[Senate Report 106-44]
[From the U.S. Government Publishing Office]
Calendar No. 94
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106th Congress Report
1st Session SENATE 106-44
_______________________________________________________________________
FINANCIAL SERVICES MODERNIZATION
ACT OF 1999
R E P O R T
OF THE
COMMITTEE ON BANKING, HOUSING,
AND URBAN AFFAIRS
UNITED STATES SENATE
to accompany
S. 900
together with
ADDITIONAL VIEWS
April 28, 1999.--Ordered to be printed
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U.S. GOVERNMENT PRINTING OFFICE
69-010 WASHINGTON : 1999
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PHIL GRAMM, Texas, Chairman
RICHARD C. SHELBY, Alabama PAUL S. SARBANES, Maryland
CONNIE MACK, Florida CHRISTOPHER J. DODD, Connecticut
ROBERT F. BENNETT, Utah JOHN F. KERRY, Massachusetts
ROD GRAMS, Minnesota RICHARD H. BRYAN, Nevada
WAYNE ALLARD, Colorado TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming JACK REED, Rhode Island
CHUCK HAGEL, Nebraska CHARLES E. SCHUMER, New York
RICK SANTORUM, Pennsylvania EVAN BAYH, Indiana
JIM BUNNING, Kentucky JOHN EDWARDS, North Carolina
MIKE CRAPO, Idaho
Wayne A. Abernathy, Staff Director
Steven B. Harris, Democratic Staff Director and Chief Counsel
Linda L. Lord, Chief Counsel
Geoffrey P. Gray, Senior Professional Staff Member
Stephen S. McMillin, Financial Economist
Geoffrey C. Gradler, Economist
Martin J. Gruenberg, Democratic Senior Counsel
Mitchell Feuer, Democratic Counsel
Joseph R. Kolinski, Chief Clerk & Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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Page
Introduction..................................................... 1
History of the Legislation....................................... 1
Background....................................................... 3
Need for Legislation............................................. 4
Purpose and Scope of the Legislation............................. 6
Section-by-Section Analysis...................................... 20
Regulatory Impact Statement...................................... 37
Cost Estimate.................................................... 38
Changes in Existing Law (Cordon Rule)............................ 50
Additional Views of:
Senators Bennett and Shelby.................................. 51
Senator Santorum............................................. 52
Senators Sarbanes, Dodd, Kerry, Bryan, Johnson, Reed,
Schumer, Bayh and Edwards.................................. 54
Senator Reed................................................. 77
(iii)
Calendar No. 94
106th Congress Report
1st Session SENATE 106-44
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FINANCIAL SERVICES MODERNIZATION ACT OF 1999
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April 28, 1999.--Ordered to be printed
_______
Mr. Gramm, from the Committee on Banking, Housing, and Urban Affairs,
submitted the following
R E P O R T
together with
ADDITIONAL VIEWS
[To accompany S. 900]
The Committee on Banking, Housing, and Urban Affairs,
having considered the Financial Services Modernization Act of
1999, reports favorably thereon as an original bill and
recommends that the bill do pass.
Introduction
On March 4, 1999, the Senate Committee on Banking, Housing,
and Urban Affairs (the ``Committee'') marked up and ordered to
be reported the ``Financial Services Modernization Act of
1999,'' to enhance competition in the financial services
industry by providing a prudential framework for the
affiliation of banks, securities firms, insurance companies,
and other financial service providers, and for other purposes.
HISTORY OF LEGISLATION
The Committee held three days of hearings on this landmark
legislation to modernize the financial system and the laws
governing financial intermediaries. At the first hearing on
Tuesday, February 23, Federal Reserve Board Chairman Alan
Greenspan testified.
On Wednesday, February 24, Secretary of the Treasury Robert
E. Rubin testified, as did John D. Hawke, Jr., Comptroller of
the Currency; James L. Pledger, Commissioner, Texas Savings and
Loan Department, representing the American Council of State
Savings Supervisors; Ellen S. Seidman, Director, Office of
Thrift Supervision; George Nichols III, Commissioner of
Insurance, State of Kentucky, representing the National
Association of Insurance Commissioners; Arthur Levitt, Jr.,
Chairman, Securities and Exchange Commission; Thomas E. Geyer,
Commissioner, Division of Securities, State of Ohio,
representing the North American Securities Administrators
Association; Donna A. Tanoue, Chairman, Federal Deposit
Insurance Corporation; and Catherine Ghiglieri, Commissioner,
Texas Department of Banking, representing the Council of State
Bank Supervisors.
On Thursday, February 25, the Committee received testimony
from Michael Patterson, Vice President, J.P. Morgan and
Company, representing the Financial Services Council; Ms. E.
Lee Beard, President and CEO, First Federal Bank, Hazleton,
Pennsylvania, representing America's Community Bankers; William
L. McQuillan, President, City National Bank, Greeley, Nebraska,
representing the Independent Bankers Association of America;
James D. Ericson, President and CEO, Northwest Mutual Life
Insurance Company, representing the American Council of Life
Insurance, the American Insurance Association, the Alliance of
American Insurers, the National Association of Independent
Insurers, and the National Association of Mutual Insurance
Companies; Jeff Tassey, Senior Vice President, American
Financial Services Association; Robert W. Gillespie, Chairman
and CEO, Key Corp, representing the Bankers Roundtable; Marc E.
Lackritz, President, Securities Industry Association; Hjalma
Johnson, Chairman and CEO, East Coast Bank Corporation,
representing the American Bankers Association; Scott A. Sinder,
Esq., representing the Independent Insurance Agents of America,
the National Association of Life Underwriters, and the National
Association of Professional Insurance Agents; John G. Finneran,
Jr., Senior Vice President and General Counsel, Capitol One
Financial Corporation, representing the Association of
Financial Services Holding Companies; Mary Griffin, Insurance
Counsel, representing the Consumers Union; Kathy Ozer,
Executive Director, National Family Farm Coalition; F. Barton
Harvey, Chairman and CEO, Enterprise Foundation; John Taylor,
President and CEO, National Community Reinvestment Coalition;
and Deborah Goldberg, Neighborhood Reinvestment Specialist,
Center for Community Change.
On March 4, the Committee met in Executive Session to mark-
up the Committee Print. During the mark-up, the Committee
considered several amendments. Senator Shelby offered an
amendment which was adopted by voicevote to allow officers and
directors of public utilities to serve as officers or directors of
banking and securities companies, subject to certain safeguards against
conflicts of interests; Senator Shelby also offered an amendment
adopted by voice vote to permit one or more thrift institutions to own
bankers' banks. A third amendment offered by Senator Shelby (as amended
by Chairman Gramm), adopted by a vote of 11-9 (Senators voting
``Aye''--Gramm, Shelby, Mack, Bennett, Grams, Allard, Enzi, Hagel,
Bunning, Crapo and Johnson. Senators voting ``No''--Sarbanes, Dodd,
Kerry, Bryan, Reed, Schumer, Bayh, Edwards and Santorum) exempts from
the requirements of the Community Reinvestment Act of 1977 those banks
and savings and loan associations with total assets up to $100 million
and that are located in non-metropolitan areas. Senator Grams offered
an amendment which was adopted by a vote of 11-9 (Senators voting
``Aye''--Gramm, Shelby, Mack, Bennett, Grams, Allard, Enzi, Hagel,
Santorum, Bunning and Crapo. Senators voting ``No''--Sarbanes, Dodd,
Kerry, Bryan, Johnson, Reed, Schumer, Bayh and Edwards) creating a
presumption that general State insurance licensing statutes or
regulations are not applicable to short-term motor vehicle rental
companies (or their employees) unless a State's statute or regulations
specifically provide for such licensing. Senator Grams also offered an
amendment (as amended by Senator Dodd) adopted by voice vote expressing
the sense of the Congress that State insurance regulators develop
uniform insurance agent and broker licensing and qualification
requirements. Senator Bryan offered an amendment (as amended by
Chairman Gramm) which was adopted by voice vote to substitute certain
provisions of section 104 of the Committee Print, dealing with
insurance sales activities of banks. Chairman Gramm offered an
amendment which was adopted by voice vote permitting certain
institutions that become bank holding companies following the date of
enactment of the Financial Services Modernization Act of 1999 to
continue to engage in or control shares of a company engaged in
commodities trading, sales, and investment activities under certain
conditions. Senator Sarbanes offered an amendment in the nature of a
substitute, which was defeated by a vote of 11-9 (Senators voting
``No''--Gramm, Shelby, Mack, Bennett, Grams, Allard, Enzi, Hagel,
Santorum, Bunning and Crapo. Senators voting ``Aye''--Sarbanes, Dodd,
Kerry, Bryan, Johnson, Reed, Schumer, Bayh and Edwards).
The Committee then voted 11-9 to report the amended
Committee Print to the Senate for consideration. Senators
Gramm, Shelby, Mack, Bennett, Grams, Allard, Enzi, Hagel,
Santorum, Bunning and Crapo voted in favor of the motion to
report the bill from the Committee. Senators Sarbanes, Dodd,
Kerry, Bryan, Johnson, Reed, Schumer, Bayh and Edwards voted
against the motion to report the bill from the Committee.
BACKGROUND
For over a decade, the Committee has been concerned that
the statutory framework governing financial services has become
outdated. Many of the statutes addressing financial services,
dating from the Great Depression or even earlier, are not well
adapted to the changes taking place in the financial services
industry. In particular, developments in technology,
globalization of financial services, and changes in the capital
markets have rendered the laws governing financial services
unsuitable and outdated in many respects. In 1988 and in 1991,
the Committee reported bills that would have modernized the
regulation of financial services.\1\ In reporting the Financial
Services Modernization Act of 1999 to the Senate, the Committee
recommends a regulatory framework suitable for financial
services as we move into the twenty-first century.
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\1\ In 1988 the Committee reported S. 1886, the Financial
Modernization Act of 1988. While the Senate passed this legislation,
the full House took no action. In 1991 the Committee reported S. 543,
the Comprehensive Deposit Insurance Reform and Taxpayer Protection Act
of 1991. While portions of this bill were enacted as the ``FDIC
Improvement Act of 1991'', the provisions restructuring the financial
services industry were not enacted into law.
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NEED FOR THE LEGISLATION
The Committee believes that overhaul of our financial
services regulatory framework is necessary in order to maintain
the competitiveness of our financial institutions, to preserve
the safety and soundness of our financial system, and to ensure
that American consumers enjoy the best and broadest access to
financial services possible with adequate consumer protections.
It is important that the statutes regulating financial services
promote these goals because of the crucial role that financial
services play in the American economy. Not only does
thefinancial services industry account for about 7.5 percent of our
nation's gross domestic product and employ approximately 5 percent of
our workforce, it is vital to the growth of the rest of the economy by
serving as a channel for capital and credit. The financial services
industry provides opportunities for savers, investors, borrowers, and
businesses to realize their goals. It allows for the transfer of
various kinds of risk to those most able to bear those risks. The pace
of economic growth in this country depends in large part on the ability
of the financial services industry to function efficiently.
The financial services industry is currently constrained by
statutes that impose hurdles or outright prohibitions on the
affiliation of banks on the one hand and securities firms and
insurance companies on the other. These restrictions, many of
which were enacted after the bank failures of the Great
Depression, were intended to protect the financial system by
insulating commercial banking from other forms of risk. Over
time, these restrictions have hampered the ability of financial
institutions to diversify their products. This inability to
diversify actually increases risks to the financial system. By
limiting competition, the outdated statutes also reduce
incentives to develop new and more efficient products and
services. This deprives consumers of the benefits of the
marketplace.
Federal Deposit Insurance Corporation (FDIC) Chairman Donna
Tanoue indicated that the current system, which divides the
various sectors of the financial services industry, should be
updated:
The financial markets have changed dramatically since
the 1930s when many of our nation's laws governing the
financial system were written. Improvements in
information technology and innovations in financial
markets have rendered the current system increasingly
obsolete and unable to provide the full range of
financial services required by businesses and
individual consumers in today's global economy.
Modernization of the financial system is not only
desirable, but necessary, to enable the financial
services industry to meet the challenges that lie
ahead.\2\
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\2\ Tanoue Testimony at 1.
As the various sectors of financial services converge,
providers of financial services are seeking to serve customers
better by com- bining those sectors in one organization.
Testifying for the American Bankers Association, Hjalma
Johnson, Chairman and CEO of East Coast Bank Corp, Dade City,
Florida, described the blurring of the divisions between the
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financial services sectors:
The virtually unanimous agreement among financial
service providers that the time has come to modernize
our financial structure is perhaps the most obvious
evidence of the need for reform. Revolutionary
improvements in technology and escalating competition
are redefining the financial services business. The
lines between different types of financial service
firms have been blurred beyond recognition.
Today, my customers have the option to write a check
on a money-market mutual fund to pay their bills; they
can have a credit card issued by a phone company; and
they can get a home mortgage from an automobile
manufacturer. This list of non-traditional suppliers of
financial services competing for my customers gets
longer every day. Even defining the term ``financial
service'' is becoming difficult in today's market.\3\
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\3\ Johnson Testimony at 2.
In addition, as the number of nations participating in the
global capital markets increases, providers of financial
services face greater competition and seek greater economies of
scale. Federal Reserve Board Chairman Greenspan describes the
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pressure that U.S. firms are experiencing:
In the United States, our financial institutions have
been required to take elaborate steps to develop and
deliver new financial products and services in a manner
that is consistent with our outdated laws. The costs of
these efforts are becoming increasingly burdensome and
serve no useful public purpose. Unless soon repealed,
the archaic statutory barriers to efficiency could
undermine the competitiveness of our financial
institutions, their ability to innovate and to provide
the best and broadest possible services to U.S.
consumers, and ultimately, the global dominance of
American finance.\4\
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\4\ Greenspan Testimony at 2.
As banks, insurance companies, and securities firms enter
one another's markets, regulation of financial services has
become increasingly arbitrary. Witnesses identified numerous
examples of this phenomenon to the Committee. Under current
regulatory interpretation, national banks may sell insurance
nationwide so long as such sales are based in a place of less
than 5,000 people. Sales of insurance products may be subject
to significantly different regulationdepending on whether those
sales are made by a bank or an insurance agent. Similarly, sales of
securities may be regulated differently depending on whether they take
place through a bank or a securities broker.
In many cases, existing statutes create impediments and
inefficiencies for the affiliations occurring in the
marketplace. Regulators and courts have on occasion fashioned
paths around these impediments, but such actions are no
substitute for the establishment of fundamental policy by
Congress. As Federal Reserve Board Chairman Alan Greenspan
testified:
Without congressional action to update our laws, the
market will force ad hoc administrative responses that
lead to inefficiencies and inconsistencies, expansion
of the federal safety net, and potentially increased
risk exposure to the federal deposit insurance funds.
Such developments will undermine the competitiveness
and innovative edge of major segments of our financial
services industry. We believe that it is important that
the rules for our financial services industry be set by
the Congress rather than, as too often has been the
case, by banking regulators dealing with our outdated
laws. Only Congress has the ability to fashion rules
that are comprehensive and equitable to all
participants and that guard the public interest.\5\
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\5\ Greenspan Testimony at 2.
Creating a new statutory framework for the financial services
industry should translate into greater safety and soundness for
the financial system, increased efficiency for financial
services providers, and more choices and lower costs for
consumers.
PURPOSE AND SCOPE OF THE LEGISLATION
The Financial Services Modernization Act of 1999, as
reported by the Committee, repeals the provisions of the Glass-
Steagall Act that restrict the ability of banks and securities
underwriters to affiliate with one another. Second, within the
framework of the Bank Holding Company Act, the bill allows for
a broader range of financial services to be affiliated,
including commercial banking, insurance underwriting and
merchant banking as defined in the legislation. It also
contains provisions intended to provide appropriate regulation
of bank sales of insurance. The bill also allows national banks
with consolidated total assets not exceeding $1 billion, and
not affiliated with a bank holding company, to engage in a
broader range of financial services through subsidiaries. In
order to engage in expanded activities in a principal capacity,
the subsidiary must comply with certain safety and soundness
requirements.
Permissible Affiliations
Banks, securities firms, and insurance companies will be
able to affiliate with one another through the bank holding
company model. Bank holding companies will be allowed to engage
in activities that are financial in nature or incidental
thereto. This is a broader standard than the Aclosely related
to banking'' standard that currently delineates the permissible
activities of bank holding companies.
The Committee believes that allowing broader affiliations
within the bank holding company should place no segment of the
financial services industry at a disadvantage. Banks, insurance
companies, and securities firms should have equal opportunities
to affiliate with one another.
Broader affiliations within the holding company structure
will present new challenges for safety and soundness regulation
of financial institutions. To meet these challenges, the bill
establishes the Federal Reserve Board (the ``Board'') as the
umbrella regulator of bank holding companies engaged in
expanded financial activities. In order to engage in expanded
financial activities, insured depository institution
subsidiaries of a bank holding company must be well capitalized
and well managed. The bill expressly provides that the
provisions in Prompt Corrective Action (Section 38 of the
Federal Deposit Insurance Act) will be used for purposes of
determining whether an insured depository institution
subsidiary of a bank holding company engaged in the new
financial activities is well capitalized and whether an insured
depository institution affiliate of a national bank with a
financial subsidiary is well capitalized. Under Section 38(c)
of Prompt Corrective Action, each Federal banking regulator has
promulgated regulations specifying the levels at which an
insured depository institution that is supervised by that
regulator is well capitalized, adequately capitalized,
undercapitalized, or significantly undercapitalized. To
eliminate confusion and the potential for conflicting
interpretations, the Committee intends that only the
appropriate Federal banking agency for each insured depository
institution subsidiary of a bank holding company or affiliate
of a national bank shall determine the capital category for
that institution in accordance with its regulations. In other
words, the determination of whether an insured depository
institution is well capitalized under this Act will be made by
the OCC in the case of a national bank, the Board in the case
of a state-member bank, the FDIC in the case of a state non-
member bank, and the OTS in the case of an insured savings
association.
Organizational structure
The bank holding company
The Committee carefully analyzed whether the holding
company or the operating subsidiary approach is the appropriate
organizational structure for new activities conducted by an
insured bank. Some have characterized this debate as solely one
of jurisdiction between the Board and the Treasury. The
Committee disagrees. This is a fundamental issue which must be
handled carefully in the context of the significant reforms in
activities that we are considering.
Congress must be careful to provide sufficient safeguards
for our new financial framework. The Committee does not want to
see a repeat of the savings and loan crisis where the taxpayer
had to bail out federally insured institutions that assumed
excessive risks and operated without effective management,
internal controls, and supervision. The deposit insurance funds
must be adequately insulated from paying the losses of firms
which are affiliated with insured banks. The Committee believes
that the holding company structure best achieves this purpose.
The Committee took into consideration Federal Reserve Board
Chairman Greenspan's views on this topic. Many distinguished
former regulators share his views. In a recent editorial,
former Federal Reserve Board Chairman Paul Volcker wrote:
The commercial bank must be a separate organization,
insulated legally from its sister entities providing
financial services. Moreover, that arrangement is more
easily compatible with continued ``functional''
supervision of the component parts * * * \6\
\6\ Volcker, Paul. ``Boost for Banking''. Washington Post.
September 10, 1998.
Finally, the Committee has previously endorsed the holding
company framework. In 1991, the Committee approved S. 543,
which repealed the Glass-Steagall Act and allowed banks to
affiliate with securities firms using the holding company
structure to ensure safety and soundness, a level competitive
playing field, and protection of the taxpayer. The bill also
adopts the holding company framework, but expands the range of
permissible financial affiliations to include insurance
underwriting, merchant banking, and activities complementary to
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financial activities.
National bank subsidiaries
While the general approach to affiliations under the bill
is through the bank holding company framework, limited
authorization also is granted to smaller national banks (those
with consolidated assets not exceeding $1 billion that are not
part of a holding company structure) to affiliate with other
financial service providers through subsidiaries meeting
certain safety and soundness requirements. Such financial
subsidiaries, as defined in the bill, are authorized to conduct
financial activities in a principal capacity.
The bill also expands the activities in which banks may
engage. Section 121 of the bill authorizes national banks to
underwrite municipal revenue bonds. Section 123 of the bill
allows national bank subsidiaries to engage in any type of
financial activity in an agency capacity. With respect to
agency activities other than the sale of insurance products,
the bill would prohibit States from preventing or restricting
bank activities in these areas.
For at least 30 years, national banks have been authorized
to invest in operating subsidiaries that are engaged only in
activities that national banks may engage in directly. For
example, national banks are authorized directly to make
mortgage loans and engage in related mortgage banking
activities. Many banks choose to conduct these activities
through subsidiary corporations. Nothing in this legislation is
intended to affect the authority of national banks to engage in
bank permissible activities through subsidiary corporations, or
to invest in joint ventures to engage in bank permissible
activities with other banks or nonbank companies.
Treasury role in determining ``financial in nature''
The Committee believes that the Treasury Department's views
regarding what activities are ``financial in nature'' are
highly relevant. Accordingly, the bill creates an explicit role
for the Treasury Department in the Board's review process.
The Board must coordinate and consult with the Treasury
Department in making its determinations regarding financial
activities. The Board may not determine that an activity is
financial in nature if the Treasury Department believes that it
is not financial or incidental to a financial activity. The
TreasuryDepartment may also recommend that an activity be
deemed to be financial in nature, and the Board must determine within
thirty days whether to initiate a public rulemaking regarding the
Treasury Department's proposal.
Merchant banking
The bill creates a new Section 4(k) of the Bank Holding
Company Act (the ``BHCA''). Section 4(k)(4)(H) recognizes the
essential role that principal investing, or merchant banking,
plays in modern finance. A bank holding company or its non-bank
affiliate (collectively, the ``BHC'') whether directly,
indirectly, or through a fund, may make investments in any
amount in, or otherwise acquire control of, a company, subject
to conditions designed to maintain the separation between
banking and commerce. The ownership interests must be acquired
for appreciation and ultimate resale or other disposition. Such
disposition can be subject to a variety of factors, including
overall market conditions, the condition and results of
operation of the portfolio company's business, and its duties
to co-investors and advisory clients. The Committee recognizes
that certain investments may be held for a period of time in
order to realize their potential value.
The Committee believes that compliance with the
requirements of Section 4(k)(4)(H) can be ascertained either by
periodic reports from, or by examination of, the holding
company or affiliate making the investment. No examination of
the portfolio company is necessary other than in the case in
which reports or examinations are necessary to assure
compliance with restrictions governing transactions involving
depository institutions and portfolios companies.
Furthermore, the Committee intends Section 4(k)(4)(H) to
permit investment banking firms to continue to conduct their
principal investing in substantially the same manner as at
present. A BHC should not be placed at a competitive
disadvantage with firms unaffiliated with any depository
institution. The Board shall not require, even informally, any
pre-clearance of principal investments and not impose arbitrary
or unduly restrictive limitations on the holding period for
such investments. Moreover, the Board should challenge the
exercise of discretion regarding the duration of an investment
only if clearly inconsistent with the purposes of this section.
Finally, the Committee intends that the Board be the sole
entity with legal standing to allege that a BHC is in violation
of Section 4(k)(4)(H) with respect to a particular investment.
Functional regulation
The bill generally adheres to the principle of functional
regulation, which holds that similar activities should be
regulated by the same regulator. Different regulators have
expertise at supervising different activities. It is
inefficient and impractical to expect a regulator to have or to
develop expertise in regulating all aspects of financial
services. Accordingly, the bill is intended to ensure that
banking activities are regulated by bank regulators, securities
activities are regulated by securities regulators, and
insurance activities are regulated by insurance regulators. The
bill establishes procedures for determining whether future
products should be underwritten within a bank, subject to
banking regulation, or by an insurance company subject to
insurance regulation. Similarly, the bill contains procedures
for determining whether new products should be subject to
banking regulation or securities regulation.
Securities activities of banks
The bill includes other provisions that pertain to the
treatment of banking products that are also ``securities'' for
the purposes of the Federal securities laws and certain
traditional banking activities that involve securities
transactions. Currently, banks are exempted from the definition
of ``broker'' and ``dealer'' in the Securities and Exchange Act
of 1934 (the ``1934 Act''), and are, therefore, not required to
register as broker-dealers with the Commission. The legislative
history of the 1934 Act indicates that banks were excluded from
the definition of ``broker'' and ``dealer'' because Congress
recognized at that time that these institutions were already
subject to a comprehensive scheme of Federal regulation.\7\
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\7\ See, American Bankers Association v. SEC, 804 F.2d 739 (D.C.
Cir. 1986), which includes a thorough and lengthy analysis of the
legislative history behind the bank exemption from the 1934 Act.
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In recent years, however, the bank regulators have
permitted banks and bank holding companies to expand their
securities activities. The bill accommodates this trend within
a functional regulatory framework. The repeal of Glass-
Steagall's anti-affiliation rules and the blanket exemption for
banksfrom broker-dealer registration raises the issue whether,
and under what circumstances, such products and activities should be
``pushed out'' of (i.e., moved out of) a bank and into a registered
broker-dealer affiliate.
The Committee does not believe that an extensive ``push-
out'' of or restrictions on the conduct of traditional banking
services is warranted. Banks have historically provided
securities services largely through their trust departments, or
as an accommodation to certain customers. Banks are uniquely
qualified to provide these services and have done so without
any problems for years. Banks provided trust services under the
strict mandates of State trust and fiduciary law without
problems long before Glass-Steagall was enacted; there is no
compelling policy reason for changing Federal regulation of
bank trust departments, solely because Glass-Steagall is being
modified. Under IRS regulations, banks must offer self-directed
Individual Retirement Accounts (``IRAs'') in either a trustee
or custodial capacity. Services rendered as a trustee do not
require registration as a broker-dealer to the extent that
these services fall within the trust exemption. The Committee
believes that bank custodial, safekeeping, and clearing
activities with respect to IRAs do not need to be pushed-out
into a Commission registered broker-dealer.
Banks also provide services for employee benefit plans,
dividend reinvestment plans, and issuer plans. Currently, such
service plans can offer direct execution services to
participants through transfer agents. By removing the
intermediaries from the execution process, these plans provide
cost-savings for their participants. The transfer agents
receive a payment which is calculated based on transaction
volume (typically, a set number of basis points of the volume).
The bill does not prevent the offering of such services for
transaction-based fees. Since transfer agent activities are
regulated, and the transaction-based fees are for ministerial
services which provide significant cost-savings for
shareholders, the Committee finds no compelling reason to
impose restrictions on transaction-based fees.
With respect to private placements, the Committee believes
that, to the extent that these transactions are conducted
pursuant to applicable Federal law or the rules and regulations
issued thereunder, there is no compelling reason to ``push-
out'' these activities (which have been supervised by banking
regulators).
The bill gives both the Board and the Commission a role in
determining whether new products must be pushed-out to a
registered broker-dealer. The Committee believes these changes
will allow banks to develop new products cheaply and
efficiently, while giving due consideration to the dual goals
of safety and soundness and investor protection.
Insurance activities
As approved by the Committee, the bill creates a new
Federal framework for insured depository institutions to
affiliate with other financial firms and to engage, directly or
indirectly, in a variety of financial activities. The Committee
recognizes, however, that States have long had regulatory
authority over certain financial activities, such as the
business of insurance. Thus, it is the Committee's intent that
the affiliations and activities authorized or permitted by
Federal law be conducted in a manner that is consistent with
applicable State regulation.
On the other hand, the Committee is aware that some States
have used their regulatory authority to discriminate against
insured depository institutions, their subsidiaries and
affiliates. The Committee has no desire to have State
regulation prevent or otherwise frustrate the affiliations and
activities authorized or permitted by the bill. Thus, Section
104 clarifies the application of State law to the affiliations
and activities authorized or permitted by the bill (or other
Federal law), and ensures that applicable State law cannot
prevent, discriminate against, or otherwise frustrate such
affiliations or activities.
Preemption of State anti-affiliation laws
Subsection 104(c)(1) preempts State laws that prevent
affiliations authorized or permitted by the bill. It provides
that a State may not by statute, regulation, order,
interpretation, or other action ``prevent or restrict'' the
affiliations authorized by the bill. Currently, a number of
States have such so-called ``anti-affiliation'' laws in effect.
Without Section 104(c)(1), such laws would frustrate one of the
principal purposes of the bill, which is to permit insured
depository institutions to affiliate with other financial
firms, including securities and insurance firms. An example of
a State law that would be preempted under the ``prevent or
restrict'' standard is the Florida law that prohibits a
Florida-licensed insurance agent from being associated with,
owned, or controlled by a financial institution.
Subsections 104(g) (1) and (2) complement subsection
104(c)(1). Those subsections prohibit States from preventing or
placing certain limitations on affiliations between insurance
underwriters and insured depository institutions. The Committee
does not intend to imply, however, that the State actions
described in subsections 104(g)(1) and (2) are not otherwise
subject to preemption under the terms of subsection 104(c)(1).
Exception for insurance affiliations
In its effort to strike an appropriate balance between the
preemption of State anti-affiliation laws and State regulation
of the business of insurance, the Committee created a limited
exception to Section 104(c)(1) for affiliations between insured
depository institutions, their subsidiaries and affiliates, and
insurance underwriters. Subsection 104(c)(2) provides that
States may collect, review, and take actions on the
acquisitions, changes, or continuations of control of an entity
engaged in the business of insurance that is domiciled within
the State.
This exception is aimed at affiliations between an insured
depository institution, or a subsidiary or affiliate thereof,
and firms engaged in the business of insurance. It permits a
State to review such applications in order to ensure that the
affiliation does not jeopardize the solvency of the
underwriter.
Actions taken by a State pursuant to this exception cannot
be inconsistent with the purpose of the bill to permit
affiliations between insured depository institutions, their
subsidiaries and affiliates, and the underwriters of insurance
or annuities. Furthermore, State actions may not have the
practical effect of discriminating, either intentionally or
unintentionally, against an insured depository institution,
subsidiary or affiliate thereof, or any other person or entity
affiliated with an insured depository institution.
General preemption standard for State laws related to
authorized activities
Subsection 104(d)(1) is a general preemption standard
applicable to all State laws related to activities authorized
or permitted by the bill. This general preemption standard
provides that no State may take any action to ``prevent or
restrict'' the ability of an insured depository institution, or
subsidiary or affiliate thereof, from engaging directly or
indirectly, either by itself or in conjunction with a
subsidiary, affiliate, or any other entity or person, in an
activity authorized by the bill. The Committee recognizes that
this general preemption standard may not be appropriate for all
types of State law. For example, the general ``prevent or
restrict'' standard could, unintentionally, preempt capital and
solvency requirements applicable to insurance underwriters.
Thus, as explained below, the Committee established separate
preemption standards for Stateinsurance laws and certain other
categories of State law.
Preemption standards for State insurance sales laws adopted
prior to September 3, 1998
States have long been the primary regulators of insurance.
In recognition of this, the bill establishes separate
preemption standards applicable to State insurance sales,
solicitation, and cross-marketing laws. These preemption
standards distinguish between State insurance sales,
solicitation, and cross-marketing laws adopted prior to
September 3, 1998, and such laws adopted after that date.
The Committee believes that State insurance sales,
solicitation, and cross-marketing laws adopted prior to
September 3, 1998 should be subject to preemption under the
preemption standards applicable when such laws were adopted.
Thus, it is the Committee's intent that such laws may be
subject to preemption under applicable case law, and the
statutory preemption standard set forth in subsection
104(d)(2)(A), which is patterned after such case law. There is
an extensive body of case law related to the preemption of
State law. For example, in Barnett Bank of Marion County, N.A.
v. Nelson, 116 S.Ct. 1103 (1996), the U.S. Supreme Court noted
that Federal courts have preempted State laws that ``prevent or
significantly interfere'' with a national bank's exercise of
its powers; that ``unlawfully encroach'' on the rights and
privileges of national banks; that ``destroy or hamper''
national banks' functions; or that ``interfere with or impair''
national banks' efficiency in performing authorized functions.
One example of a State law that would be preempted under
the standard set forth in subsection 104(d)(2)(A) is a statute
that requires all shareholders of an insurance agency to be
licensed by the State. Such a requirement would prevent or
significantly interfere with the ability of an insured
depository institution, subsidiary, or affiliate to engage in
insurance sales, since it is practically impossible for all
shareholders of such entities to be licensed. Another example
of a State law that would be preempted under the standard set
forth in subsection 104(d)(2)(A) would be a statute that limits
the volume or portion of insurance sales made by an insurance
agent on the basis of whether such sales are made to customers
of an insured depository institution or any affiliate of the
agent. Such a statute would prevent or significantly interfere
with the sale of insurance to an insured depository
institution's customers.
Preemption standards for insurance sales laws adopted after
September 3, 1998
For laws enacted after September 3, 1998, the Committee
believes it is appropriate to apply not only traditional
standards of preemption, but also a new, statutory
nondiscrimination standard. The application of this additional
test reflects the fact that versions of Section 104 have been
pending in Congress since September 3, 1998. Therefore, State
insurance sales, solicitation, and cross-marketing laws adopted
after September 3, 1998, are subject to preemption not only
under applicable case law and the statutory standard based upon
that case law, which is set forth in subsection 104(d)(2)(A),
but also to the nondiscrimination standard established in
subsection 104(e).
The nondiscrimination standard created in subsection 104(e)
preempts any State statute, regulation, order, interpretation,
or other action that--
(1) distinguishes by its terms between insured
depository institutions, or subsidiaries or affiliates
thereof, and other persons or entities engaged in such
activities, in a manner that is in any way adverse to
any such insured depository institution, or subsidiary
or affiliate thereof;
(2) as interpreted or applied, has or will have an
impact on depository institutions, or subsidiaries or
affiliates thereof, that is substantially more adverse
than its impact on other persons or entities providing
the same products or services or engaged in the same
activities that are not insured depository
institutions, or subsidiaries or affiliates thereof, or
persons or entities affiliated therewith;
(3) effectively prevents a depository institution, or
subsidiary or affiliate thereof, from engaging in
insurance activities authorized or permitted by this
Act or any other provision of federal law; or
(4) conflicts with the intent of this Act generally
to permit affiliations that are authorized or permitted
by federal law between insured depository institutions,
or subsidiaries or affiliates thereof, and persons and
entities engaged in the business of insurance.
An example of a State law that would be preempted under
this standard is a law that would prohibit the sale of
insurance within 100 yards of a teller window. While such a law
would apply equally to all parties, it would have an impact on
an insured depository institution that is substantially more
adverse than its impact on other persons engaged in insurance
sales.
Finally, it is the Committee's intent that courts apply the
various preemption standards applicable to State insurance
sales, solicitation, and cross-marketing laws so as to give
effect to each of the standards. In other words, the standards
are intended to be complementary alternatives. One standard is
not intended to limit or reduce the scope of another.
Safe harbors
The Committee determined that certain categories of State
insurance sales, solicitation, and cross-marketing laws that
relate to insured depository institutions should not be subject
to preemption under traditional case law, the preemption
standard established in subsection 104(d)(2)(A), or the
nondiscrimination standard established in subsection 104(e).
The Committee recognizes that many of these categories of State
insurance sales, solicitation, and cross-marketing laws, which
appear in subsection 104(d)(2)(B), are already subject to
Federal banking agency advisories and guidelines. Thus,
subsection 104(d)(2)(B) lists various categories of State
insurance sales, solicitation, and cross-marketing laws that
are not subject to preemption under the terms of this bill.
With respect to the enumerated safe harbors, however, it is the
Committee's intent that any restrictions imposed by the States
not be more burdensome or restrictive.
Under the terms of subsection 104(d)(2)(B), a State may
impose restrictions on the use of advertising or other
promotional material by an insured depository institution to
ensure that such advertisements or promotional materials do not
cause a reasonable person to believe that a State or the
Federal Government guarantees the insurance. This provision is
necessary to avoid any potential for confusion by the
purchasers of insurance products. On the other hand, it is not
intended as a means for States to impose a complex regulatory
structure related to the review and approval of advertisements
that is not otherwise applicable to other providers of
insurance.
Similarly, subsection 104(d)(2)(B) permits a State to
require that any person who receives a commission as an
insurance agent hold a valid State license for the applicable
class of insurance sold. Such a provision ensures that only
qualified individuals act as agents and protects the purchasers
of insurance from unprofessional, and potentially improper
sales practices. On the other hand, such a provision is not
intended to encourage States to impose different qualification
standards for licenses held by agents that sell insurance by or
on behalf of an insured depository institution than are
applicable for other agents. Furthermore, this provision is not
intended to suggest that an insured depository institution,
itself, be licensed as an agent in order to either employ
agents or contract with others to sell insurance.
Also, subsection 104(d)(2)(B) permits a State to prohibit
the payment of any compensation to an individual who is not
licensed to sell insurance if the compensation is based on the
purchase of insurance by the customer. This provision is
intended to prevent employees of insured depository
institutions from having inappropriate incentives to sell
insurance to customers. It is not, however, intended to apply
to the payment of compensation for referrals when such
compensation is unrelated to the purchase of insurance by a
customer.
The Committee does not intend that State laws falling
within any one of the safe harbor categories be identical to
any one of those categories. However, the bill does provide
that in order to fall within any one of these categories the
State law must be substantially the same as the corresponding
category in subsection 104(d)(2)(B), and no more burdensome
than such category.
Preemption standard for other State insurance laws
The Committee recognizes that, as a general rule, State
laws related to insurance underwriting activities have not been
applied in a manner that is discriminatory to insured
depository institutions, their subsidiaries, or affiliates.
Thus, subsection 104(d)(3) provides that the general preemption
standardapplicable to authorized activities (subsection
104(d)(1)) does not apply to State statutes, regulations,
interpretations, orders or other actions otherwise addressed in the
subsection provided that such State actions do not contravene the
nondiscrimination standard established in subsection 104(e).
Exceptions for certain categories State law
Subsection 104(d)(4) provides that the general preemption
standard applicable to authorized activities (subsection
104(d)(1)) does not apply to State statutes, regulations,
interpretations, orders, or other actions that are not
otherwise addressed in the subsection (such as zoning laws),
provided such State actions do not discriminate against insured
depository institutions, their subsidiaries, and affiliates,
and others engaged in the same activity. In other words, the
general preemption standard applicable to authorized activities
would not reach State zoning or criminal laws that may apply to
an insured depository institution, subsidiary or affiliate
thereof, engaged in an authorized activity.
Subsection 104(f) provides that neither the preemption of
State anti-affiliation laws (subsection 104(c)) nor the various
activity preemption standards in subsection 104(d) apply to
State securities investigations and enforcement actions, or to
State laws, regulations, orders, interpretations, or other
actions related to corporate governance or antitrust, provided
such corporate or antitrust laws, regulations, orders,
interpretations, or other actions are of general applicability
and are not inconsistent with the purposes of the Act to
authorize affiliations and remove barriers to such
affiliations.
Holding company regulation
The bill seeks to provide regulation of BHCs that is
sufficient to protect the safety and soundness of the financial
system and the integrity of the Federal deposit insurance funds
without imposing unnecessary regulatory burdens. While
functional regulators are supervising various holding company
subsidiaries, the Committee believes there is a need for
oversight of the organization as a whole as well as
subsidiaries not subject to functional regulation. The need for
holding company regulation was stressed by witnesses before the
Committee as well. For example, William McQuillan, President of
City National Bank of Greeley, N.E., testified, ``the IBAA
strongly supports the establishment of an umbrella regulator
for diversified financial services firms and feels the only
Federal regulator equipped for this job is the Federal
Reserve.'' \8\
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\8\ McQuillan Testimony at 10.
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Accordingly, the Board has authority to examine the holding
company and, under certain circumstances, any holding company
subsidiary that poses a material risk to an affiliated bank.
The Committee does not intend for holding company
regulation to override functional regulation of holding company
subsidiaries. For functionally regulated subsidiaries, the
Board is required, to the greatest extent possible, to rely on
reports required by and examinations conducted by the
functional regulator. Thus, the Board must generally defer to
regulation by the State insurance commissioners, the State and
Federal banking agencies, the Securities and Exchange
Commission (the ``Commission''), the State securities
commissioners, and appropriate self-regulatory organizations.
The Board may not require that an insurance company or
securities firm provide financial support to a troubled bank
affiliate if the functional regulator determines this would
have a materially adverse effect on the financial condition of
the insurance company or securities firm.
Too-big-to-fail
The Committee felt strongly that language should be added
to the bill to address the ``too-big-to-fail'' concerns.
Accordingly, the bill amends the Federal Deposit Insurance Act
to prevent the use of Federal deposit insurance funds to assist
affiliates or subsidiaries of insured depository institutions.
The intent of this provision is to ensure that the FDIC's
deposit insurance funds not be used to protect uninsured
affiliates of financial conglomerates.
Insurance customer protections
The Committee recognizes the importance of protecting
customers who will now be able to purchase a broader ranger of
financial products from affiliated providers of financial
services on the premises of or through banks. The wider variety
of financial products available at a bank raises potential
customer confusion about the insured status, risks, the issuer
and the seller of thenew products. The Committee is concerned
about past instances in which depositors have purchased unsuitable
investment products without understanding their nature, and wants to
take reasonable steps to prevent misunderstanding and confusion when
bank customers receive unsolicited sales presentations or see
advertisements for securities and insurance products for purchase
through the bank.
The bill requires, to the extent practicable, that sales
take place in an area separate from the deposit-taking area, so
that retail customers can distinguish whether a bank, a
securities broker or insurance agent is offering the product.
Salespersons would be required to inform potential customers
about whether the products are insured or carry risks with
conspicuous and readily understandable disclosures before sales
occur, and would be prohibited from misrepresenting the
products' uninsured nature. The bill requires sales personnel
to be appropriately licensed. Unlicensed employees, such as
tellers, would be allowed to receive a nominal, one-time,
fixed-dollar fee for referring a customer to the stock or
insurance broker, provided such fee's payment is not
conditioned on whether the customer executes a transaction.
The bill requires the Federal bank regulators, in
consultation with State insurance authorities, as appropriate,
to issue regulations that are consistent with the requirements
of the Act that apply to the retail sale of insurance products
by or through banks. The Commission would administer the
amended provisions of the 1934 Act affecting the retail sales
of securities through networking arrangements on or off bank
premises.
Community Reinvestment Act (CRA)
The bill does not expand the application of the Community
Reinvestment Act (CRA). Thus, the criteria for engaging in
expanded financial activities by a bank holding company, or by
a qualifying national bank through a subsidiary, remain as in
current law the fulfillment of capital and management
requirements.
In addition, the bill makes CRA examinations meaningful by
deeming an insured depository institution in compliance with
the CRA (i.e., that the institution has met the credit needs of
its entire community) if it has achieved at least a
``satisfactory'' rating in all of its CRA examination during
the immediately preceding 36-month period. The presumption of
an institution's CRA compliance may be rebutted or challenged
by substantial verifiable evidence brought to the attention of
the appropriate Federal bank regulatory agency. The objector
will bear the burden of proving the substantial verifiable
nature of the evidence.
The cost of regulatory compliance on smaller institutions
is a matter of concern to the Committee. To this end, the bill
also exempts from the requirements of the CRA small banks and
thrifts (those with total assets not exceeding $100 million)
located in non-metropolitan areas. The exemption would, in
effect, apply only to 38% of all banks and thrifts, which
control less than 3% of banking assets nationally.
Community banks
Small independent banks are confronting unprecedented
challenges as a result of growing competition from all
financial service providers, the accelerating pace of
technological change and the innovation it promotes, changing
demographic patterns, and shifting consumer attitudes towards
managing their personal finances. The Committee has attempted
in this and other legislation within its jurisdiction to
recognize the importance of community-oriented banks to our
economy and the local markets they serve.
Because the Committee wants to make every effort to
preserve the role of community banks, this bill includes a
requirement for a General Accounting Office (the ``GAO'') study
of certain revisions to S corporation tax rules permitting
greater access by community banks to S corporation treatment.
Federal Home Loan Banks
The bill includes certain provisions addressing the Federal
Home Loan Bank (``FHLB'') System. The last major reform of the
FHLB System took place in the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 (``FIRREA''). In 1989,
Congress permitted commercial banks to gain access to the
system. The provisions in the bill addressing the FHLB System
are intended to recognize the changes in membership and
regulatory structure put in place by FIRREA.
There are four major provisions in the bill affecting the
FHLB System. The first changes the membership of thrifts from
mandatory to voluntary. Thesystem provides enough benefits to
its members to ensure that it can sustain itself on the membership of
those who wish to join. Second, the bill gives small banks greater
access to advances by expanding the types of assets they may pledge as
collateral. Third, the Resolution Funding Corporation obligation was
changed from a fixed dollar figure to a percentage of the system's
current net earnings. Lastly, many of the day-to-day management
functions of the Federal Housing Finance Board (``FHFB''), which
regulates the FHLB System, have been decentralized. Many of the day-to-
day functions of the FHLBanks currently require approval from the FHFB.
These approval requirements largely date to an earlier period when the
FHLBanks were regulated by the Federal Home Loan Bank Board. Several
studies, including one by the GAO, have suggested that the FHFB is too
involved in day-to-day management decisions of the FHLBanks. The bill
also requires a study by the GAO relating to the capital structure of
the FHLB System.
Foreign banks
The bill gives the Board explicit authority to apply
comparable capital and management standards to foreign banks
operating a branch or agency or owning or controlling a
commercial lending company in the United States.
Congress amended the International Bank Act (``IBA'') in
1991, after the Bank of Credit and Commerce International
(``BCCI'') affair, to require that a foreign bank could not
establish a representative office without obtaining the prior
approval of the Board. In keeping with the common understanding
of representative offices, a subsidiary of a foreign bank was
excluded from the IBA definition of a representative office.
The Committee has become aware that some foreign banks are
seeking to avoid the prior approval requirement of the IBA by
establishing separate subsidiaries or using existing nonbank
subsidiaries to act as representative offices. Although the
subsidiary is separately incorporated, it carries out the same
representative function as if it were a traditional
representative office of the foreign bank. A number of States
do not distinguish between representative offices that are
direct offices of the foreign bank and those that are
subsidiaries. Accordingly, the bill would eliminate this
loophole by striking the subsidiary exclusion from the
definition of representative offices.
In addition, the bill clarifies the Board's authority to
examine a U.S. affiliate of a foreign bank with a
representative office in order to determine the compliance of
the representative office with requirements of U.S. law.
Presently, if a foreign bank has only a representative office
and no other banking office in the United States, the Board may
examine only the representative office. The Board cannot
currently examine or seek information from U.S. affiliates of
such foreign bank. This limitation could become a problem if
there were serious questions raised about the nature or
legality of relationships or transactions between the
representative office and its U.S. affiliates. To illustrate
such a problem, it must be recalled that BCCI illegally used
its representative offices to engage in deposit-taking and
money laundering in the United States.
Unitary thrift holding companies
Under the bill, new unitary savings and loan holding
companies will not enjoy the benefits of unitary status and
will be subject to the activity limitations of the Savings and
Loan Holding Company Act. Existing unitary savings and loan
holding companies (those meeting the grandfather date
requirements of the bill) will not be subject to those
limitations. Although some have advocated that the rights of
those existing unitary companies should be extinguished upon
sale, the bill reflects the Committee's judgment that the value
of those companies, built up in justified reliance on a
legitimate legal structure authorized by Congress, and often
with the encouragement of Federal regulators, should not be
subject to destruction or diminution resulting from the
imposition of such restrictions. Instead, the bill preserves
the existing transferability rights of such companies.
SECTION-BY-SECTION ANALYSIS
Title I--Facilitating Affiliation Among Banks, Securities Firms, and
Insurance Companies
Subtitle A--Affiliations
Section 101. Glass-Steagall reformed
Section 101 repeals Sections 20 and 32 of the Glass-
Steagall Act, allowing affiliations and interlocking employment
among banks and securities firms.
Section 102. Financial activities
Section 102 establishes the existing bank holding company
(BHC) structure as that under which banks may affiliate with
securities and insurance firms. A BHC may so affiliate and
engage in a broad range of financial activities and activities
incidental thereto if all of its insured depository
subsidiaries are well capitalized and well managed.
Activities that are ``financial in nature'' or ``incidental
to financial activities,'' include:
Lending and other traditional bank activities;
Insurance underwriting and agency activities;
Providing financial, investment, or economic advisory
services;
Issuing or selling instruments representing interests
in pools of assets that a bank may own directly;
Securities underwriting and dealing, and mutual fund
distribution;
Merchant banking;
Any activity that the Federal Reserve Board (the
``Board'') has deemed ``closely related to banking''
under the Bank Holding Company Act;
Any activity that the Board has already approved for
U.S. banks operating abroad;
Any other activity the Board may approve as
``financial in nature'' or ``incidental'' to a
financial activity; and
Activities that are complementary to financial
activities, or any service that the Board determines
not to pose a substantial risk to the safety or
soundness of depository institutions or the financial
system generally.
The Board will determine by regulation or order which
activities are financial in nature or incidental to financial
activities. In determining whether activities are financial in
nature or incidental to financial activities, the Board must
take into account expected changes in markets or technology,
and international competition.
The Board must coordinate and consult with the Treasury
Department in making its determinations regarding financial
activities. The Board may not determine that an activity is
financial if the Treasury believes that it is not financial or
incidental to a financial activity. The Treasury may also
recommend that an activity be deemed financial, and the Board
must determine within 30 days whether to initiate a public
rulemaking regarding the proposal.
In determining whether an activity is financial in nature
or incidental to one or more financial activities, the
Committee intends that the Board take into account a number of
factors. Those factors include the purposes of the Financial
Services Modernization Act of 1999 (the ``Act'') and the BHCA,
changes that have occurred or are reasonably expected in the
marketplace in which bank holding companies compete or in the
technology for delivering financial services, whether the
activity in necessary and appropriate to allow a financial
holding company and its affiliates to compete effectively with
any company seeking to provide financial services in the United
States, and any available or emerging technological means for
providing financial services to customers or allowing customers
to use financial services.
This authority includes authority to allow activities that
are reasonably connected to one or more financial activities.
For example, the Board has, under the existing closely related
to banking test, permitted bank holding companies to engage in
activities, such as processing any type of data or providing
general management consulting services, that are incidental to
permissible nonbanking activities, subject to certain limits.
The Board has also allowed bank holding companies to market
excess capacities that have been developed or acquired in the
course of conducting permissible activities, in order that bank
holding companies may make and plan for the most cost effective
acquisition of technological and other facilities. This
authority provides the Board with some flexibility to
accommodate the affiliation of depository institutions with
insurance companies, securities firms, and other financial
services providers while continuing to be attentive not to
allow the general mixing of banking and commerce in
contravention of the purposes of this Act.
This section also grandfathers commodity activities and
affiliations of certain companies becoming bank holding
companies after the date of enactment of the Act. Generally,
these companies may continue to engage in or, directly or
indirectly, own or control shares of a company engaged in
activities related to the trading, sale or investment in
commodities and underlying physical propertiesif the holding
company or any subsidiary was lawfully engaged in such activities as of
September 30, 1997 in the United States; and the holding company is
predominantly engaged in activities financial in nature.
Section 103. Conforming amendments
Section 103 amends the Home Owners' Loan Act of 1933 to
permit multiple savings and loan holding companies to engage in
activities permissible for bank holding companies.
Section 104. Operation of State law
Section 104 establishes the core rules that will apply to
state regulation of the affiliations and activities authorized
under the Act.
Section 104(a) simply restates that the McCarran-Ferguson
Act, 15 U.S.C. Sec. Sec. 1011 et seq., remains the law of the
United States.
Section 104(b)(1) generally requires any person providing
insurance in a State as principal or agent to be licensed as
required by the appropriate insurance regulator of such State
in accordance with the relevant State insurance law. This
requirement is subject to the general preemption and
nondiscrimination requirements set forth in Section 104 (c),
(d) and (e).
Section 104(c), in general, preempts a State's ability to
prevent or restrict affiliations between insured depository
institutions and financial entities, except that a State
insurance regulator may collect, review and take actions on
applications and documents or reports necessary or required in
connection with proposed acquisitions, changes or continuations
of control of entities domiciled within the State. The State
actions must not have the practical effect of discriminating,
intentionally or unintentionally, against an insured depository
institution, subsidiary or affiliate thereof, or against any
person or entity based upon affiliation with an insured
depository institution.
Section 104(d)(1), in general, preempts a State's ability
to prevent or restrict the sales activities authorized under
this Act of an insured depository institution or subsidiary or
affiliate thereof with the exception of insurance sales and
certain other insurance activities.
Section 104(d)(2)(A) then establishes the general
preemption rule that applies to state regulation of insurance
sales, solicitation or cross-marketing activities. In
accordance with the legal standards for preemption set forth in
the decision of the Supreme Court of the United States in
Barnett Bank of Marion Co., N.A. v. Nelson, 116 S. Ct. 1103
(1996), no State may prevent or significantly interfere with
the ability of an insured depository institution, or a
subsidiary or affiliate thereof, to engage in insurance sales,
solicitation and cross-marketing activities.
Section 104(d)(2)(B) establishes 13 separate ``safe
harbor'' provisions. These ``safe harbors'' permit a State to
impose restrictions that are substantially the same as but no
more burdensome or restrictive than the requirements included
in each ``safe harbor'' provision. Any state law that falls
within a safe harbor cannot be preempted under the provisions
of Section 104(d)(2)(A). The ``safe harbors'' apply both to
state laws and regulations already in place and to those that
may be enacted in the future. They protect state restrictions--
Prohibiting the rejection of an insurance policy
required in connection with a loan solely because it
was sold or underwritten by an unaffiliated agent.
Prohibiting the imposition of extra charges on
insurance policies required in connection with a loan
that are purchased from unaffiliated agents.
Prohibiting misrepresentations regarding the insured
or guaranteed status of any insurance product.
Requiring that commissions can be paid only to
licensed insurance agents.
Prohibiting any referral fees paid to non-licensed
individuals to be based on whether the referral results
in a transaction.
Prohibiting the release of insurance information to
nonaffiliated third parties for the purpose of
soliciting or selling insurance without the express
written consent of the customer.
Prohibiting the use of health information obtained
from insurance records without the express written
consent of the customer.
Prohibiting tying arrangements.
Requiring the written disclosure, prior to any
insurance sale, that the products is--(1) not a
deposit; (2) not insured by the FDIC; (3) not
guaranteed by the financial institution or its
subsidiaries or affiliates; and (4) where appropriate,
involves investment risk, including loss of
principal.This disclosure may be required to be in writing where a
writing is practicable.
Requiring the disclosure, when insurance is required
in connection with a loan, that the purchase of
insurance from an unaffiliated agent will not affect
the loan decision or the credit terms in any way.
Requiring the completion of credit and insurance
transactions through separate documents.
Prohibiting the inclusion of the expense of insurance
premiums in a primary credit transaction without the
express consent of the customer.
Requiring the maintenance of separate insurance books
and records that must be made available to state
insurance regulators for inspection.
The Act provides special rules with respect to State laws,
regulations, orders, interpretations and other actions enacted,
issued or taken prior to September 3, 1998. Pursuant to Section
104(d)(2)(C)(ii), these laws and other actions will not be
subject to the Act's nondiscrimination provisions found at
Section 104(e). In addition, pursuant to Section
104(d)(2)(C)(i), when these laws and other actions are reviewed
in the courts, traditional rules of judicial deference will be
applied. These special rules do not apply to State laws and
other actions that fall within the ``safe harbors'' found at
Section 104(d)(2)(B).
With respect to State laws, regulations, orders,
interpretations and other actions enacted, issued or taken on
or after September 3, 1998, the Act will apply a
nondiscrimination standard found at Section 104(e), unless the
laws or actions fall within the safe harbors found at Section
104(d)(2)(B). Courts reviewing State laws enacted on or after
September 3, 1998 will also apply new provisions relating to
deference, found at Section 203(e).
Whether or not a State law, regulation, order,
interpretation or other action involving insurance sales,
solicitation or cross-marketing activities was enacted, issued,
or taken prior to or on or after September 3, 1998, the
principles of the Barnett case will still apply, as well as the
statutory preemption standard at Section 104(d)(2)(A), except
to the extent that the State law or action falls within the
safe harbor protections.
Finally, Section 104(d)(2)(C)(iii) provides generally that
Section 104(d)(2) should not be construed to limit the
applicability of the Barnett decision or draw inferences
regarding other State law not referenced by one of the 13 safe
harbors.
Sections 104(d) (3) and (4) clarify that no preemption
under paragraph (d)(1) is intended with respect to certain
State laws that do not violate the nondiscrimination standards
established in Section 104(e).
Section 104(e) establishes a second preemption standard
that prohibits a State from regulating the activities
authorized or permitted under this Act or any other provision
of law in a manner that--(1) distinguishes by its terms between
insured depository institutions and other persons engaged in
similar activities that is in any way adverse to an insured
depository institution; (2) as interpreted or applied, has or
will have an impact on insured depository institutions that is
substantially more adverse than its impact on other persons
providing similar products and services; (3) effectively
prevents an insured depository institution from exercising its
powers under this Act or Federal law; or (4) conflicts with the
intent of this Act.
Section 104(f) makes clear that nothing included in Section
104 is intended to affect the investigatory and enforcement
powers of State securities regulators or the application of
state laws, regulations, orders, interpretations or other
actions of general applicability, including state antitrust
laws that are not inconsistent with the purposes of this Act.
Section 104(g) provides that, except as provided in Section
104(d)(2), no State may prevent or restrict the ability of an
insurer, or an affiliate of an insurer, to become a BHC.
Section 104(g) further provides that no State may limit the
amount of an insurer's assets that may be invested in the
voting securities of an insured depository institution or a
company that controls such an institution, except that the
State of the insurer's domicile may limit the investment to 5
percent of the insurer's admitted assets. Section 104(g) also
provides that no State other than the State of the insurer's
domicile may prevent, restrict, or have the authority to
review, approve, or disapprove a plan of reorganization from
mutual to stock form. The Committee notes that the State of
domicile is not necessarily the State in which most of the
insurer's policyholders reside. Therefore, in a proposed
reorganization from mutual to stock form, the appropriate
regulatory authority of the insurer's State of domicile is
required toconsult with the appropriate regulatory authority in
other States in which the insurer conducts business, regarding issues
affecting the best interests of policyholders.
Section 104(h) establishes a special rule that applies to
the licensing of any person engaged in the sale of insurance
products in conjunction with the short-term rental of motor
vehicles. Unless a State statute, rule, or regulation expressly
requires such persons to be licensed, then such persons need
not be licensed pursuant to Section 104(b)(1). This provision
is not intended to impede a State's ability to require rental
car company employees to be licensed in any way. It is instead
intended to foreclose third parties from seeking damages
related to the sale of insurance products by unlicensed rental
car agents unless and until a State has affirmatively concluded
that such agents must be licensed.
Subtitle B--Streamlining Supervision of Bank Holding Companies
Section 111. Streamlining bank holding company supervision
Section 111 provides that the Board may require any bank
holding company or subsidiary thereof to submit reports
informing the Board of its financial condition, financial
systems and statutory compliance. The Board is directed to use
existing examination reports prepared by other regulators,
publicly reported information and reports filed with other
agencies to the fullest extent possible.
The Board is authorized to examine each bank holding
company and its subsidiaries. However, it may examine
functionally regulated subsidiaries only if the Board has
reasonable cause to believe that the subsidiary is engaged in
activities that pose a material risk to the depository
institution or is not in compliance with certain statutory and
regulatory restrictions. The Board is directed to use to the
fullest extent possible examinations made by appropriate
Federal and State regulators.
If a bank holding company is not ``significantly engaged''
in non-banking activities (e.g., a shell holding company), the
bill would authorize the Board to designate the appropriate
bank regulatory agency of the lead depository institution
subsidiary as the appropriate Federal banking agency for the
bank holding company.
The Board is not authorized to prescribe capital
requirements for any functionally regulated subsidiary of a
holding company that is in compliance with applicable capital
requirements of another Federal regulatory authority, a State
insurance authority, or is a registered investment adviser. In
developing, establishing, and assessing holding company capital
or capital adequacy rules, guidelines, standards, or
requirements, the Board also has been prohibited from taking
into account the activities, operations, or investments of an
affiliated investment company, unless the investment company is
a bank holding company or a bank holding company owns more than
25 percent of the shares of the investment company (other than
certain small investment companies). The Committee adopted this
measure because investment companies are specially regulated
entities that must meet diversification, liquidity, and other
requirements specifically suited to their role as investment
vehicles. Consequently, the Committee believed that it was
important to ensure that the Board not indirectly regulate
these entities through the imposition of capital requirements
at the holding company level, except in the very limited
circumstances noted above.
Section 111 makes clear that securities and insurance
activities conducted in regulated entities are subject to
functional regulation by relevant State securities authorities,
the Securities and Exchange Commission (the ``Commission''), or
relevant State insurance regulators.
Section 112. Authority of State insurance regulator and
Securities and Exchange Commission
Section 112 amends Section 5 of the BHCA to prohibit the
Board from requiring a broker-dealer or insurance company that
is a bank holding company to infuse funds into an insured
depository subsidiary if the holding company's functional
regulator, the Commission or State insurance regulator,
determines in writing that ``such action would have a material
adverse effect on the financial condition of the insurance
company or the broker or dealer, as the case may be.'' If the
Commission or State insurance regulator makes such a
determination, the Board can order the holding company to
divest the insured depository institution.
Section 113. Role of the Board of Governors of the Federal
Reserve System
Section 113 adds a new Section 10A to the BHCA. Section 10A
is intended to protect functionally regulated subsidiaries from
additional and duplicative regulation by the Board. Section 10A
prohibits the Board generally from the entry of orders,
imposition of restraints, restrictions, guidelines, or other
requirements with respect to a functionally regulated
subsidiary of a bank holding company unless the action is
necessary to prevent or redress an unsafe or unsound practice
or breach of fiduciary duty by that subsidiary that poses a
``material risk'' to the safety and soundness of an affiliated
insured depository institution or the domestic or international
payment system and that the Board cannot protect against
through action directed at or against the affiliated insured
depository institution or insured depository institutions
generally.
The term ``material risk'' should be interpreted to mean
that level of risk which, under the circumstances, poses a
threat to the financial safety, soundness or stability of a
particular insured depository institution, insured depository
institutions generally, or to the domestic or international
payment system. The Committee expects that the Board and other
Federal banking agencies and functional regulators, as
appropriate, to exercise their authority in order to protect
against such feared risk, and to coordinate with and
accommodate requests for action by the Board.
Section 114. Examination of investment companies
Federal banking agencies are prohibited from inspecting or
examining registered investment companies unless the investment
company is a bank holding company or savings and loan holding
company. The Commission is directed to provide to any Federal
banking agency, upon request, examination reports, records, or
other relevant information. The section does not prohibit the
FDIC from examining an investment company affiliate of an
insured depository institution, pursuant to its authority under
Section 10(b)(4) of the Federal Deposit Insurance Act, as
necessary, to disclose fully the relationship between the
insured depository institution and the affiliate, and the
effect of such relationship on the insured depository
institution.
Section 115. Equivalent regulation and supervision
Section 115 provides that the limitations imposed upon the
Board pursuant to the provisions of Section 5(c), 5(g) and 10A
of the BHCA also limit the authority of the other Federal
banking agencies to require reports, make examinations, impose
capital requirements, or take other actions with respect to
holding companies and their functionally regulated
nondepository institution subsidiaries. This section ensures
that the OCC, the Office of Thrift Supervision (the ``OTS'')
and the FDIC will not be able to assume and duplicate the
function of being the general supervisor over functionally
regulated subsidiaries. The Committee recognizes that, under
the concept of functional regulation, the extent of the
authority of these agencies to take actions under any statute
against, or with respect to, functionally regulated
subsidiaries should not be any greater than that of the Board
under Sections 111 and 113.
Section 116. Interagency consultation
Section 116 states the Committee's intent that the Board as
the appropriate Federal banking regulator, and the State
insurance regulator as the functional regulator of insurance
activities, should consult with each other and share
examination reports and other information. It provides that
upon the request of a State insurance regulator, the Board may
provide any information regarding the financial condition, risk
management policies, and operations of any bank holding company
that controls an insurance company regulated by that State
insurance regulator, and vice versa. It further provides that
upon the request of a State insurance regulator, the
appropriate Federal banking agency may provide information
about any transaction or relationship between a depository
institution and affiliated insurance company regulated by that
State insurance regulator, and vice versa. In addition, the
appropriate Federal banking regulator is required to consult
with the appropriate State insurance regulator before making
determinations between an insured depository institution or
bank holding company with an insurance company.
Section 117. Preserving the integrity of FDIC resources
Section 117 amends Section 11(a)(4)(B) of the Federal
Deposit InsuranceAct generally to prohibit the use of the Bank
Insurance Fund and the Savings Association Insurance Fund to benefit
any shareholder, subsidiary or nondepository affiliate.
Subtitle C--Activities of National Banks
Section 121. Authority of national banks to underwrite
municipal revenue bonds
Section 121 amends 12 U.S.C. 24(7) to expand the scope of
securities activities permissible for a national bank to
include the underwriting of municipal revenue bonds, limited
obligation bonds and other obligations that satisfy the
requirements of Section 142(b)(1) of the Internal Revenue Code
issued by a State or political subdivision thereof.
Section 122. Subsidiaries of national banks
Section 122(a) adds a new Section 5136A to the Revised
Statutes of the United States. Pursuant to and in accordance
with Section 5136A(a), a national bank is permitted to control
a ``financial subsidiary'' or to hold an interest in a
financial subsidiary only if the bank has consolidated total
assets not exceeding $1 billion, is not affiliated with a bank
holding company, is well capitalized and well managed (along
with its insured depository institution affiliates), and
receives OCC approval to engage in the proposed activities. The
OCC is authorized to prescribe regulations for the enforcement
of these requirements. A financial subsidiary is defined to
mean a company that is a subsidiary of a national bank that
engages as principal in any activity that is permissible for a
bank holding company under Section 4(k) of the BHCA but is not
permissible for national banks to conduct directly.
In order to conduct activities through a financial
subsidiary, the national bank must comply with certain safety
and soundness requirements: for purposes of determining
regulatory capital, a deduction from assets and tangible equity
is required for the aggregate amount of outstanding equity
investments by the national bank in a financial subsidiary;
also for determining regulatory capital, the assets and
liabilities of the financial subsidiary may not be consolidated
with those of the national bank; and the approval of the OCC is
required prior to making any equity investment in the financial
subsidiary if the investment, when made, would exceed the
amount that the national bank could pay as a dividend without
obtaining prior regulatory approval. The national bank also
must maintain procedures, among others, for identifying and
managing financial and operational risks within the bank and
financial subsidiary.
New Section 5136A is intended to allow small, independent
national banks an opportunity to take advantage of financial
modernization legislation without being required to incur the
added costs and burdens of forming a bank holding company.
Pursuant to Section 5136A(e), a national bank is authorized
to retain control of a company or retain an interest in a
company, and conduct through such company activities lawfully
conducted therein as of the date of enactment of this Act. This
subsection also clarifies that a national bank may conduct
through a subsidiary any activity in which national banks may
engage directly. The Committee does not intend that this
provision be construed to authorize the retention by national
banks of DPC assets beyond those periods permitted by the OCC
under applicable regulations. Further, the Committee does not
intend to limit the authority that national banks have under
Federal statutes such as Section 25A of the Federal Reserve
Act, the Bank Service Company Act or the Small Business Act
that specifically authorize national banks to own an interest
in specific types of companies. The enactment of new Section
5136A does, however, make the OCC's Part 5 Rule inoperative.
Section 122(b) amends Section 23A of the Federal Reserve
Act to include a financial subsidiary of a national bank within
the definition of ``affiliate.'' The purchase of or investment
in equity securities issued by the financial subsidiary will
not be deemed to be a covered transaction.
Section 122(c) provides that a financial subsidiary of a
national bank engaging in activities pursuant to Section
5136A(a) of the Revised Statutes of the United States will be
deemed to be a subsidiary of a bank holding company for
purposes of the antitying provisions of the Bank Holding
Company Act Amendments of 1970.
Section 123. Agency activities
Section 123 provides that national bank subsidiaries may
engage in agency activities that have been determined by the
OCC to be permissible for national banks or to be financial in
nature or incidental to financial activities (pursuant to
Section 4(k) of the BHCA) provided that the subsidiary engages
in the activities solely as agent and not directly or
indirectly as principal.
Section 124. Misrepresentations regarding financial
institution liability for obligations of affiliates
Section 124 makes it a crime for bank or bank affiliate or
bank subsidiary personnel to fraudulently represent that the
bank will be liable for any obligation of a bank affiliate or
subsidiary.
Section 125. Insurance underwriting by national banks
Section 125(a)(1) establishes the general rule that a
national bank may only provide insurance as principal in
accordance with Section 5136A(a) of the Revised Statutes of the
United States, as added by this Act.
Section 125(a)(2) provides for an exception to that general
rule. Without regard to the requirements of Section 5136A(a), a
national bank is permitted to offer any ``authorized insurance
product'' in a principal capacity.
Under Section 125(b), a product is ``authorized'' if, as of
January 1, 1999, national banks were lawfully providing it as
principal or the OCC had determined in writing that national
banks may provide it as principal; no court of relevant
jurisdiction had, by final judgment, overturned a determination
by the OCC that national banks may provide it as principal; and
the product is not an annuity contract subject to tax treatment
under Section 72 of the Internal Revenue Code. Under the
Committee bill, the provision by national bank subsidiaries of
title insurance in a principal capacity is not prohibited.
Section 125(c) defines ``insurance'' for purposes of
Section 125. Under Section 125(c)(1), ``insurance'' means any
product regulated as insurance as of January 1, 1999 in the
State in which the product is provided. Under Section
125(c)(2), insurance means any product first offered after
January 1, 1999 which a State insurance regulator determines
shall be regulated as insurance in the State in which the
product is provided because the product insures, guarantees, or
indemnifies against loss of life, loss of health, or loss
through damage to or destruction of property. Insurance is
defined to exclude those products which are a product or
service of a bank, such as a deposit product, loan, discount,
letter of credit, or other extension of credit; a trust or
other fiduciary service; a qualified financial contract as
defined in Section 11(e)(8)(D)(i) of the Federal Deposit
Insurance Act; or a financial guaranty. A bank product does not
include a product that has an insurance component such that if
offered by a bank as principal the product would be treated as
a life insurance contract under Section 7702 of the Internal
Revenue Code, or losses incurred with respect to the product
would qualify for treatment under Section 832(b)(5) of the
Internal Revenue Code if the bank were subject to tax as an
insurance company under Section 832 of the Internal Revenue
Code. The term ``financial guaranty'' in Section 125(c)(2)(v)
is not intended to exclude surety bonds from the definition of
insurance. Under Section 125(c)(3), insurance means any annuity
contract on which the income is subject to tax under Section 72
of the Internal Revenue Code.
Subtitle D--National Treatment of Foreign Financial Institutions
Section 151. National treatment of foreign financial
institutions
Section 151 amends Section 8(c) of the International
Banking Act of 1978 (IBA) by adding a new paragraph (3) to
permit termination of the financial grandfathering authority
granted by the IBA and other statutes to foreign banks to
engage in certain financial activities. The bill provides that
foreign banks should no longer be entitled to financial
grandfathered rights authorized under new Section 4(k) of the
BHCA after the bank has filed a declaration under Section 4(l)
of the BHCA.
Section 152. Representative offices
Section 152(a) removes the exemption for subsidiaries of
foreign banks from the definition of a representative office.
Thus, direct subsidiaries of foreign banks will need Board
approval as ``representative offices'' of the foreign bank.
Section 152(b) provides that the Board may examine any
affiliate of a foreign bank in any State.
Title II--Insurance Customer Protections
Section 201. Functional regulation
Section 201 provides that, subject to Sections 104(c), (d)
and (e), the insurance sales activities of any person or entity
shall be functionally regulated by the States. Section 104
establishes a safe harbor for State regulation of insurance
sales, as well as a method for determining whether State
regulation falling outside the safe harbor would be preempted.
Section 202. Insurance customer protections
Section 202 includes several consumer protection
requirements that the Federal banking agencies will be required
to implement within one year from the date of enactment of the
Act. These requirements would establish federal minimum
consumer protections. They require the promulgation of
regulations--
Prohibiting discrimination against non-affiliated
agents provisions by providing expedited or enhanced
treatment if insurance is purchased from affiliated
agents;
Prohibiting tying and other coercive practices;
Prohibiting misrepresentations regarding the
federally insured or guaranteed status of any insurance
product;
Requiring, to the extent practicable, the separation
of insurance and deposit-taking activities;
Limiting the payment of referral fees to bank tellers
to a nominal amount that may not be based on whether
the referral results in a transaction;
Requiring the disclosure, prior to any insurance
sale, that the insurance is--(1) not a deposit; (2) not
insured by the FDIC; (3) not guaranteed by the
financial institution or its subsidiaries or
affiliates; and (4) where appropriate, involves
investment risk, including loss of principal;
Requiring that an acknowledgment be obtained whenever
a disclosure is required from the customer verifying
receipt of the disclosure.
In promulgating the requisite regulations, the Federal
banking agencies must ensure that the regulations do not have
the practical effect of discriminating, either intentionally or
unintentional, against any person engaged in insurance sales or
solicitations that is not affiliated with an insured depository
institution. The Federal banking regulators are required to
determine whether any parallel state customer protection
requirement is more protective; if it is not, the Federal
banking regulators must advise the State that the Federal
requirement will apply. The State may then ``opt-out'' of this
preemption if it enacts a statute within three years of the
receipt of Federal notice.
Section 203. Federal and State dispute resolution
Section 203(a) provides that in the event of a regulatory
conflict between a State insurance regulator and a Federal
regulator as to insurance issues, including whether a State
statute, regulation, order, or interpretation regarding
insurance sales or solicitation activity is preempted under
Federal law, either regulator may seek expedited judicial
review. Either regulator may file a petition for review in the
U.S. Court of Appeals for the District of Columbia Circuit or
in the U.S. Court of Appeals for the circuit in which the State
is located.
Under Section 203(b), the relevant U.S. Court of Appeals
must complete all action on the petition, including rendering a
judgment, within 60 days from the filing of the petition unless
all parties agree to an extension. Under Section 203(c), any
request for certiorari to the U.S. Supreme Court must be filed
as soon as practicable after the judgment of the U.S. Court of
Appeals is issued. Section 203(d) provides that no action
challenging an order, ruling, determination, or other action of
a Federal or State regulator may be brought under these
procedures after the later of (i) 12-months after the first
public notice of the order, ruling, or determination in its
final form, or (ii) 6-months period after the order, ruling, or
determination takes effect.
Section 203(e) requires the court to base its decision on
an action filed under this section upon its review on the
merits of all questions presented underFederal and State law.
The court must review the nature of the product or activity and the
history and purpose of its regulation under Federal and State law. The
court must accord equal deference to the Federal regulator and the
State insurance regulator.
Title III--Regulatory Improvements
Section 301. Elimination of SAIF and DIF special reserves
Section 301 amends the Federal Deposit Insurance Act to
eliminate the SAIF special reserve created by the Deposit
Insurance Funds Act of 1996.
Section 302. Expanded small bank access to S corporation treatment
Section 302 requires that the GAO conduct a study of
possible revisions to the rules governing S corporations,
including increasing the permissible number of shareholders in
such corporations; permitting shares of such corporations to be
held in individual retirement accounts; clarifying that
interest on investments held for safety, soundness, and
liquidity purposes should not be considered to be passive
income; discontinuation of the treatment of stock held by bank
directors as a disqualifying personal class of stock for such
corporations; and improving Federal tax treatment of bad debt
and interest deductions. The study is also to report on the
impact that such revisions might have on community banks.
Section 303. Meaningful CRA examinations
Section 303 provides that an insured depository institution
rated as ``satisfactory'' or better in its most recent
examination under the CRA, and in each such examination during
the immediately preceding 36-month period shall be deemed to be
in compliance with the requirements of the CRA (i.e., that the
insured depository institution has met the credit needs of its
entire community) until the completion of a subsequent
regularly scheduled CRA examination, unless substantial
verifiable information arising since the time of the most
recent CRA examination demonstrating CRA noncompliance is filed
with the appropriate Federal banking agency. The appropriate
Federal banking agency must determine, on a timely basis,
whether the information filed to challenge the insured
depository institution's CRA compliance provides sufficient
proof of the institution's CRA noncompliance. The person filing
information with the appropriate Federal banking agency bears
the burden of proving the substantial verifiable nature of that
information.
Section 304. Temporary extension of bank insurance fund member FICO
assessment rates
Section 304 extends for three years, until December 31,
2002, the BIF-member FICO assessment rates.
Section 305. Cross-marketing restrictions; limited purpose bank relief;
divestiture
Section 305(a) amends Section 4(f) of the BHCA by striking
paragraph (3). This provision would repeal the current cross
marketing restriction, allowing CEBA banks to cross market
their products and services with the products and services of
affiliates.
Section 305(b) amends Section 4(f) of the BHCA by adding a
new paragraph (3) to permit certain overdrafts. This provision
would expand ``permissible overdrafts'' to include overdrafts
incurred by affiliates that incidentally engage in financial
services activities, if the overdraft is within the
restrictions imposed by Section 23A and 23B of the Federal
Reserve Act.
Section 305(c) amends Section 2(c)(2)(H) of the BHCA.
Section 2(c)(2)(H) exempts industrial loan companies from the
definition of ``bank'' for purposes of the BHCA. Under Section
2(c)(2)(H), the exemption is conditioned on an industrial loan
company's not permitting an overdraft on behalf of an
affiliate, or incurring an overdraft on behalf of an affiliate
at its account at a Federal Reserve bank, unless such overdraft
is the result of an inadvertent computer or accounting error.
Section 305(c) amends Section 2(c)(2)(H) to allow industrial
loan companies to incur the same overdrafts on behalf of
affiliates as are permitted for banks described in Section
4(f)(1) of the BHCA (banks that, prior to the enactment of the
Competitive Equality Banking Act of 1987 (``CEBA''), either
made commercial loans or accepted insured deposits but did not
do both).
Section 305(d) amends Section 4(f) of the BHCA. This
provision repeals therestriction which prohibited limited-
purpose banks from engaging in activities they were not engaged in
prior to March 5, 1987. Limited-purpose banks would still be prohibited
from both accepting demand deposits and engaging in the business of
commercial lending (i.e. a limited-purpose bank can do one or the
other, but not both). This section also clarifies that a limited
purpose bank may acquire without limit the same type of consumer assets
that it can originate.
Section 305(e) amends Section 4(f)(4) of the BHCA. This
section would modify the provision of CEBA which requires
divestiture of a limited-purpose bank in the event the bank or
its owner fails to remain qualified for the CEBA exception. The
amendment allows limited-purpose bank owners to avoid
divestiture by promptly correcting the violation (within 180
days of receipt of notice from the Board) that would otherwise
lead to divestiture and implementing procedures to prevent
similar violations in the future.
Section 306. ``Plain language'' requirement for Federal banking agency
rules
Section 306 directs the Federal banking agencies to use
plain language in all proposed and final rulemakings published
in the Federal Register after January 1, 2000. Not later than
March 1, 2001, each Federal banking agency shall submit to the
Congress a report describing how the agency has complied with
that requirement.
Section 307. Retention of ``Federal'' in name of converted Federal
savings association
Section 307 would permit Federal savings associations that
convert to National or State bank charters to keep the word
``Federal'' in their names. For example, if First Federal
Savings Bank converts from a Federal savings association to a
State bank charter, it may retain its former name.
Section 308. Community Reinvestment Act exemption
Section 308 exempts from the requirements of the CRA FDIC-
insured banks and thrifts with total assets not exceeding $100
million and that are located in non-metropolitan areas. A non-
metropolitan area is defined as any area, no part of which is
within an area designated as a Metropolitan Statistical Area by
the United States Office of Management and Budget. The $100
million amount is to be adjusted annually by the annual
percentage increase in the Consumer Price Index for Urban Wage
Earners and Clerical Workers published by the Bureau of Labor
Statistics.
Section 309. Bank officers and directors as officers and directors of
public utilities
Section 309 amends Section 305(b) of the Federal Power Act
to permit generally officers or directors of public utilities
to serve as officers or directors of banks, trust companies, or
securities firms if certain safeguards against conflicts of
interest are complied with.
Section 310. Control of bankers' banks
Section 310 amends Section 2(a)(5)(E)(i) of the BHCA to
allow one or more thrift institutions to own a state-chartered
bank or trust company, whose business is restricted to
accepting deposits from thrift institutions or savings banks;
deposits arising from the corporate business of the thrift
institutions or savings banks that own the bank or trust
company; or deposits of public funds.
Section 311. Multi-state licensing and interstate insurance sales
activities
This section expresses the sense of the Congress that by
the end of the 36-month period beginning on the date of
enactment of the Act, the States should implement uniform
insurance agent and broker licensing application and
qualification requirements; eliminate pre- or post-licensure
requirements having the practical effect of discriminating,
directly or indirectly, against nonresident insurance agents or
brokers; and if such actions are not taken, Congress should
take steps to rectify the problems noted. Any entity
established by the Congress should be under the supervision and
oversight of the National Association of Insurance
Commissioners.
Title IV--Federal Home Loan Bank System Modernization
Section 401. Short title
Section 401 designates this subtitle as the ``Federal Home
Loan Bank System Modernization Act of 1999''.
Section 402. Definitions
Section 402 provides technical changes to definitions
within the Federal Home Loan Bank Act (``FHLBA''). It also
creates a new class of ``community financial institutions''
with average total assets less than $500 million, based on an
average of total assets over the preceding 3 years. Adjustments
to the $500 million limit will be made annually based on the
annual percentage increase, if any, in the Consumer Price Index
for all urban consumers, as published by the Department of
Labor.
Section 403. Savings association membership
Section 403 makes Federal Home Loan Bank (``FHLBank'')
membership voluntary, as of June 1, 2000, for savings and loan
associations. Under current law, membership is mandatory.
Section 404. Advances to members; collateral
Section 404 expands the types of assets which can be
pledged as collateral for advances for certain institutions.
Currently, only mortgage loans, mortgage-backed securities,
FHLBank deposits, and certain other real estate assets may be
used as collateral for advances. Many smaller banks are unable
to hold sufficient mortgage loans to pledge as collateral. The
bill would permit banks with assets of $500 million or less, to
pledge secured small business and agriculture loans as
collateral (including securities representing a whole interest
in such secured loans), and use the advances to fund small
business, small farm and small agri-business loans. The Federal
Housing Finance Board (``FHFB'') would also be allowed to
review, and if necessary for safety and soundness, increase
certain collateral standards.
Section 405. Eligibility criteria
Section 405 waives the ten percent residential mortgage
asset test for FDIC-insured institutions with assets of $500
million dollars or less. All institutions are currently
required to have ten percent of their total assets in
residential mortgage loans in order to become members of the
system.
Section 406. Management of banks
Section 406 transfers from the FHFB to the individual
FHLBanks authority over a number of operational areas,
including director and employee compensation, terms and
conditions for advances, interest rates on advances, dividends,
and forms for advance applications. The section also clarifies
other powers and duties of the FHFB with regard to enforcement.
Section 407. Resolution Funding Corporation
Section 407 changes the current annual $300 million funding
formula for the Resolution Funding Corporation obligations of
the FHLBanks to a percentage of annual net earnings. This
change will become effective on June 1, 2000.
Section 408. GAO study on Federal Home Loan Bank System capital
Section 408 directs the GAO to conduct a study of possible
revisions to the capital structure of the FHLB System,
including the need for more permanent capital; a statutory
leverage ratio; a risk-based capital structure; and the impact
such revisions might have on the operations of the FHLB System.
Title V--Functional Regulation of Brokers and Dealers
Section 501. Definition of broker
Section 501 amends the Securities and Exchange Act of 1934
(the ``1934 Act'') definition of ``broker'' to narrow the
blanket exemption for banks. A ``broker'' is defined as ``any
person engaged in the business of effecting transactions in
securities for the account of others''. The bill exempts a bank
from classification as a ``broker'' only to the extent that the
bank engages in activities that are enumerated in this section.
Section 502. Definition of dealer
Section 502 amends the 1934 Act's blanket exemption for
banks from the definition of ``dealer''. A ``dealer'' is
defined as ``any person engaged in the business of buying or
selling securities for such person's own account through a
broker or otherwise''. The bill exempts a bank from
classification as a ``dealer'' only to the extent that the bank
engages in: transactions for investment purposes for accounts
where the bank acts as a trustee or fiduciary; transactions in
commercial paper, bank acceptances, commercial bills, qualified
Canadian government obligations, and Brady bonds; the issuance
or sale of asset backed securities to qualified investors; or
transactions in ``traditional banking products.''
Section 503. Definition and treatment of banking products
Section 503 defines ``traditional banking product,'' for
the purposes of the bank broker-dealer exemptions. The
definition includes: deposit accounts; deposit instruments
issued by a bank; bankers acceptances; letters of credit or
loans issued by a bank; debit accounts arising from a credit
card or similar arrangement; loan participations sold to
qualified investors; and swap agreements as defined in Section
11(e)(8)(D)(vi) of the Federal Deposit Insurance Act.
With respect to new products, the Commission may, with the
concurrence of the Board, determine by regulation that a new
product is a security, subject to registration with the
Commission, as opposed to a banking product. The Commission may
not require the registration of a new product as a security
unless, with the concurrence of the Board, the SEC determines
by regulation thatthe product is a new product; the product is
a security; and that the imposition of registration requirements is
necessary or appropriate in the public interest and for the protection
of investors. The section makes clear that the rights or authority of
the Board, any appropriate Federal banking agency, or any interested
party under any other provision of law shall not be affected in any way
to object to or seek judicial review as to whether a product or
instrument is or is not appropriately classified as a traditional
banking product.
Section 504. Qualified investor defined
Section 504 defines ``qualified investor'' to include: any
registered investment company; bank; savings and loan
association; broker; dealer; insurance company; business
development company; licensed small business investment
company; State sponsored employee benefit plan or employee
benefit plan under ERISA (other than an IRA); certain trusts;
any market intermediary; any foreign bank or any foreign
government; any corporation, company or individual who owns and
invests at least $10 million; any government or political
subdivision who owns and invests at least $50 million; and any
multinational or supra-national entity; or any other person
that the Commission determines to be a qualified investor.
Section 505. Government securities defined
Section 505 amends the 1934 Act definition of ``government
securities'' to include qualified Canadian government
obligations for the purposes of Section 15C (which governs
government securities brokers) as applied to a bank.
Section 506. Effective date
Section 506 provides that the subtitle shall take effect
one year after enactment.
Section 507. Rule of construction
Section 507 provides that the bill shall not be construed
so as to limit the scope or applicability of the Commodity
Exchange Act.
Title VI--Unitary Savings and Loan Holding Companies
Section 601. Prevention of creation of new S&L holding companies with
commercial affiliates
Section 601 amends Section 10(c) of the Home Owners' Loan
Act to terminate expanded powers for new unitary savings and
loan holding companies, excepting those that become a savings
and loan holding company pursuant to an application filed with
the OTS on or before February 28, 1999. Certain existing
unitary savings and loan holding companies are exempted from
these restrictions. In particular, these prohibitions do not
apply to a unitary savings and loan holding company in
existence on February 28, 1999, or that was formed pursuant to
an application pending before the OTS on or before that date,
provided that the company continues to meet the requirements to
be a unitary savings and loan holding company under 12 U.S.C.
1467a(c)(3) and controls at least one of the savings
associations that the company controlled (or had applied to
control) as of February 28, 1999, or the successor to such a
savings association (a ``grandfathered unitary savings and loan
holding company'').
regulatory impact statement
In accordance with paragraph 11(g), rule XXVI of the
Standing Rules of the Senate, the Committee makes the following
statement regarding the regulatory impact of the bill.
The bill establishes a comprehensive framework to permit
affiliations between banks, securities firms and insurance
companies. It would modernize and reform outdated laws
governing the financial system. The new framework promotes
competition, enhances consumer choice, safeguards the Federal
deposit insurance system, and protects the safety and soundness
of insured depository institutions and the stability of the
payment system.
The bill reduces substantially the current regulatory
burdens placed on financial intermediaries--banks, broker-
dealers, insurance and securities firms--in several ways.
First, the bill incorporates the principle of functional
regulation. By clearly allocating regulatory responsibility to
Federal and State financial regulators, the proposed system of
functional regulation promotes efficiency, eliminates
regulatory overlap and duplication, and promotes increased
investor, depositor and taxpayer protections.
Second, the bill streamlines the regulatory process by
requiring coordination and information-sharing between the
various Federal and State regulators. The bill seeks to provide
regulation of financial holding companies that is sufficient to
protect the safety and soundness of the financial system and
the integrity of the Federal deposit insurance funds without
imposing unnecessary regulatory burdens.
Third, the bill eliminates many notification and approval
procedures mandated under current law. Because the bill seeks
to streamline and update the financial regulatory framework,
the Committee believes that this legislation will have a
favorable regulatory impact.
congressional budget office cost estimate
Senate rule XXVI, section 11(b) of the Standing Rules of
the Senate, and Section 403 of the Congressional Budget
Impoundment and Control Act, require that each committee report
on a bill containing a statement estimating the cost of the
proposed legislation, which was prepared by the Congressional
Budget Office. The Congressional Budget Office Cost Estimate
and its Estimate of Costs of Private-Sector Mandates, both
dated April 22, 1999, are hereby included in this report.
Congressional Budget Office,
U.S. Congress,
Washington, DC, April 22, 1999.
Hon. Phil Gramm,
Chairman, Committee on Banking, Housing, and Urban Affairs, U.S.
Senate, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate and mandate statements for
the Financial Services Modernization Act of 1999. One enclosure
includes the estimate of federal costs and the estimate of the
impact of the legislation on state, local, and tribal
governments. The estimated impact of mandates on the private
sector is discussed in a separate enclosure.
If you wish further details on these estimates, we will be
pleased to provide them. The CBO staff contacts are Robert S.
Seiler (for costs to the Federal Home Loan Banks), Mary
Maginniss (for other federal costs), Carolyn Lynch (for federal
revenues), Marjorie Miller (for the state and local impact),
and Patrice Gordon (for the private-sector impact).
Sincerely,
Barry B. Anderson
(For Dan L. Crippen, Director).
Enclosures.
Financial Services Modernization Act of 1999
Summary
The bill would eliminate certain barriers to ties between
insured depository institutions and other financial services
companies, including insurance and securities firms. While
these changes could affect the government's spending for
deposit insurance, CBO has no basis for predicting whether the
long-run costs of deposit insurance would be higher or lower
than under current law. Because insured depository institutions
pay premiums to cover these costs, any such changes would have
little or not net impact on the budget over the long term.
CBO estimates that implementing this act would decrease
other direct spending by $42 million in 2000 and $338 million
over the 2000-2004 period, and would decrease revenues by $3
million in 2000 and $15 million over the 2000-2004 period.
Because the bill would affect direct spending and receipts,
pay-as-you-go procedures would apply. Assuming appropriation of
the necessary amount, CBO estimates that federal agencies would
spend $3 million to $4 million annually from appropriated funds
to carry out the provisions of the bill.
The legislation contains several intergovernmental mandates
as defined in the Unfunded Mandates Reform Act (UMRA), but CBO
estimates that these mandates would not impose significant
costs on state, local, or tribal governments. Any such costs
would not exceed the threshold established by that act ($50
million in 1996, adjusted annually for inflation). The bill
also contains private-sector mandates as defined in UMRA. CBO's
estimate of the cost of those private-sector mandates is
detailed in a separate statement.
Description of the bill's major provisions
The Financial Services Modernization Act of 1999 would:
Permit affiliations of banking, securities, and
insurance companies;
Eliminate the requirement that the Federal Deposit
Insurance Corporation (FDIC) retain a ``special
reserve'' for the Savings Association Insurance Fund
(SAIF);
Amend the Federal Deposit Insurance Act to prevent
the use of deposit insurance funds to assist affiliates
or subsidiaries of insured financial institutions;
End the requirement that banks and thrifts located in
rural areas and having assets less than $100 million
comply with the provisions of the Community
Reinvestment Act (CRA);
Reform the Federal Home Loan Bank (FHLB) System,
making membership voluntary and replacing the $300
million annual payment made by the FHLBs for interest
on bonds issued by the Resolution Funding Corporation
(REFCORP) with an assessment set at 20.75 percent of
the FHLBs' net income;
Require the Federal Reserve, along with the Treasury,
to determine which activities bank holding companies
may engage in;
Create a system of functional regulation, whereby
institutions that conduct banking, securities, or
insurance activities would be regulated by the agency
responsible for each such activity (regulatory
conflicts on insurance issues between federal and state
regulators would be resolved on an expedited basis by
the federal courts);
Terminate the authority of the Office of Thrift
Supervision (OTS) to grant new thrift charters for
unitary savings and loan holding companies for all
applications other than those approved or pending as of
February 28, 1999;
Extend for three more years the formula for
determinig how much BIF-insured and SAIF-insured
institutions will pay towards the interest payment on
bonds that the Financing Corporation (FICO) issued to
help pay for losses of failed savings institutions;
Require federal banking agencies to develop
regulations governing sales or offers of insurance
products; and
Require the General Accounting Office (GAO) to
prepare two reports.
Estimated cost to the Federal Government
The bill would make a number of changes affecting direct
spending and revenues, which would result in net increases in
spending by the banking regulatory agencies, decreased spending
by the Treasury, and a decrease in the annual payment--recorded
as revenues--that the Federal Reserve remits to the Treasury.
Assuming enactment late in fiscal year 1999, CBO estimates that
direct spending would decrease by about $338 million over the
2000-2004 period and that revenues would decline by $15 million
over the same period. The legislation also would lead to an
increase in discretionary spending of an estimated $16 million
over the 2000-2004 period, assuming appropriation of the
necessary amounts. The estimated budgetary impact is shown in
the following table. The outlay effects fall within budget
functions 370 (commerce and housing credit) and 900 (interest).
----------------------------------------------------------------------------------------------------------------
By fiscal year, in millions of dollars--
-----------------------------------------------------------------
1999 2000 2001 2002 2003 2004
----------------------------------------------------------------------------------------------------------------
DIRECT SPENDING
Spending Under Current Law: \1\
Estimated Budget Authority................ 3,830 3,830 3,830 3,830 3,830 3,830
Estimated Outlays......................... -1,503 473 1,438 2,074 2,564 2,967
Proposed Changes:
Estimated Budget Authority................ 0 -45 -63 -71 -80 -87
Estimated Outlays......................... 0 -42 -61 -70 -79 -86
Spending Under the Bill:
Estimated Budget Authority................ 3,830 3,785 3,767 3,759 3,750 3,743
Estimated Outlays......................... -1,503 431 1,377 2,004 2,485 2,881
CHANGES IN REVENUES
Estimated Revenues \2\........................ 0 -3 -3 -3 -3 -3
CHANGES IN SPENDING SUBJECT TO APPROPRIATION
Estimated Authorization Level................. 0 4 3 3 3 3
Estimated Outlays............................. 0 4 3 3 3 3
----------------------------------------------------------------------------------------------------------------
\1\ Includes spending for deposit insurance activities (subfunction 373) and Treasury payments for interest on
REFCORP bonds.
\2\ Includes changes in the annual payment from the Federal Reserve to the Treasury. A negative sign indicates a
decrease in revenues.
Basis of estimate
Direct Spending and Revenues: The Financial Services
Modernization Act could affect direct spending for deposit
insurance by increasing or decreasing amounts paid by the
insurance funds to resolve insolvent institutions and to cover
the administrative expenses necessary to implement its
provisions. Changes in spending related to failed banks and
thrifts could be volatile and vary in size from year to year,
but any such costs would be offset by insurance premiums. Thus,
their budgetary impact would be negligible over time. The major
budgetary impact of the bill would stem from an increase in the
annual payments by the FHLBs for interest on bonds issued by
the REFCORP. As a result, Treasury outlays for such interest
would decline. In addition, changes in regulatory activities
would result in small outlay increases and revenue decreases.
Deposit Insurance Funds.--Enacting the bill could affect
the federal budget by causing changes in the government's
spending for deposit insurance, but CBO has no clear basis for
predicting the direction or the amount of such changes. Changes
in spending for deposit insurance could be significant in some
years, but would have little or no net impact on the budget
over time.
A number of provisions in the bill could affect spending by
the deposit insurance funds. Some are likely to reduce the
risks of future bank failures. For example, the bill would
permit affiliations of banking, securities, and insurance
companies, thereby giving such institutions the opportunity to
diversify and to compete more effectively with other financial
businesses. Changes in the marketplace, particularly the
effects of technology, have already helped to blur the
distinctions among financial service firms. Further, regulatory
and judicial rulings continue to erode many of the barriers
separating different segments of the financial services
industry. For example, banks now sell mutual funds and
insurance to their customers and, under limited circumstances,
may underwrite securities. At the same time, some securities
firms offer checking-like accounts linked to mutual funds and
extend credit directly to businesses. Because the legislation
would clarify the regulatory and legal structure that currently
governs bank activities, CBO expects that its enactment would
allow banks to compete more effectively and efficiently in the
rapidly evolving financial services industry. Diversifying
income sources also could result in lower overall risks for
banks, assuming that the expansion of their activities is
accompanied by adequate safeguards. The bill would specifically
prohibit the FDIC from using the resources of the BIF to assist
affiliates or subsidiaries of insured financial institutions.
It is also possible, however, that losses to the deposit
insurance fund could increase as a result of enacting the bill.
The increase in scale and complexity of the new financial
holding companies could challenge the ability of the regulators
to manage any additional risk of losses to the deposit
insurance funds. If additional losses were to occur, the BIF
would increase premiums that banks pay for deposit insurance.
Similarly, if losses were to decrease, banks might pay smaller
premiums. As a result, the net budgetary impact over the long
term is likely to be negligible in either case.
Federal Home Loan Banks.--The bill would make a number of
reforms to the FHLB system. Beginning in 2000, membership in
the FHLB system would become voluntary. The bill also would
require the FHLBs to replace the $300 million annual payment
for the interest on bonds issued by the REFCORP with an
assessment set at 20.75 percent of the FHLBs' net income. The
Federal Housing Finance Board, which regulates the FHLBs, would
be authorized to extend or shorten the period over which
payments are made such that, over time, the average payment
would equal $300 million a year, on a present-value basis.
Based on CBO's analysis of the FHLB system's balance sheet
and income statement, and using CBO's current economic
assumptions, we estimate that the provisions affecting the
FHLBs would increase their payments to REFCORP by $45 million
in 2000 and a total of $346 million over the 2000-2004 period.
CBO expects that the estimated increase in payments in the near
term would be offset by a decrease in payments of an equal
amount (on a present-value basis) in future years.
The FHLB system is a government-sponsored enterprise and
its activities are not included in the federal budget. But,
because the Treasury pays the interest on REFCORP bonds not
covered by the FHLBs, this change would reduce Treasury outlays
by $346 million over the five-year period.
Regulatory Costs.--The Federal Reserve, the Securities and
Exchange Commission (SEC), the state banking regulators, and
other federal banking regulators--the Office of the Comptroller
of the Currency (OCC), the FDIC, and the OTS--would have
primary responsibility for monitoring compliance with the
statute. CBO expects that higher costs for regulatory
activities would increase outlays by $9 million and would
decrease revenues by $15 million over the 2000-2004 period.
The banking agencies would be required to implement new
regulations, policies, and training procedures related to
securities, insurance, and other areas. The bill also would
permit national banks with assets of $1 billion or less to
conduct certain financial activities through operating
subsidiaries. CBO expects that the FDIC would spend between $3
million and $4 million annually for these new activities. The
OCC and the OTS would also incur annualexpenses for these
purposes--estimated to total between $1 million and $2 million for each
agency, but those costs would be offset by increased fees, resulting in
no net change in outlays for those agencies.
Under this legislation, in insuring compliance with the CRA
statutes, banking regulators would no longer have to examine
institutions with assets less than $100 million (indexed for
inflation) and located in a rural area--about 37 percent of all
insured banks and thrifts. We estimate that the FDIC would
realize savings of about $2 million annually from this change.
CBO estimates that savings from fewer CRA exams for the OTS and
for the OCC would total about $1 million annually for each
agency. The OTS and the OCC would reduce fees to reflect these
savings, resulting in no net budgetary effects.
CBO estimates that, under this bill, the Federal Reserve
would spend an additional $15 million over the 2000-2004
period. This bill would require it to supervise the activities
of new bank holding companies and, in conjunction with the
Treasury Department, to define new financial activities. Based
on information from the Board of Governors of the Federal
Reserve System, CBO estimates that the Federal Reserve's new
supervisory activities would result in added examination costs
of about $4 million per year once the act's requirements were
fully effective in 2000. That increase in examination costs
would total an estimated $20 million over the 2000-2004 period.
The Federal Reserve's cost of processing applications is not
expected to be affected. Applications for the newly authorized
activities of holding companies would increase, but the added
workload would likely be offset by a decrease in applications
for nonbanking activities, resulting in no significant net
budgetary impact.
The reduction in government receipts would be partially
offset by a lowering of examination costs due to the amendment
to CRA. The exemption from CRA of non-metropolitan financial
institutions with assets of $100 million or less would result
in less stringent examination, thereby decreasing the operating
costs of the Federal Reserve System. Based on information
provided by the Federal Reserve, we estimate that the CRA
amendment would save the Federal Reserve $1 million annually
beginning in 2000, for a total of $5 million over the 2000-2004
period. Other provisions in the bill would not significantly
affect spending by the Federal Reserve.
The net effect of these provisions on the administrative
costs of the Federal Reserve would be an increased in costs of
$15 million over the 2000-2004 period. Because the Federal
Reserve System remits its surplus to the Treasury, the
increased costs would reduce governmental receipts, or
revenues, by the same amount.
SAIF Special Reserves.--The bill would repeal the
requirement for the Savings Association Insurance Fund to
retain a special reserve fund. CBO expects that the cost of
that repeal would total less than $500,000 in any year. The
Deposit Insurance Funds Act of 1996 required the Federal
Deposit Insurance Corporation to set aside, on January 1, 1999,
all balances in the SAIF in excess of the required reserve
level of $1.25 per $100 of insured deposits. The funds in this
special reserve become available to pay for losses in failed
institutions only if the SAIF's balance (excluding the reserve)
subsequently falls below 50 percent of the required reserve
level, and the FDIC determines that it is expected to remain at
that level for a year. In January 1999, the FDIC allocated $1
billion of the SAIF's balances to the special reserve. CBO's
baseline assumes administrative costs and thrift failures will
remain sufficiently low to avoid raising assessment rates on
SAIF-insured institutions through 2004. We expect that the
SAIF's fund balances of about $10 billion will continue to earn
interest, and that the fund's ratio of reserves to insured
deposits will climb each year, reaching over 1.4 percent by
2004.
Although CBO's baseline estimates do not assume that the
cost of thrift failures in any year would exceed the net
interest earned by the SAIF, unanticipated thrift failures
could result in a drop in the SAIF's reserve ratio below 1.25
percent. The baseline reflects CBO's best judgment as to the
expected value of possible losses during a given year, but
annual losses will likely vary from the levels assumed in the
CBO baseline. Thus, some small probability exists that thrift
failures could increase sufficiently to drive the reserve ratio
below the required level of 1.25 percent, but not so low as to
trigger use of the special reserve.
When the balance of an insurance fund dips below the
required ratio, the FDIC is forced to increase assessments for
deposit insurance to restore the fund balance to the required
level. Thus, if thrift losses were to exceed baseline estimates
by a significant amount, we would expect the FDIC to increase
insurance premiums in order to maintain the SAIF's fund
balance. Eliminating the special reserve would add to the fund
balances and would make it less likely that the FDIC would have
to raise insurance premiums. The probability that this change
would affect premium rates is quite small, however, and
therefore CBO expects that the loss of deposit insurance
premiums that could result from eliminating the special reserve
would total less than $500,000 in any year.
Spending Subject to Appropriation: A number of federal
agencies would be responsible for monitoring changes resulting
from enactment of the legislation. CBO estimate that total
costs, assuming appropriation of the necessary amounts, would
be about $3 million annually beginning in 2000, primarily for
expenses of the SEC, GAO, and the Treasury Department. The SEC
would incur costs to monitor market conditions, to examine
firms offering certain security products, and to investigate
practice to ensure compliance with the statute. We expect these
additional rulemaking, inspection, and administrative expenses
of the SEC would total about $2 million annually.
The bill would require several reports and would direct GAO
to conduct two studies. CBO estimates that GAO would spend
about $1 million in 2000 to prepare the reports.
Pay-as-you-go considerations
The Balanced Budget and Emergency Deficit Control Act sets
up pay-as-you-go procedures for legislation affecting direct
spending or receipts. Legislation providing funding necessary
to meet the deposit insurance commitment is excluded from these
procedures. Most of the FDIC's additional costs that would
result from this bill ($3 million to $4 million a year) would
be covered by this exemption. CBO believes that the various
costs of the legislation related to consumer protection and
eliminating SAIF's special reserve, along with the savings
related to CRA compliance, would not qualify for the exemption
that applies to the full funding of the deposit insurance
commitment, and thus would count for pay-as-you go purposes.
These changes would result in a net decrease in the FDIC's
supervisory costs totaling about $2 million annually, for a
total of $23 million over the 2000-2009 period. Net savings
each year for similar activities of the OCC and the OTS, which
are estimated to total about $1 million for each agency, would
be offset by increases in fees of an equal amount, resulting in
no significant net budgetary impact for those agencies.
CBO estimates that provisions affecting the FHLBs would
result in an increase in their payments for REFCORP interest,
and a corresponding decrease in Treasury outlays, totaling $919
million over the 2000-2009 period.
CBO estimates that the exemption from the requirements of
CRA for certain depository institutions would reduce the
administrative costs of the Federal Reserve and thus increase
Treasury receipts by $1 million per year beginning in 2000,
increasing to $2 million by 2005, for a total of $15 million
over the 2000-2009 period. CBO also expects that the Federal
Reserve would incur additional expenses associated with
consumer issues that are not directly related to protecting the
deposit insurance commitment. We estimate that the resulting
increase in regulatory and other costs would reduce the surplus
payment that the Federal Reserve remits to the Treasury by less
than $500,000 annually.
The net changes in outlays and governmental receipts that
are subject to pay-as-you-go procedures are shown in the
following table. For the purposes of enforcing pay-as-you-go
procedures, only the effects in the current year, the budget
year, and the succeeding four years are counted.
--------------------------------------------------------------------------------------------------------------------------------------------------------
By fiscal year, in millions of dollars--
-------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
--------------------------------------------------------------------------------------------------------------------------------------------------------
Changes in outlays:
DIC..................................................... 0 -2 -2 -2 -2 -2 -2 -2 -2 -2 -3
REFCORP payment......................................... 0 -45 -63 -71 -80 -87 -94 -100 -109 -126 -144
-------------------------------------------------------------------------------------------
Total................................................. 0 -47 -65 -73 -82 -89 -96 -102 -111 -128 -147
Changes in receipts......................................... 0 1 1 1 1 1 2 2 2 2 2
--------------------------------------------------------------------------------------------------------------------------------------------------------
Estimated impact on State, local, and tribal governments
This bill contains a number of intergovernmental mandates
as defined in UMRA, but CBO estimates that these mandates would
not impose significant costs on state, local, or tribal
governments. Any such costs would not exceed the threshold
established by that act ($50 million in 1996, adjusted annually
for inflation). Other provisions in the bill, which are not
mandates, would affect the budgets of state and local
governments, and are discussed below.
Mandates: A number of provisions in the bill would preempt
state banking, insurance, and securities laws. States would not
be allowed to prevent or restrict either the affiliations
between banks, securities firms, and insurance companies
authorized by the bill, or the expanded activities permitted
banks by the bill. Further, while the bill would endorse
states' primary role in licensing and regulating insurance
operations, it would preempt their authority over these
operations in a number of ways.
Based on information provided by organizations representing
state and local governments, CBO expects that enactment of
these provisions would not result in significant costs for such
governments. While they would be prevented from enforcing
certain rules and regulations, they would not be required to
undertake any new activities.
Other impacts: State and local governments might benefit
from a provision of this bill that would give national banks
the authority to underwrite certain state and local
obligations, including municipal revenue bonds. This provision
would widen the market for these obligations and could reduce
state and local borrowing costs.
To the extent that enactment of this bill would facilitate
the integration of different types of financial services, it
may have a variety of impacts on state finances. It is possible
that its enactment could affect states' administrative and
legal costs, revenues from fees imposed on regulated
businesses, and insurance guarantee funds. It would be
difficult, however, to separate the impact of this legislation
from ongoing changes to the structure and regulation of
financial services occurring under current federal law.
Estimated impact on the private sector
The bill would impose several private-sector mandates as
defined in UMRA. CBO's analysis of those mandates is contained
in a separate statement on private-sector mandates.
Estimate prepared by: Costs for FHLB's: Robert S. Seiler;
Other Federal Costs: Mary Maginniss; Federal Revenues: Carolyn
Lynch; Impact on State, Local, and Tribal Governments: Marjorie
A. Miller.
Estimate approved by: Robert A. Sunshine, Deputy Assistant
Director for Budget Analysis.
congressional budget office estimate of costs of private-sector
mandates
Financial Services Modernization Act of 1999
Summary
Overall, the bill would reduce existing federal regulation
of the financial services industry by relaxing certain
restrictions on financial transactions throughout the economy.
In particular, the bill would eliminate certain barriers to
affiliations among banking organizations and other financial
firms, including insurance firms and securities businesses. At
the same time the bill would impose restrictions on newly
authorized financial activities and prohibit associations
between thrifts and commercial entities through new unitary
thrift holding companies.
The bill would impose several new private-sector mandates
as defined by the Unfunded Mandates Reform Act of 1995 (UMRA).
The mandates in the bill would affect the Federal Home Loan
Banks, banking organizations, U.S. operations of foreign banks,
and insured depository institutions that pay interest on bonds
issued by the Financing Corporation. CBO estimates that the net
direct costs of mandates in the bill would not exceed the
statutory threshold for private-sector mandates ($100 million
in 1996 dollars, adjusted annually for inflation) in any one
year for the first five years that the mandates are effective.
Private-sector mandates contained in bill
The bill contains several new mandates on businesses in the
financial services sector. If enacted, the principal mandates
in the bill would:
Replace the $300 million fixed annual payment for
interest on Resolution Funding Corporation (REFCORP)
bonds with a 20.75 percent annual assessment on the net
earnings of the Federal Home Loan Banks (FHLBs);
Require banking organizations to adopt several
consumer protection measures affecting sales of
insurance products;
End the blanket exemption provided banks from the
definition of ``broker,'' and ``dealer,'' making them
subject to regulation by the Securities and Exchange
Commission;
Require that foreign banks seek approval from the
Federal Reserve before establishing separate
subsidiaries or using nonbank subsidiaries to act as
representative offices that handle primarily
administrative matters, and give the Federal Reserve
the authority to examine a U.S. affiliate of a foreign
bank with a representative office; and
Extend the current two-tiered schedule of Financing
Corporation (FICO) assessment rates for an additional
three years which under current law, would be replaced
by a uniform rate for banks and thrifts starting on
January 1, 2000.
Estimated direct cost to the private sector
Most of the cost of the mandates in the bill would result
from changes in payments from the Federal Home Loan Banks to
REFCORP. CBO estimates the Federal Home Loan Banks would
increase their payments to REFCORP by a total of $346 million
over the 2000-2004 period as compared with current law. The
short-term costs are somewhat misleading, however, because CBO
expects that the estimated increase in payments in the near
term would be offset by a decrease in payments of an equal
amount (on a present-value basis) in future years.
Mandates on banks, banking organizations, and foreign banks
would impose some incremental costs of compliance on the
industry. The additional costs to these institutions would
depend on the actions of regulators and the degree to which new
customer protection regulations would preempt state laws. The
direct costs of mandates on banks and banking organizations
could be at least partially offset by savings from changes the
bill would make to expand the powers of banks and bank holding
companies. Because of the multiple uncertainties involved and
the complex interactions in the financial services sector,
CBOcannot estimate the direct costs, net of savings, with any
precision. However, based on discussions with federal banking agencies,
securities regulators, and industry trade groups, CBO expects that the
costs to banking organizations and domestic operations of foreign banks
of complying with mandates in the bill are not likely to exceed the
annual threshold established in UMRA.
Insured depository institutions pay interest on FICO bonds
based on their deposits in the Savings Association Insurance
Fund (SAIF) and the Bank Insurance Fund (BIF). The increase in
costs to institutions that would pay a high premium on SAIF-
assessable deposits (as compared with the expected premium rate
under current law) would be completely offset by savings to
institutions that would pay a lower premium on BIF-assessable
deposits.
Federal Home Loan Bank System: Section 407 would replace
the current method of payment made by FHLBs for the interest on
REFCORP bonds with a 20.75 percent assessment on the annual net
earnings of each FHLB. That is, FHLBs would no longer have to
pay a fixed amount regardless of annual earnings; under the
bill they would have to pay a fixed percentage of net earnings.
Based on projections of net earnings, CBO estimates that the
new assessment rate would increase the payments made by FHLBs
above the current payment of $300 million annually by $45
million in fiscal year 2000 and a total of $346 million over
the 2000-2004 period. However, CBO expects that the present
value of the total amount paid by the FHLBs to the federal
government would not change. The bill would authorize the
Federal Housing Finance Board, which regulates the FHLBs, to
extend or shorten the period over which payments are made such
that, over time, the average payment would equal $300 million a
year, on a present-value basis.
Consumer Protection Regulations--Insurance Sales: Section
202 would direct the federal banking regulators to issue,
within one year of enactment, final consumer protection
regulations that would govern the sale of insurance by any bank
or by any person at or on behalf of a bank. According to the
bill, the regulations should include requirements for: (1)
anti-coercion rules (prohibiting banks from misleading
consumers into believing that an extension of credit is
conditional upon the purchase of insurance); (2) oral and
written disclosures about whether a product is insured by the
Federal Deposit Insurance Corporation (FDIC), about the risk
associated with certain products, and about the prohibition
against anti-tying and anti-coercion practices; (3) customer
acknowledgment of disclosures; (4) an appropriate delineation
of the settings and circumstances under which insurance sales
should be physically segregated from bank loan and teller
activities; and (5) rules against misleading advertising.
Except for the anti-coercion provision, the provisions in
section 202 are based on current industry guidelines issued in
1994 by bank regulators in an Interagency Statement on Retail
Sales of Nondeposit Investment Products. The anti-coercion
provision is similar to the anti-tying provision in current
law. Other new regulations would largely codify a modified
version of existing guidelines drafted by the federal banking
regulators and, therefore, would not likely impose large
incremental costs on banks that currently engage in insurance
activities. Moreover, in states where state insurance laws are
inconsistent with the prescribed federal regulations but deemed
to be at least as protective as those regulations, the new
federal insurance customer protection regulations would not
apply.
Regulation of Securities Services: The Glass-Steagall Act
generally prohibits banks from underwriting and dealing in
securities, except for ``bank-eligible'' securities. Eligible
securities are limited to those offered and backed by the
federal government and federally-sponsored agencies, and
certain state and local government securities. As banks have
sought to expand their product lines, federal regulators have
provided banks, through affiliated firms, limited authority to
underwrite and deal in other types of securities. Generally, a
firm that provides securities brokerage services (known as a
broker-dealer) must register with and be regulated by the
Securities and Exchange Commission (SEC) and at least one self-
regulatory organization such as the National Association of
Securities Dealers, the New York Stock Exchange, or the
American Stock Exchange. Banks, however, are currently exempted
from those requirements.
The bill would end the current blanket exemption for banks
from being treated as brokers or dealers under the Securities
Exchange Act of 1934. Securities activities of banks would,
therefore, be subject to SEC regulations, with some exceptions.
The bill would exempt from SEC regulation the securities
activities of banks handling fewer then 500 transactions
annually. Many of the roughly 300 small banks that currently
provide brokerage services on bank premises would fall under
this exemption. Sections 501 and 502 also would exempt several
traditional securities activities of banks from the
registration requirements and regulations that apply to brokers
or dealers under SEC regulation. The exemptions would cover
most products and services that banks currently offer as agents
so that they would not trigger SEC regulation. However, for the
products and services related to securities that would no
longer be exempt under the bill, banks would most likely
channel the non-exempt activities through their own securities
affiliate or establish a relationship with a broker-dealer. A
substantial number of banks that currently handle securities
activities have a broker-dealer affiliate so that the
incremental cost of complying with SEC regulation would involve moving
non-exempt activities to such an affiliate and would not be
significant.
Foreign Banks: Section 152 would amend the International
Banking Act of 1978 (IBA) to require that foreign banks seek
prior approval from the Federal Reserve Board for establishing
separate subsidiaries or using nonbank subsidiaries to act as
representative offices. Under current law, a foreign bank must
obtain the approval of the Federal Reserve Board (FRB) before
establishing a representative office in the United States. A
representative office handles administrative matters and some
types of sales for the foreign bank owner, but it does not
handle deposits. In some cases, foreign banks are establishing
separate subsidiaries or using nonbank subsidiaries to act as
representative offices and thereby escaping the requirement for
approval by the FRB. The bill would strike the exclusion for
subsidiaries from the IBA and close this loophole. The industry
association estimates that there are fewer than 20 entities
that would have to register their subsidiaries as a
representative office. CBO expects that the cost to existing
subsidiaries of filing with the FRB would be small.
Section 152 also would require that U.S. affiliates of
foreign banks with a representative office be subject to
examination by the Federal Reserve Board. Under current law, if
a foreign bank has only a representative office and no other
banking office in the United States, the FRB may examine only
the representative office. The FRB cannot examine or seek
information from U.S. affiliates of such a foreign bank. The
bill would give the FRB the authority to examine a foreign bank
affiliate in this situation. CBO has no basis for estimating
the potential costs to the industry of such examinations.
According to one industry expert, it is likely that the FRB
would only use this authority in a case where suspicious
behavior warrants further examination. If the FRB would examine
affiliates under such limited circumstances, the costs of the
mandate to the industry would be very modest.
Three-Year Extension of FICO Assessment Rates: The Deposit
Insurance Funds Act of 1996 provided for the payment of
interest on bonds issued by the Financing Corporation. Those
payments which amount to approximately $780 million per year,
are made by all institutions that are covered by FDIC
insurance. Under the act, the FICO obligation was to be split
between Bank Insurance Fund (BIF) deposits and Savings
Association Insurance Fund (SAIF) deposits such that the rate
on SAIF deposits was five times the rate on BIF deposits. Also,
under current law, the rates are to be equalized no later than
January 1, 2000. The annual FICO assessment rate is currently
about 6.10 basis points for SAIF-assessable deposits and 1.22
basis points for BIF-assessable deposits.
Section 304 would freeze the current FICO contribution
formula for 3 years. Without the freeze, on January 1, 2000,
both BIF and SAIF members will pay a uniform rate of about 2.2
basis points on insured deposits. Under the bill, for the next
3 years, institutions with SAIF-assessable deposits would have
to pay a higher amount than under current law. Institutions
with BIF--assessable deposits would pay less than under current
law. Some BIF and SAIF members hold assessable deposits in both
funds--almost 40 percent of the SAIF-assessable base is held by
BIF members and about 2 percent of the BIF-assessable base is
held by SAIF members. Since the annual FICO payment would
remain constant, the net cost of the freeze to BIF- and SAIF-
insured institutions would be zero.
Estimate Prepared By: Patrice Gordon and Robin Seiler--
Federal Home Loan Banks.
Estimate Approved By: Roger Hitchner, Acting Assistant
Director for Natural Resources Commerce Division.
CHANGES IN EXISTING LAW
In the opinion of the Committee, it is necessary to
dispense with the requirement of section 12 of rule XXVI of the
Standing Rules of the Senate in order to expedite the business
of the Senate.
ADDITIONAL VIEWS OF SENATORS BENNETT AND SHELBY
We join the Chairman in voicing our strong support for the
Financial Services Modernization Act of 1999. The banking laws
in the United States are outdated and no longer provide a
useful framework for the regulation of the many diverse
activities our financial institutions are conducting or seeking
to conduct to remain competitive in the global economy. Yet
legislative reform of these laws has been elusive. Now, as we
move toward the 21st century, it is important to reform these
laws and to do it without imposing any unnecessary restrictions
that will limit the competitiveness of our financial
institutions.
While we support this bill generally, we believe that the
provisions governing operating subsidiaries unnecessarily limit
the ability of financial institutions to structure their
operations in the manner they deem most effective. The expert
testimony presented to the Committee suggests that there is no
reason to limit the use of the operating subsidiary structure
to institutions with assets under $1 billion. Rather, there are
important reasons why we support extending the use of that
structure to all financial institutions.
Foreign banks operating in the United States are permitted
to use the operating subsidiary structure without regard to
size, and failing to give U.S. institutions the same choice
will create a competitive disadvantage. Furthermore, the
Chairman of the Federal Deposit Insurance Corporation has
testified that the operating subsidiary structure creates no
safety and soundness risks and may provide more protection to
the bank insurance fund in the event of a failure. If there is
no safety and soundness problem associated with operating
subsidiaries, then all financial institutions should be given
as much choice as possible in structuring their business
operations, certainly the same choice enjoyed by foreign
financial institutions operating in the United States.
We urge the Chairman to remove the arbitrary $1 billion
asset limitation, and give American financial institutions
choice in structuring their operations to maximize their
competitiveness in the global economy.
Robert F. Bennett.
Richard C. Shelby.
ADDITIONAL VIEWS OF SENATOR SANTORUM
As reported by the Senate Banking Committee, the Financial
Services Modernization Act of 1999 includes a provision to
extend for three years the existing premium disparity between
Bank Insurance Fund (BIF)- and the Savings Association
Insurance Fund (SAIF)-insured institutions. This provision is
of particular interest and concern to me as I had hoped that it
could have been fully debated and addressed before the
committee reported the bill.
In 1996, Congress enacted legislation, the Deposit
Insurance Funds Act (``Funds Act''), to avert a potential
crisis in the federal deposit insurance system. The legislation
sought to capitalize the SAIF and ensure the health of the
federal deposit insurance system.
Prior to passage of that legislation, the SAIF did not meet
statutory capitalization requirements. This situation arose, in
part, from the fact that SAIF-insured institutions were
required to pay annual FDIC insurance premiums of 23 basis
points to capitalize the SAIF while banks paid an assessment
rate of 4.6 basis points. Additionally, SAIF-insured
institutions were solely responsible for paying the interest
obligation on Financing Corporation (FICO) bonds used to
resolve the Federal Savings and Loan Corporation. As a result,
insured deposits were being shifted from the SAIF into the BIF,
thereby shrinking the SAIF's assessment base, diminishing the
BIF's reserve ratio and making capitalization of SAIF difficult
to achieve. Realizing the gravity of this problem, Congress
enacted the Funds Act at the urging of the FDIC, the Federal
Reserve Board, the U.S. Department of Treasury, and the Office
of Thrift Supervision.
The Funds Act set out to capitalize the SAIF by requiring
SAIF-insured institutions to make a one-time payment of $4.5
billion while spreading the FICO interest obligation to all
FDIC-insured institutions. Also spelled out under that Act was
the scenario for the BIF and SAIF to be merged before 2000, but
contingent upon convergence of the thrift and commercial bank
charters. In the interim, BIF members were required to pay one-
fifth of the FICO assessment rate of SAIF members until ``the
earlier of (a) December 31, 1999 or (b) the date as of which
the last savings association ceases to exist,'' (Funds Act,
Sec. 2703). After whichever date governed, BIF and SAIF member
institutions were to pay the same assessment rate for FICO of
2.2 basis points.
Calculating that the merger of charters will not occur
before December 31, 1999, the Senate Banking Committee included
a three-year extension of the premium disparity in the
committee print. In my view, changing the rules less than one
year prior to when rate equalization was to occur is unwise.
SAIF-insured institutions have made their legally required
payments--nearly $6 billion--to capitalize SAIF and meet their
FICO obligations. The Funds Act was successful in its goal, and
resulting from its mandate is a healthy BIF and SAIF.
As consideration of the Financial Services Modernization
Act of 1999 moves forward, I encourage my colleagues to
reconsider inclusion in the bill of any provision that extends
the premium disparity.
Rick Santorum.
ADDITIONAL VIEWS OF SENATORS SARBANES, DODD, KERRY, BRYAN, JOHNSON,
REED, SCHUMER, BAYH, AND EDWARDS
1. introduction
The Democratic Members of the Senate Committee on Banking,
Housing, and Urban Affairs strongly support financial services
modernization legislation. Last year, every Democratic Member
of the Committee voted for financial services modernization in
the form of H.R. 10, the Financial Services Act of 1998. That
bill was reported by the Committee on a bipartisan vote of 16
to 2. This year, every Democratic Member of the Committee voted
for financial services modernization in the form of a
Substitute Amendment offered by Senator Sarbanes. The
Substitute Amendment contained the text of last year's bill,
with the addition of a bank operating subsidiary provision
supported by the Treasury Department. The Substitute Amendment
was defeated at the Committee's markup on a party line vote of
11 to 9. It has since been introduced by Senator Daschle and
every Democratic Member of the Committee as S.753, the
Financial Services Act of 1999.
The Democratic Members supported these efforts, both last
year and this year, because the legislation met certain basic
goals. These include permitting affiliations between banks,
securities firms and insurance companies; preserving the safety
and soundness of the financial system; continuing access to
credit for all communities in our country; and protecting
consumers. Because the bill now reported to the Senate does not
meet these goals, every Democratic Member of the Committee
voted against it.
The partisan divide that produced the reported bill is
striking in view of the bipartisanship that has characterized
the Committee's previous attempts to enact financial services
modernization legislation. In 1988 and 1991, the Committee
reported financial services modernization legislation to the
full Senate with support from both sides of the aisle. Sixteen
out of eighteen Committee Members voted for last year's bill.
The broad, bipartisan margin of support enjoyed by last year's
bill reflected the careful compromises struck during the course
of its consideration. It was not opposed by a single major
financial services industry association.
We are disappointed that the Committee Majority has
abandoned the consensus so carefully developed last year. The
Substitute Amendment reflects compromises among Committee
Members and among industry groups on a wide range of issues,
including the Community Reinvestment Act, consumer protections,
and the separation of banking and commerce. The decision by the
Committee Majority to abandon these compromises has led some
industry groups to oppose the reported bill or important
provisions thereof. Civil rights groups, community groups,
consumer organizations, and local government officials also
strongly oppose the reported bill.
We are disappointed as well that the Committee Majority has
refused to recognize that enactment of financial services
legislation entails accommodation of differing views. The
Committee Majority's Report makes no mention of either the
bipartisan bill reported last year or the Substitute Amendment
offered at this year's markup, as if these events had never
occurred. This is in keeping with their failure to consider the
views of Democratic Members, a failure that led directly to the
party-line vote on the reported bill.
The views not only of Committee Members but also of the
White House and the Treasury Department should have been
considered. On March 2, 1999, before the Committee's markup,
President Clinton wrote:
This Administration has been a strong proponent of
financial legislation that would reduce costs and
increase access to financial services for consumers,
businesses, and communities. * * * I agree that reform
of the laws governing our nation's financial services
industry would promote the public interest. However, I
will veto the Financial Services Modernization Act if
it is presented to me in its current form.
The President warned that the bill ``would undermine the
effectiveness of the Community Reinvestment Act,'' ``would deny
financial services firms the freedom to organize themselves in
the way that best serves their customers,'' ``would * * *
provide inadequate consumer protections,'' and ``could expand
the ability of depository institutions and nonfinancial firms
to affiliate * * *.'' The Committee Majority did nothing at
markup to resolve these concerns. Unless the concerns of the
Administration are resolved, it is clear that the reported bill
will be vetoed.
ii. community reinvestment act
As noted above, all Democratic Members of the Committee
support financial services modernization. Financial services
modernization legislation, however, must ensure that financial
services are available to all communities in our country. The
Community Reinvestment Act (``CRA'') has played a critical role
in expanding access to credit and investment in low- and
moderate-income rural and urban communities. Accordingly, we
cannot support legislation that would undermine the
effectiveness of CRA.
The bill reported by the Committee fails this standard in
three ways. First, it fails to require that a bank have and
maintain a ``satisfactory'' CRA rating to engage in the new
affiliations permitted by the legislation. Second, it provides
a safe harbor to banks with a ``satisfactory'' CRA rating,
effectively eliminating public comment on the CRA performance
of these banks when they submit applications to regulators.
Finally, it exempts all small rural banks from CRA.
President Clinton has stated that ill-conceived CRA
provisions will result in a veto of this legislation. President
Clinton's March 2, 1999 letter stated in part:
[W]e cannot support the ``Financial Services
Modernization Act of 1999'' * * *. In its current
form, the bill would undermine the effectiveness of the
Community Reinvestment Act (CRA), a law that has helped
to build homes, create jobs, and restore hope in
communities across America. The CRA is working, and we
must preserve its vitality as we write the financial
constitution for the 21st Century.
Background on CRA
CRA was enacted in 1977 to encourage banks and thrifts to
serve the credit needs of their entire communities, including
low- and moderate-income neighborhoods, consistent with safe
and sound banking practices.\1\ CRA reflects the view that
banks and thrifts, although privately owned, receive public
benefits in the form of deposit insurance and access to the
Federal Reserve's discount window and payments system. In
return, they have charter obligations to serve the
``convenience and needs'' of their local communities.\2\
---------------------------------------------------------------------------
\1\ 12 U.S.C. Sec. 2903(a)(1).
\2\ 12 U.S.C. Sec. 2901(a)(1).
---------------------------------------------------------------------------
CRA requires the appropriate federal bank regulator to
assess an institution's record of meeting the credit needs of
its entire community. It does not place burdensomerequirements
on banks. Compliance examinations typically occur 18 to 24 months
apart. CRA performance evaluations are very flexible. Most banks and
thrifts are assessed on three factors: lending, service, and investment
performance. Small banks and limited purpose institutions have
streamlined examinations. Based on their performance, institutions
receive a rating of ``outstanding,'' ``satisfactory,'' ``needs to
improve,'' or ``substantial non-compliance.'' These ratings are made
available to the public.
Benefits of CRA
CRA has significantly improved the availability of credit
in historically underserved communities. CRA has been credited
with a dramatic increase in home ownership by low- and
moderate-income individuals. Between 1993 and 1997, private
sector conventional home mortgage lending in low- and moderate-
income census tracts increased by 45%.\3\ CRA has also helped
spur bank and thrift investment in multi-family rental housing
development and rehabilitation and community economic
development. In 1997, large banks and thrifts made
approximately 525,000 small business loans totaling $34 billion
to entrepreneurs located in low- and moderate-income areas.\4\
Commercial banks and thrifts also invest in community
development projects--nearly $19 billion in 1997 alone.\5\ For
example, according to the Office of the Comptroller of the
Currency (``OCC''), CRA lending and investments have
underwritten the expansion of African-American churches in
Brooklyn, the renovation of a 100-unit apartment complex in a
disadvantaged neighborhood in Washington, D.C., the provision
of much needed retail services in the Roxbury section of
Boston, and the strengthening of small business through the
Enterprise Development Center in Louisville, Kentucky. Federal
Reserve Chairman Alan Greenspan noted during his testimony
before the House Banking Committee on February 11, 1999, that
CRA has ``very significantly increased the amount of credit in
communities'' and that the changes have been quite profound.''
---------------------------------------------------------------------------
\3\ Attachment to FFIEC Press Release, August 6, 1998 (Table 7).
\4\ Attachment to FFIEC Press Release, August 24, 1998 (Table 4.2).
\5\ Attachment to FFIEC Press Release, August 24, 1998 (Table 5).
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The benefits of CRA extend beyond urban communities. CRA
has also helped alleviate credit needs and improve services in
rural areas. Banks and thrifts made $11 billion in small farm
loans in 1997.\6\ Low- and moderate-income rural communities
benefited from $2.8 billion in small business loans in 1997.\7\
Banks have entered into partnerships with community groups to
provide affordable housing in many rural communities, such as
in northeast Indiana and in Hillsborough, North Carolina.
---------------------------------------------------------------------------
\6\ FFIEC Press Release, August 24, 1998.
\7\ Id. at Table 4.2
---------------------------------------------------------------------------
With encouragement from CRA, banks have also increased
their services on Native American reservations. For instance,
there were only three bank branches and two ATMs on Navajo
reservations in 1994. At the end of last year, there were 12
branches and 19 ATMs.\8\ The Navajo reservation branches are
highly profitable for banks. Residents of the reservation have
benefitted from an array of new mortgage and small business
loans.
---------------------------------------------------------------------------
\8\ Source: Department of the Treasury.
---------------------------------------------------------------------------
There is a consensus among the regulatory agencies,
community groups, local and state elected officials, and many
bankers that CRA has been beneficial. President Clinton has
repeatedly reaffirmed his support for CRA:
[W]e should all be proud of what [CRA] has meant for
low and moderate-income Americans of all races.
Although we still have a long way to go in bringing all
Americans into the economic mainstream, under CRA the
private sector has pumped billions of dollars of credit
to build housing, create jobs and restore hope in
communities left behind.\9\
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\9\ President Clinton, Remarks at White House on 20th Anniversary
of CRA, October 12, 1997.
Chairman Greenspan has noted that ``CRA has helped
financial institutions to discover new markets that may have
been underserved before.'' \10\ The U.S. Conference of Mayors
has promoted CRA as an essential tool in revitalizing cities,
while the National League of Cities has listed CRA preservation
as a major federal priority for 1999. Hugh McColl, Jr.,
chairman and CEO of BankAmerica Corp., stated earlier this
year: ``My company supports the Community Reinvestment Act in
spirit and in fact. To be candid, we have gone way beyond its
requirements. * * * We're quite happy living with the existing
rules.'' \11\
---------------------------------------------------------------------------
\10\ Remarks, Social Compact Awards Luncheon, May 17, 1995.
\11\ Bridge News, ``Bank America CEO Opposes Linking CRA Reform to
Banking Reform,'' January 4, 1999.
---------------------------------------------------------------------------
CRA has accomplished these goals by encouraging banks and
thrifts to make profitable, market rate loans and investments.
It does not jeopardize the safety and soundness of any
depository institution. Chairman Greenspan noted last year that
there is ``no evidence that banks' safety and soundness have
been compromised by [low- and moderate-income] lendingand
bankers often report sound business opportunities.'' \12\
---------------------------------------------------------------------------
\12\ Remarks at Community Forum on Community Reinvestment and
Access to Credit, January 12, 1998.
---------------------------------------------------------------------------
Loans and banking services to low- and moderate-income
communities have increased tremendously in recent years.
Disparities still exist, however, in lending and banking
services. CRA must remain a vital force in helping ensure that
all creditworthy borrowers have access to essential capital and
all communities have a chance to thrive.
CRA provisions of substitute amendment
The Substitute Amendment would require that banks have at
least a ``satisfactory'' CRA rating as a precondition for
affiliation with securities and insurance firms. Banks in the
financial holding company would be required to maintain the
``satisfactory'' CRA rating in order to continue the new
affiliations. As noted above, the Committee last year by a vote
of sixteen to two approved financial services modernization
legislation containing these provisions. Every financial
services industry group accepted the bill with these
provisions.
Those provisions were viewed as necessary to maintain the
effectiveness of CRA within the expanded holding company
structure. Currently, the application process serves as the
mechanism for regulatory review and assessment of a bank or
thrift's performance in meeting the credit needs of the
communities it serves as well as its capital and management
performance. Capital, management, and CRA performance are at
issue when an institution files an application for deposit
insurance, a charter, a merger, an acquisition or other
corporate reorganization, a branch, or the relocation of a home
office or branch.
The Substitute Amendment would permit holding companies to
acquire insurance and securities firms without submitting
applications for approval with the federal bank regulators.
This is an important change from current law, which requires
banks to submit applications before affiliating with non-banks.
Accordingly, the CRA precondition requirement, like the
preconditions regarding capital and management, would take the
place of the review that now takes place in the application
process. Without this requirement, an institution with an
unsatisfactory CRA rating could nevertheless engage in the
expanded affiliations permitted by the legislation.
This requirement is supported by the Treasury, FDIC, Office
of Thrift Supervision, and OCC. As FDIC Chairman Donna Tanoue
has said:
The bank and thrift regulatory agencies consistently
take into account an insured institution's record of
performance under CRA when considering an application
to open or relocate a branch, a main office, or acquire
or merge with another institution. As this legislation
would enable institutions to enter into additional
activities, it would seem consistent that CRA
compliance should continue to be a determining
factor.\13\
---------------------------------------------------------------------------
\13\ Responses of FDIC Chairman Tanoue to Questions from Senator
Paul S. Sarbanes, April 9, 1999 (``Tanoue Responses''), at A.1.
---------------------------------------------------------------------------
CRA Provisions of reported bill:
On a party line vote, the Committee Majority this year
rejected last year's bipartisan approach. The reported bill
contains three CRA provisions that are unacceptable to
Democratic Members of the Committee and the Administration.
1. Eliminates ``satisfactory'' CRA rating as a precondition
of expanded affiliations
Unlike the Substitute Amendment, the reported bill does not
require that all banks within a holding company have and
maintain ``satisfactory'' CRA ratings in order to engage inand
maintain expanded affiliations. The Committee Majority has asserted
that an explicit requirement that banks have a ``satisfactory'' CRA
rating to engage in these affiliations is not needed because, unlike
last year's bill, the reported bill does not create a ``financial
holding company.'' Instead, it expands the Bank Holding Company Act to
permit broader financial activities. Since CRA applies to banking
activities under the Bank Holding Company Act, it is argued that it
would apply to the broader financial activities as well.
In reality, CRA would not apply to these activities.
Current law does not explicitly permit affiliations between
banks and other financial services firms. Both the Substitute
Amendment and the reported bill would change current law to
permit these affiliations explicitly. Since these affiliations
would be permitted pursuant to new statutory authority, new
statutory authority is needed to condition these affiliations
on compliance with bank regulatory standards. Both the
Substitute Amendment and the reported bill make compliance with
bank capital and management standards a statutory precondition
for the new affiliations. Both do so because, the assertions of
the Committee Majority's Report notwithstanding, compliance
with capital and management standards are not currently a
statutory requirement for banks' affiliations with nonbanks.
However, the reported bill fails to make CRA compliance a
precondition. By virtue of the failure to include CRA
performance as a condition to affiliations, the reported bill
cannot be described as ``neutral.'' In fact, enactment of the
reported bill without the precondition of a ``satisfactory''
CRA rating would dramatically undermine CRA. Under the bill,
bank holding company acquisitions of banks would remain subject
to CRA. However, banking industry experts and regulators agree
that most of the consolidations within the banking community
have occurred. Mergers among banks, securities and insurance
firms are likely to increase. As Treasury Secretary Robert
Rubin testified to the House Banking Committee on February 12,
1999,
If we wish to preserve the relevance of CRA at a time
when the relative importance of bank mergers may
decline and the establishment of non-bank financial
services will become increasingly important, the
authority to engage in newly authorized activities
should be connected to a satisfactory CRA performance.
2. Safe harbor for banks with a ``satisfactory'' CRA rating
The Democratic Members strongly oppose the provision in the
reported bill providing a safe harbor for banks with a
``satisfactory'' or better CRA rating. This provision would
effectively eliminate public comment on CRA performance at the
time of bank applications. Under this provision, a bank that
received a ``satisfactory'' or better CRA rating at its most
recent examination and at each examination during the preceding
three years would be deemed in compliance with CRA. It would be
immune from public comments on CRA performance during pending
bank applications. This immunity would remain unless
individuals or groups presented ``substantial verifiable
information to the contrary'' arising since the last
examination. The provision imposes the burden of proof on those
presenting the information.
Federal bank regulatory agencies oppose this provision.
They agree that a ``satisfactory'' CRA rating is not conclusive
evidence that a bank is ``meeting the credit needs of all of
its communities.'' On the contrary, they welcome comments from
the public regarding the CRA performance of the institutions
they supervise. Comptroller of the Currency John Hawke said:
Public comment is extremely valuable in providing
relevant information to anagency in its evaluation of
an application under the CRA, convenience and needs, and other
applicable standards--even by an institution that has a
``satisfactory'' CRA rating. This amendment would limit or reduce
public comment that is useful in our application process.\14\
---------------------------------------------------------------------------
\14\ Responses of Comptroller of the Currency Hawke to Questions
from Senator Paul S. Sarbanes, March 23, 1999 (``Hawke Responses''), at
A.2.
Ellen Seidman, Director of the Office of Thrift Supervision
---------------------------------------------------------------------------
(``OTS''), testified before the Committee on February 24, 1999:
[w]e generally find that the information received
from those few who do comment on applications is
relevant, constructive, and thoughtful, and frequently
raise issues that need to be considered. In order for
us to reach a supportable disposition on an
application, and satisfy our statutory
responsibilities, we need to have public input.
Public comment is especially useful in the case of large
banks serving multiple markets, because regulators sample only
a portion of these markets to determine the institution's CRA
rating. Performance in small communities is weighted less than
performance in larger areas. Public comment provides an
opportunity for community members to point out facts and data
that may have been overlooked in a particular examination.
Moreover, circumstances can change rapidly over the course of
an examination cycle.
The safe harbor provision of the reported bill would stifle
public comment on banks' and thrifts' CRA performance, because
nearly all banks and thrifts receive ``satisfactory'' or better
CRA ratings. In fact, 97% of institutions examined in 1997 and
1998 received CRA ratings of ``satisfactory'' or better.\15\
While the Committee Majority asserts that the public comment
process has been routinely abused, that assertion is not
supported by the record. The vast majority of applications
reviewed on CRA grounds are approved expeditiously and do not
receive any adverse comments. Data collected from the four
regulatory agencies show that less than one percent of
applications subject to CRA received adverse comments.\16\ Of
those applications that received adverse comments, only one
percent were denied. The data also show that few applications
that receive adverse CRA comments are significantly delayed.
According to the OCC, since 1995 ``the average time for
processing protested applications is only 27 days beyond
standard processing targets.'' \17\
---------------------------------------------------------------------------
\15\ FFIEC Web Site, ``Interagency CRA Ratings,'' visited March 22,
1999.
\16\ See, e.g., Hawke Responses at A.5 (``In the past three years,
less than one percent of the applications subject to CRA that were
filed with the OCC were protested.'').
\17\ Hawke Responses at A.5.
---------------------------------------------------------------------------
The exception to the safe harbor provision for CRA comments
based on ``substantial verifiable information'' is unworkable
in practice. Under the bill's rebuttable presumption,
information relevant to a bank's CRA performance could not be
introduced if it relates to problems existing at the time of
the last examination. The provision places an excessive burden
on ordinary citizens and community organizations, which would
need to provide comments on every bank examination. FDIC
Chairman Tanoue stated, ``public comments relating to CRA
should not bear a burden of proof that is not imposed on public
comment related to any other aspect of a bank's performance.''
\18\ Comptroller Hawke warned ``the agencies will have to make
the examination much more searching and time consuming than it
is at present.'' \19\ It also unfairly singles out CRA comments
for restrictive treatment. Individuals seeking to comment on
other aspects of the bank's performance, such as financial and
managerial resources or competitive implications, would not
have their rights similarly curtailed.
---------------------------------------------------------------------------
\18\ Tanoue Responses at A.2.
\19\ Id. at A.2.
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3. Small bank exemption \20\
---------------------------------------------------------------------------
\20\ Senator Johnson does not join in this portion of the
Additional Views.
---------------------------------------------------------------------------
Eight Democratic Members also oppose the provision which
would exempt from CRA rural institutions with less than $100
million in assets. If enacted, the provision will have
devastating consequences for low- and moderate-income rural
communities, which depend almost exclusively on small banks for
their credit needs. Access to credit in rural areas is already
scarce, due in part to the lack of competition in those
markets.
Over 76% of rural U.S. banks and thrifts have assets less
than $100 million.\21\ It is asserted that these small rural
banks by their nature serve the credit needs of their local
communities. However, small banks have historically received
the lowest CRA ratings. Institutions with less than $100
million in assets accounted for 92% of institutions receiving
``substantial noncompliance'' ratings in 1997-1998.\22\ Small
banks are subject to CRA because they receive public benefits,
namely deposit insurance and access to the Federal Reserve's
discount window and payment system.
---------------------------------------------------------------------------
\21\ Source: Federal Deposit Insurance Corporation.
\22\ FFIEC Website, ``Interagency CRA Ratings,'' visited March 22,
1999.
---------------------------------------------------------------------------
Although many small banks do serve the needs of their
communities, statistics from the Federal Deposit Insurance
Corporation reveal that 57% of small banks and thrifts have a
loan-to-deposit ratios below 70%, with 17% of these having
levels less than 50%.\23\ Observers note that small banks often
invest in government securities rather than in their own
communities. A 1995 editorial in the Madison, Wisconsin Capital
Times summed up the practice of many banks in rural
communities:
---------------------------------------------------------------------------
\23\ Source: Federal Deposit Insurance Corporation.
[M]any rural banks, establish a very different
pattern [than reinvesting in their communities], where
local lending takes a lower priority than making more
assured investment, like federal government securities.
Thus, such banks drain local resources of the very
localities that support them, making it much harder for
local citizens to get credit.\24\
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\24\ ``Bank Measure Bad for Farms,'' July 20, 1995.
An exemption for small banks is unnecessary to relieve
regulatory burden. The Federal bank regulators revised their
CRA regulations in 1995 to reduce small banks' cost of
compliance. This action followed the review of thousands of
public comments, submitted by financial institutions,
organizations, and individuals. According to the American
Bankers Association, ``[f]or the vast majority of banks it
reduced record keeping, exams went quicker and banks now know
what is required of them.'' \25\ The new CRA rules, which took
effect January 1, 1996, provide a streamlined examination for
banks with less than $250 million in assets. These institutions
generally need not do paperwork or keep records beyond what
they would do in the ordinary course of their business. The new
rules exempt small banks from reporting requirements and
emphasize institutions' actual performance rather than
paperwork and process. CRA ratings for small banks focus
exclusively on lending and lending-related activities: loan-to-
deposit ratio, percentage of loans in a given political
subdivision, lending to borrowers of different income and
different sizes, and geographic distribution of loans.
Moreover, banks that find it difficult to meet the requirements
outlined in the regulations have the option of developing a
strategic plan by which they will be evaluated.
---------------------------------------------------------------------------
\25\ American Banker, ``Ludwig Gets Bankers' Credit for Helping
Modernize Industry,'' January 20, 1998.
---------------------------------------------------------------------------
The FDIC, OTS, and OCC support the application of CRA to
small banks. OTS Director Seidman has stated:
Small banks should be subject to CRA. The simple
assumption that if an institution is small it must be
serving its community is not entirely correct. It is
the unfortunate fact that it is possible for an
institution to make money simply by arbitrating the
spread between insurance-backed deposits and other safe
investments, including Treasury bonds. Although the
overwhelming majority of small institutions have a
favorable CRA ratings history, during 1998 alone 18 of
the 24 (66%) thrifts that were rated Substantial
Noncompliance or Needs to Improve by OTS had assets
under $100 million. Overall, 40% of OTS-regulated
institutions have assets under $100 million.
FDIC Chairman Tanoue stated similarly:
Although the vast majority of institutions
satisfactorily help to meet the credit needs of their
communities, not all institutions may do so over time,
including small institutions. Some institutions may
unreasonably lend outside of their communities, or
arbitrarily exclude low- and moderate-income areas or
individuals within their communities. We believe that
periodic CRA examinations for all insured depository
institutions, regardless of asset-size, are an
effective means to ensure that institutions help to
meet the credit needs of their entire communities,
including low- and moderate-income areas.\26\
---------------------------------------------------------------------------
\26\ Tanoue Responses at A.4.
---------------------------------------------------------------------------
Conclusions regarding CRA
Reinstating the ``satisfactory'' CRA rating as a
precondition of expanded affiliations and deleting the safe
harbor and small bank exemption would bring the reported bill
in line with the approach taken by the House Banking Committee.
The bill reported by the House Banking Committee on March 11,
1999 by a vote of 51 to 8 (also known as H.R. 10) dealt with
these three issues in the same way as the Substitute Amendment
supported by the Democratic Members. This is the same approach
to these three issues that passed the full House and the Senate
Banking Committee last year. By including these onerous CRA
provisions, the reported bill moves in a direction previously
rejected in both Houses of Congress and makes passage of
financial services modernization legislation significantly more
difficult.
III. OPERATING SUBSIDIARIES OF NATIONAL BANKS
One of the difficult issues raised in the financial
services modernization debate over the past two years has been
what activities may take place in subsidiaries of banks, and
under what conditions. The bill reported by the Committee last
year contemplated that activities as principal, such as
underwriting of securities and insurance, would take place in
holding company subsidiaries rather than bank subsidiaries.\27\
Certain agency activities, such as sales of insurance, were
permitted in bank subsidiaries. While this approach was
supported by the Federal Reserve, it was opposed by the
Treasury Department. The Federal Reserve argued that the
holding company structure offered greater safety and soundness
protection. The Treasury Department pointed out the bill would
restrict banks' ability to organize their operations as they
think best and that financial activities could be conducted as
safely in a bank subsidiary as in a holding company subsidiary.
The FDIC agreed with the Treasury that financial activities in
bank subsidiaries can be consistent with safety and soundness
and protection of the deposit insurance funds.
---------------------------------------------------------------------------
\27\ Holding company subsidiaries are often referred to as ``bank
affiliates.''
---------------------------------------------------------------------------
As the legislative process has proceeded, the Treasury
Department has agreed to significant additional safeguards
regarding the scope and regulation of bank subsidiaries'
activities, discussed in detail below. With these safeguards,
the Democratic Members believe banks should be given the option
of conducting financial activities in operating subsidiaries.
Moreover, President Clinton has indicated that he will veto the
reported bill, in part because it ``would deny financial
services firms the freedom to organize themselves in a way that
best serves their customers * * *.'' The Substitute Amendment
supported at the Committee's markup by all Democratic Members
therefore would allow certain financial activities to take
place in bank subsidiaries, subject to those safeguards.
Safeguards on bank operating subsidiaries
1. Insurance underwriting
First, the Treasury has agreed that insurance underwriting
may not take place in a bank subsidiary. In his February 24,
1999 testimony, Secretary Rubin explained that the business
nexus between commercial banking and insurance underwriting is
not as great as that between commercial banking and investment
banking. Therefore, the Treasury would support legislation
containing a prohibition on insurance underwriting in bank
subsidiaries. Banks also have less experience with insurance
underwriting than with other financial activities, such as
securities underwriting. This suggests that insurance
underwriting in bank subsidiaries might pose greater risks than
other activities. The prohibition on insurance underwriting
would be in addition to an explicit prohibition on real estate
development conducted by bank subsidiaries, to which the
Treasury agreed last year.
2. Merchant banking
The Treasury has also agreed that the Federal Reserve shall
have exclusive authority to define merchant banking activities
in bank subsidiaries. Merchant banking refers to the practice
whereby an investment bank takes a passive equity stake in a
company in connection with the provision of financial services,
such as underwriting the company's securities, with a view
towards appreciation and eventual sale. In the context of an
investment bank's affiliation with a commercial bank, merchant
banking activities present a potential breach in the separation
of banking and commerce. They raise the possibility of
commercial bank lending decisions being influenced by the
merchant banking investments of an affiliate, with accompanying
risks to the Federal deposit insurance fund.
The possible dangers would be increased if two different
regulators, namely the OCC and the Federal Reserve, were to
define the dimensions of merchant banking activities
permissible in two different categories of bank affiliate,
namely bank subsidiaries and bank holding company subsidiaries.
Defining the scope of merchant banking will involve drawing
fine lines. In response to this concern, the Treasury
Department agrees that the Federal Reserve should have
exclusive rulemaking authority over merchant banking
activities. The Federal Reserve will define merchant banking
both for the bank holding company subsidiaries it already
regulates and for bank subsidiaries, over which the Federal
Reserve otherwise has no authority. This meaningful step on the
part of the Treasury will contribute to bank subsidiary
activities being structured in a prudent fashion.
3. Joint rulemaking
The potential competition between bank regulators is
present in other contexts aswell. Having the OCC define what
activities are ``financial in nature'' when they take place in a bank
subsidiary, while the Federal Reserve defines what is ``financial in
nature'' for a holding company subsidiary, would be troubling. It could
put pressure on each regulator to interpret its regulations broadly, so
as not to lose regulatory jurisdiction to the other. The Treasury
Department endorses a number of steps intended to eliminate this risk.
The Treasury Department agrees that the Secretary and the Federal
Reserve shall jointly determine which activities are ``financial in
nature,'' both for a holding company subsidiary and for a bank
subsidiary. The Secretary and the Federal Reserve shall also jointly
issue regulations and interpretations under the ``financial in nature''
standard.
4. Regulatory parity
To further place activities on an equal footing, the same
conditions would apply to a national bank seeking to exercise
expanded powers through a subsidiary as to a holding company
seeking to exercise those powers through a subsidiary. These
conditions are that the banks be well capitalized, well
managed, and in compliance with CRA. The same penalties would
apply to an institution that falls out of compliance with those
provisions. The Treasury also supports the application of
functional regulation to securities and insurance activities
taking place in bank subsidiaries just as it applies to holding
company subsidiaries. The Securities and Exchange Commission
thus would have the same authority over a broker-dealer
subsidiary of a bank as over a broker-dealer subsidiary of a
holding company. State insurance regulators would have the same
authority over an insurance agency owned by a bank as over an
insurance agency owned by a holding company. These provisions
should ensure a level competitive playing field for financial
firms and appropriate regulation for financial activities,
wherever they take place.
In addition, the Treasury supports a requirement that
national banks with total assets of $10 billion or more retain
a holding company, even if they choose to engage in expanded
financial activities through subsidiaries. This is designed to
preserve the oversight that the Federal Reserve now has over
the nation's largest commercial banks via their holding
companies. The Federal Reserve believes this oversight
capability is crucial to the conduct of monetary policy and to
identification of systemic risks to the financial system.
5. Additional safeguards
The Substitute Amendment supported by the Democratic
Members contained certain additional safeguards that the
Treasury Department has advocated for financial services
modernization legislation. Every dollar of a bank's investment
in a subsidiary would be deducted from the bank's capital for
regulatory purposes. In this way, the bank would have to remain
well-capitalized even after deducting the investment in the
subsidiary and even should it lose its entire investment.
Further, a bank could not invest in a subsidiary an amount
exceeding the amount the bank could pay to its holding company
as a dividend. This should place investments in bank
subsidiaries and investments in holding company subsidiaries on
a level regulatory footing. While a bank's investment in a
subsidiary would still be counted as an asset for financial
accounting purposes, these provisions should lead the financial
markets to treat a bank subsidiary in the same manner as a bank
affiliate.
Finally, Sections 23A and 23B of the Federal Reserve Act
would apply the same strict limits on transactions between
banks and their subsidiaries as already apply to transactions
between banks and their affiliates. These statutes restrict
extensions of credit from banks to their affiliates, guarantees
by banks for the benefit of their affiliates, and purchases of
assets by banksfrom their affiliates. Sections 23A and 23B
require that all such transactions be at arms' length and fully
collateralized and limit the total amount of such transactions between
a bank and all of its affiliates.
In total, these safeguards pertaining to the regulation of
bank subsidiaries should eliminate any economic benefit that
may exist when activities are conducted in bank subsidiaries
rather than holding company subsidiaries. The provisions
regarding the scope of activities permissible for bank
subsidiaries should remove any opportunity for regulators to
compete with one another to the detriment of the safety and
soundness of the banking system or the separation of banking
and commerce. FDIC Chairman Tanoue testified to the Committee
on February 24, 1999:
From a safety-and-soundness perspective, both the
bank operating subsidiary and the holding company
affiliate structures can provide adequate protection to
the insured depository institution from the direct and
indirect effects of losses in nonbank subsidiaries or
affiliates. . . .[I]n practice, regulatory safeguards
for operating subsidiaries [discussed above] and
existing safeguards for affiliates, such as Sections
23A and 23B of the Federal Reserve Act, would inhibit a
bank from passing any net marginal subsidy either to a
direct subsidiary or to an affiliate of the holding
company.
Chairman Tanoue's position is echoed by three former Chairmen
of the FDIC. In a September 2, 1998 American Banker editorial,
former Chairmen Ricki Tigert Helfer, William M. Isaac, and L.
William Seidman wrote,
Whether financial activities . . . are in a bank
subsidiary or a holding company affiliate, it is
important that they be capitalized and funded
separately from the bank. If we require this
separation, the bank will be exposed to the identical
risk of loss whether the company is organized as a bank
subsidiary or a holding company affiliate.
On the basis of the provisions agreed to by the
Treasury Department and the testimony given by the
FDIC, the Democratic Members believe that permitting
bank operating subsidiaries can be consistent with the
goals of preserving safety and soundness, protecting
consumers, and promoting comparable regulation.
Accordingly, the Substitute Amendment that was
supported by all Democratic Members included authority
for bank operating subsidiaries, subject to all the
restrictions discussed above.
The reported bill authorizes operating subsidiaries only
for certain small banks, namely those with less than $1 billion
in assets. In his February 24, 1999 testimony, Secretary Rubin
opposed putting a limit on the asset size of banks allowed to
choose the operating subsidiary structure. Given the position
of President Clinton as stated in his March 2, 1999 letter
cited earlier, this provision of the reported bill would also
result in a veto. The Democratic Members believe that adoption
of the operating subsidiary provisions of the Substitute
Amendment would be a meaningful step toward enactment of
financial services modernization legislation into law.
IV. CONSUMER PROTECTION
The Democratic Members believe that any financial services
modernization bill must ensure adequate consumer protections.
The blurring of lines between banking, securities and insurance
products and the consolidation of these different financial
services under one corporate roof increase the potential for
confusion on the part of consumers. For example, the wider
variety of financial products available through banks raises
potential customer confusion about the insured status, risks,
and the issuer and seller of those products. In the past, some
depository institutions have sought to take advantage of this
confusion. Appropriate measures addressing issues such as
disclosure to customers and licensing of personnel can
keepmisunderstandings to a minimum. Such provisions must be included in
any financial services modernization bill. The reported bill, however,
fails to include important consumer protection provisions that passed
the Committee overwhelmingly last year.
Insurance sales
Insurance sales have always been regulated at the State
level. The State insurance commissioners have staff and
expertise in this area. Roughly 30 States have enacted statutes
specifically addressing sales of insurance by banks. Currently,
under the Supreme Court's Barnett Bank decision,\28\ States may
regulate sales of insurance by national banks so long as they
do not ``prevent or significantly interfere'' with such sales.
---------------------------------------------------------------------------
\28\ Barnett Bank v. Nelson, 517 U.S. 25 (1996).
---------------------------------------------------------------------------
The Committee Print presented at the March 4, 1999 markup
would have contained broad preemption provisions. It would have
preempted State laws that differentiate in any way between
sales of insurance by agents and sales of insurance by banks.
Accordingly, regulations in those 30 States that differentiate
between sales of insurance by banks and sales of insurance by
brokers without ``significantly interfering'' with bank sales
would nevertheless have been preempted as ``discriminatory.''
At markup, the Committee adopted an amendment offered by
Senator Bryan. The Bryan Amendment substituted the provisions
from last year's bipartisan bill addressing the ability of
States to regulate sales of insurance by banks. It deleted the
overbroad preemption contained in the Committee Print. Instead,
it codifies the Barnett Bank holding that States may not
prevent or significantly interfere with a national bank's
ability to sell insurance. It protects thirteen specific areas
of State regulation from preemption. These include restrictions
on the payment of commissions and referral fees to unlicensed
bank personnel, restrictions on the release of customer
insurance information, and requirements that banking and
insurance transactions be documented separately.
While substituting these provisions from last year's bill
did much to improve the consumer protection provisions of the
reported bill, more remains to be done. The Substitute
Amendment required the Federal bank regulators to establish
mechanisms for receiving and addressing consumer complaints.
The reported bill contains no such requirement. In addition,
the Substitute Amendment provided that Federal regulations
would supersede State regulations when the Federal regulations
afforded greater protection for consumers. The reported bill
allows State regulations to trump Federal regulations, even
when the State offers less protection to consumers. These
deficiencies in the bill should be rectified.
Securities activities
The reported bill reduces consumer protections not just in
the conduct of insurance activities by banks but in the conduct
of securities activities by banks as well. The Substitute
Amendment ensured that the protections of the Federal
securities laws were available to consumers in a wider range of
circumstances than does the reported bill.
Currently, banks enjoy a total exemption from the
definitions of ``broker,'' ``dealer,'' and ``investment
adviser'' under the Federal securities laws. Because of the
blanket exemption, the Securities and Exchange Commission
(``SEC'') cannot regulate securities activities taking place
directly within banks. Banks are exempt from oversight by the
securities self-regulatory organizations as well. This was
appropriate in 1933 and for many yearsthereafter, when
securities activities of banks were strictly limited.
Beginning in the 1980's, bank regulators have allowed banks
greater participation in securities activities. Banks may now
offer brokerage services and conduct private placements.
Because of the blanket exemption, consumers who purchase
securities from banks do not receive any of the protections of
the securities laws. These protections are in many ways
superior to those offered by the banking laws. For example,
broker-dealer personnel have an obligation to recommend to
their clients only transactions that are suitable, based on
their clients' tolerance for risk, overall portfolio and so on.
Bank personnel have no such obligation. Broker-dealer personnel
must pass licensing exams given by the National Association of
Securities Dealers (``NASD'') and are subject to continuing
education requirements. Bank personnel are exempt from these
requirements. Disciplinary histories of broker-dealer personnel
are made publicly available to investors by the NASD and State
securities regulators. No such history is available regarding
bank personnel. Broker-dealer managers have a duty to supervise
their sales personnel that is enforceable under the Federal
securities laws. Bank managers do not. Finally, customers'
disputes with brokerage firms are subject to arbitration, which
offers a specialized, quicker, and cheaper forum for settling
disputes. No arbitration exists for customers' disputes with
banks.
Like the Substitute Amendment, the reported bill would
repeal the total exemption banks enjoy from the definition of
``broker'' and ``dealer.'' Also like the Substitute Amendment,
it contains a number of exceptions that allow certain
securities activities to continue to take place directly within
banks. However, the exceptions in the reported bill are
significantly wider than those in the Substitute Amendment.
For example, the reported bill allows a bank trust
department conducting securities transactions to be compensated
on a transaction-by-transaction basis, just like a broker. It
also allows a bank conducting transfer agent services for
employee benefit plans and dividend reinvestment plans to be
compensated on a transaction-by-transaction basis. This gives
banks an opportunity to move brokerage activities directly into
the banks, where customers receive less protection as detailed
above. The Substitute Amendment would require the compensation
to be a flat administrative fee in both cases. Where the
Substitute Amendment would allow a bank to sell unregistered
securities exclusively to sophisticated investors, the reported
bill allows a bank to sell unregistered securities to all
investors. Where the Substitute Amendent would prevent a bank
from selling unregistered securities when the bank has a
securities affiliate, the reported bill allows a bank that has
securities affiliates to sell unregistered securities directly
from the bank. Finally, the reported bill prohibits the SEC
from determining that a new product is a security, and
therefore must be sold by an SEC-registered broker-dealer,
unless the Federal Reserve concurs. Over time, this will move
even more securities activities directly into banks. The
Substitute Amendment would afford the SEC the first opportunity
to define new products as securities. In each of these
circumstances, purchasers of securities will receive less
protection under the reported bill than they would receive
under the Substitute Amendment.
The reported bill also provides less protection to mutual
fund investors than would the Substitute Amendment. The SEC
regulates mutual funds and their investment advisers. As noted
above, banks are exempt from the definition of ``investment
adviser.'' Therefore, when a bank serves as investment adviser
to a mutual fund, the SEC can review only one side of the
equation. The Substitute Amendment would remove the exemption
from the definition of ``investment adviser'' when banks advise
mutual funds. The reported bill does notinclude this provision.
It leaves the SEC with less authority over bank-advised mutual funds
and with less ability to protect investors in those funds.
Finally, the Substitute Amendment would have required the
Federal banking regulators to issue regulations regarding the
sale of securities by banks and bank affiliates. The bank
regulators would have established mechanisms to review and
address consumer complaints. Currently, the Federal bank
regulators have issued guidelines, which do not have the force
of law, rather than regulations. The reported bill does not
include this provision, leaving only the guidelines in force.
The failure of the bank regulators to issue regulations
underscores the importance of maintaining SEC oversight of
securities activities.
The Committee Majority's Report correctly notes that
``sales of securities may be regulated differently depending on
whether they take place through a bank or a securities
broker.'' The reported bill, however, would actually make those
regulatory discrepancies worse. The reported bill falls short
in this area and thereby places investors at risk.
V. BANKING AND COMMERCE
A final aspect of the reported bill that differs
significantly from the Substitute Amendment is its approach to
the separation of banking and commerce. U.S. law has long
separated banking activities from commercial activities.
Currently, a commercial firm such as General Motors or
Microsoft may not own a bank or be owned by a bank.
A number of commentators, including Chairman Greenspan,
Secretary Rubin, former Federal Reserve Chairman Paul Volcker,
banking industry associations and public interest groups,
expressed caution regarding breaching the separation of banking
and commerce. Chairman Greenspan testified to the Committee on
February 23, 1999, ``[i]t seems to us wise to move first toward
the integration of banking, insurance, and securities and
employ the lessons we learn from that important step before we
consider whether and under what conditions it would be
desirable to move to the second stage of the full integration
of commerce and banking.'' Secretary Rubin has stated, ``[w]e
continue to oppose any efforts to expand the integration of
banking and commerce.'' \29\
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\29\ Responses of Secretary of the Treasury Rubin to Questions from
Senator Paul S. Sarbanes (``Rubin Responses''), at A.1.
---------------------------------------------------------------------------
The Substitute Amendment reflects careful bipartisan
compromises developed last year on the issue of banking and
commerce. In general, it would have allowed affiliation between
banking and commercial firms only in the context of merchant
banking and insurance underwriting activities. The reported
bill weakens the separation of banking and commerce by
permitting broader combinations of banking and commerce than
are allowed under current law. The Independent Bankers
Association of American has expressed its ``strong opposition''
to the reported bill, terming it ``dangerous since it would
permit the almost unbridled cross-ownership of banks and
commercial firms.''30 In his March 2, 1999 letter stating he
will veto the bill in its current form, President Clinton
objected to the bill because it ``could expand the ability of
depository institutions and nonfinancial firms to affiliate, at
a time when experience around the world suggests the need for
caution in this area.'' \30\
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\30\ News from IBAA, ``IBAA/IBAT Label Senate Banking Bill
`Dangerous','' March 4, 1999.
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Traditional separation of banking and commerce:
The separation of banking and commerce has long been a
feature of U.S. law. Itwas embodied in the national bank system
established by the National Bank Act of 1864, which specifically
forbids banks to engage or invest in commercial or industrial
activities. Except in certain limited situations, a national bank may
not own for its own account any shares of stock of any corporation.\31\
---------------------------------------------------------------------------
\31\ 12 U.S.C. Sec. 24.
---------------------------------------------------------------------------
When the rise of bank holding companies opened the
possibility of the combination of banking and industrial firms
through the holding company structure, Congress enacted the
Bank Holding Company Act of 1956. This statute prohibited
commercial firms from owning banks and prohibited holding
companies owning two or more banks from owning commercial
firms. This policy was strengthened by the Bank Holding Company
Act Amendments of 1970, which extended the prohibition on
owning commercial firms to holding companies owning just one
bank. This policy was supported by both the Nixon
Administration and the Democratic Congress. In submitting the
1970 Amendments, President Nixon said, ``the strength of our
banking system depends largely on its independence. Banking
must not dominate commerce or be dominated by it.'' \32\
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\32\ Statement of President Richard M. Nixon of March 24, 1969,
reprinted in H. Rep. No. 1747, 91st Cong., 2d Sess. 11 (1970).
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Potential Risks of Mixing Banking and Commerce
Allowing bank affiliations with commercial firms could
raise numerous concerns relating to risk to the deposit
insurance funds, the impartial granting of credit, unfair
competition, and concentration of economic power. A bank that
is affiliated with a commercial firm could have an incentive to
make loans to that firm, even if the firm is less credit-worthy
than other borrowers. The bank could have a similar incentive
not to lend to the firm's competitors, even if they are credit-
worthy. If banks were to make lending decisions based on
criteria other than creditworthiness, the taxpayer-backed
deposit insurance fund ultimately would be put at risk.
Some financial experts have pointed out these dangers.
Secretary Rubin testified before the House Banking Committee on
March 1, 1995 that mixing banking and commerce
* * * might pose additional, unforeseen and undue
risk to the safety and soundness of the financial
system, potentially exposing the federal deposit
insurance funds and taxpayers to substantial losses. .
. . Equally uncertain is the effect such combinations
might have on the cost and availability of credit to
numerous, diverse borrowers and on the concentration of
economic resources.
Noted economist Henry Kaufman has warned that mixing banking
and commerce would lead to conflicts of interest and unfair
competition in the allocation of credit. In his view,
A large corporation that controls a big bank would
use the bank for extending credit to those who can
benefit the whole organization. . . . The bank would be
inclined to withhold credit from those who are, or
could be, competitors to the parent corporation. Thus,
the cornerstone of effective banking, independent
credit decisions based on objective evaluation of
creditworthiness, would be undermined.\33\
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\33\ Talk Before UBS Securities Global Banking Conference, April
29, 1997.
Some public interest groups have made the same points.
Consumers Union testified before the Committee on February 25,
1999 that it opposes ``permitting federally-insured
institutions to combine with commercial interests because of
the potential to skew the availability of credit, conflict of
interest issues, and general safety and soundness concerns from
expanding the safety net provided by the government.''
Some believe that the difficulties experienced in Asia
demonstrate the risks associated with mixing banking and
commerce. Both Secretary Rubin and Chairman Greenspantestified
that the financial crisis in Asia was made worse by imprudent lending
by banks to affiliated commercial firms. Secretary Rubin said that his
serious concerns about mixing banking and commerce ``are heightened as
we reflect on the financial crisis that has affected so many countries
around the world over the past two years.'' Chairman Greenspan
testified ``the Asian crisis highlighted some of the risks that can
arise if relationships between banks and commercial firms are too
close, and makes caution at this stage prudent in our judgment.'' Other
factors, including weak bank supervision and lack of transparency,
contributed to the Asian financial crisis as well. Former Federal
Reserve Chairman Volcker has written:
Recent experience with the banking crises in
countries as different in their stages of development
as Japan, Indonesia and Russia demonstrates the folly
of permitting industrial-financial conglomerates to
dominate financial markets and potentially larger areas
of the economy. But we need look no further than our
own savings-and-loan crisis in the 1980s for the
lesson. Combinations of insured depository institutions
and speculative real estate developers cost American
taxpayers, who ultimately stood behind the thrift
insurance funds, tens of billions of dollars.\34\
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\34\ Washington Post, ``Boost for Banking,'' September 10, 1998.
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Substitute Amendment Retained the Separation of Banking and Commerce
Under the Substitute Amendment, agreed to as part of last
year's bipartisan compromise, banks could be owned by bank
holding companies and by new ``financial holding companies'' as
well. While the financial holding companies could engage in a
broader range of financial activities, they would not be
allowed to own commercial firms.
The Substitute Amendment would allow bank affiliates to
engage in merchant banking activities, subject to certain
specified conditions. As discussed above, merchant banking
refers to the practice of taking a passive equity stake in a
company in connection with the provision of financial services
with a view towards resale. Under the Substitute Amendment,
bank affiliates could invest in a ``bona fide'' merchant
banking activity for the purpose of appreciation and ultimate
resale. The investment could be held ``only for such a period
of time as will permit the sale or disposition thereof on a
reasonable basis,'' and the bank could not actively participate
in the company's day to day management.
The Substitute Amendment also would prohibit the formation
of new unitary thrift holding companies by commercial firms. As
noted above, a holding company that owns even one bank may not
own a commercial firm, nor may a holding company that owns more
than one thrift. However, a holding company that owns just one
thrift (a ``unitary thrift holding company'') is not subject to
the same prohibition. This provision of the law may take on
greater importance than in prior years, as the statutory focus
on residential mortgage lending for thrifts has been modified.
The Substitute Amendment would prohibit any company that
engages in commercial activities from acquiring control of a
thrift. Under a ``grandfather'' provision, existing unitary
thrift holding companies would be allowed to retain their
commercial affiliations. The ``grandfather'' would also apply
to any unitary thrift holding company formed pursuant to an
application already pending before the Office of Thrift
Supervision. The Substitute Amendment would continue to allow
these thrifts to be acquired by financial companies, such as
insurance companies and securities firms. However, it would
prohibit the sale of these thrifts to commercial firms. There
are currently over 500 thrifts owned by unitary holding
companies. Allowing these thrifts to be transferred to
commercial ownership would call the separation of banking and
commerce into question. The Substitute Amendment would
createparity of opportunity for banks and thrifts to be acquired by the
same types of financial institutions.
Reported bill weakens separation of banking and commerce
Unlike the Substitute Amendment, the reported bill
significantly weakens the separation of banking and commerce.
It goes beyond what is necessary to accomodate commercial bank
affiliations with insurance companies and securities firms.
First, it allows for unnecessarily open-ended Amerchant
banking'' investments. Next, it continues to allow commercial
firms to acquire thrifts through the unitary holding company
provision. Finally, it permits holding companies to engage in
any nonfinancial activities that regulators believe are
Acomplementary'' to financial activities.
1. Merchant banking
Like the Substitute Amendment, the reported bill permits
bank affiliates to acquire any type of company in connection
with merchant banking activities, defined to include
``investment activities engaged in for the purpose of
appreciation and ultimate resale or disposition of the
investment.'' However, the reported bill drops safeguards on
merchant banking activities that were contained in last year's
bipartisan bill. It would not prohibit a bank holding company
from actively participating in the day-to-day management of the
companies in which it invests. It also would not limit the
duration of the investment to ``such a period of time as will
permit the sale or disposition thereof on a reasonable basis.''
Thus, the reported bill would not place restrictions on a bank
holding company's acquisition and operation of any company,
including commercial companies of any size and in any industry.
This could effectively break down the separation of banking and
commerce. Over time, the lending decisions of the affiliated
bank could be biased to benefit the commercial firm. The
potential risks raised by mixing banking and commerce could
then be squarely presented: the commercial firm may have a
competitive advantage over its rivals and the deposit insurance
fund might be exposed to unnecessary risk.
2. Unitary thrift holding company provision
The reported bill does not effectively close the unitary
thrift holding company provision. While the bill would prevent
a commercial company from acquiring a thrift after March 1,
1999, it would allow a commercial company to acquire any of the
existing unitary thrift holding companies. Unitary thrift
holding companies currently own over 500 thrifts. Allowing
these thrifts to be acquired by commercial firms would move far
down the road toward a mixing of banking and commerce, with all
its attendant dangers.
Some financial leaders and banking industry groups advised
the Committee to prohibit commercial firms from acquiring
control of thrifts. Chairman Greenspan testified on February
23, 1999, that ``the Board continues to support elimination of
the unitary thrift loophole, which currently allows any type of
commercial firm to control a federally insured depository
institution.'' He recommended that financial services
modernization legislation ``at least prohibit or significantly
restrict the ability of grandfathered unitary thrift holding
companies to transfer their legislatively created grandfather
rights to another commercial organization through mergers or
acquisitions.'' Secretary Rubin has stated,
There are currently some 580 unitary thrift holding
companies. If financial modernization legislation were
enacted, insurance companies and securities firms would
be free to affiliate with banks, and the unitary thrift
holding company might be attractive primarily to
commercial firms seeking to avoid the general
prohibition against owning banks. For that reason, we
support the bill'sprohibition against forming
additional unitary holding companies, and would further support an
amendment terminating the grandfather rights of existing unitaries if
they were transferred to commercial firms. Without such a limit on
transferability, existing charters may tend to migrate to commercial
firms and could become a significant exception to the general
prohibition against commercial ownership of depository
institutions.\35\
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\35\ Rubin Responses at A.1.
The American Bankers Association and Independent Bankers
Association of America both testified before the Committee on
February 25, 1999 expressing their support for closing the
unitary thrift holding company provision, including restricting
transferability of existing unitaries. The American Bankers
said, ``commerce and banking should not be allowed to mix in
the wholesale fashion permitted under the unitary thrift
concept.'' The Independent Bankers oppose the reported bill
because it ``would perpetuate the unitary thrift loophole by
permitting more than 500 existing unitaries to be sold to
commercial firms.''
OTS Director Seidman testified in favor of retaining the
current features of the thrift charter, including the unitary
holding company. She testified before the Committee on February
24, 1999:
In our experience, the modern thrift charter provides
business flexibility and choice coupled with sound
regulatory oversight. It permits affiliations of
insured depository institutions with insurance,
securities, and other firms, but with built-in
safeguards to avoid undue risks to the taxpayer and to
meet the needs of consumers and communities. Based on
our experience, there is no evidence that shows that
affiliations permitted in the unitary thrift holding
company structure are inherently risky and should be
constrained. In fact, there are numerous reasons to
retain the structure in its current form.
Some have argued that limiting transferability of unitary
thrift holding companies would be unfair because companies
bought thrifts at a time when they could sell to any commercial
company. In the past, however, Congress has changed statutes
governing savings associations and required compliance. For
example, in 1987 Congress imposed a ``qualified thrift lender
test'' requiring thrifts to hold a percentage of their total
assets as ``qualified thrift investments.'' A unitary thrift
holding company owning a thrift that failed to comply with the
new requirement was required to divest its commercial
activities. Also in 1987, Congress limited the transferability
of non-bank banks by requiring that upon transfer the new owner
bank would be required to register as a bank holding company.
Because the Congress broke no contracts in taking these
actions, they created no liability for the Federal government.
These prior Congressional actions provide a precedent for the
position taken by the Substitute Amendment and are advocated by
Chairman Greenspan, Secretary Rubin and others.
3. ``Complementary'' activities
Finally, as would the Substitute Amendment, the reported
bill allows holding companies that own banks to engage in
activities that are ``financial in nature or incidental to such
financial activities.'' Both would also permit numerous
specific non-banking activities. These include activities
consistent with reasonably expected changes in technology or
the financial marketplace and investments in commercial firms
by insurance companies.
The reported bill goes even further, by authorizing holding
companies to engage in activities that are ``complementary''
activities that are financial in nature and incidental thereto.
While subject to interpretation by regulators, the reported
bill itself provides no definition of or limitations on these
``complementary'' activities. Some ``complementary'' activities
would very likely be commercial in nature, raising the
potential dangers of biased lending decisions described above.
This open-ended grant of authority seems unnecessary.
vi. conclusion
The Democratic Members of the Committee support financial
services modernization legislation. All Democratic Members of
the Committee supported last year's bipartisan bill. All
Democratic Members of the Committee this year supported the
Substitute Amendment, which contained the text of last year's
bipartisan bill with the addition of authority for bank
operating subsidiaries and appropriate safeguards. These
provisions achieve the primary objective of financial services
modernization, namely allowing affiliation of banks, securities
firms and insurance companies. The provisions do so while
preserving safety and soundness, protecting consumers,
providing for regulatory parity, and promoting the availability
of financial services to all communities.
The bill now reported by the Committee, however, falls
short of these goals. It undermines the Community Reinvestment
Act. It does not protect purchasers of securities and insurance
products from banks. It does not provide bank operating
subsidiaries with the scope sought by the Treasury Department.
Finally, it breaches the separation of banking and commerce.
For these reasons, President Clinton has declared he will veto
it in its current form.
If financial modernization legislation is to be enacted,
the Senate must return to the bipartisanship that characterized
legislative efforts in this area until this year. The
Substitute Amendment offered at the Committee markup has been
introduced by Senator Daschle and every Democratic Member of
the Commitee as a stand-alone bill, S. 753. It is a balanced,
prudent approach to financial services modernization. It
reflects careful, bipartisan compromises struck last year. It
is not opposed by any financial services industry association.
It is similar to the bill passed with broad bipartisan support
by the House Banking Committee earlier this year. It is clearly
the approach most likely to achieve the enactment of financial
services modernization legislation.
Failure to proceed on a bipartisan basis will, at best,
waste the Senate's time in fruitless effort. At worst, the
reported bill would increase risks to the taxpayer-backed
deposit insurance funds, reduce the availability of credit in
underserved communities, and expose consumers to unnecessary
confusion.
Paul S. Sarbanes.
John F. Kerry.
Tim Johnson.
Richard H. Bryan.
Evan Bayh.
John Edwards.
Charles Schumer.
Jack Reed.
Christopher J. Dodd.
ADDITIONAL VIEWS OF SENATOR REED
At the outset, I would like to indicate my desire to pass
financial services modernization legislation. Indeed, I believe
the existing legal framework governing the financial services
industry is an anachronism that bears no relationship to the
realities of today's financial markets. Moreover, the theories
advanced at the time of Glass-Steagall's enactment which
suggested the need to separate banking, securities, and
insurance as a prudential measure, have long since been
abandoned. In fact, today there is general consensus that these
activities can safely be conducted in one firm if appropriate
firewalls are in place.
For these reasons, I am a proponent of financial
modernization. More specifically, I support legislation that
will allow financial institutions to affiliate, while
preserving safety and soundness, and ensuring community access
to credit. I believe last year's financial modernization bill,
H.R. 10, which passed the House and overwhelmingly passed the
Senate Banking Committee, adequately addressed these
priorities. Unfortunately, that bill was prevented from coming
to the Senate floor because of a desire by some to eliminate
the Community Reinvestment Act (CRA) provisions included in the
bill. As a result, the Senate missed an historic opportunity to
enact fair and balanced financial modernization legislation.
The bill now being considered substantially deviates from
the bipartisan compromise passed by the Committee last year. To
be sure, this legislation falls woefully short on a range of
issues which, in my opinion, are essential components of
financial services modernization.
First, the current modernization bill includes several
provisions that would significantly undermine CRA--legislation
which has been responsible for $1 trillion in loans and loan
commitments to low-income communities since its enactment in
1977. For example, one provision of the bill would create an
exemption to CRA for rural financial institutions with assets
under $100 million. Although this exemption is limited to the
smallest institutions, over 76 percent of rural banks would be
covered. This is of great concern since small banks have
historically received the lowest CRA ratings. In fact,
institutions with less than $100 million in assets accounted
for 92 percent of institutions receiving ``substantial non-
compliance'' CRA ratings in 1997-1998.
I am also concerned about this exemption because banks are
typically the primary sources of credit in rural communities.
Hence, absent CRA, it is likely that many rural communities
could become credit-starved.
The bill also includes a provision that would provide a
safe harbor for banks with a ``satisfactory'' or better CRA
rating. Specifically, institutions receiving a satisfactory CRA
rating at their most recent examination would be presumptively
in compliance with CRA, unless ``substantial verifiable
information'' to the contrary was presented.
I am concerned about this provision because it establishes
a very difficult-to-satisfy burden of proof for individuals or
groups wishing to protest a bank merger on CRA grounds. Indeed,
I fear this provision will greatly inhibit the ability of
groups to get the necessary information from banks to protest a
merger. Also, when considering the fact that 97 percent of
institutions receive a satisfactory or better CRA rating, it is
clear that this provision will effectively eliminate CRA
comment on a bank merger.
In addition to CRA, provisions in the bill establishing a
$1 billion asset cap for banks engaging in securities
underwriting and merchant banking in an operating subsidiary
raiseconcerns. I believe that banks of any size should have the
flexibility to engage in the designated principal activities in an
operating subsidiary as long as the proper safeguards are in place such
as capital deduction requirements and limitations on self-dealing. In
accordance with my views on this issue, I offered an amendment to H.R.
10 in the Banking Committee last year that would have allowed banks to
engage in securities underwriting and merchant banking in an operating
subsidiary. This amendment has been incorporated into an alternative
Democratic financial services modernization bill, S. 753.
The financial modernization bill is also problematic since
it does not include provisions to require prior approval from
the Federal Reserve Board (FRB) before allowing a bank to merge
or engage in new activities. At a minimum, the FRB should be
required to consider whether the merger or new activity will
compromise safety and soundness, will adversely affect
competition, and will serve the public interest. Such
provisions were included in H.R. 10 and have been included in
the Democratic alternative.
I also have general concerns about the regulatory scheme
established in the modernization bill. For example, the bill
expands the powers of financial institutions, while
simultaneously limiting the powers of federal regulators. This
is evident in section 114, which prohibits the Office of the
Comptroller of the Currency (OCC) and the Office of Thrift
Supervision (OTS) from examining a mutual fund being operated
by a bank or thrift. This provision curtails existing powers of
the OCC and OTS, both of which currently have limited authority
to examine a mutual fund operated by a bank or thrift. I
believe it is important that this authority be maintained.
Another similarly restrictive provision found in section
111 would prohibit the FRB from examining a securities or
insurance affiliate unless there is ``reasonable cause to
believe'' the affiliate is engaging in a risky activity. Absent
the ability to examine the affiliate, it is unclear how the FRB
could determine whether the affiliate is engaging in a risky
activity.
Ultimately, I am concerned that this regulatory scheme, as
illustrated by the foregoing provisions, is too porous. I fear
that regulators may sometimes be unable to coordinate their
responsibilities, which could result in situations in which
detrimental practices may go unchecked.
Finally, provisions of the bill that would limit the FRB's
authority to require an insurance affiliate to recapitalize a
failing bank raise concerns. These provisions undermine the
``source of strength'' doctrine, and, in my opinion, could lead
to a regulatory standoff between the FRB and state insurance
commissioners. I could easily envision a situation in which a
state insurance commissioner acts out of his/her political
interest and prohibits a well-capitalized insurance affiliate
from assisting a failing bank. In this case, the FRB's only
recourse would be to require the bank holding company to sell
off the bank. However, it is unlikely that there would be a
buyer for an insolvent bank, in which case deposit insurance
funds would have to cover losses.
In view of my concerns with the Committee-passed bill, I
joined my Democratic colleagues in introducing an alternative
financial modernization bill, S. 753, which is substantially
similar to the H.R. 10 bill that enjoyed broad industry support
and which passed the House and Senate Banking Committee last
year. In my opinion, S. 753 addresses the need to modernize our
financial services system, while preserving safety and
soundness, as well as protecting community access to credit. I
hope my colleagues can support S. 753 if we have an opportunity
to consider it on the Senate floor.
Jack Reed.