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F6rHreiease uh delivery
$8$0 a.m.
April 4, 1984

Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
before the
Subcommittee on Telecommunicationsf Consumer Protection and Finance

of the
Committee on Energy and Commerce
United States House of Representatives
April 4, 1984

1 appreciate the opportunity to appear before this
Subcommittee to review with you a wide range of issues
affecting developments in markets for banking and other
financial services,
I have repeatedly expressed my conviction that Congress
should move with a sense of urgency to reform the existing
legislative framework governing banking organizations.


need assurance that the powerful forces of change in the
marketplace for financial services are channeled in a manner
consistent with the broad public interests at stake —


need to maintain a safe and sound financial system, to assure
equitable and competitive access to financial services and
credit by businesses and consumers, and to preserve an
effective mechanism for transmitting the influence of monetary,
credit and other policies to the economy*
that assurance is lacking today.

The simple fact is

Quite to the contrary, we

have a system that is changing, helter skelter, in response
to a variety of economic and other forces, but with little
sense of the public policy issues at stake.
The process has emerged over a number of years, but it
is accelerating.

Much of the change is, in fact, a constructive

response to technological and market pressures and the
opportunities made possible by deregulation*

New combinations

of firms in the financial area, new services, and new packaging
of older services can be vehicles for responding more effectively
to consumer needs and new communications technology.


What is so disturbing is not that change is taking

Rather it is that much of the activity we see is

forced into "unnatural" organizational forms by provisions of
existing law and regulation and that some of the fundamental
concerns that motivated those laws and regulations are
being lost or overlooked without considered judgment about
the continued validity of those concerns•

The old laws and

rules may or may not serve today's purposes? in some instances,
they may themselves be a source of distortions, competitive
imbalance and weakness.

But deregulation by fiatf by

exploitation of loopholes, and by diverse actions taken by
individual states is hardly an appropriate response, and
threatens to undermine and render ineffective federal oversight
of banking.

For all these reasons, I appreciate the opportunity

to review with you some general considerations that we at the
Federal Reserve feel are relevant in assessing what legislative
steps are necessary and desirable*
The Current Situation
The accelerated pace of change in the structure of our
financial system grows out of several developments.


technology has lead to computerization of banking services,
and made it easier for institutions to provide those services,
or to combine several services.

Business and consumer experience

with inflation and related high interest rates of the late
1970's and early 1980's has increased the premium on moving
money flexibly.

Deregulation of interest rates ceilings on

depository institutions9 liabilities has spurred efforts by
those institutions to attain new asset powers and new sources
of income•

Nonbainks have sought ways to enter the banking

business to gain access to insured deposits and the payments
There have been numerous reactions to the forces
driving change I have just mentioned*

We see new combinations

of financial institutions and new services —

the rapid growth

of the money market mutual fund and, more recently, an
explosion in brokerage of insured deposits, are leading cases
in point*

There is the phenomena of so-called "non-bank

banks," providing a vehicle by which financial and nonfinancial
firms can enter the banking business outside the framework of
law and regulation surrounding bank holding companies, and
actually or potentially violating the policy proscriptions of
combinations of banking and commerce.

There is a blurring of

distinctions among depository institutions themselves*, with some
thrifts increasingly assuming the characteristics of commercial

At the same time, states are enacting banking and

thrift legislation much more permissive than federal law; a
narrow purpose is often evident -- to attract institutions
and new employment opportunities —

rather than broader

judgments about sound national policy*
New and sometimes conflicting federal regulatory
initiatives seek to facilitate changes or to maintain
Congressional intent, but those approaches are circumscribed

and often rendered ineffective by the outmoded character of
the basic legislation.

As a result, legal challenges through

the courts to stop or speed the process, depending upon the
particular private interest concerned, are proliferating, and
the court rulings themselves are not guided and informed by
any fresh indications of Congressional intent*
All of this has naturally been reflected in an unusual
sense of uncertainty and uneasiness among the affected
institutions themselves.

After decades of stability in the

relative position of commercial banks in our financial system,
owners and managers of those institutions feel their position
threatened by a situation in which they remain heavily
regulated but in which other financial or nonfinancial firms
can perform basic banking functions.

That is one reason why

banks are driven to exploit "loopholes" in legislation designed
to limit their activities or to turn to state legislatures.
Concerns of the thrifts as to how they could survive in
the highly competitive environment have also been acute.


part because of the large portfolios of fixed rate mortgages
acquired at lower interest rates, they have b^en under particularly strong earnings pressure and their capital positions
have eroded.

With their future prospects seeming in jeopardy,

the whole orientation of the industry is in a state of flux.
Some individual institutions respond to immediate concerns
and earnings pressures by taking greater risks, and others are
turning away from their traditional role oriented toward

housing finance -~ a role that through the years has been the
justification for special benefits provided by federal law.
Deposit-like instruments and payments services are
springing up in significant volume partially or wholly outside
the framework of governmentally protected and supervised
depository institutions*
have today —

Depository institutions themselves

in this highly competitive environment ~


potentially more volatile structure of liabilities and smaller
capital cushions than in the past, and there are strong
incentives to take advantage of the most liberal (or least binding)
legal and regulatory philosophies and frameworks -- between
thrifts and banks, between federal and state laws, and
potentially even among federal regulatory authorities.
anomalies in the structure of our regulatory system —


challenges to long-standing regulatory and legal interpretations -—
are quickly eroding traditional constraints intended to
separate deposit taking from other activities#
As regulators and legislators concerned with the public
interest, our task is not to block responses to real needs in
the marketplace.

But I do believe we have a responsibility

to see that change is channeled along constructive lines and
sensitive to abiding and valid concerns of the public interest.
Left unattended, there is no assurance that the process
of change now underway will adequately address these concerns.
In fact, it is clear that some of these concerns are being
violated as market pressures and competitive instincts play


against an outmoded legal and regulatory structure.


longer we postpone difficult decisions about the direction in
which change should be encouraged or discouraged by public
policy the more difficult those decisions will ultimately
become, and the greater the risk that continuing policy concerns
including the safety and soundness of the banking system


will be undermined*
General Considerations
The continuing goals of public policy in this area are
easy to summarizes

We want to encourage competition in the
provision of banking and financial services;


We want to promote efficiency and minimal cost?


We want to protect against discrimination,
conflicts of interest, and other potential abuses;

We want equitable and consistent treatment of
competing financial institutions; and


We want a strong and stable banking system,
implying continuing attention to safety and
soundness of banks•

These "core" goals in some circumstances may be in
conflict or point to different approaches•
stances —

In normal circum-

and in most industries -- it may be enough to

look to the marketplace to promote competition and efficiency.
But when safety and soundness, broad confidence in banking

institutions, and continuity in the provision of money and
payments services are at stake, competition alone cannot be
relied upon to achieve the goals*

In recognition of that

fact, the creation of the Federal Reserve and federal deposit
insurance systems —

both the FDIC and the FSLIC —

have long

been accepted as important elements in a "safety net" supporting
depository institutions.

And the existence of that "safety

net," and the special privileges it implies, is naturally
matched by burdens and responsibilities not shared by other
institutions in our society.
The need to protect the integrity of the payments
system deserves special attention*

In seeking an overall

balance between protections and restrictions for banking
institutions, we can and should avoid placing depository
institutions at a competitive disadvantage relative to others.
To do otherwise would be to erode the vitality and strength
of the very sector of the financial system deemed of special
importance to the economy.

To the extent that other institutions --

financial or nonfinancial -- operating outside the protected,
regulated framework nonetheless tend to perform the essential
function of banks, there are several alternatives.

We can

encompass those institutions within a basic framework of supervision and regulation designed to assure safety and soundness
and competitive equality (such as regulation as bank holding
companies or application of reserve requirements on all types
of transactions balances).

We can, if consistent with other

objectives, relieve the regulatory burden on banks (such as
streamlining bank holding company applications procedures
and paying interest on reserves).

Or, we can confine the

performance of essential banking functions (such as third
party payments and direct access to the clearing mechanism or
the coverage, implicit or explicit, of deposit insurance) to
banks alone.

In practice, some or all those approaches can

be adopted.
Banks and Their Regulation
The regulation of banks, and the related "safety
net," has long reflected their critical role as operators of
the payments system, as custodians of the bulk of the liquid
savings of the country, as essential suppliers of credit, and
as the link between monetary policy and the economy.

In that

connection, I must emphasize that individual components of the
banking and payments systems are, to a large extent, dependent on
the health of other elements.

Adverse developments here or

abroad affecting one institution, particularly of substantial
size, can dramatically and suddenly affect other institutions,
some of whom may not even have a business relationship
with the institution in difficulty.

While secondary and

tertiary effects are, of course, present in some degree in
the failure of any business firm, seldom will the effects be
so potentially contagious or so disruptive as when the
stability of the banking system or the payments mechanism is

at stakes

At such times, serious implications for overall

output? employment, and prices -- indeed, for the entire
fabric of the economy —

are apparent.

The first and most important line of defense is the
interest of banking institutions themselves in maintaining
the confidence of their customers,

But long ago, in establishing

the Federal Reserve System, the FDXC, and the FSLIC, the
government determined that normal market incentives and
protections needed to be supplemented by an official support

Ironically, the confidence and related competitive

advantages engendered in the public by that support apparatus
can, over time, induce greater risk-taking by the depository
institutions that benefit from it.

That is one reason why I

believe a comprehensive system of examination, supervision
and regulation, limitations on permissible activities, and
insurance premiums, will remain necessary*
The practical and ongoing issues in this area, it
seems to me, do not involve a wholesale revolution in past
approaches, but a reexamination of the appropriate balance


the balance between desirable risk-taking and safety, and the
balance among competing depository and non-depository
institutions —

in today's market circumstances*

One important area that is beginning to receive
attention is the appropriate structure of deposit insurance*
The insurance agencies are rightly concerned about the
proliferation of insured brokered deposits, which have been


particularly important in the case of a number of failing
institutions and those characterized by aggressive risktaking, and the unintended effect such activity may have on
both the insurance funds and structure of depository institutions.
I share the concerns of the FDIC and FSLIC.

The Federal

Reserve Board has taken the position that legislation to
permit regulatory agencies to set a cap on such deposits






lo w level tied to some ratio of deposits or capital

would be an appropriate approach.

Absent such legislation,

I support the action taken recently by the insurance agencies
to limit severely insurance protection of brokered deposits.
Developments in this area are one example of how the marketplace
can respond to one element of government intervention —
this case deposit insurance —


in a manner that can, despite

some immediate benefits, have unintended and undesirable
effects on the banking system or the regulatory system generally.
More generally, recognizing that deposit insurance has become
such an important element in the support apparatus for depository
institutions, substantial change requires careful assessment of
the possible consequences.
Bank Holding Company Regulation
Concern with the activities of organizations encompassing
banks cannot stop with the bank itself.

The restrictions

long applied to bank holding companies are importantly rooted
in prudential considerations; experience strongly suggests
the difficulty of insulating a bank from the problems of a
company affiliated with a bank through a holding company.


-11be sure? the fortunes of the bank and its affiliates can be
(and are) separated to a degree by restrictions on the
transactions among them.

But I doubt the insulation can

ever be made so complete -- at least without defeating the
business purpose in the affiliation -- as to rely on those
rules alone«

The holding companies themselves9 the securities

markets, and the general public tend to look upon affiliates as
part of a larger whole.
Other concerns -- potential conflicts of interest and
concentration of resources, particularly through extensions
of credit by the bank to customers of the nonbanking subsidiaries
can also be addressed by law or regulation.

But againr

insulation is not likely to be complete at all times.
At the same time, segregating nonbanking activities
of a bank holding company outside the bank itself can provide
important advantages.

To some degree, the bank may be shielded

from the activities of other elements of the holding company.
Segregation from the banks should, in any event, make it
easier to assure regulatory consistency and competitive
equity between nonbanking affiliates of a bank holding company
and other businesses providing comparable services.
Regulations specific to nonbanking activities may not
always reflect certain important prudential concerns of bank
supervision? to that degree, nonbanking activities conducted
by banking organizations may appropriately be subject to
rules or surveillance by banking regulators.

Conversely, when

bank holding companies engage in nonbanking activities, we
should seek to avoid competitive advantages arising simply

from the association with a banking institution able, implicitly
or explicitly, to draw upon government support*

One considera-

tion in this regard is the capitalization of the nonbanking

The higher degree of leverage common in banking

should not automatically extend to nonbanking activities?
capitalization of the nonbank subsidiaries should broadly
reflect that required of non-governmental protected competitors
by market forces and other regulatory agencies, federal and

Indeed, adequate capitalization of a bank holding

company as a whole, taking account of the particular nature
of the nonbanking activities, is important to the safety and
soundness of the bank.
In the end, the appropriate range of activities for a
bank holding company should remain, in my judgment, a matter
for determination by a balance of public policy considerations?
it should not be solely a matter of market incentives, and
some degree of supervisory oversight over the activities of
the holding company as a whole will remain important.


traditional presumption has been that there should be some
separation of banks from businesses engaged in a general
range of commercial and industrial activities, and vice versa.
That presumption still seems to me a reasonable starting
point in approaching particular questions.

At the margin,

that separation will be arbitrary, but in a broad way it
reflects legitimate and lasting concerns about risk, about
potential conflicts of interest between a bank as owner of a

nonfinancial firm and as an impartial provider of credit to
the community, and about the dangers of excessive concentration
of economic power.

Moreover, to the degree that affiliation

with a bank implies the need for some regulatory or supervisory
oversight, practical and desirable limitations on the reach
of such regulation into industrial and commercial activities
implies some limitation on the scope of bank holding company
Within this general framework, the precise line dividing
what ought to be permissible for banking organizations to do
and what should be proscribed does need reexamination in the
light of current market conditions, changes in technology,
consumer needs, and the regulatory and economic environment.
Some activities now denied banks would seem natural extensions
of what these institutions currently do, involving little
additional risk or new conflicts of interest, and potentially
yielding significant benefits to consumers in the form of
increased convenience and lower costs•

For some time, for

instance, the Federal Reserve has suggested that banking
organizations be allowed to underwrite municipal revenue
bonds and establish and distribute mutual funds*


brokerage activities have already been approved within existing
law, as have a wide range of data processing services•
Other activities seem ripe for and are being given
consideration by other Congressional committees• One general
category would be further extension of "brokerage" or "agency"


activities, including sales of a variety of real estate,
insurance, and travel products.

Insurance underwriting,

currently limited largely to credit-related insurance, is
being considered within a framework that limits concentration
of resources and risk to the banking organization taken as a
Some activities that have been discussed raise
considerably greater questions in my mind primarily because
of risk, but also because possibilities of conflicts of
interest or concentration of economic resources might not be
contained without the most elaborate and self-defeating kinds
of regulation.

Corporate securities underwriting, some forms

of real estate development, and, more generally, significant
equity positions in unrelated nonfinancial activities fall
into that category.
In any event, to the extent that regulation is needed,
the goal should be to minimize the costs and burdens of
regulation, consistent with the public interest.

For example,

experience has convinced us that some of the present procedural
requirements for bank holding company applications under the
Bank Holding Company Act can lead to unnecessary delay.


Federal Reserve Board has gone as far as it feels it can,
consistent with present law, to speed up procedures and lessen
regulatory burden.

Specifically, present statutory requirements

for approval of nonbanking activities could be modified to
permit simpler "notice" procedures, with a presumption of


approval unless there is a judgment that "safety and soundness11
and similar considerations are adverse.

Such recommendations

have been made in legislation supported by the Administration
and in bills already introduced in the Senate, and they
appear to have broad support.
Consistency in Bank-Thrift Regulations
The observation that thrift institutions have
essentially become bank-like institutions is indisputable
with respect to the powers they are allowed to exercise and
increasingly accurate with respect to the powers they do

Moreover, in important instances powers available

to thrift institutions extend well beyond those available
to banks and call into question the separation of banking and
commerce now applicable to banks.

Considerations of competitive

equity alone would seem to dictate that the special privileges
and restrictions of banks and thrifts be brought into a more
coherent relationship.
Anomalies go beyond considerations of competitive equity.
The kind of considerations I just reviewed with respect to the
powers of banking organizations cannot be valid for commercial
banks alone; limitations on bank holding companies could not
be effective to the extent thrift institutions could simply
substitute as a vehicle for combining various activities.


recognize there are difficult questions posed by the firms
that already have operations on both sides of the line between
commerce and "thrift banking", but some way needs to be found to


resolve these questions and establish a firmer policy for the
future if we are to bring a rational structure in this regard.
The implication is not that all thrifts and their
holding companies must be regulated in all ways like commercial
banking organizations.

There are ways of adequately defining

a thrift institution which would allow us to achieve necessary
functional consistency and assure the integrity of our policy
intent, while still permitting the special benefits provided
by law for institutions truly concentrating on residential
mortgage lending.

Various asset tests have been suggested

for eligibility for treatment as a "unitary" savings and loan
holding company -— a minimum percentage of assets in residential
mortgages and mortgate-backed securities or such a test in
combination with a supplemental test of a maximum of assets
in commercial loans.
The interest of investment companies, securities firms,
and commercial companies in acquiring savings and loans
suggests that an asset limitation too broad in nature would
not deter substantial non-depository participation in deposit
taking and payments services.
acquisitions —
banks —

Specific limitations on such

similar to those limiting their acquisitions of

appear necessary if the basic prohibitions of the

Glass-Steagall Act against combining commercial banking and
the underwriting of corporate securities are to remain valid.

*n» " 7 —

F^ederal^State Relations
For over a century this country has maintained a dual
system for the regulation and supervision of banking.

On the

whole, this dual banking system has played a useful and
constructive role in encouraging innovation in the financial
regulatory environment and in helping to accommodate local
differences in the needs of banking organizations and their
The system has worked as well as it has because the goals
and techniques of regulation were commonly shared, and the
divergences between federal and state systems were kept
within tolerable bounds.

As I mentioned earlier, this

commonality of goals appears to be breaking down, as states
consider expansions of powers for banks and thrifts —
attract institutions and jobs —
allowed by federal law.


that go far beyond standards

Yet, they would still rely on the

federal safety net for their state-chartered institutions.
Recent developments strongly point to the need to
provide a new framework for the dual banking system.

We need

an arrangement for the exercise of the discretion of states
in authorizing new powers for state-chartered banking institutions
without that discretion being pushed to the point of undercutting
vital national policies.

Otherwise, to the extent Congress, in

the national interest, finds it necessary to circumscribe the
activities of depository institutions and their holding


companies, such limitations will be rendered null and void
over time by unrestrained state action.
For example, we at the Board/ in view of existing law
and expressions of Congressional intent, and with the knowledge
that the matter is currently under intensive Congressional
review, have recently indicated that we could not approve the
acquisition of state-chartered banks by bank holding companies
with the apparent intent of undertaking, under relevant state
law, widespread insurance activities beyond the state in
which the bank is chartered*

This is one illustration of an

area in which we need Congressional direction in setting
appropriate guidelines.
In the area of securities powers, the Glass-Steagall Act
presumably was originally intended to apply to virtually all

However, even in this case the statutory framework

needs to be examined because, as a result of changes in law
in the late 1930's regarding the requirement of Federal
Reserve membership for all insured banks, the question has
arisen whether certain sections cover state chartered non-member

In fact, the FDIC has a proposed rule that would

permit holding companies with state non-member banks to
engage in securities activities prohibited for banks or bank
holding companies generally.


Interstate Banking
The geographic scope of depository institutions has
long been a key question of federal-state relations.


proliferation of nonbank affiliates of bank holding companies
operating across state lines, loan production and "Edge Act"
offices, integrated national markets for money and credit at
the wholesale level, the current action of some states themselves
to permit entry of out-of-state banking organizations, and
the broadened power of thrift institutions able to operate
interstate have by now led to interstate banking de facto for
many banking services.

But, as a general matter, we have

still prohibited on an interstate basis the provision of an
integrated range of services in a single office, and we force
particular activities into "unnatural," and less efficient,

Even in the consumer area, restrictions are rapidly

breaking down.

Recently, we were compelled by existing law

to approve the acquisition of a Florida "nonbank bank,"
designed to engage in a full range of deposit-taking and
consumer lending, by an out-of-state bank.

We simply, under

the provisions of the Bank Holding Company Act, felt we had
no alternative.
We sorely need a fresh Congressional review of our
entire policy toward interstate banking.

While most of the

issues in this controversial area will need to be held over
to a later Congress, the present movement toward regional
interstate banking arrangements does need to be dealt with



Just last week the Board approved two bank holding

company mergers under the reciprocal arrangements of
Massachusetts and Connecticut, even though there are serious
questions both about the constitutionality of such arrangements
and their implications for public policy.

If Congress wishes

to support these regional arrangements, appropriately limited to
a transitional period, legislation explicitly authorizing that
approach should be enacted.
The legislative framework governing the banking system
is sorely in need of change —

change that can take account

of the vast changes in the environment for the conduct of
banking and our future needs.

After long discussion and

debate, the time is ripe for action.

I believe there is a

wide area of "conceptual" consensus, and agreement on a
critical "core" of legislation -- on the definition of a bank
and a qualified thrift and on regulatory simplification —
clearly within grasp.


The remaining issues surrounding the

particular powers of a bank holding company are inevitably
more controversial, but nonetheless ready for decision.


should not confuse lack of agreement among affected industry
interests with absence of necessary information and argumentation,
Workable approaches responsive to the various concerns elicited
by months of debate and study can be developed in this
legislative session.


I know of the potential difficulties in completing
legislation this year.
much time.

But the simple fact is we don't have

A failure of Congress to act only means that the

decision-making about the evolution of the banking and
financial system will fall to others, without Congressional

The current framework and intent of banking law

cannot hold in the face of technological change, intense
market pressures, competition among states, and potentially
conflicting decisions of courts attempting to apply old law
to today's circumstances.

Regulators are being pushed to and

beyond the outer boundaries of the legal framework established
by the Congress.

None of this will stop in the absence of

Congressional action.

The system will change, but not in

ways that fit into a coherent whole, responsive to national

The clear risk is that the overriding public interest

in a strong, stable, and competitive financial system will be lost,
We want competition, and the benefits to the consumer
inherent in competition.

We also want a safe and sound

banking system, stable in itself, and contributing to a larger
economic stability.
If we act —
those aims.

and act promptly -- we can further both

We want to cooperate with you actively in working

toward that end.

* * * * * * * * * *