Regional President Speech

READING COPY MAY 24, 1983 REGULATION: A CHANGING ENVIRONMENT REMARKS OF JOHN J. BALLES, PRESIDENT FEDERAL RESERVE BANK OF SAN FRANCISCO MEETING OF ALASKA BANKERS ASSOCIATION FAIRBANKS, ALASKA JUNE 4, 1983 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 1 - - REGULATION IN A CHANGING ENVIRONMENT DEPOSITORY INSTITUTIONS ARE UNDERGOING MAJOR CHANGES. THE RECENT INTRODUCTION OF MONEY MARKET DEPOSIT ACCOUNTS HAS FINALLY ENABLED THESE INSTITUTIONS TO COMPETE WITH THE MONEY MARKET FUNDS. THE NEW ACCOUNTS HAVE SWELLED TO ABOUT $350 BILLION, WITH A SURPRISINGLY LARGE SHARE COMING FROM OUTSIDE THE BANKING SYSTEM. THIS GROWTH DEMONSTRATES THE ADVANTAGE THAT BANKS HAVE IN THE FINANCIAL SYSTEM SO LONG AS THEY ARE ALLOWED TO COMPETE FREELY. WHAT I WOULD LIKE TO DO TODAY IS BRIEFLY TO OUTLINE HOW THE CHANGING REGULATORY ENVIRONMENT IS AFFECTING DEPOSITORY INSTITUTIONS AND, CONVERSELY, HOW THE CHANGING FINANCIAL ENVIRONMENT IS AFFECTING REGULATION. AT THE END OF MY REMARKS, I WILL DISCUSS HOW I PERCEIVE REGULATION AND THE FINANCIAL STRUCTURE EVOLVING IN THE 1980'S. BANKING REGULATIONS FEW INDUSTRIES ARE AS THOROUGHLY REGULATED AS BANKING. AN ENCOMPASSING LEGAL AND REGULATORY NET HAS CIRCUMSCRIBED DEPOSIT RATES, PRODUCT LINES, AND GEOGRAPHIC MARKETS OF BANKS AND OTHER DEPOSITORY INSTITUTIONS. MANY OF THESE RESTRICTIONS WERE A RESPONSE TO THE FINANCIAL COLLAPSE AND BANKING PANICS OF THE EARLY 1930'S ASSOCIATED WITH THE GREAT DEPRESSION. WITH THE INTENTION OF "ESTABLISHING A SOUND FINANCIAL SYSTEM," CONGRESS PASSED THE BANKING ACT OF 1933 (GLASS-STEAGALL ACT), THE BANKING ACT OF 1935, AND THE SECURITIES ACTS OF 1933 AND 1934. TAKEN TOGETHER, THESE LAWS PLACED BANKING Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis AND SECURITIES MARKETS UNDER A COMPREHENSIVE REGULATORY UMBRELLA, WHICH (AMONG OTHER THINGS) PROHIBITED EXPLICIT INTEREST ON DEMAND DEPOSITS, CREATED THE AUTHORITY FOR REGULATION Q INTEREST-RATE CEILINGS ON TIME DEPOSITS, AND DREW A DISTINCT LINE BETWEEN COMMERCIAL BANKING AND INVESTMENT BANKING. (RESTRICTIONS ON INTERSTATE BANKING ALREADY WERE IN PLACE IN THE FORM OF STATE LAWS THAT WERE FEDERALLY SANCTIONED BY THE MCFADDEN ACT OF 1927.) REGARDLESS OF THE LEGISLATORS' ORIGINAL INTENT, THIS LEGISLATIVE AMALGAM IN PRACTICE HAS TENDED TO LIMIT COMPETITION AND IN SO DOING OFTEN INTERFERE IN THE EFFICIENT OPERATION OF THE FINANCIAL SYSTEM. REGULATIONS AND INNOVATION QUITE NATURALLY, FINANCIAL INSTITUTIONS OVER TIME HAVE INNOVATED IN AN ATTEMPT TO AVOID SUCH RESTRICTIONS. FOR EXAMPLE, AS A CONSEQUENCE OF RESTRICTIONS ON GEOGRAPHIC MARKETS (MCFADDEN ACT AND STATE LAWS), PRODUCT LINES (GLASS-STEAGALL) AND MAXIMUM DEPOSIT RATES (BANKING ACT OF 1935 AND REG. Q), BANKS HAVE UTILIZED THE HOLDING COMPANY AS A DEVICE FOR GETTING AROUND THESE BARRIERS AND IN THAT WAY COMPETE MORE EFFICIENTLY. BUT CONGRESS ACTED TO LIMIT THIS AVENUE BY PASSING THE BANK HOLDING COMPANY ACT OF 1956, INCLUDING THE INTERSTATE BANKING RESTRICTIONS OF THE DOUGLAS AMENDMENT, AND ADDING AMENDMENTS TO THE ACT IN 1966 AND 1970. TO SUPPLEMENT AND ENFORCE THESE LAWS REGULATORS ADDED A COMPLEX REGULATORY STRUCTURE. THE SITUATION HAS BEEN SIMILAR WITH DEPOSIT RATE CEILINGS: REGULATIONS HAVE PROLIFERATED IN BELATED RESPONSE TO THE INNOVATIONS INTRODUCED BY DEPOSITORY INSTITUTIONS TO GET AROUND THESE CEILINGS. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis MCA AND DEREGULATION IN ADDITION TO ITS EFFECTS ON MONETARY CONTROL AND THE FED'S OPERATING ENVIRONMENT, THE DEPOSITORY INSTITUTIONS DEREGULATION AND MONETARY CONTROL ACT OF 1980 REPRESENTED A SIGNIFICANT STEP IN DISMANTLING THE MASSIVE LEGISLATIVE AND REGULATORY FRAMEWORK THAT ENVELOPED BANKING. PERHAPS MOST IMPORTANTLY, IT ESTABLISHED THE DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE (DIDC) TO OVERSEE THE PHASEOUT OF REG. Q DEPOSIT-RATE CEILINGS OVER A SIX- YEAR PERIOD ENDING APRIL 1986. THE ACT ALSO ALLOWED BANKS AND THRIFTS TO OFFER INTEREST- BEARING NOW ACCOUNTS NATIONWIDE, PRE-EMPTED STATE MORTGAGE USURY CEILINGS (SUBJECT TO STATE OVER-RIDE WITHIN THREE YEARS) AND EXPANDED SOMEWHAT THE LENDING POWER OF THRIFT INSTITUTIONS. DESPITE MANY OTHER SIGNIFICANT ASPECTS OF THE ACT (E.G., FED MEMBERSHIP, PRICING, MONETARY CONTROL), PERHAPS ITS MOST PROFOUND CONSEQUENCES CAME FROM THE EXTENSION OF CHECKING PRIVILEGES TO THRIFTS AND FROM THE ULTIMATE PROMISE OF MARKET-DETERMINED RATES OF INTEREST ON ALL BANK AND THRIFT DEPOSITS. GARN-ST. GERMAIN ACT IN RESPONSE TO CONTINUING CONCERN OVER DEPOSITORY INSTITUTIONS' COMPETITIVE DISADVANTAGE COMPARED TO UNREGULATED FINANCIAL INTERMEDIARIES LIKE MONEY MARKET FUNDS, AND TO THE PROBLEM OF FAILING BANKS AND THRIFTS, CONGRESS PASSED THE GARN- ST. GERMAIN DEPOSITORY INSTITUTIONS ACT LAST OCTOBER. ALTHOUGH THERE ARE MANY COMPONENTS OF THIS IMPORTANT PIECE OF LEGISLATION, IT HAS BECOME BEST KNOWN FOR ITS KEY PROVISIONS IN THE FOLLOWING THREE AREAS: 1) THE ACT REQUIRED THE DIDC TO CREATE WITHIN 60 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis DAYS A DEPOSIT INSTRUMENT FOR BANKS AND THRIFTS THAT WOULD BE COMPETITIVE WITH MONEY MARKET FUNDS; 2) IT RESTRUCTURED AND EXPANDED THE POWERS OF THRIFT INSTITUTIONS; AND 3) IT GAVE THE REGULATORS EXPANDED FLEXIBILITY IN ARRANGING FOR EMERGENCY TAKEOVERS OF FAILED OR FAILING DEPOSITORY INSTITUTIONS, AND IN PROVIDING CAPITAL ASSISTANCE TO TROUBLED INSTITUTIONS. UNDER THE SECOND SET OF PROVISIONS, THE GARN-ST. GERMAIN ACT EXPANDED THE POWERS OF THE FEDERAL THRIFTS BY ALLOWING THEM TO OFFER DEMAND DEPOSITS TO PERSONS HAVING A BUSINESS RELATIONSHIP, PERMITTING OVERDRAFT LOANS ON ALL TRANSACTION ACCOUNTS, ALLOWING LOANS ON NONRESIDENTIAL PROPERTY UP TO 40 PERCENT OF ASSETS, AND ALLOWING FEDERAL THRIFTS TO PUT A LARGER PORTION OF THEIR ASSETS INTO INVESTMENTS IN STATE AND LOCAL GOVERNMENT OBLIGATIONS, AND TO PLACE UP TO 10 PERCENT OF THEIR ASSETS IN COMMERCIAL AND AGRICULTURAL LOANS. THESE NEW POWERS GIVEN TO THRIFTS, TOGETHER WITH GREATLY EXPANDED THRIFT HOLDING COMPANY POWERS AUTHORIZED BY THE FEDERAL HOME LOAN BANK, HAVE DONE A GREAT DEAL TO MAKE THRIFTS MUCH MORE LIKE BANKS. MOREOVER, THE BRANCHING RESTRICTIONS OF THE MCFADDEN ACT DO NOT APPLY TO THRIFTS, AND EXISTING RESTRICTIONS ON THRIFT HOLDING COMPANIES ARE CONSIDERABLY LESS STRINGENT THAN THOSE PLACED ON BANK HOLDING COMPANIES BY THE BANK HOLDING COMPANY ACT. FEDERAL REGULATORY STRUCTURE THE GROWTH OF MONEY MARKET FUNDS, THE SCHEDULED REMOVAL OF DEPOSIT RATE CEILINGS, EXPANDED POWERS OF THRIFT INSTITUTIONS, AND ENCROACHMENT OF BROKERAGE HOUSES AND RETAIL FIRMS INTO ACTIVITIES LIKE PROVIDING LIQUID FORMS OF SAVINGS INSTRUMENTS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 5 - - HAVE RAISED SERIOUS QUESTIONS ABOUT THE RELEVANCE OF EXISTING PRODUCT-LINE AND INSTITUTIONAL DISTINCTIONS IMPOSED BY REGULATIONS. MOREOVER, INTERSTATE ACTIVITIES ARE EXPANDING RAPIDLY THROUGH BANK AND THRIFT HOLDING COMPANIES AND THROUGH THE EXPANSION OF BANK-LIKE SERVICES PROVIDED BY BROKERAGE HOUSES, INSURANCE COMPANIES, AND RETAIL OUTLETS. AS A RESULT, THE CURRENT SYSTEM OF FEDERAL REGULATION OF FINANCIAL INSTITUTIONS MAY NOT BE WELL SUITED TO THIS NEW ENVIRONMENT. EACH ELEMENT OF THE CURRENT SYSTEM WAS CREATED IN RESPONSE TO SPECIFIC PROBLEMS OR NEEDS, BUT RECENT TRENDS IN THE FINANCIAL SYSTEM AS A WHOLE HAVE CHALLENGED THE ABILITY OF THIS SYSTEM OF PIECEMEAL REGULATION TO FUNCTION EFFICIENTLY OR EQUITABLY. AS A RESULT, BOTH POLICYMAKERS AND REGULATORS ARE REVIEWING THE APPROPRIATENESS OF THE EXISTING STRUCTURE AND PROCEDURES. VICE PRESIDENT BUSH IS HEADING A TASK GROUP ON REGULATION OF FINANCIAL SERVICES WHICH IS UNDERTAKING A STUDY OF THE PROBLEMS OF THE EXISTING SYSTEM OF FEDERAL FINANCIAL REGULATION. AT THIS POINT, THE TASK GROUP HAS ONLY IDENTIFIED THE MAJOR PROBLEMS THAT IT WISHES TO ADDRESS. THESE INCLUDE THE OVERALL SCALE OF REGULATORY CONTROL, AGENCY RESPONSIVENESS, AND THE QUESTION OF JURISDICTIONAL OVERLAPS, EITHER AMONG VARIOUS FEDERAL AGENCIES OR BETWEEN THE FEDERAL AGENCIES AND THEIR STATE COUNTERPARTS. THE BUSH TASK GROUP INTENDS TO COMPLETE ITS REVIEW OF THE CURRENT REGULATORY SYSTEM BY THIS FALL AND TO REPORT TO THE PRESIDENT CONCERNING AREAS FOR CHANGE. THE TASK GROUP AS YET HAS NOT DISCLOSED ALL THE ALTERNATIVES IT WILL CONSIDER, BUT IT SEEMS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis LIKELY SOME CONSOLIDATION OF SUPERVISORY FUNCTIONS WILL BE ON THEIR AGENDA OF RECOMMENDATIONS. AS YOU KNOW, SUCH CONSOLIDATIONS HAVE BEEN RECOMMENDED BY SEVERAL REGULATORY-REFORM COMMISSIONS IN THE PAST THIRTY YEARS, INCLUDING THE HOOVER COMMISSION OF 1949, THE HUNT COMMISSION OF 1972, AND A STUDY BY THE HOUSE BANKING COMMITTEE IN 1975. THE BUSH TASK GROUP IS WELL AWARE, OF COURSE, OF THE ARGUMENTS FOR AND AGAINST EXTREME CONSOLIDATION OF RESPONSIBILITY -- AND, IN FACT, ALREADY HAS COME OUT AGAINST THE CONCEPT OF A "SUPER-AGENCY." A MAJOR CONSIDERATION FOR THE COMMISSION AS IT CONSIDERS ALTERNATIVES PRESUMABLY WOULD BE TO REDUCE DUPLICATION WHILE AVOIDING ARBITRARY OR INFLEXIBLE BEHAVIOR (THAT MIGHT RESULT, FOR EXAMPLE, FROM AN ALL-POWERFUL AGENCY). IN ESSENCE, THE CHALLENGE TO THE TASK GROUP IS TO FIND A PATH THAT YIELDS THE ADVANTAGES OF AGENCY PLURALISM WITHOUT PERPETUATING THE COMPLEX STRUCTURE OF REGULATION THAT CURRENTLY EXISTS. IN MY VIEW, IT WOULD BE UNWISE TO CONTEMPLATE A MAJOR RESTRUCTURING OF REGULATORY OR SUPERVISORY AUTHORITY AT THIS TIME. WE ARE AT A CROSSROAD WHERE THE PRIVATE FINANCIAL SYSTEM IS CHANGING VERY RAPIDLY, AND DEREGULATION IN SOME IMPORTANT AREAS SUCH AS DEPOSIT-RATE CEILINGS IS MAPPING OUT YET-UNKNOWN COURSES. IN MY OPINION, IT WOULD BE BEST TO ALLOW THE EFFECTS OF DEREGULATION TO UNFOLD MORE FULLY BEFORE RESTRUCTURING OUR REGULATORY AND SUPERVISORY INSTITUTIONS. ANY CONSIDERATION OF ULTIMATE REFORM RAISES THE ISSUE OF THE APPROPRIATE ROLE OF THE FEDERAL RESERVE SYSTEM IN SUPERVISION AND REGULATION. MY POSITION IS THAT THE RESPONSIBILITY OF THE Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE AS THE NATION'S ARCHITECT OF MONETARY POLICY, ALONG WITH ITS KEY ROLE AS LENDER OF LAST RESORT TO DEPOSITORY INSTITUTIONS, AUTOMATICALLY IMPLIES A CONCERN FOR THE STABILITY AND SOUNDNESS OF FINANCIAL INSTITUTIONS AND MARKETS. BANKING REGULATION AND SUPERVISION SERVE AS SOURCES OF INFORMATION AND EXPERTISE CONCERNING THE LIKELY INSTITUTIONAL IMPACT OF MONETARY POLICY. REGULATORY AND SUPERVISORY POLICIES CAN INFLUENCE THE CHANNELS OF TRANSMISSION OF MONETARY POLICY, THE MEANING OF THE FINANCIAL AGGREGATES, AND THE SOUNDNESS OF THE INSTITUTIONS THAT MAKE UP THE MONETARY SECTOR. THUS, ANY RESTRUCTURING OF REGULATORY AUTHORITY IDEALLY WOULD RETAIN SUFFICIENT AUTHORITY IN THE FEDERAL RESERVE TO CONDUCT MONETARY POLICY AND PROMOTE FINANCIAL STABILITY. CHANGES IN REGULATORY AUTHORITY PROBABLY WOULD BE BEST STRUCTURED ALONG FUNCTIONAL OR PRODUCT LINES, WHEREAS SUPERVISION IS MOST EFFECTIVE WHEN IT HAS A SELECTIVE, INSTITUTIONAL FOCUS. THIS MIGHT IMPLY A BROADER ROLE FOR THE FEDERAL RESERVE IN REGULATION, AND A NARROWER ROLE IN SUPERVISION, IN WHICH THE FEDERAL RESERVE WOULD FOCUS ONLY ON INSTITUTIONS THAT PLAY KEY ROLES IN THE FINANCIAL MARKETS. THESE INSTITUTIONS COULD BE IDENTIFIED BY THEIR HOLDING COMPANY AFFILIATION, OR BY THE EXTENT OF INTERSTATE BANKING ACTIVITY, OR SIMPLY BY THEIR SIZE AS MEASURED BY AGGREGATE ASSETS. EMERGING TRENDS IN THE 80'S THE 1980'S BEGAN A NEW ERA FOR BANKING. IN THE 1980'S, BANKS WILL NOT ENJOY THE "QUIET LIFE" ASSOCIATED WITH PAST REGULATIONS. THEIR UNIQUENESS IN BEING ABLE TO OFFER CHECKING Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 8 - - ACCOUNTS, AND THE PROTECTION FROM COMPETITION OFFERED BY INTEREST-RATE CEILINGS, HAVE BOTH DISAPPEARED, WHILE GEOGRAPHIC AND PRODUCT-LINE DISTINCTIONS ARE RAPIDLY ERODING. THE NEW WORLD OF BANKING IS ILLUSTRATED BY THF, RECENT RASH OF APPLICATIONS FOR "NONBANK BANKS.” ALTHOUGH THE COMPTROLLER OF THE CURRENCY HAS RECENTLY IMPOSED A MORATORIUM ON APPLICATIONS FOR ESTABLISHMENT OF DE NOVO NON-BANK BANKS, ONE APPLICATION RECEIVED IN EARLY MARCH BY THE COMPTROLLER ILLUSTRATES THE TREND. DIMENSION FINANCIAL CORPORATION OF KANSAS APPLIED TO SET UP 31 "NONBANK BANKS" IN 2 5 STATES AROUND THE COUNTRY. DIMENSION "BANKS" INITIALLY WOULD HAVE CONCENTRATED ON PROVIDING TRUST SERVICES AND LINES OF CREDIT TO PREFERRED CUSTOMERS. BUT DIMENSION ALSO WAS CONSIDERING ULTIMATELY A FULL RANGE OF SERVICES THAT WOULD HAVE INCLUDED A DISCOUNT BROKERAGE, SWEEP ACCOUNTS, INSURANCE PRODUCTS, TAX PLANNING AND PREPARATION, AND FINANCIAL PLANNING. THE "BANKS" DID NOT PLAN TO ENGAGE IN COMMERCIAL LENDING ACTIVITIES, AND SO WOULD NOT HAVE MET THE DEFINITION OF A BANK CONTAINED IN THE BANK HOLDING COMPANY ACT. THE DIMENSION APPLICATION ILLUSTRATES THAT THE FUTURE IS ALREADY UPON US. IT IS CLEAR THAT THERE WILL NEED TO BE FURTHER BANKING DEREGULATION IF BANKS ARE TO COMPETE WITH SUCH "NEAR­ BANKS" IN THE MARKET FOR FINANCIAL SERVICES. CHANGING TECHNOLOGY IS ALSO A MAJOR FORCE PROMOTING DEREGULATION TODAY. AUTOMATIC-TELLER MACHINES (ATMS) AND POINT- OF-SALE TERMINALS ALREADY ARE ECONOMICALLY VIABLE, AND ARE PROVING INCREASINGLY POPULAR WITH CONSUMERS. SUCH TECHNOLOGY Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis WILL EXERT FURTHER PRESSURE ON INTERSTATE RESTRICTIONS, AND ON BRANCHING LAWS--AT LEAST WITHIN METROPOLITAN AREAS. MOREOVER, THRIFT INSTITUTIONS ALSO ARE BECOMING AWARE OF THE MERITS OF ATMS AND SHARED COMPUTER TECHNOLOGY, AND THEY WILL EXPAND THEIR CONSUMER SERVICES ACROSS STATE LINES THROUGH THESE MEANS. DEREGULATION OF GEOGRAPHIC LIMITATIONS ON BANKS WILL HAVE TO COME EVENTUALLY, IF THE BANKING INDUSTRY IS TO BE ABLE TO COMPETE WITH OTHER FINANCIAL INSTITUTIONS THAT CAN EXPAND NATIONALLY WITHOUT RESTRICTIONS. TECHNOLOGICAL CHANGE WILL INTENSIFY COMPETITION FOR COMPREHENSIVE PERSONAL CASH-MANAGEMENT SERVICES. MONEY-MARKET FUNDS, BROKERAGE HOUSES, AND LARGE RETAILERS ALL WILL BE PROVIDING PERSONAL CASH MANAGEMENT SERVICES. EVEN IF DESIRED, FURTHER REGULATIONS OR LAWS PROBABLY COULD NOT HALT THIS TREND, BECAUSE SUCH SERVICES PROBABLY COULD TAKE AN ALMOST INFINITE VARIETY OF FORMS. THE TRENDS I HAVE MENTIONED WILL WILL OCCUR WHETHER OR NOT BANKING REGULATIONS ARE RELAXED. IN THIS ENVIRONMENT, OUR BANKING SYSTEM WILL BEST BE ABLE TO SURVIVE IF THE DIRECTION OF DEREGULATION CONTINUES. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

John J. Balles (1983, June 3). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19830604_john_j_balles

@misc{wtfs_regional_speeche_19830604_john_j_balles,
  author = {John J. Balles},
  title = {Regional President Speech},
  year = {1983},
  month = {Jun},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19830604_john_j_balles},
  note = {Retrieved via When the Fed Speaks corpus}
}