(Archived Content)
FROM THE OFFICE OF PUBLIC AFFAIRS
pr071797bSafety-and-Soundness Safeguards 1
Insurance Powers of National Banks and Their Subsidiaries 3
National Council on Financial Services 5
Bank Holding Company Capital 5
Wholesale Financial Institutions 6
Functional Regulation 8
National Association of Registered Agents and Brokers 9
Federal Home Loan Bank System 9
FDIC Board 10
In approaching financial modernization legislation, the Administration has three key objectives: First, to protect the federal deposit insurance funds and the safety and soundness of our financial system. Second, to reduce costs and increase access to financial services for consumers, businesses, and communities. And third, to promote innovation and enhance the worldwide competitiveness of the U.S. financial services industry.
H.R. 10 as reported by the Committee on Banking and Financial Services (the bill), uses as its baseline the draft legislative proposal transmitted by the Secretary of the Treasury on June 2, 1997. However, a number of amendments were made to the draft proposal that give the Administration concern. We look forward to working with Members to resolve these concerns.
Safety-and-Soundness Safeguards
Lack of Divestiture Requirement
Sections 103, 141, and 142 of the bill would establish a framework under which an FDIC-insured depository institution could affiliate with a company engaged in nonbanking activities. Although these sections deal with different types of affiliations, they would each require the depository institution to be well-capitalized and well-managed. If regulators found a capital or managerial deficiency, they would be required to give the regulated entity formal notice of the deficiency, and then give that entity at least 45 days to execute an agreement to correct the deficiency. But unlike the Treasurys proposal, those sections would not require the affiliation to terminate if the depository institution persistently failed to remain well-capitalized and well-managed. The bill would make divestiture merely an option for the depository institutions primarily federal regulator, and create no safeguards against excessive forbearance.
We believe that termination of the affiliation should be mandatory if the depository institution fails to correct its capital or managerial deficiencies after being given a reasonable opportunity to do so. Specifically, if the deficiencies were not corrected within 180 days, we would require that the affiliation (or, at the regulated entitys election, the nonbanking activities) terminate then or within such additional time as regulators may allow.
The prospect of mandatory termination would give a depository institutions owners and managers strong incentives to keep the institution well-capitalized and well-managed -- and thus minimize the chances of it ever causing a loss to the FDIC. In our view, these rules strike a reasonable balance between mandatory safeguards and regulatory discretion.
Holding Company Commitment to Keep Its FDIC-Insured Depository Institutions Well-Capitalized
The bill should include section 121 of the Treasury proposal, which would require a bank holding company -- as a condition of qualifying for broader affiliations -- to make an acceptable written commitment that it will either keep its FDIC-insured depository institutions well-capitalized or will divest them in a manner that leaves them well-capitalized. Such a commitment would strengthen the holding companys incentives to keep its insured depository institutions safe and sound, and would thus help protect the federal deposit insurance funds. If Congress were to retain section 106 of the bill (the so-called reverse basket), which permits a nonfinancial company to own a bank and exempts it from holding company regulation, it would be particularly appropriate to require such a commitment from the company.
Programs for Promoting Housing Finance
Like our proposal, section 315 of the bill would create a program for assuring that depository institutions may continue to specialize in housing finance. However, section 315 would go too far by treating real estate development the same as real estate lending. Real estate development is riskier and has caused problems in the past. It should be deleted from section 315.
Insurance Powers of National Banks and Their Subsidiaries
Section 151 of the bill dealing with the insurance powers of national banks, is discriminatory and anticompetitive, and we cannot support this provision.
Section 151 could have a serious adverse effect not only on future national bank insurance-related activities, but also on banking activities that any single state insurance regulator may label insurance. It would bar national banks from engaging as principal in insurance activities unless (1) the OCC has authorized the activity in writing on or before January 1, 1997, or (2) one can show that national banks have engaged in the activity on or before that date. By labeling a product or activity insurance, any state insurance regulator could bar national banks from engaging in the activity unless one of those two tests were met or unless, through an elaborate process, the National Council on Financial Services found the product or activity not to be insurance. Thus a state regulators labeling of a product or activity as insurance would not simply mean that it would be regulated as insurance; it may result in prohibiting all national banks from engaging in the activity.
Many state laws currently define insurance to include activities -- such as indemnities, guarantees, and acting as a surety -- that could be construed to cover many banking functions. Thus section 151 could cut off current and future banking-related functions unless one of the two documentation requirements above is satisfied or someone successfully runs the gamut of the Council process to prove that the activity is not insurance. The bill would impose no similar restrictions on state banks.
State regulation of insurance activities conducted by national or state banks is an entirely legitimate issue. But the solution is not to deprive national banks of their current powers to conduct activities that may be found to be part of or incidental to banking just because those activities may also be labeled insurance activities. Section 151 should, at a minimum, be amended by modifying the provisions unduly restricting bank powers, and by changing the issue to be determined by the National Council to whether a particular product should be regulated as an insurance product or a banking product. This would preserve the statesrole in regulating insurance activities while not undermining the national bank charter.
The procedures prescribed by section 151 are flawed. The process by which the National Council on Financial Services would review state insurance regulatorschallenges to OCC rulings on permissible insurance products would be time-consuming and cumbersome. In an effort to mitigate some of the defects of that process, section 151 would have the Federal Reserve Board determine whether a petition presents a substantial question for review by the Council, but we believe it is inappropriate to use the Federal Reserve essentially as a reviewing agency for decisions of the OCC. And section 131, by requiring the Federal Reserve to defer to state regulators in interpreting state insurance law, could defeat the apparent purpose of such screening by virtually assuring that any state regulators petition would present a substantial question.
The bill would also retain current law regarding the insurance agency powers that national banks can exercise directly, including the restriction on offering insurance only from towns whose population does not exceed 5,000. We strongly believe that meaningful financial services reform should remove such outdated and cumbersome barriers to competition and permit national banks to conduct full insurance agency activities from any location as long as they do so in accordance with state law generally applicable to all insurance providers in the state. Although very large banks have little difficulty establishing an office in a town of less than 5,000 solely in order to sell insurance, mid-sized and smaller banks may well find it difficult or exceedingly costly to do so, and may thus in practice be foreclosed from exercising these powers.
Similarly, there is no reason to prevent financial subsidiaries of national banks from engaging as principal in the full range of financial activities, including insurance underwriting and merchant banking. The capital deduction and other safeguards applicable to such subsidiaries would protect the parent bank from any risks in the subsidiary and prevent the subsidiary from having funding or other competitive advantages over other insurance providers. Insofar as insurance underwriting is involved, the subsidiaries would be subject to state law applicable to insurance providers in the state.
Section 151(c), which would generally prohibit national banks and their subsidiaries from underwriting or selling title insurance, is an example of the kind of protectionism that a financial modernization bill should avoid. If its goal really were consumer protection, then it logically should apply to national and state banks alike. Yet the prohibition would single out national banks, which are strictly regulated and many of which have long engaged in title insurance activities. At the same time, the bill would evidently permit a title insurance company to affiliate with a bank through a holding company.
We strongly object to provisions that would single out national banksinsurance activities -- or any other activities -- for restrictive treatment. Congress should not skew the balance between state and federally chartered depository institutions.
National Council on Financial Services
We support creation of a National Council on Financial Services, but we have several concerns about provisions of the bill relating to the Council. Section 121(b) would provide for the appointment of one individual with experience in state-level securities regulation, one individual with experience in state-level bank supervision, and two members with experience in state-level insurance regulation. We believe that one insurance member would suffice to ensure that the views of the state regulators are adequately represented. In the context of such a change, the legislation could express a preference for (but not require) the President to appoint a sitting insurance commissioner rather than a former commissioner.
The Banking Committees changes in the membership of the Council, together with the creation of an Advisory Council on Community Revitalization, would increase the costs charged to each member agency. The Treasurys proposal contemplated seven agency members and one appointed member, with the member agencies sharing the appointed members expenses pro rata. Section 121 would provide for six agency members and four appointed members. Section 123 would create an Advisory Council with five additional appointed members. The bill specifies that the six member agencies would, pro rata, bear the expenses of all nine appointed members. Budget authority would be needed to cover at least some of these expenses.
Finally, section 123 would not clearly specify the duration of the Advisory Council. It implies that the Advisory Council will have a limited life, since members will be appointed for the life of the Advisory Council and since the Advisory Councils reporting obligations terminate after five years. We recommend inclusion of a sunset provision to take effect at that time.
Bank Holding Company Capital
Section 133 of the bill would give the Federal Reserve Board excessively broad authority to impose capital requirements on bank holding companies. Despite captions that suggest significant constraints on the Boards discretion (e.g., Focus on double leverage), that discretion is essentially open-ended. We urge the Committee to strike this section -- and thus preserve current law -- or replace it with section 143 of the Treasury proposal.
Wholesale Financial Institutions
Sections 161 and 162 of the bill, dealing with wholesale financial institutions (WFIs), are seriously flawed. We urge the Committee to substitute sections 171, 172, and 173 of the Treasury proposal.
Our specific concerns are as follows:
Discriminatory Policy-Setting
Section 161 of the bill would essentially give the Federal Reserve exclusive control of policy relating to WFIs -- including rulemaking, other standard-setting, and exemptions -- even if the WFIs have national bank charters. We strongly object to this subversion of the dual banking system. The section should be modified to give the Federal Reserve and the Comptroller of the Currency joint rulemaking authority regarding such matters as capital standards, capital categories for prompt corrective action, and exemptions from other laws. The Federal Reserve should have unilateral authority to protect the payments system (in addition to the Boards existing authority) by taking into account the financial condition of a WFIs affiliate when setting credit limits or by prescribing special clearing balance requirements for WFIs.
Inadequate Safeguards
Section 161 of the bill contains inadequate safeguards to protect consumers, the payments system, and the taxpayers. The Federal Reserve Board may exempt WFIs from most provisions of law (i.e., those other than the WFI statute) as long as the exemption is not inconsistent with a vague set of objectives, which include the protection of the deposit insurance funds and the protection of creditors and other persons . . . engaged in transactions with WFIs. Similar objectives would govern the process of setting capital requirements for WFIs. The minimum tier 1 capital ratio would impose little constraint on regulatory laxity because tier 1 capital is a regulatory construct meaning what regulators say it means. By contrast, section 171(g) and (h)(3) of the Treasury proposal would provide stronger, clearer requirements designed to protect the taxpayers and the financial system from risks associated with WFIsaccess to the payments system and the discount window, and to minimize any moral hazard related to that access.
Section 161 would in effect permit WFIs to serve retail customers who may need deposit insurance and consumer protections. It would require only an initial deposit of $100,000 or more in a WFI, and would permit the WFI to derive up to 5 percent of its total deposits from accounts with initial deposits of less than $100,000. The bill should be amended to screen out retail customers. Section 171(f)(1) of the Treasury proposal would require a $100,000 minimum balance, with no 5 percent leeway. We would be open to other approaches that effectively screen out retail customers. We also believe that regulators should be able to exempt a WFI from the consumer protections of section 112 only if they specifically determine that the WFI does not sell investment products to customers needing the protections of that section (section 171(f)(4) of the Treasury proposal).
Section 161 purports to apply to WFIs the prompt corrective action provisions of the Federal Deposit Insurance Act. But those provisions have as their lodestar the purpose expressed in section 38(a)(1) of that Act: namely, resolving the problems of insured depository institutions at the least possible long-term loss to the deposit insurance fund. Because WFIs are uninsured, this purpose logically does not apply; it certainly fails to provide clear guidance for dealing with WFIs. Section 171(e)(2) of the Treasury proposal would avoid this pitfall by specifying that, in the case of WFIs, the purpose of prompt corrective action shall be to protect taxpayers and the financial system from risks associated with WFIsaccess to the payments system and the Federal Reserve discount window.
Insolvency
Under the Treasury proposal (sections 171(i) and 173), failed WFIs would be resolved under the Bankruptcy Code -- thus sending an important signal to capital markets that creditors of WFIs should not expect troubled WFIs to receive special treatment, as if they were too big to fail. The bill should be amended to incorporate this policy.
WFI Holding Company Regulation
The bill would subject companies that own a WFI but not an FDIC-insured depository institution) to regulation under the Bank Holding Company Act. Despite the extreme complexity of these WFI holding company provisions, it is not clear whether they would provide much more flexibility than other provisions of the bill, notably those that would (1) define a broad range of investment activities, including merchant banking, as financial; (2) permit a qualified bank holding company to derive 15 percent of its revenues from nonfinancial activities; and (3) permit a nonfinancial company to control a full-service, FDIC-insured bank with revenues up to 15 percent as large as its own.
We see no need for the bills restrictive complexity in this regard. Under the safeguards provided in sections 171-173 of the Treasury bill, there would be no need to apply the Bank Holding Company Act to WFIs with no FDIC-insured affiliates. An acceptable alternative might be to limit ownership of WFIs to companies that derive a specified percentage of their domestic gross revenues from financial activities.
Functional Regulation
Bank-Issued Securities
Unlike section 205 of the Treasury proposal, the bill would not transfer oversight of bank-issued securities from the banking agencies to the SEC. We see no justification for continuing the present system of overlapping and duplicative functions by four banking regulators and the SEC. For the most part the banking regulators already administer these functions comparably to SEC regulation. Thus, consolidating these functions in the SEC would promote efficiency in government and reduce regulatory costs. It would be consistent with the goals of functional regulation by ensuring uniformity of regulation and enforcement.
Authority to Define Banking Products
Section 152 of the bill would authorize the Federal Reserve Board -- rather than the National Council on Financial Services -- to decide whether a product is a banking product exempt from broker-dealer regulation under the Securities Exchange Act, thus potentially giving a single banking agency a decisive influence over future product innovation and financial structure. Vesting this authority solely in the Federal Reserve would fail to provide the SEC with a voice on an issue that directly affects its mission, exclude the views of the other banking regulators even though the determination applies to depository institutions within their primary jurisdiction, and deny the Council dispute resolution authority for which it is well designed.
A better approach would involve a joint determination of the issue by the SEC and the banks primary federal regulator, with the Council resolving any disputes (as under section 207 of the Treasury proposal). The procedure is designed to accommodate fully the views of both the SEC and the banking regulator and to encourage them to resolve differences without having to resort to a Council determination. If they were unable to agree, the Council would be the appropriate arbiter because its membership would consider the issue from a broad financial services perspective.
National Association of Registered Agents and Brokers
We see logic in establishing a self-regulatory organization for insurance agents and brokers, as under title IV of the bill. But such an organization must not become a means by which one group of competitors gives itself an advantage over others -- e.g., by discriminating against agents and brokers because they are affiliated with depository institutions.
Title IV would not only fail to prohibit such discrimination but would actually facilitate it. The new self-regulatory organization, to be known as the National Association of Registered Agents and Brokers (NARAB), could adopt licensing standards for sellers of products that any state labels as insurance, as well as separate and unequal classes of membership. Because NARAB would derive its rulemaking powers from Congress, depository institutions could not use the principles articulated in the Supreme Courts Barnett decision to resist NARAB rules that were discriminatory in purpose or effect.
Federal Home Loan Bank System
The Federal Home Loan Bank System has structural flaws that raise serious policy and safety and soundness concerns. Changes in housing finance, technology, and the Systems membership have rendered the Systems 65-year-old structure obsolete, and raise questions about the allocation and effectiveness of the Systems federal subsidy.
The FHLBank provisions contained in the bill would likely expand the size of the System without increasing its focus on meeting a clearly defined public purpose. The bill contains some positive provisions such as eliminating mandatory membership and fixing the REFCorp allocation formula, and adding a risk-based element to FHLBank capital requirements. However, the bill would: open FHLBank membership to insured depository institutions with less than $500 million in assets without any limit; significantly increase the membership and advance activity of large financial institutions; place only modest limitations on investments, and then only at the discretion of the Finance Board; and create 12 different capital structures. The net result of these amendments would likely be an unfocused increase in FHLBank advance activity (especially to large financial institutions) and only limited reform of the FHLBankshuge investment-arbitrage portfolios.
We believe that comprehensive reform of the FHLB System should be reserved to another time so that Congress can focus clearly on the needs of the System. We urge that all of sections 171 through 179 be eliminated from the bill.
FDIC Board
In the context of abolishing the federal thrift charter, ending the separate regulation of thrift institutions, and combining the OTS with the OCC, we support restoring the FDICs Board of Directors to the three-member configuration it had for 56 years until 1989 (when the OTS was established). This included 12 years with a three-member board fully subject to the Government in the Sunshine Act.
Section 334 of the bill would, at an additional cost of over $1 million annually, maintain a five-member Board of Directors. No showing has been made that the FDIC needs a five-member board to get its work done. Indeed, the only case that has been advanced for the five-member size has been the agencys desire to avoid the constraints of the Government in the Sunshine Act. We believe that to be an inadequate reason to justify the expenditures involved. The federal government currently includes at least seven three-member boards: the Farm Credit Administration, Merit Systems Protection Board, National Credit Union Administration, National Mediation Board, Occupational Safety and Health Review Commission, Railroad Retirement Board, and Tennessee Valley Authority.