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NATIONAL ASSOCIATION OF STATE TREASURERS ANNUAL CONFERENCE FEDERAL RESERVE BANK OF CHICAGO Chicago, Illinois August 8, 2000 ..................................................................... Gramm-Leach-Bliley and Changes in the Financial Landscape Thank you for inv iting me here to speak today on such a subject as dynamic as the changing financial landscape. Most organizations ask me to talk only about the economic outlook. I must admit I don’t mind getting away from my stump speech. The last time I was supposed to talk about Gramm-Leach-Bliley, weather prevented my plane from taking off. The good thing about such an experience is that no matter how tough this audience is, it’s got to be better than being stuck at the airport. Truly one of the rewards of working for the Federal Reser ve is the range of topics that fall under our auspices. Many people associate us with monetar y policy, thanks to Alan Greenspan’s high profile. But we actually have three distinct primar y roles. In addition to monetar y policy, we prov ide financial ser v ices to financial institutions and the U.S. gover nment. And we’re also responsible for superv ising and regulating banks — which is why I’ve been asked to speak to you here today about Gramm-Leach-Bliley. But before I get into that, let me briefly describe these three activ ities. First and foremost, the Fed sets monetar y policy. You may not know that the Chicago Fed is one of 12 regional Federal Reser ve banks. The Fed’s regional structure is crucial to the setting of monetar y policy. Because we know well both our local banks and our local economy, we can bring that knowledge to monetar y policy discussions in Washington. A second role of the Federal Reser ve is to prov ide ser v ices to financial institutions and the gover nment. This includes processing paper checks and electronic payments, as well as handling the sale and redemption of U.S. Treasuries. One of the Fed’s key goals is to encourage the use of electronic payments to help make the payments system as efficient as possible. I say this even though process- Michael Moskow Speeches 2000 319 ing checks is one of our main businesses. Our nation’s check clearing system is ver y efficient given the amount of paper we move across the countr y. But electronic payments offer some obv ious benefits for customers. I certainly encourage you to take advantage of electronic payments whenever possible. The Fed’s ser v ices also include prov iding currency to banks, which explains why the Fed has vaults of cash in its basement and the sort of security you’d expect to find at Fort Knox. You may have noticed, we’ve given you samples of what we store in our vaults. We’ve shredded it for your convenience. There are also materials explaining the functions of the Fed in greater detail. The exact nature of the Fed’s third role, that of bank super v isor, has been evolv ing under GrammLeach-Bliley, which I’ll discuss in a few minutes. Let me just give you a sense of the extent of our involvement in super v ision and regulation. Our role is to help maintain the safety and soundness of the banking system. We monitor the relationship between the financial industr y and the economy, with specific responsibility for super v ising state member banks, bank holding companies and branches of foreign banks. Now that you know a little more about the Federal Reser ve, let’s get back to our main topic of the changing economic and financial landscape, and Gramm-Leach-Bliley (GLB). Financial change is just one example of our rapidly changing economic env ironment. In fact, I bet if you polled ever y CEO and politician in America about the speeches they’ve given (or heard) over the past year, “change” would stand at the top of the list of topics. The remarkable pace of change in America today per meates nearly ever ything we do. Take the current economy, for example. The current expansion ranks as the longest in U.S. histor y. And the last four years or so have been especially remarkable. Growth in our real GDP has been above 4 percent each year, and we’re running at a 5 percent pace so far in 2000. Our national unemployment rate has fallen from 5 1⁄2 percent (at the end of 1995) to 4 percent in June. That’s near a three-decade low. And inflation measures that exclude volatile food and energy prices generally have remained relatively low, though they are up somewhat so far this year. By historical standards, most sectors of our economy—from autos to housing to banking—are in ver y good health. And much of this has been made possible by rapid changes in the economy. Changes in technology. Changes in the way we manage our businesses. Changes in the flexibility of the labor market. Numerous changes that make us a more productive society. Over the past four to five years, the productiv ity of our workers has increased at an average pace the U.S. has not seen in more than a quarter of a centur y. And as productiv ity growth increases, our economy can expand more rapidly than before without inflationar y pressures building as soon. Higher productiv ity growth lifts our standard of liv ing, and that’s good for ever yone. But a major debate right now is on how long we can expect the recent fortuitous productiv ity gains and economic outcomes to continue. In fact, there are a number of imbalances in our economy that could undermine the economy’s extraordinar y perfor mance. One major imbalance is that growth in domestic demand has outstripped that of our potential supply for some time now. Simply put, the U.S. is consuming more than it’s producing and the gap is being filled by imports. Although we’ve seen some signs recently that this gap in aggregate supply 320 Michael Moskow Speeches 2000 and demand may be narrowing, the ev idence has been mixed. Another imbalance stems from our tight labor markets. As the pool of available workers is depleted, the possibility increases for higher wage increases than can be justified by productiv ity growth, which in tur n might lead to higher inflation down the road. This hasn’t happened yet, but we need to remain particularly v igilant on the inflation front at this point in our record-breaking expansion. The economic prosperity of the last few years opened many windows of opportunity for Americans. Many indiv iduals found jobs for the first time, and have been able to remain employed and gain skills and invest in their future. Congress took this opportunity to bring financial legislation in line with a changing banking world. Let’s now look at what that change in the financial industr y entails. I’d like you to remember what banking was like 25 years ago. I’ll assume you were all under the age of ten at the time, so you’ll need a reminder. How many of you had a sav ings passbook? Back then families kept most of their sav ings in bank accounts. If you wanted to deposit or withdraw money, what did you do? You went to the bank and stood in line. After a considerable wait, you presented your passbook to the teller for updating. Now give a thought to when was the last time you stocked up on cash in person at your bank teller, rather than using an ATM? Y2K weekend doesn’t count, by the way. It’s been a long time, hasn’t it? Now let’s fast-for ward to today. How does your family do its banking today? How do you think they’ll do it tomorrow? I’ll give you a hint: one large bank has just come out with a wireless banking ser vice. On their palm pilot customers can v iew account balances, make bill payments, and transfer funds. They can also get stock and mutual-fund quotes, buy and sell stocks, and create personalized stock alerts and watch lists. Not only that, they can get customized news, check the weather, look at their horoscope, find out how many frequent-flyer miles they have, and order books on-line — through their bank no less! All this infor mation is available at their fingertips, 24 hours a day, 7 days a week, from any where around the globe. Technology has shaken-up and reshaped the banking industr y as much as it has the rest of the economy. Technology challenged the industr y, and the industr y responded. Banks have new products, more competitors and different risks. All this has led to a dramatic restructuring of the industr y. For example, consolidation has dominated industr y headlines. Twenty-five years ago there were about 14,000 banks; today there are approximately 8,500 — a reduction of about 40 percent. Ser v ice has been maintained because during the same period, the number of banking offices increased, from about 45,000 to about 71,000. Consolidation at the top of the industr y is even more striking. Two-and-a-half years ago, the top three bank holding companies combined were worth $942 billion in assets. Today, following the Citigroup and Bank of America / Nations Bank megamergers, the top three companies control $1.8 trillion — almost double the amount. While big banks are getting bigger, we’ve also seen a flurr y of new banks. These so-called de novo banks often attract customers dissatisfied with the results of large bank mergers. Many consumers feel that community banks have advantages in the areas of indiv idual attention, in-depth knowledge of customers, and rapid decision-making. Another major change in the banking landscape is the convergence of banking, securities and insurance. We’ve seen various models of this convergence. Travelers Group, a giant securities and insur- Michael Moskow Speeches 2000 321 ance fir m, merged w ith Citibank, a giant bank, to for m Citigroup in 1998. E arly this year, Charles Schwab, the discount brokerage, acquired a much-smaller pr ivate bank, U.S. Tr ust. This allows Schwab to expand its product line and obtain access to U.S. Tr ust’s high-net-worth customer base. Norther n Tr ust, a banking organi zation heav ily involved in tr ust activ ities, prov ides a third alternative. With the goal of cross-marketing, Norther n Tr ust has entered into a joint venture w ith Northwester n Mutual Life Insurance Company to offer tr ust ser v ices to Northwester n Mutual’s customers. For all its scope and potential impact, the five basics of GLB are straightfor ward and clear. First, the law creates an important new institution: financial holding companies. These entities have fewer statutor y limitations on their activ ities. Many types of financial ser v ice prov iders can apply to become financial holding companies — large institutions and community banks alike. So this law w ill greatly affect all of you as treasurers, no matter what type of banking organi zation your state deals w ith. Once an organization qualifies, it can engage in a wide-range of new activ ities: for example, underwriting of insurance, debt and equity financing, and a full line of investment products. Some restrictions do remain on the location of the new or expanded non-bank financial activ ities within a banking organization. But the bottom line is that more and more people will now tur n to the place where they deposit their paycheck for the purchase of a wide-range of financial products, and more. Financial holding companies will be as central to banking tomorrow, as good old-fashioned banks were in the passbook days we talked about earlier. To summarize, this first basic element of GLB recognizes that some customers want one-stop shopping for all their financial ser v ices, large business customers in particular. At the same time, the new law still limits the mixing of banking and commerce. In effect, GLB recognizes the sort of mergers, like Travelers and CitiCorp, just mentioned. Tur ning to the second basic of GLB: The law spells out the roles of super v isors. It div ides them into two categories: the functional super v isors, each of whom look at a specific legal entity; and the umbrella super v isor, who is responsible for the overall risk of the consolidated company. Basically this means that super v isors will look at the activ ities of any financial holding company in light of both the soundness of that particular subsidiar y, and the risk it represents to the insured depositor y institution and the institution as a whole. The functional super v isors have responsibility for the same activ ities as they had in the past. So under GLB, state insurance regulators will continue to super v ise insurance subsidiaries, bank regulators will continue to super v ise bank subsidiaries, and securities regulators will continue to superv ise securities subsidiaries. GLB gives the Fed the role of “umbrella” super v isor. As the umbrella super v isor, the Fed’s focus is on the material risk of the consolidated organization and how the organization is managing these risks. This means the Fed will assess the health of the financial holding company as a whole, relying on input from functional regulators. The other part of the Fed’s dualrole super v isor y responsibility is its role as a regulator for state member banks. This role has not changed under GLB. Let’s now tur n to the third basic element of GLB — privacy protections. GLB recognizes some customers may not want their megamerger bank to be sharing their personal financial infor mation. 322 Michael Moskow Speeches 2000 Therefore, GLB restricts disseminating infor mation about customer accounts to third parties. The privacy prov isions of GLB require financial institutions to disclose for mal privacy policies at the time a customer relationship is established and annually after that. They also allow customers to “opt out” of infor mation-sharing arrangements with most unaffiliated third parties. Fourth, the act contains several prov isions affecting the implementation of the Community Reinvestment Act. GLB reduces the frequency of CRA exams for small banks with at least a satisfactor y rating. It reinforces CRA in a non-burdensome way by including a satisfactor y CRA rating as a requirement for becoming a financial holding company. GLB also requires public disclosure of all CRA agreements, the so-called “Sunshine Prov isions.” And finally, GLB closes the loophole by which commercial fir ms could acquire a single sav ings and loan and thus be able to engage in expanded activ ities. It also refor ms the Federal Home Loan Bank (FHLB) system so that more small banks will be able to become FHLB members and so that more of their assets can be used as collateral. Taken as a whole, these basics of GLB mean that bank holding companies that are well-capitalized, well-managed and have satisfactor y CRA ratings can now become financial holding companies. And once they’ve achieved this status, they can engage in activ ities new to bank financial subsidiaries and bank holding companies. Many financial institutions you deal with ever y day may already be under writing insurance, issuing annuities and engaging in merchant banking. You may also be interested to know that banks are now able to directly under write and deal in municipal revenue bonds. I know that many of you deal with community banks as well as large banks. It’s interesting to note that many community banks are applying for FHC status. In fact, two-thirds of those that have received approval so far are community banks. How will GLB affect the operations of state gover nments? State-chartered banks know they’ve got to change to stay competitive with the national banks and financial holding companies. This means that states must rev iew their banking laws to see whether state banks have the same access to new powers as national banks and financial holding companies. GLB does make some new requirements of the states. For example, states have three years to enact unifor m licensing and continuing-education requirements for insurance agents and companies. If a majority of states do not act by the deadline, the law creates a new self-regulator y organization, and states could end up losing some of their powers to regulate insurance. Super v ision is changing on the state level as well. Existing infor mation flows between state and federal banking regulators must expand to include state insurance and securities regulators. Two-way communications with the Federal Reser ve as umbrella super v isor are particularly important. The legal and institutional frameworks for this expanded communication are starting to be put in place and can build on the excellent working relationships the Fed already enjoys with the state banking departments. Lastly, the privacy prov isions of GLB demand attention from the states — as they apply to all financial companies. But the federal regulations in this area will not preempt state laws that prov ide greater protections to the consumer. Its up to the Federal Trade Commission to deter mine whether a state law prov ides greater protection. Michael Moskow Speeches 2000 323 In conclusion, our remarkable economic env ironment has opened up many opportunities for our nation. We’ve seen many changes in the way America does business. The financial ser v ice industr y is no different. With the passage of GLB, financial holding companies obtained the ability to offer an expanded array of financial products. Customers such as state treasurers stand to benefit from having financial ser v ice prov iders offering a more complete range of financial options without regard to regulator y distinctions between the products and ser v ices available. Consumers also stand to benefit from increased competition in the market place. But recent changes will also mean new challenges. New opportunities offered by GLB could also increase an organization’s risk profile if it doesn’t use its new powers correctly. More than ever, banks will need to pay close attention to the basics of banking — to maintaining an adequate funding base and making sound loans. Successful organizations will need to choose carefully how they will capitalize on their newly acquired powers. But in one sense the more things change, the more they stay the same. For both the financial ser v ice industr y and its regulators, sound risk management must be our top priority. GLB is by any measure an important piece of legislation at an important time in the histor y of the banking industr y. GLB has equipped the financial industr y to nav igate this sea of economic change that is all around us. The financial industr y is now better positioned to become even more streamlined and high-tech. Bank super v isors will play their part to help bank management prepare for whatever lays ahead, be it rough waters or smooth sailing. Because in the long run, the success of GLB will depend on whether the industr y continues to steer a steady course. 324 Michael Moskow Speeches 2000
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