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Regulatory Burden from a Regulator's Perspective
Address by
Lawrence B. Lindsey
to
The American Bankers Association
1993 National Regulatory Compliance Conference
San Diego, California
June 28, 1993

Regulatory Burden from a Regulator's Perspective
Thank you.
issue

of

It is a pleasure to be here today to discuss the

regulatory

burden

Reserve Board Governor.

from

the

perspective

of

a

Federal

My old friend Rob Rowe of ABA's Washington

Office tells me that most of you are responsible for reading and
interpreting for your institutions all of the new regulations we
are issuing.
it

will

On the assumption that misery loves company, I hope

make

you

feel

a

little

bit

better

to

know

that

my

colleagues and I have to read all of those documents before we send
them

out

to

you.

In

any

event,

I'm

sure

your

bosses

have

recognized all of the extra work you've been doing and have given
you a raise proportional to the increased paper flow.

No?

Well

maybe when you return you'll be sure to mention that you heard the
issue raised by a Federal Reserve Governor.
Unfortunately, the problem we face with the banking industry's
ever mounting

regulatory burden is no laughing matter.

As my

colleague John LaWare told the Congress earlier this year, "In an
increasingly global and competitive financial market, the U.S. can
ill afford to handicap its banking institutions -- and therefore
the individuals and businesses they serve

-- with stifling and

constantly changing rules and regulations."
Today

my

task

is

twofold:

to

provide

a

perspective

on

regulatory developments and to make some suggestions on what banks
might do to relieve some of the regulatory burden.

The focus of my

remarks will be on the types of regulations I deal with as Chairman
of the Board's Committee on Consumer and Community Affairs.
regulations

--

the

Community Reinvestment Act

(CRA) , the

These
Home

2
Mortgage Disclosure Act

(HJ4DA) , the new Truth in Saving rules, and

fair lending practices seem to be the primary focus of bankers'
complaints about regulatory burden.
is

important

to

put

these

rules

However, I do believe that it
in

the

larger

perspective

of

regulation generally.
Quantifying regulatory burden has become a bit of an industry
unto itself.

The ABA has estimated that regulatory burden in 1991

amounted to $10.7 billion, about 10 percent of operating expenses
and

59 percent

of profits.

The

IBAA rated

the

13 most

regulations as costing roughly 28 percent of income.

costly

The FFIEC,

Federal Financial Institutions Examinations Council has estimated
regulatory

costs

to

be

in

the

range

of

6

to

14

percent

of

noninterest expenses.
While I applaud these efforts to estimate regulatory burden,
all face a key methodological hurdle.
should

these

regulatory

costs

To what state of the world

be

compared?

Should

our

counterfactual baseline be the complete absence of regulation and
supervision?

I don't

mention

customers,

its

supervision.

wonders

so.

benefit

from

industry

itself,

safety

and

not

to

soundness
--

millions of checks and billions of dollars moving each night

--

some basic

of

The

our modern payments mechanism

requires

The

think

faith in

the soundness of

the

institutions

participating in the process.
Regulatory burden therefore emerges not from the mere presence
of a bank regulator engaging in a supervisory function.
suspect

that

in

the

absence

of

our

state

and

I strongly

federal

bank

3
regulatory bodies, the industry would adopt some kind of self
regulation.

Zero regulation is therefore not an appropriate

baseline for comparison. Realizing this conceptually, let us call
our hypothetical baseline level of regulation the "minimalist"
approach.
On the other hand, in recent years the banking industry has
seen a substitution of regulation for supervision.

Regulation

entails formal rules being codified and universally applied, and
thus

less

subject

to

institutional setting.

interpretation

given

a

particular

In addition, we have had a spate of

increasingly specific and prescriptive legislation which limits the
leeway of regulatory bodies in interpreting Congressional intent.
Far from being minimalist, we are on the verge of a maximalist
approach to regulation, where increasing amounts of the detail of
bank policies are being made in the legislative arena.

The

ultimate result of this maximalist approach is to turn banking into
the equivalent of a regulated utility.
Left unchecked, the end result of this process will be a
weaker and less resilient industry with fewer choices available to
the consumers of banking services.

The increasingly prescriptive

approach Congress has taken toward banking regulation is no doubt
well intended.

But nothing has been more obvious to me in my 19

months

Board

on

the

as

the

possibility

that

well

intended

legislation and regulation may have unintended, often pernicious
consequences.
Indeed, while those who would try to measure the regulatory

4
burden have a conceptual problem in seeking a base of minimalist
regulation, supporters of the maximalist view of regulation also
have a problem.

They implicitly argue that anything

that goes

wrong in the world must be the result of an inadequate level of
regulation.

Their view assumes that the ideal we must achieve is

an error free world.

They assume that a perfect world, with an

ideal set of regulations, is both achievable and desirable.
the

luxury

criticize

of

the

20-20
errors

hindsight
of

these

supporters

those who had

With

regulation

with

to deal

of

challenges

before the fact, not after the outcome was known.
Specifically,

let

us

consider

two of

the

regional

disasters of recent years: Texas and New England.

banking

Let me state up

front that in both instances there were some shady operators and
some folks who were downright foolish.
those

people

will,

if

the

system

either in court or in bankruptcy.

That is always the case and

works

right,

find

themselves

But in neither case were either

crooks or fools the majority of the players.

And in both cases

virtually an entire industry was wiped out.
In Texas,

the root cause of the collapse was a sudden and

unexpected decline in the price of oil from $30 a barrel to $6 a
barrel.

Granted, any banker who financed a deal on the assumption

that oil would go to $100 should be criticized.

But does that mean

that everyone should have had perfect foresight on the collapse?
Could regulators have predicted such a phenomenon?

In fact, the

U.S. Department of Energy did not foresee the collapse.
we

possibly

expect

even

the most

talented

and

How could

omnipotent

bank

regulator to have done better?
Or, consider New England, in which I had a bit of a personal
stake.
piece

In October 1988 I had published in the New York Times a
entitled

"Massachusetts: Miracle

or Mirage?",

opted for the mirage, a distinctly minority view.

in which

I

And so the next

Spring, my wife and I took the first offer we got on our house, in
spite of having the real estate broker tell me to hold out
more.

Given

the general

decline

in housing prices,

for

one of my

firmest wishes is never to run into the couple we sold the house
to.

Here was a case, in retrospect, of a clearly unsustainable

bubble based on a temporary defense buildup.
story

not

only

fooled

the bankers

and

Yet, the "miracle"

the bank

regulators,

it

propelled the Governor of the state to his party's Presidential
nomination, and led to glowing stories in the nation's media.
the stock market was fooled.

Even

Those New England banks which were

the most aggressive were trading at a premium as late as the Spring
of 1989.

Again, is it reasonable to expect even the most talented

regulator to have known better?
I therefore believe that the best role for a bank supervisor
to play is as a second opinion or second judgment.

I am told by

folks who have .been in the industry a long time that that is the
way it used to be; that many bankers often welcomed their examiners
as an opportunity to gain some additional insight.

Today it might

seem difficult to imagine that such a world ever existed.
it did, the term "regulatory burden" was not heard.
phrase would have been "regulatory benefit".

But when

The correct

6
The

proper

design

of

regulation,

from

this

regulator's

perspective, is to return wherever possible to this earlier model.
A second judgment, or second opinion,
perfect,

but

it

does

carry

the

comparison across institutions.

is just that: it is not

weight

of

experience

and

of

However, judgment ceases to be

such when it is mandated from above.

Judgment necessarily involves

examination of the detailed circumstances in which a given loan is
made.

When rules replace judgment, costs are incurred.
Consider

a

couple

of

examples.

Recently

the

Board

of

Governors and the other financial regulatory bodies proposed to
raise the threshold amount of a loan for which the use of certified
or licensed appraisers was mandatory from $100,000 to $250,000.
These appraisals relate to Title XI of FIRREA.
they were

costly

to banks and

As you all know,

their customers alike.

A

$500

appraisal on a $100,000 home with 20 percent down is the equivalent
of asking the buyer for another month's mortgage payment.
American families,

at

the margin,

could

not

because of the original $100,000 requirement?

How many

become homeowners

What was gained?

Do

we really think that the appraisers, even certified and licensed
ones, will predict the next Texas or the next New England?

Do we

really think that these people care more about the fate of a loan
than the loan officer whose job is at stake or the bank whose
profits are at risk?
Even more pernicious in my view were the regulations related
to loan to value ratios which were issued last year.

What we ended

up with was much improved over the original proposal.

The original

7
proposal,

for example, mandated maximum loan to value ratios on

single family owner occupied homes of 80 percent.

In other words,

every family would have had to put 20 percent down on their homes.
This would have devastated the ability of low and moderate income
families, who often have trouble coming up with closing costs, from
acquiring homes.

Our staff estimated that some 9 million American

families would have been frozen out of homeownership by the new
rules.

What were the benefits?

presented

that

a 20 percent

At no time was concrete evidence

downpayment

requirement

effective way of minimizing delinquency costs.
rule was changed.

was a cost

Fortunately, the

Still, we have established rules that treat all

farmland the same for loan purposes whether it is threatened by
wetlands

regulation

or protected

under

price

support

programs.

Surely this cannot be good regulation.
Why then do we have all this highly prescriptive legislation
in the first place?
sums it up nicely.

I think the phrase, "there oughta be a law"
We Americans, confronted with an outrage, seem

to instinctively seek legislative relief.

Frequently the outrage

to be legislated against is simply a symptom of a wider problem
which may go unsolved.
maximalist

Again,

the basis

interpretation of the

for comparison is the

"correct" state of nature.

If

something goes wrong, then the right approach is legislation to fix
it.
I believe that this is also the reason why we have recently
seen

a

revival

of

legislative

activity

There is no question that outrages exist.

on

the

consumer

front.

The maximalist response

8
to these outrages is legislation intended to make sure that these
problems do not happen again.
Consider a prime example which has recently come on line:
Truth in Saving.

This legislation had remained dormant in the

Congress for years.

But, during 1991, the practice of some banks

paying interest using what

they called

method" became widely criticized.

"the investible balance

The case for this method was

that reserve requirements limited the amount of any deposit that
could be invested in loans or securities.

So, given a 12 percent

reserve requirement, only 88 percent of the funds could earn money
for the bank.

These institutions decided to change policy and pass

this along to the customer.

So a 5 percent account using the

investible balance method would pay only 4.4 percent.
This is an outrage, and Truth in Saving moved through Congress
in large part because it outlawed the procedure.

Customers should

not be told their accounts pay 5 percent when in fact they pay 4.4
percent.

I would call this a true case of "Falsehood in Savings"

which Truth in Savings legitimately corrects.
Unfortunately, the law went further.

Its purpose, admittedly

well intentioned, was to make the stated yield on all accounts
comparable,

thus

allowing

comparison shop with ease.
regulations

is

that

life

the

consumer

the

opportunity

to

What we have learned in writing the
is

not

so

simple.

Consumer

saving

products differ not only in the rates of interest they pay, but in
the period of compounding used for those rates and the time at
which money becomes available on those accounts.

The result has

9
become nightmarishly complex as we search for a

"right" answer

where arguably there is none.
Let

me

Account".

give

an

example.

Two

banks

a

"5

Percent

One pays you $50 on every $1000 you deposit on the year

anniversary

of

your

deposit.

Another

automatically for $12.50 every 3 months.
same?

offer

sends

you

a

check

Are these accounts the

Both depositors have earned $50 at the end of a year.

if there is any time value to money,

But,

receiving $12.50 every 3

months is clearly better than waiting a whole year to receive $50.
Shouldn't the every 3 month account show a higher yield since in
effect,

the

questions.
reinvest

money

compounds

quarterly?

This

raises

other

Should it matter whether the customer has the option to

the

interest

in her

certificate

of

compound along with the original principal?
time value of money should be assumed?

deposit

and

thus

If withdrawn, what

The list of questions is as

endless as the possible number of ways to market a product.
Or, consider the phrase "free checking".

We can all agree

that this probably means no monthly maintenance fee or per check
charge.

But what about

the

fee for printing

checks?

account be "free" if it is subject to a minimum balance?

Can an
Does

having a free checking account automatically mean unlimited free
use of a bank's automatic teller machines?
other A.T.M.s?

What about free use of

The law requires us to give a definitive answer to

each of these questions.
Let me tell you, our phones have been ringing off the hook as
each permutation is questioned.

Here is an aspect of regulatory

10
burden that is not measured, and may not even be measurable.

If,

for example, we decide that a free checking account does not imply
free use of foreign A.T.M.s, then what happens to those banks who
offer this service?

Bank A, with free foreign A.T.M. service, gets

no advantage when Bank B can advertise an equally "Free Checking"
account without

that

service.

The market

result

is to reduce

customer service to the lowest common denominator -- that defined
by the regulator.
Furthermore, this loss of consumer benefit is not just a one
time static
permanent

loss when

loss of

the

rules are

implemented.

competition through

innovation.

There

is a

When a new

product comes along, say banking by phone or by computer, what
incentive does any bank have to offer the service if it is not
required by the regulator?
Let me give a second example of an outrage that is now in the
process of creating new legislation.

You are probably all familiar

with the stories arising out of Atlanta and Boston of abusive
lending

practices

Contractors

would

to

low

appear

repairs or cash loans.

and

with

moderate

"pre

approved

income
credit"

residents.
for

home

The actual contract terms often involved

outrageous points and/or interest rates and some of the individuals
involved lost their homes as a result.

The practice has earned the

name "reverse redlining".
I have met with some of the victims of these scams, and I find
the way these individuals were treated to be totally outrageous.
One loan was approved in which the borrower signed the disclosure

11

statement with an

n

X", instead of her name.

Another signed even

though her monthly payment was more than her income.

Tell me, do

you think that the person making that loan should be able to call
himself a "banker"?
involved

and

Even forget, if you can, the moral outrage

consider

only

responsibilities of the job.

the

safety

and

soundness

Surely the individuals approving

these loans must have had their suspicions aroused.
Of course, the Congressional response has been predictable:
legislation

designed

to protect

including more disclosures.

folks

from

abusive

practices,

Frankly, I have my doubts that any

amount of disclosure would have helped the lady who signed with an
"X" or even the individual who saw on the disclosure that her
monthly payment was more than her income.

I also testified that I

felt that some legitimate lending might be stopped by the law in
its present form.

But let me say that I fully concur with the

members of Congress who are totally outraged by such behavior and
are

frustrated

that

we have a banking

industry

that

let

such

practices occur.
One of my tasks today was to suggest how regulatory burden
might be reduced.

How can we prevent

the maximalist model of

regulation from reducing banks to regulated utilities?
suggested
Instead,

that

zero

regulation

I recommended

approach is judgment.

is

not

the minimalist

the

right

approach.

I have

alternative.
Key

to

that

We are in the process of substituting rules

for reason and punitive justice for judgment because reason and
judgment have not been used in the past.

No banker I know who used

12
reason

and

judgment

would

have

adopted

Method of compensating his customers.

the

Investible

Balance

No banker I know who used

reason and judgment would have actively solicited a high interest
loan from someone who is clearly unable to meet the payments.
So when we denounce the regulatory burden that we now face,
when

we

criticize

the

loss

of

incentives

for

innovation,

and

complain that it is the consumer who is paying the real cost of
excessive regulation, we had better have a workable alternative in
mind.

A

market

based

contradiction in terms.
does not

solution

which

is

full

of

abuses

is

a

A service industry, like banking, which

serve its customers, or which operates

in a vacuum of

reason and judgment will soon find the vacuum filled by legislative
fiat.
Before

ending

today,

I would

like

to

turn

to

the area

of

banking activity that I see as having the greatest potential for
further legislative and regulatory activity: fair lending.

It is

also the area in which the opportunities for the banking industry
are the greatest.

There is no area more fraught with emotion.

Nor

can I imagine anything more important to the fundamental values we
all

believe

in.

democratic society.
capitalism and

Discrimination

tears

at

the

fabric

of

our

It also tears at the fabric of our faith in

the market.

One of the great advantages of the

market is that it is supposed to be color blind.

If that turns out

not to be the case, then the foundations of our economic system as
well as our political system are at risk.
Recently, I was accused in the American Banker of engaging in

13
"politically correct theatrics" on this subject.

Those who know me

know that I do not have a politically correct bone in my body.
let

me

turn

to

the

facts and

the

reasoning

I use

to

So,

reach my

conclusions.
The Federal Reserve Bank of Boston ran what is certainly the
most comprehensive statistical analysis of lending patterns by race
that has ever been conducted.

That study found that what I would

call "old style" discrimination did not exist.
qualified

applicants

of

any

race

were

That is, clearly

approved

for

loans

clearly unqualified applicants of any race were rejected.

and

The days

when members of minority groups who meet all of a bank's criteria
for lending are rejected anyway, seem to be gone.

I believe that

is why bankers believe so strongly that they do not discriminate.
However,
statistical

what

the

comparison

study
of

also

applicants

found
who

was

that

were

less

a

careful

than

ideal

indicated that imperfect white applicants were more likely to be
approved

than

imperfect

black

applicants.

explanations for this have been advanced.

Three

types

of

First, some have argued

that the results are proof that racism still exists in our society
and in the banking industry.

From a statistical point of view,

there is no way that this hypothesis can really be tested.
be true.

It may

My own judgment is that while some racism may exist, it

is probably not the dominant factor in bank decision making.
institutions

in

question

all

have

stated

policies

The

against

discriminatory practices, and the extent of discrimination found,
which affects roughly 6 out of every 100 minority applicants does

14
not

comport with racism as dominating the process.

I say that

reiterating what I said above, that any amount of discrimination is
totally unacceptable.
The

second

hypothesis

is

that

there

is

no

racism

in

the

process, that in fact the banks have gotten their lending practices
about right.

What is missing from the Boston study is a careful

look at the long term default risks on these loans.

It is true

that the Boston study did not go into a detailed examination of the
actual loan files to see if some other explanation for rejection
existed.

Where this has been done, some of the disparate rejection

rate has been explained.

But, ultimately this hypothesis, like the

racism hypothesis, cannot be statistically tested.

We cannot tell

today what the ultimate outcome of the loans we make today will be.
So, like the first hypothesis, I accept that this one might well be
the case, but that the evidence before me today suggests that it is
not.
The

third hypothesis

is

that

some

racially disparate

loan

practices are occurring in spite of bank policies to the contrary.
This hypothesis not only comports with the Boston findings, it also
suggests

that

relatively

minor

adjustments

behavior will be appropriate remedies.

in

institutional

The Federal Reserve Bank of

Boston has recently put out a pamphlet on these remedies called
Closing

the Gap:

A Guide

to

Equal

Opportunity

Lending

which

I

commend to all individuals in the financial services industry.
Let me
appears

also

stress

outrageous

to

that

as

long

reasonable

as behavior

individuals,

exists which

the

threat

of

3.5

legislative and/or regulatory action, with all of its attendant
burdens remains likely.

Banks have a responsibility not only to

end the practice of discrimination, but end the appearance that
discrimination is occurring as well.
minority

As long as large numbers of

customers remain dissatisfied with the treatment

receive, greater regulation remains a likely prospect.
President
argued,

Jordan of

the

Federal Reserve Bank of

they

Or, as

Cleveland has

"This problem is not solved until everyone agrees it is

solved."
The prospective regulatory burden which will result from not
solving

this problem

is enormous.

The ultimate

remedy

is

to

completely replace bank judgment and reason about loan approval
with statistical rules.

I fear that in some instances, the use of

statistics to establish discrimination may go too far.

At the

Federal Reserve we are using computer based statistical models as
a part of our examination process.
used

to

closely.

select

particular

loan

However, these models are only
applications

to

examine

more

The statistical models in and of themselves will not, and

should not, be used to determine whether discrimination exists.
Instead,

the

computer will

select

individual matched

actual applications to be examined.
improve the

examination process by

pairs

of

We believe that this will
reducing

the

randomness

in

selecting applications to be examined.
The potential overuse and abuse of statistics in this area
threatens the imposition of a burden in at least two ways.

First,

the use of statistical models as the sole criteria when the details

16

of such models are unknown to the banks being examined means that
no bank can know what rules it actually has to comply with.

It

would be like replacing the speed limit on our nation's highways
with

some

computer

determined

"Conditions

Adjusted

Velocity"

formula in order to enforce traffic laws and not tell motorists
what the Conditions Adjusted Velocity formula was.

Laws can only

work if people know what they have to do to obey them.
Second, the likely result of statistics based examination of
loan approvals is statistics based approval of loans.

This, in

turn is likely to work against individuals who do not meet the
"normal criterion" of a one-size-fits-all statistical rule.

One

need only look at the historic performance of the secondary market
to

see

that

minorities

and

other

disadvantaged

groups

find

themselves only further disadvantaged by such a practice.
One returns to the ultimate limitations of legislation and
regulation as a form of industrial structure.

The foresight and

insights of the legislator and regulator are not apt to be any
greater than those of a normal, well meaning, individual.

Just as

a regulator could not foresee the collapse of the price of oil or
the end of the Massachusetts miracle, they cannot be expected to
foresee changing demographic or economic conditions.

The law of

unintended consequences will continue to hold sway.
The real solution to regulatory burden in this area, as in
other areas, is a return to reason and judgment.

In the purest

sense

an

of

the

word,

discrimination

means

profitable sale is passed up by the seller.

that

otherwise

This is not good

17
banking.

Although no one has ever established that markets work

perfectly in all instances,

markets do offer us the opportunity to

adjust to changing conditions, foresee the unexpected, and avoid
unintended consequences as well as any other system yet devised.
When public faith in the

and

inte 3 r it y

ot

the *e y p ^ e r s

in markets returns, so will a reliance on their reason.

When that

day comes, the issue of regulatory burden will take care of itself.