FDIC Banking Review The U.S. Federal Financial Regulatory System: Restructuring Federal Bank Regulation by Rose Marie Kushmeider*
of whether and, if so, how the U.S. financial regulatory systemand
particularly the federal bank regulatory systemshould be restructured are
hardly new. The debate over federal bank regulatory structure and organization
goes back for nearly a century. Although studies, commissions and committees
of banking scholars, high-level government officials and industry practitioners
have been common, change has come only sporadically.1 For the most
part, the U.S. financial regulatory system remains a highly decentralized
system that has muddled along more or less in its present form since the New
Deal reforms of the 1930s.
observers of the U.S. financial regulatory system would agree that if it did
not already exist, no one would invent it.2 The overlap in tasks
among federal regulators and between federal and state regulators, particularly
for banks, creates a confusing system that no one building a system anew would
want to duplicate. That said, most observers would also admit that for all its
faults, the system seems to have served both the industry and the industrys
customers wellassuring a safe and sound financial systemthough the
inefficiencies inherent in such a patchwork system undoubtedly impose costs.
For the most part, entities within the financial services industry have learned
how to operate and even thrive under the regulatory system that has developed.
U.S. consumers enjoy an immense array of financial products and services, and
the capital markets provide funding for businesses large and small.
there is value in taking a fresh look at the structure and organization of the
U.S. financial regulatory system and providing some thoughtful review as to how
it could function more efficiently and effectively. Past studies have
generally confined themselves to reviewing the bank regulatory system, although
many have also included the regulation of savings and loans (S&Ls) and
credit unions. Although the present study focuses primarily on the federal
bank regulatory agencies, it addresses other areas of the federal financial
regulatory structure when appropriate.
least part of the reason for the past focus on reform of the bank regulatory
structure is that until recently, dividing financial services regulation along
industry lines was relatively easy to do. In addition, banking was the segment
of the industry with the greatest number of federal regulatory agencies. The
financial services industry, however, has continued to evolve and become more
complex. Products and services once provided by distinct industries have
become increasingly similar (a process referred to as product and service
convergence). In fact, the convergence that began in the 1970s has not only
continued but also accelerated as securitization and the development of
derivatives markets have added to the blurring of the once-clear lines among
banks, thrifts, securities firms and insurance companies.
paper will discuss the creation and evolution of the U.S. financial regulatory
system and compare its structure to that which other countries are now adopting
for the regulation of their financial services industries. It will then look
at past regulatory restructuring proposals and the arguments for and against reform.
Major issues in designing a regulatory structure will be discussed and finally
some options and a model for financial restructuring will be proposed.
The Structure, Creation, and Evolution of the U.S. Financial Regulatory System
The current system for regulating and supervising financial institutions is
complex.3 At the federal level, commercial banking organizations
are regulated and supervised by three agenciesthe Office of the Comptroller of
the Currency (OCC), the Federal Reserve System (Federal Reserve), and the
Federal Deposit Insurance Corporation (FDIC). Thrifts are regulated and
supervised by the Office of Thrift Supervision (OTS) and credit unions by the
National Credit Union Administration (NCUA). The federal regulatory system
also includes regulation of the securities industry by the Securities and
Exchange Commission (SEC) and the Commodities Futures Trading Commission
(CFTC),4 regulation of Fannie Mae and Freddie Mac by the Office of
Federal Housing Enterprise Oversight (OFHEO), regulation of the Federal Home
Loan Banks (FHLBs) by the Federal Housing Finance Board, regulation of the farm
credit system by the Farm Credit Administration, and regulation of pension
funds by the Employee Benefits Security Administration in the Department of
Labor and by the Pension Benefit Guaranty Corporation. The Departments of the
Treasury (Treasury), Justice (DOJ), and Housing and Urban Development (HUD) and
the Federal Trade Commission (FTC) play ancillary roles. Noticeably absent at
the federal level is regulation of the insurance industry, which is performed
exclusively by the states. In addition, each of the states regulates financial
services providers which are chartered or licensed in their jurisdictions.
federal financial regulatory systemand specifically the dual banking system,
that is, the system of federal as well as state chartering and supervision of
commercial banksdid not emerge until 1863, when Congress passed the National
Currency Act, creating the OCC to establish a system of national banks.5
Until that time, the states had regulated the entities in the financial system.6
The second major step in developing a federal financial regulatory system was
passage of the Federal Reserve Act of 1913, which created the Federal Reserve
System. After that, not until the Great Depressionthe turmoil of 1929 and the
early 1930swas there a major impetus for federal regulation of the financial
1932, Congress passed the Federal Home Loan Bank Act, which established the
Federal Home Loan Bank System. The following year was particularly active
witnessing passage of the Securities Act of 1933, the Home Owners Loan Act,
and the Banking Act of 1933. The Securities Act addressed the need for
disclosure regarding debt and equity securities sold in interstate commerce or
through the mail. The Home Owners Loan Act established the federal chartering
of S&Ls; it also gave the Federal Home Loan Bank Board (FHLBB)
responsibility for regulating, examining and supervising S&Ls. The Banking
Act of 1933, among other things, created the FDIC, which was given not only the
role of providing a federal system of deposit insurance, but also the role of
regulator of insured state banks that were not Federal Reserve members.7
1934 Congress passed the Securities Exchange Act, the Federal Credit Union Act
and the National Housing Act. The Securities Exchange Act extended the
disclosure principles of the Securities Act of 1933 to debt and equity
securities already outstanding if listed on national exchanges, and created the
SEC. The Federal Credit Union Act provided for the establishment of federal
credit unions. The National Housing Act created the Federal Savings and Loan
Insurance Corporation (FSLIC) and provided for the chartering of national
mortgage associations as entities within the federal government.8
In 1935 Congress passed the Banking Act of 1935, which among other provisions,
expanded the FDICs supervisory powers.
much of the present federal regulatory system was created in the 1930s. Since
then the system has been changed and expanded piecemeal. In 1940, the
Investment Company Act and the Investment Adviser Act brought investment
companies and investment advisers under SEC regulation. In 1956, the Bank
Holding Company Act brought multibank holding companies under Federal Reserve
regulation. In 1970, the Bank Holding Company Act Amendments brought one-bank
holding companies under Federal Reserve regulation.9
1966, the Bank Merger Act divided the authority to approve bank mergers among
the banking agencies and DOJ, making the banking industry the only industry to
have its merger activity independently reviewed outside the DOJ or the FTC. In
1967 the Savings and Loan Holding Company Act Amendments provided for the regulation
of savings and loan holding companies by the FSLIC. In 1970 the Federal Credit
Union Act Amendments established the National Credit Union Administration as an
independent agency to regulate federal credit unions; it also established
federal credit union insurance under the National Credit Union Share Insurance
Fund. Also in 1970, the Currency and Foreign Transactions Reporting Act and
the Bank Secrecy Act brought the Treasury into the picture, allowing it to
monitor large cash and foreign-currency transactions.
the late 1960s concerns about consumer protection gained prominence as consumer
credit and consumer credit instruments began growing rapidly. These concerns
led to the passage of federal laws that expanded consumer protection to the
financial services industry. In 1968 the Consumer Credit Protection Act, which
included the Truth in Lending Act (TLA), gave the Federal Reserve rulemaking
authority for truth-in-lending, although enforcement of TLA is the
responsibility of all the federal financial regulators for depository
institutions and the FTC for non-depository lending institutions, such as
mortgage and finance companies. Also passed in 1968 was the Fair Housing Act,
which is administered by HUD and enforced by the federal financial regulators.
In 1970 the Fair Credit Reporting Act was passed, which the FTC administers;
the federal financial regulators examine depository institutions for compliance
under the act.
S&L crisis of the 1980s led to the establishment of a new federal regulatory
agency for thrifts: in 1989, the Financial Institutions Reform, Recovery and
Enforcement Act (FIRREA) abolished FSLIC and the FHLBB and created, in their
place, the OTS to regulate and supervise thrifts.10 FIRREA also
established the Federal Housing Finance Board to regulate the FHLBs. Then in
1992 the Federal Housing Enterprises Financial Safety and Soundness Act created
OFHEO to oversee Fannie Mae and Freddie Mac, which had previously been
regulated by HUD and the FHLBB.11
laws identified above form the legal basis of the federal financial regulatory
system. The list is not exhaustive.12 Various other laws govern
the regulation of U.S. financial markets and institutionssuch as those
affecting trusts and pension plans. Although many of the newer laws have
focused on consumer protection, a number of others have addressed issues of
regulation and supervision related to concerns
about safety and soundness. The latter group includes the International
Banking Act of 1978 and the Federal Deposit Insurance Corporation Improvement
Act (FDICIA) of 1991.13 The Gramm-Leach-Bliley Act of 1999 (GLB)
formalized the use of functional regulation for financial services
conglomerates and entrusted supervision of Financial Holding Companies (FHCs)
to the Federal Reserve.14 The Sarbanes-Oxley Act of 2002, in
addition to addressing issues of corporate governance, expanded the powers of
the SEC and established the Public Company Accounting Oversight Board.
complicated regulatory structure came about because financial regulation has
been responsive to several traditional themes in U.S. history.15
Among them are a distrust of concentrations of financial power, including a
concentration of regulatory power; a preference for market competition; and a
belief that certain sectors of the economy should be ensured access to credit,
a belief that has led to a multiplicity of niche providers of credit. The
nations complex regulatory structure was designed to deal with all of these
sometimes conflicting objectives.
is precisely because the patchwork nature of the system remains an artifact of
U.S. politics that there has been no comprehensive overhaul of the federal
financial regulatory system.16 Despite the complexity of the system
and the resulting plethora of proposals for change, concerns about
concentrations of power, preservation of the dual banking system, and the role
of the central bank, among other issues, dominate the debate, now as in the
past. The repeated failure of proposals to reform the system suggests how
sensitive the issues are for the many varied interest groups involved.17
Trends in the Regulation of the Financial Services Industry
the lack of impetus for regulatory reform in the United States, in many other
countries reform efforts have taken hold. Although many countries continue to
regulate and supervise their financial institutions through multiple entities
(ministries of finance, central banks, and specialized independent agencies),
in nation after nation, serious study has been given to devising regulatory
arrangements to deal with a new, more integrated, financial world. The trend
has been to bring together in one agency financial supervision and regulation
of the major types of financial institutions. In addition, many nations are
moving the regulatory and supervisory functions outside the central bank.18
Rationalization of Financial Services Supervision
in the mid-1980s a number of countries examined their financial regulatory
structures and concluded that changes were needed. Researchers at the World
Bank recently reported that at the end of 2002, at least 46 countries had
adopted a model of unified (or integrated) supervision, either by establishing
a single supervisor for their entire financial sector or by centralizing in one
agency the powers to supervise at least two of their main financial
general, countries that have adopted integrated supervision believe that a
single supervisor is more effective than multiple supervisors in monitoring
risks across financial institutions and in responding to real or potential
threats that may undermine the stability of a financial system. Adoption of
the new regulatory regimes has been motivated largely by concerns that the old
regulatory structureswhich were organized by and focused on types of
institutionswere becoming increasingly, and perhaps dangerously, disconnected
from the realities of the marketplace. The convergence of financial products
and services means that many of the delineations among products, services, and
types of institutions are becoming irrelevant. The new regulatory structures
taking shape around the world represent efforts to keep supervision meaningful
and effective in a rapidly evolving financial environment.20
the trend is toward integrated supervision, there is variation in the scope of
regulatory and supervisory powers the consolidated agencies have been given.
Of the 46 countries that have changed their supervisory structures, only 22
(beginning with Norway in 1986) have consolidated the regulation and
supervision of all financial institutions into a single supervisory authority.
In the remaining 24 countries the powers to supervise at least two of the main
financial institutionssuch as banks and securities firms or securities firms
and insurance companieshave been centralized in one agency.21 (See
table 1.) In either case, the structure and organization of the supervisory
system has been rationalized to reflect the belief that fewer supervisors can
more effectively monitor and respond to risks within the financial system. The
United Kingdom represents the first approach (a single supervisory authority),
and Australia represents the second (multiple supervisory agencies but
Table 1 - Countries That Have Adopted Integrated Supervision
Supervision with a Single Regulator
most prominent example of the trend toward regulatory consolidation is the
United Kingdom, whose government moved in 1997 to establish a single regulatory
authoritythe Financial Services Authority (FSA). In so doing, the U.K.
government decided not only to consolidate all financial services supervision
within one agency, but also to move that function outside the central bank. In
terms of regulatory restructuring, this was the shot heard round the world.
Created as an independent agency, the FSA is responsible for regulating and
supervising all forms of financial services activity; it combines the regulatory
and supervisory functions previously carried out by nine bodies.22
describing the initial steps taken to establish the FSA its chairman, Howard
Davies, focused on the development of the Complex Groups Division. This
division has become the lead regulator for 40 to 50 institutionsbanks and
otherswhose scale of operation is significant within the United Kingdom, which
have a material international presence, whose products and services span a wide
area and which are complex or innovative and require advanced risk-management
techniques. Other institutions are supervised by other divisions within the
FSA, such as the Banking Division or the Insurance Division. Thus, within the
FSA there is functional regulation. This realignment of responsibilities is
based on a distinction between wholesale and retail businesses and is an
attempt to ensure the adequate oversight of a rapidly changing financial
Supervision with Multiple Regulators
Australian model illustrates a supervisory system that has been consolidated,
but has multiple supervisors. Like the United Kingdom, Australia has moved
toward regulatory consolidation outside the central bank, but unlike the United
Kingdom, Australia has drawn a sharp distinction between prudential
regulation (safety-and-soundness regulation) on the one hand, and regulation
to ensure market integrity and consumer protection, on the other hand.
Australia has placed responsibility for the two in separate regulators.
the recommendations contained in the final report issued by the committee
established by the government to make recommendations (the Wallis Committee),
Australia established its centralized regulatory system in 1998.
Responsibility for market integrity and consumer protection now lies with the
Australian Securities and Investments Commission (ASIC), while prudential
regulation has been vested in the Australian Prudential Regulation Authority
(APRA). ASICs jurisdiction extends across institutions and the financial
system, and covers investment, insurance, and superannuation (pension)
products. APRA provides prudential regulation of superannuation, insurance,
and deposit-taking institutions. The Reserve Bank of Australia (the central
bank), although it no longer has supervisory responsibilities for individual
institutions, retains its responsibilities to protect the payments system and
the broader economy from inflation and financial instability.
for Reform? Arguments and Past Proposals
for regulatory restructuring have a long history in the United States. The
arguments for reform focus primarily on the issues of regulatory overlap and
duplication while the arguments against focus on the notion that despite its
faults, the present regulatory system works well. Virtually every study of the
federal financial regulatory system has recommended some form of regulatory
reform. The goal of most of the studies has been to streamline regulation
within the banking industry so that there is less overlap among the federal
regulators and fewer federal regulators examining the same banks and bank
Arguments for Regulatory Reform
mentioned above, the debate about reform is grounded in the complexity of the
U.S. financial regulatory system. The complexity of the system has several
undesirable consequences that reformers seek to mitigate or eliminate.
and duplication. The system as it has evolved entails substantial overlap and
duplication in the regulation and supervision of financial institutions,
especially BHCs. It is common for BHCs and their subsidiaries to have more
than one federal bank regulator and for their roles to overlap. For example,
in its examination of national banks the OCC looks at a banks interactions with
its nonbank affiliates; the Federal Reserve frequently repeats part of this
process when it looks at nonbank subsidiaries in connection with its inspection
of bank holding companies. Further, as the permissible activities of financial
conglomerates have expanded, so has the potential for overlap and duplication
between bank and other financial services regulators. Under GLB, for example,
the securities broker-dealer of a financial holding company (FHC) is regulated
by the SEC, but the Federal Reserve is the FHCs umbrella supervisor. Another
often cited area of duplication is in antitrust enforcement, which is carried
out by the Federal Reserve, the DOJ, and the states.
overlap and duplication in agency jurisdictions requires agencies to manage
their shared responsibilities to try to minimize the time and money required to
perform their tasks. Coordination among agencies is required for dealing with
failing institutions and for developing uniformity in examinations and
information collection. The difficulty in coordinating regulatory actions and
procedures, however, results in inefficienciesdelaying the resolution of
issues. Such delays can impose a significant burden on financial institutions,
possibly raising the cost of product development or deterring it entirely.
and duplication of responsibilities can also result in conflicting rulings from
the regulatory agencies that can be difficult to resolve and that can create
opportunities for the same regulation or law to be applied unevenly to
different institutionspotentially resulting in a less than level playing
field.23 The current system of regulatory specialization may create
artificial advantages or disadvantages for particular types of competitors. As
financial institutions and the products they offer have become more similar and
increasingly compete with one another, differences in regulatory controls are
much more likely to artificially influence the behavior of financial
institutions and their customers. This may occur, for example, when banks,
insurance companies, securities firms, or others compete in the same product
arena, but are not subject to a common set of regulatory requirements or when
those requirements are subject to interpretation and are, therefore, applied
differently by various regulatory agencies.
conflicting decisions that are possible when there is overlap and duplication
of regulatory authority may also reflect a deliberate attempt by one regulator
to benefit its constituents or gain converts by adopting a permissive
regulatory policywhat has been termed a competition in laxity.24
What some may see as a competition in laxity, however, others may see as part
of a dynamic process of regulatory competition that furthers innovation in the
financial services industry.
authority and lack of accountability. The current system also has engendered debate
over who has the authority to regulate and supervise financial institutions and
their products and services. In the 1980s, the Federal Reserve and the FHLBB
engaged in a dispute about who was entitled to have a NOW account.25
The FHLBB adopted a more liberal regulation for S&Ls than the Federal
Reserve adopted for commercial banks. More recently, federal bank regulators
disagreed with the SEC regarding proposed rules to exempt banks from being
treated as brokers. Although the quality of the resolutions in these instances
would not necessarily have been better had there been only one agency making
the decision, when ultimate authority for a particular problem is not clearly
identified, the regulatory system may lose some of its effectiveness and its
ability to maintain safety and soundness may be impeded.26
addition to blurring the lines of authority, the current federal financial
regulatory system makes it hard for any one agency to be held accountable for
its actions or lack, thereof. Such an absence of regulatory accountability
enables regulators to pass the buck but, more importantly, it may leave holes
in the regulatory structureregulatory gapsthat should not go unfilled. The
complicated structure of regulation may lead to some problem or abuse not being
detected, because a particular agency believes the problem lies in some other
agencys jurisdiction. Determining if there are deficiencies in laws or
regulations may be difficult when those laws or regulations are administered by
against Regulatory Reform
of regulatory reform proposals have been effective at preventing a wholesale
restructuring of the federal financial regulatory system and are likely to
continue being effective. Experience suggests that the constituency for
maintaining the status quo is strong.
against regulatory restructuring frequently revolve around two notionsthat the
present system has worked reasonably well and that a single agency will not
assure uniform performance in all supervisory activities. It is hard to
disagree with these notions. Despite the regulatory burden imposed by the
present system, banks and other financial services providers appear quite
profitable and the United States has developed the broadest and deepest
financial markets in the world. In addition, there is much to be said for the
notion that a single federal regulator may become too bureaucratic and
the corollary argumentthat multiple regulators are necessary to preserve the
process of dynamic tension in bank rulemakingseems at odds with the changes
that have occurred in bank regulation and supervision. Over the past 25 years
much effort has been made to bring uniformity and consistency to the federal
bank regulatory process. For example, recognizing that insured depository
institutions faced multiple federal regulatorswith sometimes conflicting rules
and regulations, Congress in 1978 passed the Financial Institutions Regulatory
and Interest Rate Control Act. This act created the Federal Financial
Institutions Examination Council (FFIEC) to promote consistency in the
examination and supervision of financial institutions.27
of the regulatory status quo also cite as important the goal of maintaining the
dual banking system. Proposals for regulatory restructuring, however, have
focused on regulation at the federal level and have not challenged the right of
states to charter and supervise banks. Nevertheless, those opposed to
regulatory restructuring would argue that having one federal bank regulator
would de facto end the dual banking system. This argument does not explain the
existence of one federal regulator for thrifts or credit unions or suggest how
to deal with the stresses that bank mergers and consolidation have placed on
the viability of the dual banking system. In addition, legislationsuch as the
Depository Institutions Deregulation and Monetary Control Act of 1980, FIRREA
and FDICIAhas reduced the differences in banking regulations and powers
between state-chartered and national banks and has increased the regulatory
authority of the federal bank regulators vis-à-vis state regulators over
the years, a number of those opposed to regulatory restructuring have argued
thatdespite the inefficiencies resulting from a multiplicity of regulatorsthe
current system promotes innovative approaches to regulation. The claim is that
the current system, in effect, maintains a degree of checks and balances among
regulators, and probably results in more opportunities for industry innovation and
change than would a monolithic regulatory structure. The Federal Reserve, in
particular, has argued that, single regulator would be more likely to make
sudden and, perhaps, dramatic changes in policy that would add uncertainties
and instability to the banking system.28 Others would argue,
however, that innovation is driven by the marketplace, not by the regulators.
Regulators mostly react to the events that drive the regulated institutions and
are kept in check by congressional oversight, the courts, the press, and market
Issues in Designing a Regulatory Structure: Structural vs. Functional
Regulation, Umbrella Supervision vs. Consolidated Regulation, and the Role of
the Central Bank
the changes made to the financial system by GLB, the U.S. regulatory system
still largely assumes a financial marketplace with well-differentiated products
and services and with financial services providers that can be categorized by
function. Yet many banking, securities, and insurance products and services
now overlap in purpose, effect, and appearance, and financial services
providers have found numerous ways around the restrictions that attempt to
confine them to particular regulatory niches. The result is that the dynamic
financial marketplace is in effect creating organizations that manage their
risks and market their products and services as unified entitiesbut are
subject to the oversight of a comparatively static and complex regulatory
structure that looks largely at individual pieces of larger organizations. In
considering how to regulate these increasingly complex entities, choices have
to be made between structural and functional regulation, umbrella supervision
and consolidated regulation, and between whether and, if so, to what extent the
central bank should be part of the financial supervisory system.
versus Functional Regulation
or institutional regulation is characterized by having a single agency exercise
all of the different types of regulatory controls applicable to a single
financial firm. It allows a single regulator to examine a firms operations as
a whole, to evaluate risk across product lines, and to assess the adequacy of
the firms capital and operational systems that support all the business lines.
In structural regulation, integrated supervisory and enforcement actions can be
taken that will address problems affecting several different product lines.
Structural regulation assumes that the financial firm being regulated serves a
distinct market segment with limited overlap into other market segments.
regulation, in contrast, is regulation of a common activity or product by a
single agency under a common set of rules irrespective of the type of
institution involved; it may artificially divide a firms operations into
departments by type of financial product or service being offered. Because
structural regulation developed at a time when types of financial organizations
(commercial banks, S&Ls, credit unions, securities firms, and insurance
companies) provided products and services that were largely distinct from one
another, structural regulation was more or less equivalent to functional
regulation. A bank regulator supervised banking products and services while a
securities regulator oversaw activities and products in the securities
industry. Some overlap existedsuch as in bank trust departments, where bank
regulators performed the role of securities regulatorbut overlap was not
pervasive. Although many financial services firms still provide niche
services, for many others the old market distinctions are invalid.
regulation went unchallenged until the 1980s. By then, however, defining how
one financial services firm differed from another was becoming more difficult.
The advent of money market accounts, NOW accounts and share drafts; the growth
of mortgage activity in commercial banks; the development of Section 20
companies; and the renewal of interest in the Industrial Loan Company charter,
among other developments, led to the blurring of distinctions between types of
organizations that had once been largely distinct. As the once well-defined
lines separating financial services firms were being erased, the way in which
these entities were regulated became problematic. The development of direct
competition among different types of financial firms brought out the problem of
having different regulators governing equivalent products and services. The
regulatory inequities that resulted from this differential regulation hindered
some firms ability to compete and called into question their viability
vis-à-vis their differentially regulated counterparts. Accordingly, the idea
developed that financial firms should be regulated along functional lines.
idea of applying functional regulation to the banking industry was first put
forth in a 1982 Treasury proposal to expand the securities powers of commercial
banking organizations.30 Then-Secretary of the Treasury Donald
Regan proposed that commercial banks be required to place their securities
underwriting and dealing activities in a separate subsidiary, which would be
subject to regulation by the SEC or National Association of Securities Dealers.31
In 1984, the Bush Task Group endorsed the concept of functional regulation,
stating that all institutions engaged in similar activities should be subject
to the same regulations. Functional regulation as defined by the task group
seeks to have each common activity or product regulated by a single agency
under a common set of rules, irrespective of the type of institution involved.
The idea is that functionally equivalent products and services should be
regulated alike, regardless of the type of entity performing the function. GLB
proscribed functional regulation for certain affiliates within an FHC.
Supervision versus Consolidated Regulation and the Emergence of Consolidated
system of complex financial institutions that manage risk across affiliates,
the potential exists for regulatory issues to be overlooked under functional
regulation. Because of this, GLB designated the Federal Reserve as the
umbrella supervisor of FHCs. Umbrella supervision focuses on the collection of
information in order to monitor and assess the risks that an FHC and its subsidiaries
impose on an insured depository institution.32 As umbrella
supervisor, the Federal Reserve may take actions against affiliates of banks
when those affiliates are deemed to pose a material risk to the bank, but the
Federal Reserve may only instigate such actions in consultation with the
affiliates functional regulator. The Federal Reserve may not establish
capital requirements for or impose limits on the products of functionally
regulated affiliates of the bank.
regulation, in contrast, is about proscribing actions. The term consolidated
regulation is generally associated with the panoply of regulations and
supervisory powers applied to BHCsthe authority to set BHC capital
requirements; to set limits on or prohibit activities that may be conducted in
nonbank units of a BHC; and to enforce regulatory and supervisory decisions. A
consolidated regulator has the authority to require the divestiture of
affiliates that are deemed to pose a safety-and-soundness risk to the bank.33
the past decade, the concept of consolidated supervision34 has taken
hold around the world, as recognition has grown that functional regulation
treats financial institutions as disparate units rather than cohesive wholes.
In 1991, the Foreign Bank Supervision Enhancement Act required consolidated
supervision of all foreign banks that had operations in the United States. In
1992, the Basel Committee on Banking Supervision adopted its Minimum Standards
for Consolidated Supervision, establishing the principle that a bank should be
subject to a supervisory regime in which its financial statements are
consolidated and subject to review by home country authorities. The Joint
Forum (comprising the Basel Committee for Banking Supervision, the
International Organization of Securities Commissioners, and the International
Association of Insurance Supervisors) furthered the trend by developing
principles appropriate to the supervision of entities that operate within
financial groups. In 2002, the European Parliament passed a directive
requiring all financial services firms doing business in the EU to be
supervised on a consolidated basis by a home-country supervisor approved by the
much of the restructuring of financial supervision around the world came about
because of the view that financial conglomerates need to be regulated and
supervised on a consolidated basis. In developing its principles, the Joint
Forum was concerned that, although individual financial companies within a
group might be subject to prudential supervision, the consolidated financial
group might not be subject to appropriate oversight. This lack of appropriate
oversight could lead to relationships or transactions that could pose financial
risk to the regulated parts of the group. The Joint Forums principles were
developed to ensure that there were no material gaps in supervisors
understanding of interaffiliate relationships within a financial group that
could cause financial instability.36
Supervision and the Central Bank
the United States the issue of the role of the central bank and the
relationship between monetary policy and bank supervision has proved especially
hard to resolve. Proposals to consolidate bank regulatory authority outside
the central bank or to significantly reduce the regulatory authority of the
central bank have been vigorously opposed, particularly by those within the
Federal Reserve. Representatives of the Federal Reserve have maintained that
such proposals are fatally flawed because they would undermine the ability of
the Federal Reserve to conduct monetary policy, to achieve its mission of
ensuring financial stability, and to oversee a smoothly functioning payments
system. According to their arguments, These responsibilities are mutually
reinforcing and are integrally linked to the banking system.37
discussing the link between monetary policy and bank regulation and
supervision, representatives of the Federal Reserve argue that keeping bank
supervision within the central bank allows monetary policymakers to better
understand the relationship between their actions and bank behavior. In a
study of the usefulness of supervisory data to macroeconomic forecasting, Peek,
Rosengren and Tootell (PRT) found that confidential information obtained
through bank supervision can potentially improve the accuracy of macroeconomic
forecasts, a tool that is essential to the conduct of monetary policy.38
They hypothesized, for example, that problems in the banking sector might serve
as an early indicator of deteriorating macroeconomic conditions. In a
follow-up study, PRT tested to determine which institutions could provide the
greatest synergies for the conduct of monetary policy; they argued that these
are the institutions the Federal Reserve should regulate. They found that
state-chartered institutions provided the most useful supervisory information
and they suggested that the Federal Reserve should be responsible for
supervising these institutions.39 A similar study by Feldman, Kim,
Miller and Schmidt, however, concluded that there is no evidence to support the
claim that confidential supervisory information would have improved
macroeconomic forecasts in an important way.40
existence of a link between supervisory information and better economic
forecasts would not, by itself, prove that the Federal Reserve needed to have
bank supervisory powers. The Federal Reserve currently receives information
about the majority of banks from the other banking regulators, both state and
federal; it directly regulates and supervises only 12 percent of banks,
representing 25 percent of bank assets.41 PRT acknowledge that
their argument relies on the assumption that information cannot be effectively
transferred between agencies, an assumption championed by officials within the
Federal Reserve. Eliminating the Federal Reserves regulatory and supervisory
function would deprive the central bank of complete information about the ways
that levels of reserves, movements of monetary aggregates, and fluctuations in
the federal funds rate are being affected by regulatory policy and decisions by
their results, PRT state that Federal Reserve staff do not incorporate
supervisory information into their forecasts, possibly because the highly
confidential CAMEL ratings are not provided to staff involved in the
macroeconomic forecast.43 Rather, they find evidence for retaining
bank supervisory powers within the Federal Reserve by noting that the governors
and presidents of the regional Federal Reserve Banks are actively involved in
bank supervisory issues and use this knowledge to alter the internal
macroeconomic forecasts. PRT state that supervisory information is important
only to the extent that the Federal Reserve understands the rating process and
how it may change over time. Likewise, they conclude that the loss of bank
supervisory responsibilities might reduce the Federal Reserves ability to
understand the nuances in supervisory data and might therefore make the data
less useful for purposes of monetary policy. Nevertheless, PRT warn other
countries that have reduced their central banks oversight role that they
should be careful to gather the information that is provided in supervisory reports.
arguments that have been put forth to justify the Federal Reserves continuing
role in bank supervision have focused on its responsibility as the lender of
last resort and as overseer of the nations payments systemroles that make the
Federal Reserve more sensitive to systemic risk than other bank supervisors
would be. These arguments have stressed the usefulness of supervision, for it
provides a kind of hands-on knowledge of what is happening in the banking
system that could not be gotten elsewhere, not even from examination reports
written by examiners in other agencies.44 In a discussion of PRT,
Bernanke notes his reservations about the arguments for central bank
supervisory responsibilities but states that the information transfer argument
is stronger in the context of crisis management, when highly detailed and
complex information must be transferred quickly.45
most common argument for placing supervisory responsibility outside the Federal
Reserve is that doing so would mitigate potential conflicts of interest between
the conduct of monetary policy and supervision of banks. Such conflicts arise,
for example, in economic downturns as concerns about safety and soundness cause
banks to be procyclical in their lending behavior while monetary policy is
trying to be countercyclical.46 Moreover, this behavior is
reinforced during bank examinations because the number of classified assets
tends to increase in economic downturns. Regardless of whether examination
standards are actually tightened during an economic downturn, the number of
assets classified by examiners is likely to be procyclical. As this happens,
banks are likely to adjust their lending. Thus the overall effect of the
examination process may be to intensify the business cycle, an effect that
would conflict with a monetary policy that was designed to be countercyclical.
is argued that in such circumstances the Federal Reserve could apply moral
suasion to bankers, urging them to increase lending during a downturn or
restrict lending in an upturn. To many, however, the idea of the Federal
Reserve using its leverage as a regulator to persuade bankers to alter their
lending decisions or to take other actions in line with monetary policy is
troubling and demonstrates the danger of having the central bank regulate and
supervise the banking system.47 Although the use of moral suasion
as a tool of monetary policy has always been discounted in the United States
simply because of the difficulty of using it effectively with so many banks,
the possibility that it could be used effectively increases as the number of
banks declines and as fewer banks hold a greater percentage of the industrys
determine whether and to what extent the Federal Reserve needs to be involved
in the regulation of banks, BHCs, FHCs or some other financial service
provider, one must judge whether the benefits for the Federal Reserve of having
first-hand information about an institution outweigh the inherent potential
conflicts when the conduct of monetary policy is combined with supervision. Is
it possible to get an accurate picture of the financial system from information
provided by others directly responsible for regulation and supervision? Will
the central bank have the tools it needs to deal with a crisis? In other parts
of the world the answer has been to place supervisory responsibilities outside
the central bank, but these structures are relatively new and have not yet been
tested in a crisis.
a Model for Restructuring the Federal Financial Regulatory System
thinking about a restructuring of the federal financial regulatory system, one
should begin by considering the reasons for regulating the financial system.
An overriding parameter of any restructuring proposal should be to build a
system that minimizes access to the federal safety net while ensuring that the
institutions that are being regulated are viable, competitive, and capable of
meeting the needs of their customers. One should also consider how events,
which are now playing out or which are likely to occur, may propel adjustments
to the systemwhether incremental or wholesale.
Goals of Regulation
some would argue that regulation exists because of the provision of the
financial safety netspecifically, access to the discount window and deposit
insurancein fact, the evolution of the regulatory structure over the years
suggests that even without a safety net, some degree of regulation,
particularly to protect consumers, would exist. As the federal financial regulatory
structure evolved, three goals emerged: to ensure the safety and soundness of
the financial system, to foster efficiency within and competition among
financial institutions, and to protect consumers.
safety and soundness. The principal goal of the federal regulation of depository
institutions is to ensure their safety and soundness and by so doing promote
stability within the financial system. Operationally, this means that
disruptions in the financial system should not have a significant effect on
aggregate real economic activity. Thus, the failure of even a large financial
institution should not be a concern unless the failure is allowed to propagate
or become systemic.48 Because the provision of deposit insurance eliminates
the incentive for insured depositors to monitor and discipline their banks
(that is, it creates moral hazard), someone else must assume the function of
monitoring bankers and preventing them from taking excessive risks. In the
United States, this responsibility has fallen to bank regulators who fulfill
this function primarily through safety-and-soundness regulation and
a safe and sound banking system and promoting financial system stability while
undertaking regulatory restructuring require balancing the need for effective
regulatory oversight with the possibility that too much regulation can have the
opposite effecttoo much regulation can hinder an entitys ability to compete
or induce it to undertake risky activities that it would otherwise not
undertake. Fulfilling this goal also requires developing a system that limits
the extension of the financial safety net in order to encourage market, as well
as regulatory, discipline.
efficiency and competition. Fostering efficiency within and competition among
regulated institutions so that customers are provided quality products and
services at competitive prices is another goal of regulation. Efficiency and
competition are closely linked. Efficiency is promoted by fostering fair and
equal competition among firms. In a competitive financial system firms must
operate efficiently in order to keep their customers and remain in business.
Competition also spurs innovation.
maintain a competitive system, regulators must be concerned with such issues as
the prevention of excessive concentration of economic power, and the ease of
entry into financial markets. Regulators must also consider the allocation of
resources among financial firms, promoting competitive standards that do not
differ significantly among financial institutions and that do not place some
financial firms at a disadvantage relative to otherswhat has otherwise been
termed, maintaining a level playing field. Another goal of regulatory reform,
therefore, should be to foster efficiency in regulated entities and to ensure a
level playing field for all competitors.
Protecting consumers (including consumers as investors) is the third goal of
federal financial regulation and covers such concerns as enforcing contracts,
protecting consumers against fraud, and providing full and accurate information
on the terms and conditions of obtaining credit or purchasing financial
products. Much of the legislation and regulation in this area is concerned
with maintaining market integrityproviding meaningful disclosure in order to
afford consumers and investors a basis for comparing and making informed
choices among different products and services. Equal treatment and equal
access to credit are also important objectives. More recent legislation
focuses on privacy concerns.
discussed above, consumer protection regulation in the financial services
industry is administered by a variety of agencies, and can result in
differential regulation and the inequitable treatment of firms competing in the
same market. Members of the public can suffer too, if they receive different
levels of protection when they purchase similar products or services from
different financial firms, or if differences in the application of laws and
regulations hinder their ability to compare products and services. Here too,
rethinking the regulatory system in light of the realities of the changing
marketplace could lead to better consumer protection.
Problems Will Affect the Regulatory Structure Debate
of whether one believes that regulatory reform is likely, events and issues are
sure to stimulate discussion of it in coming years. Among such issues are
funding for the OCC and OTS,49 disagreements between the federal and
state banking regulators over rights of preemption,50 questions over
how financial firms should be regulated for compliance with anti-money
laundering and other anti-terrorist financing regulations,51 growth
in the number of issues that cross the lines separating functional regulators,52
the need to provide consolidated supervision for financial service firms that
are interested in operating in the European market,53 consideration
of the expansion of the products and services offered by ILCs,54 and
a widening of the differences between the largest banking organizations and the
rest of the banking industry, including differences between them in risks
Restructuring the Federal Financial Regulatory System
options for restructuring the federal financial regulatory system outlined
below range from the least intrusive and most easily accomplished reformsones
that regulators could undertake themselves or that require little legislative
changeto a full-scale restructuring of the federal financial regulatory
system. There are valid arguments for taking either approach or even for
finding some middle ground, such as a thorough restructuring of only federal
bank regulation rather than of the entire financial regulatory system. Within each
option there is room for debate over how regulation might be structuredfor
example, which financial entities might be included.
Approach to Regulatory RestructuringWhat Can Regulators Do?
the difficult political questions that would have to be resolved if the federal
financial regulatory structure were to be restructured, a number of observers
have recommended that any approach taken be incremental. The benefit of an
incremental approach (which would involve simplification rather than
consolidation) is that it would be likely to spark less debate that would
stymie action and it would not limit the options for later reform.
Simplification (such as eliminating redundancies in current supervisory policy)
would not tread on the dual banking system, nor would it limit the central
banks authority to obtain whatever data it might need to play its desired role
in the nations financial system. Simplification promulgated by the agencies
themselves would give decision makers time to evaluate and correct their
actions as they went along. It might also be achievable because it would
require neither legislation nor a crisis.
conference hosted by the FDIC a number of speakers made explicit suggestions
for initiatives that the regulatory agencies could undertake themselves.55
Chief among these were for the agencies to develop ways of sharing resources
and various kinds of expertise. It was suggested, for example, that the
Federal Reserve could take the lead in setting and enforcing risk-based capital
rules, and the OCC could take the lead in defining and enforcing rules for the
sale of non-deposit investment products. Under such a scheme, other regulators
with jurisdiction over an institution would be required to abide by the
judgment of the lead agency in the specific area. Disputes would be resolved
among the agencies, each of which would have the right to review reports
generated by the others. Other suggestions along this line included having the
regulatory agencies contract with other regulatory agencies when in need of
specialized expertise rather than building it in-house or having regulators
establish cross-agency teams to supervise specialized institutions regardless
of a particular institutions charter.56
way for agencies to streamline regulation would be to improve the rulemaking
process. Disagreements and inconsistencies among the regulatory agencies make
for bad policy, increased confusion, and increased costs for supervised
institutions.57 It has been proposed that the federal financial
regulatory system move toward integrated rulemaking while maintaining separate
supervisors.58 Other suggestions are for the agencies to specify
what regulations are outmoded and how they can be changed. The EGRPRA project
currently headed by the FDIC is making progress in this area.59
is another area where regulators may be able to achieve efficiencies and reduce
the cost of regulation, both for themselves and for the firms they regulate.
For example, each of the federal bank regulators maintains its own headquarters
and regional offices, its own administration and personnel staff, its own
computer system, its own contracting offices, its own data collection and
dissemination facilities, its own economic analysis and research function, and
its own training facility. The FDIC has estimated that the OTS, the OCC, and
the FDIC spend in total more than $200 million annually on backroom operations
to support their supervisory activities.60 Sharing these functions
may be one way to reduce costs, increase the sharing of information among the
bank regulators, and ease the regulatory burden on the industry.
A Possible Model for Reform
An approach that contrasts with the incremental
option is to think about how one would develop a system of federal financial
regulation if one were starting anew. Such an attempt at comprehensive reform
raises complex issues regarding dual banking (or more generally, the role of
the federal and state governments in regulation); deposit insurance and the
extension of the financial safety net; and the role of the Federal Reserve.
Many proposals have foundered because they were unable to generate consensus on
these issues. The model presented here will undoubtedly also spark controversy,
but nevertheless presents a framework for comprehensive reform. The discussion
is based on three assumptions: that the dual banking system will remain; that
the Federal Reserve will intervene in a systemic crisis and needs the tools to
do so effectively and efficiently; and that the deposit insurer needs to be
able to control its risk.
The model will have to deal with three
questions. The first concerns financial conglomerates, the second concerns the
two-tiered nature of the banking industry, and the third concerns the
relationship between consumer protection regulation and prudential
Banks have been subject to the most rigorous
regulation and supervision in the financial services industry mainly because of
their special nature,61 but financial modernization and the
movement toward financial conglomerates have lessened the special distinctions
between banks and other financial service providers, and have increased the
types of financial organizations that may be capable of posing a systemic risk
to the financial system. Many of these large financial conglomerates do not
fall under the purview of the safety-and-soundness regulation of the federal
bank regulators. Accordingly, in designing a financial regulatory system, one
needs to decide whether these entities should be regulated in the same manner
as BHCs or whether the regulation of BHCs should change to be more like that
currently applied to nonbank financial conglomerates. However the issue is
resolved, regulatory restructuring should be concerned with creating a more
uniform approach to all large financial conglomerates.62
The second important issue when one is modeling
a regulatory system is how to deal with the fact that financial products and
services are provided by a two-tiered industry. Over the past decade the
introduction of new products and services, the process of product and service
convergence, and the ability of banks to expand their operations across state
lines have created a bifurcated banking industry. Current regulatory practice
recognizes this bifurcation and makes some adjustments for it.63 In
considering reform of the regulatory system, however, one must consider whether
these adjustments are adequate, or whether the differences between small and
large financial service providers warrant separate regulatory and supervisory
treatment. As former FDIC Chairman Powell has asked, How do we design
safety-net arrangements to work most effectively in an industry consisting of a
few large banks on one side and thousands of community banks on the other?64
The last question affecting the model outlined
below is whether consumer protection regulation and investor protection (termed
market integrity) regulation would be more effectively and efficiently
administered by those who administer safety-and-soundness regulation or by an
independent entity. As the discussion above of the U.K. and Australian systems
indicates, opinions differ.
The model that follows would reconfigure the
current system of federal financial regulation into four independent agencies.
The first (Agency A) would administer all consumer protection regulation for
the financial services industry. The second and third would administer the
safety-and-soundness regulation deemed necessary for federally insured
depository institutions and their parent companies and affiliates. One of the
two would administer the regulation for small and noncomplex institutions
(Agency B); the other would administer the regulation for large or complex
institutions (Agency C).65 The fourth agency (Agency D) would
administer the federal deposit insurance programs for all insured
depositories. In addition, the Federal Reserve would have authority to require
information from or conduct examinations of any financial institution deemed to
pose a systemic risk to the financial system regardless of its insurance
status. As described later, the model also considers antitrust enforcement and
The model is based on the size and the degree of
complexity of a particular financial organization. The vast majority of
financial organizations are not large and complex, and for this majority,
regulation of the insured financial entity without the need for consolidated
regulation or umbrella supervision of the parent company should be sufficient.
For large or complex organizations, however, an additional layer of supervision
(in the form of umbrella supervision of the parent company) is needed to ensure
that risk is managed between entities.
The key question, therefore, is no longer which
industry a financial organization fits into, but whether the institution is
large or complex. In any event, for all institutions a case could be made for
putting consumer and investor protection in the hands of a single regulator
(that is, for functional regulation). Much of the regulation protecting
consumers crosses industry lines and in these areas consumers of financial
products would likely find it easier to deal with one regulator rather than
with the current maze of regulators.
Consumer protection and market integrity
The regulator for consumer protection (Agency A) would administer federal
consumer-related and investor-related regulations for all financial service
providers. This agency would take over the regulation and supervision of
depository institutions with respect to consumer protection laws and would
administer the current functions of such agencies as the SEC, the CFTC, the
Employee Benefits Security Administration of the Department of Labor, and the
Pension Benefit Guaranty Corporation, among others.
the past several years, emphasis has also been placed on obtaining strategic
law-enforcement information gathered from reports supplied by a variety of
financial services firms. Enforcement of the Bank Secrecy Act and other
anti-money laundering and anti-terrorist financing laws, currently carried out
by federal bank regulators in conjunction with the Treasury and the Department
of State, among others, could also be consolidated under this regulator.
Safety-and-soundness regulator for relatively
small, noncomplex insured depository institutions. This agency (Agency
B) would be the federal safety-and-soundness regulator for relatively small,
noncomplex insured depository institutions regardless of charter.66
This regulator would have the authority to grant federal charters, establish
capital requirements, enforce prompt corrective action, collect information
necessary for the timely monitoring of the institution, and take action to
ensure that firewalls were not breached.
If insured depository institutions were part of
a larger organization, they should be separate affiliates within a holding
company structure. Administration of consumer protection regulation for the
insured depository institutions and any nonbank affiliates would be functional.67
The parent holding company would be unregulated, although it would be required
to provide such information as would be necessary for the regulator to
determine that the firewalls were not being breached.68 This
information would be obtained through supervision of the regulated financial
regulator for other insured depository institutions. This agency (Agency
C) would be the federal safety-and-soundness regulator for insured depositories
that are deemed large or complex or that are part of a large, complex financial
conglomerate.69 As above, the insured depository institutions
should be separate affiliates within the holding company structure. Also, as
above, the regulator would have the authority to establish capital
requirements, enforce prompt corrective action, collect information necessary
for the timely monitoring of the institution, and take whatever action was
needed to ensure that firewalls were not breached.
In addition, this
regulator would exercise umbrella supervision of the parent financial holding
company and of the nonbank affiliates of the bank.70 In this
context, umbrella supervision refers to the ability to collect information
about the parent financial company and its affiliates; and the ability to
monitor, assess and act to control the risks imposed on the insured institution
by other parts of the organization.71 Umbrella supervision here
would not extend consolidated regulation (as currently applied to BHCs) to the
parent holding company or its affiliates.72 The purpose of umbrella
supervision would be to enhance the effectiveness of the firewalls separating
the insured entity from its parent and affiliates.
This regulator would
also apply safety-and-soundness regulation to nondepository financial
institutions or organizations that are large or complex and that pose a
contingent liability to the government. Fannie Mae, Freddie Mac, and the FHLBs
would fall into this category, for example.
for federal deposit insurance programs. This agency (Agency D) would be the regulator
for all federal deposit insurance programs. It would administer deposit
insurance and receivership functions and would maintain backup supervisory and
enforcement authority over insured depository institutions.
Role of the central bank. Although under this
model the Federal Reserve would no longer have a direct role in the supervision
of depository institutions, it would maintain and even expand its role in
controlling systemic risk wherever systemic risk might occur in the financial
system. As noted above, in a recent speech, Franklin Raines discussed the need
for having a single umbrella financial regulator that would monitor
systemic-risk issues and set broad policies to control systemic risk.73
Although he did not cite the Federal Reserve as this regulator, the Federal
Reserve is an obvious choice because of its role in promoting financial
stability and its history of intervening in crises involving systemic risk
within the financial system.
To fulfill this role,
the Federal Reserve would have backup authority to intervene in financial
markets to ensure financial stability. It would retain a supervisory interest
in financial institutions that were deemed to pose an ongoing systemic risk to
the financial system regardless of whether such institutions were supervised by
another federal regulator. The list of these institutions would be
distinguished by their activities as well as their size. Examples would be
institutions with a substantial market position in a financially critical
market, such as providers of a significant portion of payments-clearing
Antitrust enforcement. Antitrust enforcement
would be administered by either the DOJ or the Federal Reserve. An argument
for having the Federal Reserve maintain this function is that in applying the
antitrust statutes, the Federal Reserve would be able to consider the likely
effects of consolidation on systemic risk. Conversely, antitrust enforcement
could be placed solely within the purview of the DOJ, and the Federal Reserve
could make its views known if it believed there were systemic risk
Dual banking and the role of the states. States would maintain
their role as regulator and supervisor of all state-chartered institutions.
For state-chartered institutions that did not have a federal
safety-and-soundness regulator, states would be the sole safety-and-soundness
regulators. For state-chartered institutions that were federally regulated and
supervised, states would share regulatory responsibilities with their federal
Reform of the U.S.
financial regulatory system is far from assured. Matters are complicated by
the dual system for regulating financial services firms. State
regulatorsincluding banking commissioners, states attorneys general and
otherscompete with their federal counterparts in the regulation and
supervision of financial services firms. In addition, state regulators are the
sole supervisors of insurance companies, since the United States has no
national charter for these firms.
The dynamic tension
created by the presence not only of state regulators but also of multiple
federal regulators has led many banking commentators to observe that nothing
will change the regulatory structure of the financial services industry unless
the politics of the current system are taken into consideration. Unlike
citizens of other countries, who may not worry about concentrations of power,
U.S. citizens have demonstrated a clear preference for decentralization.
Further, it is commonly said that regulatory reform in the United States will
be very hard to achieve without a big event to propel it forward. Although
some tinkering around the edges may be possible, wholesale changewhich would
require congressional actionis not likely in the absence of a crisis that
would minimize battles over turf and unite the entrenched constituencies.
That said, a number of
industry observers have speculated that product convergence, or what Schooner
and Taylor have termed functional despecialization, could provide a powerful
argument for regulatory consolidation in the United States.75
Indeed, many of the countries opting for regulatory consolidation have cited
concerns over an apparently increasing divergence between their old regulatory
structure and the financial industry that the structure was responsible for
regulating. The main factors hastening the divergence are financial
innovation, a growing similarity between financial products, the widespread
availability of new information technologies, and globalization.76
This paper has provided background and a
framework for thinking about the issues involved in restructuring the federal
financial regulatory system. It has reviewed past proposals and investigated
ways in which other countries are restructuring their systems. Although many
observers of the banking system doubt that the U.S. system will ever undergo
restructuring, the financial services industry continues to evolve and, as it
does so, questions continue to be raised as to whether the current regulatory
system is up to the challenge. The task of legislators, regulators and others
is to be sure that the regulatory system can accommodate financial change yet
promote the regulatory objectives of ensuring safety and soundness, fostering
efficiency and competition, and protecting consumers, all the while maintaining
the stability of the financial system. Whether a restructuring of the federal
financial system will eventually occur remains to be seen.
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Department of the Treasury. 1991. Modernizing the Financial System:
Recommendations for Safer, More Competitive Banks. Department of the
Larry D. and Robert A. Eisenbeis. 1999. Financial Regulatory Structure and
the Resolution of Conflicting Goals. Journal of Financial Services Research
16, nos.2 and 3:133-45.
Peter J. 1999. The Feds Dual Roles as Monetary Authority and Bank
Supervisor. Speech before the Support Group for Modern National Banking,
Washington, D.C., May 24.
2003. Remarks. Presented at the American Enterprise Institute Conference, Is Consolidated Financial Regulation Appropriate for the United States?
John A. 2002. Competition among Bank Regulators. Federal Reserve Bank of
Richmond Economic Quarterly, Fall:19-36.
Proposals for Regulatory Restructuring
appendix briefly describes the 24 major proposals for regulatory restructuring
that have been made (but not acted on) since the bulk of the federal regulatory
system was instituted in the early 1930s.
Study. In the 1930s, the Brookings Institution analyzed the federal
bureaucracy for a Senate committee. Among the recommendations was one to
reorganize the bank regulatory structure. The FDIC would have become the
principal federal bank regulator, the OCC would have been abolished, and the
Federal Reserves examination and supervisory responsibilities for state banks
would have been transferred to the FDIC.
Commission. In 1949, three Hoover Commission task forces recommended
that federal bank regulatory authority be centralized. One task force wanted
to transfer the FDIC to the Federal Reserve, the second wanted to transfer the
OCC to the Federal Reserve, and the third wanted to fold both the FDIC and the
OCC into the Federal Reserve. The Commission itself opted for a fourth
approach, recommending that the FDIC be transferred to the Treasury Department.
on Money and Credit. In 1961, the Commission on Money and Credit
recommended that the functions of the FDIC and the OCC be transferred to the
Committee on Banking. In 1962, the OCCs Advisory Committee on Banking
proposed eliminating the Federal Reserves bank supervisory role. All
supervisory authority relating to national banks would have been exercised by
the OCC. All supervisory authority relating to state banks would have been
exercised by the FDIC, which would have been placed within the Treasury
Bill. A proposal in 1965 by House Banking Committee Chairman Wright
Patman, H.R. 6885, would have consolidated all federal bank regulation,
including deposit insurance functions, in the Treasury Department.
Commission. In 1971 the Hunt Commission, formally titled the
Presidential Commission on Financial Structure and Regulation, recommended the
establishment of three new independent agencies: (1) the Administrator of
National Banks, which would have replaced the OCC; (2) the Administrator of
State Banks, which would have assumed the supervisory functions of the FDIC and
the Federal Reserve; and (3) the Federal Deposit Guarantee Administration,
which would have incorporated the FDIC, the FSLIC, and the credit union
of Major Issues in Bank Regulation. In 1975 the Senate Banking
Committee commissioned a series of papers on issues of structural reform from
preparers outside the government. Several papers recommended that the FDIC
become the primary federal bank supervisor, mainly because the deposit insurer
has ultimate responsibility for all bank supervisory activities.
Proposal. In testimony before Congress in 1975, FDIC Chairman Frank
Wille proposed the creation of a five-member Federal Banking Board to
administer the deposit insurance system. He also called for a Federal
Supervisor of State Banks to assume the combined supervisory functions of the
FDIC and the Federal Reserve vis-à-vis state banks.
Study. In 1975, the House Banking Committee held a series of hearings
on regulatory structure. The product of the hearings was a four-volume work
titled Financial Institutions and the Nations Economy (FINE) Discussion
Principles. The study recommended the establishment of a Federal Depository
Institutions Commission to administer all supervisory functions of the FDIC,
the Federal Reserve, the OCC, the FHLBB, and the NCUA. Insurance functions
would be handled by a subsidiary agency within the commission.
Senate Governmental Affairs Committee Proposal. In 1977, the
Senate Governmental Affairs Committee recommended the consolidation of the bank
regulatory agencies into a single agency. The Consolidated Banking Regulation
Act of 1979 would have merged supervisory functions into a five-member Federal
Deposit Insurance in a Changing Environment. In a 1983 study,
the FDIC recommended the merger of the FSLIC into the FDIC. In addition, it
recommended that the FDIC be removed from all regulatory functions not directly
related to safety and soundness. The bank and thrift regulatory and
supervisory functions of the Federal Reserve Board, the OCC, and the FHLBB
would be consolidated in a new separate agency. The FDIC would have the
authority to conduct examinations, require reports, and take enforcement
actions, but it would limit its attention to problem and near-problem
Bush Task Group. In 1984, the Task Group on Regulation of
Financial Services, chaired by thenVice President George H.W. Bush, produced
Blueprint for Reform. The recommendations would have reduced the number of
agencies involved in day-to-day bank supervision from three to two. A new
Federal Banking Agency (FBA) would continue the OCCs supervisory
responsibilities. The Federal Reserve would take over supervision of all
state-chartered banks except banks in states where the state supervisory
authorities were certified to perform the function themselves. Except for
about 50 international-class holding companies, the federal supervisorthe FBA
or the Federal Reserveof a bank would also supervise the parent holding
company. The Federal Reserve would supervise the internationals. The FDIC
would lose day-to-day supervisory authority; its responsibilities would be
confined to providing deposit insurance, although it would be able to examine
troubled banks in conjunction with their primary supervisor. Finally,
functional regulation would play a role in that enforcement of antitrust and
securities laws would be transferred to the Justice Department and the
Securities and Exchange Commission, respectively.
Depository Institutions Affiliation Act (DIAA). The DIAA was a
piece of legislation that languished in several Congresses in the 1980s. The act
would have established a National Financial Services Committee consisting of
the chairmen of the Federal Reserve, the FDIC, the SEC, and the Commodity
Futures Trading Commission; the Secretaries of Commerce and the Treasury; the
Comptroller of the Currency; and the Attorney General. The committee would
seek to establish uniform principles and standards for the examination and
supervision of financial institutions and other providers of financial
National Commission on Financial Institution Reform, Recovery and
Enforcement. In Subtitle F, Title XXV, of the Comprehensive Crime
Control Act of 1990, Congress created an independent commission to examine the
thrift crisis of the l980s and to make appropriate recommendations. In its
study, Origins and Causes of the S&L Debacle: A Blueprint for Reform, the
commission recommended that federal deposit insurance be limited to accounts in
monetary service companies, which would be able to invest only in short-term,
highly rated market securities. A corollary recommendation was that the FDIC
be made the sole federal insurer of depository institutions and the sole
federal charterer and regulator of insured institutions. The OCC and the OTS
would be eliminated. The FDIC would remain an independent agency but would be
required to consult regularly with the Federal Reserve and make available to it
all pertinent information about the condition of insured depository
institutions. The Federal Reserve would appoint an independent Oversight Board
to evaluate new and proposed programs, statutes, rules, and regulations. The
Oversight Board would not take actions on its own but would report its findings
and recommendations to Congress and the public.
Modernizing the Financial System. The regulatory structure
recommendations of the 1991 Treasury-led study of the federal deposit insurance
system largely followed the recommendations of the 1984 Bush Task Force. The
four federal banking regulatorsthe Federal Reserve, the FDIC, the OCC, and the
OTSwould be reduced to two, and the same federal regulator would be
responsible for both a bank holding company and its subsidiary banks. A new
Federal Banking Agency (FBA) within the Treasury Department would succeed to
the responsibilities of both the OCC and the OTS. The FBA would also be
responsible for the bank holding company parents of national banks. The
Federal Reserve would have responsibility for all state-chartered banks and
their parent holding companies. The Federal Reserve and the FBA would jointly
agree on bank holding company regulatory policies. The FDIC would focus solely
on the deposit insurance system and on the resolutions of troubled banks and
H.R. 1227, the Bank Regulatory Consolidation and Reform Act.
This 1993 bill, introduced by Representative Jim Leach, would have combined the
OCC and the OTS into a separate independent federal banking agency that would
regulate all federally chartered thrifts and their holding companies as well as
national banks and their holding companies unless a holding companys assets
exceeded $25 billion. The FDIC would regulate all state-chartered thrifts and
their holding companies as well as state-chartered banks and their holding
companies unless a holding companys assets exceeded $25 billion. Bank holding
companies with assets above $25 billion, and their subsidiary banks, would be
regulated by the Federal Reserve.
H.R. 1214, S. 1633, the Regulatory Consolidation Act. These 1993
bills, introduced in the House by Banking Committee Chairman Henry Gonzalez and
in the Senate by Banking Committee Chairman Donald Riegle, would have
consolidated federal bank and thrift regulatory functions into a single
independent commission, the Federal Banking Commission. The OCC and the OTS
would be abolished. The Federal Reserve would continue to manage monetary
policy. The FDIC would continue to administer deposit insurance and exercise
conservatorship and receivership functions, but its regulatory duties with
respect to nonmember banks would be transferred to the commission. The bills
differed in several respects. The main differences were the number of members
on the independent commission and the composition of the FDIC Board of
Directors. Under the House bill, the commission would have seven members: the
Secretary of the Treasury, the Chairman of the Federal Reserve Board, the
Chairman of the FDIC, and four public members, one of whom would serve as the
commissions chairman. The five-member FDIC Board of Directors would be
composed of the chairman of the commission and four public members, one of whom
would be the FDIC Chairman. (And the commission would have a consumer division
to enforce consumer protection laws.) Under the Senate bill, the commission
would have five members: the Secretary of the Treasury or his or her designee,
a Federal Reserve Board Governor, and three public members. The five-member
FDIC Board would be composed of the Secretary of the Treasury or his or her
designee, the chairman of the commission, and three public members, one of whom
would be the FDIC Chairman.
Clinton Administration. In a November 1993 document titled
Consolidating the Federal Bank Regulatory Agencies, the Treasury Department
proposed the consolidation of federal bank and thrift regulatory functions in
an independent Federal Banking Commission (FBC). The proposal is similar to
the approaches of H.R. 1214 and S. 1633. The FDIC would be limited to
insurance functions, including the handling of failed and failing
institutions. The Federal Reserve would keep its central banking functions but
would have no primary bank regulatory responsibilities, although it would be
able to participate in the FBCs examination of a limited number of banking
organizationsthe ones most significant to the payments system. The states
would continue to regulate the banks they charter. Thus, state banks would be
regulated by both the FBC and the states. The FBC would have five members: a
chairperson appointed by the president; the Secretary of the Treasury or his or
her designee; a member of the Federal Reserve Board, selected by the Board; and
two other presidentially appointed members. An early 1994 revision of the
proposal expanded the Federal Reserve Boards participation to include joint
examinations of a sampling of both large and small banks, joint examinations of
the largest bank holding companies, lead examinations of holding companies
whose main bank is state chartered, and backup authority to correct emergency
problems in any of the 20 largest banks.
Federal Reserve Board. In January 1994, Federal Reserve Board
Governor John P. LaWare advanced a five-component plan. First, the OCC and the
OTS would be merged. The resulting agency might be called the Federal Banking
Commission (FBC). Second, the FDIC would be removed as a regulator of healthy
institutions. It would keep its insurance functions. Third, examination by
charter would be replaced by the principle of one organization, one examiner.
The FBC would examine organizations whose lead depository institution was a
national bank or thrift. The Federal Reserve would examine organizations whose
lead depository institution was state chartered. Fourth, as an exception to
the previous point, a small number of financially important organizations would
be treated somewhat differently. The holding companies and nonbank
subsidiaries would be regulated and supervised by the Federal Reserve, whereas
the bank subsidiaries would be regulated and supervised by the primary
regulator of the lead bank. Fifth, the Federal Reserve would remain in charge
of holding company rulemaking and supervision as well as the regulation of
foreign banks. The FBC would write rules for national institutions, and the
Federal Reserve would write rules for state institutions, but the two
regulators would be required to make their rules as consistent (each with the
others) as possible.
H.R. 17, the Bank Regulatory Consolidation and Reform Act. This
1995 bill, introduced by House Banking Committee Chairman Jim Leach, is similar
but not identical to Leachs 1993 proposal (H.R. 1227). The OCC and the OTS
would be consolidated into a new independent agency, the Federal Banking
Agency, which would regulate all federal depository institutions (except those
that are subsidiaries of depository institution holding companies regulated by
the Federal Reserve or the FDIC); savings and loan holding companies whose
principal depository institution subsidiary was a federal savings association;
and bank holding companies that had consolidated depository institution assets
of less than $25 billion and whose principal depository institution subsidiary
had a federal charter. The FDIC would regulate all state-chartered nonmember
depository institutions except those that were subsidiaries of depository
institution holding companies regulated by the Federal Banking Agency or the
Federal Reserve; savings and loan holding companies whose principal depository
institution subsidiary was a state savings association; and bank holding
companies that had consolidated depository institution assets of less than $25
billion and whose principal depository institution subsidiary was a
state-chartered nonmember depository institution. The Federal Reserve would
regulate all state-chartered Federal Reservemember depository institutions
except those that were subsidiaries of depository institution holding companies
regulated by the Federal Banking Agency or the FDIC; bank holding companies
that had consolidated depository institution assets of less than $25 billion and
whose principal depository institution subsidiaries were state-chartered
Federal Reservemember depository institutions; and all bank holding companies
with consolidated depository institution assets of $25 billion or more.
Federal Deposit Insurance Act Amendment of 1995. House Banking
Committee Vice Chairman Bill McCollum included a regulatory restructuring
proposal in a bill (H.R. 1769) he introduced to capitalize the Savings
Association Insurance Fund and spread the debt service costs of the Financing
Corporation to all FDIC-insured institutions. The McCollum proposal would
consolidate the OCC and the OTS into a new independent agency similar to that
in the Leach bill (H.R. 17).
The Thrift Charter Convergence Act of 1995. Representative Marge
Roukema included a regulatory restructuring proposal in a bill (H.R. 2363) she
introduced to capitalize the Savings Association Insurance Fund and spread the
debt service costs of the Financing Corporation to all FDIC-insured
institutions. The Roukema proposal provided for the conversion of federal
savings associations into banks; the treatment of state savings associations as
banks for purposes of federal banking law; the abolition of the OTS; and the
transfer of OTS employees, functions, and property to the OCC, the FDIC, and
the Federal Reserve, as appropriate.
General Accounting Office. In testimony before Congress in May
1996, the General Accounting Office, based largely on a review of foreign bank
regulatory systems, made four recommendations for changes in the U.S. bank
regulatory system. First, the number of federal agencies with primary
responsibilities for bank oversight should be reduced by consolidating the OTS,
the OCC, and the FDICs primary supervisory responsibilities into a new agency.
Second, the Federal Reserve and the Treasury Department should be included in
some fashion in bank oversight. Third, the FDIC should have the necessary
authority to protect the deposit insurance funds. Fourth, mechanisms to help
ensure consistent oversight and reduce regulatory burden should be incorporated
into the regulatory system.
Financial Modernization, 105th Congress. Financial modernization
was a topic of broad interest in the 105th Congress (19971998). As reported
out of the House Banking Committee in June 1997, H.R. 10, the Financial
Services Competition Act of 1997, combined elements of several bills, including
the House version of the Depository Institution Affiliation Act and a
Department of the Treasury proposal. Regarding regulatory restructuring, H.R.
10 would have abolished the OTS, merging it into the OCC, and would have
created a National Council on Financial Services composed of the Secretary of
the Treasury; the Chairmen of the Federal Reserve Board, the FDIC, the SEC, and
the CFTC; the Comptroller of the Currency; a state securities regulator; a
state banking supervisor; and two presidential appointees with experience in
state insurance regulation. These regulatory restructuring measures were not
in the version of H.R. 10 that was passed by the House in May 1998, and they
were not revived in later versions of the bill.
* The author is a senior financial economist in the FDICs Division
of Insurance and Research. The author would like to thank colleagues at the
FDIC and Robert Pollard for their helpful comments. Steven McGinnis provided
research assistance for the paper. The opinions expressed herein are those of
the author and do not necessarily reflect the views of the FDIC.
1 For a brief overview of past regulatory restructuring proposals,
see the appendix.
2 See, for example, FDIC (2003a) and Spong (2000), 15.
3 Regulation consists of the laws, agency regulations, policy
guidelines and supervisory interpretations under which financial firms
operate. Supervision refers to the monitoring of the condition of financial
institutions and to the enforcement of regulations. The bank supervisory
system, for example, includes: on-site examinations and off-site monitoring of
banks and bank holding companies, enforcement of banking laws and regulations,
and the resolution of problem and failed banks.
4 The SEC and CFTC oversee numerous self-regulatory
organizationsincluding the organized exchanges, the National Association of
Securities Dealers, and the National Futures Associationthat provide
supervision and much of the regulation for the securities industry.
5 Technically, the federal government entered into bank regulation
in 1791, when it chartered the First Bank of the United States. The bank not
only operated as a commercial bank, but also assumed some of the functions of a
central bank, such as acting as a fiscal agent for the Treasury. In 1811,
however, the bank was not rechartered. In 1816, the federal government
chartered the Second Bank of the United States, which also failed to survive.
Its charter was not renewed in 1836. Not until 1863, when political pressure
for a uniform national currency mounted, was a permanent federal role established
in the banking industry. The National Currency Act was extensively rewritten
and strengthened in the National Bank Act of 1864.
6 The earliest banks received their charters through special acts of
their state legislatures and the states played a limited role in their
supervision. With the development of free banking in the 1830s, which
allowed anyone meeting certain standards and requirements to secure a bank
charter, states began supervising bank operations.
7 The FDIC was given the authority to examine all insured banks, but
to prevent regulatory duplication, it confined itself largely to regulating
state nonmember banks.
8 The only association formed was the National Mortgage Association
of Washington, which eventually became Fannie Mae. See: Frame and White
9 Especially important to the issue of regulatory restructuring is
how banks and their holding companies are regulated. Passage of the Bank
Holding Company Act and its amendments placed oversight of bank holding
companies (BHCs) with the Federal Reserve. This meant that, effectively, BHC
regulation was separated from bank regulation; each was put on its own track;
the result was overlap, duplication, and conflicts of purposeif not of
interestthat had not existed previously. Golembe (2000), 3.
10 The insurance function for savings associations was transferred to
11 Although Fannie Mae and Freddie Mac have one regulator and the
FHLBs have another, all of them constitute the housing GSEs
12 See Spong (2000) for a description of banking regulation and the
laws to which banking organizations are subject.
13 The International Banking Act applied federal regulation to
foreign banks. FDICIA tightened the regulation and supervision of banks and
thrifts in a number of ways. Besides establishing specific requirements for
bank capital and examinations, it authorized the FDIC to conduct back-up
examinations. It also incorporated the Foreign Bank Supervision Enhancement
Act under its Title II provisions.
14 A discussion of functional regulation is provided below. Briefly,
functional regulation is regulation of a common activity or product by a single
regulator for all types of financial institutions.
16 As Golembe (2000) has observed, In a country possessing immense
natural resources, the development of which depended to a considerable extent
on financing, bankinghow it would be organized and who would control itbecame
major political issues. Political parties were often formed around, or came apart
because of, views on banking. The result was free banking, dual banking,
and deposit guarantee. All were products of their time, all are still alive,
and all help account for the present fragmented regulatory structure. (p. 3).
18 De Luna Martinez and Rose (2003) report that, of the 15 systems
they examined in detail, 14 have created a separate supervisory agency outside
the central bank. They go on to warn, however, that not all of the newly
created agencies are as powerful as they seem. Ministries of finance and
central banks continue to play a key role in issuing and amending prudential
regulations, authorizing licenses, and establishing important laws for the
entire financial system. (p. 12).
20 Financial innovation and globalization, driven by an interactive
process of new information technology, competition and deregulation, are,
unquestionably, progressively blurring the traditional boundaries between
different forms of financial intermediation. So regulation based on particular
categories of institutions has increasingly become overlaid by functional
regulation. This has made the whole regulatory structure increasingly complex,
both for the regulated firms and for the consuming public at large. George
22 The nine are the Supervision and Surveillance Division of the Bank
of England, the Building Societies Commission, the Friendly Societies
Commission, the Insurance Directorate of HM Treasury, the Investment Management
Regulatory Organization, the Personal Investment Authority, the Registry of
Friendly Societies, the Securities and Futures Authority, and the Securities
and Investments Board.
27 The council is composed of the Comptroller of the Currency, one
governor of the Federal Reserve, the director of the [now] OTS, and the
chairmen of the FDIC and NCUA. A liaison committee comprised of five
representatives from state financial regulatory agencies is also included on
28 See: Board of Governors of the Federal Reserve System (1994),
31 The policy was endorsed by SEC Chairman John Shad (1982).
32 As Haubrich and Thomson (2005) state, the umbrella supervisor is
charged with producing a comprehensive picture of an institution as the
collection of its parts, leaving regulation and examination of each
holding-company subsidiary to its functional regulator.
44 In discussing how the Federal Reserve managed to avert a banking
crisis in New England in the early weeks of 1991, Syron (1994) states that the
discount function has many similarities to the work of bank examiners. He
explains that both of them involve the examination of loans, appraisals of
collateral, and verification of secured interests. The examiners work was
critical to our ability to respond quickly to the need for establishing
sufficient collateral for discount window borrowing. (45). Syron also argues
that other agencies have a more limited focus to their bank examinationsthat
is, the other agencies focus on the safety and soundness of individual
institutions and the exposure of FDIC insurance funds to bank actions. The
Federal Reserve, by contrast, must be aware not only of these considerations
but also of ways in which problems can spill over to other participants and
markets. Syron argues that examiners who focus solely on the safety and
soundness of individual banks frequently do not have the training and the interaction
with payments operations that are critical in identifying possible systemic
problems. See also: Wall and Eisenbeis (1999).
47 As Bernanke (2001) noted, Giving the central bank too broad a
range of powers may invite abuse. . . . The potential for moral hazard is real
and should be a concern for those who supervise the supervisors. (29697).
49 Consolidation among banks has affected the funding of both the OCC
and OTS and has raised questions about how state banks are charged for their
own supervision. Additionally, as the thrift industry continues to shrink, the
role of the OTS becomes more problematic: legislation has taken away the
advantages of operating thrifts, and a declining industry is unlikely to be
able to support an independent agency.
50 Both the OCC and OTS have been active in preempting certain state
consumer laws affecting the institutions they regulate. See: OCC (2003).
51 Recent controversies regarding the vigilance with which anti-money
laundering and anti-terrorist financing laws have been enforced by bank
regulators have led to questions about whether this function should be
administered elsewhere. Administration of these laws is the responsibility of
the Treasury and involves coordination with many agencies, both in the United
States and abroad.
52 As banks, securities firms and insurance companies continue to
find ways to compete with one another, it will become impossible to separate
banks from the larger financial services industry of which they are a part.
Thus, issues will arise between regulators over how similar products and
services are regulated and who has ultimate jurisdiction over them. For
example, the SEC and federal banking regulators have differing views on the
issue of how to apply brokerage rules to banks.
53 For BHCs and FHCs and their subsidiaries operating in the EU, the
Federal Reserve provides consolidated supervision; however, other financial
service providers operating in the EU will be regulated by the EU if they do
not have a consolidated supervisor. The SEC has issued a proposal to provide
consolidated supervision for broker-dealers that meet minimum capital
requirements; one of their reasons for doing so is to allow these broker-dealers
to meet the EU requirements. Similarly, the OTS has designated itself the
consolidated supervisor of thrift holding companies.
54 Questions about the regulation of ILCs have increased as the
number of commercial companies and others that are not regulated as BHCs seek
to acquire this charter. For a further discussion of the issues posed by ILCs
and the mixing of banking and commerce, see: Blair (2004).
61 The special nature of banks has been widely discussed. It focuses
particularly on the ability of banks to offer transactions services and
administer the payments system, their role as providers of backup liquidity to
the economy, and their role as transmitters of monetary policy. See: Corrigan
(1982), 224. Banks also have access to the federal financial safety net.
62 See, for example, Raines (2004) and McDonough (1997).
65 Complexity refers to the scope of products and services offered by
the the financial entity and the degree of risk inherent in those products and
66 The size of the institution is based on that of the insured entity
or sum of entities, if there are multiple affiliated insured institutions.
Although the exact definition would have to be determined, a possible
definition of a relatively small, noncomplex insured depository is an
institution with less than $5 billion in assets, with a relatively simple
balance sheet (that is, an institution primarily engaged in providing
traditional products and services according to its charter type), with no
significant off-balance-sheet exposures, and with a minimal reliance on
intangible income sources. [Daniel Nuxoll (senior economist, FDIC) in
discussion with author. 2003.]
67 They would be regulated by the agency in charge of consumer
protection and by any appropriate state authority.
68 Consolidated regulation currently exercised over BHCs would be
abandoned. In 1987, an FDIC study concluded that banking companies could be
allowed to offer a wider variety of products because banks could be insulated
from the risks associated with nonbank affiliates without the need to spin a
regulatory web around the entire organization. FDIC (1987), 1012.
69 As one would expect, any depository institution that does not fall
into the category of small and noncomplex would be placed here. The criterion for
determining a large or complex financial conglomerate is problematic and is
beyond the scope of this paper to develop.
70 For financial companies owned by a nonfinancial commercial parent,
umbrella supervision would be applied to the financial entities but would not
extend to the parent commercial firm. The financial entities of these
companies would be placed into the appropriate regulatory category on the basis
of the size and complexity of the operations of the financial entity regardless
of the parent company.
71 See Helfer (1997), 10: In view of the increasing complexity of
the financial marketplace, functional regulation alone may not be sufficient to
ensure effective and efficient oversight of banks and other providers of
financial services. . . . Some activities, practices, and intercompany
dealings that affect the distribution of risk across the organization may go
unnoticed if there is singular reliance on a functional approach. This
suggests a need for some coordination and attention to interstitial concerns,
such as maintaining accurate information regarding all operations in the
organization, and monitoring compliance with the rules on intercompany
dealings . . .