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BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM For immediate release July 16, 1947• STATEMENT OF CHAIRMAN ECCLES BEFORE HOUSE BANKING AND CURRENCY COMMITTEE ON H.R. 3351 .Mr. Chairman and Members of the Committee: The purpose of this b i l l (H.R. 3351) is to regulate bank holding companies so that their operations v i l l be i n accordance with established banking principles and public policy. This b i l l r e f l e c t s the Federal Reserve Systems experience over a period of approximately fourteen years i n dealing w i t h bank holding company problems. Since i t s introduction i t has been studied and appraised by various interested banking groups. With suggested technical amendments and others, a l l of which a r e acceptable t o the Reserve Board and none of which would a f f e c t i t s basic purposes, the b i l l conforms to recommendations made i n reports by the Fede r a l Advisory Council of the Federal Reserve System and by the Association of Reserve C i t y Bankers. I n a d d i t i o n , i t has the support of the two Independent Bankers Associations of the country and of the great m a j o r i t y of the major batik holding companies. The bank holding company problem is not a new one to the Congress. I n 1933> after extensive hearings which began in 1930, Congress recognized the need for and undertook to provide effective regulation of bank holding companies. As a part of the Banking Act of 1933, Section 51M of the Revised Statutes was amended by adding several new paragraphs applying exclusively to bank holding companies (called ^holding company affiliates 1 1 i n the amendment) and placing limitations and restrictions upon the right of such companies to vote the stock of member banks which they owned. Prior to 1933, this section merely defined the rights of stockholders of national banks to vote their stock i n such banks. As amended, and as i t now stands, t h i s section provides t h a t a holding company, before i t may vote i t s stock of a member bank, must f i r s t obtain a permit to do so from the Federal Reserve Board. The Board, i n t u r n , i s authorized i n i t s d i s c r e t i o n t o g r a n t or deny such a permit. As a condition t o the granting of the permit the holding company i s required, on behalf of i t s e l f and i t s controlled banks, to agree to submit t o examinations, t o e s t a b l i s h c e r t a i n reserves, t o agree t o dispose of a l l i n t e r e s t i n s e c u r i t i e s companies, and i t s o f f i c e r s , directors and agents are subject t o the some penalties f o r f a l s i f i c a t i o n of records as those applicable i n the case of n a t i o n a l banks. Congress presumably f e l t that these amendments would be adequate to insure effective regulation. The Board's experience in administering those provisions, however, has demonstrated clearly the need for additional legislation £f regulation is to be effective i n correcting and preventing practices which are contrary to public policy and interest. - 2PRESENT L W IS ENTIRELY VOLUNTARY A No one would suggest that i n amending Section 5144 in 1933> Congress intended to bring some bank holding companies under regulation and to leave others, even though meeting the same definitions, free from regulation. Yet that i s what the lav now permits because i t i s based solely upon the voting permit. A holding company becomes subject to the law only i f a voting permit is issued* But there is no mandatory requirement in the lav that a holding company obtain such a permit. Undoubtedly i t was believed that a l l would do so. A l l have not done so, however, because as a practical matter holding companies can in many instances control the operations of banks without the need for voting their shares in such banks. I n one instance disclosed by the Board1 s f i l e s a holding company owns a controlling stock interest in 24 member banks, yet has obtained voting permits covering only 2 of these banks. Whenever the Board receives an application for a voting permit, i t makes a thorough examination of the holding company and i t s a f f i l i a t e s to determine what corrections, i f any, are necessary to meet basic standards. I f such corrections appear necessary, they are made a condition to the granting of the voting permit. I n one important case, however, when advised of the need for such corrections, the applying company simply abandoned i t s application for a voting permit. I t was able to control i t s banks without voting the shares which i t owns i n these banks, and thus was able to escape such regulation as existing law provided. Clearly the law should apply to a l l bank holding companies alike. This cannot be accomplished by a law which permits a holding company to elect not to subject i t s e l f to regulation. The law must be mandatory to be effective. The proposed b i l l provides that a l l bank holding companies meeting the prescribed definition shall register with the Board and, having registered, shall be automatically subject to a l l of the regulatory provisions of the statute. PRESENT DEFINITION OF HOLDING COMPANY INADEQUATE Not only does the present law f a i l to reach those companies which elect not to apply for a voting permit, but i t also f a i l s to reach others because of inadequacies in the definition of a "holding company a f f i l i a t e . 1 1 The present definition embraces only those holding companies which control member banks. This excludes from any regulation those companies which operate in a l l respects as bank holding companies, but which control only nonmember banks, even though, as i s frequently the case, the l a t t e r include insured banks. Thore are a number of companies i n this category which operate numerous banking offices having substantial amounts of deposits. Another and more important defect is in that portion of the present definition which defines a bank holding company as any company "which owns or controls, directly or indirectly, either a majority of the shares of capital stock of a member bank cr more than 50 per centum of the number of shares voted for the election of directors of any one bank at the preceding election, * * * . " - 3The purpose underlying this definition is to reach those companies which control the management and policies of banks, and with this basic premise the Board i s i n entire agreement. However, i t has long been recognized by Congress and by the courts that effective control of one company by another does not depend upon the ownership or control of a majority of the voting shares. Control can be, and often i s , exercised through the ownership of a much smaller proportion of the t o t a l shares outstanding. Sometimes i t i s maintained without the ownership of any shares. Similarly, the number of chares owned or controlled, as compared with the number of shares voted for the election of directors at the preceding election is an unsatisfactory basis for determining whether a holding company relationship exists. Such a restricted test puts i t within the power of the holding company to establish an absence of control when, in fact, i t is at the same time exercising most effective control. The case in which regulation is most necessary is usually the case in which the attempt is made to take advantage of the existing definition to escape regulation. The definition of a bank holding company i n H.R. 3351 ~conforms more nearly to the practical r e a l i t i e s of intercorporate relationships. I t is derived i n large part from the definition of a holding company adopted by Congress when i t enacted the Public U t i l i t y Holding Company Act of 1935. The f i r s t part of the definition extends automatic coverage to a l l companies which own 15 per cent or more of the voting shares of two or more banks. However, even though a company may own more than 15 per cent but less than a majority of such shares, i f i t can demonstrate that i t does not exercise a controlling influence over the management and policies of i t s banks, i t would not be subjected t o regulation under the Act. The second part of the definition permits the Board to declare a company to be a bank holding company even though i t owns less than 15 per cent, or possibly none, of the shares of two or more banks, provided the Board finds, after hearing, that the company does i n fact control such banks. The Board believes that this definition is practical and just. A l l companies owning the specified number of shares are affected alike. Each has a ready procedure a t hand for escaping regulation by demonstrating t h f t i t does not control the management and policies.of two or more banks. I n the clear cases (such, for example, as insurance companies which own bank shares purely for investment purposes) absence of control may be easily demonstrated without hardship. I n the close cases, the burden of proof would be upon the company to. show that i t is not i n fact exerting the kind cf influences upon banks which require that i t be subjected to regulation. beguutori aspects Turning now to the regulatory aspects of the problem, under the present law the only provision which implies a degree of administrative supervision relates to such examinations "as shall be necessary to disclose f u l l y the relations between11 the holding company and i t s controlled banks, and the further provision that for violation of the statute or of i t s agreement with the Board, the holding company's voting permit may be revoked* I n that event, certain penalties affecting the banks i n the holding company system may be applied. -4These provisions, particularly when considered in the light of the voluntary aspects of the existing law, f a l l far short of providing effective regulation. I n the f i r s t place, the Board1s right to examine a holding company and i t s controlled banks i s not coupled with the specific power to require corrections. Furthermore, the penalties for violations of the statute or of a holding company's agreement with the Board are directed primarily at the banks in the holding company group and not at the holding company i t s e l f . The existing law contains no declaration of Congressional policy upon matters which v i t a l l y affect the entire problem. The Board feels that bank holding company legislation should include as many specific declarations of Congressional purpose as possible, and that,, where the exercise of administrative discretion must of necessity be called ;into play, the legislative standards for the exercise of such discretion should clearly stated. The provisions of H.R. 3351 are designed to give effect to thbse principles. NONBANKING ACTIVITIES OF BANK HOLDING COMPANIES One of the most salutary requirements of H.R. 3351 i s that contained in Section 5, which would require that the activities of bank holding companies be limited solely to the business of banking or of managing and controlling subsidiary banks. To that end a holding company would be required within a stated period to divest i t d e l f of any securities except those i n companies which are necessary and incidental to i t s banking operations, or which are eligible for investment by national banks. The reasons underlying this requirement are simple. Accepted rules of law confine the business of banks to banking and prohibit them from engaging in extraneous businesses such as owning and operating industrial and manufacturing concerns. I t is axiomatic that the lender and borrower or potential borrower should not be dominated or controlled by the same management. I n one exceptional situation, however, the corporate device has been used to gather under one management many different and varied enterprises wholly unrelated to the conduct of a banking business. When a bank holding company has expanded i t s operations into other and unrelated f i e l d s , i t tends more and more to take on the characteristics of the type of institution to which the Investment Company Act of 1940 was addressed. Yet such a company, i f i t holds a voting permit from the Board, is exempted from the provisions of the Investment Company Act. I t is necessary, in keeping with sound banking principles, that such a company should be required by law to adjust i t s a f f a i r s so as to become either a bonk holding company or an investment company. I t should not be permitted to remain a hybrid beyond a period reasonably necessary for i t to adjust i t s a f f a i r s . Section 5 would make i t unlawful after two years, or longer i f the Board deemed i t necessary to avoid undue hardship, for a bank holding company to own the securities of any company other than a bank or to engage in any business other than that of banking or managing and controlling bapks. However, i f , - 5 - pursuant to the requirements of this section, a holding company distributes i t s nonbanking assets to i t s stockholders, such a transaction is given appropriate tax exemption under one of the amendments being proposed by the Board. This amendment, which was prepared tinder the supervision of the Treasury tax experts, recognizes the d i f f i c u l t i e s which may bo encountered by a holding company i n making such distributions i n kind and specifically allows for the croation of a separate company to which tho nonbanking assets of the holding company may be transferred without recognition of loss or gain, provided the shares of the new company are promptly distributed to tho stockholders of tho holding company. I f such a company should be organized and divorso securities and properties arc transferred to i t , thon i n a l l probability that company would bo subjoct to the jurisdiction of tho Securities and Exchange Commission under tho requirements of tho Investment Company Act* BANK HOLDING COMPANY EXPANSION Tho problem of how far bank holding company systems should be permitted to oxpand has long boen of serious concern. Thcro i s perhaps a greater neod for a positive declaration of Congressional policy on this question than on any other phase of the holding company problem. I t is in this area that one of the greatest potential evils of bank holding company operations exists. That e v i l , which permits a holding company without legal hindrance to dominate major portions of the banking f a c i l i t i e s of particular sections, is one which strikes at the heart of our traditional system of competitive banking. Under existing law a chartered bank may be prevented by the regulatory agency to which i t is subject from expanding i t s banking offices either by the establishment of new branches or by taking over and operating the offices of other banks. I n order to establish branches, national banks must f i r s t obtain permission from the Comptroller of the Currency, State member banks from the Board, and nonmember insured banks from tho FDIC, But the bank holding company is not subject to any such requirements. I f a bank in i t s group is denied the right to establish an additional office, there i s nothing to prevent i t from acquiring the stock of an existing bank and simply adding tho institution 'to i t s l i s t of controlled banks, operating i t , for a l l practical purposos, as a branch of tho entiro system* This loophole, enabling a bank holding company to oxpand at i t s pleasure, lends i t s e l f readily to tho amassing of vast resources obtained largely from tho public, which can. bo controlled and used by the r e l a t i v e l y few who comprisc tho managemont of tho holding company, giving thorn an unfair and overwhelming advantage in acquiring additional properties and i n carrying out an unlimited program of expansion. Such power can bo used to acquire independent banks by measures which loavo tho local management and minority stockholders l i t t l e with which to defend thomsolvos oxcopt their own strenuous protests. While the managements of the great majority of the important bank holding company systems have sought the Board1 s views, i f not i t s approval, on proposed bank acquisitions, there is one case where a holding company management has openly defied the Board in i t s attempt to halt an unbridled bank expansion program. I refer to Transamerica Corporation, with i t s vast group of controlled - 6 - banks i n Arizona, California, Nevada, Oregon and Washington* The Transamerica management has publicly sought to justify i t s e l f on the ground that Congress, by withholding from the Board the direct power to curb such expansion, has thereby indicated i t s approval of Transamerica policies* I t may be interesting to the members of the Committee to have the latest figures on the size of the Transamerica banking empire. As of December 31, 1946, information available to the Board indicates that there are 41 banks in the Transamerica group, operating a total of 619 banking offices having aggregate deposits in excess of six and one-half b i l l i o n dollars* This represents moro than 40 per cent of a l l the banking offices and 38 per cent of a l l of tho commercial deposits in the five-Stato area. Since 1934 tho Transamerica group has acquired a total of 126 banks, which have been operated either as separate units or have boon absorbed by the barks in tho group* I n addition, 74- now branches have been established over this period* On December 31, 1933, this group served 242 towns; as of December 31, 1946, this number had been increased to 379• Thoso figures relate only to Transamerica1 s banking operations* I n addition, i t owns and operates many other typos of business with aggregate r e sources of moro than #275,000,000* Section 6 of H*R. 3351 would make i t impossible for this or any other holding company system, to reach out and absorb more and more banks without f i r s t obtaining the approval of some agency of the Federal Government* Under this section any direct purchase of the stock or assets of banks by a bank holding company would have to be approved by the Board* I f one of the banks in a holding company group wished to acquire the assets of a bank, the acquiring bank, i f a national bank, would have to secure the approval of the Comptroller; i f a State member bank, i t would have to obtain approval by the Board; i f a nonmember bank, i t would have to obtain the approval of the FDIC* The proposed b i l l also enumerates the standards which would guide the banking agencies in deciding whether to approve such acquisitions* F i r s t , they would have to consider the financial history and condition of the applicant and the banks concornod; their prospects; character of management; and the needs of the communities involved. These are the considerations which are today the legislative guido for administrative action i n such matters as tho admission of State banks to membership in the Federal Reserve System and the granting of deposit insuranco coverage. Next, thoy would take into consideration national policy against restraints of trade and commoroe and tho undue concentration of economic powor* This would give effect to the anti-monopoly objectives stated i n the Sherman and Clayton Acts* Finally, under an amendment suggested by the Federal Advisory Council and the Reserve City Bankers, they would consider whether an acquisition, regardless of i t s competitive effect, would extend the operations of a holding company beyond limits consistent with adequate and sound banking* The Board believes that these standards would furnish an adequate guide for administrative action. Much consideration was given to various proposals on the subject, including the fixing of r i g i d , even mathematical, formulas governing expansion, but the Board concluded that such definitions would make - 7 th© soction d i f f i c u l t to onforce from an administrative standpoint, and, as indicated by representatives of the Justice Department, might conflict with existing governmental policy respecting the antitrust statutes. Under the Board1s proposals, each case would stand on i t s own merits, considered in the l i g h t of standards which arc deeply rooted in American traditions, REMAINING PROVISIONS Tho remaining regulatory provisions of H. R. 3351 require l i t t l e discussion. The bank holding company would be required to register with tho Board and to f i l e periodic reports. I t would be subject to examination as are each of i t s subsidiaries.. Existing provisions of law respecting tho maintenance of reservos by bank holding companies would bo carriod over and made a part of the proposed now law. Upstream loans between a bank and i t s holding company would bo regulated, as well as loans involving tho securities of the holding company and i t s othor subsidiaries. Tho Board would bo authorized to scrutinize the terms of any management or sorvice contracts between a holding company and i t s banks. Finally, tho Board would bo authorized to make such rules, regulations, and ordors as might bo nocossary to enable i t to administer and carry out tho purposos of tho Act. The proposed legislation for the f i r s t time to my knowledge in any Federal banking statute contains a provision granting a statutory right of judicial review to any one aggrieved by any action of the Board taken under any of the various regulatory provisions of the b i l l * This provision should help to crystallize ct an early date the precise boundaries of Board authority under those sections involving the application of administrative discretion.