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Committee on Financial Services

United States House of Representatives

Archive Press Releases

Statement of the

Independent Bankers Association of America

Before the

Committee on Banking and Financial Services

U.S. House of Representatives


Financial Restructuring

May 7, 1997

Independent Bankers Association of America
One Thomas Circle, N.W., Suite 950
Washington, DC 20005-5802
Telephone: (202) 659-8111

Mr. Chairman, my name is Bill Sones, and I am president and CEO of State Bank & Trust Company, Brookhaven, Mississippi. I am pleased to appear before you today on behalf of the Independent Bankers Association of America (IBAA), the only national trade association that exclusively represents the interests of our nation's community banks.

We appreciate this opportunity to testify on proposed legislation to reform the nation's banking laws.

Mr. Chairman, let me first express my personal appreciation to you, and the appreciation of community bankers, for your strong leadership in the last Congress on issues vitally important to our industry. We especially want to thank you for your sensitivity to the concerns of rural areas and the majority of states which will never be the headquarters of financial conglomerates or economic and commercial conglomerates should the Baker Bill pass.

IBAA Profile

To better appreciate our perspective, here are some facts about our association and our members. IBAA represents some 5,500 independent community banks nationwide that hold nearly $375 billion in insured deposits, $445 billion in assets, and more than $240 billion in loans for consumers, small businesses and farms in the communities they serve. IBAA members also employ more than 200,000 people in their communities.

The State Bank & Trust Company has $115 million in assets and 57 employees. We are located in Brookhaven Mississippi, which has a population of 11,000 people. There are some 15 different financial institutions in our market area. My bank is locally­owned, locally­operated. Our policies are set locally, and that's what sets it apart from many other financial institutions in my market area.

Diversified Financial System

Community banks often are the very key to the survival and economic well being of many local communities. We specialize in doing business in our towns and cities and reinvest our deposits in our communities in the form of local loans. Mutual fund companies, securities companies, and insurance companies, among other financial institutions operating in our communities, cannot say this.

We serve our communities because, as a small locally owned and operated businesses, our communities are our market. Large, geographically diverse companies have multiple markets and are not dependent on any particular geographic market for their prosperity or survival. In addition, the Congress has not required non-insured entities to serve their communities as the CRA does for insured financial institutions. And the CRA rules for large insured financial institutions, especially for those that operate interstate branches, do not require that each branch serve its community in the manner, and to the extent, that community bank offices are required to serve their communities.

Community banks are also essential to maintaining diversity in the banking industry. This diversity enables the industry to meet the financial needs of all customers, with community banks serving small businesses, farmers, ranchers and consumers.

Financial Services Restructuring

The issue before this Committee is the need for financial services restructuring, and the implications that such legislation will have on financial institutions, corporations, and consumers. In your bill, H.R. 10, financial services restructuring can be defined as providing broad affiliations between financial firms, securities firms, insurance companies and banks. In Congresswoman Roukema's bill, H.R. 268, and in Congressman Baker's bill, H.R. 669, financial services restructuring would allow, respectively, either restricted or non restricted affiliations among commercial/industrial companies and banks.

We have the strongest and most diversified financial structure in the world. The Japanese model, which so enamored the Bush Administration, has grave deficiencies, and the German universal bank model is under critical review.

In our judgment, last year's regulatory actions by the Federal Reserve and the OCC raise serious questions about the need for legislation. And as members of this Committee are aware, previous banking legislation authorizing nationwide branching becomes fully effective on June 1, and this means that the historic merger and consolidation wave sweeping the banking industry will continue. Many observers of the banking industry have concluded that when this merger wave ends, our country's banking structure will be characterized by far fewer banks ­­and probably will be a bar bell banking structure characterized by some 15­20 very large banks with thousands of remaining community banks. The ranks of regional banks will be dramatically slimmed.

The issue before this Committee is whether this merger and acquisition wave should also encompass not only the securities industry and the insurance industry, but also commercial and industrial companies as well. We very much appreciate your leadership role Mr. Chairman in opposition to proposals that significantly undermined the walls separating banking and commerce. We urge this Committee to heed the concerns of consumer groups, labor, small business and agriculture in regards to these proposals which are proving to be enormously controversial in the U.S. Senate.

In its Section 20 action of last year, the Federal Reserve set new ground rules that will permit bank holding companies to acquire larger securities and insurance firms.

In turn the Comptroller's operating subsidiary rule, if carried to its logical conclusion, may permit national banks to acquire securities firms.

We feel it is a legitimate question to ask whether it would be prudent to accelerate the pace of change dramatically by passing additional legislation. In an interview in the American Banker on January 31, 1997, the highly regarded Wall Street lawyer Rodgin Cohen of Sullivan and Cromwell stated inter alia: "I think perhaps this year we may see banks acquire regional brokerage firms. The Federal Reserve has made these transactions feasible now, and some of them sit well. . . . If you had legislation letting the insurance industry and the banking industry consolidate, it could totally change the map." This statement has proved to be prophetic, as witnessed by the recent announcement of the acquisition of Alex Brown & Co. by Bankers Trust.

These hearings are a vital step in the exploration of the consequences and unintended consequences of legislative proposals that could restructure and concentrate our financial and economic system.

Banking and Commerce

Each of the financial restructuring bills introduced so far, by Chairman Leach, by Chairwoman Roukema and Ranking Subcommittee Member Vento, and by Chairman D'Amato and Congressman Baker, permit the common ownership of banks, securities firms and insurance underwriters. While we seriously question the need for such expanded powers, as outlined above, if Congress elects to proceed down this course, we believe they must do so carefully and with appropriate firewalls protecting the bank. However, banking and commerce should not be allowed to mix.

These three bills treat banking and commerce affiliations differently. Congressman Baker's bill would allow unrestricted affiliations between banks and commercial/industrial companies. Congresswoman Roukema's bill creates a 25 percent "basket" for non­financial activities, meaning major banks could buy major commercial firms. Chairman Leach's bill does not allow any affiliations between commercial firms and insured banks.

Former Federal Reserve Chairman Paul Volcker has testified that mixing banking and commerce could distort lending decisions, be anti­competitive and threaten the safety and soundness of the banking system. And Federal Reserve Governor Meyer, speaking for the Board, stated on January 24 that "the Board would prefer to proceed with the expansion in financial services and defer any discussion of commercial activities." This is very wise advice.

Since the passage of the Riegle­Neal Interstate Banking and Branching Act of 1994 there has been an unprecedented consolidation in the banking industry. It is expected that this consolidation will increase later this year when interstate branching takes effect. Major securities and insurance firms have already indicated their desire to own banks. And large banks have made known their desire to get into the securities and insurance businesses. Thus, there will be significant additional consolidation across the entire Financial Services Industry will occur if legislation is enacted. Allowing the common ownership of banks and commercial firms would also increase economic consolidation and add other negatives. In turn, the Federal Reserve Board's Section 20 actions are driving the securities industry to consolidate in order to increase their size, and thus limit their acquirability by commercial banks. The merger of Dean Witter with Morgan Stanley is an example of this consolidation. In addition, the Section 20 actions have started the wave of affiliations that will occur between banks and securities firms. The recent announcement of the acquisition of Alex Brown & Co. by Bankers Trust is but the first of many to come.

We believe any affiliations between depository institutions and commercial firms would cause severe safety and soundness concerns for the Federal safety net, and have a significant negative impact on our economic system, and, over time, destroy the impartial allocation of credit.

Congress prohibited the common ownership of banks and commercial firms because of the potential for conflicts of interest when banking and non­banking firms affiliate. Maintaining the wall between banking and commerce is critical to the free enterprise system. Our system relies on banks to allocate credit to its most productive uses. Separating banking and commerce insures that credit is allocated impartially and without conflicts of interest. Breaching that wall, even a partial breach using a "basket" approach, raises the risk that credit decisions will be based on the business strategies of the bank's corporate parent and not on economic merit. Commercial bank ownership of commercial firms and/or commercial firm ownership of banks would undermine the impartial allocation of credit ­­one of the foundation blocks of our fine financial system.

The affiliation of commercial banks and commercial firms would raise safety and soundness concerns because there is no practical way to insulate a bank from the affiliate it owns or that owns it. Firewalls do not work in times of stress, and one only has to look back a few years to Continental Illinois and its First Options affiliate to see this illustrated. Although firewalls were in place at a time when First Options suffered major losses, Continental Illinois National Bank stepped in and violated the firewalls by improperly loaning money to First Options to prop it up. Although the loan was quickly up streamed to the holding company, and the bank suffered no loss, what occurred shows how useless firewalls are. Federal Reserve Board Chairman Greenspan testified before Congress that it is not wise to put too much faith on firewalls, because "under stress, they tend to melt." This would place additional stress on the safety net provided by the Federal Deposit Insurance System.

Allowing the mixing of banking and commerce would result in economic concentration. Concentration would hurt consumers, small businesses, farmers and ranchers by making it more difficult, and more expensive, for them to obtain credit. Banks with less than $300 million in assets, holding less than 20% of U.S. deposits, account for close to 50% of small business loans under $250,000. Consolidation that is wrongly structured would drive out smaller players to the detriment of the ongoing financing of small business and agriculture.

These cross­industry combinations will benefit the Northeast and New York City to the detriment of other sections of the country. The restructuring proposals would benefit regional interests and not national interests.

In addition, access to the payment system must be limited to FDIC-insured institutions. Various entities that are interested in breaching the banking and commerce wall have stated that one of their objectives in doing so is to gain access to the payment system. Limitations on access are critical in order to limit risks to the payment system. FDIC-insured institutions are the only entities that are subject to examination and regulation in a manner that gives the Federal Reserve Board sufficient control to manage risk in the system. Chairman D'Amato is questioning whether access to the payment system should be opened to all players.

The "Basket" Approach

The basket approach has been offered as an alternative to full scale banking and commerce. However, it suffers from all of the deficits that exist with regard to banking and commerce. In addition, the concept has additional flaws.

There are a number of basket options that have been put forward. For example, Congresswoman Roukema's test would allow 25% of the "business" of the holding company to be in commercial/industrial activities. The Treasury Department is working on a proposal that reportedly would base the test on "revenues." Whatever test is used, there is a fatal flaw. If the commercial/industrial company's "business" or "revenue" grows faster than the "business" or "revenue" of the rest of the entity, eventually, the limit will be reached. It is virtually impossible to control growth in a commercial/industrial company. For example, the production line cannot be shut down, because the under-served customers would be lost forever, and existing and new customers would be very hesitant to purchase seeds from the company because they would be unsure of the continued availability of product. So the only remedies left are divestiture or breaching the cap. The former would be unacceptable to the business entity, the latter would make a mockery of the limitation.

In addition, the basket approach brings virtually no practical limitations with it. Under this scenario, with no size restrictions, Citicorp could buy ITT, Federal Express, or Microsoft. Chase could acquire USAirways, Reynolds Metals or ConEdison. If Citi first merged with Merrill Lynch, AIG and GE Capital, it could purchase Sears, Boeing, Coca Cola, or any other company outside the top 15. Think of the impact these combinations could have on the national economy, or the economies of whole regions of the country.

Treasury Proposal

It has been reported that the Treasury Department has been floating a 25% revenue basket. To address the concentration of assets concerns, they will prohibit the 1,000 largest U.S. commercial firms from affiliating with a bank. Under the Treasury proposal, a bank would be allowed to affiliate with an industrial firm as long as the non-financial revenues of the combined company do not exceed 25% of its total revenue.

Simply put, to fall under this 25% "merger cap," an industrial company would have to affiliate with a bank at least three times its size (three quarters of total revenue from the bank, versus one quarter from the industrial company).

If the largest 1,000 commercial firms are taken out of play, this would prevent a Citi-Microsoft affiliation. However, it still would permit the creation of substantial banking-commercial/industrial combinations. The 1,001st largest U.S. corporation is Amphenol Corporation, which had revenues last year of roughly $800 million. So even if you exempt the largest 1,000 commercial firms, you are still talking about very large companies. Some of the other companies that would still be in play include Getty Petroleum, Riceland Foods, Greyhound Lines, U.S. Can, Houghton Mifflin, Control Data, America Online, and Starbucks. These are not small companies.

To put this in better perspective, Mr. Chairman, under this scenario, Norwest could acquire Bandag, Inc., Casey's General Stores, Lee Enterprises and Interstate Power Company in the state of Iowa, with total revenues of about $2.2 billion per year. In Minnesota, Chase could acquire eleven Minnesota companies including Apogee Enterprises, St. Jude Medical, American Crystal Sugar, and Buffets, Inc.

Think of what impact these combinations would have on the economies of the states of Iowa and Minnesota. And this is a small sample of what could happen cross the country, even when you take the largest 1,000 commercial firms out of play.

Relationship of Basket to Financial Affiliations

The securities and insurance industries have argued that a basket is necessary to allow a full two-way street. They claim that without a basket, they would have to divest permissible commercial affiliations in order to affiliate with a bank. At the outset, the IBAA notes that a full two-way street is available without the need for any divestiture. If no basket is permitted, a bank could affiliate only with insurance and securities firms that do not have commercial affiliations. Likewise, only insurance and securities firms without commercial affiliations could affiliate with banks. The decision of whether or not a securities or insurance firm has commercial affiliations is a business decision of that firm. There is nothing that would inherently give such a firm the right to affiliate with both commercial firms and banks. Because of the federal safety net, banks ownership and activities have always been restricted. The banking industry because of the safety net, is not and cannot be fully market driven

Under H.R. 10, merchant banking activities and passive equity investments of insurance firms would not have to be divested in order for such firm to affiliate with a bank. The bill recognizes that passive investments do not constitute the same risks as do active investments. Therefore, most commercial "affiliations" of securities and insurance firms would not have to be divested.

According to the Securities Industry Association (SIA), only eight of its over 700 members are owned by commercial firms. Although to our knowledge data is not yet available on SIA's membership's ownership of commercial firms, it is believed to be relatively small. Therefore, we do not believe that this is a significant issue for the securities industry. We are unaware of comparable data with regard to the insurance industry.

IBAA believes that the burden should fall on those entities asking for a change in the status quo to justify the need for the change. Neither the securities industry nor the insurance industry has put forth any facts that would indicate that there is any volume of affiliations with commercial firms, outside of the investment banking and passive investment banking area, that would justify a basket. Congress should not even consider a "basket" approach until such time as a factual case can be made that there is a substantial segment of the market which would be adversely affected without the change.

International Experience with Banking and Commerce

The mixing of banking and commerce has not been successful in other countries where it has been tried. Former Federal Reserve Chairman Paul Volcker pointed out that New York and London are the financial capitals of the world, and the mixing of banking and commerce does not occur in the United States or the United Kingdom. Chairman Leach, in your testimony before the Subcommittee on Capital Markets of the House Banking Committee on March 12, 1997, you noted that in Japan, significant losses have occurred as a result of the relationship between banks and commercial firms. In Germany, industrial conflicts have created such problems as to have begun a debate aimed at changing the German universal bank to a bank closer to the American model. In Spain and Mexico, bank/commercial investments have proved expensive to the public Treasuries. Martin Mayer, in a March 28, 1997, Wall Street Journal article, noted that in France, Spain, Sweden and Finland, the universal bank led to failed banks, money losing non-financial subsidiaries, and government bail-outs.

The IBAA believes that the evidence is clear: The mixing of banking and commerce has not been successful in the international marketplace.

Consumers and Small Businesses

We also would like to remind the Committee that concentrated markets are neither consumer nor small business friendly. It is important for Congress to insure that consumers, small businesses, farmers, and ranchers do not pay the price of economic concentration. Past experience suggests that they will. For example, the four largest banks in California control over 60 percent of the state's bank deposits (and over 80 percent of the local banking markets are considered highly concentrated under Justice Department merger guidelines). A 1992 study showed that California banks pay interest on deposits that are significantly lower than both the national average and the average paid in out­of­state metropolitan areas. For interest charged on loans, the converse is true­­California banks charged higher rates than the national average and the average rates charged in out­of­state metropolitan areas. For users of the financial system, concentration means less competition and higher prices.

Consumers are not the only losers in a concentrated market. Small businesses come up big losers as well. Many larger banks simply do not find it economical to make small business and consumer loans. Richard Thomas of First Chicago Corporation told the House Government Operations Committee a few years ago that:

In a large bank, it would be difficult to make money on a loan of less than half a million dollars. I suspect the number might be $25,000 for a much smaller bank with a much smaller overhead.

Indeed, as noted above, banks with less than $300 million in assets, holding less than 20% of U.S. deposits, account for close to 50% of small business loans under $250,000. Consolidation that is wrongly structured would drive out smaller players to the detriment of the ongoing financing of small business and American agriculture.

Communities Hurt

Proponents of concentration will argue that this will create more opportunities for community banks to fill the niche deserted by the banking­industrial complexes. But the plain facts are that the community banking industry simply does not have the capacity and resources to fill the void. Although some local banks may prosper temporarily, many communities will suffer, and in the long run so will the local banks. There were approximately 360 sales of banks under $1 billion in 1996. The number of new banks chartered was less than half this number.

As an example, a few years ago when North Carolina National Bank (now NationsBank) took over a number of failed banks in Texas, it became one of the largest agriculture lenders in the State. When it decided to abandon the agricultural lending field because the new bank personnel did not have the expertise or the experience to evaluate ag loans, this benefited a few local banks. However, it devastated the agricultural community because farmers and ranchers were scrambling to find alternative sources of credit during a critical time in the production cycle, and the community banks did not have the resources to meet all of the agricultural credit needs. This had a significant adverse impact on the recovery of the Texas economy, and is a perfect example of the negative impact massive economic concentration can have on an economy.

Safety and Soundness

Breaching the banking and commerce wall also undermines bank supervision by threatening the safety and soundness of our financial system. There is no practical way to separate a bank from its affiliates, either operationally or in the public's perception. Former Fed Chairman Volcker warned of this danger repeatedly and testified before the Senate Banking Committee that "problems in one part of the system will inevitably be transmitted to other parts."

Federal Reserve Board Chairman Alan Greenspan echoed those concerns in testimony before the House Banking Committee as we indicated earlier.

Competition in the Marketplace

I am confused when advocates of sweeping consolidation characterize the IBAA as anti­competitive. How is competition furthered by allowing the largest banks, securities firms and insurance firms to buy one another, then only to be bought by a major industrial firm? The IBAA understands competition in the marketplace to mean more, not fewer competitors. The number of banks and thrifts peaked at 18,033 at the end of 1985. At the end of 1996, there were only 11,452 banks and thrifts and since the those numbers include the component part of holding companies, the number of independent banks is considerably less. With interstate branching happening in all but two states this June, the consolidation trend will continue. And the securities industry is consolidating with itself and with banks right now. Enactment of this legislation will only serve to hasten consolidation, and thus lessen competition.

Financial Affiliations

Under all of the bills, a new form of holding company called a Financial Services Holding Company could own or affiliate with companies engaged in a much broader range of activities than is permitted for bank holding companies under current law, including ownership of or affiliations with securities firms.

In the last Congress IBAA supported the original Leach proposal on Glass­Steagall reform in part because it contained significant firewalls to separate the deposits insured by FDIC insurance from the non­insured securities affiliate. Our later withdrawal of that support was based on elements that were added to the bill, such as permitting affiliations with insurance underwriters, that made the entire bill unacceptable. Mr. Chairman, your bill incorporates these firewall protections. The other bills have significantly lower firewalls protecting the insured bank.

Still, we are skeptical about firewalls in general, as we have discussed, and question whether the protections in any of the bills are sufficient to protect 1) the safety and soundness of the banking system, 2) the legitimate competitive interests of all banks, and not just the large financial institutions that can take advantage of what the bills offer, and 3) the potential conflicts of interest that could arise because of the affiliation of such diverse entities.

Cross Selling

Cross­selling of services is very important in companies with multiple arms. Banks, subject to the Bank Holding Company Act, can only engage in activities closely related to banking. By contrast, if diversified firms owned banks, they would be free to combine banking with a wide variety of financial or other services. Former FDIC Chairman William Seidman testified before the Senate Banking Committee that the non­bank bank loophole, which breaches the wall between banking and commerce, "is highly inequitable and detrimental. Allowed to grow, nonbank banks can weaken the real banks by competing in an unfair contest in the marketplace."

Insurance Underwriting

Insurance underwriting brings increased risks with it. Although insurance companies are financial companies, they also engage in commercial activities. Insurance companies engage in financial services that are the same or similar to those offered by commercial and investment banks, along with the underwriting of insurance. They also engage in commercial activities; for example, some are direct investors in and developers of real estate. Yet insurance companies are not Federally­regulated.

This Committee should be very careful about allowing affiliations between an insured bank and a company that is not only exempt from Federal regulation, but also can engage in a wide range of financial services and in commercial activities including real estate speculation that proved fatal to many Federally­insured institutions. This Committee should be most careful, indeed, in putting financial entities together in a common structure with different regulatory structures, particularly in light of concerns a number of highly respected observers, including Fed Chairman Alan Greenspan, have raised about the efficacy of firewalls.

Retail Insurance Sales

It should be pointed out that the concerns we have expressed relate to insurance underwriting and not to insurance sales. Retail insurance powers do not contain any safety and soundness threat to insured banks. Bank­employed and affiliated sales people are licensed by the state with the same license that independent agents must have. Banks currently are required by law to disclose that annuities are not insured by the FDIC or guaranteed by the bank. IBAA has always supported the expansion of opportunities for community banks to sell insurance products.

The insurance industry has taken the position that if financial affiliations occur, they must occur in the context of rules that would roll back existing national bank retail insurance sales powers. The powers of national banks to sell insurance have been part of the National Bank Act since 1916. The Supreme Court, in a unanimous decision handed down in 1996, upheld the validity of the power of national banks to sell insurance from an office in a place of less than 5,000. It also upheld the proposition that a State cannot prevent or significantly interfere with a national bank's ability to sell insurance.

Mr. Chairman, attempting to restrict a national bank's ability to sell insurance has no place in any financial restructuring legislation. These bills are all described by there authors as "financial modernization" legislation that will allow banks to effectively compete as we enter the new century. Yet the actions that these bills would take will help only large banks -- those large enough to acquire non-bank financial firms, or large enough to be attractive acquisitions for non-bank financial firms. If retail insurance powers, which are a critical component of the community bank's ability to compete in the financial marketplace is restricted, you will have served a competitive double whammy to community banks. You will have given big banks additional competitive opportunities, while restricting our existing opportunities.

Mr. Chairman, any legislation that is enacted to change our financial system must not contain regressive changes in national bank insurance sales powers. The only insurance sales power that should be modified is to lift the place of 5,000 restriction from national banks.

Regulatory Structure

Mr. Chairman, under your proposal, The Federal Reserve Board would be the "umbrella" regulator that oversees the entire financial services holding company. However, under Congresswoman Roukema's and Congressman Baker's bills, financial services holding companies would not be subject to the bank­like regulation that currently applies to the capital and activities of bank holding companies.

In addition, all of the bills would apply, in general, other requirements including affiliate transaction restrictions such as Sections 23A and 23B of the Federal Reserve Act, a prohibition on credit extensions to non­financial affiliates, a requirement that subsidiary banks be well capitalized, and a divestiture requirement applicable to banks within any financial services holding company that fails to satisfy certain safety and soundness standards.

Congresswoman Roukema's bill would apply the "holding company risk assessment provisions" to financial services holding companies. Essentially, this is a scheme of functional regulation -- the holding company would not be regulated as a bank holding company, and each subsidiary of the holding company would be regulated by its primary regulator, if it has one. The holding company would be subject to some supervisory requirements regarding the protection of the safety and soundness of the bank.

IBAA believes that the safety and soundness of the bank cannot be protected without Federal Reserve Board supervision of the holding company in the manner that now occurs under the Bank Holding Company Act. The holding company can be characterized as the brain and nerve center of such an entity. One regulator should have oversight over this brain center since the failure of such an integrated structure could carry with it systemic risk to the financial system and the economy. Our recent financial history makes very clear that the largest financial entities in our nation will not be allowed to fail. The Federal Reserve is best equipped to carry forward this sensitive mission and has a proven track record of insulation from the political process. This becomes particularly important since many expert witnesses question whether firewalls work.

Laurence H. Meyer, a member of the Board of Governors of the Federal Reserve System, in a recent speech before the Southwestern Graduate School of Banking, identified two important principles of bank regulation:

Two special characteristics of banking are critical to understanding why banks are regulated. First, banks have access to a government safety net through deposit insurance, the discount window, and payment system guarantees.

The second characteristic of banking is that banks ­­especially large ones ­­are capable of being the conduits of systemic risk and crisis in financial markets. A breakdown of the payments system or other contagion effect that hampers the ability of banks to intermediate credit flows could have serious consequences for the economy. The challenge is to maintain sufficient regulation to protect taxpayers, avoid unnecessary extensions of the safety net, and mitigate moral hazard incentives without undermining the competitiveness of the banking industry and its ability to take risk.

Our reading­between­the­lines interpretation is that very large financial entities whose failure would present a systemic risk for the financial system will always be regulated because they will never be allowed to fail. The issue of whether the FDIC or the U.S. taxpayers directly would pay for the rescue is a separate issue.

Wholesale Financial Institutions

Last summer, Chairman Leach proposed to include wholesale financial institutions, or "woofies" in H.R. 2520, the banking restructuring bill. At that time, IBAA came out strongly against woofies and they were not part of the banking bill that passed in the final hours of the 104th Congress.

The creation of woofies opens up the potential for new, specialized charters that could be superior to a banking charter because they could be exempt from banking regulations. And very important from a public policy standpoint, since woofies can also be owned by bank holding companies, wholesale deposits could be moved from the insured bank to the un­insured woofie, which could narrow the deposit insurance fund base and lead to a de­stabilization of the deposit insurance funds. We also have payment system concerns.

The woofie issue is highly contentious and should not be made part of this bill.

Chartering Issue

Under H.R. 10, the federal thrift charter would be eliminated, and thrifts would be required to convert to a state or national bank, or a state savings bank. Thus, the BIF and the SAIF could be merged under the terms established in last year's banking bill.

H.R. 10 contains what has become known as the "charter down" option whereby the existing national bank charter would be the model for a common charter for all national financial institutions. IBAA has expressed concerns in the past about "chartering up," or granting all financial institutions the authority to engage in greater powers with which they have little or no expertise, including real estate investment and other powers that contributed to the thrift crisis in the 1980s.

IBAA believes that a limited "Charter Up" option should be the standard. Retail financial powers are the lifeblood of community banks. We must be able to compete with non-bank financial firms in the retail area in order to retain our customers and remain competitive. If a securities/insurance company, such as Merrill Lynch, that already offers a full range of investment services (i.e, insurance products, consumer loans, insured brokered deposits, etc.) were to affiliate with a unitary thrift, that provides a full range of retail deposit products, the lure of "one stop shopping" would be the straw that broke the community banking industry's back. In order to maintain our customer base, community banks need to be able to offer the same range of products and services to compete.

Unitary Thrifts

H.R. 10 would grandfather existing unitary thrifts that are affiliated with commercial entities. The thrift would have to maintain compliance with the QTL test and with the current Thrift asset limitations.. While recognizing that Congress seldom requires divestiture, we are nonetheless concerned about allowing the unitaries with commercial affiliations to continue to operate.

The unitary thrift holding company loophole breaches the separation of banking and commerce. Under current law, unitary thrift holding companies are not prohibited from affiliating with commercial firms. This loophole should be closed or, at the very minimum, not expanded further.


Thank you, Mr. Chairman, for this opportunity to testify before the Committee. We appreciate your voice of relative moderation and sensitivity for the complex issues before this Committee. IBAA believes that Congress must proceed prudently and cautiously because the future structure of our financial system and thus our economy hangs in the balance. Our present system is the envy of the world. The system's enormous diversity insures pro­consumer competition for financial products and services and the availability of financing for business and agricultural units of all sizes.

The banking and securities industry is in the midst of a historic consolidation wave partially driven by the 1994 Riegle­Neal bill which mandates full interstate branching in June of this year and by the Federal Reserve's Section 20 regulatory actions. Legislation and regulatory actions over the last three years guarantee additional massive consolidation in the months and years ahead. Very large financial organizations spanning the banking, securities and insurance industries may logically emerge from the Federal Reserve's Section 20 action and the Comptroller's operating subsidiary rule.

Such financial conglomerates will test the mettle of our financial regulators and, unfortunately, the FDIC and the American taxpayer should they fail.

The IBAA is puzzled about Congressional and regulatory support for sweeping legislative proposals that would accelerate and expand this consolidation to commercial firms. Legislation encouraging the common ownership of the largest banking, insurance, securities and commercial firms in the United States is neither pro­competitive nor "modern." Rather, it harks back to the financial and industrial cartels that characterized the United States in the early years of this century and the German and Japanese economic systems before their slide into fascism.

Legislation that encourages the massive consolidation of economic and financial power in fewer and fewer hands and in fewer and fewer cities is not pro­growth, pro­consumer, or pro­democracy.

If the congressional leadership decides to move such radical financial restructuring legislation, and we hope that they do not, the following principles would mitigate against some of the damage:

(1) Banking and commerce should not be mixed because this destroys the impartial allocation of credit, the fundamental foundation block of our financial system. An incremental approach via a commercial firm ownership basket would still impair the impartial allocation of credit.

(2) There must be an umbrella regulator of the resulting diversified firm and the only federal regulator equipped for this job is the Federal Reserve.

(3) The FDIC must be protected from being raided should a financial conglomerate collapse. No credible regulator claims that firewalls work in times of crisis. Non­complex depository institutions should not be left holding the bag in the event of the collapse of a financial conglomerate presenting a systemic risk to our financial system and economy.

(4) There should be provisions for liquidity for institutions serving local markets and communities. Community banks should be able to access all available financial vehicles, including the Federal Home Loan Bank System, as alternative funding sources. Main Street America communities should not be sacrificed to the avarice of Wall Street. Financial conglomerates with national reach that are largely exempt from CRA and other consumer compliance laws cannot be allowed to ravage the funding base of depository institutions serving community needs.

(5) The level of regulation should be commensurate with the systemic risk institutions present to the financial system and the economy. Consumer protection regulation, in turn, should be even handed and either lifted for all or applied to all since it represents a competitive cost.

(6) Access to the payments system should only be via FDIC­insured depository institutions to limit risks to the payments system. Legislation should not authorize the establishment of a new charter for investment bank holding companies able to access the Federal Reserve System's payments services or take uninsured deposits.

(7) Any financial restructuring should include new retail powers for banks, including­­within the parameters of safety and soundness­­unrestricted insurance agency powers and the power to sell mutual funds and other financial products and services, including annuities; and the authority to underwrite tax­deferred investments such as an annuity CD.


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Committee on Financial Services  •  2129 Rayburn House Office Building  •  Washington, DC 20515  •  (202) 225-7502
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