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For release on delivery
9:30 A.M., E.S.T.
April 17, 1985

Statement by

Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
before the
Subcommittee on Financial Institutions, Supervision, and Regulation

of the
Committee on Banking, Finance and Urban Affairs
House of Representatives
April 17, 1985

I appreciate the opportunity to appear before this
Subcommittee to review with you some of the issues involved
in proposed banking legislation.

You have requested me to

focus my remarks particularly on the long- and short-term
effects of chartering so-called "nonbank banks" and on the
provisions of H.R. 20, the "Bank Definition Act", which
addresses the proliferation of nonbank banks.
I have long supported legislation to close avenues
for evasion of some of the basic tenets of public policy,
incorporated in the Bank Holding Company Act, that have
guided the evolution of our banking system for decades.


the same time, I want also to emphasize at the outset that,
while action to close the "nonbank bank loophole" is urgently
needed, I hope the Committee and the Congress will also
deal in this session with other issues, ranging from powers
of bank holding companies to interstate banking, that should
be promptly resolved in the interest of a competitive, safe,



healthy banking system.

Some of those points are

addressed by H.R. 15 f the bill sponsored by Mr, Wylie, which
also deals with nonbank banks.
Public policy has long recognized that commercial
banks perform a unique and critical role in the economy and
the financial system.

They are operators of the payments

system; they are custodians of the bulk of liquid savings;
they are the principal suppliers of short-term credit; and
they are the critical link between monetary policy and the

Moreover, the fortunes of individual institutions

are so intertwined that instability of one may infect another,
In recognition of these circumstances, a Federal safety
net -- specifically the Federal Reserve discount window and
Federal deposit insurance —
protect the system.

has long been provided to help

Individual banks are subject to a system


of regulation and supervision to help assure their safety
and soundness.
Integral to that approach, the Bank Holding Company
Act allows ownership of a bank by another company only if that
company engages in activities that "are closely related to
banking and a proper incident thereto."

That provision is

designed to enforce a basic separation of banking and commerce/ and thus limit conflicts of interest and avoid undue
concentration of resources.

The law also provides for some

supervision and inspection of the holding company as a whole,
recognizing thatf in practice, the fortunes of one enterprise
within a holding company cannot be wholly separated from those
of its affiliates.

The provisions of the Bank Holding Company

Act also provide restrictions on interstate banking by a
holding company, paralleling the restrictions on interstate
branching in the MacFadden Act.


In our judgment, the basic concerns about the
separation of commerce and banking remain valid, and should
be your point of departure today in considering the "nonbank bank'
The definition of a bank is critical to a policy
that sets out to separate banking and commerce and to enforce
restrictions on interstate banking.

The Bank Holding Company

Act defines a bank as an institution that both accepts demand
deposits and makes commercial loans.

That definition was

designed to exclude savings and industrial banks (which at
the time had little or no demand deposits or other transactions
accounts or commercial lending authority) and limited-purpose
trust companies.
While thrift institutions today increasingly do
commercial lending and can accept transactions accounts
of individuals, FSLIC-insured institutions remain exempt


under the terms of the Garn-St Germain Act passed in 1982.
Moreover, as other forms of transactions accounts have
developed with the basic characteristic of demand deposits,
institutions with a bank charter can also take all
kinds of deposits from the public (including under current
court rulings NOW accounts) other than demand deposits and
make commercial loans without coming under the restrictions
of the Bank Holding Company Act.

These are the so-called

"nonbank banks," for which there have been hundreds of applications,
Specifically, one form of "nonbank bank" may be
owned by any company —

a steel company, a retailer, a securities

firm, an insurance company, or a real estate developer.


parent company is not subject to any of the limitations of
the Bank Holding Company Act designed to limit risk or conflicts
of interest and to avoid unfair competition or excessive
concentration of economic power.

Thus, in its present guise,


the "nonbank bank" undermines the basic separation of banking
and commerce -- a concept with deep roots in both English and
American traditions.
That seems to me the fundamental issue at stake in
closing the "nonbank bank" loophole.

By permitting commercial

companies to provide through subsidiaries almost all the same
functions as full service banks, and to obtain access to the
payments system, the discount window, and deposit insurance,
both the principle and the practical reality of the present
restrictions of the Bank Holding Company Act will be seriously
undermined over time. The competitive position of those banks
still subject to the Act will inevitably be damaged, potentially
weakening the system as a whole.
The "nonbank bank" is also, and today more commonly,
a device by which a bank holding company, or a commercial firm,


can escape from the restrictions on interstate banking
encompassed in the Douglas Amendment to the Bank Holding
Company Act.

In fact, interstate banking is a reality in

many areas through Edge Act subsidiaries, loan production
offices, finance company and mortgage banking affiliates,
credit card operations, ATM networks, and otherwise.


nonbank bank offers the added avenue of on-site offices for a
full range of consumer business or commercial lending combined
with deposit taking.

I will be testifying with respect to

interstate banking next week, and I believe some liberalization
of current restrictions is justified.

However, in my

judgment, that question should be approached on its own merits
rather than by permitting interstate banking through an
unintended "back door" device, with the inefficiencies and
inequities that involves.


I sense there is a broad consensus that it is
important to preserve the basic policies of the Bank Holding
Company Act and thatf accordingly, it is essential to close
the "nonbank bank" loophole as part of any legislative approach
toward banking.

Basically satisfactory legislative provisions

to achieve that were contained in separate bills last year.
One was reported by this Committee and another adopted by the
full Senate.

While detailed differences in approach were not

fully resolved, it appeared that it was other provisions of
proposed banking legislation, rather than basic disagreements
on the "nonbank bank" question, that stymied enactment.
H.R. 20 basically follows the approach of this

It broadly applies the provisions of the Bank

Holding Company Act to all FDIC-insured commercial banks
whatever their particular mix of business.

In addition,

those uninsured institutions that offer transaction accounts
and make commercial loans would continue to be covered.



approach is broadly satisfactory so far as it goes, as would
be the similar provisions of H.R. 15.
Before turning to areas of omissionf I would note
particularly that these bills would bring so-called consumer
banks clearly within the scope of the provisions of the Bank
Holding Company Act*

The suggestion has been made by others

that banks primarily aimed at serving the consumer might
be exempted from the general principle of the separation of
banking and commerce and from any restrictions applicable to
ordinary banks on interstate banking.
However beguilingly presented as a "family bank11
proposal, such an initiative seems to me misguided.

I would

emphasize that the great bulk of the number of existing banks
and other depository institutions are already "family" or
"small business" oriented.

We have in this country almost

20,000 banks and thrifts, nearly all actively competing for


consumer business.

Many of them do little commercial lending;

for instance, almost 20 percent of commercial banks have 5
percent or less of their assets in loans to businesses, and
nearly half have less than 20 percent of assets in such loans*
I see no justification for permitting commercial,
industrial or securities firms to compete with these institutions
for insured deposits and other banking services under different
ground rules as to ownership.

The effect could only be to

undermine the public policy objectives incorporated in the
Bank Holding Company Act generally, and there would be the
appearance and reality of unfair competition with banks subject
to the Act.
Do we really want, for example, a retail business
to be able to gather deposits under the protection of Federal
insurance and to use those deposits to fund a credit card
they sponsor more cheaply than retailing competitors?

Do we

want to bless interstate consumer banking simply because


there is a non-bank owner?

Do we want to encourage joint

marketing efforts and "tie-ins," implicit or explicit?
If we are not sensitive to these concerns, then
what is the justification for the present restrictions in the
Bank Holding Company Act?
Some of the "family bank" concepts propose a kind
of sugar coating in the form of higher capitalization, "lifeline" banking requirements, and rules requiring prompt deposit

If these are indeed valid objectives of

legislation —

and I make no judgment on that point now


then it seems to me the legislation should apply to all
depository institutions and not to just a special few.
In other respects, I believe the coverage of H.R.
20 must be broadened.

As drafted, H.R. 20 has no provision

with respect to the treatment of thrift institutions
savings banks and savings and loans.



For some federally insured thrifts —

namely, those

owned by multiple savings and loan holding companies —


legislative action appears required since their holding
companies would remain subject to the Savings and Loan Holding
Company Actf which has restrictions similar to those of the
Bank Holding Company Act*

However, others—including FDIC-

insured savings banks and privately insured thrifts—would
be subject to neither act, and unitary S&L's may engage in
substantial nonresidential lending activities without any
limitations on the commercial or industrial activities of
their corporate owners*

Left unattended, the effect would

plainly be to deflect the energies now reflected in "nonbank
banking" into banking in the guise of thrift institutions


"nonthrift thrifts."
In recent years, powers available to thrifts have
become much more like those available to banks, and indeed
the range of thrift powers today, particularly those of state-


chartered institutions, often exceeds that of banks.
Paralleling that development, there has also been increasingly
clear recognition of the need to adopt rules to assure
reasonably comparable regulatory treatment*
Considerations of competitive equity alone dictate
that the privileges off and restrictions on, banks and thrifts
be brought into a more coherent relationship*
just a matter of competitive equity.

But it is not

Restrictions on powers

of bank holding companies and on "nonbank banks11 will inevitably
be undercut, and rapidly, to the extent thrift institutions
with banking powers can simply substitute as a vehicle for
undertaking a wide range of banking services, violating the
basic separation of banking and commerce.
I recognize that there are difficult questions
posed by firms that already have operations on both sides of


the line between commerce and "thrift banking."

A number of

industrial or commercial firms own thrifts, and operate those
thrifts as separate and distinct entities without significant
problems arising.

Those combinations might logically be

permitted to continue on their present basis.

However, in

the environment we now face, these questions need to be
approached with an eye toward the future, and a firm policy
established with respect to which new combinations are acceptable
and which are not.
To deal with this problem, we have suggested that
only those thrifts that have a high percentage of their assets
in home mortgages should be exempt from the same rules as to
ownership applicable to banks and multiple S&L holding

We have suggested that present law be strengthened

to require that such a "qualified11 thrift institution have at
least 65 percent of its assets in residential mortgages or
housing-related investments.


I do not believe there is a sound rationale for
including residential mortgage originations and sales in such
a calculation.

Commercial banks, mortgage banks, and others

are all active mortgage originators.

The distinguishing

characteristic of an S&L and many savings banks historically -and the characteristic that historically has justified
special Federal support —

was that they devoted relatively

large portions of their own resources to support housing,
believe that a substantial commitment to investment in housing
should continue to be the test for exemption from certain
policies embodied in the Bank Holding Company Act and the
Savings and Loan Holding Company Act for multiple S&L holding

Furthermore, any holdings of liquidity included

in a thrift test should be confined to amounts legally required,
A further step is necessary to limit conflicts of
interest and tie-ins when a qualified thrift has a commercial


Specifically, joint marketing of services and products
be prohibited.


I am not suggesting that "nonthrift thrifts" need
be brought under the Bank Holding Company Act administered by
the Federal Reserve.

I am suggesting that institutions that

have essentially the same characteristics as commercial banks
should have broadly parallel restrictions on combinations
with commercial firms, and those restrictions be administered
by the appropriate regulator -- for savings and loans and
Federal Savings Banks, the Federal Home Loan Bank Board.
Moreover, we calculate about three-quarters of all savings
and loans would meet the thrift test I have proposed today,
and thus would not be restricted as to commercial ownership.
H.R. 20 does not prohibit an affiliation of thrift
institutions and non-member banks with securities firms.
That existing loophole in the Glass-Steagall Act should be
closed in the interest of competitive equity and the purposes


of the Glass-Steagall Act.

Such a provision has been

recommended by the Federal Home Loan Bank Board with respect
to thrifts.
In all these areas, appropriate transition periods
should be provided, and other detailed questions would need
to be resolved.

We would be glad to work with the Committee

in developing such provisions.
Finally, Mr. Chairman, I would like to comment on
the provision of the bill which grandfathers certain nonbank
banks acquired on or before July 1, 1983.

You and the Chairman

of the Senate Banking Committee have strongly supported July 1,
1983, as the appropriate date for grandfathering nonbank

I would point out that, even before that date,

institutions were well aware that the nonbank bank loophole
was a matter of policy and Congressional concern.
We have reviewed both the institutions that would
be subject to grandfathering and the activities that are


conducted by them.

As far as we can determine, H.R. 20 would

grandfather about 24 FDIC-insured nonbank banks; most of
these are small in asset size, with at least 10 essentially
engaged in trust activities and six or seven in credit card

Given this situation, we believe that grandfathering

as of the July 1, 1983 date, subject to appropriate conditions
to assure that their grandfather status is not abused by
expansion geographically or otherwise, would not be inconsistent
with the objectives of the Act.
Should the grandfather date be moved toward the
current date, an increasing number of insurance, securities,
and retail firms that were

fully on notice about the likelihood

of Federal legislation would be permitted to retain bank

It is our understanding that few of these

institutions have yet made substantial investments, and the


larger number of charter rights that would be involved would
increasingly impair the objectives sought by H.R. 20.
In concluding my testimony, I would note that one
Federal District Court in Florida has enjoined the Comptroller
from issuing final nonbank bank charters because it found, as
a matter of lawf that the National Banking Act does not permit
the Comptroller to issue a charter which does not provide for
the exercise of full National banking powers.

As a result of

that decision, final National bank charters for new nonbank
banks are not currently possible, and the Federal Reserve
Board has suspended processing such applications by bank
holding companies.

However, state-chartered nonmember "nonbank

banks11 can still be created.

While final disposition of the

legal issues involved for the National banks may take some
time, any reversal of the District Court opinion will quickly
touch off a flood of new National nonbank banks.


Consequently, the need for clear and effective
action to deal with the nonbank bank question continues to
rest with the Congress*

I urge you to act expeditiously in

this area, and then promptly turn your attention to other
areas of banking that desperately need legislative resolution
and clarification.