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/ 0 ST/* ™ r ( DEREGULATION AND BANK SUPERV] PRESENTED TO COMMERCE, CONSUMER, AND MONETARY AFFAIRS SUBCOMMITTEE M OU t> d--COMM ITT EE ON GOVERNMENT OPERATIONS H W S e - e M Æ f >R fô E ffF A T W ê S BY & . L. WILLIAM SEIDMAN CHAIRMAN FEDERAL DEPOSIT INSURANCE CORPORATION Room 1310, Longworth House Office Building April 22, 1986# 1 :00 p.m. Mr. Chairman, members of the subcommittee, I am pleased to have this opportunity to present the FDIC's views on the adequacy of our current banking laws. Your initiative to evaluate the fundamental premises underlying much of our present banking legislation is commendable. I. Background As a starting point, I believe that we must continue to accept the propo sition that banks, as providers of insured deposits and as key participants in the nation's payment system, play a "special" role in our economy. there is a security strong for demand their insurance at our security. This, the insurer. by depositors hard-earned nation's in savings. banks turn, for institutions The existence for deposits necessitates a that can of federal First, provide deposit up to $100,000 provides supervisory presence to this protect Second, it is also clear that the failure of our banking system could have severe implications for our nation's economy and indeed for much of the world economy. By accepting the view that banks are "special" in these two ways, we implicitly acknowledge that banks or, more generally, depository institutions, require some level of government regulation and supervision from which nonde pository institutions are exempt. The primary objectives of such regulation and supervision should be to provide a safe place for the funds of savers, to provide an efficient financial resource system, and to assure the continued soundness and stability of the financial system. Additional secondary objectives include controlling conflict-of-interest abuses, ensuring adequate levels of competition. consumer protection, and maintaining vigorous and equitable 2 - While until there may have been - certain inadequacies in our banking laws, recently the system has been stable and there was little pressure for legislative reform. Significant changes Our more recent in our financial of pressure on our nation's banks. communications experience has been environment are putting Technological and changing economic conditions stimulated competition among financial to the development of a financial different. a great deal advances in computers and have allowed many nondepos itory institutions to provide bank-like services. ers have quite These new nonbank provid institutions and contributed marketplace that is much more responsive to consumer preferences. New developments have benefited the general public and investors. Small savers, who for years were forced to subsidize borrowers by accepting artifi cially low return. interest rates on their deposits, now receive market rates of Investors now have a much wider range of investment opportunities available to them. For example, the so-called "securitization of bank loans has provided a mechanism through which financial institutions can spread risks, reduce costs, and facilitate the flow of funds from savers to spenders. Many formerly illiquid assets, such as mortgage and automobile loans, are now being packaged and sold to investors in a form that suits their needs. In turn, these new investors liquidity and enlarge the pool result, financial institutions provide financial of funds available enjoy reduced risk institutions with greater in those markets. and lower costs and As a the general public benefits from expanded investment opportunities. We fully recognize that new market opportunities also create risks for -3- some banks. latory Thus, we must proceed carefully in assessing possible new deregu- initiatives. at a time. We should adopt a measured pace, proceeding We must also place a premium on bank supervision, one step in order to forestall excessive risk-taking and insider abuses that could threaten stabili ty in the banking system. mission high priority. As FDIC Chairman, I intend to give our supervisory This is not reregulation — it is safety supervision of a partially deregulated system. II. New Powers New powers for banks can improve the system. We believe that banks should be allowed to exercise limited new powers in order to remain viable competitors in the financial services marketplace. The new powers we propose would authorize banks to underwrite and deal in mortgage-backed securities, commercial paper, and municipal revenue bonds. We also believe banks should be allowed to sponsor mutual funds. These new powers are a "natural fit" for banks. Authorizing banks to underwrite and deal in mortgage-backed securities would afford banks greater flexibility in an area where they have developed significant expertise. It is a natural loans to package those loans and sell however, are largely prohibited extension of writing home mortgage them to interested investors. from underwriting and dealing Banks, in mortgage- backed securities. Banks also should be permitted to underwrite and deal in commercial -4- paper. Increasingly, the larger and more creditworthy business firms choose to raise funds by issuing their own commercial paper rather than by borrowing from banks. by the Banks' securities efforts to industry. lucrative and safe activity, compete If banks in this are area excluded have from been this challenged potentially they must attempt to stimulate loan demand in other, perhaps more risky, areas. Today, banks are unable to sponsor mutual funds. ingly difficult for them to compete in the growing This makes it increas IRA and Keogh markets. Banks can act as agents in joint ventures with securities firms to sell mutual funds, and while this helps, banks are effectively prevented from obtaining a full share of income from this lucrative activity. Moreover, banks should be permitted to underwrite and deal in municipal revenue bonds. The most likely reason why banks were not given explicit authority under the Glass-Steagal 1 Act to underwrite and deal in such bonds is that they were virtually nonexistent at that time. to underwrite general obligation bonds and some revenue bonds issued by states and municipalities. However, over the years, general obliga tion bonds bond market. and deal have in Banks are permitted comprised a smaller and smaller portion of the municipal As revenue bonds have grown in importance, banks increasingly have been left behind. I don't mean to suggest that new powers for commercial banks are a panacea that pose no additional risks. As the links between various types of finan- -5- cial services are expanded, there is more opportunity for abuse. tial that banks be granted new powers. soundness concerns demand this. It is essen Competitive equity and safety-and- However, it is also essential that, as new powers are granted to banking organizations, adequate levels of bank supervi sion and appropriate safeguards are put in place. Ill. Role of Supervision and Safeguards Let me turn first to supervision. As deregulation proceeds and as the links between banks and the providers of other types of financial and commer cial products grow, 'the need for adequate levels of bank supervision increases rather than decreases. One of the byproducts of a competitive marketplace is that not all firms achieve financial success. are losers. There are winners and there It seems likely that there will be more problem banks and more failed banks than in years past when banks were insulated from competitive pressures. This alone suggests a need for increased levels of bank supervi sion. Not only must regain its profitability, closely. owners regulators take they must steps to monitor help the a problem bank's institution actions much more This increased level of supervisory attention is necessary because of incentive a bank experiencing to engage in financial self-dealing difficulties or other forms will have of dishonest a greater behavior. To the extent that a problem bank has links to other financial or commercial enterprises, there will be an even greater potential for abuse. Of course, the discipline supervision on banks. of the marketplace Shareholders imposes its own form of have an incentive to monitor management -6- performance, in order to prevent self-dealing and related abuses that could destroy the value of their stock. The disclosure provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934 enhance the effective ness of shareholder monitoring. Government supervision should complement, not supplant, such market-based discipline. In sum, activities as deregulation become more proceeds, intertwined, and as we will various need supervision and more sophisticated supervisors. is to keep pace with fast changing events, supervisory system remain independent. types increased of financial levels of bank However, if bank supervision it is essential that the bank After 36 years, the Office of Manage ment and Budget has suddenly asserted new (and we believe unfounded) jurisdic tion over the FDIC, the Comptroller of the Currency, and the Federal Loan Bank Board under the Antideficiency Act of 1950. move immediately to exempt the three Federal control the in order regulators' to maintain operation. In independence, doing so, Home The Congress should institutions from asserted 0MB competence, the Congress and flexibility is well aware in that the regulatory agencies are self-funded and do not require taxpayer dollars. Oversight of agency budgets should remain under the Congress. Let me now address some of the safeguards that may be needed as banks are granted new powers. In some instances, the FDIC has already implemented safeguards for banks that wish to conduct new activities. engage some in Glass-Steagall securities Act. activities prohibited Nonmember banks to member banks under the State-chartered banks often have much broader authority |/- to engage in activities such as real estate investment and insurance underwrit ing. As a general activities of rule, banks in the FDIC separate has sought subsidiaries, requirements and other restrictions. to segregate the nonbanking subject to separate capital Bank participation in these new activi ties is beneficial to the general public and enables banks to compete fairly with their nonbanking rivals. At the same time, we believe that a certain degree of insulation between the bank and its nonbank activities is desirable to help reduce risk and safeguard against abuse. Separating the bank from its nonbanking activities does not eliminate all risk or potential for abuse, but it is an important safeguard. and-soundness are reduced by such separation and it is easier for the concerns appropriate regulatory authorities to monitor bank Safety- activities. Limits can be placed on the financial dealings between banks and their subsidiaries or affiliates. organization In part, these limits can be used to ensure that the banking remains to work well, help deter adequately Congress must abuses. Finally, diversified. give the regulators If structural safeguards greater enforcement are powers to laws should also guarantee that there is adequate disclosure of information with which to assess a company's financial activities. IV. Emergency Interstate Acquisitions Before closing, I will briefly highlight one more area where legislative reform is necessary. Just as our changing environment necessitates new powers for banks, it requires additional authorities for bank regulators. Specifical- - ly, we 8 - propose broadening the bank acquisition provisions of the recently- extended Garn-St Germain Act of 1982. Our proposal would do four things. old of First, it would lower the size thresh a bank eligible for acquisition from $500 million to $250 million. Second, it would permit the acquisition of failing as well as failed commercial banks. Third, it would extend holding company systems as well the scope of theprovision to include bank as banks. Fourth, it would require equal treatment for acquiring banks in the state of acquisition. The specifics of our proposal -- which is supported by all of the bank regulatory agencies -- are set forth in my April 9, 1986 written testimony before the Subcommittee on Financial Institutions of the House Banking Commit tee. I refer you to that testimony for a more detailed analysis of this initiative. V. Conclusion At some point in the future, Congress may wish to consider more far-reach ing deregulatory changes. It may wish to evaluate research which suggests that safety and soundness would not be undermined by the relaxation of GlassSteagall Act, McFadden Act, and Bank Holding Company Act restrictions. Those issues are not, however, before you today. What we need here and now is action on two far more modest, cautious, narrowly-crafted reforms — increased powers and emergency interstate acquisitions. Congress to move forward swiftly in those two areas. Thank you very much. I strongly urge
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