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For release on delivery 10:00 a.m. EDT June 4, 1986 Statement by Manuel H. Johnson Member, Board of Governors of the Federal Reserve System Before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the Committee on Banking, Finance and Urban Affairs United States House of Representatives June 4, 1986 I appreciate the opportunity to appear before the Subcommittee today on behalf of the Federal Reserve Board to discuss H.R. 3567, the Depository Improvement Act and H.R. Institutions Examination 2282, the Truth in Savings Act. I will begin by offering the Board's evaluation of H.R. 3567 and then turn to H.R. 2282. posed The Board's responses to the questions in Chairman St Germain's letter of May 27, 1986, are appended to this testimony. The purpose of the proposed legislation is to improve the quality of depository institutions supervision by assuring that the federal compensation personnel, programs supervisory and benefits agencies to attract provide and retain by improving the efficiency of and by providing supervisory agencies. for the adequate competent examiner certification We are in agreement with training of state the basic objectives of the proposed legislation, and have taken steps to achieve many of them. We do have reservations concerning the arrangements the bill would establish to accomplish certain of the objectives, however, and I will discuss them as I proceed. With respect to the major provisions of the bill that would exempt the supervisory agencies from federal civil service laws and the federal budgetary process, we would point out that the Federal Reserve is already exempt from these constraints under specific provisions of the Federal Reserve Act. Accordingly, the Board believes that the Federal Reserve should be excluded from this portion of the bill. At the same - 2 - time, the Board supports the legislation insofar as it applies to the other supervisory agencies. The legislation will provide them with the flexibility necessary to establish their own employee compensation programs and budgets and thereby enable them to maintain a qualified examination and supervisory staff. The Examination proposed Council legislation to conduct would regional also require the studies of private sector pay scales and employee benefits for jobs comparable to those of federal examiners. The Council would report the results of these studies to the federal regulatory agencies, which would be required to take them into account in setting pay scales for their personnel. Under existing practice, the Federal Reserve Banks, which employ substantially all of the System's examiners, set their salary levels commensurate with those being offered by banks and other financial institutions in their local areas. In determining what the local salary levels are, the Federal Reserve Banks conduct surveys that are essentially the same as envisioned for the Council. The Federal Reserve would be prepared to share with the Council the information that the Reserve Banks gather. out, is that, while Our survey experience, we would point the federal pay scale is below going compensation levels in certain sections of the country, significantly above local levels in other sections. it is - 3- As important as the issue of examiner compensation is, it cannot be considered without regard for the continuing need to control costs government-wide and to achieve budgetary savings consistent with the Gramm-Rudman-Hollings legislation. Although the Federal Reserve System is not covered by Gramm-Rudman, Chairman Volcker has stated the Federal Reserve System's intention to comply voluntarily with that legislation. revised to meet Gramm-Rudman Accordingly, the for 4.3 other reductions were made by commitment to budgetary the Board's percent government restraint, 1986 budget reduction agencies the Reserve mandated and Banks. the the spirit of by comparable Despite Federal was this Reserve is increasing the number of its on-site examinations and hiring additional examiners to help conduct them. These measures are, in our opinion, necessary to meet growing supervisory concerns regarding banks and bank holding companies that are under the Federal Reserve's regulatory authority. Because of these concerns with supervision, we support the bill's objective to provide the other supervisory agencies with adequate budgetary flexibility to meet increased requirements for bank supervision. It is, of course, particularly difficult to strengthen our supervisory function at a time when our overall budget is being reduced. Of necessity, we have expanded the supervisory function by less than we had planned and, to meet the added expenses of the expansion that has been accomplished, have had - to make cuts Congress 4 - in other areas of our were to provide the other budget. Thus, agencies with compensation and budgetary authority, we would from salary this action in setting our own if the Jjlexible take guidance and budgetary policies. The proposed legislation would also provide development of a proposal examiner would to consolidate all training programs under require that the federal for agency the Examination Council and Council study the feasibility of establishing a graduate education program for examiners. understand it, the Council har- the- concept of under authority, a program. from offering such respect to consolidating all other examiner As I a graduate education program under study ano1 is not, restricted the its current training With in the Council, we believe that in addition to the present schools the Council conducts for all the agencies, serious consideration should be given to having the Council assume responsibility for conducting certain "core" courses for examiners. short, however, of having the Council responsibilities activities and for the agencies. responsibilities assume all educational Each that agency require training for its examiners — for example, holding and company examinations. the inspections Thus, flexibility Edge it is essential to offer special training needs. their own We would stop has unique specialized in the area of bank Act corporation that the agencies courses to meet retain their - 5 - The proposed legislation would also direct the Council to establish standards for judging the adequacy of state supervisory agencies and to conduct reviews of individual state supervisory departments to determine whether should rely on their examinations. federal agencies It seems more appropriate to have the federal supervisory agencies ultimately charged with the responsibility for ensuring the safety and soundness of state institutions assigned the requisite for certifying the states. portion of establish the the proposed necessary legal authority Thus, the Board cannot support this legislation because interrelationship of it does authority not and responsibility. I would point out that the federal agencies that have statutory supervisory responsibility over state-chartered institutions already have in place programs to coordinate their supervisory Reserve, efforts with state authorities. The Federal for example, has voluntary arrangements with several qualified states to conduct alternate examinations on an annual or more frequent basis. Furthermore, we have recently undertaken to expand its use of examination reports prepared by state examiners. I might add that the Federal Reserve System has also taken steps to help supplement the training programs for state examiners. The Board has authorized scholarship funds for the Education Foundation of State Bank Supervisors and instructed - 6 - the Reserve Banks to provide financial assistance directly to state bank examiners who attend Federal Reserve training schools. In summary, we support the main thrust of the bill to provide, where flexibility — needed, adequate compensation and budgetary authority the Federal Reserve already has — to assure a continued high priority for adequate supervision of the nation's benefits depository to be gained institutions. We also see certain from further coordinating the examiner training programs of the agencies. We do not, however, believe it is appropriate to vest in the Council responsibility for certifying the acceptability of a state's examination reports for use by the federal supervisory agencies. I would now like to direct the balance of my comments to the provisions of H.R. 2282. H.R. 2282 would address deposit account advertising and disclosures by establishing uniform requirements applicable to all depository advertisements institutions. regarding interest The rates bill calls to state an for annual percentage yield and an annual rate of simple interest as well as other factors. With respect to disclosures, depository institutions would be required to provide schedules of fees and charges for all existing accounts and prior to any changes in the schedules. Rule writing authority to implement these - requirements for all 7 - institutions is given to the Board of Governors of the Federal Reserve System. Since 1969, the Board has had regulations on advertising in Regulation Q. year, the Board proposed clarify, and This proposal simplify ("APY") a series of amendments its current advertising to update, requirements. service charges in At the same time the Board directed its staff the need for action on disclosure account information to bank customers. of and complete when is their accounts and detailed The Board also supports providing bank customers with clear they open issues such as requiring an annual percentage and a statement concerning advertisements. to explore In January of this addresses many of the same advertising covered by H.R. 2282, yield comprehensive planning information a Policy Statement encouraging disclosures by member banks. In considering this Policy Statement, the Board has taken into account that the level of information provided to bank customers has been high. Over the past two years, only approximately 4 percent of the total complaints received by the Board on member banks pertained to advertising and disclosure issues similar to these contained in the bill. Moreover, January 1986 Survey of Consumer Attitudes conducted for a the Board by the University of Michigan indicated that 94 percent of current deposit account owners felt that they had received the information that they needed to know about the terms and - conditions of their 8 - accounts. Eighty-two percent of the families who opened a checking account and 73 percent of those opening a savings account in the past two years reported they had received a written explanation of the terms and conditions of their new account. Although the survey did not provide information on the nature of the disclosures made form, in written it did indicate that a significant majority of consumers are receiving what they believe to be adequate disclosures on their accounts in written or oral form. While H.R. 2282 would have the advantage of extending uniform advertising and depository institutions, thrift disclosure to all including member and nonmember banks, institutions and credit flexibility. requirements unions, it may unduly limit In particular, by attempting to establish uniform requirements applicable to all accounts, H.R. 2282 does not allow sufficient latitude to tailor advertising and disclosure requirements to individual account characteristics individual customers' use of accounts. and For example, H.R. 2282 requires advertisements regarding the rate of interest payable on an account to state the annual percentage yield the annual rate of simple interest. ("APY") and Similarly in its January proposal, the Board included three alternatives for advertising interest on deposits: simple interest, or an APY, or both. While the Board's Consumer Advisory Council supports requiring both the APY and the simple interest rate, public commenters - were divided as to which 9 - alternative Given this difference of opinion, was most appropriate. flexibility may be required in determining if the same requirements should apply to all. Other regulatory advertising provisions flexibility in requirements. of H.R. 2282 may establishing also clear hamper and It may be unnecessary simple to require advertisements containing annual percentage yields to refer to the method of compounding or to require advertisements to state the method concerning elements of paying account interest. charges characteristic of Similarly, required the by H.R. 2282 transaction penalties, and might be refers accounts, transaction fees, and elements of time deposits, withdrawal statement simplified such to as such as early to avoid confusing bank customers as to the charges applicable to their account. With respect to disclosures, H.R. 2282 could be read to require depository institutions to provide customers with schedules of fees and charges applicable to all accounts and services and a description schedules when account of all changes terms are changed, in the previous even through such schedules may not be applicable to the customer's account. order to avoid confusion, limited to changes disclosure in information requirements relevant deposit relationship with the institution. should In be to a customer's 10 - Allow me, at Board this position. The disclosure by depository - point, supports to clear reiterate advertising institutions and our basic and full has proposed for comment amendments to update and clarify its advertising rules and is working toward a Policy Statement disclosures by member banks. that will address As both of these efforts would be limited to member banks, the Board is consulting with the other regulatory agencies in an effort to obtain a uniform application of these concepts to all depository institutions. While we are not seeking legislation, if Congress believes that legislation uniformity agencies, is the necessary Board to believes achieve that the legislation provide a more flexible statutory mandate. the Board benefits to structure as new rules that types of deposits among would evolve the should This would permit enhance while customer minimizing customer confusion and the burden on depository institutions. Responses to Questions Posed in May 27, 1986 Letter of Chairman St Germain 1. In your view, are the employees of your agency public sector or private sector employees? Are the examiners in your agency public sector or private sector employees? The Federal Reserve Board is best characterized as an independent agency of employees are public the United sector States, employees. and as While such the its Federal Reserve Banks, which employ substantially all of the System's examiners, are organized in corporate form and their shares are held by members banks, United States and they act as their officers instrumentalities of the and employees, in this capacity, carry out specific public functions under statutory author ity. 2. What specific salary and benefit provisions in present law are lacking in order to retain examiners in your agency? Is it possible to keep financial institutions regulatory agency personnel subject to civil service pay scales, generally, but to provide certain limited exemptions where needed? As I have noted above, Federal Reserve examiners are employed by the Federal Reserve Banks and thus are not subject to federal civil service laws. However, by policy we have kept the salaries of our Federal Reserve Board personnel consistent with federal pay scales. The same policy has also had some effects on the scale of compensation offered Banks. Thus, at the Reserve should the Congress provide more compensation flexibility to the other agencies than they now possess under laws governing the Federal civil service and the budgetary - process, the System would 2 view - this action as providing guidance for its own policies. 3. The Gramm-Rudman legislation only applies to the regulatory agencies when a sequestration order takes effect. Every effort is being made by the Congress to meet the FY 1987 budget deficit target of $144 billion. In the present situation, there is unlikely to be a sequestration order until October of 1987. In light of these circumstances, where is the immediate necessity for taking examiners out from under Gramm-Rudman until other factors develop that may require such measures? While it is true that the agencies only come Gramm-Rudman as sequestration takes place, under the agencies cannot ignore the potential for sequestration in setting their hiring and budget policies. The Federal Reserve too must be sensitive to these possibilities, since it is now voluntarily complying with the spirit of the Gramm-Rudman law. Thus, in light of the need to strengthen the supervision of depository institutions, additional compensation and budgetary flexibility, where needed, would promote a more effective set of employment and budget practices. 4. Will raising the pay levels of federal examiners cause state regulators to lose many of their examiners? Certain states may already have lost some examiners to federal agencies because the current federal civil service pay scale substantially exceeds the pay levels for examiners in a number of states. The broader problem facing these states, - however, is competitive Moreover, 3 - that their compensation with those offered if compensated employees in (adequate, in some from levels the states the are also private are not standpoint sector or at other levels of government), sector. adequately of retention in the face of higher wages offered not employee in the private this should not be permitted to interfere with the efforts of any federal agency to attract and retain qualified personnel. 5. Is there a problem with turnover rates at your agency with personnel other than examiners? If so, please explain fully. While the Federal Reserve Banks are able to establish salary levels to meet the competition, we are experiencing increasing difficulties in retaining examiners, particularly in certain areas of the country. We are also losing some key Reserve Bank people to the private sector in other functions of the bank. In recent years, retaining experienced the Board has also had a problem personnel. encountered difficulties In in retaining financial analysts and secretaries. particular, attorneys, we have economists, Many experienced employees in these job families are leaving the Board because they were offered substantially higher salaries and because they were unwilling to invest their future here when the prospects salary growth are severely restricted. for - 6. 4 - What would be your alternative to the approach taken the latest version of the Carper/Lundine bill? As indicated in my testimony, the Board supports the main thrust of the bill with regard to providing federal supervisory agencies in appropriate compensate their examiners competitively. the other authority to ANALYSIS OF H.R. 2282 Prepared by the Staff of The Board of Governors of the Federal Reserve System H.R. 2282 would provide for a single regulatory agency to promulgate regulations on the advertising of interest-bearing deposits and on the disclosure of terms and conditions applicable to offered depository institutions. by deposits and services The bill routinely as written presents a number of significant issues. Section number of 3. factors Section 3 requires the statement of in "each advertisement, announcement, a or solicitation made by any depository institution regarding the rate of interest which is payable on any account." The legislation appears to require the same mandated statements in all media — newspaper, billboards, radio and television. The staff believes that such a requirement may inhibit advertising in various media such as radio and television where the time constraints inherent in short advertising spots may limit the information that can be provided. The bill should provide the flexibility to tailor rules to different media. This issue was raised in the Board's January proposals to amend Regulation Q advertising rules and flexibility was supported by the majority of commenters who addressed this issue. ° 3(a) — This section interest-bearing advertisements appears deposit for demand to apply accounts. deposit only to Consequently, accounts may not be 2 - covered. - Some advertisements may be misleading. for demand deposit accounts For example, an advertisement for "free checking" may be misleading when there is a minimum balance requirement to avoid service charges. of the disclosure appears to provisions encompass Further, the scope in section 4 of demand deposit the bill accounts. Consideration should therefore be given to also including demand deposit accounts within section 3. 3(a)(1) — This provision would require the statement of an annual percentage yield interest ("APY") is compounded. reference to the If and the method by which the APY compounding method is required, can be the deleted. Compounding methods are reflected in the calculation of the APY. 3(a)(3) — Advertisements would be required to state the frequency with •depositor. which interest Inclusion of advertisements and is this usually would be payable information may of little to a "clutter" importance to depositors when viewing advertisements. 3(a)(4) — Minimum balance requirements would be required to be stated. It is unclear whether the "minimum balance" required to be stated account, avoid the is that balance needed to open an imposition charges, or earn interest. that member banks state of penalties or service The Board currently requires in advertisements any minimum balance required to earn the advertised rate of interest. - 3(a)(6) — 3 - This provision mandates language to be used in advertisements concerning the presence of early withdrawal penalties and statement is too restrictive would service charges. confuse consumers. The staff believes and overbroad the in scope and Early withdrawal penalties are solely a function of time deposits and do not apply to transaction accounts. On the other hand, transaction accounts are subject to service charges which generally are not assessed against time deposits. The mandated statement would these cause confusion by blurring distinctions. Staff believes that a more generic statement such as "this account is subject to service charges" or "service charges on this account may reduce your yield" are more appropriate in an advertising context. Of the 66 commenters addressing this issue in the Board’s January proposals, use of a statement such as the 55 supported first one quoted above, although several of these commenters expressed the opinion that the statement was not strong enough or sufficiently detailed. Current Board regulations require a statement concerning the early withdrawal penalty. 3(a)(7) — This section would permit advertisements for accounts with maturities of less than one year to exclude APYs. If APYs are included, then a specified concerning the yield would be required. this section be deleted structure appropriate and flexibility regulatory statement Staff recommends provided requirements. to Exclusion 4 - of an APY consumers' for - shorter-term time deposits would ability to compare deposits of various limit types. Further, the statement appears to be overly long and could be simplified. 0 3(c) -- This provision requires that written summaries of the information request. required by section 3 be provided on Staff believes this issue is more appropriately addressed under section 4. Section 4 . This section establishes detailed disclosure requirements as well as procedures for maintaining and disseminating the required information. 0 4(a) — Under this provision, each depository institution would be required to maintain a written schedule of "all fees, charges, and terms and conditions which apply to each type of account and service depository institution." routinely offered Although specified disclosure factors present no major is concerned that broader than intended. provide consumers accounts. require inclusion the scope information as drafted, of of issues, section 4(a) The purpose of this bill adequate However, such A list of charges to be included in the schedule is also in the provision. staff by all concerning section 4(a) routinely offered the the is is to their appears to services, including those services involved in correspondent banking relationships and large commercial accounts schedule. in a single Even more retail oriented services may not be - 5 - appropriate for inclusion in a schedule when they are not used by the customer receiving the schedules. The regulator charged with promulgating regulations under the Act should be given sufficient flexibility to make these distinctions, or, amended in the alternative, to require separate the bill should be schedules with information limited to particular types of accounts in each schedule. 4(b) — This provision requires that the written schedule be given to all depositors, each potential customer, and any individual who requests it. Further, section 4(b) (2) would require a new schedule with an explanation of changes to be mailed to account holders not less than 30 days prior to the effective date of any change in the schedule. Written schedules of fees and prior notification of changes in such fees are important pieces of information which should be given affected depositors, however, the bill as written may, in fact, work to the ultimate detriment of consumers. As embodied in the case of in section 4(b) section 4(a) , the principles can be retained by allowing for separate schedules for each type of account.' For example, depositors would receive a schedule of fees and terms and conditions that is relevant to their relationship with the bank. with A depositor that does not have a transaction account a depository institution would receive demand deposit disclosures. consequently not ICE depositors decide - 6 - to use a service or open an account other than one that they have already received information on, the depository institution need only provide the necessary information at that time. only Further, those changes provided to him. targeted disclosure would mean relevant to the depositor that would be Consideration should also be given to requiring prior notification only of changes to an account relationship that are adverse to a depositor. Prior notice of adverse changes would permit depositors to take whatever steps they account, deem appropriate, such as changing their before the effective date of the change. We do not believe that such a concern is warranted where changes are favorable to a depositor, however. a prior notification requirement In such instances, would appear to only increase costs without any increased consumer benefit. a potentially • Right analogous to Financial situation, Privacy Act coverage of the Act due, Congress to limit amended the scope (In the of in part, to an estimate that the cost of notifying all customers of their rights under the Act would be approximately $922 million.) Section 5. This section authorizes the Board to promulgate regulations to effectuate the bill's provisions. further requires that any regulations provide that APYs calculated on the basis of a 365-day period. The It are staff believes this latter provision is unnecessary because it would not improve a consumer's shopping ability. APYs calculated - 7 - through the use of uniform formulas, such as those contained in the current Board proposal, will produce the same rankings among institutions using different compounding methods as would APYs that have been "converted" to a 365-day basis. ° 5(b) (2) — The grant of authority to make special rules for particular kinds of accounts should be broader than merely prescribing uniform rate calculation flexibility may also be needed for variable variable. rate Thus, for example, includes a requirement accounts Special in determining the proper advertising and disclosure rules. Board's current proposal methods. state that the the that ads rate is Such a provision may also be needed under this law and the Board should have sufficient flexibility to adopt it. ° The bill, as drafted, between state the proposed laws. Since does not address disclosure the bill the relationship provisions would cover and existing institutions already subject to state disclosure laws, it should clarify Congress' intention with regard to those laws.