Regional President Speech

.. ... - AFTER DEREGULATION: THE ROLE OF THE REGULATOR Remarks by Roger Guffey President, Federal Reserve Bank of Kansas City 1983 Annual Convention Missouri Bankers Association Kansas City, Missouri May rO, 1983 . .. - ;;&.<tf' 7~ ~;aJ ~ ~~~. . c9 dd,;t.M ~" ~ rtHE-·J~ ~ ~ y;;yy/ ~~ /~~~ 7 ~ /,:'~' 2~- .. ~ ~ -;{~- ~ . /":7 ~ ~~./..cfJ~ ~ .~ .z­ y- ~,#,c~ ~ ~ c:7iI~~ ~~C)~~~~~ ~/G ~ ~~O-~~~ ~~~~~. • • THE ROLE OF THE REGULATOR AFTER DEREGULATION Deregulation of the financial services markets, and of ..... ­ banking in particular, is proceeding swiftly on a broad front. Deregulation of interest rates the elimination of deposit interest ceilings -- is largely over. However, for product and geographic deregulation, / the battle is now becoming intense. Product constraints -- which historically have kept banks from offering certain financial services and nonbank firms from offering other services considered to be exclusively for 'flow banking -- areAcrumbling away. Companies like Sears, Merrill Lynch, American Express and Prudential are causing banks competitive fits. There is now the "nonbank bank" further eroding banking's unique role in delivering financial services to the mar ket place. Significantly, the "nonbank bank" also has become an alternative to the geographic restrictions of the McFadden Act and the Douglas Amend-ment. While the nonbank firms have made inroads into banking, banks, too, have broadened their presence in the markets by offering brokerage and other related services to the public. Local legislatures have permitted or invited out-of-state holding ~ companies into their markets and they are permitting banks to offer a broad range of insurance, real estate and security services. Finally, the availability of computer technology is accelerating the industry's ability to provide financial services across the country. .. - 2 ­ From these fundamental events has come the question, or issue, of how changes in the financial services industry should be allowed to proceed and whether the bank regulatory and curre~t supervisory framework is adequate to continue to promote a sound ~ , . ; , :7~ financial industry. ,~ Paul Volcker ha:S1 wisely " asked , for a moratorium on the spread of "nonbank banks" and other efforts to ci cumvent statutes requiring separation of commerce and banking. C1h­ w~Aa not concerned so much by change itself but because it is occurring by regulator fiat rather than through the legislative process. Congress also is now studying both the issue of a proper supervisory structure and is reviewing developments in the markets for banking and other financial services. Finally, Vice President Bush's Task Group on Regulation and Financial Services has been set up to review and perhaps recommend changes in the current regulatory structure. We all hope that constructive suggestions will come forth to point the direction for the 11",,/ S . (~ /,I financial services industry and to clarify how thi /I industry should be supervised. As this review process has gotten under way, one disturbing view surfaces with some re ularity~ This view suggests that the S· . ~C Federal Reserve should beA~ t ofrbank regulation and supervision.~ Other agencies and observers suggest that monetary and regulatory policies are unrelated in a broad olicy sense and, therefore, regulatory matters need not be a direct policy concern to the Federal Reserve. The Association of Registered Bank Holding Companies and the Amercian Bankers Association have suggested - 3 ­ that the Federal Reserve's "regulatory role should be focused strictly on monetary policy formulation and implementation, through the elimination of the burden of regulatory and supervisory responsibilities not necessary to the conduct of monetary policy". I do not agree with these comments and suggestions. I believe these statements are in error and I welcome this opportunity to offer my views regarding the importance to the . Federal Reserve of its regulatory and supervisory role withithe financial system. In doing this, I will outl ine br iefly my thoughts on why financial institutions should be subject to some supervision and suggest some alternative regulatory structures that might work in the emerging financial industry. My theme is based on my very strong belief that the Federal Reserve, as the nation's central bank and monetary authority, is principally responsible for the nation's financial stability. To effectively meet this responsibility, the Federal Reserve must have a central in regulatory oJ and supervisory matters Why We Regulate Financial Institutions Various discussions I have shared with bankers suggest to me that a subtle but significant reason for the desire to see the Federal Reserve out of regulation is the perception that the central bank has moved too slowly in deregulating the industry. These bankers suggest that the Federal Reserve has failed to - 4 ­ recognize, in today's environment, that the growth and prosperity of the u.s. economic system relies on our willingness to allow risk into the economic system and our acceptance of some business failures. Although I certainly concur that our markets must be competitive, I also believe that consistent economic growth requires economic stability free from massive institutional f. ailures ~ and disruptions. Certainly, the Federal Reserve, and others, must not needlessly inhibit change, but we must also strive to assure that prospective change is consistent with the public interest and the need for a sound financial industry. Perhaps this point was best put by a prominent banker who, when compar ing the Federal Reserve with other regulatory agencies, commented that, "Maybe if I had responsibility for the monetary health of the nation and also regulated the institutions which control the bulk of the nation's money, I'd act like the Fed". Indeed, financial institutions, and banks in particular, bring savers and investors together and facilitate the exchange of goods and services in the economy through their payments systems. Accordingly, they represent the channels through which national monetary and credit policies are implemented, and they significantly affect the nation's level of employment and income. Moreover, as we have seen recently, problems which develop in these institutions spread rapidly because of sophisticated le-nding and investing linkages. - 5 ­ The importance of these institutions to the vitali ty of the ~ -uu.. p-.d-' economic system, therefore, has led government{ to monitor their activities closely and to limit their activities to minimize the risk of failure. Furthermore, Congress created the FDIC and the FSLIC to share responsibility with the Federal Reserve for avoiding a crisis of confidence in the financial system when individual institutions fail. As fhe deregulatory process continues, the importance of financial institutions certainly will not diminish. Moreover, as the lines separating banking and commerce fade and as the financial bonds between them become more complex, the risks to the system will increase proportionately. Thus, it is clear to me that some regulation and supervision will be needed regardless of the financial structure that emerges from the deregulatory process. The Federal Reserye's Role in and Supervision statutory Recognition Recognizing, then, thatA regulation and supervision will not diminish in the future, who should do the regulating? In response to this question, I would first note that the Federal Reserve's current role has not evolved as a ~ ,a,;~ patchwork quilt. Rather, it has developed rationally, recognizing that the Federal Reserve's central bank function is necessarily broader than monetary policy alone. The Federal Reserve Act states that "The Federal Reserve System was - 6 ­ established to furnish an elastic currency, ••• and to establish a more effective supervision of banking in the United States It The Act clearly intends to provide the Federal Reserve with author i ty to establish reasonable behavior for financial institutions. The Bank Holding Company Act also recognizes the importance of the Federal Reserve in influencing our financial markets by directing the Federal Reserve to monitor and control the expansion of banking institutions into nonbank activities and to ensure the basic financial soundness of the bank holding company in its relationship to the bank. In addition, Congress assigned total responsibility for the administration of the Act to the Federal Reserve, regardless of the charter held by the subsidiary bank. Interaction of Monetary and Supervisory Policy What these statutes recognize is that the Federal Reserve's ability to control money and bank credit, and thereby influence real economic activity, would be compromised if it could not also influence the overall condition of the institutions through which money and credit flow. Because the strengths and weaknesses of financial organizations provide constraints within which monetary policy must operate, the Federal Reserve has a ~ continuing/I direct interest in promoting strong banking organi­ zations through careful supervision. - 7 ­ Also, to the extent that bank regulation affects -money, - credit and interest rates, regulation should complement monetary policy goals. As an active participant in domestic and international monetary and credit mar kets, the Federal Reserve is, in my judgement, best situated to ensure that regulatory policies are consistent with overall monetary policy objectives. -F-o.r -e-x-a-m-p-le, .­capital guidelines obviously involve issues of bank soundness~ but they also affect economic and credit activities. - Thus, capital guidelines should be evaluated in light of other monetary policy and credit objectives and their impact on financial institutions and markets should be evaluated before such guidelines are changed or new policies implemented. Thus, over any economic period, the Federal Reserve should retain the broadest perspective and pursue those monetary and supervisory policies that are coordinated, timely and effective. The s Role in Managing Financial _Crisis Feder~ ~§erye' On another level, it is a fact that in nearly every major financial cr isis, we look to the central bank for help. This role for the Federal Reserve derives from its position as a primary regulator of banks and bank holding companies 'l' its daily participation in financial market and its close relations with foreign central banks and other supervisory authorities. This experience, coupled with the Federal Reserve's ability to provide immediate liquidity to the economy as lender of last resort, give the Federal Reserve a unique ability to stern the spread of - 8 ­ financial problems and offer the broadest possible perspective to -rlcc~ solving these problems. You might recall', for example, that when u. S. financial markets carne under stress following the failure of the Drysdale securities firm, the Federal Reserve played the central role in maintaining order in the market place. Other episodes, such as the Hunt silver affair, the failure of Penn Square and the recent strains in the international markets resulting from foreign loan problems all created serious liquidity problems among u.S. banks and other financial institutions. The Federal Reserve has been heavily involved in finding solutions to each of these problems while at the same time providing necessary credit and acting in the markets to preserve stability. Some groups suggest that the central bank can work to solve these kinds of problems if it is simply supplied information from an independent su ervisor. I -d-i-s-a-g-re-e. Our ability to act immediately on problems requires t hat the Federal Reserve have d,;.u. the relevant current information and the/! people who can act decisively. Secondhand information is not enough. Moreover, decisions involving difficult trade offs among competing policy goals require access to timely information and an exper ienced staff. This to decide issues is not acqui~ed on the sidelines, bu trenches where supervisory and financial market operations are carried out. - 9 ­ Monetary and Supervision Policy In A Dynamic Financial Environment In today' s dynamic financial system, the effectiveness of monetary and supervisory policies also depends significantly on the Federal Reserve's knowledge of, and influence on the development of new financial products and services. Although the Federal Reserve must not needlessly inhibit change, it should act deliberately to assure itself that prospective change is consistent with the public interest and a sound industry. The Federal Reserve can only achieve this goal if it has timely, significant information gained -­ in part, at least through its direct involvement in the supervisory process. We are now enmeshed, for example, in the issue of the "nonbank bank," the movement of Sears and others into banking, and the issue of to what extent banks should be allowed to engage in commerce. The analysis of these events involves more than a review of potential competitive impacts on existing market participants. Such analysis, in fact, involves fundamental issues of money growth and issues of financial soundness which can be adequately addressed only if the central bank has a clear insight into how financial innovations operate and who they affect. It is obvious to me that such knowledge will come to us most directly through the supervision function. - 10 - Alternatiye Structures For Regulating The Financial Industry Finally, as I noted earlier, the issue for the Federal Reserve is not whether it should be involved in supervision, but rather to what extent the Federal Reserve supervises. Assumin~ Fe~eral involvemen~ Reserve there are, of course, various supervisory structures which might be effective. For example, we could continue with the current structure. While the current multi-agency structure is not the most efficient means of regulating, supervising and examining financial institutions, it has provided a good system of checks and balances to control the use of regulatory powers. Moreover, I have seen no substantial evidence that the structure has failed. However, if the desire for improved supervisory efficiency takes precedence over other considerations, the Federal Reserve's n need for a major nhands-on role in supervision could be met if the central bank was assigned supervision of the npace setting" institutions most clearly able to affect financial markets. For example, the Federal Reserve might supervise the largest national and regional institutions or those engaged in activities crossing ,state lines. It might supervise institutions having assets exceeding a half a billion dollars or those with bank or nonbank financial offices in more than one state. Institutions which confine their activities to a single state or which have less than a half a billion dollars in assets would be supervised completely by the states or other regulatory authority. This approach might simplify the current supervisory structure while preserving our basic dual banking system. - 11 ­ Conclusion I cannot say which supervisory alternative may ultimately be chosen. The groups now studying the issue must decide. However, let me conclude by emphasizing that, in my view, efficiency should not be the pr incipal cr iterion for determining how the financial industry should be regulated, supervised and examined. A more important consideration should be that the Federal Reserve, as the central bank, remains ultimately responsible for the soundness of our financial system. To successfully meet this responsibility, the Federal Reserve requires the author i ty to regulate and to maintain close surveillance and supervision of the var ious activities of banks and diversified banking organizations. The Federal Reserve requires this author i ty to maintain the financial integrity of individual institutions; it requires this authority for proper administration of the discount window; and it requires this authority to implement both monetary and regulatory policies in a carefully evaluated, closely coordinated, and most effective manner.

J. Roger Guffey (1983, May 19). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19830520_j_roger_guffey

@misc{wtfs_regional_speeche_19830520_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1983},
  month = {May},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19830520_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}