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Statement by

Jeffrey M. Bucher

Member, Board of Governors of the Federal Reserve System

before the

Subcommittee on Securities

of the

Committee on Banking, Housing and Urban Affairs

United States Senate

December 9, 1975

I am pleased to present the views of the Board of Governors
o£ the Federal Reserve System on various issues raised in connection
with the Subcommittee1s study of the securities activities of commer­
cial banks.

The Study Outline prepared by the Subcommittee indicates

a desire to reexamine the provisions of Federal banking and securities
laws as they may apply to bank involvement in securities activities,
especially new activities which, in recent years, banks have demonstrated
increased interest in pursuing.
Bank participation directly in certain securities activities
has been limited since enactment of the Glass-Steagall Act in 1933.
A key purpose of that Act was to separate commercial banking from cer­
tain investment banking and securities distribution activities, which
in combination had resulted in numerous abuses and exposed the banking
system to considerable risk.

Thus, commercial banks are expressly pro­

hibited from underwriting and dealing in corporate securities.


various other securities activities, however, there often have been dif­
ferences in interpretation as to whether or not the Act prohibits
commercial bank involvement.

Most of the activities in which the

Subcommittee has indicated a special interest have come into question,
for one reason or another, with regard to the applicability of Federal
banking or securities laws.

- 2 -

The range of activities under your review might be categorized
conveniently as functions in which the bank performs in the capacity
as agent, as investment adviser, or as underwriter.

In the agent

capacity, the new services being investigated are dividend reinvestment
plans and automatic stock purchase plans.

In the investment advisory

function, relatively new service areas are certain investment management
services for individuals and the provision of advisory services to real
estate investment trusts and closed-end investment companies.


regard to underwriting, the Subcommittee is focusing on the issue of
bank underwriting of municipal revenue bonds, which is not permitted by
the Glass-Steagall Act.
The interest of commercial banks in offering new types of
financial services to the public has been generated by their percep­
tion of a potential market for these services and the potential profits
which may be earned, along with competitive pressures from other
financial institutions, such as insurance companies.

All of the ser­

vices singled out by the Subcommittee are substantially related to
activities in which banks have engaged in prior to and since enactment
of the Glass-Steagall Act.

The relatively new agency services, for

example, are specialized products developed from the usual agency functions
performed by banks.

New investment management services derive from

traditional trust department activities, while underwriting of municipal
revenue bonds would be an extension of bank participation in the under­
writing of general obligation issues.

- 3 -

It is still too early to determine whether or not banks have
accurately judged the market for several new services.

In numerous

areas the present situation appears quite fluid, and the future evolu­
tion of the market is not at all clear.

The extent of bank involvement

in several of the new product areas is quite small, with around 30
banks offering automatic investment plans, for example.

And these

plans apparently have a considerably smaller number of customers than
had been anticipated by some banks«

On the other hand, dividend reinvest­

ment plans now cover about 450 corporations, although comprehensive
information on shareholder participation is not available.
The likely future extent of bank participation in offering new
agency and investment advisory services depends upon a variety of factors.
Among these is the regulatory climate, of course.

But, in addition,

factors influencing bank participation are the demand for the services
and the ultimate profitability for banks.

Demands for the services

offered by banks are related to the financial market environment -for example, the poor price performance of equity markets in general
over the past few years has discouraged investor participation -- and
importantly to the competitive environment among banks and nonbank
institutions offering similar services«

Thus, in some lines of

activity the markets may broaden and encourage increased participation
by banks and other firms, while other activities are likely to remain
comparatively small with little interest for commercial banks over-all.
An appraisal of the desirability of continuing to permit bank
activities of the sort under discussion, or extending the range of

- 4 -

activities in the case of commingled managing agency accounts and under­
writing of municipal revenue bonds, needs to take carefully into account
the likely public benefits and risks of the activities.

As a general

matter, the Board believes that, within limits, commercial banks in
securities-related activities can play a constructive role in serving
the public, strengthening competitive forces, helping to enhance
individual participation in capital markets, and ensuring efficiency in
the allocation of investible funds.

At the same time, the need for

adequate safeguards for the public and the banks must be given appro­
priate attention.

Each securities-related activity will tend to raise,

issues of its own, but an overview of the nature of the benefits and
risks of the services will help provide a perspective of the Board's
position on bank involvement in new service areas«
A principal benefit to the public from banks' offering
securities-related services is the convenience to the public at reason­
able cost.

In a number of cases banks have offered services not readily

available elsewhere.

The automatic investment plans, for example, pro­

vide small investors with an opportunity to participate regularly in
particular equity issues of their own choice«

The brokerage industry

generally has not aggressively sought to provide extensive services to
small investors, primarily because of the high cost and low return«
Through the automation of many aspects of servicing accounts, and the
ability to achieve economies in transactions costs by pooling small orders,




banks are largely filling a need not previously met by other market

Dividend reinvestment plans also are geared to providing

a convenient service to small investors.

In the case of individual

portfolio management services, the willingness of some banks to take
on clients with relatively small portfolios is perhaps the first time
such services have been available to small investors.
Bank participation in new financial service areas seems likely
to provide greater convenience and lower cost to the public over time as
a result of competitive forces.

Innovative efforts by a few banks are

likely to prompt increased competition from other banks and other
financial institutions.

The public could thus be a beneficiary of the

interplay of competitive forces in the market-place.
Efforts by banks to provide new services may also help to
generate broader public participation in capital markets, particularly
equity markets.

Over recent years, individual investors have reduced

their participation in equity markets, reflecting high transactions costs,
poor performance of the market, and growth of substitute investment

If we are to meet effectively the substantial capital needs

of our economy, increased participation of individual investors in equity
markets is necessary and desirable.

Individuals traditionally


been a source of liquidity in equity markets, and consequently broadbased participation of individuals in equity markets will help streng­
then the performance of the market.

The limited evidence available

suggests that banks have been moderately successful in attracting new



individuals into the market.



Surveys by three banks showed that

roughly between 40 and 60 per cent of the participants in automatic
investment plans were first-time stock market investors.
Benefits to the banks will accrue in the form of additional
profits, assuming their services on the whole prove successful.

In a

number of agency and investment advisory activities, additional services
may provide opportunities for more efficient use of existing data
processing and bank customer service capabilities.

Hence, the activities

are a natural extension of services which should provide economies of
The public risks of bank participation in securities-related
activities would seem to relate principally to the potential for con­
flicts of interest.

These potential conflicts are not new, since they

already exist in the traditional agency, trust, and underwit in g
activities of banks.

Areas of possible conflict arise, for example,

with regard to use of inside information, inappropriate timing of buy
and sell orders, and attempts to influence the value of corporate
shares for the banks' own benefit.

In our judgment, even though the

potential for abuse exists, banks on the whole have performed in a
prudent manner.
Moreover, there are safeguards to insure against inappropriate
bank behavior with regard to potential conflicts of interest.


safeguards include the Federal and State bank examination procedures,

- 7 -

and the Federal securities and other laws applicable to the conduct of
those handling financial transactions.

With regard to examination pro­

cedures, all State member banks exercising trust powers are examined
annually by Federal Reserve, bank examination personnel.

This examina­

tion is designed to determine whether the bank's fiduciary activities
are conducted in accordance with safe and sound banking practices
and, if they are not, to define any contingent liability that may
follow from the inappropriate practices and the potential impact on the
over-al.1 condition of the bank.

Of particular concern to trust examiners

are transactions or relationships which may involve conflicts of interest
arising from the bank's trust or investment activities.
Another type of risk in new securities-related activities is
the potential exposure of bank capital and the possible impact on bank
soundness in the event of adverse experiences.

Since most of the

activities are not capital intensive, bank capital is not put at risk

In the case of municipal revenue bond underwriting and

dealing, however, bank capital would be risked when positions are taken
in the normal course of business.

Setbacks suffered by banks in some

of these new activities, as well as in their long-standing functions,
could conceivably have spill-over effects on the bank as a whole.
Depositors, for example, might lose confidence in the bank and withdraw
funds, threatening the viability of the institution.

While such an

event is not likely except in rare cases, the possibility needs to be
considered in the framing of public policy.



A different type of potential risk that often receives
attention is the long-run effect of increased competition on the con­
centration of resources.

Some observers have suggested that bank

entrance into various activities will only supplant those of existing
market institutions and ultimately lead to increased concentration of
resources as well as reduced competition.

It is by no means clear

that the activities under review pose such a threat, or that a potential
threat would in fact be realized.

But in a broader perspective, we

must, nonetheless, remain alert to the dangers of moving to a position
where banks or other institutions command overwhelming control of
capital markets and the economy.
In reviewing the securities-related activities of commercial
banks that are considered in the Study Outline, the Board has taken
into account the potential benefits and risks I have enumerated.
might be useful at this point to

review briefly


each of these

activities and to indicate the Board's current thinking on the desir­
ability or need to amend the Glass-Steagall Act.
First, with regard to agency-type activities, the GlassSteagall Act expressly permits national banks to purchase and sell
securities without recourse upon the order and for the account of

Banks acting as agents perform an intermediary role between

their own customers and broker/dealers who execute transactions.
of the traditional bank services in this area
custodial accounts.


is the offering of





securities and the bank -- at the direction of the customer or his
financial advisor —

will buy or sell securities, collect dividends and

interest, disburse proceeds of tie account, and provide for the safe­
keeping of securities.

Another traditional bank agency service involves

the transfer of shares and disbursements of dividends on behalf of
corporate security issuers.
The newer types of bank agency activities in general appear
to be outgrowths of these traditional agency activities of bank trust

The dividend reinvestment plan, for example, provides a

means for shareholders of a participating corporation to direct their
dividends to a bank which purchases additional shares of stock for the

Shareholders using such plans may also channel additional

cash to the bank for the purchase of shares.

In the automatic invest­

ment plan, a bank checking account customer may elect to have a specified
amount of funds deducted monthly or semi-monthly from his account and
used to purchase shares of stock in companies selected by the customer
from a list compiled by the bank.

The stocks appearing on the list,

under current practice, generally are those of the 25 to 40 largest
corporations traded on the New York Stock Exchange.
The Board believes that both dividend reinvestment services
and automatic investment services are appropriate activities for com­
mercial banks.

For both services there appear to be minimal potential

risks to the banks and the public, while there are appreciable potential

- 10 -

benefits to the public.

Hence, the Board believes that banks should be

authorized to continue offering these services.
A second broad category of bank activity in securities markets
results from commercial banks offering investment advisory services.
Commercial banks have long acted in an investment advisory capacity in
connection with the fiduciary and custodial activities of their trust

In this function banks have handled the assets of indivi­

dual as well as institutional customers.

Much of the institutional

service is accounted for by the management of assets in private pension
or profit-sharing plans.

In recent years the investment advisory

activities of banks have been expanded, within existing trust depart­
ments as well as by establishing investment advisory affiliates of bank
holding companies.
Investment management services for individuals until recent
years generally had been offered to those with portfolios of $100,000
or larger.

However, some banks are now offering portfolio management

services, on a discretionary or nondiscretionary basis, to customers
with portfolio values of considerably smaller amounts.

These services

are also provided by a number of banks for self-employed individuals
under Keogh plans, and could well emerge for Individual Retirement
Accounts, given recently enacted legislation.

The Board believes that

the potential benefits of these services outweigh presently forseeable

- 11 -

The efforts of banks to provide certain types of investment
management services to small investors have been constrained, however,
by the Supreme Court decision in 1971 which provided that commingled
managing agency accounts were in violation of the Glass-Steagall Act.
As a result, banks are not permitted to achieve the economies of pooling
for nontrust or agency accounts, and this acts to limit indirectly the
extent of the potential market for bank management services available
to small investors.

The question of amending Glass-Steagall to permit

commingled managing agency accounts is one that the Board has not yet
explored with sufficient thoroughness to arrive at a judgment.
Other types of investment advisory services being examined
are those where banks or affiliates of bank holding companies have
acted as advisors to real estate investment trusts and closed-end
investment companies.

These are areas where the Board believes legisla­

tion is unnecessary at the present time.

It should be noted, however,

that the Board regulation in the investment company area is presently
being challenged in the courts.
The third general area covered by the Subcommittee’s Study
Outline deals with bank underwriting and dealing in municipal revenue

Bank underwriting and dealing in Federal Government obligations

and general obligations of State and local governments were expressly
permitted by the Glass-Steagall Act.

In the early 1930fs revenue bond

issues were a relatively unimportant source of funds to governmental
units, but as their capital needs have increased revenue issues have
been employed to an appreciable extent.

- 12 -

Over the past two decades or so there have been a number of
bills introduced in the Congress to authorize bank underwriting and
dealing in revenue bonds.
arguments have emerged.

During this period numerous pro and con
The pro arguments generally focus on the

benefits to governmental units in the form of lower interest costs
and improved market efficiency, while the con arguments center on
potential conflicts of interest and risks of market concentration.


Board, on a number of occasions, has reviewed the question of extending
bank underwriting privileges to municipal revenue bonds of investmentgrade quality, and since 1967 has consistently voiced its belief that
the public benefits of such action outweigh any potential risks.


view of recent developments in the municipal securities markets, however,
the Board would wish to take a fresh look at the situation before
reaffirming its position on this matter.
In conclusion, the Board believes that appropriate public
policy in regard to the securities-related activities of commercial banks
requires a careful and considered weighing of the potential risks and

The experience of recent years suggests the need for pru­

dence in the expansion of bank activities, and an awareness of the
potential risk new activities pose to the adequacy of the capital base
of banks.

Furthermore, undue potential conflicts of interest must be

avoided and safeguards to the public must remain adequate.

But we should

not overlook the benefits to be derived from bank participation

- 13 -

in certain securities-related activities.

The erection of barriers to

restrict bank competition in new activities would limit benefits to
investors and serve to hamper the efficient performance of the nation's
financial markets.