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For release on delivery 9:30 a:.m. BDT June 23, 1992 Testimony by John P. LaWare Member, Board of Governors of the Federal Reserve System before the Subcommmittee on Financial Institutions Supervision, Regulation and Insurance of the Committee on Banking, Finance and Urban Affairs U.S. House of Representatives June 23, 1992 I am pleased to be here to address issues of regulatory burden: how it might be eased for well-run depository institutions, and what long-term regulatory and legislative efforts are needed to keep excessive requirements in check. These hearings are extremely important because over time, the regulatory burden on U.S. depository institutions has grown progressively to the point where it may well threaten the viability of the banking industry itself. Both the Congress and the regulatory agencies must act now to stem the tide of ever increasing regulatory burden and to explore ways of reducing existing burdens. Nature of Banks' Regulatory Burden The U.S. banking system operates under a wide array of statutory and regulatory constraints imposed on it for a variety of reasons. Some restrictions, such as those related to anti-trust matters, reflect broad public policies to promote free markets and to prevent abusive business practices that we have seen in the past. With only a few exceptions, these laws apply to businesses of all kinds. Other statutes and regulations, however, apply only to banks and other insured depositories because of the special and critical functions they perform: 2 (1) their role in the payments mechanism, which facilitates payments by businesses, governments, and consumers domestically and throughout the world; (2) their role as a chartered recipient of federally insured deposits providing a source of savings and investment to the general public that is free of the risk of default, up to $100,000; (3) their role as important credit intermediaries to all segments of society; and not least (4) their importance as the principal vehicle through which the nation’s monetary policy is implemented. Society's reliance on the banking system for these and other functions, combined since the 1930s with the government's direct exposure arising from its deposit insurance guarantee, led to the belief that banks should be treated differently from most businesses and that they be held to somewhat higher standards. As a result, banking is, and has long been, among the most regulated industries. Without doubt, some regulation is needed to minimize excessive risktaking by banks, to protect financial markets and the payments system, to minimize the government's exposure since it is the ultimate guarantor of bank deposits, and— through such burdens as reserve requirements— to implement monetary policy. However, during the past quarter century or so, the Congress has enacted additional financial services laws designed 3 to achieve a variety of other objectives. They are most frequently directed at protecting consumers, assuring that services are made available to all members of society, and enforcing tax and criminal laws. They typically impose specific and detailed requirements on depository institutions that, in most: cases, are not placed on mutual funds, insurance companies, and other nondepository financial institutions. Obviously, this places depositories at a competitive disadvantage. While these statutes and regulations— both those related to safety and soundness and those related to other public policy goals— may address legitimate public policy concerns, they also impose significant costs, both direct and indirect, on the banking system. The direct costs of regulation include additional personnel and equipment to assure compliance, the diversion of management from other business activities, deposit insurance premiums, and lost revenues from non-interest-bearing reserves maintained at the Federal Reserve. The public at large also bears a substantial direct cost in the expanding size of regulatory agencies to administer the growing volume of laws and regulations. For some depository institutions, these latter costs fall at least partly on them through examination fees. Indirect costs may be even larger than direct costs. They include the reduced flexibility of U.S. banks to react to changing conditions, their inability to engage in certain activities, and— importantly— the impairment of the industry’s competitive position relative to nonbank lenders and foreign 4 banks. For example, by devoting substantial attention to new and frequently changing statutes and regulations, bankers have less time and resources to develop new markets and services or to improve their current activities. For years, informed members of the Congress, executive branch officials, the regulatory agencies, scholars, and certainly bankers have been concerned that the cumulative costs of regulations are placing the U.S. banking system at a growing competitive disadvantage. In an environment in which rapid technological change and market innovations have caused thoughtful observers to question whether banks in their present form can even survive, these regulatory burdens are of much more than an academic or passing interest. In the short-run, the effect of an additional regulation is sometimes difficult to see; it is implemented, and business goes on. In the long-run, though, many regulatory and other costs are passed on to bank customers in the form of lower interest rates on deposits and higher borrowing costs, which have their own undesired effects on the macro-economy and the ability of the banking system to compete. We should recognize that in our society banks, like other businesses, must generate an adequate profit in order to survive and attract the capital needed to support sound growth. Indeed, costs not borne by their competitors must be absorbed by banks either by operating more efficiently than their competitors or by providing their shareholders with lower rates 5 of return. At some point, the markets will refuse to accept lower rates of return, and the industry will wither for lack of investor funds. It may be possible to calculate some of these regulatory costs with precision— such as the three-fold increase in deposit insurance premiums since 1989, the opportunity cost of non-interest-bearing reserve requirements (which varies with the level of interest rates), and the additional personnel required to implement regulations. It is impossible, however, to calculate the costs of the industry's reduced flexibility and competitiveness, which are significant burdens, nonetheless. When considering costs, we should recognize that the overwhelming majority of bank managements are committed to operating in a safe and sound manner, regardless of any government role. Accordingly, they would voluntarily adopt many policies and practices to that end without specific statutes and regulations, although perhaps not exactly in the manner we might prescribe. It is in a bank's competitive interest, for example, to operate prudently, to provide financing so its community can prosper, and to be honest and forthright with its customers. But the fact is, the burden of bank regulation has clearly grown, and the cost of that burden has, we believe, fallen disproportionately on smaller institutions which do not have the resources to acquire the specialized personnel to assure compliance with the growing number of statutes and regulations. 6 The time has long passed that Congress, the banking agencies, and the intended beneficiaries of regulation can think of the planned benefits of existing or future regulations as free. level. The costs and burdens may have already reached a dangerous Each cut, as it were, may only wound, but a thousand cuts may kill. Efforts to Minimize Burden The Board has had a formal program since 1978 to minimize regulatory burden on the financial institutions that it regulates. This effort includes a review of both new and existing regulations to help ensure that they do not impose unnecessary requirements and that they fulfill current policy objectives. This program, in turn, expanded upon earlier efforts begun in 1975 that focussed on reducing the industry's regulatory reporting costs and that continue in force today. Within the Federal Reserve System, there are a number of levels at which new reporting requirements are reviewed and costs and burdens evaluated, including reviews by senior staff, System staff committees, bank technical advisors, Reserve Bank presidents, and members of the Board. In other efforts, the federal bank regulatory agencies work to coordinate common policies, procedures and reporting requirements through the Federal Financial Institutions Examination Council (FFIEC), partly to minimize confusion and inconsistencies that might otherwise arise. The Council, which I 7 currently chair, was established by Congress in 1978 for that purpose. It is supported by a small staff that has worked diligently to accomplish its stated goals. Earlier this year, the Board undertook a review of all of its regulations and reporting requirements to determine which requirements are specifically required by statute and which ones are not. Those not required by the letter of the law were then reviewed more thoroughly to assess whether their costs are outweighed by public benefits, such as contributing importantly to the safety and soundness of the banking system or carrying out various Congressional mandates. This review disclosed a number of areas where burden could be reduced further, and the Board is in the process of addressing those situations. Examples include eliminating unnecessary applications and approvals for bank holding companies and member banks and streamlining other applications procedures. The Federal Reserve is also participating with the other federal banking and thrift regulatory agencies in a "Regulatory Uniformity Project" that has the goal of promoting consistency and reducing regulatory burden to the minimum consistent with Congressional and regulatory intent. To that end, the agencies will seek to apply uniform policies and regulations in their implementation of similar federal statutes. They will also attempt to combine, simplify, or eliminate any duplicate or outmoded policies, procedures, and regulations and 8 will also seek to coordinate their efforts more closely with those of state bank and thrift supervisors. In addition, under section 221 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), the FFIEC is required to review the policies and procedures and the recordkeeping and documentation requirements of its member agencies that are needed to monitor and enforce compliance with laws under their jurisdiction. The purpose of this review is to identify burdens that could be removed without diminishing compliance with or enforcement of consumer laws or endangering the safety and soundness of insured depository institutions. This review is well underway. Only last week the FFIEC held public hearings on regulatory burden in Kansas City and San Francisco, and another is scheduled here in Washington later this week. A final report to Congress on this effort should be completed by the December 19th deadline specified in the Act. Reducing Burden for Well-Run Banks Mr. Chairman, you asked that I address how burdens could be reduced for well-run banks. The short answer is that, given the objectives of each statute and regulation, a better case to be made is that regulations with excessive net costs should be eliminated or reduced for all. We cannot make the case, for example, that call reports, examinations, basic prudential standards, reserve requirements, anti-trust, 9 truth-in-lending, truth-in-savings, etc. should not apply only to some banks if they apply to any. There are, however, some burdens that could be lessened for well-run institutions. Risk-based deposit insurance premiums will distribute the cost of deposit insurance more fairly among healthy and riskier banks, but there are practical limits to both the level and the range of premiums to ensure that the burden on troubled institutions does not in fact hasten their demise. The application process for acquisitions by bank holding companies offers another area where requirements could differ on the basis of an institution's overall strength and condition. For example, a notice requirement could be substituted for formal applications to conduct activities permitted by law and regulation, provided that engaging in such activities leaves the bank or other appropriate entity well-capitalized. More generally, in its reform proposals last year, the Treasury advocated that restrictions on additional activities be relaxed for bank holding companies with well-capitalized bank subsidiaries. These included nationwide interstate branching, insurance sales and underwriting, and full investment banking powers for such banking organizations. strongly supports this approach. As you know, the Board Well-capitalized banks rely far less on the safety net and thus should be permitted a broader range of activity. Changing technology and the public benefits of wider competition are important factors that led to the Board's support. In addition, the reward of expanded powers for 10 well-capitalized, well-managed banks would provide a powerful incentive for banks to build and maintain their capital and be managed prudently. Potential to Reduce Burden Without prejudging the results of regulatory reviews currently underway, it seems clear that if regulatory burden is to be reduced significantly, legislative changes are needed. In the final analysis, Congress must revisit its general approach to developing banking laws by establishing a more direct process for balancing the benefits of proposals with the burdens they impose. In the Board's view, as I have noted, the net burden on all banks has increased significantly in recent years. As I noted, small banks find paperwork costs particularly burdensome because of staff limitations. While excessive burden should be lifted wherever it exists, perhaps special consideration could be given to reducing the volume of paperwork required of them. To reduce on-going regulatory burden more generally, the Congress ought to take steps to avoid legislation that requires the imposition of regulations at the micro-level. The growing practice of stating specific standards in statutes or requiring, by law, that banks adopt detailed operating procedures developed by the regulatory agencies eliminates flexibility that is important in a dynamic industry that is competing on an international basis. Sound supervisory standards can be 11 developed and enforced without minutely detailed regulations in all areas. Let me use FDICIA as an example of Congressionally imposed burdens of this kind. Virtually every observer finds difficulty with the section 132 "tripwires" that require standards to be established by banking agencies specifying operating procedures for information systems, loan documentation, minimum ratios of market-to-book values, and the compensation of bank employees. The Board understands the frustration of Congress at providing federal borrowing to replenish the FDIC fund, but such a response creates more cost than benefit. Each of these issues can be addressed in the supervisory process without the need for detailed implementing regulations. Similarly, reimposing deposit rate ceilings for lessthan-well-capitalized banks runs the risk of distorting bank decisionmaking and creating exactly the inefficiencies that the Congress sought to remove through the Depository Institutions Deregulation Committee. The same objectives intended by the reimposition of deposit rate ceilings in FDICIA could be obtained, at much less cost and with greater flexibility, by a simple Congressional instruction that supervisors use their cease and desist powers whenever banks offer deposit rates that are inconsistent with safe and sound banking practices. Still another example is FDICIA's requirement that the Federal Reserve develop specific regulations imposing limits on interbank liabilities. Far less costly, and achieving the same 12 results, would be a general instruction to supervisors to evaluate carefully such interbank exposures. Indeed, in drafting our regulation to implement this provision of FDICIA, the Board has attempted, within the limits of the law, to focus on a bank's own evaluation of its interbank risk. While not a micro-management issue, I would also note the unusually high reporting burden imposed by FDICIA in the requirement that banks report detailed data on their loans to small businesses and farms. The Board and other government agencies would find the information helpful for policymaking, but bank accounting systems simply do not lend themselves to providing this information in an easy way. Yet the law requires that we collect these data from every bank on the call report. Some balancing of burden and benefit is clearly called for in this provision. I might also add that, regardless of their societal benefits, one cannot help but be impressed with the frequency and intensity of complaints by banks of all sizes about the heavy burden of Community Reinvestment Act paperwork costs— and those that will be involved in impending Truth-in-Savings Act requirements. I have just returned from hearings in several cities around the country and was particularly impressed with the intensity of bankers' concerns about the burden of these requirements— requirements that they note are not imposed on their nondepository rivals. 13 Bankers also cite the frequency with which statutes and regulatory changes are made. Experience with the Truth in Lending Act provides an excellent example of this point. Congress completely revamped the Act in 1980 as part of other legislation, and the Board rewrote its Regulation Z in 1981 to implement those changes. In 1984, the Congress changed the way credit card surcharges were to be treated under the law; in 1987 it added a requirement that variable interest rates be capped; and in 1988 it added two extensive sets of new requirements, one dealing with solicitations of credit card customers and one dealing with home-secured lines of credit. Furthermore, there are currently at least three bills under consideration that would amend the Truth in Lending Act again this year. The sheer volume of banking laws and regulations suggests that occasional amendments will be needed. But efforts to avoid what appears to bankers to be constant changes would help a great deal. Balancing the objectives Congress had in mind in enacting these provisions— and many others— against their burden is not an easy task. One potentially promising approach for resolving such trade-offs may be to establish a nonpolitical commission to address a broad range of banking issues and offer guidance for legislative and regulatory change. Such a commission could have as a specific goal assessing both the domestic and international competitive position of U.S. banks and the reduction of regulatory burden. 14 Conclusion In closing, while the Federal Reserve strongly supports efforts to reduce regulatory burden, the prospects for meaningful reductions seem small without legislative relief. The most immediate step the Congress could take would be to repeal certain segments of FDICIA before they take effect, provisions such as section 132, the effective reimposition of Regulation Q, limits on interbank liabilities, and the burdensome reporting of information not easily available to banks. In that way, not only would Congress be reducing burden, it would be limiting the imposition of additional burden and sparing the industry the initial compliance costs. Longer term, we welcome the Congressional awareness of this issue that this hearing confirms. We also look forward to assisting this Committee in the future to identify ways to reduce regulatory burden and avoid future additions.
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