CRS EXAMINES THE GOVERNMENT'S REGULATORY ROLE IF BANKS ASSUME EXPANDED POWERS.
88-7 E
- AuthorsWells, F. Jean
- Institutional AuthorsCongressional Research Service
- Subject Area/Tax Topics
- Index Termsbank
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 88-9594
- Tax Analysts Electronic Citation88 TNT 258-39
CRS 88-7 E
Congress is currently considering legislation dealing with expanded powers for banking organizations. A major policy issue is how organizations should be structured and regulated if additional powers were to be permitted. Of particular interest are the possible roles of the various Federal financial institution regulators and of State authorities.
by
F. Jean Wells
Specialist in Money and Banking
Economics Division
December 28, 1987
CONTENTS
CURRENT REGULATORY ARRANGEMENTS
PROPOSED REGULATORY ARRANGEMENTS UNDER ALTERNATIVE PROPOSALS
Structural Proposals Regulatory Approaches
POLICY ISSUES
General Philosophies of Regulation Alternative Structural Approaches Possible Roles for the Various Regulators Functional Regulation Institutional Arrangements for the Regulators State versus Federal Regulation
CONCLUSION
BIBLIOGRAPHY
FINANCIAL INSTITUTION RESTRUCTURING PROPOSALS: IMPLICATIONS FOR GOVERNMENT REGULATION
The question of whether permissible powers for organizations conducting banking activities should be expanded is being considered in both the House and the Senate. 1 The legislative proposals are an outgrowth of provisions of P.L. 100-86 which place a moratorium on expanded powers for banks until March 1, 1988. The moratorium was enacted with the understanding that Congress would review the issue in the meantime.
In addition to the overall question of whether new activities should be permitted banking organizations, several related questions arise. The proposals to expand powers contain important differences in their provisions for regulation of the new activities. The manner in which regulatory responsibility is allocated among the various Federal financial institution regulators also differs from proposal to proposal. In part, the distinctions arise from differences in proposed structural arrangements under which new activities would be permitted. Various views also exist about the proper role of Federal and State regulators. These questions are explored in more detail below.
CURRENT REGULATORY ARRANGEMENTS
Under current regulatory arrangements, banking entities may be either State or federally chartered. The chartering authority is the institution's primary regulator. Banks may also be insured by the Federal Deposit Insurance Corporation and be members of the Federal Reserve System, in which case they are also subject to regulation by these agencies. The primary Federal regulator for savings institutions is the Federal Home Loan Bank Board (FHLBB), of which the Federal Savings and Loan Insurance Corporation is a part.
The relationship between regulation and institutional structure is evident in current arrangements which specify the manner in which activities related to banking are to be organized. Both banking organizations and savings institutions may be encompassed either in a single institution or in a holding company arrangement. A single institution in turn may have subsidiaries performing related functions. A holding company may consist of several banking institutions and other subsidiaries doing related business. The Federal regulator for all bank holding companies is the Federal Reserve Board. The FHLBB regulates savings and loan holding companies. Both federally chartered and State-chartered institutions may be part of a holding company.
Depository institution organizations are responsible to other Federal regulatory agencies, such as the Securities and Exchange Commission (SEC) and the Justice Department, for particular aspects of their business. For example, banking organizations may be subject to regulation by the SEC when they sell stock to raise equity funds. The Justice Department has a role in mergers and acquisitions within the banking industry.
PROPOSED REGULATORY ARRANGEMENTS UNDER ALTERNATIVE PROPOSALS
The central question in the bank powers issue is whether the safety and soundness of the depository institutions system can be preserved if institutions offering deposit services are permitted to engage in other activities to a greater extent than now is the case. Most proposals take a structural approach to dealing with this issue. Underlying this approach are a variety of attitudes about the proper role of regulation in the financial system.
STRUCTURAL PROPOSALS
Two types of structural proposals are most often advanced. One would permit related activities to be conducted in subsidiaries of banking units. The other would permit a mix of activities within a holding company framework. Banking and nonbanking functions would be carried on in separate subsidiaries of the holding company.
A main difference in the two arrangements is that the nonbanking activities would be structurally further removed from the banking unit in the holding company approach than in the direct subsidiary approach. Although it would appear structurally that the nonbanking activities would be further removed from the banking functions under the holding company approach, whether in practice that approach would provide more of a safeguard is open to debate.
REGULATORY APPROACHES
In part one's view about appropriate structural arrangements depends on one's attitudes about regulation. Various kinds of regulation are possible: for example, direct regulation by supervisory agencies, self-regulation by industry groups, regular audits within an institution itself, and required disclosure intended to encourage public scrutiny. A further distinction is whether the entire organization should be regulated in an umbrella fashion by one regulatory agency or whether the parts should be regulated independently of one another by specialized agencies. This latter approach is known as "functional" regulation.
The question of whether State or Federal regulations dealing with powers of depository institutions should be primary for institutions subject to regulation by both levels of Government has been a point of argument for many years. In some cases, State law might be more permissive than Federal law; in other cases, more restrictive. The question of expanded powers again raises the issue of whether State or Federal law should prevail.
POLICY ISSUES
GENERAL PHILOSOPHIES OF REGULATION
Under almost any proposal, it is generally agreed that the Federal Government has an ongoing responsibility for the safety and soundness of the banking system. How that can best be achieved is what is open to question.
On the one hand, some would argue in a general sense that the Government would be less vulnerable than it is now if banks were given more powers. Those who hold this view stress the value of diversification in spreading risks. Under current circumstances, they argue banks have their portfolios limited primarily to loans at a time that business is being cut into by non-bank competitors. This development is especially pronounced in the commercial lending area. There, corporate customers increasingly use other sources of funds: either borrowing direct, or through financial intermediaries other than banks, or by using forms of financing other than bank loans. Thus, they argue banks are more at risk if they AREN'T permitted to diversify than if they do.
According to this line of argument, banking organizations would have more flexibility to adapt to the ever-changing business environment if they were given expanded powers. This view holds that diversification could strengthen the banking system, thereby relieving pressure on regulators.
On the other hand, the Government opens itself to certain risks if it lets banks take on new activities. The new environment could prove incompatible, in which case banking organizations could find themselves in weakened situations. Under such circumstances, claims on the deposit insurance funds could increase. If the insurance funds' resources should be depleted, or if the banking industry were to suffer systemic problems, then the Government itself could be called on to provide funds for dealing with troubled institutions.
To the extent that problems in the banking system could contribute to an unstable financial climate, the Government also has an interest, specifically because of the Federal Reserve's role as lender of last resort. Thus, evaluations of the effect on the overall financial climate are important when determining the extent to which banking institutions should be permitted to diversify.
Related to these overall responsibilities are questions about how regulation should best be exercised. Some would argue that Government should specify what can and cannot be done; others would argue that regulation should apply by exception -- that limits should not be placed on institutions until they demonstrate problems. In the latter case, industry groups or end users of banking services might be drawn into the regulatory process. Market discipline would make bank customers, a more integral part of the regulatory process. As contrasted with direct Government regulation, self-regulation would put more reliance on industries and individual institutions to monitor their activities themselves.
In comparison with direct Government regulation, industry or marketplace regulation would depend on more public disclosure of information by individual institutions about their condition. Whether or not such information, publicly disclosed, would be properly analyzed and interpreted is open to debate. What kinds of deterrents should be put into place to discourage excessive risk-taking would be an adjunct question. Some hold the view that if penalties are sufficiently onerous, institutional behavior will be contained, whatever the form of regulation. This too is open to debate.
ALTERNATIVE STRUCTURAL APPROACHES
In order to resolve some of the conflicts that could arise from many types of activities, including depository activities, being conducted in one firm, an oft-made suggestion is that nonbanking activities be conducted in separate subsidiaries of a holding company, or, in the case of independent institutions, in subsidiaries or affiliates of the institution. Some also suggest that if additional activities are to be authorized, the activities should be performed not by subsidiaries of depository institutions but instead by holding company affiliates of the depository institution.
From the standpoint of "safety and soundness," it has sometimes been argued that the "separate subsidiary" approach would permit some latitude for varying the treatment of institutions' powers, since it would result in nonbanking activities being structurally separated from banking activities. However, the "separate subsidiary" approach itself has both its supporters and detractors.
Much of the controversy stems from differences of opinion about whether conflicts of interest and tie-ins could be controlled. Such abuses could arise in instances where a firm was involved in several aspects of a transaction, for example, representing both a buyer and a seller; or through the opportunities for a banking unit to fund activities of affiliates in a multifaceted organization.
Proponents of the "separate subsidiary" approach for holding companies argue that setting up nonbanking businesses in separate subsidiaries of a holding company would protect depository institutions from any problems that might occur in affiliated lines of business. They argue that any tendency to give preferential treatment to affiliates could be controlled through legal restrictions on financial and like transactions, and through regulatory enforcement.
Opponents of the "separate subsidiary" approach as an effective means of insulating a depository institution from other activities of a holding company argue that, despite laws and regulations to restrict intercompany financial transactions which could weaken the depository institution, such legal restrictions could be difficult to enforce. Further, it is argued that the public most often perceives an organization as an entity and that a depository institution could, therefore, be adversely affected by public reaction if related businesses were to suffer reverses.
The separate subsidiary approach for independent institutions has been seen by some as having advantages similar to those for subsidiaries of holding companies. Activities would be separated under these conditions from those of the depository institution and crosslines of activity could be more carefully controlled. Small institutions argue that the separate subsidiary approach is not feasible for them, however, because of the costs involved. According to these institutions, requirements to engage in certain activities through separate subsidiaries would unfairly preclude them from engaging in such activities. They would prefer to be able to expand activities within the banking entity itself.
Others have argued for the holding company rather than the bank subsidiary approach on the grounds that the first approach would provide a better safeguard against deposit funds being used for other purposes. Their concern is that bank subsidiaries could downstream funds from the bank more easily than subsidiaries in a holding company arrangement. Thus, the bank could be more vulnerable to other businesses' downfalls than if the activities were more structurally separate. In turn, it is argued, such an arrangement could increase risks for the Federal regulatory structure.
POSSIBLE ROLES FOR THE VARIOUS REGULATORS
A basic question is whether in a diversified company there needs to be an overall regulator which has some oversight authority for the individual activities as well, or whether the different kinds of activities can be monitored by specialized regulators independent of regulatory arrangements for the parent company. To state the problem another way: should regulation be by institutional type or by type of activity, wherever performed? Related questions involve the institutional arrangements for the regulators, and the roles of Federal versus State regulation.
FUNCTIONAL REGULATION
The approach to regulate different activities separately is known as functional regulation. Basically, it means that "firms engaged in the same activities are subject to the same rules, enforced by the same regulators." 2 With functional regulation, for example, expanded securities activities of banking organizations would be regulated by the Securities and Exchange Commission. Thus, all firms offering securities activities would be subject to the same regulation of this type of undertaking.
Functional regulation differs from the current situation where the banking agencies regulate some securities activities carried on within banking organizations. In such cases now, law specifies that the bank regulatory agencies shall apply regulations equivalent to those imposed by other regulators for certain functions common both to banks and nonbanking firms.
Those who argue for functional regulation feel that all entities performing a certain kind of task should be subject to the same, rather than equivalent, regulation and standards. Regulation by function has support from those who see it as enabling more diversified businesses to offer services now associated with depository institutions.
Those who argue for an overall regulator of an organization conducting banking functions feel that an umbrella approach is necessary to best safeguard bank deposits. They feel that regulators must have access to both the holding company and its affiliated companies if regulation is to be effective. This is the philosophy now applied to bank holding companies, whereby the holding company is regulated by the Federal Reserve, even though the component parts may be subject to other Federal as well as State regulation.
INSTITUTIONAL ARRANGEMENTS FOR THE REGULATORS
A further question is whether there can be comparable regulation of various kinds of financial institution holding companies and their components or whether they should be subject to the same regulation. The issue has already arisen with regard to commercial bank versus savings institution holding companies.
The question raises two primary issues. First, combining all financial holding company regulation in one agency would concentrate financial regulatory power. Various proposals to consolidate regulatory arrangements for depository institutions have been advanced over the years and debate on the subject has identified general concerns. For every argument for consolidation, there is an argument against it.
For example, supporters of consolidation argue that multiple agencies can lead to gaps in regulation, causing problems in effective regulatory control, particularly in the banking system. Further, they argue that consolidation could lead to operating efficiencies. On the other hand, it is pointed out that financial regulation as it is currently practiced requires exchange of information among different regulatory units, whether or not they are housed in one agency, so that consolidation would not assure that regulation would be improved. By the same token, administrative efficiencies might not result.
It is also argued that consolidation could reduce conflicts which now occur among agencies since policy decisions could be made by a single governing body or unit and could be implemented uniformly for all types of depository institutions. Alternatively, it is argued that consolidation could result in undesirable concentration of power in the surviving regulator and could stifle diversity and innovations in the financial system.
Second, combining regulation of financial institutions in one entity could raise questions about the distinction between different forms of depository institutions. Views on this aspect of the issue too have developed over time as regulation of savings institutions and commercial banks has been debated. Supporters of the savings industry argue that the mission and regulatory requirements of savings institutions continue to differ substantially from those of commercial banks; therefore, the institutions should continue to be regulated by separate agencies. Others argue that the distinctions between banks and savings institutions are being lessened with deregulation, and that the regulatory structure should be revised accordingly to keep pace.
STATE VERSUS FEDERAL REGULATION
Finally, there is the question of State versus Federal regulation. With the development of financial deregulation in recent years, more conflicts have arisen between Federal and State regulators than was earlier the case as to what powers might appropriately be conducted by firms engaged in the banking business. Some have argued that experimentation should be allowed on the State level in order to encourage the development of financial innovations. According to this view, the development and application of new ideas is important in maintaining and improving the functioning of the financial system and individual States can be used as laboratories to test such approaches.
Others argue that if the powers question is to be addressed on the Federal level, regulatory provisions should be enacted at the same time to make sure Federal regulation has primacy. The purpose of this approach would be to help assure some control over banking organizations as they venture forth into new activities to make certain that deposits are safeguarded and the Government's potential liability limited.
CONCLUSION
As been suggested above, it is difficult to evaluate the proposals for regulating expanded powers of depository institutions since there is little recent experience with broader powers and there is such a range of opinion about likely outcomes. The range of views on the subject does suggest that any proposed legislation is likely to be greeted by a variety of points of view. Thus, any legislation that might result is likely to reflect a balancing of interests of various constituencies.
BIBLIOGRAPHY
U.S. Library of Congress. Congressional Research Service. Banking and securities regulation: exploring alternatives. (by) Bruce K. Mulock, F. Jean Wells, and Kevin F. Winch. (Washington) 1986. 27 p.
CRS Report 86-500E
** Depository financial institutions: alternative regulatory approaches. [by] F. Jean Wells. [Washington] 1986. 9 p.
CRS Report 86-174 E
** Depository financial institutions: regulatory restructuring? [by] F. Jean Wells. [Washington] 1984. 54 p.
CRS Report 84-139 E
** Proposed safeguards to protect bank deposits should Glass- Steagall be repealed. [by] M. Maureen Murphy. [Washington] 1987. 24 p.
CRS Report 87-897 A
** The Report of the Vice President's Task Group on Regulation of Financial Services: A brief summary and evaluation. [by] F. Jean Wells. [Washington] 1985. 12 p.
CRS Report 85-693 E
FOOTNOTES
1 The term "banking" is used broadly here to include savings institutions as well as commercial banks.
2 Testimony of the Honorable Donald T. Regan, Secretary of the Treasury, before the Senate Committee on Banking, Housing and Urban Affairs, March 28, 1984. p. 9.
- AuthorsWells, F. Jean
- Institutional AuthorsCongressional Research Service
- Subject Area/Tax Topics
- Index Termsbank
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 88-9594
- Tax Analysts Electronic Citation88 TNT 258-39