[House Hearing, 110 Congress] [From the U.S. Government Publishing Office] H.R. 698, THE INDUSTRIAL BANK HOLDING COMPANY ACT OF 2007 ======================================================================= HEARING BEFORE THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED TENTH CONGRESS FIRST SESSION __________ APRIL 25, 2007 __________ Printed for the use of the Committee on Financial Services Serial No. 110-25 U.S. GOVERNMENT PRINTING OFFICE 36-820 PDF WASHINGTON DC: 2007 --------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866)512-1800 DC area (202)512-1800 Fax: (202) 512-2250 Mail Stop SSOP, Washington, DC 20402-0001 HOUSE COMMITTEE ON FINANCIAL SERVICES BARNEY FRANK, Massachusetts, Chairman PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama MAXINE WATERS, California RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York DEBORAH PRYCE, Ohio LUIS V. GUTIERREZ, Illinois MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York PETER T. KING, New York MELVIN L. WATT, North Carolina EDWARD R. ROYCE, California GARY L. ACKERMAN, New York FRANK D. LUCAS, Oklahoma JULIA CARSON, Indiana RON PAUL, Texas BRAD SHERMAN, California PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts WALTER B. JONES, Jr., North RUBEN HINOJOSA, Texas Carolina WM. LACY CLAY, Missouri JUDY BIGGERT, Illinois CAROLYN McCARTHY, New York CHRISTOPHER SHAYS, Connecticut JOE BACA, California GARY G. MILLER, California STEPHEN F. LYNCH, Massachusetts SHELLEY MOORE CAPITO, West BRAD MILLER, North Carolina Virginia DAVID SCOTT, Georgia TOM FEENEY, Florida AL GREEN, Texas JEB HENSARLING, Texas EMANUEL CLEAVER, Missouri SCOTT GARRETT, New Jersey MELISSA L. BEAN, Illinois GINNY BROWN-WAITE, Florida GWEN MOORE, Wisconsin, J. GRESHAM BARRETT, South Carolina LINCOLN DAVIS, Tennessee JIM GERLACH, Pennsylvania ALBIO SIRES, New Jersey STEVAN PEARCE, New Mexico PAUL W. HODES, New Hampshire RANDY NEUGEBAUER, Texas KEITH ELLISON, Minnesota TOM PRICE, Georgia RON KLEIN, Florida GEOFF DAVIS, Kentucky TIM MAHONEY, Florida PATRICK T. McHENRY, North Carolina CHARLES WILSON, Ohio JOHN CAMPBELL, California ED PERLMUTTER, Colorado ADAM PUTNAM, Florida CHRISTOPHER S. MURPHY, Connecticut MICHELE BACHMANN, Minnesota JOE DONNELLY, Indiana PETER J. ROSKAM, Illinois ROBERT WEXLER, Florida KENNY MARCHANT, Texas JIM MARSHALL, Georgia THADDEUS G. McCOTTER, Michigan DAN BOREN, Oklahoma Jeanne M. Roslanowick, Staff Director and Chief Counsel C O N T E N T S ---------- Page Hearing held on: April 25, 2007............................................... 1 Appendix: April 25, 2007............................................... 51 WITNESSES Wednesday, April 25, 2007 Bair, Hon. Sheila C., Chairman, Federal Deposit Insurance Corporation.................................................... 9 Colby, Robert, Deputy Director, Market Regulation, Securities and Exchange Commission............................................ 14 Connelly, Arthur R., Chairman and Chief Executive Officer, South Shore Bancorp MHC, on behalf of America's Community Bankers.... 37 Douglas, John L., Alston & Bird LLP, on behalf of the American Financial Services Association................................. 41 Ghiglieri, James P., Jr., President, Alpha Community Bank, on behalf of the Independent Community Bankers of America......... 38 Isaacs, Amy, National Director, Americans for Democratic Action.. 35 Kohn, Donald L., Vice Chairman, Board of Governors of the Federal Reserve System................................................. 12 Lackritz, Marc E., Chief Executive Officer, Securities Industry and Financial Markets Association.............................. 43 Leary, G. Edward, Commissioner, Department of Financial Institutions, State of Utah.................................... 17 McVicker, Earl D., Chairman and Chief Executive Officer, Central Bank & Trust Company, on behalf of the American Bankers Association.................................................... 40 Reich, Hon. John M., Director, Office of Thrift Supervision...... 13 Stevens, Thomas M., Immediate Past President of the National Association of Realtors........................................ 45 APPENDIX Prepared statements: Bair, Hon. Sheila C.......................................... 52 Colby, Robert................................................ 71 Connelly, Arthur R........................................... 82 Douglas, John L.............................................. 87 Ghiglieri, James P., Jr...................................... 95 Isaacs, Amy.................................................. 113 Kohn, Donald L............................................... 121 Lackritz, Marc E............................................. 138 Leary, G. Edward............................................. 149 McVicker, Earl D............................................. 172 Reich, Hon. John M........................................... 183 Stevens, Thomas M............................................ 200 Additional Material Submitted for the Record Gillmor, Hon. Paul E.: Letter from the American Bankers Association................. 210 Letter from America's Community Bankers...................... 211 Letter from Independent Community Bankers of America......... 212 Letter from the National Association of Realtors............. 214 Letter from the Sound Banking Coalition...................... 215 Statement of Thomas J. Bliley, Jr., on behalf of the Sound Banking Coalition.......................................... 217 H.R. 698, THE INDUSTRIAL BANK HOLDING COMPANY ACT OF 2007 ---------- Wednesday, April 25, 2007 U.S. House of Representatives, Committee on Financial Services, Washington, D.C. The committee met, pursuant to notice, at 10:08 a.m., in room 2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. Present: Representatives Frank, Waters, Maloney, Watt, Sherman, Meeks, Moore of Kansas, Baca, Scott, Green, Cleaver, Davis of Tennessee, Sires, Ellison, Klein, Wilson, Perlmutter, Donnelly, Marshall; Bachus, Castle, Royce, Gillmor, Manzullo, Feeney, Hensarling, Brown-Waite, Barrett, Pearce, Neugebauer, and Bachmann. Also present: Representative Matheson. The Chairman. The hearing will come to order. The Committee on Financial Services meets today to consider legislation dealing with the Industrial Bank Holding Company Act, which was filed by myself and the ranking minority member of the Committee on Financial Services, the gentleman from Ohio, Mr. Gillmor. It deals with the question of whether or not the entity known as the Industrial Loan Corporation ought to be expanded or maintained at its current level. I begin by saying that there's been a debate about the ILCs. It does seem to me that those who profess to be strong supporters of the Industrial Loan Corporation form ought to be the ones initiating legislation. That is, if you genuinely believe that the ILCs are an important financial institution, how does anyone justify limiting them so that only six States can charter them? I know of no other generally approved entity which can only be chartered by six States. So I understand people who think ILCs are a wonderful thing and would therefore like to have them freely chartered. I understand those of us who think that we should restrict them. It is hard for me to understand a rational argument for the status quo in which we have this entity that exists in only a few States. Why would anyone do that? Let me put it this way. It is inconceivable to me that anyone starting from scratch in a situation would say, ``Okay, here's a nice institution we ought to have; we're going to call it an industrial loan corporation, and let's pick six States that are allowed to charter it.'' I don't know how you would pick the six States. I assume a dartboard would be an essential part of that decisionmaking process. In other words we have what is the result of a historical accident, and it seems that we go one way or the other. There are also people who argue that we have had the ILCs for this considerable period and there has not been any problem. Well, those of us who support this legislation generally agree with that because we are trying to preserve the status quo. Nothing that is being proposed would undo the current situation with regard to ILCs that exist. Indeed, we had previously been told by the State of Utah where they are important, and I note the presence of our colleague from Utah, a former member of this committee, whose disagreement with us was sufficiently strong to cause him to return. And he has been a very able advocate of the interests of his State. But I do note that the last information we had was that over 90 percent of the ILC assets in the State of Utah would be unaffected by our legislation because they would meet the test of 85 percent financial. But I do return to the point that we have an anomaly. I can understand going forward, I can understand going backward, but I do not see how anyone public policy can justify staying where we are. Now what we find is--and people said, ``Why are you dealing with this now if they haven't caused problems?'' But what we are confronted with is people who have decided to significantly expand this entity, including major commercial organizations. Again, I understand the argument from those who say that the distinction between commercial and banking activities is an artificial one, that it should fall. But if you believe that, then where's the language to repeal the restriction? Again, why this halfway, to put it in a way that will meet the rules of propriety, approach to a situation? What again is the justification for maintaining the general principle of a separation between banking and commerce and allowing this one narrow exception? We, I hope, will go forward. We are trying again not to disturb the status quo. We have had some conversations with a kind of a border area involving securities, border in the sense, these are financial institutions and we will be--we have been working and having conversations and I want to thank-- Chairwoman Bair is here and she has, on this as in so many other issues, been extremely helpful. We are trying to work out the various regulatory approaches that should go forward. I do want to say that this has been one of the rare occasions in my memory when the Federal Reserve has been very flexible, and I hope that this is a pattern that we will see going forward. But I think we have a very reasonable approach in the legislation. Obviously we are prepared to listen. And with that, I will recognize the ranking member. Mr. Bachus. I thank Chairman Frank for holding this hearing on H.R. 698, which is the Industrial Bank Holding Company Act of 2007. This legislation would enhance regulatory supervision of our ILCs, grandfather existing ILCs, and at the same time, prohibit commercial firms in the future from acquiring ILC charters. At the outset, I want to commend the chairman and the gentleman from Ohio, Mr. Gillmor, who both worked tirelessly over the past several years to craft legislation on this complex issue. Today's hearing will hopefully help us to better understand ILCs and the regulatory framework that surrounds the ILC charter. As ILCs have grown in size, number, and complexity, several supervisory and policy questions have arisen, including whether current regulatory structure for overseeing ILCs is adequate. Insured ILCs are subject to State banking supervision and FDIC oversight as State, non-member banks. Nonetheless, owners of ILCs do not have to be bank holding companies subject to the Federal Reserve's consolidated supervisory authority. In the absence of Federal Reserve's supervision of ILC holding companies, the FDIC has employed what some call a bank- centric supervisory approach that primarily focuses on isolating the insured institution from potential risk posed by holding companies and affiliates, rather than assessing these potential risks systematically across the consolidated holding company structure. Some have suggested that this regulatory regime does not provide sufficient protection against the potential risk that parent companies and non-banking affiliates may pose to the safety and soundness of ILCs. Another matter of concern about ILCs is the extent to which they can mix banking and commerce through the holding company structure. An exemption in current banking law permits any type of company, including a commercial firm, to acquire an ILC in a handful of States. For some, this is the crux of the issue. Certainly the separation of banking and commerce will be discussed in today's hearing. There is also likely to be a debate over the fairness of excluding some commercial firms from owning or controlling ILCs when other similarly situated commercial entities already own them. Once again, I want to thank Chairman Frank and Ranking Member Gillmor for their work on this important issue, and look forward to hearing from our witnesses today on their views on the legislation before us. The Chairman. I will now recognize for 5 minutes one of our members who has been most active in this, the gentleman from Georgia, Mr. Marshall. And I will exercise my option to go to 15 minutes. The gentleman from Alabama may, if he wishes to, as well. So Mr. Marshall is recognized for 5 minutes. Mr. Marshall. Thank you, Mr. Chairman. I don't believe I'll need 5 minutes. I appreciate the Chair recognizing me, and giving me an opportunity to say a few words on this particular subject. It's kind of interesting. The first major problem we had in this country with mixing business and commerce resulted in legislation back in 1838 in New York and Georgia. Georgia actually took the lead in 1838 in forcing the separation of banking and commerce. We've had other instances during our Nation's history where we inadvisably mixed the two. I shudder to think what kind of consequences we might have had had we not had those kinds of rules and we saw the collapses of entities like WorldCom, Enron, etc. It just seems to me that we are in a very poor position to understand all of the complexities of the typical business operation in today's world and appreciate fully the risks associated with mixing those complex business operations with banking. It's tough enough for us just to regulate our banks without mixing--attempting to additionally understand all the complexities associated with some of our current financial operations. That said, clearly we have to grandfather, and it seems to me that the grandfathering provisions we should consider wouldn't simply stop at those ILCs that have been authorized thus far, but might consider those ILC applications that have been submitted in reliance upon the performance of the board with regard to granting ILCs because there are a number of entities that have legitimately gone out and relied upon the expectation that their ILC application will be approved, to their detriment if in fact this legislation is successful, and the cutoff is actually acquiring an ILC before the legislation is approved. I do think that no further ILCs should be approved pending our consideration of this legislation. And then I'll simply add that there's a parallel here, it seems to me, between this issue and the question of whether or not banks should own real estate companies and other ventures that banks are sometimes interested in. It seems to me that the banking industry, which is interested in not having commerce compete with banks through ILCs, should acknowledge that in fact banks should not be competing with commerce through business ventures like real estate, etc. And I think perhaps, Mr. Chairman, if the chairman will move in that direction, it's something that we ought to consider. I appreciate the opportunity to say a few words, and I yield back, Mr. Chairman. The Chairman. I now am pleased to recognize the coauthor of this bill, the ranking Republican on the Financial Institutions and Consumer Credit Subcommittee, the gentleman from Ohio, Mr. Gillmor, for 5 minutes. Mr. Gillmor. Thank you very much, Mr. Chairman, and let me also say that I have appreciated the opportunity over the past three Congresses to work with you on this issue. We have been successful in the House; our amendment has passed two Congresses in a row. It didn't make it through the Senate, but I think that probably the third time is the charm, and I think we may get a different result in the Senate this time and get legislation to the President's desk. I also want to commend Chairman Bair and the rest of the FDIC Board for their work on this issue. I want to thank all of our bank regulators for recognizing that the issue of the future of ILCs is a question that Congress should address. It is good and effective regulation that's the first line of defense in protecting the safety and soundness of our financial systems. The principle here is real simple; it's the separation of banking and commerce. And financial systems which have not followed that principle have had a number of problems and, in fact, have had a number of crises because of it. The United States codified this principle after the problems in the 1920's and the Great Depression. Over the last several decades, loopholes and exemptions in bank law have gradually been closed. In 1999, during consideration of Gramm- Leach-Bliley, Congress eliminated the unitary thrift loophole, and now it's time to close the ILC exception, which allows for full service banking by commercial firms. This is a kind of historical accident, and frankly it wasn't much of a problem when there were only a few out there in existence, but what has happened is that a number of commercial and industrial firms have discovered this loophole, are applying for charters, and are going to try to drive a train right through the loophole unless Congress acts responsibly to close that loophole. The bill that we've introduced, H.R. 698, would bolster the authority of the FDIC, limit the business activities of certain ILCs already in existence, and most importantly establish a cutoff date for new, commercially owned ILCs. Today we have approximately 120 cosponsors on the bill, and it's my hope that this bipartisan legislation will receive consideration in the committee in the near future and on the House Floor shortly thereafter. And Mr. Chairman, I would ask that the following materials be submitted for the record: H.R. 698 support letters written by the Realtors, by the ICBA, by ACB, and by the ABA. Also, submitted testimony by former Congressman Tom Bliley on behalf of the Sound Banking Coalition, and a letter of support from the Coalition. And I would also ask unanimous consent to enter into the record a March 2007 GAO report which details suggestions for collaboration among the consolidated regulators. [The GAO report referenced above (GAO-07-154) is available from the Government Accountability Office--www.gao.gov.] The Chairman. Without objection, it is so ordered. And now, on the unanimous consent--because I mentioned before, we've been joined here at the podium by a former colleague, our colleague from Utah, and he does represent a State where these are very important, so I would ask unanimous consent that the gentleman from Utah be allowed to participate in the hearing today. I thank the ranking member. It is important that we get the diversity of views. I will now recognize the chairwoman of the Financial Institutions and Consumer Credit Subcommittee, but I also want to explain. In about 5 minutes, I will be going around the corner to testify on the issue of fishing safety. The City of New Bedford, which I represent, is the leading fishing port in the country and we've had some safety issues. So I will be abstaining myself for a few minutes, but I will be back. We do appreciate--and I mentioned some of the regulators, Mr. Reich, it is very helpful to us to have had the cooperation of all the regulators in this as we have worked together on this operation, and we appreciate that, and the SEC as well. The gentlewoman from New York is now recognized for 5 minutes. Mrs. Maloney. Thank you, Mr. Chairman. I appreciate your holding this hearing to discuss a bill that you and Mr. Gillmor have worked so hard on, and I join Mr. Gillmor in hoping that the third time is a charm. As he mentioned, there is a strong cross-section of support for this bill. And in the bill, this committee has struggled to balance the need for the financial services that ILCs can provide with the primary imperative to preserve the safety and soundness of the banking system. This bill, in my view, has largely succeeded in doing that. I am particularly sensitive to this issue since the savings and loan crisis, the bailout of the savings and loans crisis, was really the first issue that I voted on when I came to Congress, so I am keenly attuned to safety and soundness issues, and I hope we won't confront that again. For the past year, the debate over ILCs has been largely shaped by the application of big commercial concerns and major auto companies--their push to own ILCs. Many members felt that these large companies were exploiting a loophole in Federal banking laws to merge commerce and banking, a combination that traditionally has been tightly restricted in the United States. Last year, the Government Accountability Office issued a report specifically addressing these type of applications, saying that allowing commercial firms to own ILCs would ``pose unnecessary risk,'' to the Federal Government's deposit insurance funds. Though the FDIC does have authority over insured ILCs, the GAO concluded that the fact that this authority does not explicitly extend to ILC holding companies, and therefore is less extensive than the authority that the consolidated supervisors have over banks and thrift holding companies, means that from a regulatory standpoint these ILCs, in their opinion, pose more risk of loss to the bank insurance fund than other insured depository institutions operating in a holding company. In the wake of the GAO report, the Federal Reserve, including former Federal Reserve System Chairman Alan Greenspan and current Chairman Ben Bernanke, call for changes that would extend the regulations that apply to banks and bank holding companies to the ILCs and the companies that own them. The need for new legislation arises in large part because of the change in the ILC industry over the past 20 years. ILCs were created in 1910 as limited purpose institutions to allow workers for big companies to get credit when they couldn't otherwise get loans. But according to the GAO report, ILC assets grew more than 3,900 percent between 1987 and 2006 to more than $155 billion, up from $3.8 billion. ILCs also changed their character from small, community- based entities to large, company-based ones. From 1987 to 2006, the number of ILCs actually declined 42 percent, dropping to 61 from 106. As of March 2006, 9 of the country's ILCs were among the 271 financial institutions in the United States that hold more than $3 billion in assets. Six ILCs own more than 80 percent of the assets in the ILC industry with more than $125 billion in assets and $68 billion in FDIC-insured deposits. Large ILCs divide between those that are owned by financial companies, subject to functional regulation by the SEC, such as Merrill and Morgan Stanley, and those that are owned by commercial firms, such as Target and GE. The bill very sensibly treats them differently and includes limits on activities to non-grandfathered entities to make sure that this distinction is preserved. I support this distinction but only to the extent that it is squared off soundly with safety and soundness, which is first on the agenda for this committee. I look forward to the testimony. I see that Sheila Bair is back before us again; we have kept her very busy in this Congress. I look forward to all of the testimony. Thank you. Mr. Scott. [presiding] Thank you. The gentleman from California, Mr. Royce, is recognized for 3 minutes. Mr. Royce. Thank you, Mr. Chairman. Thank you very much for holding this hearing as well, and I want to thank our witnesses today for their testimony. It has been mentioned that ILCs have been in existence in this country for, oh, I guess, about a hundred years. And it's very, very recently, I think, that the charter has garnered a great deal of attention. I encourage an open and honest debate on this, but I believe some of the criticisms of ILCs are misguided. The amount of regulatory authority over the relationship between the ILC and their parent company continues to be a point of criticism for those who are opposed to the existence of ILCs, and some have expressed concern that an ILC might be used to subsidize a parent's cost to capital. Others have suggested that the ILC regulatory structure, in their view, is deficient because some ILC parents are not subject to supervision at the holding company level. Well, just the beginning point I'd like to lay out is that industrial loan companies are regulated in a similar manner to all other federally insured depository institutions. They are subject to the same minimum capital standards, and subject to the same prompt corrective action provisions as every other bank we oversee in this committee. They must adhere to sections 23A and 23B of the Federal Reserve Act, just as all other FDIC- insured depository institutions do. And as you know, these two provisions in the Federal Reserve Act subject all ILCs to very strict rules when it comes to relationships with any of their affiliates. Just to go down the rules very quickly: an ILC's total covered transactions with any affiliate cannot exceed 10 percent of the bank's capital; the ILC's total covered transaction with all affiliates combined cannot exceed 20 percent of the bank's capital; and with few limited exceptions, covered transactions must be fully secured with qualifying capital, and an ILC cannot purchase a low qualifying asset from an affiliate. In addition, an ILC must deal with an affiliate on market or arm's length's term. It cannot, as a fiduciary, purchase securities or other assets from an affiliate unless permitted by statute or court order and the ILC cannot purchase securities while an affiliate is a principal underwriter for those securities. Neither the ILC nor its affiliate may purchase any advertisement or make any agreement stating or suggesting that the ILC shall in any way be liable for the obligations of the affiliate. So that's the law. That's the current law. And in closing, the bill put forth today does nothing more than shield incumbent banking institutions, in my view, from competition. While I welcome the discussion on the fate of future industrial loan companies, I am concerned this bill could have some unintended consequences, which could have adverse impacts on the financial services industry and the economy as a whole. Industrial loan companies have proven their ability to create more competition in the industries, resulting in better prices and services for consumers in this country. Mr. Chairman, thank you again for holding this hearing, and I look forward to hearing from our witnesses. Mr. Scott. Thank you. The gentlelady from California, Ms. Waters. Ms. Waters. Thank you very much. Good morning ladies and gentlemen. I want to thank Chairman Frank and Ranking Member Bachus for holding today's hearing on H.R. 698, the Industrial Bank Holding Company Act of 2007. Industrial loan companies, that is ILCs, state-chartered, FDIC-insured banks, were first established early in the 20th century to make small loans to industrial workers. Today's ILCs, which are supervised to some extent by the FDIC as well as by the chartering State, have grown dramatically in number and size and scope of activity. From 1997 to 2006, the assets held by Utah ILCs increased nearly 500 percent, from $25 billion to $150 billion, and the deposits held by Utah ILCs increased by more than 800 percent, from $11.9 billion to $107 billion. A special exemption in current law, however, permits any type of company, including a commercial or retail firm to acquire an ILC in a handful of States, principally Utah, California, and Nevada, and to avoid the activity restrictions and supervisory requirements imposed on bank holding companies under the Federal Bank Holding Company Act. ILCs were mostly small, local institutions that had limited deposit taking and lending powers until 1997 when Utah changed this law to permit Utah-chartered ILCs to call themselves banks and exercise the same powers as state-chartered commercial banks, resulting in the stampede of ILCs. Thus, Utah-chartered ILCs now may engage in any type of lending activity. The ILC charter is also a way for companies to avoid the activity restrictions and consolidated supervisory capital, managerial, and community reinvestment act requirements imposed on bank holding companies under the Bank Holding Act. CRA has been an effective tool to require banks to make investments in low- and moderate-income communities. So should ILCs be subject to CRA? In 1997, the number of Utah ILCs had tripled and now there are more than 30 ILCs chartered in Utah, including a number that are owned by commercial companies such as General Electric, BMW, Pitney Bowes, and Sears. Home Depot is seeking to acquire an existing ILC. The largest ILC at the time of the exemption adopted in 1987 had assets of less than $400 million. The largest ILC today has more than $62 billion in assets and $54 billion in deposits, making it the 12th largest insured bank in the United States by deposits. Importantly, the ILC exemption does not limit the chartering of new ILCs. Utah and other States that are grandfathered by the exemption may continue to grant new ILC charters without limit. Congress maintains the separation of banking and commerce and reaffirmed this policy in the Gramm-Leach-Bliley Act of 1999, when it closed the unitary thrift loophole and authorized banks to affiliate only with companies that are generally engaged in financial activities. Congress determined in the GLB Act that with regard to financial affiliations, a bank holding company could only affiliate with a full service securities or insurance firm if the bank holding company held all its subsidiary depository institutions well-capitalized and well-managed in its subsidiary depository institutions, maintain at least a satisfactory CRA rating. The ILC exception disadvantages bank holding companies and undermines these requirements by allowing some financial firms to operate federally insured ILCs without meeting these requirements. The parent companies of exempt ILCs are not subject to consolidated supervision under the Bank Holding Company Act. For this reason, the GAO concluded that ILCs may pose a greater risk to the deposit insurance funds than banks operating within the bank holding company structure. Since 1956, consolidated supervision has been a fundamental component of bank supervision in the United States. It provides the board with both the ability to understand the financial strength and risk of the overall organization and the authority to address significant management, operational capital, and other deficiencies within the overall organization before these deficiencies pose a danger to a subsidiary bank in the Federal safety net. The FDIC itself has acknowledged that it does not have the same supervisory, capital, and enforcement authority with respect to the holding companies of an ILC that the Board has with respect to bank holding companies. The ILC exemption also allows foreign banks to enter the banking business in the United States without meeting the requirements in the Bank Holding Company Act that the bank be subject to comprehensive consolidated supervision in its home country. I believe this loophole must also be addressed. Therefore, I am pleased to hear from our witnesses today on ILCs, and I yield back the balance of my time. Mr. Scott. Thank you, Ms. Waters. We'll get right to the witnesses. Just one point I wanted to mention, BMW and Target have ILCs and I think that brings up 2 questions that might be significant here this morning. Number one, how do we tell the average American why Ford and Home Depot should not be able to have what these other companies have? And number two, what studies have been done or what evidence or information do we have that BMW or Target are threatening to destroy our system of banking? So with those questions, we'll get right to our witnesses. We'll start with Chairman Sheila Bair of the Federal Deposit Insurance Corporation. Thank you. STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION Ms. Bair. Thank you very much. Members of the committee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation concerning Industrial Loan Companies. The FDIC strongly supports efforts to provide statutory guidance on the key issues regarding the ILC charter, especially the issue of commercial ownership. Many of the issues surrounding ILC ownership involve important public policy considerations that are best left to Congress for resolution. This hearing and congressional discussions regarding possible legislative solutions are encouraging developments that hopefully will lead to the resolution of key ILC-related issues by the end of the year. ILCs have existed for almost 100 years, and for most of that time they operated similar to finance companies, providing loans to wage earners who could not otherwise obtain credit. ILCs have proven to be a strong, responsible part of our Nation's banking system and have offered innovative approaches to banking. Many have contributed significantly to community reinvestment and development. For example, a nonprofit community development corporation operates an ILC designed for the express purpose of serving the credit needs of people in east Los Angeles. Other ILCs serve customers who have not traditionally been served by other types of financial institutions such as providing credit for truck drivers to buy fuel far from home. The record to date demonstrates that the overall industry has operated in a safe and sound manner and that the FDIC has been a vigilant, responsible supervisor of that industry. ILCs represent a very small part of the overall banking industry, composing less than 1 percent of the almost 8,700 insured depository institutions in this country, and only 1.8 percent of the assets. Of the 58 existing ILCs, 43 are either widely held or controlled by a parent company whose business is primarily financial in nature. These ILCs represent approximately 85 percent of ILC assets and 89 percent of ILC deposits. The remaining 15 ILCs are associated with parent companies that may be considered non-financial. There has been significant growth in the ILC industry since the passage of CEBA in 1987 when the industry had $4.2 billion in assets. Over the years, total ILC industry assets have grown to $212.9 billion. Most of the growth has occurred since 1996 and has been concentrated in a small number of financial services firms. In addition to the growth in the ILC industry, the character of ILCs has been changing. In the current business environment, many ILCs tend to be more complex and differ substantially from their original consumer lending focus. In many instances these ILCs serve a particular lending, funding, or processing function within a larger organization or directly support one or more affiliate's commercial activities. Under this kind of ownership model, consolidated supervision may not be present and the current supervisory infrastructure may not provide sufficient safeguards to address safety and soundness issues and risks to the Deposit Insurance Fund. To address these developing concerns, the FDIC has taken a number of actions regarding ILCs since this committee's last hearing on the topic. In July 2006, the FDIC Board of Directors adopted a 6-month moratorium on all applications for deposit insurance and change in control notices for ILCs. During this pause in processing ILC applications, the FDIC sought public comment on 12 specific questions that focused on developments in the industry, the supervisory framework, and the issues surrounding commercial ownership. In response, the FDIC received more than 12,600 comment letters. The 6-month moratorium allowed the FDIC to evaluate public and industry comments, assess developments in the industry, and consider how to best supply the Corporation's statutory powers for oversight of these charters. It is clear that the most significant concern regarding ILCs is their ownership by companies engaged in non-financial activities. Based on the FDIC's analysis, the FDIC Board recently voted to extend the moratorium for an additional year. Under the extended moratorium, the FDIC will not take any action on any application for deposit insurance or any change in control notice for any ILC that would be controlled by a company primarily engaged in commercial activities. Although commercially owned ILCs have not resulted in serious problems to date, the FDIC will continue to closely monitor existing ILCs that currently are controlled by commercial companies in light of the concerns that have been expressed. The moratorium extension does not apply to ILCs that would be controlled by a company engaged only in financial activities or that would not be part of a holding company structure. In addition to providing the FDIC with time to examine the appropriate supervisory structure for the changing ILC industry, extending the moratorium provides additional time for Congress to consider legislation. Although the FDIC is not endorsing any particular legislative approach, H.R. 698 does provide a workable framework for the supervision of ILC holding companies. In closing, ILCs have a good safety and soundness record to date and have proven to be a strong, responsible part of our Nation's banking system. Yet the types and number of ILC applications have evolved in recent years and these changes do pose potential risks that deserve further study and raise important public policy issues. The FDIC has a responsibility to consider applications under existing statutory criteria and make decisions. While it is appropriate to proceed cautiously, the FDIC cannot defer action on these matters indefinitely. The current statutory exemption providing for the ILC charter is quite broad. By providing clear parameters to the scope of the charter, Congress can eliminate much of the uncertainty and controversy surrounding it. Resolving these issues will enhance the value of the ILC charter going forward. The FDIC looks forward to working with Congress in the coming months as you work to bring these matters to closure. This concludes my statements, and I will be happy to answer any questions the committee might have. Thank you, Mr. Chairman. [The prepared statement of Chairman Bair can be found on page 52 of the appendix.] Mr. Scott. Thank you. Thank you very much. Now we'll hear from Mr. Donald Kohn, Vice Chairman of the Board of Governors of the Federal Reserve System. STATEMENT OF DONALD L. KOHN, VICE CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. Kohn. Thank you. I am pleased to be here today to provide the Federal Reserve Board's views on Industrial Loan Companies and H.R. 698. The Board commends the committee for considering the important public policy issues raised by the special exemption for ILCs. ILCs are state-chartered and federally insured banks that have virtually all the powers and privileges of other insured banks. They operate under a special exception to the Federal Bank Holding Company Act that allows any type of company to acquire an ILC and avoid the restrictions Congress has established to separate banking and commerce. The exception also creates a special safety and soundness risk by allowing a company or foreign bank that is not subject to supervision on a consolidated or group-wide basis to acquire an insured bank. By its nature, the exception creates an unlevel playing field that gives a growing number of firms a competitive edge over other community-based, regional, or diversified organizations that own an insured bank. When the special exception was adopted in 1987, most ILCs were small, locally owned institutions with limited powers. The size and activities of ILCs, however, have expanded significantly in recent years. Today many are controlled by large, internationally active firms. Importantly, there is no limit on the number of ILCs that a handful of grandfathered States may charter or on the size that these institutions may attain. If left unchecked, the growth of ILCs threatens to undermine the policies that Congress has established governing the separation of banking and commerce and the proper supervisory framework for companies that own a federally insured bank. That is why we believe congressional action is needed. Only Congress can address the full range of issues created by the ILC exception in a comprehensive and equitable manner. H.R. 698 takes an important step by granting the FDIC new consolidated supervisory authority for the corporate owners of ILCs that are not already supervised by a Federal agency. H.R. 698, however, would not fully address the other important regulatory and competitive issues raised by the exception. For example, the bill would allow additional firms to acquire an ILC and derive up to 15 percent of their revenues from commercial activities. This commercial basket is sizeable and at odds with the decisions made by Congress in the Gramm-Leach-Bliley Act to maintain the separation of banking and commerce. The Board believes that Congress should consider carefully the costs and benefits of changing the Nation's policies concerning the mixing of banking and commerce in a comprehensive way rather than to allow this policy to be eroded through the exploitation of a loophole. H.R. 698, as introduced, also would allow the owners of ILCs to avoid the CRA, capital, and managerial requirements that apply to financial holding companies, and it would allow foreign banks that are not subject to consolidated supervision in their home country to acquire an FDIC-insured ILC. These advantages granted, ILC owners would perpetuate competitive imbalances, provide incentives for firms to continue to exploit the exception, and undermine the prudential framework established for all other domestic and foreign firms that own an insured bank. The Board believes the best way to address these issues is to close the ILC loophole going forward. This approach recognizes the simple fact that ILCs are insured banks. It would prohibit additional firms engaged in commercial activities from acquiring ILCs, and would require that any new financial owner of an ILC operate under the same activity restrictions and regulatory framework that apply to bank holding companies. For reasons of fairness, the Board also supports grandfathering those firms that currently own an ILC, subject to appropriate restrictions. This mirrors the approach that Congress took in 1970, 1987, and 1999, when earlier banking loopholes were used in unintended and potentially damaging ways. Thank you for the opportunity to testify on behalf of the Board. We would be pleased to continue to work with the committee in developing and improving legislation that addresses the very important public policy issues raised by the ILC exception. [The prepared statement of Mr. Kohn can be found on page 121 of the appendix.] Mr. Scott. Thank you very much, Mr. Kohn. Now we will hear from the Hon. John Reich, who is the Director of the Office of Thrift Supervision. STATEMENT OF THE HONORABLE JOHN M. REICH, DIRECTOR, OFFICE OF THRIFT SUPERVISION Mr. Reich. Thank you. Good morning, Mr. Chairman, Ranking Member Bachus, and members of the committee. I appreciate the opportunity to testify on H.R. 698, introduced by Chairman Frank and Mr. Gillmor to address the activities, ownership, and control of Industrial Loan Companies. I applaud your leadership and the work of other members of the committee who cosponsored this legislation. H.R. 698 addresses several pending policy issues with respect to the key areas of the permissible activities and oversight of companies that own or control or seek to acquire or control an ILC. For our part, at the Office of Thrift Supervision, we appreciate the recognition in H.R. 698 of the important and continuing role that the OTS has in our oversight and supervision of several of the largest companies that currently own and control ILCs. OTS has statutory authority for the consolidated supervision of General Electric, Merrill Lynch, Morgan Stanley, Lehman Brothers, American Express, USAA, Bell Financial, and General Motors. The eight ILCs within these OTS-regulated savings and loan holding company structures control about two- thirds of the ILC assets in the country as of December 31, 2006. Functional regulation and consolidated regulatory oversight have been important considerations by the committee. H.R. 698 maintains a clear focus on the enterprise-wide safety and soundness of holding companies that own or control institutions with access to the Federal safety net. The bill also is sensitive to the potential exposure of the Federal safety net by a company that owns or controls an ILC by focusing on the interrelationships within an ILC holding company and how the ILC is integrated within the structure. Effective oversight of holding companies requires adequate regulatory controls to monitor and intervene when necessary without unduly interfering with the ongoing business operation and activities of an enterprise. It's a balance, requiring judgement based on expertise in a wide range of areas. As detailed in my written statement, the OTS focuses and tailors its holding company supervision based on the complexity of the structure and the level of risk inherent in the holding company enterprise. Comprehensive holding company supervision is a combination of ongoing offsite monitoring, targeted reviews of key businesses or functions, and regular onsite examinations. This approach permits OTS to understand the business and its inherent risks as well as the affiliations and the transactions of the enterprise. It also enables us to assess the potential impact of the broader economy, the insured depository institution, and the potential exposure to the Federal safety net. As currently drafted, H.R. 698 preserves OTS's statutory oversight of savings and loan holding companies that own or control ILCs, promotes functional regulation while promoting consolidated regulatory oversight and it maintains a risk-based focus on companies owning or controlling institutions with access to the Federal safety net. For these reasons, we support H.R. 698 as introduced by Chairman Frank, Congressman Gillmor, and other sponsors on the committee. Thank you, and I'll be happy to take questions. [The prepared statement of Director Reich can be found on page 183 of the appendix.] The Chairman. Thank you, and next we have Mr. Robert Colby, who is the Deputy Director of the Division of Market Regulation of the SEC. Mr. Colby, thank you. Please go ahead. STATEMENT OF ROBERT COLBY, DEPUTY DIRECTOR, MARKET REGULATION, SECURITIES AND EXCHANGE COMMISSION Mr. Colby. Thank you. I'm very pleased to have the opportunity this morning to describe the Securities and Exchange Commission's program for supervising U.S. securities firms on a consolidated basis and how this provides protection to all regulated entities in the consolidated group including industrial loan companies that are the topic of this morning's hearing. And I appreciate the discussions we've had with Chairman Frank and his staff about possible amendments to H.R. 698 that would avoid subjecting U.S. securities firms already supervised by the Commission under comprehensive and effective program to a second and duplicative consolidated supervision regime. The Commission currently supervises five of the major U.S. securities firms on a consolidated or group-wide basis. For such firms, referred to as Consolidated Supervised Entities, or CSEs, the Commission oversees not only the U.S.-registered broker dealer, but also the holding company and all affiliates on a consolidated basis. These affiliates also include other regulated entities such as foreign registered broker dealers and banks as well as unregulated entities such as derivatives dealers. Four of the CSEs, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley own ILCs that account for 1.1-, .7-, 7.2-, and 1.2 percent of their consolidated assets respectively. Three of the firms, Lehman Brothers, Merrill Lynch, and Morgan Stanley also own thrifts that account for 3.8-, 1.7-, and less than one one-hundredth of one percent of their consolidated assets respectively. The CSE program provides consolidated supervision to investment bank holding companies that's designed to be broadly consistent with the Federal Reserve oversight of bank holding companies. This prudential program is crafted to allow the Commission to monitor for and act quickly in response to financial or operational weakness in a CSE holding company or its unregulated affiliates that might place regulated entities, including U.S. and foreign registered investment banks and broker dealers or the broader financial system at risk. When a CSE firm has a regulated entity in the consolidated group that is subject to oversight by another functional regulator, the Commission defers to that functional regulator as the supervisor of the regulated affiliate. We also share relevant information concerning the holding company with our fellow regulators both domestically and internationally. The Commission's CSE program has been recognized as equivalent to that of other internationally recognized supervisors, including the U.S. Federal Reserve, for purposes of the European Union's Financial Conglomerate Directive. While maintaining broad consistency with the Federal Reserve holding company oversight, the CSE program is tailored to reflect two fundamental differences between investment bank and commercial bank holding companies. First, the CSE program reflects the reliance of securities firms on market-to-market accounting as a critical risk and governance control. Second, the design of the CSE program reflects the critical importance of maintaining adequate liquidity in all market environments for holding companies that do not have access to the external liquidity provider. The Commission's concern regarding the need for group-wide risk monitoring, which developed over the course of a number of years beginning with the Drexel Burnham liquidation in 1990, was paralleled by the European Union's Financial Conglomerate Directive, which essentially requires non-EU financial institutions doing business in Europe to be supervised on a consolidated basis. In response, in 2004, the Commission crafted a new, comprehensive consolidated supervision program that was intended to protect all regulated entities within a group, including broker-dealers. The rule restricted CSE eligibility to groups with large and well-capitalized broker-dealers. The Commission believed that it could only supervise on a consolidated basis those firms engaged primarily in securities business and not holding companies that are affiliated with the broker-dealer as an incident to their primary business activities. To this end, the rule effectively requires that the principal broker-dealer have a tentative net capital of at least $5 billion. The CSE program has five principal components. First, CSE holding companies are required to maintain and document a system of internal controls that must be approved by the Commission at the time of initial application. Second, before approval, and on an ongoing basis, the Commission examines the implementation of these controls. Third, CSEs are monitored continuously for financial or operational weakness that might put at risk regulated entities within the group or the broader financial system. Fourth, CSEs are required to compute a capital adequacy measure at the holding company level that's consistent with the Basel standard. Finally, CSEs are required to maintain significant pools of liquidity at the holding company where these are available for use in any regulated or unregulated entity within the group without regulatory restriction. I'd like to point out that these five principal components are implemented in conjunction with the authority to protect regulated entities within the groups. When potential weaknesses are identified, the Commission has broad discretion under our rules to respond. For example, the Commission could mandate changes to a firm's risk management policies and procedures, effectively require an increase in the amount of regulatory capital maintained at the holding company, or require an expansion of the pool of highly liquid assets held at the parent. These powers are not theoretical abstractions. All three of these steps have been taken at various CSEs over the past 2 years. This program of consolidated supervision reduces the likelihood that weakness within the holding company or an unregulated affiliate will place a regulated entity including the ILC or the broader financial system at risk. My written testimony describes in greater detail the means by which we monitor the financial operational condition of the holding company. In conclusion, while we generally support the goals of H.R. 698, the bill as introduced would subject the CSEs that are already highly regulated under the Commission's consolidated supervised program to an additional level of duplicative and burdensome holding company oversight. We believe the bill should be amended to recognize the demonstrated ability of the Commission to comprehensively supervise the consolidated groups that are overwhelmingly in the securities business, especially given the heightened focus on these issues in an area of increased global competitiveness. Because the Commission has established a successful consolidated supervision program based on its unique expertise in overseeing securities firms, the CSE should be carved out of this legislation in the same way as the holding companies supervised by the Federal Reserve and OTS. Thank you again for the opportunity to speak on behalf of the Commission. [The prepared statement of Mr. Colby can be found on page 71 of the appendix.] The Chairman. Thank you, Mr. Colby. And finally I want to again welcome Commissioner Leary from the Department of Financial Institutions, State of Utah. He has been very accommodating in appearing before the committee and helping us in our deliberations. Commissioner, thank you, and please proceed. STATEMENT OF G. EDWARD LEARY, COMMISSIONER, DEPARTMENT OF FINANCIAL INSTITUTIONS, STATE OF UTAH Mr. Leary. Good morning. Thank you, Chairman Frank, Ranking Member Bachus, and members of the committee. Thank you for the opportunity to share Utah's view on H.R. 698, the Industrial Bank Holding Company Act of 2007. I am Edward Leary, commissioner of financial institutions for the State of Utah. I have been involved with banking for 33 years, first as a community banker, then 15 years in various bank examiner positions with the Utah department and for the last 15 years as its commissioner. The Utah Department of Financial Institutions views H.R. 698 as unnecessary and an effort to restrict and restrain state-chartered industrial banking without a valid safety and soundness concern or a crisis. Utah believes there is good supervision and good regulatory model over the industry without a question of the competency of the regulators in that there has not been an industrial bank failure warranting this change in public policy. I believe that I am here today because of the success of that regulatory model, not its failure. Utah, in partnership with the FDIC, has built a regulatory model to which the financial services market has reacted favorably. This regulatory model is not a system of lax regulation and supervision or inadequate enforcement. Utah industrial banks are safe, sound, and appropriately regulated by both the State which charters them, and the FDIC, which is the relevant Federal regulator and deposit insurance provider. I am told the articulated threat which warrants passage of this bill is a potential threat of misuse of the charter by holding companies which are non-financially oriented. This bill seeks to remove a potential threat even before the threat has materialized or manifests itself. We should be clear. We are talking about an industry today that constitutes 1.8 percent of banking assets. This is not a systemic crisis that threatens banking. An analysis of the numbers as of December 31, 2006, developed by Utah, indicates that we hold 88 percent of all industrial bank assets. Based upon our knowledge of the holding companies, we estimate that 86 percent of Utah industrial bank assets would be considered held by financial entities, constituting 22 companies, and 14 percent by non-financial entities, constituting 9 companies. Our analysis is that 7 of Utah's industrial banks, representing approximately 80 percent of our assets are subject to consolidated Federal agency supervision at the holding company level. The Federal agencies we considered are: one, the Federal Reserve, with jurisdiction over our 2nd largest bank; the OTS, with jurisdiction over our largest, 3rd, and 4th largest banks; and the SEC, with jurisdiction over our 6th largest bank. The record of the last 18 months is that no de novo industrial bank charter was approved by the FDIC from November 4, 2005, until March 20, 2007. H.R. 698 will dismantle a Utah industrial banking industry of 31 charters and a regulatory structure that has matured over 20 years with a record of safe, sound operations to forestall one entity from being granted a charter. This bill, with its provisions that are designed to block any and all conceivable ways in which a retailer may employ an industrial bank charter today or in the future are disappointingly anti-competitive and anti-consumer. The targeted large retailer withdrew its application with the application having never been accepted by the Utah department. H.R. 698 provisions are being justified under the text of preserving the prohibition against the merging of banking and commerce. The broad brush strokes of this bill include as collateral damage large financial arms of entities which have been in the financial arena for decades, such as Daimler Chrysler and Ford. The former submitted an application for an industrial bank charter in May of 2005, which was approved by my State a year ago. Now, under the provisions of this bill, we will not be allowed to proceed. This is a disappointing outcome when other auto lenders have a bank charter. The supporters of 698 present the bill as a compromise piece of legislation. I am challenged to determine how this bill is a compromise when industrial banks do not receive additional powers or authorities or have any of the current restrictions lifted, let alone given the right to issue commercial mal accounts as has previously been passed by this committee. As a State regulator, what is most disappointing to observe is that while this committee is aggressively moving H.R. 698, a bill which restricts and limits the one segment of state- chartered banking that could be identified as innovative and creative, Congress has not taken seriously the threat to State banking of the broad, Federal preemption of State laws by the Comptroller's office. Many State commissioners believe that without congressional intervention, the diminishing assets under State charter will eventually render the State banking system irrelevant. In conclusion, the industrial banking industry represents 1.8 percent of total banking assets. This is not an industry which threatens the safety and soundness of banking. The regulatory model is not a parallel bank regulatory system in that 80 percent of Utah assets are subject to Federal agency oversight at the holding company level. Thank you for allowing me the opportunity to express my thoughts and for your willingness to listen to a State regulator. [The prepared statement of Mr. Leary can be found on page 149 of the appendix.] The Chairman. I'm going to begin with that. Your suggestion that we don't pay attention to State regulators is really unfounded, and I vigorously disagree with your assertion that we are ignoring the implications for federalism of the preemption decision. Many of us in this committee last year were quite active in opposing that. When party control changed, frankly, and some of us had the opportunity to do something about it, we held off because of the pendency of the Wachovia decision. And, frankly, contrary to the suggestion you made implicitly, I think it would have been irresponsible for us to have jumped in while the Wachovia decision was pending, because there was a real issue there. The Supreme Court voted 5 to 3, I think, if Justice Thomas hadn't recused, looking at the past, it would have been 5 to 4. Well, a 5 to 4 decision suggested there was some real uncertainty. And, no, we couldn't act until we knew that. Now many of us do plan to act, and the gentlewoman from New York and I have had several conversations about this. I don't know that we--I don't think, to be honest, that we're in a position to have the votes to overturn that. We do plan to ask the Comptroller and the Office of Thrift Supervision, who are the ones who now have preempted, to tell us what they plan to do with regard to enforcement. And that includes trying to restore, in my judgment, some State visitation rights. So I just want to clear up what I think is an erroneous suggestion that we have been indifferent to that. And as I said, we would have started on it quicker, but we waited for Wachovia. We have had these conversations. Second, I just want to ask you, would you favor legislation that removed the restriction on the granting of ILC charters to only those six States that were grandfathered? Mr. Leary. I have been asked in numerous forums, Mr. Chairman, how I address that issue that only six, I believe the exemption granted in-- The Chairman. No, I just asked you--no, excuse me, Mr. Leary. Excuse me. History isn't the fact here. I'm asking you as a matter of public policy if you would support our removing that restriction and allowing every State to do it. Mr. Leary. I have no problem with that, provided that the safety and soundness and the-- The Chairman. Well, I have no problem with--are you in favor--would you support such a bill? Mr. Leary. I am. The Chairman. What about the fundamental distinction between banking and commerce that's in Gramm-Leach-Bliley? Would you support that? I say that because some advocates of the ILC say really that's a mistake to have that, to maintain that restriction. Would you maintain it or abolish it? Mr. Leary. I went on record last time when I was in front of the subcommittee saying I do not favor repeal of the Bank Holding Company Act, no. I'm a lifelong regulator; I believe in slow, measured steps towards this system. I believe what Utah created is a safe and sound system. I am articulating, I hope-- The Chairman. So you would maintain the distinction between banking and commerce? Mr. Leary. I would work towards a system where this could be more competitive than it currently is. The Chairman. I don't understand that. Would you maintain the distinction between banking and commerce? Mr. Leary. I do not believe that I would. The Chairman. So you would do away with the distinction-- you would do it more slowly than some others might. But you-- Mr. Leary. I would do it, as I tried to say, in slow, measured steps. The Chairman. Okay, and I think that puts it fairly. I think that's a defensible and actual position with which I disagree. I do not think it is a defensible and actual position to say that we should maintain the distinction between banking and commerce and allow six States to be exceptions from it. You haven't maintained that. Others have. And I do think it's-- people ought to understand the implications of what we are doing. Let me ask Chairwoman Bair, who has a major role in this, and whose administrative limbo we hope to--I notice that the Pope is thinking of doing away with the kind of ambiguous category. We should do at least the same for you. [Laughter] The Chairman. But one--look, the House is going to pass a bill that I believe is fairly restrictive. I also understand that the Senate is probably not going to pass a bill similar to ours. Indeed, there are days, of course, when one wonders whether the Senate will ever pass any bill at all on anything, but that's a broader set of questions. If we were to go to a House-Senate conference in which something very much like the bill the gentleman from Ohio and I have sponsored had passed the House, and a bill had passed the Senate that allowed for some things. It's no secret. The commissioner mentioned, for instance, the Daimler Chrysler and Ford situations. There is a GM thing, and we appreciate it, and as you know, when GM wanted to sell to Cerebus, we communicated that we thought that was a situation that could get resolved. It's not a secret that the Senate is probably going to do, I believe something, not quite as restrictive as--if the Senate were to pass legislation that allowed for some continuation but with some restriction--or let's put it this way. If you were given the authority, not that you asked for it, but if you were given the authority to grant sort of limited extensions, would you have the power now to enforce that? I guess that's the question. That if there is--there will be two questions. Is there a hybrid of some sort? And the gentleman from Ohio and I want as little of that as possible. I'm not encouraging it or asking for it, but I recognize that it may happen. If it does, it does seem to me then the one critical question will be, what will be the enforcement, the capability of the FDIC to impose these restrictions and subsequently to enforce them? Would you address that? Ms. Bair. The Fed and FDIC both agree that the current exception is quite broad. So for us to come in and say, certain categories of commercial owners can have ILCs and certain categories cannot, I don't see how we can do that under the existing framework, which is again where we think legislation would be very helpful. We're not taking a position about where to draw the line, but we think clarification would be very helpful. So, once Congress clarifies what those parameters are, yes, we would have--or we could use our existing enforcement authority regarding the ILC. And assuming we were given holding company authorities, we would be able to supervise them. The Chairman. And we would do that for all of the agencies. And I do want to say in closing, we appreciate the cooperation, frankly, that we've seen from all of the agencies here. And maybe you have--the fact that were all able to cooperate so well may to some extent alleviate the FSA envy that appears to have run through the American financial entities in which the lament the fact that there are so many of you and dream of having only one. Since that dream is not going to come true, we are pleased that you were able to show them an ability to cooperate in this situation. The gentleman from Alabama. Mr. Bachus. Thank you, Mr. Chairman. My first question I'll just ask all the regulators is, I'll start with Chairman Bair maybe and work across. Have ILCs, including those owned by commercial firms, posed safety and soundness problems to a greater or lesser extent than those depository institutions owned by traditional bank holding companies? Ms. Bair. No. The safety and soundness record to date is very comparable to that of other types of depository institutions. That was acknowledged in the GAO report. I would also add that actually the commercially-owned ILCs have the better safety and soundness record. Among commercially-owned ILCs, as well as Utah-chartered ILCs, there has never been a failure. Mr. Bachus. Okay. Anybody? Mr. Kohn. No, sir. I don't think that the ILCs to date have posed an unusual safety and soundness issue. But as all of us have pointed out in our testimony, we're really at the cusp of a change, a wave of change, in how the ILC charter has been used. Some of those changes are very recent, and therefore the amount of deposits and assets in ILCs have grown extraordinarily rapidly in the last few years. And if something isn't done, it'll grow even more rapidly in the future. So, yes, this is about a potential problem. Mr. Bachus. Okay. Mr. Kohn. And the potential problem is the inadequate supervision and regulation of the companies that own ILCs. Mr. Bachus. All right. There's a notion that if commercial companies own ILCs, the deposit insurance fund is at risk if the company encounters financial difficulties. Is that true? And I guess as the assets grow, it becomes-- Mr. Kohn. I think there's a history of problems spilling from one part of a holding company to another, even when--say, the insured entity in the holding company has been well- regulated. There are reputational risks. There are legal risks. Many of these ILCs and banks, for that matter, are managed on a very closely integrated basis with their affiliate companies. The companies that manage depository institutions and holding companies don't really differentiate between the depository institution, many of them, and the other entities. The public is looking at the consolidated entity. Therefore, it doesn't really differentiate, and many of the depository institutions rely on the affiliates for many of the services they use. So, I think there is a history of problems occurring outside the depository that impugn and reflect on the reputation of the depository itself. That's why Congress itself in 1957, 1970, 1987, and 1999 decided that consolidated regulation was the way to protect-- Mr. Bachus. Okay. Let me--Mr. Leary, let me ask you. Has there ever been a case when an ILC owned by a commercial firm has had financial difficulty that affected the ILC? Mr. Leary. In our case, the two cases which you could cite, which would be Conseco and Tyco, both--one case, the ultimate parent filed bankruptcy. In the second one, the parent had difficulties in both case. The industrial bank component within that entity in one case was sold off. In the other case, they spun it off in an IPO and actually incurred a premium from that. So, I would not want to represent that it was not without lots of concerns, blood, sweat, and tears. It successfully passed the test, and those examples are in my testimony. Mr. Bachus. Okay. Mr. Leary. May I respond to your question on commercial entities? Mr. Bachus. Yes. Mr. Leary. Because I don't believe the lines are as solid as some would like to believe. Two of our nine nonfinancial entities, one of which is BMW, have already been cited. The other is Volkswagen. Both of those, while they are perceived in the United States as being commercial entities, have very large banking operations in Europe. So, I believe the line is not as strict as it is. And if I can beg your indulgence one step further, one of the others, Transportation Alliance Bank, is the one cited, I believe by Chairman Bair in her testimony, which has specifically targeted long-haul truckers and the trucking industry, which they believe is underserved by existing financial services companies. And they have targeted that business line and tried to provide financial services to that industry. Mr. Bachus. You know, you're talking about BMW and Volkswagen, I guess, are both German companies-- Mr. Leary. Correct. Mr. Bachus. So they have a strong banking regulator in their home country. But what if it were, say, they were headquartered in a country that didn't have a--where they weren't subject to consolidated supervision in their home country? Would that concern you? Mr. Leary. We would require them to establish U.S. operations. And before we'd even consider the applications, it would be strictly reviewed. I think as we looked at, for example, UBS, we relied on the FDIC to look at the home country supervisor and supervision at that level, but we also required strong measures and prudential standards when we chartered UBS Bank in Utah. Mr. Bachus. I know Mr. Kohn mentioned that the ILC exception, however, allows a foreign bank that is not subject to consolidated supervision in its home country to evade this requirement and acquire an FDIC-insured bank with broad deposit taking and lending power. This gap in current law needs to be addressed. Would the two of you comment on that? Mr. Kohn. I think my testimony speaks for itself, Mr. Bachus. Congress passed that requirement after BCCI, which was a case in which there were regulated entities in the United States but problems overseas in a vast network of unregulated entities or inadequately regulated entities, that ended up spilling over into and onto the U.S. entities. So, just having a regulated entity in the United States, in Congress's view, and I agree with it, was not sufficient to protect. Mr. Bachus. Does this legislation set up such a protection, or would it still be-- Mr. Kohn. Not as currently submitted. It does not have the requirement for consolidated supervision of a foreign entity. Mr. Bachus. So a foreign bank in a country where it doesn't have consolidated supervision could obtain a-- Mr. Kohn. Could establish an ILC under the law, under the act as proposed, bill as proposed. Mr. Bachus. Okay. Thank you. Mrs. Maloney. [presiding] Thank you. The Chair recognizes herself for 5 minutes, and I raised the question with--the same question with Chairman Frank earlier, and he says that they are working with language that would require the consolidated supervision. So that is a positive step forward coming out of this hearing. I heard in some of the testimony that the current regulatory structure of the ILCs creates an uneven playing field within the banking industry. Could you please explain this further and what we can do to level this playing field? Ms. Bair. Well, I think the argument is that ILCs chartered in the States specified in CEBA are exempt from Bank Holding Company Act regulation. I think that is at the core of the regulatory playing field argument. It has also been argued, especially by community banks, that it doesn't work both ways. The commercial entities under the ILC exception can own banks, but banks can't do commercial activities, so I think those are the arguments. Mrs. Maloney. You outlined in your testimony, Ms. Bair, the regulatory tools for ILC parents being the same as for bank holding companies. If that was legislated into law, would that address this challenge? Ms. Bair. Yes. There are a variety of holding company regimes. The Fed obviously is the leading bank holding company regulator. The OTS has also long been involved in holding company supervision, and the SEC has recently crafted its own system of consolidated supervision, so you have a variety of different approaches. We think, as my written testimony indicates, that we would like powers comparable to the Fed. If you're going to make us a holding company supervisor, we think all three are certainly very good supervisors, but the Fed's authorities under the Bank Holding Company Act would be most desirable. Mr. Kohn. Congresswoman, may I comment? Mrs. Maloney. Surely. Mr. Kohn. There's another aspect of the competitive inequality, and that's the mixing of banking and commerce. So even under the bill as proposed, the ILCs would be able to have 15 percent commerce activities, and that is not permitted to financial holding companies and bank holding companies. So the supervision, the consolidated supervision, is an extremely important point, clearing up the foreign bank issue is an extremely important point, but it doesn't go all the way to leveling the playing field. And the way to level the playing field is to simply close the loophole and make insured ILCs subject to the same regulations every other insured bank is subject to. Mrs. Maloney. Under Gramm-Leach-Bliley, doesn't that allow a 15 percent-- Mr. Kohn. No, ma'am, it does not. In Gramm-Leach-Bliley, there was a transition provision such that a financial holding company that had commercial activities would have some time to get rid of those commercial activities, but it must divest itself of those commercial activities. There is no commercial basket in Gramm-Leach-Bliley. And the Federal Reserve gives banks--or financial holding companies--2 years, which can be extended for a couple of years, up to 5 years, to divest themselves of all their commercial activities. There are no commercial activities, except as might be incidental to a financial activity, allowed in Gramm-Leach-Bliley. There is no 15 percent basket there. Mrs. Maloney. Would you elaborate further on the risks of mixing banking and commerce? You seem tremendously concerned about this. What are the conflicts of interest that arise between the bank and the commercial transactions of a business? Could you elaborate further why you feel this so-called loophole should be closed? Mr. Kohn. I think mixing banking and commerce raises a number of very difficult issues that the Congress needs to consider thoroughly before allowing even a limited exception to this. There is the potential for conflicts of interest. Is the bank making loans on more favorable terms to its affiliates-- there are restrictions here--or to customers of its affiliates, than it would to a customer of an unaffiliated institution? If a commercial firm owns a bank, can competitors of that commercial firm have the same access to credit on the same terms as the commercial firm itself? There are issues about the potential for spreading the safety net. Banks are special. They have deposit insurance. They have access to the discount window. Congress has recognized that this carries the risk that there will be a perception that they have specific protections. They have access to the safety net. I think because, as I noted before, banks and their affiliates often operate on a very consolidated basis, there's a risk that when a commercial affiliate is connected with a bank, the perception will be that the authorities wouldn't let problems in that commercial affiliate sort of cascade into the bank, that the commercial affiliate would have a special access to the safety net. And finally, as I think Mr. Marshall pointed out in his opening comments, I think the consolidated regulation that we're talking about imposing would be much more difficult if there is a commercial component to the holding company. Working with the SEC, the thrift regulators, and insurance regulators, I think we have a better handle on the safety and soundness of non-bank financial affiliates of banks. I think this would be very, very difficult to really do effective consolidated regulation if there is a commercial affiliate of the regulated institution. Mrs. Maloney. Well, this is--just very briefly, could we just go down the line and see how people feel? Do they feel that this is--that the 15 percent commercial activity is a challenge? Ms. Bair? Ms. Bair. We think the 15 percent is workable. We're being agnostic about where you want to draw the line. I would say, again, in the past, there already has been some experimentation with commercial ownership with the ILC charter to date. We have a good safety and soundness record to date. It certainly would also be within the prerogative of the committee to allow some limited mixing using this 15 percent criterion. In our view, it's the committee's decision. It's a policy call to make. Mrs. Maloney. Okay. Mr. Reich. I would agree with Chairman Bair. It certainly is the committee's policy call. I think there are other examples, particularly in the tax code, where 15 percent has been used sort of as a de minimis level of unrelated income. Mr. Colby. This is not an area of core expertise for the Commission. We really think it's an area for the Congress to decide. Mrs. Maloney. Okay. Commissioner? Mr. Leary. I would endorse it, yes. I believe what we have attempted to do in Utah is to very effectively work within this core threat of having a commercial parent and allowing a basket, whatever the committee establishes, I think we would be very comfortable with. We are currently working with General Electric, that has an OTS bank and a Utah Industrial Bank, and I think we are working very carefully at ensuring that safety net does not extend to the whole GE operation, that we isolate that--those insured entities very carefully. Mrs. Maloney. Okay. My time has expired. Mr. Gillmor, the co-sponsor of the legislation. Mr. Gillmor. Thank you, Madam Chairwoman. A couple of questions, Commissioner Leary. You stated a number of times that the legislation would restrict banks and would make State banking irrelevant. I don't think that's an accurate description of the legislation. The legislation doesn't do anything to affect the operation of the bank. Nothing. The only thing the legislation deals with--well, I'll ask you. Maybe you could point out specifically what it does to restrict, because mainly what we're talking about is ownership at a holding company. Mr. Leary. I would answer it this way, sir. In our case, we've approved three charters that the FDIC, under its moratorium, has not been able to successfully approve. We would not have approved those charters if we did not believe they warrant the granting of the charter and warrant the granting of deposit insurance from the entities. I believe that what we have developed is a safe and sound model. Mr. Gillmor. Well, I guess the other thing I'd like you to do, since other state-chartered banks and other banks are subject to these same rules, do you think those rules restrict them? I mean, why would it only restrict ILCs? Mr. Leary. I would probably take a tack that I've developed in my own logic trail over the years. What I believe we're doing with a number of these companies is when they've been identified as commercial entity, I do not see it much differently than the majority of my community banks that are primarily owned by businesspeople in the community, whether it's the lumber operator, the gas station owner, or whatever. So, they bring with them a specific commercial expertise and a commercial perspective. I think that's very similar to what we're doing with some of these companies. Do we want to isolate that and provide safety and soundness mechanisms? I believe Regulation 23A and B does that, and for the ILCs, we religiously enforce that upon them. So, my answer is, I think there is conceptually, it's not far to go from businesspeople owning a community bank to an entity that is large that has a small component which is an insured bank. I hope I've answered your question. Mr. Gillmor. I think we just have a different philosophy. For example, when you said that restricting commercial ownership of ILCs would be anticompetitive, do you think the Bank Holding Company Act is anticompetitive? Mr. Leary. No. But I think I've already gone on record as saying I think there are some areas that could be worked on. Do I endorse repealing? No. Mr. Gillmor. You don't endorse repealing that? Mr. Leary. I do not. Mr. Gillmor. But you don't want ILCs subject to comparable type of provisions? Mr. Leary. I think they are. Everybody keeps talking about the one side, but the ILCs are limited. They cannot have demand deposits if they exceed $100 million. I brought up in my remarks that at one point, the committee passed a bill that would allow commercial NOW accounts for ILCs, somewhat leveling the offerings that the industrial banks can offer to their customers. So, I think it's a very delicate balance, but I do not have a problem with what we're doing here, provided it's safe, and provided it's sound. Mr. Gillmor. Okay. Thank you. Let me ask the SEC, because there's a possibility under this legislation that you're going to be a consolidated regulator. If you were given the power to regulate industrial bank parents, depending on what kind of parent it is, do you think the SEC would have to request additional powers to provide for safety and soundness, or are you equipped now to do that? Mr. Colby. I believe that the program that we're currently operating can take into account the needs of the ILC because the possibility that what happens in the holding company could affect the ILC, so I don't think you'd need more safety and soundness power. Mr. Gillmor. Okay. Mr. Colby. But if the Congress decides that's something that's appropriate for the bank regulators to have, we wouldn't oppose it. Mr. Gillmor. Let me ask Mr. Kohn. Mr. Leary said that it would be okay, in his view, to repeal the Bank Holding Company Act. Would you like to make the other case? Mr. Kohn. I think I already did, Mr. Gillmor. And I will just repeat that I think the mixing of banking and commerce would be a very major step. The U.S.--Mr. Bachus cited two German firms that operate in a country in which banking and commerce have been closely integrated over the years. I think the U.S. financial system has benefitted considerably by having these two separate. We have a much more resilient financial system in which commercial firms have many avenues for raising funds that are not tied to their banks. And as a consequence, I would tread very, very lightly on moving away from a formula that has given us, I think, a very safe banking system, a resilient financial system, one in which of course there are always difficulties and conflicts of interest, but have stayed away from some of the difficulties that could arise if we mixed banking and commerce. I don't know that the answer is zero banking and commerce, but I think I would be very cautious about moving away from what Congress just looked at 8 years ago and made a very conscious decision that zero was the right number. Mr. Gillmor. Thank you very much. I was going to throw a softball to Chairman Bair, but my time has expired, so I yield back. The Chairman. I thank the gentleman for his restraint. And I now recognize the gentleman from New York who has been very interested in this and has an issue that we're going to pursue. I guarantee him that at some point, it's going to get resolved; we're just not sure when. The gentleman from New York. Mr. Meeks. I was going to ask their opinion on that particular issue just to see what their interpretation would be on a hypothetical situation that I've been working with the chairman on. And that is, say there's a company that is primarily financial in nature. It receives its approval for an ILC to finance a particular service industry after October 1, 2003, but before 2007. The parent company receives some commercial revenue of less than 10 percent. In the years following 2007, the commercial revenue of the parent company exceeds 15 percent. Are there any restrictions upon the ILC once that 15 percent commercial revenue threshold has been reached or exceeded? What's your opinion? Ms. Bair. Well, this is a question about the construction of the legislation. As I understand it, if it's chartered between October 2003 and January 2007, it is not subject to the 15 percent. However, its business plan is frozen and it is prohibited from additional branching. So, even though the 15 percent commercial revenue limitation would not apply, it could not undertake new activities beyond what is already in its business plan, nor could it establish new branches. Mr. Meeks. Do you agree? Mr. Kohn. Yes, I agree. Mr. Meeks. Okay. Let me ask Ms. Bair, do you believe that the FDIC currently has the authority that it needs to fully deny an ILC any future powers that it may request? Ms. Bair. Well, in terms of the activities of the ILC, yes. That is subject to exactly the same activity restrictions that other depository institutions are subject to. We're finding that most of the issues relate to commercial entities owning an ILC. But in terms of the ILC's activities itself, those are subject to the same restrictions. Mr. Meeks. And, Mr. Kohn, I know that you believe that we should separate--that commercial entities shouldn't own ILCs, etc. But say if, in fact, they continue to own them, who do you think should regulate them? Should it be the FDIC which currently regulates, or the Federal Reserve Bank, which has more experience with consolidation regulation? Mr. Kohn. I think the most important thing is that someone should regulate the consolidated entity. That's my first point. Mr. Meeks. You should be up here. That's a political answer. Mr. Kohn. Secondly, I think that if Congress were to give this authority to the FDIC, it would be creating another parallel regulatory environment. We already have both the Fed and the OTS regulating financial holding companies, depending on the nature of the subsidiary depository institution. This would create a third line of regulation, one that could define financial in a different way than the Federal Reserve defines financial. So I would think Congress should think very carefully before creating another line of parallel regulation for consolidated entities. Mr. Meeks. Ms. Bair, do you agree? Ms. Bair. We are not seeking to become a holding company supervisor. We're happy to have the authorities should Congress decide to grant those to us. We have tremendous respect for the Fed. If we were given those authorities, we would consult with them closely. I agree. We would not want differentiations in how financial is defined. I would also have to say that if you let the SEC in, you're going to have four. But, you know, I think the argument for allowing the FDIC to become holding company supervisor is that we do have the longest history with this industry, with these individual institutions. Also, the Fed already has two ILCs in holding companies subject to Fed supervision. Eight are under the OTS. And I believe four more would be under the SEC if you recognize them. So it would only be with regard to the remaining institutions where we would be having that role. Mr. Meeks. Thank you. I yield back. The Chairman. The gentleman from Texas, Mr. Neugebauer. Mr. Neugebauer. Thank you, Mr. Chairman. Ms. Bair, in your testimony you specified that there are four categories of ILCs, and the fourth one is those that directly support the parent companies' or organizations' commercial activities and that they can maintain those entities by funding them, the parent, through forms of deposits, borrowings, and equity and so forth. How does your regulatory or oversight of those ILCs differ from the other ILCs that you oversee? Ms. Bair. Well, those types of applications obviously go through a very stringent Section 23A and 23B review. This is an area where we very closely consult with the Fed in terms of how to interpret and apply those provisions, and our supervisory program also heavily scrutinizes those relationships to make sure there is full compliance with 23A and 23B. Mr. Neugebauer. And have you ever experienced any problems with those relationships? Ms. Bair. There is one institution that comes to mind, though I don't like to talk publicly about individual cases. If you'd like to submit a question in writing, we can have our general counsel put something together to respond to that. Mr. Neugebauer. All right. Thank you. I guess this is a question to the panel as a whole. If we go forward with this legislation, we are going to, in fact, grandfather some institutions that came in under the previous regulation, and, therefore, if there are other organizations that would be, you know, competing with those organizations, in fact they are now going to maybe have a competitive advantage because they were grandfathered. Is that good, fair, consistent policy for this country? And I'll just go down the-- Ms. Bair. Well, I don't know how else to do it. You had to do it when you closed the non-bank bank loophole. You had to do it when you closed the unitary thrift loophole, and inevitably, there are going to be some winners and some losers. Mr. Kohn. I agree with Chairman Bair. I think the problem, as she notes, is that you can't make everybody happy here. I think the most important thing is to cut things off. And there are people who have been operating under this charter for a while, and they should be allowed to continue operating under the charter. But it would give them at least some competitive advantage against others, as I think Commissioner Leary was pointing out about the auto companies. But I think that's kind of the lesser of the evils. I'd rather have the loophole closed, people grandfathered in, and have no more going forward. Mr. Reich. It would not be a perfect solution by any means, but it would--it is about the only option you have if you were to move in that direction. Mr. Colby. I have nothing to add to that. Mr. Leary. From my perspective, I don't believe the cutoff is needed. Mr. Neugebauer. Mr. Leary, if this legislation--because your State is one of the States that still allows that kind of activity--what do you see the impact moving forward with future ILC applications and activity in your State? Mr. Leary. With the commercial activity restricted? I would hope it would continue. I cannot predict how it would continue. I would simply indicate that while Utah may be an anomaly in that our commercial bankers and our industrial bankers are in the same association and work well together thus far in all of these operations, I would hope that it would continue. Mr. Bachus. Would the gentleman yield? Mr. Neugebauer. Yes, I would. Mr. Bachus. In the conversation about our automobile manufacturers, you said the only option would be to close the loophole and leave some in and some out. Obviously, what concerns many of us is that Ford and Chrysler are the two that do not have ILCs are our domestic producers, two of our three domestic producers. And our domestic automobile manufacturers, I think, are very important in a bipartisan way. I guess there would be another solution, and that's as only to automobile manufacturers to allow a continuing or to allow a certain space of time to those that had made application. Any comment on that? Mr. Kohn. I think I'd be a little concerned that once you crack the door, people would be pushing against it, and more would want to come in. So I do think the-- Mr. Bachus. Of course if it were narrowly drawn and in that one regard. But I understand, it is a quandary. The Chairman. If the gentleman would yield. My sense is, and I know the gentleman from Ohio and I have talked about this, my impression is that's an issue we will be dealing with when the bill comes out of the Senate. And sufficient unto the day is the evil thereof is, I think, the appropriate model there. But I do think being realistic, there will be some Senate negotiations, and I think there will be some distinction drawn ultimately--this is a prediction--between those entities that are very limited to a kind of a self-financing situation in which they are processing some of their own paper, and entities that might seek a broader kind of franchise. But I do believe that's something we will be dealing with at that time. Mr. Bachus. Thank you. Because as you know, many members are concerned about that. The Chairman. The gentleman from Georgia. Mr. Scott. Thank you very much, Mr. Chairman. Let me start if I may by looking at this from a concept of what is in the best interests of the consumer. Because in the final analysis, that's really what we're here for. And that begs the question as to what is in the best interest of the consumer is the fact that the genie is sort of out of the bottle, because there are some companies who are already doing this. What empirical data do we have that these companies provided a threat to our way of life, to the banking system? There has been none. You have Target; you have GE; you have Sears; and a number of others. But in fact, in some cases, the consumer has benefitted through added consumer convenience and lower costs in some areas. But in each of your testimonies, there has been consistent woe, but there has been no evidence, no empirical evidence that those who have the charter have been threatening to the system in any way. And I was wondering. And by that, Ms. Bair, I mean, wouldn't the FDIC, don't you think that they have the current oversight to make sure that these safeguards are there? And again, what evidence do we have that-- Ms. Bair. Well, Congressman, you're right. To date, the commercially owned ILCs have a good safety and soundness record. They have been the source of product innovations and expansion of financial services to certain segments of the population. I think what we're really talking about is prospectively how far you want to go with this. The current ILC exception is quite broad, and I think a lot of the concern about some of the pending applications that have gotten so much press and controversy has been not so much about what's currently being proposed, but what might happen in the future, where do we draw the line? Do you want major retailers being able to provide the full panoply of financial services? We're being agnostic. Those are the kinds of policy issues that Congress needs to make. But, you know, I think they are good questions to be asking, and I think perhaps going forward, you do want to consider providing some limited ability to experiment with a very limited mixing of banking and commerce. Those are the right questions to be asking, but, again, we think it's a policy call for Congress to make. Mr. Scott. Mr. Kohn, let me get to a point that you talked about in terms of some issues and complexities you said, conflicts of interest. Let us take an example. In the provision, isn't it true that the ILCs have what we call an anti-tying prohibition that is a safeguard? Under this provision, an ILC could not condition a loan on a requirement that the borrower obtain services from an affiliate, and the affiliate could not tie a product sale to a requirement that the customer obtain banking services from the ILC. So, if the Home Depot, for example--it's a good example here, which I think as we move this process along, I think the bill will move forward. And when it gets to the Senate, there's going to be some deliberation. I agree with your point, but I do think that we ought not to sort of throw the baby out with the bath water here. But maybe to look at some of these situations on an individual basis. So, for example, if the Home Depot were to operate an ILC, they could not require contractors to finance their supplies through the ILC, nor could the ILC require loan applicants to use the loan proceeds to buy supplies from the Home Depot. And I point this out because the anti-tying requirement for traditional banks, on the other hand, are applicable only to the bank itself. So my--the point I want to make is that in some cases, for example, we take again the Home Depot case where this is going on now. I mean, it's basically a design to have a major consumer benefit. Now a consumer comes in, and they want to expand their line of credit. We're talking about a very small amount here that is certainly nonthreatening, but would be a major help to the consumer, to be able to transact his transaction there. Now this same process happens, but in this case, Home Depot has to go and farm this out to, say, a CitiGroup or a bank like that, when you could have it here. And I think with the anti- tying provisions in here, there should be safeguards in and of itself. Mr. Kohn. I think there are regulations in place and that could be put in place which help protect against this sort of thing. Now, whether they would really protect a consumer or a contractor who felt somewhat dependent on Home Depot, that consumer or contractor really felt that they had a fully panoply of choice and weren't being pushed into the financial offering that Home Depot was tying to its transaction, I think is an open question. We've talked a lot about competition here, and the consumer. You've framed our question in terms of the consumer. There is a lot of competition in the financial services industry. There is relatively free entry into banking and thrifts. We charter hundreds of new institutions a year. I think if there is a need for financial services, there are people out there willing to start institutions or expand what they're doing-- The Chairman. Mr. Kohn, you have to wrap this up, please. Mr. Kohn. Okay. That concludes my response. The Chairman. Thank you. The gentleman from California, then the gentleman from Ohio. The gentleman from California. Mr. Sherman. Thank you. I got a button yesterday, ``Don't Mix Banking and Commerce.'' I got it from the Independent Community Bankers Association and I'd put in the record, but the pin would stick people. And I've been interested to see the development of the whole idea of mixing banking and commerce. Because I've seen many bank regulators, particularly the Fed, be opposed to commercial institutions entering banking, and not nearly as opposed to banking institutions entering commerce. That is to say, when Wal-Mart wants to enter banking, the banking world says, Oh my God, look at Japan. Look at what happens when you mix banking and commerce.'' But when banks want to go into real estate sales, auto sales, whatever, the bank regulators have been helping them, and we in Congress have stopped the presumed train wreck described by the community bankers when you mix banking and commerce. So perhaps you could comment, is it as bad an idea for bankers to get into commerce as for commercial organizations to get into banking? Mr. Kohn. I think it would be a bad idea for bankers to get into commerce in a major way. What we allow now are commercial activities that are incidental to the basic financial activities of the banks. This is under the guidelines put out by Congress. Mr. Sherman. But we could call anything incidental to banking. I bought this tie in a tie store, but I financed it on a credit card, and I hope before it wears out, I will pay off that bill. So it was a financial institution. In fact, the bank may make a larger profit on this tie than the haberdasher. That being the case, is it your position that anytime you sell something that has to get financed--and I'd like to hear from your colleague sitting to your left as well. Mr. Reich. I think we regulators are a pretty conservative group when it comes to banks expanding into a variety of commercial activities. We are not the cheerleaders for the banking industry to expand into commercial activities. Mr. Sherman. Is there anyone on the panel who thinks that real estate sales is somehow incidental to real estate financing or is for some other reason not part of commerce? Let the record show there were no responses, and I yield back. The Chairman. I thank the gentleman. The one example he did give might have been covered by the anti-tying rules. [Laughter] The Chairman. The gentleman from Ohio. Mr. Wilson. No questions. The Chairman. The gentleman from Colorado. Mr. Perlmutter. Pass. The Chairman. The gentleman from Utah probably doesn't want to pass. I would note again, the gentleman from Utah is not now a member of the committee, but we did get unanimous consent, given his interest, for him to participate. Mr. Matheson. And I would be remiss if I did not open by thanking both Chairman Frank and Ranking Member Bachus for their generosity in allowing me to participate today. It is very nice of you to do that. I have all kinds of questions in 5 minutes, so we'll see how this goes. Mr. Leary, if you could just briefly confirm a couple of things for me. Number one, there were some references made in opening statements about lack of CRA participation by ILCs. Could you clarify what's really going on with CRA participation? Mr. Leary. I think from the State of Utah, and even from consumer activist groups, they would tell you CRA activity of the industrial banks in Utah is outstanding. They have been noted for proactive work. They are out there doing it the best they can. And what is unusual, while my background and experience is in community banking, the CRA group has sat down and tried to proactively figure out ways that create micro enterprise loan funds. They've created Utah Community Reinvestment Corporation. I think they've been very aggressive. Mr. Matheson. Thank you. I think it's interesting to note that from the chairman's opening remarks to just about everybody on the panel, I think everybody here has said that there's no safety and soundness issue to date in this industry. And it reminds me of when we had the subcommittee hearing in the last Congress, and when then-subcommittee Chairman Bachus concluded the hearing, he said, you know, legislation is usually a solution to a problem, and it isn't clear where the problem is. He said that at the time, I'm not sure there is a problem. And I think that's the underlying question we need to be talking about today is where is the problem? Since we've all apparently stipulated there's no safety and soundness issue to date in this industry. And yet, Mr. Leary, some people are concerned that only six States benefit. You've already said you wouldn't care if other States had access to this charter. Mr. Leary. I do not. Mr. Matheson. Is it your understanding that the beneficiaries of industrial-owned company services, namely, consumers, that those beneficiaries are in all 50 States, and in fact people throughout this country benefit from the industry? Mr. Leary. Yes they are. Mr. Matheson. Ms. Bair, I wanted to know, is it true--would you verify that the FDIC does in fact vigorously enforce Sections 23A and 23B in the anti-tying provisions applicable to the banks you regulate? Ms. Bair. Yes, we do. Mr. Matheson. You said you were agnostic about what we do. But you enacted a moratorium, and I don't know that that's agnostic. Ms. Bair. Yes. Mr. Matheson. And you've extended the moratorium, and if you ask Mr. Leary about what that's meant to people who are applying for charters, that is not a hold-harmless provision. That is not agnostic. Ms. Bair. Yes. Mr. Matheson. And I'm curious what's happened at the FDIC to sort of change this position? Because if you look at what your predecessor said, I quote remarks before State bank supervisors in 2003, after describing the FDIC's examination of industrial loan banks, he said, ``These organizations are rigorously and sufficiently supervised by the state supervisors and the FDIC on an ongoing basis.'' And then he addressed concerns about oversight of the parent companies. And he said, ``While I understand these concerns, the FDIC has, and often uses, a number of tools to manage both the holding company's involvement with the financial institution and to manage transactions between the two entities. We can and do visit the parent companies and other affiliated entities for that matter, to look over issues or operations that could impact the insured institution. Congress has given us the power to protect the integrity of those relationships. We have exercised that power, and we have coordinated closely with you, the State regulators, in our work. We have found parent companies of ILCs to be acutely conscious of their responsibilities with respect to their ILC subsidiaries and the consequences of violating applicable laws and regulations.'' He has also said, ``We at the FDIC must be vigilant in our supervisory role, but I will reiterate, the FDIC believes the ILC charter per se poses no greater safety and soundness risk than other charters.'' Ms. Bair. Yes. Mr. Matheson. What has changed? Ms. Bair. Well, I could read excerpts from the GAO report, from our own IG, from a number of members of this committee and in the Senate, and from a number of public commentors who would raise a lot of concerns about the current regulatory structure. I felt when I came into this situation at the end of June last year that we needed to take a step back and evaluate all the issues, given that there were a lot of credible voices saying that the supervisory regime was not adequate. And, Congressman, I do honestly think that this controversy about the ILC charter is not going to go away, because there are in fact no meaningful limitations on the FDIC's ability, other than safety and soundness considerations, to prevent major commercial entities from getting into banking in a very large way. That has not happened to date. Mr. Matheson. And you're questioning the FDIC's ability to adequately regulate, along with the State, those-- Ms. Bair. I'm questioning whether the FDIC should be the decisionmaker in allowing major commercial retail entities to get into banking in a major way in this country. I don't think that's our decision right now. Mr. Matheson. Let me just ask if Congress did decide to allow this to happen instead of this legislation that's being proposed, do you think the FDIC has the adequate capability to regulate that industry in that context? Ms. Bair. We will have to evaluate each application on a case-by-case basis. But any decision we made would have to be based on safety and soundness considerations. It couldn't be based on policy considerations relating to commercial ownership. Mr. Matheson. Do you think that the commercial ownership issue has evolved in the last few years due to a particular application? Ms. Bair. Our decision wasn't driven by any individual applications, but there has been a trend and greater interest in this charter by major retailers, yes. Mr. Matheson. Do you think that when you look at FDIC and the bank-centric model that we've had here, do you see areas that we--or capabilities that you don't have now that would help you better regulate this industry, or are you satisfied with the tools you have at your disposal? Ms. Bair. I think holding company authorities, particularly the ability to examine affiliates, would be helpful, yes, I do. Mr. Matheson. And you don't think you have that-- Ms. Bair. We do not have that now, no. We have-- Mr. Matheson. Do you take issue with what your predecessor said about that? Ms. Bair. Well, our ability to examine affiliates is only with regard to determining what the relationship is with the ILC. So unless there's a relationship, we could be challenged in our ability to examine affiliates. Mr. Matheson. Okay. Mr. Chairman, I see my time has expired, and I do not want to abuse the privilege. Thank you so much. The Chairman. I thank the gentleman. And with that, we will thank the witnesses. Did the gentleman from Illinois wish to ask questions? Then we thank the witnesses very much, and we will ask them to leave expeditiously, and we'll empanel the next panel. And everybody who wants to be polite to each other, do that in the hall. Just leave quickly. We ask people to leave quickly. Don't black the aisles, one panel to the next panel. We'll try to do as much as we can before we're interrupted for votes. And let us have the next panel be seated, please. Would the members of the panel please move up here and be seated so we can get started? Would the people to the Chair's left please leave? Thank you. The second panel will begin. We will ask that those doors be closed. And the first witness is Ms. Amy Isaacs, who is the national director of Americans for Democratic Action. Please just sit down and let us start talking, guys. Come on, we're in a hurry. Ms. Isaacs. Excuse me. Members of the staff, close those doors, please. People either seated, or on the other side of the door. Thank you. Please continue. STATEMENT OF AMY ISAACS, NATIONAL DIRECTOR, AMERICANS FOR DEMOCRATIC ACTION Ms. Isaacs. Mr. Chairman, thank you. I appreciate the opportunity to testify representing our more than 65,000 members. Unlike my colleagues on this panel and the preceding one, I am not an expert in banking. I am, however, a consumer, as are the members of my organization. And because we are concerned about the impact that granting an ILC charter to any retail enterprise could have on individual consumers and small business, we endorse H.R. 698, the Industrial Bank Holding Company Act of 2007. Although H.R. 698 is not specifically about Wal-Mart, I will focus on Wal-Mart as perhaps the most pernicious example of the problems which can arise when banking and commerce are intertwined. We believe a bright line between the two must be drawn. Wal-Mart's recently withdrawn application to enter the banking business was fraught with risk, which would have been guaranteed by American taxpayers. A bank tied to one of the world's largest retailers would face unique commercial and reputational risks. Regulatory agencies charged with supervising these risks lack the experience or the capacity to understand how to evaluate or minimize them. Giant retailers have been forced into Chapter 11 or have disappeared because of changes in the commercial environment. K-Mart, Ames, Woolworth, and Montgomery Ward are examples of retailers who have reorganized or have disappeared. Business models change, as do consumer preferences. The Federal Government is not and should not be in the business of understanding the risks of large-scale retailing. It should not have to worry about the safety and soundness of a global retail business, dependent on complex global supply systems. If the retail operation faces disaster, so will the bank. Wal-Mart also faces the risk of social ostracism for its routine antisocial behavior. Wal-Mart has an established pattern of irresponsible practices. It shorts employees on health care, it has flouted hourly wage laws, and it has been involved in multiple cases of alleged discrimination. The company has been accused of using undocumented workers and a senior executive said he padded his expenses to conceal anti- union expenditures. Such behavior carries the risk of a damaged reputation, and with it, a run on the bank. The government cannot be in the position of insuring against the risk. There are many other examples of antisocial behavior leading to the demise of financial institutions. Riggs Bank is a prime example. We also are deeply concerned that large scale commercial enterprises could misuse their market power. As state-chartered ILCs, they would not be subject to the stricter regulations of bank holding companies. They could use their position in the marketplace and control of prime real estate for their own advantage, instead of the interests of the community they purport to serve. Had Wal-Mart been granted an ILC charter, it would have been able to offer anything an ordinary bank could--savings accounts, checking accounts, mortgages, and a variety of loans for everything from home improvement to car purchases to small business loans. The potential for conflict of interest is obvious. Would retailers make loans to competitors? Should they have access to credit information about competitors? Retailers operate with the goal of dominating markets. They work to control competition. The result has been the extinction of long-term community small businesses. There is no reason to believe that a foray into banking would have a different outcome. Retailers are not offering banking services to save consumers money. They are not charities. They are in business to make money. They want to use their retail power to muscle their way into the financial services industry. Had Wal-Mart been granted a charter, it would have used its power to muscle past community banks and credit unions, which do care about their own communities. Among the factors the law requires be considered in accepting an application for an ILC charter is the convenience and needs of the community to be served. Mixing retail commerce and banking makes it impossible to meet that standard. The conflict of interest and the push for market dominance argue against a charter serving any need or convenience other than the retailers'. Existing institutions leasing space in retail stores serve customers. Many banks have arrangements with supermarket chains. These bank branches meet the needs of both consumers and the community. Wal-Mart saw the handwriting on the wall when it withdrew its application. But until and unless H.R. 698 is signed into law, we cannot guarantee that a similar problem will not recur. Americans for Democratic Action stands for liberal values. We see bank regulation as an area where true conservative values should prevail. By granting a charter and deposit insurance, the government should not be risking regulating a business it does not understand. It should not insure depositors against a corporation's antisocial behavior and the attendant risks. For these reasons, Americans for Democratic Action urges passage of H.R. 698. Thank you for your consideration. [The prepared statement of Ms. Isaacs can be found on page 113 of the appendix.] The Chairman. Thank you. And next, testifying on behalf of America's Community Bankers, for the chairman a familiar face, not to mention accent, one of our leading bankers in Massachusetts, Arthur Connelly from South Shore Bank. STATEMENT OF ARTHUR R. CONNELLY, CHAIRMAN AND CHIEF EXECUTIVE OFFICER, SOUTH SHORE BANCORP MHC, ON BEHALF OF AMERICA'S COMMUNITY BANKERS Mr. Connelly. Thank you. Chairman Frank, Ranking Member Bachus, and members of the committee, thanks for inviting me to testify before you today on the Industrial Bank Holding Company Act of 2007. My name is Art Connelly, as the chairman said. I am the chairman and CEO of South Shore Bancorp, and I also serve as the first vice chairman of America's Community Bankers, and I am here today to testify on their behalf. The appropriate regulatory structure for industrial loan companies is incredibly important and should be addressed by Congress. First, I want to say that ACB strongly supports H.R. 698. We believe that this commonsense legislation is necessary to improve the safety and soundness of the banking system. ACB believes that the withdrawal of Wal-Mart's ILC application does not end the need for comprehensive ILC regulatory reform. The ILC charter is the only bank charter that can be obtained by a commercial entity. Furthermore, there is no holding company oversight for ILCs that are not otherwise supervised by the OTS or the Federal Reserve. These structural issues run contrary to legislation passed by Congress. Consistently throughout the 20th century, Congress made it clear that it does not want commercial ownership of banks in the United States and wants insured banks to have consolidated holding company oversight. There are good reasons to have concerns about commercial ownership of banks, especially with ILCs. Commercially owned banks can face conflict of interest pressures from their commercial owners. We have seen this problem in other countries, where a commercially owned bank can be pressured by its parent to make loans based not on sound underwriting but on the needs of its commercial parent. Concerns about the payment system integrity might also exist if a commercial parent improperly influences the actions of an ILC subsidiary that processes payments. Furthermore, these problems are greater for ILCs because commercially owned ILCs that are not affiliated with a bank or a savings association have no holding company regulator that can help oversee risks to the depository institution on a consolidated basis. While the FDIC has done an admirable job in regulating ILCs for safety and soundness so far, it does not have the statutory authority to examine the parent company. The recent surge in commercial ILC application brings these concerns to the forefront. Until recently, the majority of ILC asset growth has been in ILCs that are affiliated with banks or savings associations and have holding company supervision. If no regulatory supervision is passed, we could see dramatic growth in commercially owned ILCs with no holding company oversight. That brings me to H.R. 698. On examining the bill, it is helpful to look at Gramm-Leach-Bliley, where Congress prohibited any future ownership of unitary thrifts by commercial companies. However, Congress grandfathered all unitary thrifts that were commercially owned prior to 1999. This appears to be the model for the Industrial Bank Holding Company Act, and we believe it to be a fair one. H.R. 698 creates an FDIC regulated holding company structure for ILCs not regulated as a bank or a savings and loan holding company. Providing the FDIC with the authority to supervise the parent companies of these ILCs on a consolidated basis will allow it to ensure the safety and soundness of the institution. The legislation also utilizes a grandfathering system similar to the one in Gramm-Leach-Bliley. In conclusion, Mr. Chairman, we believe H.R. 698 is sound legislation that will fill a current gap in our financial regulatory structure. I will gladly take any questions that you might have. Thank you. [The prepared statement of Mr. Connelly can be found on page 82 of the appendix.] The Chairman. Thank you. Next, from the Independent Community Bankers of America, Mr. Jim Ghiglieri. Please, Mr. Ghiglieri. STATEMENT OF JAMES P. GHIGLIERI, JR., PRESIDENT, ALPHA COMMUNITY BANK, ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS OF AMERICA Mr. Ghiglieri. Mr. Chairman, Ranking Member Bachus, and members of the committee, my name is Jim Ghiglieri, and I am president of Alpha Community Bank in Toluca, Illinois. I am also chairman of the Independent Community Bankers of America. ICBA is pleased to have this opportunity to testify. The ILC charter threatens our Nation's historic separation of banking and commerce and undermines our system of holding company supervision. The fact that Wal-Mart has withdrawn its ILC application does not diminish the need to act. Other applications are pending and more could be filed. ICBA was pleased that the FDIC unanimously adopted the recommendations of Chairman Frank and Representative Gillmor and many of their colleagues to impose a 1-year moratorium on ILC applications by commercial firms. The entire FDIC Board clearly recognizes that these applications raise broad public policy issues that Congress must confront. Congress can do that by enacting H.R. 698. Like much good legislation, H.R. 698 is a compromise. That is its strength. Institutions that are already in business could remain in place. Financial companies could continue to acquire, establish, and operate ILCs. The legislation addresses the key concerns without needlessly disrupting ongoing activity, and it gives the FDIC the basic tools it will need to be an effective consolidated regulator. Why do we ask Congress to pass this bill? First, the loophole threatens the safety and soundness of the financial system. Second, mixing banking and commerce presents serious conflicts of interest. Third, ILCs could destabilize local communities and harm consumers. Fourth, ILCs could jeopardize the payment system. And, fifth, ILC holding companies need stronger regulation. Let me briefly elaborate. First, safety and soundness. Allowing commercial firms to own federally insured ILCs adds tremendous new risk to the Deposit Insurance Fund. For example, Ford Motor Company applied for an ILC charter. Ford's financial difficulties are well-documented. Banking regulators will not allow banks to buy Ford bonds. Ford hardly sounds like a source of strength for an FDIC-insured ILC. Home Depot and its ILC acquisition target are susceptible to fluctuations in real estate. According to Bloomberg News on February 21st, and I quote, ``Home Depot reported its biggest drop in quarterly profit as the decline in U.S. home sales sapped demand for building supplies.'' Financial services regulators, no matter how competent, do not have the expertise to understand each of these economic areas and protect the safety and soundness of an ILC from problems that may befall its parent. A financial regulator should not become involved in market decisions of a major commercial firm. Second, conflicts of interest. Home Depot could be tempted to direct its bank to offer unsound loan terms to its customers provided they agree to purchase products from Home Depot. Or Home Depot could offer discounts on its product if a customer takes out a loan from its bank. The idea that a bank should be an objective credit grantor gets thrown out the window either way. Third, harm to consumers and communities. An ILC owned by a retail firm is unlikely to make loans to its local competitors. An ILC with a nationwide deposit taking network could draw funds out of local communities, sending them to corporate headquarters. Major commercial firms have the size and resources to engage in predatory pricing for as long as it takes to drive local competitors out of the market, both locally owned small businesses and community banks. Fourth, the payment system. The Wal-Mart application highlighted potential risk to the objectivity and security of the payment system. If retailers control the payment system, they will seek competitive advantage rather than control risk. Consumers, small businesses and banks of all sizes would be the victims. And finally, lack of regulatory authority. The FDIC currently lacks clear statutory authority to consider all of the broad policy implications when considering ILC applications and to regulate ILC holding companies. While ICBA believes that the FDIC has ample grounds under current law to deny several of the pending applications, especially Home Depot's, it may eventually be compelled to grant a disturbing number of them. Senator Garn told the FDIC that the ILC charter was grandfathered in 1987 and exempted from the Bank Holding Company Act to serve narrow purposes. But that is rapidly changing. A GAO report highlighted the need for enhanced supervision of ILCs, especially the need for consolidated supervision over both the ILCs and their holding companies. Successive Federal Reserve chairmen have repeatedly made similar points. Congress has ample precedent for closing the ILC loophole. You closed the non-bank bank loophole in 1987 and closed the unitary thrift loophole in 1999. Now it is time to close the ILC loophole. Thank you very much. [The prepared statement of Mr. Ghiglieri can be found on page 95 of the appendix.] The Chairman. Thank you. Next, Mr. McVicker, who is the chairman and CEO of the Central Bank and Trust Company, and he is testifying on behalf of the ABA, the American Bankers Association. Mr. McVicker. STATEMENT OF EARL D. McVICKER, CHAIRMAN AND CHIEF EXECUTIVE OFFICER, CENTRAL BANK & TRUST COMPANY, ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION Mr. McVicker. Mr. Chairman, and members of the committee, my name is Earl McVicker. I am chairman and CEO of Central Bank and Trust Company in Hutchinson, Kansas, and chairman of the American Bankers Association. Thank you for the opportunity to present ABA's views on the regulation of ILCs. Since Congress last enacted legislation concerning the ownership of ILCs nearly 20 years ago, the ILC industry has changed dramatically. Unfortunately, these changes now threaten to undermine the separation of banking and nonfinancial commerce that has long been a feature of U.S. law. In fact, over the last 50 years, Congress has repeatedly curtailed the ability of nonfinancial commercial firms to engage in banking activities. In each of these instances, the legislation was a reaction to nonfinancial firms that were taking advantage of statutory provisions to engage in banking. Moreover, in each instance, Congress was consistent in enacting legislation to maintain the separation between banking and nonfinancial commerce. Today, unintended use of the ILC charter has made it necessary for Congress to act once again to maintain this separation. When the term bank was redefined in 1987, ILCs were specifically excluded from the definition. At that time, most ILCs were small. And the few States that were able to charter ILCs were not promoting the charter. Simply put, there was no significant risk that problems caused by mixing banking and nonfinancial commerce would arise at the time the exemption was codified. That is not the case today. By the end of 2006, aggregate ILC assets totaled almost $213 billion, an increase of more than 5,500 percent since 1987. The average ILC now holds close to $3.7 billion in assets. Recent ILC asset growth is no accident. When Congress cut off the ability of nonfinancial commercial firms to engage in banking through unitary thrifts in 1999, these firms were forced to look for other means of doing so. It is no coincidence that total aggregate ILC assets more than doubled from $44 billion in 1999 to over $90 billion in 2000. Clearly, with the closure of one avenue into the banking world, nonfinancial commercial entities began to exploit another. It is fair to assume that Congress did not anticipate that the ILC exemption would be used for this purpose. There is a significant risk if the separation is not maintained. A nonfinancial parent, seeking to further its commercial pursuits, could put depositors' funds, the capital of the bank and the deposit insurance fund at risk. Congress has recognized these risks and should once again act to preserve the separation of banking and nonfinancial commerce by closing this exemption. Thus the ABA supports the Frank-Gillmor bill, H.R. 698, which would create a general rule that commercial firms may not own an ILC. The bill would grandfather commercial firms that currently own an ILC, and we support bringing grandfathered institutions within the jurisdiction of a Federal bank regulator, and vesting that regulator with the full range of supervisory and enforcement tools. We stand ready to work with Congress to maintain the important separation between banking and commerce. Thank you. [The prepared statement of Mr. McVicker can be found on page 172 of the appendix.] The Chairman. Thank you very much, Mr. McVicker. Next, John Douglas from Alston and Bird, who is testifying on behalf of the American Financial Services Association. STATEMENT OF JOHN L. DOUGLAS, ALSTON & BIRD LLP, ON BEHALF OF THE AMERICAN FINANCIAL SERVICES ASSOCIATION Mr. Douglas. Mr. Chairman, and members of the committee, thank you very much for allowing us to present testimony on this important bill. American Financial Services Association is the national trade association representing many of the Nation's most important lenders, providing access to credit for millions of consumers and small businesses. AFSA strongly believes that the industrial bank option represents a safe and sound and appropriate means to deliver financial services to the public. Congress established a framework within which commercial companies can provide deposit, loan, and other banking products to their customers. This framework is highlighted by stringent and appropriate supervision, by strong enforcement powers, and by a structure of laws and regulations that mitigate the consequences of the hypothetical and unproven evils raised by the opponents of commercial ownership of industrial banks. I testified on this issue last year and don't intend to repeat my testimony. Since that time, we've endured a lengthy moratorium by the FDIC and a long comment period where the FDIC sought guidance on how to deal with this important issue. There were thousands of comments, most in opposition. It is important to recognize, however, that nothing, no event, no failure, no fact, lends any substance to the allegation of the great dangers to our economy that would result from commercial ownership of industrial banks. Indeed, all we have is speculation. There are three main allegations. First, that there is some gap in our supervisory framework that poses danger to our economy and banking system. Second, that if commercial companies are allowed to own industrial banks, rampant tying or other unseemly activities would occur and the FDIC couldn't stop them. And, third, there is something fundamentally un- American and dangerous about mixing banking and commerce. I respectfully submit that these allegations are not true. First, industrial banks are subject to the same comprehensive framework of supervision and examination as normal commercial banks. They have no special powers, no special authorities, and are exempt from no statute or regulation. They comply with 23A and B, regulation O, capital requirements, prompt corrective action, anti-tying provisions, and the Community Reinvestment Act. Second, the FDIC has been given full and ample authority to supervise and regulate these institutions and can exercise the full range of enforcement powers. I was a participant in the political process that led to a rewrite of these provisions in 1989 as part of FIRREA and it was our intention to give the FDIC and the other regulators all the enforcement powers they needed, which they exercised. Third, I can attest from experience that the FDIC does exercise these powers. It requires an independent board, adequate capital, safe and sound operations, and effective internal audit. It examines, it scrutinizes, and it exercises its powers to protect our system. And finally, the FDIC's experienced with industrial banks, similar to the experience of the OTS with respect to diversified owners of savings associations, belies any fundamental concerns to threats to our banking system. This is a well-capitalized, well-managed segment of the industry, making important contributions to consumers and small businesses. The FDIC's experience has been good. Finally, I want to address once more this myth of separation in banking and commerce. The Gramm-Leach-Bliley Act, to say that it was designed to make permanent that separation, is to ignore important provisions of that Act. There have always been affiliations and relationships between banking and commercial firms. These relationships have been carefully reviewed by Congress. If we were serious about eliminating it, we would preclude our banks from being affiliated with any entity. We wouldn't let Bank of America be affiliated with Bank of America securities, lest it favor its customers over those of Merrill Lynch. We would more closely scrutinize the propriety of a small business owner, a real estate developer, a car dealer owning a commercial bank in a small community, where sources of credit are lax. If we were really concerned, we would repeal the merchant banking powers in Gramm-Leach-Bliley and repeal the FDIC's power to grant commercial activity--permit commercial banks to engage in commercial activities in FDICIA. It is anomalous at best to be asserting that there is something wrong with a commercial entity engaging in banking when we have opened the door broadly and widely for banks to engage in and invest in commercial activities. I want to emphasize this last point. It is permissible under current law for any one of a number of banking organizations to use their powers granted under Gramm-Leach- Bliley to acquire any commercial entity. This bill would preclude any commercial entity from establishing a bank to facilitate the needs of meeting its customers, regardless of the size of the bank, the needs of its customers, or any other factor that might benefit our economy or our communities. I would submit that the breadth of our markets and the strength of competition in our financial services industry has served us well and submit that it would be unwise to roll back the clock by taking steps to limit competition in this area. Thank you very much. [The prepared statement of Mr. Douglas can be found on page 87 of the appendix.] The Chairman. Thank you, Mr. Douglas. And next, Mr. Marc Lackritz, who is the chief executive officer of SIFMA. STATEMENT OF MARC E. LACKRITZ, CHIEF EXECUTIVE OFFICER, SECURITIES INDUSTRY AND FINANCIAL MARKETS ASSOCIATION Mr. Lackritz. Thank you, Mr. Chairman. I appreciate the opportunity to testify today before the committee, because the SIFMA members own a vast majority of the industrial bank assets in the United States. And as you know, Mr. Chairman, Congress passed Gramm-Leach-Bliley back in 1999 to allow affiliations between and among securities firms, banks, and insurance companies, combined with functional regulation. This ability to structure their operations optimally within existing law has really been critical to the success of industrial banks and their owners. Many of these companies are among the most advanced, sophisticated, and competent providers of financial services anywhere. And we support the ability of regulated securities firms to continue to own industrial banks the way they do under existing law. Federally insured industrial banks are subject to State banking supervision, FDIC oversight, and all the banking laws that govern relevant banking activities. Most importantly, the FDIC has the authority to examine the affairs of any affiliate of any depository institution, including its parent company. The FDIC's regulation of industrial banks has proven safe and effective. Industrial banks do not pose any greater safety and soundness risks than any other charter types and should not be subject to additional constraints beyond those imposed on other FDIC insured institutions. H.R. 698 would create a new holding company regime for the owners of industrial banks by expanding the existing authority of the FDIC over the owners of these institutions. Bank and thrift holding companies that own industrial banks would be exempted from this regime, presumably because they are already subject to holding company oversight by the Fed or the Office of Thrift Supervision. However, the bill fails to provide an exemption for industrial bank owners who are regulated as consolidated, supervised entities by the SEC. We believe it is critical that H.R. 698 be amended to recognize the SEC's CSE regime. The Commission established its CSE framework in 2004 in part to allow major securities firms doing business in the European Union to comply with its financial conglomerates directive. That directive requires that non-European firms doing business in Europe demonstrate that they are subject to a form of consolidated supervision by their home regulator that is equivalent to that required of their European counterparts. The GAO found in its recently released report on CSEs that the Federal Reserve, OTS, and the SEC were generally meeting criteria for comprehensive consolidated supervision. We agree that the CSE regime is both robust and comprehensive. Importantly, the Commission's CSE oversight, just like the Federal Reserve's oversight of bank holding companies, meets the EU's equivalency standard. In addition, the SEC's consolidated regulation standards closely parallel the Fed's standards to assess whether a foreign regulatory regime qualifies as consolidated regulation for a foreign bank operating in the United States. We therefore strongly urge the committee, Mr. Chairman, to recognize the SEC as a consolidated regulator along with the Federal Reserve and the OTS in H.R. 698. The SEC is recognized worldwide as a consolidated regulator and its regulatory requirements and procedures were very carefully designed to comply with all standards for effective consolidated regulation in the United States and abroad. That stature should be reflected in this bill, in order to ensure that global securities firms are not damaged inadvertently. Over the last 2 decades, capital markets and the financial services industry have become truly global, integrated, and interconnected. As capital markets and financial products continue to evolve, so too must our Nation's regulatory structure. We need a regulatory regime that is capable of keeping pace with rapid globalization, technological transformations, and dynamic market changes. That is why our new board of directors unanimously agreed that we will develop a long term strategy of seeking to modernize financial services regulation and deal with inconsistencies in the current regulatory system. We look forward to working with financial market participants, regulators, and legislators, and you, Mr. Chairman, to ensure that our financial services industry retains its preeminent status in the world. Thank you very much, Mr. Chairman. [The prepared statement of Mr. Lackritz can be found on page 138 of the appendix.] The Chairman. Thank you. And next is Mr. Thomas Stevens, who is the immediate past president of the National Association of Realtors. STATEMENT OF THOMAS M. STEVENS, IMMEDIATE PAST PRESIDENT OF THE NATIONAL ASSOCIATION OF REALTORS Mr. Stevens. Thank you, Mr. Chairman, and committee members. Thanks for allowing us to do the soft shoe there. My name is Tom Stevens. As the 2007 immediate past president of the National Association of Realtors, and former president of Coldwell Banker Stevens, I am here today on behalf of the more than 1.3 million Realtors who work in all fields of commercial and residential real estate. The National Association of Realtors wholeheartedly supports H.R. 698 as it closes a loophole that allows commercial companies such as Home Depot to own state-chartered, federally insured banks. Perhaps more importantly, the Industrial Bank Holding Company Act of 2007 would restore one of our Nation's most fundamental economic principles, the separation of banking and commerce. I also thank Representative Gillmor for his dedication to pursuing a legislative solution to this important issue, which was raised more than 4 years ago. Let me be clear. Realtors have long supported the national policy against the mixing of banking and commerce. We oppose any efforts to weaken this policy, either by allowing commercial firms to engage in banking, or by permitting large national banks to engage in commercial activities, such as real estate brokerage and management. Realtors believe banking and commerce should remain separate for three key reasons. First, we strongly believe that allowing commercial firms to engage in banking would create inherent and irreconcilable conflicts of interest. Second, Realtors believe that giving large commercial firms the benefits associated with owning a federally insured bank would stifle competition in the marketplace. For example, if an ILC owned by a commercial firm provided loans on more favorable terms to suppliers or customers of its parent, it could put other commercial firms at a disadvantage. Likewise, allowing national banks to engage in commercial activities such as real estate would stifle competition from nonbank firms that do not share such benefits. Third, we believe that mixing banking and commerce poses substantial risks to the financial system. Over the last few years, regulators at the Federal Reserve, the OCC, and the FDIC have considered giving banks the green light to engage in commercial activities. We believe such activities markedly increase the risk exposure of national banks and could threaten the safety and soundness of the entire banking system. Banks should be in the business of banking, not selling cars, home improvement supplies, or real estate brokerage. When banking activities and commercial activities and commercial activities mix, it can be a recipe for disaster, bad for the economy, bad for businesses, and bad for consumers. Realtors applaud Representative Gillmor and Chairman Frank for taking the lead in this important issue. And we urge the House Financial Services Committee to pass H.R. 698, the Industrial Bank Holding Company Act of 2007. We also encourage Congress to pass H.R. 111, the Community Choice in Real Estate Act, which would similarly prevent large banks from entering the real estate business. And I want to thank you for your time and would be more than happy to answer any questions. [The prepared statement of Mr. Stevens can be found on page 200 of the appendix.] The Chairman. Thank you, Mr. Stevens. I am not, myself, going to ask questions. I want to assure the panel it is not for lack of interest in what they say. Some of us have been working on this for some time. There are newer members who have concerns. I think we have had some serious conversations. So with that, I am going to turn to the gentleman from Illinois, Mr. Manzullo. Mr. Manzullo. Thank you. I--maybe the arguments here should be centered not on safety and soundness which, Mr. Douglas, you were talking about and Mr. Ghiglieri, among others. The issue here is how big are you going to get before you smash the little guys? Mr. Ghiglieri, do you want to take a stab at that question? Isn't that the issue? Mr. Ghiglieri. This is not an issue of competition. We are not and never have been afraid of competition. We compete with every financial services provider out there, from the big banks to the ILCs to credit unions to payday lenders. This is really about two issues, and that is maintaining the separation of banking and commerce, and providing a consolidated regulator at the holding company level for ILCs. But it is not about competition; we are not afraid of competition. Mr. Manzullo. Okay. Some have called this the bank of Wal- Mart. And some of the bankers that I have talked to have expressed a concern that when you get commerce on that level, that indeed will hurt competition, or if not competition, the ability to discern on the type of loan that should be given. Anybody want to take a stab at that? Mr. McVicker. It is really not about competition; it is about the issue that has been addressed from numerous panelists and the concern there is some safety and soundness risk, we believe, to the industry and to the FDIC fund. What Wal-Mart would be doing if they were approved remains to be seen. But our position was the same before Wal-Mart filed their application and remains the same after it has been withdrawn. And that is the concerns, the safety and soundness both of the regulatory system and the deposit insurance fund. Mr. Manzullo. Mr. Douglas? Mr. Douglas. I would say that if we're concerned about threats to the deposit insurance fund, there is certainly no evidence that industrial banks pose that threat. And if we look historically back the same 20-year period we've been looking at for commercial banks, one would say that consolidated supervision might pose a greater threat to our safety and soundness than an industrial bank. Virtually every financial institution that has failed in the last 20 years has been subject to consolidated supervision. The point is not that the Fed is a bad regulator or that the FDIC is a better regulator. The point here with industrial banks is that the FDIC and the States with their bank centric level of supervision has proven to be a pretty effective way of protecting our financial system. Mr. Manzullo. Do you agree with that Mr. Ghiglieri? Mr. Ghiglieri. Yes. I just think that it is a mistake to look backwards at the ILC industry and say that the system is necessarily sound because there have been no failures. I think we can all shudder to think what would have happened if WorldCom or Enron would have had an ILC. Or, going forward, if the ILC industry continues to expand like I think all of us think would happen. And I think that is where the threat to the deposit insurance comes in. Mr. Manzullo. Give us the worst possible scenario, if ILCs were allowed. I mean, it is obvious that you oppose them. Obviously, you oppose them. Mr. Ghiglieri. Well, I think you can look at the Japanese or the German model. In Japan, I remember as a young banker back in the 1970's listening to expert after expert and report after report talking about this wonderful Japanese economic model in this, you know, incredible Japanese banking model that was really built on commercial firms owning banks. It was projected to be the greatest economy the world would ever know and they were going to come to the United States and buy New York City brick-by-brick. And as we reflect back on that model, I think we can all agree that it has been a complete disaster. They've been stuck in a 20-year recession and really have no hope of getting out of it. The banking system is, in effect, insolvent. And I just--I can't imagine that is the system that we want for this industry that I love and am so passionate about. Mr. Manzullo. What is the difference between an independent bank having a presence in a Wal-Mart store and, for example, the Wal-Mart store owning the bank itself? Mr. Ghiglieri. In a concept like that, it is--you know, a lot of us have members that lease out space in Wal-Mart--it doesn't have to be Wal-Mart, it is a grocery store. There are all kinds of those operations. But those are just strictly bank branches. They lease out space and they sell their products and services. So it is much different than those commercial firms owning those branches. Mr. Manzullo. Mr. Douglas? I am trying to get a fight going here, but you guys won't put the gloves on. Mr. Douglas. Well, the truth of the matter is, Wal-Mart is attempting to meet the needs of its customers, were Wal-Mart to do this, the same way a commercial bank is trying to meet the needs of its customers, by finding locations where people can access products and services in a way that is convenient to them. One might say that one is better or worse than the other, but they are both subject to the same framework of laws and regulations. I find no fundamental unfairness or difference associated with one over the other. Mr. Manzullo. Mr. Lackritz? Mr. Lackritz. I would just say that I think the challenge you have is, and I think someone said it earlier on the earlier panel, that this thing, it is getting big and business is getting larger daily and moving at a faster pace. And I think the challenge you have is when you have a Wal-Mart that now owns a bank and you have conflicting interests, everything is great when things are going along well. You know, so was the real estate industry last year when things were going along well, and now there are challenges. And then the little things, subprime lending, those kinds of things start to crop up. But when you start to have that major corporation have some challenges and conflict, then there is a conflict with its subsidiary company or the bank that it owns, and you could have diverse decisions being made or decisions being made that aren't in the best interests of the bank or the bank's customers, versus the consumer of the goods out there. So I think it is an inherent conflict that you face. Mr. Manzullo. Thank you. The Chairman. I am going to recognize Mr. Matheson. I would just say that, in response to what Mr. Douglas said, the difference to me is in the incentives to which the economic entity responds, and that is the question, whether or not the incentive is that you make money off the loan and also off the product that is going to be bought with the loan and the extent to which that is going to alter that decision. That is the difference. And obviously, people keep talking about Wal-Mart, and it is true that Wal-Mart has withdrawn its application, but that does not change our view. I would note, however, in legal terms, Wal-Mart has withdrawn its application without prejudice. I think it is very clear that the reason Wal-Mart withdrew its application is that friends of the ILC industry said to Wal-Mart, will you please stop screwing up our industry because you are making everybody mad and would you go away. And they have withdrawn but they have not disappeared. And if we were, in fact, I think, finally to announce that there would be no such legislation and no moratorium, Wal-Mart would have every right in the world to come back in again. Mr. Matheson. Mr. Matheson. Thank you, Mr. Chairman. I just wanted to clear up one issue that came up in the subcommittee hearing last year as well, and that was comparing the Japanese model to ILC regulation. And I asked the panel of regulators in the subcommittee hearing last year if it's comparable and they said, no. So it is not exactly the same type of regulation. Would you agree with that, Mr. Ghiglieri? Mr. Ghiglieri. That may be the case. I mean, I am not a regulator. One thing that I do take issue with is this concept that ILCs and all of the rest of us are regulated the same way. We are regulated the same way at the bank level. But we have tremendous regulation at the holding company level and for a bank our size, it is a tremendous cost. Mr. Matheson. I think everyone stipulates to that, that there is a different model of regulation. It is called bottom- up for ILCs; it is top-down for other banks. And again, I don't think anybody on this committee disagrees with that. The question is, is one right and one wrong, or is there more than one right way to do something? And I think you know where I am coming from on that. But I think it is just important that we note the ILC model and the way we regulate in this country, I would not say that is the Japanese model. I just think we ought to have that for the record. You mentioned in your written testimony and your verbal comments, Mr. Ghiglieri, imagine if WorldCom and Enron had banks. And I would submit that instead of coming up with imaginary scenarios that sound pretty bad, let us look at the real scenario of when Tyco and Conseco had banks, as Mr. Leary mentioned in the previous panel. Are you familiar with that experience, where the parent companies had financial difficulties, one went into bankruptcy, and in both cases the ILC was separated from all those financial troubles? Actually, one sold as a premium after the fact? Mr. Ghiglieri. Yes. Mr. Matheson. Okay, so that's a real world example, compared to imagining scenarios. And I think that's important to point out, that the bottom-up regulation worked in those circumstances. Are you familiar with regulations 23A and 23B? Mr. Ghiglieri. Yes, I am. Mr. Matheson. Because in your testimony where you talk about how Home Depot may pressure people and that, do you recognize that would be a violation of existing law? Mr. Ghiglieri. Correct. Mr. Matheson. Okay. I just wanted to confirm that. Mr. Ghiglieri. And if I could just add to that? I think it is one thing to have a corporate decision that there would be no violation of 23A. But, you know, I think when you get down to the store level, when you get an entity that has thousands of stores, and you have people within those stores who are paid on the volume of transactions that are processed, I think it is natural, and I am very dubious about the fact that they would comply with that. And there has to be someone who complains in order to have the issue raised. Mr. Matheson. I understand your concern. Mr. Ghiglieri. But you do acknowledge that the way you describe it would be in violation of law, what is in your testimony? Mr. Matheson. I want to make sure of that. Just one quick observation for Mr. Connelly and Mr. Ghiglieri. I have been in this job now for 6 years and 4 months and I have had Utah community bankers come and meet with me on a periodic basis. Not one has ever mentioned the ILC issue. They live in the State where ILCs are based, we have all heard that. And they have never expressed concern to me. I am sure you can probably find somebody in your membership who has written me a letter. That may be. I am just saying, in my face-to-face meetings, they are far more concerned about issues--and I am not getting into this issue, Mr. Chairman-- they are far more concerned about credit unions and whatnot than they are-- The Chairman. If the gentleman would yield, we are very glad to accommodate the gentleman. But to have left the committee and then introduce the credit union issue is certainly a violation of the norm of-- Mr. Matheson. That is the benefit of leaving the committee, Mr. Chairman. The Chairman. The gentleman, I assume, would like to be welcomed back? Mr. Matheson. I am done. And I just again want to reiterate, thank you for your generosity in letting me participate today, Mr. Frank. The Chairman. I am just going to recognize myself for 1 minute, just to make a comment on the point we talked about, and it has to do with conflict of interest laws. And this is, in effect, the distinction between banking and commerce is a variant of a conflict of interest law. You do not pass conflict of interest laws to prohibit bad things. You pass substantive laws to prohibit bad things. The reason for laws prohibiting conflict of interest is that you want to reduce the number of occasions in which the temptation to do those things arises, in which incentives to violate the substantive laws are magnified, and in which the difficulty of enforcing the substantive law becomes more--greater. In other words, conflict of interest laws are to prevent you from--they are anti-temptation laws; they are not anti-act laws. Now that may or may not be right in this case, but that is the framework. So the fact that there are substantive laws that prevent things doesn't, in a number of other areas, tell us not to pass laws that diminish the incentive and opportunity for those things to happen. I thank the panel, I thank the members, and the hearing is concluded. [Whereupon, at 12:46 p.m., the hearing was adjourned.] A P P E N D I X April 25, 2007 [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]