breadth of holding
company activity should weaken the integrity of our banking system.
The contrary result was anticipated by Congress in providing regulatory
safeguards in the 1970 amendments to the Bank Holding Company Act.
Weaknesses and deficiencies have shown up but I believe their most
likely causes will be found to be attributable to entrepreneurial abuses
and regulatory myopia.
As we are all faced in greater or lesser degree with the
problem of appraising the role of bank holding companies today, I
believe we should focus attention on their effect on banking structure,
on financial services and on institutional stability.
Recent changes in the American banking structure show most
clearly one of the consequences of the widespread use of the holding
company form of organization.

In the pre-multi-bank holding company

era the several States opted for one of three types of banking structure:
unit banking with no branches; limited branching confined to the home
office city, county and, in some instances, contiguous area; and state­
wide branching.

The holding company has had almost no structural

impact on jurisdictions where statewide branching prevails such as the




-5West Coast, the inter-mountain region and certain States along the
eastern seaboard, notably the Carolinas and Maryland.
Since multi-bank holding companies are not authorized in
several unit branching States, notably Illinois, Kansas, Nebraska and
Oklahoma, and in such limited branching States as Indiana, Kentucky,
Louisiana, Mississippi and Pennsylvania, the influence of the holding
company concept in these States is apparent only from the intense
pressures generated in certain of them to authorize multi-bank holding
company operations in the near future.

One-bank holding companies are

found in all or virtually all States.
In contrast, those unit and limited branching States which
have authorized multi-bank holding companies have seen a dramatic
change in their banking structure during the past four or five years.
These States are New Jersey, Virginia, Florida, Alabama, Tennessee,
Massachusetts, Maine, Missouri, Texas and Colorado.

In most of them

there are at least a half-dozen holding companies several with represen­
tation in many, if not all, major markets in the State.

The number of

holding companies in these States changes frequently but by a mid-1974
count, there were 34 in Florida, 25 in Texas, 22 in Missouri, 12 in
Massachusetts and Virginia and 10 in New Jersey and 8 in Alabama,
Tennessee and Colorado.

In terms of statewide banking markets, the

holding companies as a group had market shares ranging from 50 to 75
per cent of State totals.




-6In the States of New York, Connecticut, Michigan, Ohio,
Wisconsin, Minnesota and Iowa the holding company has accommodated
extension of existing banking interests to additional banking markets
within the State and has brought new banking affiliations into existence.
These changes have been unfolding more slowly primarily because of the
inherent stability in existing banking structures.

In several cases,

notably Minnesota, Wisconsin and Ohio, holding companies grandfathered
from pre-1956 days have expanded further and several new companies have
been formed.

Four grandfathered companies in Minnesota compare to

8even today.

One surviving company in Wisconsin is augmented by 18

today, and one in Ohio compares to 14 today.
Holding companies in States where they have been authorized
have fostered organizations capable of offering banking services on a
statewide basis.

By doing so they have broken down local concentrations

of banking power through de novo or foothold entry or if a large or
dominant local bank has been acquired, these institutions have, on
occasion, been a vehicle for bringing into the community service standards
for depositors and loan customers previously not locally available.
While the lead bank in most holding companies is a large or
even dominant bank in its home territory, the formation of holding
companies and their expansion under the policies of the Federal Reserve
Board has been channeled in the direction of improving the competitive
environment in the several banking markets within a State.

An effective

banking competitor has to be large enough to achieve economies of scale,




-

7

-

provide entrepreneurial and managerial opportunities, to attract capital
and to make money in a competitive environment.

There is such a thing

as diseconomies of size, too; these occur when managerial foresight and
control are unequal to the complexities of sheer bigness.
For the most part, the pattern of holding company development
has included many intermediate sized organizations, compared to the
footings of large statewide branching systems.

Almost without exception,

holding companies have strengthened capital, managerial and internal
controls in the banks they have acquired.

The typical holding company

also relies on a greater delegation of operating and lending responsi­
bilities than is typical of branching systems.

Thus, so far as banking

structure is concerned, the holding company may contain the best of the
two patterns of banking development in the U.S.— unit and statewide
branching— in the form of ingredients of local autonomy and understanding
on the one hand and the efficiencies and competitiveness of size on the
other.
1 have relatively little to say about the extension of banking
services through the additional powers given holding companies.

Purely

service activities such as data processing, acting as a trust company,
an investment or financial advisor, as an insurance agent, as an under­
writer for credit, life, accident or health insurance, issuing travelers
checks, providing courier services and so forth, have generated con­
siderable opposition from non-bank interests.

However, participation

in these and similar activities seems to me clearly to have been procompetitive and to have resulted in gains for the public interest.




-8 Ventures into mortgage banking, consumer lending, business
finance, leasing and other credit granting activity which leverage
operations directly or indirectly through the holding company organiza­
tion raise an entirely different set of considerations.

Applicants

seeking entry into these businesses have uniformly voiced the view they
can provide and maintain - more diversified and higher level of services
a
than nartiolding-company affiliated concerns.
for less.

Some say they can do it

They have stressed access to equity and loan funds at lower

prices and improved availability by virtue of membership in the holding
company family.
These claims have yet to be thoroughly tested.

But since

both affiliated and non-affiliated leasing, mortgage and finance firms
abound, there will, in time, be no lack of empirical evidence to con­
firm or discount these expectations.

In the meantime, this is an issue

on which I would suspend judgment.
The question on which judgment cannot be reserved or deferred
is whether the bank holding company is contributing in any significant
way to weakness or instability in our banking system.

Before totting

up the pros and cons on this issue, I should make clear that I am not
seeking a judgment which will tolerate no exceptions.

There are bound

to be instances in which the holding company by reason of manipulation
or mismanagement can cause instability both in the lead bank and in
the affiliated banks.
tional arrangement.
exposure to abuse.




Such exceptions can be expected in any institu­
The question is one of inherent weakness or over­

-9 As bank holding companies expanded their Interests into
ownership of consumer and business finance, leasing, and mortgage com­
panies and have used the commercial paper market to provide financing
of these activities, more and more questions have been raised about
leverage and liquidity exposure for such subsidiaries.

These apprehen­

sions have grown with the downturn in economic activity and distress
in real estate markets.
The earlier phase of apprehension had given rise to two
theories about links within the bank holding company family.

One con­

cept is that since members of the family are legally independent and
operationally severable, the credit standing of each family member is
also a severable characteristic.

A wholly owned subsidiary could under

this theory fail and be liquidated with losses to creditors for borrowed
funds without serious consequences to the credit standing of the parent
or other family members.

The thrust of this argument is that the

viability and soundness of the banking members is determined by the
soundness and viability of the banking institutions themselves and is
unimpaired by credit problems of non-banking members.
The concept of severability is said to be reinforced by
physical separation of sites from which banking and non-banking opera­
tions are conducted and by distinctively different corporate names.
It is further urged that if the conventional limits on leveraging
established for non-holding-company-affiliated concerns were observed
for affiliated concerns, this would lend additional weight to the




-10-

concept of severability and strengthen the expectation that each member
of the family has an independent severable credit status.
The second and opposing concept is that so far as credit stand­
ing is concerned, there is no such thing as severability in a family of
financial institutions whose members solicit deposits and borrow in the
nation's money and banking markets.

The family name is built on confi­

dence in the credit integrity of all of its members; one of them cannot
default on its obligations without jeopardizing the integrity of the
others.
Banking history and contemporary banking practice both at
home and abroad is replete with illustrations of the lengths to which
banking institutions will go to protect their credit standing.

It is

not a question of the legal ability to avoid meeting outstanding financial
obligations; it is not even a moral or ethical issue in the final analysis.
It is a question rather of survival as a financial institution in a world
where confidence more than anything else determines the access of such
intermediaries to the liquid funds of savers and investors.
As between these two concepts of financial responsibility,
I believe there are several reasons for preferring the concept of non­
severability.
practice.

The main reason is that it is in accord with established

There may be cases in which obligations have been shucked off

but few if any have escaped the attention of the financial community
which sets this standard of behavior.

Of course, obligations have been

defaulted by discredited or deposed managements and boards of directors;
these are actions in extremis— not those of an institution that expects
to continue in business.




-11-

The other major reason for preferring the latter concept of
holding company family responsibility Is that acknowledgement of this
responsibility has a sobering effect on acquisition policy and on parent
company surveillance of the operations of its subsidiaries.

If the bank

holding company in the United States is to achieve the role in banking
measured by its potential- it will never do so, in my opinion, by taking
flyers in this or that venture and sloughing off the responsibility for
the credit obligations of these family members.
A bank holding company should be regarded as something of
special character and well outside of the pattern of contemporary con­
glomerates and of the numerous and questionable leveraging or control
devices used by utility holding companies in the past.

The bank hold­

ing company proper should have the ability to strengthen the financial
structure of its subsidiaries— bank and non-bank— to ensure and extend
the services they provide, to add to their competitive effectiveness
and thus to improve fundamentally the operation of our entire financial
system.

To accomplish these purposes, the "family" must be one for all

and all for one.




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