[Senate Hearing 110-950]
[From the U.S. Government Publishing Office]
S. Hrg. 110-950
EXAMINING THE REGULATION AND SUPERVISION OF INDUSTRIAL LOAN COMPANIES
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
ON
THE REGULATION AND SUPERVISION OF INDUSTRIAL LOAN COMPANIES
----------
THURSDAY, OCTOBER 4, 2007
----------
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
EXAMINING THE REGULATION AND SUPERVISION OF
INDUSTRIAL LOAN COMPANIES
S. Hrg. 110-950
EXAMINING THE REGULATION AND SUPERVISION OF INDUSTRIAL LOAN COMPANIES
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
ON
THE REGULATION AND SUPERVISION OF INDUSTRIAL LOAN COMPANIES
__________
THURSDAY, OCTOBER 4, 2007
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate /
senate05sh.html
----------
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania ELIZABETH DOLE, North Carolina
JON TESTER, Montana MEL MARTINEZ, Florida
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
Jim Crowell, Editor
C O N T E N T S
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THURSDAY, OCTOBER 4, 2007
Page
Prepared statement of Chairman Dodd.............................. 47
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 1
Prepared statement....................................... 47
Senator Shelby............................................... 2
Senator Johnson.............................................. 4
Prepared statement....................................... 48
Senator Bennett.............................................. 4
Senator Tester............................................... 7
Senator Bunning.............................................. 7
Senator Crapo................................................ 8
Senator Reed
Prepared statement....................................... 49
WITNESSES
Scott G. Alvarez, General Counsel, Board of Governors of the
Federal Reserve System......................................... 10
Prepared statement........................................... 154
John Bovenzi, Chief Operating Officer and Deputy to the Chairman,
Federal Deposit Insurance Corporation.......................... 12
Prepared statement........................................... 170
Scott M. Polakoff, Senior Deputy Director, Office of Thrift
Supervision.................................................... 13
Prepared statement........................................... 187
Erik Sirri, Director, Division of Market Regulation, Securities
and Exchange Commission........................................ 15
Prepared statement........................................... 196
Edward Leary, Commissioner, State of Utah Department of Financial
Institutions................................................... 17
Prepared statement........................................... 203
Response to written questions of:
Senator Shelby........................................... 323
Senator Crapo............................................ 324
Edward L. Yingling, President and Chief Executive Officer,
American Bankers Association................................... 31
Prepared statement........................................... 223
Marc E. Lackritz, President, Securities Industry and Financial
Markets Association............................................ 32
Prepared statement........................................... 237
Arthur E. Wilmarth, Jr., Professor of Law, George Washington
University Law School.......................................... 34
Prepared statement........................................... 247
Peter J. Wallison, Arthur F. Burns Fellow in Financial Policy
Studies, American Enterprise Institute......................... 36
Prepared statement........................................... 293
Brigid Kelly, Political Director, Local 1099, United Food and
Commercial Workers International Union......................... 38
Prepared statement........................................... 306
Response to written questions of:
Senator Reed............................................. 326
Jagjit ``J.J.'' Singh, Chairman, President, and Chief Executive
Officer, Transportation Alliance Bank.......................... 40
Prepared statement........................................... 315
Additional Material Supplied for the Record
Letter from E.J. ``Jake'' Garn, former U.S. Senator from the
State of Utah, to Chairman Dodd................................ 328
EXAMINING THE REGULATION AND SUPERVISION OF INDUSTRIAL LOAN COMPANIES
----------
THURSDAY, OCTOBER 4, 2007
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Sherrod Brown, presiding.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. The Committee will come to order. Good
morning to everyone.
Thank you all for joining us here today as the Committee
examines the role that industrial loan companies play in our
banking system. That system, as we know, is a continually
changing one as lenders innovate and Congress from time to time
responds to changes in the landscape. Amidst this change, some
principles remain constant. Four times in my lifetime, Congress
has acted to separate commercial firms from banks and vice
versa. Truth be told, I really was not paying particularly
close attention to the passage of the 1956 Bank Holding Company
Act. Time and again we have seen the real costs when Congress
has failed to act, from the Depression to the savings and loan
crisis. Frankly, we are seeing variations of the problem today.
In Japan, the intermingling of commerce and banking has led to
disastrous results, and here at home, where the subprime
mortgage meltdown has operated largely outside of Federal
supervision.
I have been pretty candid all year about what I think has
been the failure of the Federal Reserve to act more
aggressively to police the subprime, non-bank lenders. It would
not be inaccurate if our witness from the Fed made the same
observation about Congress and the ILCs. But I suppose it would
be impolite. We need to act this fall to address this problem,
just as we have repeatedly in the past. When commercial firms
set up single-bank holding companies, Congress amended the law
in 1970 to reach them. When commercial firms started buying
non-bank banks, Congress in 1987 stepped in again. When
commercial firms started to acquire thrifts, Congress responded
with Gramm-Leach-Bliley in 1999.
In this spring, in the wake of the tremendous growth in
industrial loan company assets since Gramm-Leach-Bliley almost
eight-fold, the House adopted Representative Paul Gillmor's
bill to prevent further commercial acquisitions of ILCs by a
vote in the House of 371-16. The strength of that vote is a
small testament to the respect in which Paul Gillmor was held
and the skill with which he did his job as a legislator.
Paul and I served in Columbus together, he in the Senate, I
in the Lower House in those days, where he had a reputation as
a solid legislator, but it was when we both moved on that our
paths crossed. I was serving as Secretary of State in 1988 when
Paul ran for the open congressional seat in northwest Ohio.
Paul won that primary by initially 35 votes. I as Secretary of
State was called in to conduct the recount, running against the
son of the retiring Congressman, Paul's opponent, and I
remember saying to my elections counsel, ``Make sure you do
this one well because the winner of this Republican primary in
this Republican district is going to be in Congress for the
next 20 years.''
I was off by a year, but I sure wish I had been off by a
lot more. Congress lost a real expert on these issues, and
Karen Gillmor and the rest of his family and friends lost a
good man. I hope we can pick up where he left off.
Senator Shelby.
OPENING STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
Mr. Chairman, I am going to have to leave this hearing
because we have on the floor of the Senate, as you know, the
Commerce, Justice, and Science appropriations bill, and I will
be helping manage that with Senator Mikulski, but I do have an
opening statement that I want to give. And, Mr. Chairman, I
have a number of questions that I would like to submit to the
panel for the record, and my staff will handle that.
Thank you, Mr. Chairman, for holding this hearing. Today we
examine the regulation and the supervision of industrial loan
companies, or ILCs. The topic raises at least three critical
questions which this Committee should consider carefully.
First, to what extent, if any, should we allow the
continued mixing of banking and commerce through commercial
ownership of banks?
Second, is a consolidated supervisory approach rather than
a more bank-centric approach the optimal method for regulating
our financial institutions?
Third, should we charge the Securities and Exchange
Commission with the additional responsibilities of a prudential
supervisor?
Although the decision by the FDIC to extend the moratorium
on ILCs owned by commercial companies gave a certain impetus to
today's hearing, the issue is not new here. In 1987, this
Committee passed the Competitive Equality Banking Act, or CEBA.
While CEBA eliminated further chartering of non-banks, it
exempted a number of entities from the requirements of the Bank
Holding Company Act. Among those entities were credit card
companies, trust companies, and ILCs.
Twelve years later, we revisited the issue of regulatory
modernization in the Gramm-Leach-Bliley Act. Gramm-Leach-Bliley
ended the ability of unitary thrift holding companies, we will
remember, to engage in bank-like activities if they were owned
by non-financial businesses. But Gramm-Leach-Bliley did not
address the exemption of ILCs and their holding companies from
Fed supervision.
Other than certain grandfathered unitary thrifts and non-
bank banks, this meant that the ILCs were the only option for
commercial firms to accept insured deposits and make consumer
and commercial loans. In the meantime, ILCs gained in
popularity. Between 1987, when CEBA was enacted, and 2004,
total assets held by ILCs rose 3,500 percent.
The mixing of banking and commerce, as the Chairman noted,
raises a number of issues which this Committee must review
carefully. Perhaps the most significant concern is the
potential for conflicts of interest on the part of commercial
owners of a bank which would jeopardize the bank's federally
insured deposits.
As we consider the supervision and the regulation of ILCs,
I believe we must be mindful of the history of the separation
of banking and commerce and the legislative exceptions to such
separation that the Congress has created over the years.
In addition to concerns about the mixing of banking and
commerce, the ILC debate also raises questions about the
optimal regulatory structure that I alluded to earlier. While
the vast majority of assets in our banking system are subject
to consolidated supervision, a significant minority have been
regulated through a more bank-centric approach. Until recently,
the FDIC had generally defended the adequacy of the bank-
centric approach to regulation. I think we should consider the
merits of both approaches, including the history of bank
failures under each approach.
This leads to a final question. Should the Gramm-Leach-
Bliley Act be revisited to give the SEC statutory authority as
a consolidated supervisor? Despite the fact that Congress did
not, as I mentioned, provide this explicit authority to the
Securities and Exchange Commission in Gramm-Leach-Bliley, the
SEC has put in place a version of this authority through its
own rulemaking. I do not believe it would be appropriate to
ratify the SEC's consolidated supervisory entities program as
an afterthought to the ILC debate.
If some form of a consolidated supervision for unregulated
broker-dealer affiliates and holding companies is needed, we
should thoroughly right here consider such a change before it
is codified in statute. In any event, we should not forget the
careful balancing that went into crafting our current
functional regulatory scheme.
These issues are important ones for this Committee with
profound implications for the safety and soundness of our
financial institutions, the future of financial regulation as
we know it, and our banking system as we know it today. As we
move forward, each of these issues will require the full
resources and attention of this Committee, as well as the
cooperation of the regulators.
I thank the Chairman for calling this hearing. I hope it is
the first of many hearings addressing this profound, complex,
and fundamental issue surrounding this important topic.
Thank you, Mr. Chairman.
Senator Brown. Thank you, Senator Shelby.
Senator Johnson, would you like to--and I would add,
Senator Johnson was very involved in this issue before I came
to the Senate, and he and I worked together on this late last
year as we prepared for all of this. Senator Johnson.
OPENING STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Mr. Chairman, I will submit my statement
for the record. Thank you.
Senator Brown. Thank you.
Senator Bennett, for an opening statement.
OPENING STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you very much, Mr. Chairman. I
appreciate both the hearing and your courtesy in allowing me
some input as to who would be invited here.
I want to welcome Commissioner Ed Leary from Utah.
Commissioner Leary began his time as the Commissioner of the
Utah Department of Financial Institutions in the same year that
I was elected to the Senate, so we have been wrestling with
this question now in tandem for about 15 years.
This is obviously a subject of great interest to me because
Utah has a number of ILCs chartered in our State. We are not
the only State that charters ILCs, but we have, we believe, the
best, well-established regulatory structure and safe and sound
record. There has never been an ILC chartered in Utah that has
failed, and this is neither by accident nor loophole.
As I look at the record and legislative history of the ILC
Charter, I see a different picture than that that many others
see. Legislation is usually the solution to a problem. It seems
to me that restrictive legislation on ILCs is a solution in
search of a problem. The ILC Charter has a sterling record. We
have not had a failure, as I say, of a commercially affiliated
ILC.
Now, some who are opponents of the ILC say, ``Yes, but what
if Enron or WorldCom had owned an ILC?'' That is an interesting
theoretical question. Let's look at the factual record.
Tyco and Conseco both did own ILCs when they ran into
serious trouble. Tyco's ILC was successfully spun off in its
own public offering, and the Conseco ILC, with the parent in
bankruptcy, was walled off, and the assets were sold for a
profit, not a loss.
The record of the ILCs clearly shows that they are among
the safest and most well-capitalized financial institutions in
the country, and that also is not by accident. The FDIC, for
those that are headquartered in Utah, in partnership with the
Utah Department of Financial Institutions, rigorously regulates
the ILC Charter, and they are subject to the same safety and
soundness, consumer protection, deposit insurance, CRA, and
other requirements as all the other FDIC-insured depository
institutions. They are subject to many of the same requirements
as bank holding companies such as strict restrictions on
transactions with their bank affiliates, and their parent
companies are subject to prompt corrective action and capital
guarantee requirements if the banks they control encounter
financial difficulties.
In some instances, they are subject to firewalls and
corporate governance restrictions that exceed those available
to bank holding companies, and these tools, in the words of the
former Chairman of the FDIC, Donald Powell, allow the FDIC to
manage the relationships between industrial loan companies and
their owners ``with little or no risk to the deposit insurance
funds and no subsidy transferred to the non-bank parent.''
I want to stress that because there has always been an
assumption there that there was some kind of subsidy to the
parent that went with owning an ILC, and as Chairman Powell
makes clear, that is, in fact, not the case.
The current Chairman of the FDIC, Sheila Bair, has said,
``ILCs have proven to be a strong, responsible part of our
Nation's banking system's innovative approaches banking. Many
have contributed significantly to community reinvestment and
development. 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.''
The ILCs exist to serve niches that the rest of the banking
system does not serve and, therefore, has a limited-purpose
charter. Let's look at the size of those niches.
The ILCs amount to 59 of almost 8,700 insured depository
institutions in this country and control only 1.8 percent of
the assets. Of the 59 existing ILCs, 15 are controlled by a
commercial parent, the others by a financial parent. This is
not threatening the stability of the banking system even if it
were weak, which it is not.
I also believe the legislative history is very clear. You,
Mr. Chairman, have referred to that, as has Senator Shelby.
Let's go through it a little bit again.
The ILC Charter is not a loophole charter. It is a
recognized and intentional exception to the Bank Holding
Company Act. There are many exceptions that have and continue
to exist. The Bank Holding Company Act has evolved from a
broadly permissive system of bank commercial affiliations. The
current law restricts but does not prohibit such affiliations.
From 1956 to 1970, BHCA covered only companies that
controlled multiple banks. Thus, BHCA allowed any company,
including a commercial firm, to control a single bank. Although
the one-bank holding company exemption was repealed in 1970,
the BHCA continues to this day to cover only companies that own
banks. This exempts individuals, families, and other non-
corporate entities from the act, allowing, among other things,
community banks to be owned by individuals who also own
commercial businesses.
If I can put it on a more humble example, your local banker
whose family owns the local bank could also own the car dealer,
the hardware store, and the drycleaner, and that would not be a
violation of BHCA. Combining banking and commerce in this
fashion is commonplace across America. We also have other
limited-purpose banks that are exempt from the BHCA, like the
one owned and operated by the Independent Community Bankers of
America. We have never had a bright line separating banking and
commerce.
Talk about Gramm-Leach-Bliley? It did eliminate the
continuation of the unitary thrift charter, mostly due to the
rumor that a certain large retailer was seeking to acquire one.
But that was not a reaffirmation of a bright line separating
banking and commerce. In fact, ILC powers and the powers of
other limited-purpose charters that permitted commercial
affiliations were expanded in Gramm-Leach-Bliley. And I go, as
my source for that, to the principal author of Gramm-Leach-
Bliley--Senator Gramm--who sat as Chairman of this Committee.
He made this comment to the American Banker in February of
2006 when he sat down for an interview. He was asked about the
statement he made on the day Gramm-Leach-Bliley was passed when
he predicted that within a decade, another banking law would
eliminate any remaining walls separating banking and commerce.
In the interview, he stated that he believed that was
inevitable. Quoting him, ``American banks are competing with
banks around the world that have varying degrees of commercial
powers so, clearly, that is going to happen. The pressure comes
from a growing recognition that this is the way business is
done financially in the world, and that if we are going to
compete successfully, we have got to play by the same rules.''
Now, it is clear that Senator Gramm did not believe that
Gramm-Leach-Bliley was or should be perceived as a
reaffirmation of a bright-line separation of banking and
commerce. And I have talked to him specifically about ILCs, and
he says, ``If you want me to, I will come down and testify in
favor of the current ILC Charter in my role as the principal
author of Gramm-Leach-Bliley.''
All right. In closing, I do not believe that an entire
class of financial institutions, which the record clearly shows
are well managed, well capitalized, well regulated, and that
provide great benefits to niches of customers in all 50 States,
should be eliminated or strangled by regulation or law because
of who their owner is. The ILCs are permitted to be owned by
commercial companies. They are not committed to be the piggy
bank of the commercial parent. There are very strict rules and
regulations which are vigorously enforced relating to
transactions between the ILC and the commercial parent. And
most of the concerns I have heard expressed regarding the ILC
Charter are hypothetical and would currently be prohibited by
existing law and regulations.
I have had a conversation with Chairman Rangel where he
expressed concern about Home Depot using an ILC to tie
purchases at Home Depot to the loans available in the ILC, and
I said, ``Mr. Chairman, that is illegal now.'' And his staff
had not been aware of that fact. And, indeed, Home Depot has a
credit card where they take advantage of people coming into
Home Depot, seeking credit support for their purchases, and
that is legal now, and the ILC activity would have no impact on
that whatsoever.
So, Mr. Chairman, I am happy to have this hearing. I look
forward to talking with you and my colleagues more about ways
to clarify the existing limited-purpose nature of ILCs. But I
am not inclined to consider overturning existing law to prevent
commercial companies from affiliating with ILCs. The track
record has been very strong, and the advantages that have come
from commercial companies with their ILCs I think will be
illustrated by some of the witnesses we will have here today.
So, with that, Mr. Chairman, I thank you for the hearing
and look forward to the witnesses that we will have come before
us.
Senator Brown. Thank you, Senator Bennett.
Senator Tester, for an opening statement, if you choose.
STATEMENT OF SENATOR JON TESTER
Senator Tester. Thank you, Chairman Brown. I appreciate you
calling this hearing together, and I also want to thank Senator
Johnson for his interest in the matter.
ILCs go back nearly a hundred years, and I look forward to
this hearing to find out more about them, because I will be the
first to tell you I do not know all of the intricacies of it.
But it appears to me--and Utah may be doing a great job, but it
appears to me that they are--well, to have the SEC, the FDIC,
the OTS, and the Federal Reserve all having oversight really
does not sound like a logical, coherent framework to me. And to
compound that, I have heard from a bunch of bankers in my State
of Montana, and I can tell you that the banking and the
individual banks around the State of Montana have played a
critical role in making Montana what it is today, in a positive
sense.
And so when they start expressing their concerns, it brings
up my antennas, and I just appreciate this hearing to learn and
hopefully, if there are problems, to fix those problems.
So, with that, Mr. Chairman, once again thank you for
having the hearing.
Senator Brown. Thank you, Senator Tester.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman Brown. So many
different Senators have chaired meetings this week, I am
wondering when it will be my turn.
[Laughter.]
Senator Brown. I have waited a long time for this, Senator
Bunning, frankly.
[Laughter.]
Senator Bunning. Rightly so.
Senator Brown. Perhaps, perhaps.
Senator Bunning. This is your first year here.
Senator Brown. Yes, but I waited a long time somewhere
else. Let's not get into that, Senator Bunning.
[Laughter.]
Senator Bunning. We have all heard a lot from folks back
home about this issue. It is important to more than just
traditional banking interests and touches many of the key
issues related to banking regulation.
Some of my colleagues were in the Congress during the
savings and loan crisis, but many were not. I remember that
time and what the bailout cost the taxpayers and the economy.
We must not allow that to happen again.
That is why the banking system in the United States has
strong regulation and some separation between banking and other
functions. In order to protect our banking system, we must
ensure appropriate regulation and oversight and proper
separation. At the same time, we must be careful not to disrupt
innovation in banking. We should not create an unlevel playing
field based solely on when a company applied for a bank
charter. Where and how we draw the lines must be chosen with
great care.
I look forward to hearing from our witnesses and other
Members of the Committee. Thank you.
Senator Brown. Thank you, Senator Bunning.
Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Chairman Brown. I
appreciate the fact that we are holding this hearing. I think
that we need to pay a lot more attention to the ILC issue and,
frankly, a lot of other regulatory issues. For my opening
statement and any questions I might have an opportunity to ask,
I am going to focus on a broader context.
The reason we are here talking about the ILC issue is
because we have problems with regard to--or let me put it this
way: We have disagreements over who should be the regulator and
what the rules should be for those who are regulated in
different aspects of our commercial and banking system.
As you may know, I worked very hard in the last few years
and last year, or the last Congress, was successful when we
finally got a reg relief bill through to kind of simplify and
try to bring some relief to the financial industries in terms
of the regulatory system with which they are faced.
We got a lot done in that bill, but we also identified a
lot more that needs to be done, and we are working now on what
I call Reg Relief II to try to move further into the arena. But
the ILC issue is just one example, probably a very significant
example, that highlights the broader issue of the regulatory
system we have in place for financial industries in the United
States. The current structure we see has multiple regulators
and multiple charters and creates the potential for those who
are regulated in one instance or another to have an advantage
or a disadvantage over others in the system. And, again, the
very reason we are here holding this hearing on ILCs is we have
that structure.
In the near future, the GAO is going to be submitting two
reports to Congress that were mandated by the Reg Relief Act.
The first report will be on the volume of currency transaction
reports filed with the Department of Treasury, including, if
appropriate, recommendations for changes to the filing system.
The second report will discuss measurements of regulatory
costs and benefits and efforts to avoid excessive regulatory
burdens, the challenges posed to financial regulators by trends
in the industry, and options to enhance the efficiency and
effectiveness of the Federal financial regulatory structure.
And it is my hope that this Committee will very seriously
consider these two reports.
I think the second report in particular will be timely in
discussing the ILC debate in the broader context of reviewing
our regulatory structure. Along with examining the regulation
and supervision of industrial loan companies, we need to
examine and consider how to modernize our Federal financial
regulatory system. Our financial regulatory structure continues
to be challenged by the industry trends that increased
consolidation, conglomeration, convergence, and globalization.
The financial services firms that offer similar products are
often subjected to different regulatory regimes, creating the
potential for inconsistent regulation.
To address this issue and to improve their competitive
position globally, some nations have now reorganized their
regulatory systems, and some have even consolidated their
regulators into a single regulatory agency while others have
created specialized regulatory agencies that focus solely on
ensuring the safety and soundness of institutions or on
consumer protections.
I am hearing a lot of talk and praise about Britain's
approach to regulation as a model for effective but not onerous
systems that oversee banks, brokers, investment funds, and a
system, frankly, that could improve the competitive position of
U.S. markets and financial markets globally. I am very
interested in the principles-based approach to regulation,
similar to the FSA in Britain, and I intend to focus my time in
this hearing in addressing those issues.
Mr. Chairman, I do not know if that is exactly the
direction we need to go, but I do know that we need to address
the complex, convoluted regulatory system that we have in the
United States today in an effort to simplify it and avoid these
kinds of circumstances where we have different parts of the
industry very intensely competing to be sure that they are not
put at a disadvantage or in some contexts be sure that they do
get an advantage over others who are performing similar
functions in the system.
So, again, I appreciate the focus of this hearing today on
the ILC issue. I hope that this Committee will expand and
continue our effort to focus on reg relief efforts in the
future, and hopefully we will be able to modernize and improve
our regulatory structure in ways that go far beyond the current
issue of just the ILC debate.
Thank you.
Senator Brown. Thank you, Senator Crapo.
I want to call up the first panel of witnesses: Scott
Alvarez has been General Counsel at the Federal Reserve Board
since 2004. Mr. Alvarez joined the Board in 1981 as a staff
attorney, became a senior attorney in 1985. He earned a B.A. in
economics from Princeton in 1977 and a J.D. from Georgetown
University Law Center in 1981.
John Bovenzi is the Deputy to the Chairman and Chief
Operating Officer of the Federal Deposit Insurance Corporation.
Mr. Bovenzi has worked at the FDIC since 1981, when he joined
the agency as a financial economist. Since then he has served
in a number of positions, including as Director of Division of
Resolutions and Receiverships, Deputy Director of the Office of
Research and Statistics, and Special Assistant to FDIC Board
Member C.C. Hope, Jr. Mr. Bovenzi holds a B.A. in economics
from the University of Massachusetts, and M.A. and Ph.D.
degrees from Clark University in Worcester, Massachusetts.
Scott Polakoff has been the Senior Deputy Director and
Chief Operating Officer, Office of Thrift Supervision, since
2005. Prior to joining OTS, Mr. Polakoff served 22 years with
the FDIC in many capacities, including an FDIC review examiner
in the Dallas Region, assistant to the Executive Director in
Washington. He most recently was Regional Director, Division of
Supervision and Customer Protection in the FDIC's Chicago
office.
Erik Sirri is the Director of the Division of Market
Regulation at the Securities and Exchange Commission. He served
as the SEC's Chief Economist from 1996 to 1999. From 1989 until
1995, he served on the faculty of the Harvard Business School.
Dr. Sirri holds his Ph.D. in finance from the University of
California, Los Angeles, an M.B.A. from the University of
California, Irvine, and a B.S. in astronomy--astronomy?--from
the California Institute of Technology. One of them.
[Laughter.]
Edward Leary was appointed Commissioner of the Utah
Department of Financial Institutions in June 1992. He joined
the department in 1977 as an examiner and held positions as
industry supervisor and chief examiner before his appointment
as Commissioner. Commissioner Leary serves as Chairman of the
Board of Financial Institutions and is the Past Chairman of the
Conference of State Bank Supervisors. Commissioner Leary holds
his B.S. in political science and an M.B.A. from the University
of Utah. He retired in 1995 as a captain in the U.S. Naval
Reserve.
Before hearing your oral testimony, Senator Reed, do you
want to make an opening statement? If you do, we can----
Senator Reed. Mr. Chairman, let me put my statement in the
record and proceed to the witnesses.
Senator Brown. Thank you for that.
I want to remind all the witnesses that your oral
statements must be under 5 minutes. Time is tight today, so we
will enforce that 5-minute rule. Your entire written statement,
of course, will be part of the record. We look forward to your
testimony.
Mr. Alvarez, please begin.
STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Alvarez. Thank you, Chairman Brown and Senator Bennett,
Members of the Committee.
Senator Johnson, we are particularly inspired by your
return to the Committee and to this issue.
I am pleased to testify before this Committee on behalf of
the Board regarding industrial loan companies. ILCs are State-
chartered banks that have access to the Federal safety net, and
they exercise virtually all the powers of commercial banks.
Nevertheless, ILCs currently operate under a special exception
to the Federal Bank Holding Company Act. This special exception
allows any type of firm, including a commercial firm or foreign
bank, to acquire an ILC chartered in one of a handful of States
without Federal supervision of the parent holding company and
without any restriction on the scope of activities conducted by
the bank's affiliates.
At the time the special exception for ILCs was adopted in
1987, ILCs were mostly small, locally owned institutions that
had only limited deposit taking and lending powers under State
law. Today, however, this exception has become the means
through which large commercial and other firms may acquire an
insured bank and gain access to the Federal safety net.
Indeed, the changes that have occurred with ILCs in recent
years have been dramatic. For example, while the largest ILC in
1987 had assets of less than $400 million, the largest ILC
today has assets of more than $60 billion and is among the 20
largest insured banks in the United States.
The exception also is open-ended and subject to very few
statutory restrictions. There is no limit on the number of ILCs
that the grandfathered States may charter going forward, and
Federal law allows ILCs to engage in virtually the full range
of deposit taking, lending, and payment-related activities.
The Board is concerned that the recent and potential future
growth of ILCs threatens to undermine the decisions that
Congress has made concerning the separation of banking and
commerce and the proper supervisory framework at the Federal
level for companies that own a federally insured bank. For many
years, Congress has sought to maintain the general separation
of banking and commerce. Congress reaffirmed this policy in the
Gramm-Leach-Bliley Act of 1999, when it closed the unitary
thrift loophole, which previously allowed commercial firms to
acquire a federally insured savings association.
As you know, the Gramm-Leach-Bliley Act allows financial
holding companies to engage in full-service securities,
insurance, and merchant banking activities. Yet Congress
allowed only broader financial affiliations and allowed these
financial affiliations, which is a lesser step than allowing
commercial affiliations, only for companies that ensure that
all of their subsidiary depository institutions remain well
capitalized and well managed and maintain at least a
satisfactory CRA rating.
The ILC exception undermines each of these decisions. It
allows insured ILCs to affiliate with commercial firms, not
just financial firms, as provided in the Gramm-Leach-Bliley
Act. Moreover, it does not impose anything comparable to the
strong capital, managerial, and CRA requirements that Congress
established for financial holding companies in the Gramm-Leach-
Bliley Act.
The ILC exception also undermines the supervisory framework
that Congress established for the corporate owners of insured
banks. Although ILCs themselves are fully and capably
supervised by both State and Federal banking authorities in the
same manner as other commercial banks, the parent company of an
ILC may not be. This creates a supervisory blind spot because
the supervisory authority over bank holding companies and their
non-bank subsidiaries under the BHC Act is significantly
broader than the supervisory authority that the primary Federal
supervisor of an ILC has with respect to the corporate owner
and affiliates of an ILC.
In 1991, Congress also made consolidated supervision a
prerequisite for foreign banks seeking to acquire a bank in the
United States. 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 insured
bank in the United States.
The Board applauds the Committee for holding this hearing.
The ILC exception is reshaping the Nation's policies on banking
and commerce and the supervisory framework for the corporate
owners of insured banks. The Board believes that the decisions
on these important policies which influence the structure and
resiliency of our financial system and economy should not be
decided by a few companies through the exploitation of an
exception, but should be decided by Congress, which can act in
the Nation's best interest.
I would be happy to answer any questions.
Senator Brown. Thank you, Mr. Alvarez.
Mr. Bovenzi.
STATEMENT OF JOHN BOVENZI, CHIEF OPERATING OFFICER AND DEPUTY
TO THE CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. Bovenzi. Senator Brown, 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 the ILC Charter involve important public
policy that are best left to Congress for resolution. This
hearing and proposals for 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 proven to be a strong, responsible part of our
Nation's banking system. Many ILCs have made significant
contributions to community reinvestment and development. Other
ILCs serve customers who have not traditionally been served by
other types of financial institutions. Overall, the ILC
industry has operated in a safe and sound manner, and 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 approximately
8,600 insured depository institutions in this country and only
1.8 percent of assets. Of the 59 existing ILCs, 44 are either
widely held or controlled by a parent company whose business is
primarily financial in nature. These ILCs represent
approximately 84 percent of ILC assets and 87 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 in
recent years, with most of that growth occurring since 1996 and
concentrated in a few number of these 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 some circumstances, consolidated
supervision may not be present and the current supervisory
infrastructure may not provide sufficient safeguards to address
safety and soundness risks to the Deposit Insurance Fund.
To address these developing concerns, the FDIC has taken a
number of actions regarding ILCs in the past year. In July
2006, the FDIC Board of Directors adopted a 6-month moratorium
on all applications for deposit insurance and changing controls
for ILCs. The moratorium allowed the FDIC to evaluate public
and industry comments, assess developments in the industry, and
consider how best to apply 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 nonfinancial
activities. Based on this analysis, the FDIC Board voted to
extend the moratorium through January 2008. Under the extended
moratorium, the FDIC will not take any action on an application
for deposit insurance or changing control for a company that
would be controlled primarily by one engaged in commercial
activities. 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.
In closing, ILCs have a good safety and soundness track
record to date. They have proven to be a strong and responsible
part of our Nation's banking system, yet the types and number
of ILC applications have evolved over the years. These changes
pose potential risks that deserve further study and raise
important public policy issues. The FDIC has the 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 statement. I will be happy to answer any
questions that the Committee might have. Thank you.
Senator Brown. Thank you, Mr. Bovenzi.
Mr. Polakoff.
STATEMENT OF SCOTT M. POLAKOFF, SENIOR DEPUTY DIRECTOR, OFFICE
OF THRIFT SUPERVISION
Mr. Polakoff. Good morning, Mr. Chairman and Members of the
Committee. Thank you for the opportunity to present the views
of the OTS on activities, ownership, and control of ILCs. There
are three points that I would like to present to you today.
No. 1, the OTS as primary Federal regulator supervises
eight savings and loan holding companies whose subsidiary ILCs
control more than 55 percent of assets in the ILC industry.
No. 2, the OTS supervises 17 commercial savings and loan
holding companies that were grandfathered with the enactment of
Gramm-Leach-Bliley. These 17 commercial firms own thrifts with
total assets in excess of $40 billion. Our effective
supervision ensures that risks from the commercial operations
do not impact the insured financial institution.
And, No. 3, the OTS in its role as the primary Federal
regulator for savings and loan holding companies that own ILCs
has an excellent working relationship with the FDIC and the
relevant State banking commissioners.
Congress gave the OTS the responsibility to supervise
savings and loan holding companies through the Homeowners Loan
Act. Congress confirmed that authority in 1999 with the Gramm-
Leach-Bliley Act. OTS currently supervises savings and loan
holding companies that control more than 55 percent of the ILC
industry assets. These holding companies, which own thrifts and
are, therefore, statutorily regulated by OTS, include Merrill
Lynch & Company, Morgan Stanley, American Express Company,
USAA, Lehman Brothers Holdings, General Electric, Beal
Financial, and General Motors Corporation.
The ILC debate raises a number of important issues with
respect to key areas of permissible activities and oversight of
companies that own or seek to acquire an ILC. Chief among these
are affiliate risks, including risks from commercial activities
that could impact the insured financial institution.
As you know, Gramm-Leach-Bliley grandfathered a number of
commercial firms within the unitary thrift holding company.
Currently, the OTS regulates 17 commercial firms that own
thrift institutions, and we have a sound improvement oversight
program that addresses potential risks arising from commercial
activities. In addition to several of the companies I just
mentioned, the commercial entities that we supervise include
Temple Inland Corporation, Archer-Daniels-Midland, John Deere
Corporation, Nordstrom, and Federated Department Stores.
In exercising our statutory authority of savings and loan
holding companies, we work cooperatively with other regulators,
including Federal and State banking agencies, functional
regulators, including State insurance supervisors, and Federal
and State securities supervisors. We also coordinate with
international financial supervisors on the oversight of the
internationally active savings and loan holding companies and
their affiliates and subsidiaries. In fact, our supervisory
program is internationally recognized by foreign regulators,
including the U.K.'s Financial Services Authority, or FSA, and
France's Commission Bancaire, and has achieved equivalency
status from the EU for three firms: General Electric Company,
AIG, and Ameriprise Financial Group.
We are also recognized by Federal statute as one of the two
U.S. regulators authorized to make a determination as to
whether a foreign bank entering the U.S. is subject to
comprehensive consolidated supervision for purposes of
coordinating consolidated supervision of its domestic banking
activities.
The OTS' status as a consolidated U.S. supervisor requires
extensive contact with the domestic and international
supervisory community for these and other internationally
active complex firms supervised by the OTS. I would also note
that the GAO has confirmed that the OTS has a strong and
internationally recognized consolidated holding company
supervision regime.
In sum, the OTS has extensive experience overseeing savings
and loan holding companies, including financial conglomerates
and commercial holding company structures. OTS supervision
provides a strong and robust regulatory framework that oversees
a holding company's risk management platform. This approach
ensures the flexibility these firms require to compete in the
dynamic marketplace while providing a strong supervisory
structure over their policies, procedures, and activities.
We support the Committee efforts to address concerns with
respect to the oversight of ILC holding company parents,
recognizing that the OTS currently exercises effective
supervision of savings and loans holding companies that control
more than half of the ILC industry assets.
In considering possible ILC legislation, we urge the
Committee to preserve existing OTS authority and oversight of
savings and loan holding companies that own or control ILCs.
This will promote functional regulation while also promoting
consolidated regulatory oversight of these companies.
Thank you, Mr. Chairman. I look forward to answering your
questions.
Senator Brown. Thank you, Mr. Polakoff.
Mr. Sirri.
STATEMENT OF ERIK SIRRI, DIRECTOR, DIVISION OF MARKET
REGULATION, SECURITIES AND EXCHANGE COMMISSION
Mr. Sirri. Chairman Brown, Senator Bennett, and Members of
the Committee, I am pleased to be here today to talk about the
SEC's program for supervising U.S. securities firms on a
consolidated basis.
The Commission currently supervises five of the major U.S.
securities firms on a consolidated, or group-wide, basis. For
such firms, referred to CSEs, consolidated supervised entities,
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 include other regulated
entities, such as foreign-registered broker-dealers, banks, as
well as unregulated entities such as derivatives dealers. Four
of these CSEs--Goldman Sachs, Lehman Brothers, Merrill Lynch,
and Morgan Stanley--own ILCs that account for 1 percent, 0.6
percent, 7.2 percent, and 1.2 percent of their consolidated
assets, respectively. Three of these firms--Lehman Brothers,
Merrill Lynch, and Morgan Stanley--also own thrifts that
account for 3.3 percent, 1.7 percent, and less than one one-
hundredth of 1 percent of their consolidated assets,
respectively.
I would like to provide some historical perspective on the
Commission's oversight of these holding companies.
Over the past 20 years, as broker-dealers have affiliated
with more and more complex holding company structures, the
Commission has become increasingly concerned about the risk
that a broker-dealer may fail due to the insolvency of its
holding company or one of its affiliates. This risk was
exemplified by the bankruptcy of the Drexel Burnham and the
consequent liquidation of its broker-dealer affiliate in 1990.
Post-Drexel, the Commission undertook a number of initiatives
to conduct group-wide risk assessments of financial
institutions with significant broker-dealer subsidiaries. These
initiatives assisted the Commission in understanding how
financial institutions with larger broker-dealer subsidiaries
managed risk globally at the group-wide level and over time
have allowed the Commission to develop the capacity to
supervise holding companies of securities firms.
The Commission's concern regarding the need for group-wide
risk monitoring paralleled the European Union's Financial
Conglomerates Directive, which essentially requires non-EU
financial institutions doing business in Europe to be
supervised on a consolidated basis. In response, the Commission
in 2004 crafted a new comprehensive consolidated supervision
program that was intended to protect all regulated entities
within a group, including the broker-dealers. The rule
restricted CSE eligibility to groups with large, well-
capitalized broker-dealers. In other words, the Commission
believed that it should only supervise on a consolidated basis
those firms engaged primarily in the securities business, and
not holding companies that are affiliated with a broker-dealer
as an incident to their primary business activities. To this
end, the rule effectively requires that the principal broker-
dealer have tentative net capital of $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 also
monitored continuously for financial and operational weakness
that might put the regulated entities at risk within the group
or put the broader financial system at risk. Fourth, CSEs are
required to compute a capital adequacy measure at the holding
company that is consistent with the Basel Standard. And,
finally, CSEs are required to maintain significant pools of
liquidity at the holding company level, where these are
available for use in any regulated or unregulated entity within
the group without regulatory restriction.
These five principal program 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 has broad discretion to mandate
changes to a firm's risk management policies and procedures,
effectively requiring an increase in the amount of regulatory
capital maintained at the holding company, or requiring an
expansion of the pool of highly liquid assets held at the
parent. The powers are not theoretical. All three of these
steps have been taken over the years at various CSEs.
The program of consolidated supervision that I have
described reduces the likelihood that a weakness at the holding
company or at an unregulated affiliate will place a regulated
entity, including an ILC, or the broader financial system, at
risk. My written testimony describes in more detail the means
by which we monitor on an ongoing basis the financial and
operational condition of the CSEs.
In conclusion, while we generally support the goals of
consolidated supervision of holding companies affiliated with
industrial loan companies, any legislation should ensure that
CSEs, which are highly regulated under the Commission's
consolidated supervision program, are not subjected to an
additional layer of duplicative and burdensome holding company
oversight. Any legislation should recognize the unique ability
of the Commission to comprehensively supervise the consolidated
groups that are overwhelmingly in the securities business,
especially given the heightened focus these days on the issue
of global competitiveness. And any legislation should carefully
respect the deference accorded by Gramm-Leach-Bliley to
functional regulators in overseeing the activities of
functionally regulated members of financial holding companies.
I would be happy to take any questions. Thank you.
Senator Brown. Thank you, Mr. Sirri.
Mr. Leary.
STATEMENT OF EDWARD LEARY, COMMISSIONER, STATE OF UTAH
DEPARTMENT OF FINANCIAL INSTITUTIONS
Mr. Leary. Good morning, Chairman Brown, Members of the
Committee. Thank you for the opportunity to share Utah's view
on supervision and regulation of industrial banks.
Since the founding of this Nation, States have chartered,
regulated, and supervised banking. The choice of charter
remains a critical component of the checks and balances of the
dual banking system. It is, therefore, vital that there is more
than one approach to the regulation and supervision of
financial institutions.
Dual banking has built upon the ability to freely choose
the supervisory structure under which the ensured entity
operates. This foundation contributes to a competition
excellence among the financial regulators.
I was invited to participate in this hearing today because
of Utah's history and experience in chartering regulated
industrial banks. My view and statement is that industrial
banks are the embodiment of what is right and proper in the
dual banking system.
Utah believes there is good supervision and a good
regulatory model over the industrial banks. Without a question
of the competency of the regulators and that there has not been
a single Utah industrial bank failure warranting a change in
public policy, there is no safety and soundness crisis evident
that warrants restricting or restraining State-chartered
industrial banking.
I believe that I am here today because of the success of
the Utah regulatory model, not its failure. Utah, in
partnership with the FDIC, has built a regulatory model to
which the financial services markets have reacted favorably.
This regulatory model is not a system of lax supervision and
inadequate enforcement. Utah industrial banks are safe, sound,
and appropriately regulated by both the States which charters
them and the FDIC, which is the relevant Federal regulator and
deposit insurance provider.
Industrial banks are subject to the same banking laws and
are regulated in the same manner as all other FDIC-insured
depository institutions, including the Community Reinvestment
Act. However, special emphasis has taken on the Federal Reserve
Regulation W and Sections 23A and B of that regulation, which
closely regulates all parent and affiliate company transactions
to ensure that there is a limit to covered transactions and an
arm's length basis for all transactions. Thus, an industrial
bank may not extend significant amounts of credit to its
holding company or affiliate or offer credit to them on
preferential or non-market terms.
The department takes this supervisory role seriously. It is
a joint effort with the FDIC in all industrial bank
examinations and targeted reviews. Our examiners are
participating in large loan, capital market, trust, information
system, consumer compliance, Community Reinvestment Act, Bank
Secrecy Act, anti-money-laundering examinations.
The supervisory model of the industrial bank has been
referred to as a ``bank-centric'' model. This is not a new
concept when examining a bank as part of a holding company
structure. Industrial banks based in Utah have represented a
laboratory for those insured institutions owned by commercial
entities.
The evolving supervisory approaches of Utah and the FDIC
have helped fine-tune processes and procedures that insulate
and insure a depository institution from potential abuses and
conflicts of interest. Critical controls have been developed of
this cooperation between Utah and the FDIC.
In the industrial bank model, the bank is insulated and
isolated from the potential negative effects of a parent
company by existing Federal banking laws. However, in addition,
we require the bank to maintain its own separate capital,
independent management, and a requirement that the board of
directors consists of a majority outside independent directors.
I think one could argue that having more banks in the
market would help supply much needed liquidity into the market,
and having a diversified parent company not solely dependent on
banking would be able to provide such needed liquidity. Having
more liquidity, more competition, more diversification of
insured deposits, less concentration by large banking
corporations is good for the market, for the FDIC, and
ultimately for the U.S. consumer.
Worst case has been postulated that a financial institution
holding company would file bankruptcy or get into financial
difficulty. While the reality is we have had both of those
occur in Utah, and while no regulator relishes stressful
circumstances, I can state that we successfully weathered the
storm.
In this final point, I think we need to keep in perspective
that the entire industrial loan industry, even with its growth
during the last 20 years, represents only 1.8 percent of
banking assets. Utah law establishes, besides all other
jurisdiction and enforcement authorities over industrial banks,
that every industrial bank holding company must register with
the department and is subject to the same jurisdiction and
enforcement authority as the bank. Utah commenced last year a
program where every holding company will receive an inspection
at least every 3 years, coupled with ongoing offsite monitoring
of rating agencies, analyst opinions, and market sources. Where
there is a Federal agency involved, we attempt to offer
resources and share work product.
Thank you for allowing me the opportunity to express my
thoughts and your willingness to listen to a State regulator.
Senator Brown. Thank you very much, Mr. Leary, for joining
us.
Mr. Alvarez, you spoke in your testimony of a supervisory
blind spot. Would you expand on that?
Mr. Alvarez. Certainly. Owners of banks are required to be
supervised under the Bank Holding Company Act by a Federal
regulator, the Federal Reserve. Owners of savings associates
are required to be supervised by the OTS. Owners of ILCs,
however, are not required to be supervised by anyone. There is
no one with authority to supervise an owner of an ILC based on
their ownership of the ILC.
That is the trend going forward. ILC growth has been by
companies that do not own a savings association or a bank or
are not part of the SEC's CSE program. So the recent
applications that the FDIC has been charged with dealing with
largely involve institutions that--corporate owners that will
not be supervised by anyone unless there is a change in the
law.
Senator Brown. Mr. Bovenzi, suppose there is an application
for an ILC that is limited, serving a niche market of some
sort. If the application is approved, are the limitations
forever part of that charter?
Mr. Bovenzi. Not necessarily. What would happen with an
application is someone would come forward with a business plan;
we would look at it and determine its appropriateness, whether
it was meeting the statutory criteria to give it approval. If
it did, it would receive approval. There would be nothing that
would stop that applicant, once approved, to come back and
request a change in their business plan at a later date, and
then that would be evaluated at that point.
Senator Brown. Is that troubling to any of you as
regulators, his answer to that? Mr. Polakoff?
Mr. Polakoff. Senator, I would offer that the examiners do
a great job of examining all insured financial institutions and
understanding the risk profile of those institutions, and
through a prudential examination program, I believe the
examiners are able to measure the risk profile versus a
constantly changing business strategy and assess the risk
properly.
Senator Brown. OK. You were going to say something?
Mr. Alvarez. The one concern I would have on the change in
conditions of charter is that it does mean that the situation
could develop over time and that conditions that initially are
imposed in order to hold still a system may not be able to
withstand the passage of time. If things do not develop that
are troubling, then the conditions often are removed over time.
So it is difficult to--it is not wise, I think, to develop
a policy based on the thought that conditions will not change
over time.
Senator Brown. Mr. Alvarez, in a slightly different
direction, I think the Federal regulators on the panel pretty
clearly agree that consolidated supervision is a good idea,
provided there is not duplication. Explain to me why this is
important. And do you have any examples of why simply looking
at a bank is not sufficient?
Mr. Alvarez. Yes. Looking at a bank is certainly a
necessary element of proper supervision. On the other hand, a
holding company can serve as a source of weakness to the Bank,
and there are examples in the ILC context. A small ILC in
California that was owned by a holding company that was engaged
itself in very risky activities had incurred significant
leverage at the holding company, was not able to access the
markets to get additional capital when its ILC ran into
trouble, and was not able to provide managerial or other
financial strengths to the ILC when the ILC was in trouble. The
ILC then failed.
The job of a supervisor of a holding company is to make
sure that a holding company does not serve as that kind of
source of weakness to identify risks at the holding company
that could be transmitted to the bank or that other things that
could be an impediment to holding company serving as a source
of strength to the bank.
Senator Brown. Thank you.
Senator Bennett.
Senator Bennett. Thank you very much.
Mr. Alvarez, I hope I am not mischaracterizing, but I got a
little sense out of your prepared testimony that the sky is
falling and we have to act really quickly or we will be hit
with great chunks of crystallized cloud and other problems
coming from above. I wonder how that is possible when we are
talking about, as pointed out, less than 1 percent of the
Nation's financial institutions and 1.8 percent of the total
assets and a history of no failures. You answers used words
like ``could'' and ``may possibly'' and things of that kind,
but dealing with the actual reality of the marketplace here, I
do not see a solid case for changing the regulatory regime.
On March 19, 1997, Alan Greenspan said the following in
testimony to the Capital Markets Subcommittee: ``The case is
weak, in our judgment, for umbrella supervision of a holding
company in which the bank is not the dominant unit and is not
large enough to induce systemic problems should it fail.''
Now, obviously, we talk about things have changed and the
attitude of the Fed has changed since Chairman Greenspan made
that statement.
What event caused the Fed to change its mind from
Greenspan's position?
Mr. Alvarez. Senator, I think there are a couple of things.
First of all, the Fed believes--and I think the Senate has
asked us to identify issues before they become a crisis and
before they become a problem as we see them developing. Since
the Gramm-Leach-Bliley Act in 1999 that closed the unitary
thrift loophole, there has been a significant increase in the
amount of applications to acquire industrial loan companies by
commercial entities. And it has become quite clear that this is
now the avenue of choice for undermining the decisions Congress
made in banking and commerce and regarding the supervisory
framework.
So I am not here to tell you that disaster has already
occurred. I am here to tell you that things are changing in a
dramatic way that we think will not be easy to unwind. It will
be very difficult once a significant number of institutions
have acquired--a significant number of institutions have
acquired ILCs, to roll back that clock. It will be very
difficult to change the supervisory framework when there is a
large group that owns ILCs outside of that statutory framework.
Senator Bennett. You say that these applications have been
undermining the decisions of Congress, and I repeat to you, as
I said in my opening statement, the man who had the most to do
with writing the decisions of Congress does not agree with you.
Senator Gramm believes that the activities with respect to ILC
were precisely what they had in mind when they passed Gramm-
Leach-Bliley.
I would like to focus for just a minute on the consumer.
The whole purpose of an ILC is to serve an underserved area in
the consumer world. If there is an area in the consumer world
that is currently being served, there is no market opportunity
for an ILC to get in there unless there is some kind of
improper advantage, and no one has suggested that that improper
advantage exists.
But the track record of ILCs is that the consumers have
benefited over a wide range of the economy in relative small
niche after niche after niche where the ILC, by virtue of its
understanding of that niche, has gone after that opportunity
and provided financial services to a consumer or a group of
consumers that did not have those services available to it in a
convenient way before that.
I am concerned that if we clamp down in the way that you
are talking about from an overall regulatory standpoint in
Washington, there is going to be a concomitant diminution of
consumer services available out in the country as a whole.
I would appreciate your comments about that, any of you.
Mr. Alvarez. Senator, if I might respond, I think that to
the extent that we believe the ILC is helpful to consumers
because it allows banks to be affiliated with commercial firms,
then perhaps we should consider the broader issue of banking
and commerce and whether Congress should change that framework
for everyone. Right now, 99 percent of the owners of banks are
prohibited from being involved in commercial activities at all.
You suggest that consumers are benefited by the fact that ILCs
are allowed to mix banking and commerce. If that is really a
benefit to consumers, then Congress should consider how to
allow more people to take advantage of that and allow consumers
to better be served by that combination and all of the kinds of
protections that Congress thinks might be appropriate in
assuring that the dangers of mixing banking and commerce also
do not get passed on to the taxpayer, but that the consumer is
able to benefit.
So we think that there is a level playing field here that
should be addressed as well, and consumers could either benefit
or be hurt in both directions.
Senator Bennett. Senator Gramm felt it was going in the
other direction.
Thank you, Mr. Chairman.
Senator Brown. Thank you.
Senator Reed.
Senator Reed. Thank you, Mr. Chairman. I just want to
follow up and try to define, in my mind at least, this
regulatory blind spot.
With Mr. Bovenzi, Mr. Polakoff, and Mr. Sirri, there is a
combination of SEC, OTS, and FDIC supervision of the ILC and
the parent in certain cases. But is there a category of
arrangements where there is no supervision of the parent
whatsoever? Mr. Alvarez.
Mr. Alvarez. Yes, Senator, there are. The universe of
companies that own a savings association is fixed. The CSE, the
group that the SEC supervises, is not fixed by statute but is
rather small. And there are several, actually, owners of ILCs
that are bank holding companies supervised by the Federal
Reserve.
But when you take those fixed universes out, there is a
large group of corporate owners of industrial loan companies
that are supervised by no one, and that is the group that is
growing over time. That is the group that wants to affiliate
with ILCs now.
Senator Reed. So that is the potential that you are
anticipating, a company that would not be subject to SEC at the
holding company level.
Mr. Alvarez. Correct.
Senator Reed. At the parent level, OTS or FDIC, they have
now sort of an open range, if you will, to acquire or create
ILCs, and unless they agree, some type of voluntary supervision
to say you do not supervise me.
Mr. Alvarez. That is correct.
Senator Reed. And that potential, if there is no boundary,
is extremely large.
Mr. Alvarez. It is. It includes all commercial companies as
well as financial companies.
Senator Reed. Let me ask another question which is
reflective of some of the comments you made. Are there any ILCs
owned by foreign entities today?
Mr. Alvarez. There is one that is owned by a foreign bank,
but a foreign bank that is supervised by the Federal Reserve.
Senator Reed. If there was an acquisition by a foreign
entity, Airbus or someone who wanted to buy it, would that
trigger some type of change in control application or could
they simply set it up, fund it, and there is no way you could
turn them down because of the nature of their activities? Is
that the latter case?
Mr. Alvarez. That would be subject to a change in control
act notice before the FDIC. That is the subject of the FDIC's
moratorium at this point, which is due to expire in January.
Senator Reed. OK. With respect to your role, Mr. Leary,
which is very critical in Utah, do you have statutory authority
to supervise the parent of the ILC?
Mr. Leary. Yes, sir. That was my final point. We do have
that authority. It has never been challenged. What we had not
done effectively until more recently was attempt--or establish
a regulatory program where we go into those holding companies.
And the universe we are talking about is really about ten
companies where there is no Federal oversight at this current
point in time.
Senator Reed. Do you have the capacity to do that?
Mr. Leary. Yes.
Senator Reed. Without being less than respectful, because,
you know, one of the issues at the State government level is
that, you know, sophisticated--the capacity to do that, the
number of examiners you have, the ability to send them to Paris
to look at the books of the companies sometimes is limited. I
speak from experience back in my own home State.
Mr. Leary. I will tell you, with respect to the domestic
side of it, our examiners are going all around the country now
to look at the operations of our industrial banks. I am
fortunate in that the industry has been very supportive of--
they want quality regulation. It is not in their best interest
or ours not to have that. So they have supported the structure
that establishes sound regulatory agency.
Senator Reed. Do you have a potential problem, at least, as
a Utah examiner goes into an ILC that has a presence in
Missouri, for example, frankly, you know, is there a problem
just of enforcing your--I guess you get the holding----
Mr. Leary. We have the holding company of the bank
headquartered and chartered in Utah; therefore, we go into it.
So my statement is we have gone around, we are going around in
large numbers looking at the operations of----
Senator Reed. All right. You said you had an independent
board. Is that independent of the holding company or of the
bank?
Mr. Leary. Of the holding company.
Senator Reed. So that they would have to have--the majority
of the members could not have any direct affiliation with the
holding company.
Mr. Leary. Absolutely.
Senator Reed. OK. And what type of powers do you have?
Could you compel the holding company to put more capital into
the----
Mr. Leary. Yes.
Senator Reed. OK. Have you ever tried to do that?
Mr. Leary. Have not.
Senator Reed. Again, I just think that Mr. Alvarez has
pointed out a situation where this could be exploited
dramatically by folks coming in, taxing the capacity of any one
States to be effective regulators. Also, on another point--and
my time is running out--which you might get to if you can weave
it into other questions and responses, is the comparative
advantage that these institutions have versus a fully regulated
financial entity in the United States, someone subject to Bank
Holding Company, FDIC, et cetera, or OTS supervision.
Thank you.
Senator Brown. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Mr. Bovenzi, last year the FDIC--you talked about the
moratorium that is set to expire in January. Will you allow it
to expire?
Mr. Bovenzi. The moratorium will automatically expire at
the end of January, and our Chairman----
Senator Bunning. But you set it, so you have the
opportunity to extend it or not to.
Mr. Bovenzi. That is correct. Our Board of Directors could
make that decision. Our Chairman stated that we do not expect
to extend it beyond the end of January.
Senator Bunning. OK. What information do you not have
access to that is needed to assess safety and soundness?
Mr. Bovenzi. The authority that we have largely relates to
the individual insured institution. We have a full range of
authority there. To the extent that it involved relationships
with affiliates of that insured institution, we have the
authority to examine--if we feel that the affiliate is having
some effect on the financial condition of the insured
institution, we have examination authority under those
circumstances. We have enforcement authority as well. So we use
that authority to gather information from affiliates and
holding companies to help assess implications for the insured
institution.
Senator Bunning. Then you are telling me that you do not
have any problems?
Mr. Bovenzi. I can tell you our history to date is that has
worked well for us.
Senator Bunning. This is for anyone. Why are you not
worried about commercial enterprises owning finance companies
as you are about them owning banks? Can lenders not cause as
much damage to our financial system as banks? Anyone.
Mr. Alvarez. Senator, one of the differences between
ownership of a financial company, say a lending company, and
ownership of a bank is that the bank collects deposits that are
insured by the FDIC and backed by the taxpayer. It is because
of that obligation of the taxpayer that the Federal Government
has traditionally insisted on supervisory authority over the
insured bank itself and the owner of the insured bank.
Senator Bunning. Mr. Leary, in your examination of
industrial banks owned by commercial enterprises, have you
found any evidence that they are more likely to fail than banks
owned by regulated holding companies?
Mr. Leary. My answer would be no, we have not found there
is a preponderance for them to fail. The holding company
business plans may change, but what we have attempted to do is
cocoon and isolate that insured bank, it has its own deposit,
it has its own board of directors, it has its own management.
And the example I tried to use is we have had two examples
where parents have had trouble, but those banks continued and
remained either in operation or somebody else came in and
bought it and established it as a bank.
The true thrust, I think, of your question, Senator, is
under a banking umbrella--and, believe me, it is in the State's
best interest to get these institutions under a strong banking
umbrella--the standards are higher, the quality of performance
demanded of management is higher, and I think the country is
well served when they are under this higher standard of
banking. And that is specifically applied to those that may be
owned by commercial entities not currently supervised by
Federal agencies.
Senator Bunning. This is for anyone. Do you have any
evidence that industrial banks owned by commercial enterprises
have endangered other regulated institutions?
Mr. Bovenzi. No.
Senator Bunning. Anybody else?
Mr. Polakoff. No, sir.
Mr. Leary. No.
Senator Bunning. If Congress enacts new regulations of
industrial banks, is there any reason not to allow banks
chartered in any State to get deposit insurance?
Mr. Leary. I would volunteer the answer from the Utah
perspective. I have been asked if the model in Utah works well,
would we support other States? While I would not support other
States, I have absolutely no problem with other States being
able to take advantage of the model----
Senator Bunning. What about the Fed?
Mr. Alvarez. Sir, if you believe that industrial loan
companies offer an advantage and that the policy of the United
States should be that there would be a mixing of banking and
commerce, then we believe it should be done on a level playing
field with all folks being----
Senator Bunning. Regulated?
Mr. Alvarez [continuing]. Able to take care of this and all
in the same framework.
Senator Bunning. OK. Thank you very much, Mr. Chairman.
Senator Brown. Thank you, Senator Bunning.
Senator Allard.
Senator Allard. Mr. Chairman, I apologize for missing the
opening statements.
Senator Brown. Proceed.
Senator Allard. I come from a State that had industrial
bank failures, and I served in the legislature at the time that
happened, and it was not a pleasant experience. We obviously
were not following the Utah model in Colorado at the time. What
it ended up being is that the State of Colorado ended up
mitigating damages to the depositors in the banks by sharing in
the cost of those lost dollars, and even despite that, those
depositors did lose money.
You know, I gather from your discussion here that you are
mainly concerned about the potential risk to the Federal
Insurance Corporation. Is that right?
Mr. Alvarez. That is right.
Senator Allard. I guess one of the things that we are
struggling with in this particular piece of legislation working
with the Chairman is what is the proper threshold of where you
consider non-financial services when you make the definition.
We have in the legislation 15 percent. I understand that there
might be members on this panel that think that should be lower,
and I would like to get some discussion on that. I think it
would be beneficial.
I think when we looked at it, we looked at it from a
practical aspect and that sometimes a bank, if they are
expanding, they will take a building that is larger than what
they need, and they will lease out that building--or maybe it
is just part of diversifying the use of that building. They
will lease it out, and it could easily exceed 15 percent--well,
I should not say ``easily.'' They could. But we thought that 15
percent was sort of a reasonable balance in that, and I would
like to hear some comment from the panel members if you would,
please.
Mr. Alvarez. Well, Senator, this is an issue that was
debated in the Gramm-Leach-Bliley Act. You may recall that
there were proposals to have a 5-percent commercial basket in
Gramm-Leach-Bliley, and after much debate, those proposals were
either withdrawn or defeated.
It is hard to figure out exactly the right place to draw
the line. The question, though, I think, is that--and I think
the concern from the Fed is that Congress should be the one
that does draw that line, and we think it would be important to
have some hearings on this issue to decide what the costs and
benefits of mixing banking and commerce at any level should be,
beyond the Gramm-Leach-Bliley Act, to look at the experience in
Asian countries and in other countries that have mixed banking
and commerce, to try to decide if that is a road we want to go
down, and if so, whether to go in stages, as you suggest, 5 or
10 or 15, or to open it up more broadly.
It is a very complicated issue. There are lots of questions
about how to prevent the transmission of risk from a commercial
entity to a bank. There are lots of questions of how to ensure
that banks that are owned or affiliated with commercial
companies are competitive and deal with everyone equally rather
than just favoring the commercial entity itself. There are
other issues in banking and commerce that deserve exploration,
and it is very difficult to say it is safe to pick one basket,
one line or another. I think we would welcome a broad debate on
the issue.
Senator Allard. It is probably best that we have some
bright line there, and then people learn to work with it.
Mr. Alvarez. But then you would be able to set the line
with some understanding of what the costs are with that line.
Senator Allard. Right. Any other comments on the panel?
Mr. Bovenzi. Senator, I would just add that we do not have
a particular view on where you want to draw that line. We do
think this is the most significant public policy issue that is
brought up and that Congress should try to draw that line and
provide everyone with a workable solution.
Senator Allard. Any other comments?
[No response.]
Senator Allard. Mr. Alvarez, you talked a little bit about
foreign countries that have combined commercial with banking
financial institutions.
Mr. Alvarez. Yes.
Senator Allard. And I am wondering, I assume the panel has
maybe looked at this in foreign countries where this happened.
Japan is the country that comes to my attention. They combine
and intermix extensively, I think, commercial and banking.
Has that worked well in Japan? Or have there been some
shortcomings? And would somebody comment on that? I would like
to know how that is working.
Mr. Alvarez. Well, I am not an expert in the Japanese
system, but it has had its advantages and its disadvantages. I
think the corporate entities in the broader affiliations have
done well during times when they have needed financing. But it
certainly was the combination of banking and commerce, and the
amount of risk that the depository institutions had taken on
from their corporate affiliates that certainly was one of the
factors in the problems Japan has encountered recently. It is
very complicated. It is only one of many factors, but it was
one of the factors in the long period of Japanese doldrums.
Mr. Polakoff. Senator, if I could offer----
Senator Allard. Yes.
Mr. Polakoff. I am certainly not an expert either. The
issue may not necessarily be ownership. The issue may be
prudential regulation, ensuring that the proper rules are in
place, the proper examination procedures are in place. And then
I would offer a level playing field amongst all the insured
institutions.
Senator Allard. I do know that some of our discussion, you
know, when we have problems with banks, we take care of it
right away. And from what I hear, in Japan it does not get
taken care of right away, and I wondered if this had anything
to do with that. So thank you for your comments.
Thank you, Mr. Chairman.
Senator Brown. Thank you, Senator Allard.
Senator Bennett and Senator Reed have asked for an
additional 3-minute second round, which we will do. I wanted to
clarify--and then Senator Carper certainly has an opportunity.
I wanted to clarify Mr. Polakoff's statements about Mr.
Alvarez's statement and part response to Senator Allard about
the comments of mixing banking and commerce in other countries,
so that the shortfall in other countries, in your mind, Mr.
Polakoff, is less the question of mixing commerce and banking
as it is the lack of a solid regulatory structure?
Mr. Polakoff. Looking at it from a domestic perspective,
Senator, I would say that the ownership issue is to an examiner
not the key point. It is having an effective prudential
examination program with the right legislative action all in
place to prevent abuses from occurring between the entities.
Senator Brown. OK. Thank you.
Senator Carper, would you like a round of questions?
Senator Carper. I would. It will be a short round.
Senator Brown. OK. Go for it. Thank you.
Senator Carper. Thank you, Mr. Chairman.
To all of our panelists, welcome today. Thanks for being
here and for your testimony and responding to our questions.
I understand that a number of auto companies have
affiliated ILCs. Does anybody know which ones?
Mr. Leary. Senator, I have the list here, if you would like
it, at least with respect to Utah. The FDIC might be better
served to have the list for all of them.
Senator Carper. OK.
Mr. Leary. BMW, Volkswagen--which is in the process of
liquidating their bank at this point in time.
Senator Carper. Any idea why?
Mr. Leary. Excuse me?
Senator Carper. Any idea why?
Mr. Leary. Change of ownership at the ultimate holding
company would require additional application, which would be
caught in the current moratorium that is going on.
Senator Carper. OK.
Mr. Leary. Simply an existing owner of Volkswagen desiring
to increase its ownership level.
With respect also to GM, GM has one--GMAC. And then we have
two--when I say ``we,'' Utah has two applications that we
have--one received and approved, one that has been delivered
from Chrysler and Ford.
Senator Carper. You say one that has been received and
approved?
Mr. Leary. The Chrysler application has been received and
approved at the State level, not at the FDIC level.
Senator Carper. OK. And did you mention Ford?
Mr. Leary. The Ford application has been--we have received
it. We have not accepted it as complete yet because of the
moratorium.
Senator Carper. Thank you.
Are there any others that were not included in that list?
Is that everybody?
Mr. Leary. In Nevada, there is Toyota, I am well aware of
it, and also not specifically auto but Harley Davidson.
Senator Carper. OK. Are there any regulatory concerns that
you all have with auto company ILCs? Either a yes or no.
Mr. Bovenzi. Up to date, everything is operated in a safe
and sound manner.
Senator Carper. OK. Anybody else?
Mr. Leary. I would respond that the provisions of 23A and B
and the firewalls that have been established there seemed
adequate to allow for prudential regulation.
Senator Carper. OK. Good.
All right. Mr. Chairman, I told you it would be a short
round, and it was. Thank you.
Senator Brown. Impressive, Senator Carper. Thank you.
Senator Bennett is recognized for 3 minutes.
Senator Bennett. Thank you very much, Mr. Chairman. I have
just two questions.
One, picking up on the final question that Senator Reed
asked when he talked about is there a competitive advantage--or
a comparative advantage, I think was the comment he made, and I
would like to know, Mr. Leary, would you respond to that? Have
you seen a comparative advantage on the part of those
commercial entities that own ILCs that are not supervised by
the Fed or somebody else to those other ILCs? Do you see a
comparative advantage there?
And, second, the question for the OTS, the Utah department
regulates 15 institutions that have a commercial owner, a
commercial affiliation. OTS regulates literally hundreds of
thrifts that have commercial affiliates, and I would like to
know what the OTS experience is, whether there is, again, some
kind of comparative advantage here.
Those are my two.
Mr. Leary. Senator, with respect to the non-financially
owned ILCs, I have one exception I have to declare so it makes
sense. GE, while it is a non-financial parent, has OTS
supervision at this current point in time. The other banks that
we have that are commercially owned are, for the most part,
smaller and I do not think their operations constitute any kind
of breach of a competition, ethic, or whatever in that area.
I mentioned two of them being the automobile makers; Target
Bank is a very small bank, established simply to provide for a
business card for foundations and nonprofits that want to buy
product or services at Target.
Mr. Polakoff. Senator, in reference to the OTS, I do not
believe we have hundreds of entities that have commercial
relationships, but of the ones that we do have commercial
relationships, the prudential supervision from the savings and
loan holding company level and the FSB level and our ability to
properly examine the regulator, deal with the functional
regulator at the affiliate level causes these institutions to
operate in a safe and sound manner.
Senator Bennett. So you see no particular difference.
Mr. Polakoff. From my perspective, within OTS they are all
under the OTS umbrella. So from our perspective, we have the
ability to examine or to work with the functional regulator.
Senator Bennett. Good. Thank you.
Senator Brown. Thank you, Senator Bennett.
Senator Reed is recognized for 3 minutes.
Senator Reed. Mr. Leary, a deposit-taking ILC in your town
must have FDIC insurance, according to State law?
Mr. Leary. Yes.
Senator Reed. OK. And in other jurisdictions would it be
possible--I go back to the Federal regulators. It would be
possible to create an ILC charter with or without FDIC
insurance. You know, a State could try to seize on this
approach, to create an industrial loan company, and then----
Mr. Alvarez. There are only a certain number of States, a
small number of States that are grandfathered under the Bank
Holding Company Act. So if a new State were to charter an ILC--
--
Senator Reed. They would have to Federal authority.
Mr. Alvarez. Right.
Senator Reed. If there is a conflict between FDIC
regulation and Utah regulation of an FDIC-insured institution,
does the FDIC trump the State of Utah?
Mr. Bovenzi. Well, we have a working relationship where we
work closely together, and to the extent differences arise, we
have been able to work them out successfully. But, for the most
part, they don't arise.
Senator Reed. If they did arise, though, is it clear to you
that you could insist upon as an insurer that your policy, what
you are----
Mr. Bovenzi. We certainly have the ability to operate
independently and go forward with our own actions if we
determined that were necessary.
Senator Reed. The point I am trying to get at is, you know,
again, Mr. Leary's department is very serious, very
conscientious, but that is not every State, and there are
several other States that are grandfathered, and also it could
change with different personalities and different policies. But
this area is one that is yet to be tested, I would assume, Mr.
Bovenzi, in terms of, you know, what you could effectively do
to object to a State policy that you thought was wrong. Is that
correct?
Mr. Bovenzi. Well, no. We are the primary--we are the
Federal supervisor for ILCs, and we can take actions if we deem
that is appropriate.
Senator Reed. Excuse me, I do not want to be preemptive,
but my time has expired. Just a final point. Your whole basis,
I presume, is safety and soundness of the institution and
functions that are permissible for a regulated institution. It
does not go to the policy issue of whether collectively these
organizations make sense in our economy. Is that a fair
statement?
Mr. Bovenzi. That is a fair statement, that Congress should
determine the appropriate role for ILCs.
Senator Reed. So all of your comments today as regulators
have been, you know, your focus is safety and soundness and
permissible activities. If the activities are permissible and
the institution is safe and sound, then you have no authority
to say you cannot do that, I do not like that, it represents a
trend that we do not approve of. Again, I do not want to put
words in your mouth, but is that a fair summary? Mr. Alvarez,
quickly, because I am abusing my time.
Mr. Alvarez. Yes, that is, but that is why we are here to
point this out to you.
Senator Reed. Thank you.
Thank you, Mr. Chairman.
Senator Brown. Thank you, Senator Reed, and thank you all
very much, the whole panel, for joining us. A special thanks,
Mr. Leary, for coming from Salt Lake. Thank you.
I want to call up the second panel of witnesses.
Thank you all for joining us.
Edward Yingling has been the President and CEO of the
American Bankers Association since 2005, following two decades
of work at the ABA, where he was responsible for legislative,
legal, regulatory, tax and policy development activities. Prior
to joining ABA, Mr. Yingling worked for 12 years as an attorney
in private practice in Washington. He graduated from Princeton
in 1970 with a degree in politics and earned his law degree in
1973 from Stanford.
Marc Lackritz is President and CEO of the Securities
Industry and Financial Markets Association. He has been
President of the Securities Industry Association since 1992 and
continued in that role through the 2006 merger of the SIA with
the Bond Market Association. Previously, he has worked as a
partner with the law firm of Wald, Harkrader and Ross. He
earned a public policy degree from Princeton and earned degrees
from Harvard and Oxford University as a Rhodes Scholar.
Peter Wallison holds the Arthur Burns Chair in Financial
Policy Studies as a Fellow at the American Enterprise
Institute. He has worked as counsel to both the Ford and Reagan
Administrations as General Counsel in the U.S. Treasury
Department from 1981 to 1985. Mr. Wallison was a partner in the
law firm Gibson, Dunn, and Crutcher in Washington, D.C. prior
to joining the AEI. He graduated from Harvard in 1963 and
earned a law degree from the same school in 1966.
Arthur Wilmarth is a Professor of Law at GW Law School. He
has published numerous articles, coauthored a book on corporate
law. He is a member of the International Editorial Board of the
Journal of Banking Regulation. Prior to joining the GW faculty
in 1986, Professor Wilmarth worked as a partner at the Jones,
Day, Reavis & Pogue law firm in Washington, although it is
Cleveland-based, I might add. He has had over a decade of
experience in private practice. He earned his BA at Yale and
law degree at Harvard.
Brigid Kelly is the Director of Politics and Communication
at the United Food and Commercial Workers Local 1099 in
Cincinnati. She is a Council Member in the suburb of Norwood,
near Cincinnati. She graduated from Xavier with a BS in
Business Administration.
J.J. Singh is Chairman, President and CEO of United
Transportation Alliance. Mr. Singh has also worked for Canada-
based Imperial Oil Limited and C.H. Robinson Company in
Minneapolis, served as President of T-Chek Systems. Mr. Singh
holds a masters degree in chemical engineering from the
University of Calgary in Alberta and a masters degree in
business administration and finance from McMaster University in
Hamilton, Ontario.
Mr. Yingling, please keep comments to 5 minutes and your
entire written statement, of course, will be included in the
record. Mr. Yingling.
STATEMENT OF EDWARD YINGLING, PRESIDENT AND CEO, AMERICAN
BANKERS ASSOCIATION
Mr. Yingling. Thank you, Mr. Chairman and members of the
Committee. I appreciate the opportunity to present the ABA's
views on the regulation of ILCs.
Our country's public policy is really clear on this issue.
Over the last 50 years, as you pointed out, Mr. Chairman,
Congress has repeatedly curtailed the ability of commercial
firms to own banks. Laws to this effect were enacted in 1956,
1970, 1987, and 1999.
In each of these laws, Congressional action was a response
to commercial firms taking advantage of statutory provisions to
engage in banking. Moreover, in each instance, Congress was
consistent. It enacted legislation to preserve the separation
between banking and commerce. Today the proposed use of the ILC
charter by commercial firms has made it necessary for Congress
to act once again to maintain the separation.
I was very involved from the private sector side in 1987
when Congress closed the so-called ``non-bank bank'' provision,
through which some non-financial companies were engaged in
banking. At that time, an exception was made for ILCs. Most
ILCs were small and the few States that were able to charter
ILCs were not promoting the charter. Simply put, it was thought
that there was no significant risk that problems caused by
mixing banking and commerce would arise at the time the ILC
exemption was created. This is not the case today. Aggregate
ILC assets now exceed $225 billion, an increase of more than
5,800 percent since the 1987 law.
Recent ILC asset growth is no accident. When Congress acted
again in 1999 to cut off the ability of commercial firms to
engage in banking, this time through unitary thrifts,
commercial firms were forced to look for other means of owning
banks. It is no coincidence that ILC assets more than doubled
from $44 billion to over $90 billion the year after Gramm-
Leach-Bliley was enacted.
We believe Congress should act finally to block the ability
to mix banking and commerce. Allowing banks to mix with
commercial firms raises a host of issues. Among these is the
potential for a conflict of interest, particularly in decisions
concerning extensions of credit.
But we think the Congress should consider more broadly what
our banking system could look like in the future if large
commercial businesses begin to own banks. As you mentioned,
Senator Brown, the experience in Japan, where cross-ownership
of large banks and commercial firms dominated the economy,
offers a test case. In Japan, business relationships were
placed ahead of sound banking practices. Preference was given
to corporate partners and credit was channeled away from
smaller businesses. This meant that more resources were steered
to less efficient firms and away from startups or competing
businesses that were better positioned to meet economic
challenges.
The rigidity of this structure explains, in part, why it
took so long for the Japanese economy to recover after its
bubble burst in the early 1990s. The intertwined relationships
between banking and commercial firms subverted corporate
governance and resulted in poor business and financial
decisions.
Contrast that to the banking system we have in the U.S. Our
mixture of numerous banks of varying sizes provides flexibility
and options for customers. Our diverse banking system is vital
to the growth of our economy, particularly with respect to new
and small businesses. In the long run, if commercial firms are
allowed to own banks, our unique system could become highly
concentrated and rigid. For very good reasons, Congress has
repeatedly and consistently taken steps to maintain the
separation between banking and commerce.
We stand ready to work with this Committee and the Congress
to enact legislation that would maintain this separation.
Thank you.
Senator Brown. Thank you, Mr. Yingling.
Mr. Lackritz, welcome.
STATEMENT OF MARC LACKRITZ, PRESIDENT AND CEO, SECURITIES
INDUSTRY AND FINANCIAL MARKETS ASSOCIATION
Mr. Lackritz. Thanks, Mr. Chairman.
First of all, it is a pleasure to be here before you. Let
me just begin by congratulating you, Mr. Chairman, on your
meteoric rise from your election to the Senate to chairing a
full Committee hearing.
Senator Brown. And the Cleveland Indians won the Central
Division, all in my first year in office. Amazing.
Mr. Lackritz. You are clearly on a roll, and I hope it
continues, particularly since I have an aging mother who still
lives in Cleveland.
I appreciate the chance to be here. It is a bit like, to
quote my own philosophical mentor, Yogi Berra, deja vu all over
again, since this is sort of where I came into the movie back
20 years ago. And the issues were about financial services
competition and the line to draw between competition and
regulation and which chartered institution should do what. So
while it has some familiar ring, we are obviously in a
different environment and a different set of challenges, which
are obviously serious and important as we look forward.
I appreciate being here because industrial loan banks owned
by our members hold the majority of all industrial bank assets
in the United States.
Congress passed, just to refer back to the Gramm-Leach-
Bliley Act, it passed that act in 1999, really almost--it was
intended 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.
We support the ability of regulated securities firms to
continue to own industrial banks, just as they do under
existing law. Federally insured industrial banks are subject to
State banking supervision, FDIC oversight, and all banking laws
governing relevant banking activities. Most importantly, the
FDIC has 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, to quote the FDA in a different context.
Industrial banks do not pose any greater safety and
soundness risks than other charter types and should not be
subject to additional constraints beyond those imposed on other
FDIC-insured institutions.
Securities firms' broker-dealer affiliates are regulated by
the SEC, as we heard on the earlier panel. And all the SIFMA
member securities firms with industrial bank subsidiaries have
elected more comprehensive enterprise-wide regulation by the
SEC--the consolidated supervised entities that Mr. Sirri
testified about before--acting as a consolidated supervisor.
The SEC's jurisdiction does not limit the concurrent authority
of the bank regulators in any way. Most of the SIFMA member
securities firms that own these banks also own savings
institutions and are regulated at the holding company level as
savings and loan holding companies by the OTS.
The SEC established its CSE framework back in 2004, in part
to allow our major global institutions doing business in the EU
to comply with its Financial Conglomerates Directive. That
directive requires that non-EU 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 report on CSEs, that the Federal
Reserve, the OTS, and the SEC were generally meeting criteria
for comprehensive consolidated supervision. We completely agree
that the CSE regime is both robust and comprehensive.
Importantly, the SEC's oversight in the CSE regime, just like
the Federal Reserve's oversight of banking holding companies,
meets the EU's equivalency standard. In addition, the SEC's
consolidated regulation standards closely parallel the Fed
standards to assess whether a foreign regulatory regime
qualifies as a consolidated regulator for a foreign bank
operating in the United States.
We strongly believe that SIFMA members that own industrial
banks and are subject to consolidated regulation by the SEC
should not be subject to additional holding company oversight.
The SEC is recognized worldwide as a consolidated regulator and
its regulatory requirements and procedures were carefully
designed to comply with all standards for effective
consolidated regulation in the United States and abroad. That
statute should be recognized in order to ensure that global
securities firms are not damaged inadvertently.
Over the last two decades, capital markets and the
financial services industry have truly become 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 we are
working to develop a long-term strategy of seeking to
modernize, harmonize and rationalize financial services
regulation. We note that the U.S. Treasury and other financial
services groups have similar projects underway.
Mr. Chairman, we look forward to working with all the
interested parties, the financial market participants,
regulators, other trade groups, and legislators to ensure a
modern, innovative, and globally responsive regulatory
structure.
Thank you very much.
Senator Brown. Mr. Lackritz, thank you.
Mr. Wilmarth.
STATEMENT OF ARTHUR WILMARTH, JR., PROFESSOR OF LAW, GEORGE
WASHINGTON UNIVERSITY LAW SCHOOL
Mr. Wilmarth. Thank you, Chairman Brown, and members of the
Committee. I appreciate the opportunity to participate in this
important hearing.
My testimony will address three major policy questions
relating to acquisitions of ILCs by commercial organizations.
First, does that ownership conflict with the general U.S.
policy of separating banking and commerce? Second, do
commercially owned ILCs present risks to the U.S. financial
system and the broader economy that are greater than the risks
posed by financial holding companies? Third, does the FDIC have
adequate supervisory power to control those risks?
As to the first question, commercial ownership of ILCs does
conflict with an established policy of separating banking and
commerce. Since our republic's founding, banks have frequently
tried to expand their activities into non-financial areas and
commercial firms have often attempted to control banks.
However, Federal and State legislators have repeatedly sought
to separate banks from commercial businesses. They have imposed
legal restraints on bank powers, and they prohibited bank
affiliations with commercial firms in one of two situations.
When one, banks were getting involved in commerce and that
threatened their safety and soundness. Or two, commercial firms
were acquiring significant numbers of banks.
As has already been stated today, on four occasions since
1956, Congress adopted anti-affiliation laws when it realized
that commercial firms were making widespread acquisitions of
banks or other FDIC-insured depository institutions. ILCs
remain the one significant exception to the general policy that
currently prohibits acquisitions of FDIC-insured depository
institutions by commercial firms.
As to the second question, ownership of ILCs by large
commercial firms does pose significant risks. It is likely to
spread the Federal safety net and too big to fail subsidies
from the financial sector to the commercial sector of the
economy. The ability of commercial owners of ILCs to gain
access to low cost FDIC-insured deposits will increase the risk
to the deposit insurance fund and will create competitive
inequities between commercial firms that do control ILCs and
those that do not. It will put great pressure on those that do
not to obtain ILCs in order to compete.
Ownership of a large ILC by a giant commercial firm would
place great pressure on Federal regulators to provide financial
support if either the ILC or its parent company was threatened
with failure. If anyone doubts the importance and potential
value of the Federal safety net, just look at what happened
when the credit markets cut off credit to subprime lenders.
Non-depository lenders who did not have access to the credit
markets rapidly went out of business. Northern Rock survived
only because the UK authorities gave a deposit guarantee and
provided liquidity support. Countrywide, in my view, survived
only because it could draw upon funding from its Federal thrift
subsidiary in the Federal Home Loan Bank system. That, to me,
proves in spades what the Federal safety net means.
These organizations are also subject to important conflicts
of interest. As our history has shown, and I pointed out in my
testimony, and as the history of other countries, including
Japan, South Korea, and Mexico shows, there are grave risks
involving preferential transfers of funds between banks and
commercial affiliates.
Now you have heard, of course, that legal restrictions on
those affiliate and insider transactions exist. However, they
have often proven to be unreliable during times of financial
stress. Many thrifts and many banks that failed during the
1980's and 1990's were found to have violated restrictions on
affiliate transactions and insider transactions. I pointed out
Lincoln Savings being one of the most notable of these
examples.
Moreover, the Federal regulators themselves may feel
compelled to waive these restrictions under times of financial
stress. After the 9/11 crisis and during the recent subprime
crisis, the Federal Reserve Board granted waivers that allowed
major banks to transfer funds to their securities broker-
dealers in excess of Section 23A limits. Thus, what you have
heard as legal firewalls tend to break down the time gets tough
and they are really under severe pressure because the
regulators will opt for financial stability.
The Bank of England tried to say we are not going to
support moral hazard by helping mortgage lenders. But when
Northern Rock experienced a bank run, they decided they better
step in and support it, moral hazard or not.
As to the third question, I think it is clear from the
previous panel that the FDIC does not have adequate supervisory
powers over commercial owners of ILCs. They clearly do not have
a full power to examine the commercial parent company and they
do not have the authority to impose capital requirements on
either the parent company or non-bank affiliates of the parent
company.
The question then would be well, should you then give the
FDIC consolidated supervision over commercial parent companies?
In my view, that would be an equally bad move because look at
the results. First of all, the FDIC would have a tremendous
increase in the supervisory burden. They would have to hire new
personnel who were familiar with many different areas of our
economy.
More importantly, in my opinion, the FDIC's designation as
consolidated supervisor would have the undesirable effect of
implying that the Federal Government is now monitoring and
assuring the overall solvency and stability of every commercial
firm that owns an ILC. That would certainly lead the market to
believe that the Federal Government would help commercial
parents if they got in difficulty.
Moreover, it would greatly increase the intrusion of
Federal regulation into our commercial sector. Certainly, I
think if you begin to have the FDIC supervising people like
Home Depot and Wal-Mart, one can only imagine the interference
with the ordinary market dynamics of our U.S. economy. So
consolidated supervision is not the answer. It is not going to
solve the problems created by commercial ownership of ILCs.
I also believe that major commercial firms that acquire
ILCs are likely to use political influence to obtain subsidies
or forbearance from regulators. Certainly, big banks have
proven to be both too big to fail and too big to discipline
adequately in the past. I could give examples, if you would
like to hear them.
But let me point to the FDIC's decision in 2006 to waive
its ILC moratorium and to improve GM's sale of control of GMAC
and its ILC subsidiary.
Senator Brown. Please summarize, please.
Mr. Wilmarth. I am sorry, my clock was not working. May I
just complete this point?
Senator Brown. Yes.
Mr. Wilmarth. They basically granted that waiver because
they felt that GM had to have that transaction. They had to be
able to sell the ILC majority control in order to get funding
that GM badly needed.
If they would do it for GM, they would waive their own
moratorium, I think that suggests what would happen if major
commercial owners get into difficulty and the Federal
regulators are faced with either supporting this ability of the
owner or enforcing their regulations.
In my view, Congress made exactly the right choice in 1956,
1970, 1987, and 1999 when it prohibited commercial ownership of
FDIC-insured depository institutions. I think it is now time
for Congress to do the same thing with regard to ILCs.
Thank you very much, and I appreciate your attention.
Senator Brown. Thank you, Mr. Wilmarth.
Mr. Wallison, welcome.
STATEMENT OF PETER WALLISON, ARTHUR F. BURNS FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Wallison. Thank you. And thank you, Mr. Chairman, and
the members of this Committee, for the opportunity to appear
before you and discuss the issue of industrial loan companies
and ILCs.
Those who want to change the current law argue that
allowing non-financial companies to acquire ILCs violates the
policy of separating banking and commerce. In my prepared
testimony, I reviewed the underlying arguments for this policy
and tried to show that the separation idea no longer has any
rational basis. Instead, the policy now serves principally to
protect the banking industry against competitive entry and to
deprive consumers of the benefits that would flow from allowing
non-financial firms to gain access to the functions that are
currently available now only to insured banks.
As I noted in my prepared testimony, by authorizing
securities firms to acquire banks, and vice versa, in the
Gramm-Leach-Bliley Act Congress had to conclude that no harm to
an affiliated bank would result from this relationship. The
essential point here is that there is no real difference
between banks being owned by say securities firms, which is
permissible of course under the Gramm-Leach-Bliley Act, and
banks being owned by commercial firms. In both cases, all of
the dangers cited by the proponents of separating banking and
commerce could occur.
Securities firms, for example, which are heavy users of
credit, could lend preferentially to a securities affiliate.
That is, a bank that had an affiliate that was a securities
firm could lend preferentially to that securities affiliate. It
could refuse to lend to competitors of the affiliate. That is
the conflict of interest argument that is made. And it could be
overreached and forced to lend to a weak securities affiliate
or other parent which could not get credit elsewhere. All those
things are possible now under the Gramm-Leach-Bliley Act.
However, even those these things are possible, Congress
made no special provision to prevent them when it passed the
Gramm-Leach-Bliley Act. It follows that Congress must have
concluded that the harms supposedly associated with banks being
acquired by commercial firms are exaggerated or non-existent.
This is probably because all of the acts that I have described
and all of the acts that have been alleged by people on this
panel and on others would be violations of banking law and
regulations. And if they occurred, would subject the officials
who approved these actions to criminal liability and personal
penalties--personal penalties--of up to $1 million per day.
Under these circumstances, it is fanciful, I think, to
believe that banks or ILCs, which are both carefully examined
and supervised, would do the things that are alleged by those
who claim that the policy of separating banking and commerce
should continue in force and be applied to ILCs.
Not only are there no sound policy reasons for applying the
separation in banking and commerce to ILCs, but doing so would
cause harm to consumers and working families. Companies that
sell goods and services to the public, retailers, auto
companies, others, can save significant cost by gaining access
to the payment system through an affiliated depository
institution such as an ILC. In today's price competitive world,
these savings are passed on to consumers. To the extent that
commercial firms are denied this opportunity, consumers and
working families are the losers.
In addition, prohibiting commercial firms from acquiring
banks and ILCs deprives the banking industry of capital,
innovation, and the competitive entry that will improve
services and reduce costs.
So if the separation of banking and commerce has no sound
policy basis and hurts consumers and working families, why is
it still around? One reason is Oliver Wendell Holmes'
observation that a good catchword can obscure analysis for 50
years. When it was first adopted, the policy had some
justification. Banks could not compete easily across State
lines and access to bank credit was crucial to the success of a
business and to personal well-being.
But 50 years later, since the liberalization of banking
laws in the 1980's and 1990's, these arguments no longer have
merit. Credit is now widely available from securities firms and
finance companies as well a banks, and banks are competing
aggressively for customers. But unfortunately, like many
outmoded policies that are not reconsidered, this one protects
the banking industry from competition despite statements in
Congress about a desire to help consumers and working families.
Indeed, it took 66 years to eliminate the Glass-Steagall Act,
which protected the securities industry from bank competition
and also had no sound policy justification.
For these reasons, Congress should leave the current law on
ILCs unchanged. Holding open this opportunity for financial
firms to combine with insured depository institutions will be
an important and useful experiment. Congress can watch how this
structure works, see the benefits it will provide to consumers,
and determine whether any of the supposed dangers actually
arise. In the end, I am confident that Congress will find that
the great hue and cry stirred up about ILCs was wholly
unnecessary.
Thank you, Mr. Chairman.
Senator Brown. Thank you very much, Mr. Wallison.
Ms. Kelly.
STATEMENT OF BRIGID KELLY, DIRECTOR OF POLITICS AND
COMMUNICATION, UFCW LOCAL 1099
Ms. Kelly. Thank you, Senator Brown, and thank you, Senator
Bennett, for holding this hearing and for the opportunity to
testify here today. I am here representing the United Food and
Commercial Workers International Union, UFCW, and Local 1099,
which represents the great States of Ohio, Indiana, and
Kentucky. Local 1099 represents almost 20,000 members and UFCW
represents more than 1.3 million. We represent workers in every
State and are the largest private sector union in North
America.
I am proud to represent UFCW and our members in Ohio,
Indiana, and Kentucky to discuss the important issue of
regulating industrial loan companies. I am especially proud to
represent Ohio, home of the late U.S. Representative Paul
Gillmor. Representative Gillmor was the original cosponsor of
the Gillmor-Frank ILC legislation in the House, and I am
pleased to be here to carry on the Ohio tradition of fighting
to close the ILC loophole and keep banking and commerce
separate.
UFCW recognized the problems with the ILC loophole years
ago and our union was one of the founding members of a diverse
group of organizations known as the Sound Banking Coalition. In
addition to the UFCW, the members of the coalition include the
Independent Community Bankers of America, the National
Association of Convenience Stores, and the National Grocers
Association.
Together with the members of the Sound Banking Coalition,
UFCW has analyzed ILCs, their growth, their regulation, and
their use by commercial entities. We are concerned that ILCs
and their parent companies are not subjected to consolidated
supervision by the Federal Reserve Board at the holding company
level. This is troubling because we have seen many bank
failures in the past. And when banks fail, people get hurt, and
we all end up paying in one way or another.
The savings of real people and real businesses are in these
institutions and it is appropriate that we take seriously our
obligation to protect people's money.
As we have learned over the course of the past century, we
are far better off with prudent financial oversight of the
entire bank holding company, enabling a strong regulatory
agency to understand the institution and address any problems
before they become too big to solve.
If I may take a few minutes to talk about our situation in
Ohio, Ohio does not have an ILC charter, but we do allow banks
from other States to branch into Ohio, including ILCs. Some
States, including Kentucky, have passed legislation taking
different approaches to stop ILCs from branching into their
States, but Ohio has not. We need Congress to act so an ILC
from another State with inadequate holding company regulation
may not branch into Ohio.
The Sound Banking Coalition is united in support for
separating banking and commerce. Separation of the financial
from the commercial spheres has proven to be sound economic
policy. Banks are supposed to be neutral arbiters of capital,
providing financing to customers on an unbiased basis,
unencumbered by commercial self-interest and competition. If
those banks are owned by commercial companies, the conflicts of
interest can skew loan decisions and lead to systemic problems.
Imagine, local businesses having no alternative but to go
to a bank owned by a competitor for a loan. This conflict of
interest could force local retailers to essentially provide
their business plans to their competition.
This is a large part of the reason why Wal-Mart's attempt
to buy an ILC was such a threat. We have watched Wal-Mart come
into town after town and decimate Main Street business by
business. Studies have documented the impact on employment,
wages, benefits, and tax revenue. If Wal-Mart had secured its
bank and turned its standard slash and burn tactic against
local banks, its economic control in these small communities
would have been almost complete.
Despite its withdrawal from the ILC market, Wal-Mart
continues to loom large over the ILC debate. Although we are
pleased the company withdrew its ILC application, its bid for a
bank put the spotlight on ILCs in general, and on the
separation of banking and commerce specifically. It is
absolutely certain that if the company had secured a bank
through a loophole in the law, the ILC loophole would have been
larger than the law. And quite frankly, we do not believe that
Wal-Mart has permanently given up going into the banking
industry.
Even with Wal-Mart, there are now a record number of
commercial companies applying for ILC charters: BlueCross
Blueshield, Home Depot, Berkshire Hathaway, these and more have
followed Wal-Mart's lead thus far. While some applications have
been withdrawn, it is clear that there is unprecedented
interest in this charter from commercial companies.
The FDIC has extended its moratorium, as referred today, on
ILC applications submitted by commercial entities. The
moratorium will not last forever, and in the meantime
fundamental policy decisions must be made. These decisions are
beyond the scope of the FDIC's authority and they are too
important to be left to a single State.
We believe the Senate must now act for all these reasons.
We believe the Senate must follow the House and pass
legislation. As you know, the House passed ILC legislation with
an overwhelming vote of 371 to 16.
We look forward to working with every member of this
Committee and the Senate to move this legislation. I urge you
to consider addressing these problems and challenges that I
have outlined today.
Thank you again for your time, and I will be happy to
answer any questions that you may have.
Senator Brown. Thank you, Ms. Kelly.
Mr. Singh.
STATEMENT OF J.J. SINGH, VICE PRESIDENT, FINANCIAL AND
COMMUNICATIONS SERVICES, FLYING J, INC.
Mr. Singh. Mr. Chairman and members of the Committee, I
thank you for the opportunity to appear before you to discuss
Transportation Alliance Bank and the industrial banks. I am
J.J. Singh and today, on behalf of the Utah Association of
Financial Services, which is a trade association, I am
representing industrial banks and consumers lenders in Utah and
in Nevada.
I am also the President of Transportation Alliance Bank,
which is located in the great State of Utah, in Ogden. We
provide a full range of banking services to our clients, who I
will talk about in a moment.
Frankly, sitting here for the first time, and I appreciate
the opportunity, and listening to some of the things being said
here, I have begun to think whether I actually have been
running an industrial chartered bank in the last 5 years. I
will make some observations to that effect when I get further
into my testimony.
Transportation Alliance Bank is a wholly owned subsidiary
of a privately held company, it is Flying J, Inc., which has
travel plazas in 40 States and seven provinces in Canada. We
are the 17th largest privately held company. It really, among
other customers, is a home for truckers away from home.
Truckers drive large rigs. They travel sometimes for a week, 2
weeks, 3 weeks before they get home. They need a place where
they can launder their clothes, have a shower, eat their food,
park their rig, and relax after a long day of driving.
I would like to use my limited time today to clarify some
of the issues related to industrial banks and provide an
accurate context to understand this market-driven, healthy,
safe, and sound industry that many people think is the best
model for banks in the current economy.
But to talk about Transportation Alliance Bank, I am here
first to talk about the customers it serves. The customers it
serves is the trucking industry, which in this country
comprises about three-quarters of a million entities. Trucking
serves about 80 percent of the communities in this country. It
has a revenue about $625 billion and contributes about 5
percent to the gross domestic product of this country.
If you look at this sector you will find, and this is from
the U.S. Department of Transportation, 91 percent of motor
carriers have 20 or fewer trucks. In essence, these are small
business owners. I am not here to talk about large trucking
companies. This segment, which is less than 20 trucks, is
really the wellspring from which the future entrepreneurs, the
larger entrepreneurs in trucking emerge from. That is the focus
of Transportation Alliance Bank.
Now why do we think we are better than others in this niche
market? The fact is, we understand the business. We understand
the business risks inherent there. And we know how to mitigate
those risks and work with those clients to provide them
services in a profitable manner, in a safe and sound manner,
and meeting all of the laws of the land. I will touch on those
in a moment.
This is what, about 15 years ago, the CEO of Flying J
recognized, that these small owner-operators actually were
undercapitalized in the liquidity issues. And that was
basically the rationale for us to look at getting into the
banking business. The only charter that would allow us to do
that was the ILC charter in the home State of Utah.
We have hundreds of customers, most of them small. And as
it may seem contrived or coincidental, but the example I am
going to present here is from the state of Ohio. A gentleman by
the name of Gregory Arthur, 4 years ago he came to us after
talking to mainstream banks, looking for a loan for a truck.
Our loan officer sat down with him and actually provided him
with a loan after we felt he had a sound plan. He is still a
customer 4 years later. He does revenues of about $500,000
today, and frankly, is a contributing entity to business in
this country.
There are hundreds of examples I can give you on that
score.
Thanks to the industrial bank charter, Transportation
Alliance Bank has been in business for about 9 years. It
currently has assets of about $500 million and provides a host
of services to the trucking industry. It makes CRA investments
into local community and its efforts are rated highly by the
regulators. It is a very safe and sound bank, serving primarily
the needs of the segment that I was talking about.
I contend, as I talk to my peers, that this is also true
for other industrial banks in Utah, which are demonstrably
among the strongest and the safest banks in the Nation, and
have been for some time. That has been talked by Commissioner
Leary, so I will not spend much time on that. But I should
mention that these banks do business not in Utah, a robust
economy. But most of their business is done in the other
States.
Based on my experience, there is no deficiency in the
regulation of these banks or their holding companies. The
regulation of industrial banks is equal to and, in some
respects, stronger than the regulation of other depository
institutions. There is also extensive effective regulation of
the holding companies and affiliates. I have gone through about
four or five safety and soundness audits. In each one of those
audits, the FDIC auditors and the State auditors have asked me
for information on financial companies business about my parent
corporation. As a matter of fact, in about 3 weeks the State
regulators have invited FDIC to do an audit of the holding
company, Flying J, Inc. We are pleased to have the regulators
there to do that. As a matter of fact, we welcome them and we
have no issues when the regulators contacted us to actually do
an audit where the auditors have spent 2 to 3 weeks at our
holding company.
So when I hear that there is no regulation of holding
companies, I find it rather surprising.
Nor is it the case that traditional holding company
regulation provides better protection for a bank subsidiary. As
a matter of fact, my views to the contrary. Large diversified
holding companies have better financial strength to support the
banks that have the industrial loan charters. In my experience,
I have never had the issue of not getting financing when I have
needed it from my parent. And as I talk to my peers, that seems
to be the case. And in some cases, there are specific
commitments that the holding companies made as part of the
completion of the application process to protect the bank.
Senator Brown. Mr. Singh, please summarize, if you could.
Thank you.
Mr. Singh. There is one point I would like to make, Mr.
Chairman, and this is important, mixing of commerce and
banking. 23A and 23B provides us with the regulatory regime to
do that, and that is pretty vigorously implemented by the
regulators when they do audit us.
In conclusion, if you peel away all of the political
rhetoric, the real issue regarding industrial banks is whether
the large number of competent and legitimate businesses in our
Nation that offer bank quality products and services will be
allowed to operate in the most efficient and profitable manner,
providing superior value to its customers in a safe and sound
manner. That is really the whole issue.
With that, I close and will be glad to answer any questions
that you may have.
Senator Brown. Thank you, Mr. Singh.
Mr. Wallison, I ask your permission to steal your Oliver
Wendell Holmes quote and request that you never use it when
speaking in Ohio, if that would be OK.
[Laughter.]
Senator Bennett will begin the questions, his 5 minutes. I
am going to slip out just for a moment. I have some students
from Ohio here I need to see, but will return as his
questioning is going on.
Thank you.
Senator Bennett. Thank you very much, Mr. Chairman.
I used to own a business in Japan. I know a little bit
about the Japanese banking system and the Japanese pattern of
supporting entrepreneurial activities. I reject the idea that
the Japanese model is in any way illustrative of what we are
talking about here.
Mr. Wilmarth, you talk about GMAC. That is an example of
the regulators giving into political pressure when GM sold
that, and that that is a sample of what is going to happen.
Mr. Wilmarth. I did not say they gave in to political
pressure. I think they felt that they were under considerable
pressure to help a major corporation get out of a very
difficult box. And they were willing to waive their rules to
help them do that.
Senator Bennett. Do you see that as a bad thing? That they
were willing to allow a corporation to sell a profitable asset
to take care of shortfalls in their own situation? The sale was
not detrimental, in any way, to the marketplace. The sale did
not put any assets at risk. The sale did not create any safety
and soundness problem. All it did was say GM, you have got a
problem. You have got a profitable asset that you want to sell,
and we are going to let you sell it.
How does that have anything to do with what we are talking
about here?
Mr. Wilmarth. My point was a broader one, which is that
Federal regulators are willing to bend their rules and
established policies when they are faced with significant
problems that could affect financial stability. I actually gave
three examples. One was----
Senator Bennett. Wait a minute. You say they are willing to
bend their rules----
Mr. Wilmarth. Yes.
Senator Bennett [continuing]. When they are faced with a
safety and soundness challenge. This was not a safety and
soundness challenge in any way. This was General Motors having
liquidity problems.
Mr. Wilmarth. Well, with all respect, it was a safety and
soundness problem to General Motors, the parent.
Senator Bennett. All right. Does that mean that their
ownership of the ILC was a risk? Their ownership of the ILC was
a benefit.
Mr. Wilmarth. Well, let me give the other two examples: the
Federal Reserve waiving Section 23A to let banks help out their
securities affiliates when they were under considerable stress;
and the Bank of England deciding to drop its distaste for moral
hazard when it had a bank run facing it.
Senator Bennett. I do not think we need worry about the
Bank of England.
Mr. Wilmarth. Well, we have done the same thing in this
country, as well.
Senator Bennett. Mr. Wallison pointed out that the kinds of
things you were talking about are perfectly available now
throughout the entire financial securities industry. So why do
we say it is terrible that a major national commercial firm,
with tremendous financial resources, will be treated
differently than a financial services firm whose resources may
not be as great? Why is that a greater--I cannot fathom why
that is a greater risk systemically to the American economy
than what we are talking about here.
Mr. Wilmarth. My concern is how far do we spread the
Federal safety net? I think everyone now is seeming to say,
which I regret I felt at the time of Gramm-Leach-Bliley, we now
seem to have spread the Federal safety net to embrace entire
financial conglomerates, not just banks.
Senator Bennett. Are you suggesting that by owning that
ILC, General Motors had access to FDIC deposits?
Mr. Wilmarth. They certainly had access to FDIC deposits.
Look at----
Senator Bennett. For General Motors' purposes?
Mr. Wilmarth. Merrill Lynch, for example, has gained $70
billion of deposits and they have said publicly that this is
the best funding source they have ever found. It is a much
cheaper funding source than when they used to have to go to the
financial markets and sell commercial paper.
The question is how large do these ILCs become? If every
commercial organization held an ILC the size of Merrill Lynch,
yes, I think you would see quite a bit of subsidization, in my
opinion.
Senator Bennett. And yet, even the legislation passed by
the House would allow Merrill Lynch to continue to own that
ILC. So the example you have given us as typical of the kind of
threat we are facing, is an example that the proposed
legislation continues.
Mr. Wilmarth. Again, the question is do you want to extend
the Federal safety net beyond the financial sector into the
entire commercial sector. That is, I believe, what is now at
stake.
Senator Bennett. Well, I obviously have problems with your
testimony and I am glad Mr. Wallison followed you immediately,
because we have a pretty clear clash here between the two.
I probably ought to calm down, Mr. Chairman, so I will quit
there.
Senator Brown. Darn, I wish I had watched that, Senator
Bennett.
[Laughter.]
Thank you.
Mr. Yingling, Mr. Wallison's comments about competition
were interesting, I thought. And while you may not have as good
a quote as he did on Oliver Wendell Holmes, tell me why he is
wrong about the banking? I have been here now, I have been on
this Committee for I guess 9 months. I have been perhaps not
amazed, but certainly intrigued by the number of actors in the
financial services business, from non-bank lenders to the Farm
Credit System, credit unions, traditional banks, payday
lenders, the Government itself, in all kinds of competition.
Tell me why he is--expand on that, why he is wrong about
the whole point of this is anticompetitive.
Mr. Yingling. Well, I think it is quite clear that we have
a very, very competitive financial system with lots and lots of
players, as you are pointing out. I think theory would tell you
that more players means more competition. So the question has
to be what are the other public policy issues that are inherent
in adding maybe more marginal competition. I do not think it is
an area that lacks plenty of competition right now.
And I think the basic public policy issue is that if the
Congress does not act fairly soon, the ILC provision could
become a vehicle that results in a major change in the
structure of our financial system. So that, at the risk of
Senator Bennett calling me Chicken Little, I will say that you
could see a situation 10 or 20 years from now where we have a
very different financial system in which you have industrial
companies, commercial companies with banks embedded in them
that dominate the financial system. And I think that raises
some very serious questions about how lending might take place,
about the ability to have a very flexible system.
I do think that, with respect to some countries, we have
seen that a financial system dominated by big conglomerates
lacks flexibility. That may affect the ability to lend to
smaller companies. And it also may mean when you have a
problem, it is more difficult to get out of it.
One of the great things we see in our financial system,
because of its flexibility, is we are able to get out of
problems more quickly than some countries. I think hopefully,
in the problem that we have right now that this Committee is so
concerned about with subprime lending, we find that the
commercial banking system and the savings institutions in this
country are in a position now to step back in and help lend to
people that need the housing loans.
Senator Brown. Thank you.
Ms. Kelly, some have argued that this whole issue is about
Wal-Mart. Since they have withdrawn their application, is there
a reason to move forward? If you substitute some other big
retailer's name, is that then a problem?
Ms. Kelly. I would say that regardless of whose name is on
the outside of the building, if you have a large retailer who
is coming in to try and, you know, just add banking sort of as
another product line, that it is a problem.
Working people are concerned about their money. I mean,
even though some of our members make minimum wage, they are
concerned about where their money goes. But if you have a
company that comes into a town, specifically a small town, and
takes over the hardware store and the florist and the bakery
and the grocery store, and then they have to be your bank, too,
that is a problem for us, whether it is Wal-Mart or another
large retailer.
I think that the primary problem is a separation of banking
and commerce. I mean, that is a fundamental problem, regardless
of whose name is on the outside of the big box.
Senator Brown. Thank you.
Mr. Lackritz, I do not think anybody is arguing for
duplicative regulation, just one regulator. Since that is
absent in the case of commercial parents of ILCs, shouldn't we
close that loophole?
Mr. Lackritz. Well, I think, from the standpoint of
addressing that, we would not--we do not need to reach that
question because in the situation that we are talking about, we
are talking about broker-dealers, who are basically financial
in nature to begin with.
And the question there is making sure that we do not have
overlapping, duplicative, or redundant regulation along the
way. So that the consolidated supervised entity regime that the
SEC has put in place, for those five large global institutions,
really serves as a very good oversight from the standpoint of
the same kinds of concerns that have been raised with respect
to oversight of financial services holding companies and bank
holding companies, as well.
So with respect to the commercially owned situation, we do
not need to get that far because we have really got a regime
now that actually works extremely well and has been very
innovative from the standpoint of the SEC and sort of our
global competitors.
Senator Brown. Thank you.
Thank you all, both the first panel and the second panel.
And thank you, the two of you, for coming a little further,
from Cincinnati and from Utah, to join us.
Senator Bennett, thank you for your passion and your
comments.
The Committee is adjourned.
[Whereupon, at 12:27 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
I want to thank Senator Brown for chairing today's hearing and
thank Ranking Member Shelby for his cooperation in putting this hearing
together, as well.
Industrial loan companies, or ILCs, are state-chartered and state-
regulated depository institutions regulated primarily by the Federal
Deposit Insurance Corporation (FDIC). They enjoy a unique status within
America's financial services landscape, the result of the Competitive
Equality Banking Act (CEBA) of 1987. ILCs can engage in most banking
activities under specific state laws and are eligible for FDIC
insurance, but are designated ``non-banks'' exempt from the statutory,
and supervisory, framework of the Bank Holding Company Act, which
restricts the mixing of banking and commercial activities for bank
holding companies and their affiliates.
In recent years, we have witnessed a significant increase in the
size and number of ILCs, and applications to acquire ILCs being filed
with the FDIC, leading to increased focus on the ILC charter and
regulatory structure. Most recently, Wal-Mart, Home Depot, and several
other large commercial firms applied to the FDIC for the right to
acquire ILCs. The Wal-Mart application, in particular, triggered fierce
opposition on various grounds from an array of interest groups,
resulting in thousands of comment letters being filed with the FDIC.
The public and congressional opposition to the Wal-Mart application
led the FDIC to impose a six-month moratorium on ILC applications. The
agency decided to extend that moratorium an additional year, through
January 31, 2008, though applied solely to application for ILCs to be
owned or controlled by commercial firms. In extending the moratorium
the FDIC sought to allow Congress to consider, and ultimately decide
upon, the public policy question brought about by the Wal-Mart
application, including the public policy implications of the mixing of
banking and commerce as it relates to ILC ownership by commercial
firms.
Today's hearing provides the Committee with an important
opportunity to hear from a broad spectrum of stakeholders on all sides
of the ILC debate--regulators, industry representatives, academics and
concerned citizens. It is my hope that Committee members will come away
from this hearing with a better understanding of the regulation and
supervision of ILCs; a historical perspective on the evolution of the
ILC structure; an understanding of the public policy concerns related
to the mixing of banking and commerce and commercial ILC ownership; and
an awareness of the arguments in favor of and in opposition to such
combining. Most importantly, Committee members will hear a wide array
of views from our witnesses on ways to enhance, strengthen or reform
the ILC charter.
I want to again thank Senator Brown for chairing today's hearing.
And I extend my thanks to all of the witnesses for taking the time to
come before the Committee today on this timely issue. I look forward to
reviewing the witness testimony, and the hearing transcript, and
working with my Committee colleagues moving forward towards a process
that I hope will result in bipartisan ILC legislation moving out of
this Committee in the coming weeks.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Good morning, and thanks to everyone for joining us here today as
the committee examines the role that industrial loan companies, or
ILCs, play in our banking system.
That system is a continually changing one, as lenders innovate and
Congress from time to time responds to the changes in the landscape.
Amidst this change, some principles remain constant. Four times in
my lifetime, Congress has acted to separate commercial firms from banks
and vice versa.
Time and again, we have seen the real costs when Congress has
failed to act, from the Depression to the Savings & Loan crisis.
Frankly, we are seeing variations of the problem today. In Japan, the
intermingling of commerce and banking has led to disastrous results.
And here at home where the sub-prime mortgage meltdown has operated
largely outside of federal supervision.
I have been pretty candid all year about what I think has been the
failure of the Federal Reserve to act more aggressively to police the
sub-prime non-bank lenders. It wouldn't be inaccurate if our witness
from the Federal Reserve made the same observation about Congress and
ILCs.
We need to act this fall to address this problem, just as we have
repeatedly in the past. When commercial firms set up single bank
holding companies, Congress amended the law in 1970 to reach them. When
commercial firms started buying non-bank banks, Congress in 1987
stepped in again. When commercial firms started to acquire thrifts,
Congress responded with Gramm-Leach-Bliley in 1999.
And this spring, in the wake of the tremendous growth in industrial
loan company assets since Gramm-Leach-Bliley, almost eightfold, the
House adopted Representative Paul Gilmor's bill to prevent further
commercial acquisitions of ILCs by a vote of 371 to 16.
The strength of that vote is a small testament to the respect in
which Paul was held, and the skill with which he did his job as a
legislator.
Congress lost a real expert in these issues with his passing, and
Karen and the rest of his family and friends lost a good man. I hope we
can pick up where he left off.
______
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Before I make a few comments regarding the regulation and
supervision of ILCs, I would like to thank Chairman Dodd for placing
the ILC issue on the top of his agenda for this fall. I would also like
to thank Senator Brown for chairing this hearing, as well as for his
interest and commitment to this very important issue.
The ILC issue raises questions that I believe the Senate must
consider: whether the scope and purpose of industrial loan companies
have expanded beyond their original purpose to serve the needs of
industrial workers; whether FDIC supervision and regulation of ILCs
needs to be strengthened; whether ILCs should be subject to the
consolidated supervision framework established in Gramm-Leach-Bliley;
and whether the ILC loophole should be closed. The House of
Representatives has already addressed these issues with their
bipartisan bill, H.R. 698.
To give some historical perspective, the current debate surrounding
the commercial ownership of ILCs is not unlike the debate surrounding
the Gramm-Leach-Bliley Financial Services Modernization Act of 1999,
and efforts to close the loophole that allowed any commercial firm to
buy a unitary thrift holding company. Congressman Jim Leach,
Congressman Steve Largent and I introduced an amendment to close the
unitary thrift loophole. Despite significant opposition, the loophole
was closed, thus eliminating a dangerous threat to the erosion of the
division between banking and commerce.
It appears that the ILC loophole, like the unitary thrift loophole,
is expressing itself as another avenue toward the mixing of banking and
commerce. This is evidenced by the increasing number of commercial
companies that have taken advantage of the exemption that allows ILCs
to own and operate banks outside of the supervisory and regulatory
framework established by Congress many years ago.
Fifty nine ILC charters have been granted since 1984 with Federal
Deposit I insurance, with one half of these after 1999. Additionally,
assets of ILCs grew from $3.8 billion in 1987 to over $155 billion in
2006. I think these numbers are telling of the potential danger this
loophole poses.
Today, ILCs are able to engage in many of the same types of
activities as other FDIC insured depository institutions. And since
Gramm-Leach-Bliley, this charter is the only vehicle through which
commercial companies and non-bank entities can control an insured
depository institution and engage in banking activities.
I don't think that Congress could have predicted the level of
growth that ILCs have experienced, and even though we specifically
created exceptions for ILCs in 1987, that does not absolve us of our
responsibility to carefully review the changes in the current landscape
and respond thoughtfully and carefully.
Today, though, we are under a time constraint. In July of 2006, the
FDIC placed a six month moratorium on any applications for deposit
insurance by an ILC. In January of 2007, that moratorium was extended
for an additional year on applications for deposit insurance and change
in control notices ILCs owned by commercial companies. This moratorium
was extended to provide Congress with the opportunity to address the
safety and soundness issues surrounding commercial ownership of ILCs
under existing law. The FDIC awaits action and guidance from the
Congress before the moratorium expires on January 31, 2008. That said,
Congress has established a framework for maintaining the separation of
banking and commerce time and time again.
Senators Brown and Allard, and I introduced S. 1356 in May. I
believe this legislation addresses the regulatory and supervisory
concerns of the ILC loophole, but I also recognize that this is not the
only way to approach this issue. I look forward to working with my
colleagues on the Banking Committee to find a workable solution to the
regulatory and supervisory concerns and the potential risks posed by
commercial ownership of ILCs.
In addition, to my statement for the record, I would also ask that
I am able to submit two letters from the South Dakota Bankers
Association and the Independent Community Bankers of South Dakota
highlighting the importance of this issue to my state's communities,
the written testimony I provided the FDIC on April 10, 2006 for their
hearing on the Proposed Wal-Mart Bank's Application for Federal Deposit
Insurance, and the GAO's September 2005 study titled ``Industrial Loan
Corporations: Recent Asset Growth and Commercial Interest Highlight
Differences in Regulatory Authority'' for the record.
______
PREPARED STATEMENT OF SENATOR JACK REED
Thank you Chairman Brown and Senator Shelby for holding this
hearing on industrial loan companies.
Industrial loan companies, started in the early 1900's, were
chartered to make uncollateralized loans to industrial workers. More
recently, the ILC industry has experienced tremendous growth, while
growing more complex. During a 20 year period ending in 2006, ILC
assets grew more than 3,900 percent from $3.8 billion to over $155
billion. While the early ILCs were small and helped to fill underserved
areas of our economy, today's ILCs closely resemble commercial banks in
the products and services offered and are owned by some of the largest
U.S. financial companies. They therefore require the same level of
oversight as traditional depository institutions.
A July 12, 2006 GAO report on ILCs outlines a critical area of ILC
regulatory oversight in need of strengthening. According to this GAO
report, ``Although FDIC has supervisory authority over an insured ILC,
this authority does not explicitly extend to ILC holding companies, and
therefore, is less extensive than the authority consolidated
supervisors have over bank and thrift holding companies.'' The report
concludes that ``. . . from a regulatory standpoint, these ILCs may
pose more risk of loss to the bank insurance fund than other insured
depository institutions operating in a holding company.'' While a
history of a healthy and successful ILC industry would indicate that
the bank-centric model has worked in the past, the growth in size and
complexity of these institutions is reason enough to address this
supervisory blind spot. Furthermore, the FDIC's authority has yet to be
tested by the parent company of a large, troubled ILC during stressed
times.
The mixing of banking and commerce in the United States is a long-
standing issue and, while there have been exceptions, there has been an
effort to keep the two separate. Critics of the idea of mixing banking
with nonfinancial entities express a concern that the risks will far
outweigh the benefits. These risks include conflicts of interest; the
creation of economic power in banking, which could impair competition;
and an expansion of the federal safety net. Given recent changes in the
ILC industry, we should assess our position on separating banking from
commerce and determine an appropriate tolerance for mixing the two,
while not punishing those that have followed the law to date.
From their early history, ILCs have filled a niche, and the
industry has operated in a safe and sound manner. I look forward to
discussing the issues and coming up with solutions that allow for the
ILC industry to continue thriving, while addressing regulatory gaps. I
want to thank the regulators for working together on this issue and I
look forward to your testimony.
______
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM EDWARD
LEARY
Q.1. What purposes do ILCs serve that cannot be adequately
served by other banking or non-banking entities?
A.1. ILCs serve a wide variety of purposes that are not
adequately served by other banking or non-banking entities. If
the purposes for which ILCs exist were being adequately served,
they would not exist; because the owners of these ILCs would
not perceive a benefit for themselves or their customers to
invest capital into an already efficient and effective market.
Due to the niche or emerging products and services provided by
many ILCs, existing traditional banking and non-banking
entities may not service these markets adequately. Where
traditional banking and non-banking entities compete to supply
consumers with similar products and services, consumers are
given better pricing, better customer service, and more
choices.
Q.2. A 2006 report from the FDIC's Office of Inspector General
detailed the widespread use of non-standard conditions in
granting deposit insurance. The State of Utah also includes
certain conditions in its orders approving new ILC charters.
Is there any question regarding the
enforceability of these conditions in a legal context?
Could the FDIC simply withdraw its deposit
insurance if the ILC does not honor the conditions?
A.2. The enforceability of conditions included in orders issued
by the Utah Department of Financial Institutions has not been
challenged by an institution in a court of law. In practice for
many decades, conditions, statutes, and rules are usually cited
in the Report of Examination as apparent violations of the
respective statute or rule. As a result of the institution's
non-compliance with a condition of an order, statute, or rule,
an informal or formal action may be brought against the
institution. These remedial actions range in severity from a
Board Resolution, Memorandum of Understanding, and Written
Agreement, to a Cease and Desist Order. Non-compliance with
administrative actions could result in removal of the offending
officer and/or revocation of the charter.
The FDIC could withdraw its deposit insurance under the
authority granted them by 8(g) of the FDI Act. The statutory
authority of the Federal banking agencies changed with the
enactment on October 13, 2006 of the Financial Services
Regulatory Relief Act of 2006, which provides that
notwithstanding the provisions of 12 U.S.C. Sec. 1818(b)(6)(a),
the appropriate Federal banking agency may enforce any
condition imposed in writing by the agency on an institution-
affiliated party (``IAP'') in connection with any action on any
application, notice, or other request concerning the depository
institution or in connection with any written agreement entered
into between the agency and an IAP. 12 U.S.C. Sec. 1831aa. This
amendment provides ``discretionary authority'' to the Federal
banking agencies ``to enforce (1) any condition imposed in
writing in connection with any action on any application,
notice, or other request, or (2) any written agreement between
the agency and an IAP. S. Rep. No. 109-256, 109th Cong., 2d
Sess. (2006) (emphasis added).
Q.3. Is the key issue in the ILC debate the commercial
ownership of a banking charter or the commercial ownership of a
Federally-insured entity?
A.3. In Utah these key issues are not mutually exclusive. Utah
law requires all depository institutions to be federally
insured. For the purposes of this question, the key issue in
the ILC debate on commercial ownership of a Federally-insured,
state chartered ILC appears to be an argument against a
commercially owned ILC that has Federal Deposit Insurance. As
argued by some, an ILC owned by a commercial entity may extend
the FDIC safety net over not only the insured depository
institutional, but also its commercial parent and affiliates
and their activities. This argument disregards twenty years of
operational experience and existing federal regulations
preventing the mixing of banking operations and parent company
activities whether commercial or not. Regulation W implements
Sections 23A and 23B of the Federal Reserve Act, which imposes
quantitative and qualitative limits on the ability of a bank to
extend credit to, or engage in certain other transactions with,
an affiliate. The history of Utah ILCs has been strict
compliance with these provisions.
----------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM EDWARD
LEARY
Q.1. As I said in the opening statement, I am hearing a lot of
praise about Britain's approach to regulation as a model for an
effective but not onerous system to oversee banks, brokers and
investment funds, and one that could improve the competitive
position of U.S. financial markets globally. When was the last
time Congress did a thorough evaluation of our financial
services regulatory structure answering these types of
questions?
Does our financial services regulatory structure
correspond to the needs and problems? (Relevance)
Does our financial services regulatory structure
achieve its objectives? (Effectiveness)
Does our financial services regulatory structure
achieve its objectives at reasonable costs? (Efficiency/cost-
effectiveness)
A.1. A state bank regulatory perspective of our financial
services regulatory structure has indicated a historic and
continuing support of the ``Dual Banking System.'' An adoption
of an FSA like model would eliminate that system of checks and
balances that has provided strength and vitality to our banking
system. Reference is made to the response of the Conference of
State Bank Supervisors dated November 30, 2007 to the
Department of the Treasury study of the, ``Review of the
Regulatory Structure Associated with Financial Institutions,''
which outlines the state view on the FSA Model and other
related issues. The hallmark of state regulation has always
been the closeness of state regulators to the people and a
deeper and better understanding of local markets and
sensitivities. The pillars of safety and soundness, consumer
protection, consumer compliance and community reinvestment are
best enforced at a local level. As an example, recently the
Office of the Comptroller of the Currency joined together with
several states by signing a Memorandum of Understanding to
institute a consumer complaint resolution process that begins
at the local level. Despite the fact that national banks are
not regulated by the state bank regulators, they have joined
forces with the Comptroller of the Currency's Office to help
consumers at a local level get answers to their complaints in
an expedited manner.
Does our financial services regulatory structure achieve
its objectives? Yes, I believe bank regulators strive to
achieve their objectives, but we can always improve. The dual
banking system puts pressure on state and federal regulators
agencies to be the best they can be. Because institutions have
a choice of charters, national or state, they have a choice in
their regulatory agencies.
Our financial services regulatory structure achieves its
objectives at reasonable costs because as stated above if they
don't, institutions will migrate to a more efficient, effective
regulatory structure.
One area that the financial services regulatory structure
could improve that Utah has observed first hand from our
inspections of financial institution holding companies is in
the coordination of regulatory activities between state and
federal regulatory agencies involved with a common parent
company. The coordination of regulatory activities between
regulatory agencies would be a small step toward Britain's
approach without dismantling a very successful and stable model
here in the United States. Also, efficiencies could be gained
by having shared or common legal functions at the Federal
Agencies. Currently, each agency has a staff of attorneys that
develop, interpret, and apply federal law for each separate
agency. These attorneys also spend a fair amount of time
evaluating other agencys' opinions at the federal statutory
level. Differences of opinions between the agencies can lead to
differences in treatment and cause institutions to convert
charters, thus allowing federal regulatory agencies to gain an
advantage in the marketplace.
Q.2. It is my understanding that Financial Services Authority
in the United Kingdom not only requires cost-benefit analysis
for proposals before going forward, but it is required to
report annually on its cost relative to the costs of
regulations in other countries. How does this contrast with our
system?
A.2. Utah would consider this question more appropriately
directed to our federal agency counterparts.
Q.3. I am very appreciative of all the hard work and
cooperation of your agencies in reviewing and preparing a
matrix of all the regulatory relief recommendations and
positions for this committee. In order to get this legislation
signed into law, all sides compromised and didn't let the
perfect stand in the way of what was possible. I would
appreciate if each agency would get back to me and the Banking
Committee with a list of their top two or three priorities from
this list that would meaningfully reduce regulatory burden for
institutions they regulate.
A.3. Utah would consider this question more appropriately
directed to our federal agency counterparts.
----------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM BRIGID KELLY
Q.1. Is there a tension between our dual banking system and our
desire to ensure a level playing field for all participants? In
other words, in our effort to eliminate competitive inequities,
do we run the risk of stifling both the dual banking system and
the innovation that is spawns?
A.1. The issue for the UFCW with respect to ILCs has never been
the question of a level competitive playing field. The UFCW
represents more than 1.1 million individual members and their
families throughout the nation. UFCW Local 1099 represents
almost 20,000 people in Ohio and Kentucky. Our members are
consumers and workers who have a strong interest in the safety
and soundness of their banking system and want to ensure that
they and their funds are protected by appropriate regulation.
What is important to UFCW members is less the theory
regarding the innovation spawned by the dual banking system,
than about the nuts-and-bolts, nickkel-and-dime impact on
America's working families. The UFCW favors innovative
regulatory protections that states put in place--both in the
banking system and in other areas of regulation.
However, there must be a basic floor of regulation. The
problem with the ILC system is that ILCs skirt the floor of
regulation that has been put in place to govern all other
companies that own banks. In fact, the ILCs represent a
loophole in the dual banking system or a little known third
banking system. This third system both does away with the
necessary safety and soundness regulation at the holding
company level that the Federal Reserve administers for other
state and federal bank holding companies and it allows for
ownership of these banks by commercial companies which is not
allowed for other state and federal banks. For this third
system, or loophole, to be the means through which these
significant policy protections are jettisoned does not make
sense.
The real question here, then, is not whether there should
be a single level playing field that does away with the dual
banking system but whether we should continue to have a third
banking system that only exists in a few states and does so
without some of the most fundamental protections that have made
our banking system strong. We believe the current system does
not make sense and that we should have legislation to close the
ILC loophole.
Q.2. When the Congress eliminated new nonbank banks and unitary
thrift holding companies in the Competitive Equality Banking
Act and Gramm-Leach-Bliley Act, it permitted many of these
entities to remain in existence under grandfather provisions.
If the Congress did prohibit commercial ownership of ILCs
based on safety and soundness concerns, would it not create
competitive inequities to grandfather existing ILCs?
To take just a single example from the automotive industry:
BMW, Volkswagen and Toyota own ILCs; should Chrysler be denied
an ILC?
A.2. Grandfathering can create competitive inequities, but this
is often how Congress chooses to make changes like it did in
CEBA and GLBA because ending an ongoing concern is seen as a
draconian response. The best policy from the UFCW's perspective
would be simply to make all ILCs subject to the Bank Holding
Company Act and not worry about grandfathering. At the same
time, we recognize that this may be seen as unfair by current
ILCs that have established themselves under the rules that have
been in place to date.
Whether the Committee decides to have a grandfathering
provision or not, however, that question should not stop the
implementation of necessary reform. The ILC loophole does not
make sense and it puts consumers, businesses, FDIC insurance
and the banking system at risk. We have seen an explosion of
interest in ILC charters from commercial companies and the
Congress's failure to act will--without a doubt--result in
additional ILC applications.
Q.3. The Gramm-Leach-Bliley Act defines activities that are
financial in nature. The National Bank Act permits activities
that are part of or incidential to the business of banking. The
Fed recently determined that WellPoint's disease management and
mail-order pharmacy activities are complementary to a financial
activity. In attempting to distinguish between banking and
commercial activities, where would you draw a line that is both
appropriate and consistent with current laws?
A.3. The UFCW has never taken a position on precisely where the
line between commerce and banking should be drawn for the
purposes of determining the complementary activities in which
banks should be allowed to engage and we are not ready to do so
at this point. We may differ with the Federal Reserve at times
when it makes individual decisions about permissible
complementary activities, but we strongly believe that the
Federal Reserve must make such decisions to avoid the profound
problems associated with the unfettered mixing of banking and
commerce. Currently, there is no check on the degree to which
commerce and banking mix through the use of ILC charters. That
is an untenable situation that must end. With that in mind, the
UFCW is quite willing to place the line-drawing authority in
the hands of the regulatory authorities at the Federal Reserve
and the FDIC.
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