Regional President Speech

I I __ SILAS KEEHN REMARKS INDIANA BANKERS ASSOCIATION SCHOOL OF BANKING VALPARAISO UNIVERSITY VALPARAISO, INDIANA JUNE 25, 1987 1. INTRODUCTION A. VERY PLEASED TO HAVE THIS OPPORTUNITY TO PARTICIPATE IN THIS IMPORTANT EDUCATIONAL EFFORT G.,,'u~~ 1. THE BANKING I~DUSTRY IS GOING THROUGH A PERIOD OF CONSIDERABLE TRANSITION AND THE EDUCATIONAL EFFORTS OF THIS ASSOCIATION AND OTHER SIMILAR r GROUPS ARE EXCEPTIONALLY IMPORTANT :i... . w I. I I ~ ~ Ml? )-.· ~l ~ \.lei ~ ~s . I I. LET ME COVER A MENU OF ITEMS / A. COMMENTING ON ISSUES OF CURRENT INTEREST 1. NO ORDER OF IMPORTANCE IN THE WAY THAT I MENTION THEM 2. NONETHELESS, ISSUES THAT THE FEDERAL RESERVE IS WORKING WITH THAT I THOUGHT YOU MIGHT BE INTERESTED IN Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 2 III. RISK BASED CAPITAL - PROPOSAL OUT FOR COMMENT A. RECENT YEARS - ARITHMETIC IN APPROACH 1. SIMPLY A RATIO CAPITAL DIVIDED BY ASSETS 2. NO ALLOWANCE FOR RISK DIFFERENTIATION 3. WHILE THE CAPITAL APPROACH WAS EVEN IN A PERCENTILE PERSPECTIVE - THE ULTIMATE EFFECT VERY &,~ 4. ~ t.r~- C',v ~ - Alo(~ 5 NO ALLOWANCE FOR OFF BALANCE SHEET ITEMS B. THE PROPOSAL - DIVIDE ASSETS INTO 4 OR 5 CATEGORIES 1. ASSIGN A RISK FACTOR TO EACH CATEGORY 2. LOW RISK ASSETS, SUCH AS CASH - 0 - ASSETS WITH A HIGHER RISK COMPONENT WOULD CARRY A HIGHER CAPITAL REQUIREMENT - LOANS 100% C. OFF BALANCE SHEET ITEMS WILL BE BROUGHT INTO THE COMPUTATION 1. THE SHEER VOLUME INCREASING - LEVELS HAVE GOTTEN VERY, VERY SIGNIFICANT Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 3 A. SWAPS, EXCHANGE CONTRACTS, LETTERS OF CREDIT B. LOAN COMMITMENTS 2. SOME INVOLVE NONTRADITIONAL BANKING RISKS - RISK FACTOR GROWING 3. N01 NECESSARILY A DELIBERATE ATTEMPT TO AVOID THE CAPITAL REQUIREMENT 4. NONETHELESS, THE EFFECT THE SAME - THE RISK ASPECTS OF THE BUSINESS HAVE INCREASED WITHOUT THE PROVISION OF ADDITIONAL CAPITAL S . G I \ J 0. "-1 fa' 'U> =4-CCiU. tZ1> > '=:?-a P U - ;,~9 olta < twal 6>-. THEREFORE , IT IS APPROPRIATE TO BRING THESE ACT IVITIES INTO THE CAPITAL COMPUTATION D. COMPANION PROPOSAL - BANK OF ENGLAND 1. A STEP TOWARD UNIFORMITY 2. INTERNATIONAL APPLICATIONS - INCREASING IN VOLUME 3. THE PROCESSING BY THE FED VERY DIFFICULT - RISKS THE POSSIBILITY OF DISCRIMINATION AND CERTAINLY UNEVENNESS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 4 4. THE PROPOSAL BEING CURRENTLY CONSIDERED BY ENGLISH BANKS c.. ~ ~~ 0""' 5. MY EXPECTATION, IT WILL BE ADOPTED - CERTAINLY ~t rt::A r . ~ 'co THERE WILL BE CHANGES, BUT THE APPROACH MAKES SENSE AND I WOULD EXPECT ULTIMATE APPROVAL 6. OTHER CENTRAL BANKS WILL MOVE TOWARD THIS CONCEPT 7. NO DOUBT THERE WILL BE LONG NEGOTIATIONS BUT THE ULTIMATE DIRECTION IS CORRECT AND IT I S MOST APPROPRIATE THAT WE MOVE TOWARD THIS WE HAVE RECENTLY DISTRIBUTED A CIRCULAR REGARDING THE FEDERAL RESERVE POL ICY TOWARD BANK HOLDING COMPANIES '1\,/ ~ ~ > A. WE ARE CLEAR THAT BANK HOLDING COMPANIES SHOULD SERVE AS A SOURCE OF STRENGTH FOR SUBSIDIARY BANKS 1. IF FUNDS ARE AVAILABLE AT THE HOLDING COMPANY LEVEL - DOES NOT SEEM RIGHT TO ALLOW A SUBSIDIARY BANK TO FAIL Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 5 2. THE FDIC IS LEFT IN THE POSITION OF PAYING OFF THE INSURED DEPOSITORS WHILE CREDITORS AT THE HOLDING COMPANY ARE NOT SHIii 4ltl Y AFFECTED - NOT ~ ~ -rtt4:f 3 , ~CR 6( 94 PA~~ ,... ,4, WHILE FUNDS ARE AVAILABLE AT THE PARENT LEVEL, THEY SHOULD BE USED TO PROVIDE FOR THE REQUIREMENTS OF SUBSIDIARY BANKS ELECTRONIC SERVICES - GROWING RISKS - TWO ISSUES A. MECHANICAL RISK - LACK OF COMPATIBILITY 1. SYSTEMS DEVELOPED OVER THE YEARS SEMI-AUTONOMOUSLY 2. VOLUME/VELOCITY - $1 TRILLION - 25% GNP 3. INTERNATIONAL ASPECTS - THE WORLD IS TOTALLY INTERCONNECTED 4. THE WHOLE SYSTEM DEPENDENT ON THE WEAKEST LINK A. BANK OF NEW YORK 5. AS THE MAJOR, REALLY ONLY, COMPONENT DOMESTICALLY - THE FED WILL HAVE TO FOCUS ATTENTION ON THE Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 6 DEVELOPMENT OF SYSTEMS THAT WILL PROVIDE FOR THE VOLUMES THAT WILL BE EXPERIENCED IN THE 1990S 6. ELECTRONICS CLEARLY A MAJOR PART OF THE PAYMENTS MECHANISM - PIPELINE - SIMPLY CANNOT RISK FAILURES IN THE PIPELINE B. CREDIT ASPECTS 1. DAYLIGHT OVERDRAFTS GROWING SIGNIFICANTLY - CLEARLY ADDING AN ELEMENT OF INSTABILITY TO THE SYSTEM 2. A NEED TO BRING THIS ISSUE UNDER CONTROL TO SAFEGUARD THE SYSTEM 3. INTRODUCTION OF PAYMENT SYSTEM RISK PROGRAM LAST YEAR SUCCESSFUL - THE LEVEL OF DAYLIGHT OVERDRAFTS HAS STABIL IZED 4. BANKS HAVE ESTABLISHED CAPS IN RELATIONSHIP TO THEIR CAPITAL POSITION Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 7 A. SELF EVALUATION B. COOPERATIVE VOLUNTARY PROGRAM C. MARVELOUS EXAMPLE OF AN ISSUE BROUGHT UNDER CONTROL BEFORE A REAL PROBLEM DEVELOPS 5. RECENTLY I NTRODUCED A REAL TIME MONITORING CAPABILITY 6. CURRENT PROPOSAL - FURTHER REDUCE CAPS A. DIMINIMOUS A VERY MAJOR ISSUE - REGULATORY, LEG I SLAT I VE REFORM - HAVE BEEN AND CONTINUE AT THE CROSSROADS A. VAST UNDERSTATEMENT - FINANCIAL SYSTEM HAS CHANGED DRAMATICALLY 1. CHANGES DRIVEN BY THE MARKETPLACE - APPROPRIATE LEGI SLATIVE CHANGES HAVE LANGUISHED 2. THE FINANCIAL STRUCTURE WHOLLY DIFFERENT THAN WHEN THE LEGISLATION WAS PUT IN PLACE Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 8 3. THE NEED FOR SPECIFIC LEGISLATIVE DIRECTION IS VERY PRESSING A. THE NO~-t,;;;JUST AN OBVIOUS EXAMPLE OF THE CURRENT SITUATION wJi.. ~ ~ ~~ B. THERE ARE ALTERNATIVE APPROACHES TO THE PROBLEM - NOT EASY 1. RE-REGULATION - HARDLY DESIRABLE - PERHAPS IMPOSSIBLE - MOST UNLIKELY 2. BUT A MAJOR SYSTEMIC C~" ' ULD CERTAINLY PRODUCE A LEGISLATIVE RE-REGULATION RESPONSE C. THE AD HOC APPROACH 1. THE WAY WE HAVE BEEN GOING AT IT FOR SO MANY YEARS 2. AGAIN1 HARDLY DESIRABLE, BUT GIVEN THE RECENT HISTORY, PERHAPS THE MOST LIKELY D. THE REGULATORS WILL BE DEALING WITH LARGER, MUCH MORE COMPLEX, ENTITIES Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 9 1. GIVEN CURRENT TRENDS, THIS SEEMS A LOGICAL DIRECTION - WITHIN THE RESTRAINT OF THE ANTI-TRUST LAWS, REGULATIONS DO NOT RESTRAIN SIZE NOR SHOULD THEY 2. BUT WHAT'S THE REGULATORY RESPONSE TO THIS A. SAFETY AND SOUNDNESS B. AGGREGATES/PAYMENTS MECHANISM OR BROADER SYSTEMIC ISSUES C. FORMER SEEMS VERY NARROW D. THE LATTER MORE LIKELY - AT THE END OF THE DAY, NO MATTER WHAT THE REGULATIONS MAY SAY, AS THE NAT I ON' S CENTRAL BANK THE PROBLEM FREQUENTLY BECOMES OURS ANYWAY (1) SILVER. GOVERNMENT SECURI~E~TS, ) CONTINENTAL E. HARD TO ESCAPE THE CONCLUSION THAT OUR REGULATORY RESPONSIBILITY HAS TO ENCOMPASS THE BROAD SYSTEMIC ISSUES Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 10 F. AND, THEREFORE, WE WILL NEED BROADER AND DEEPER SUPERVISORY AUTHORITY TO DEAL WITH THESE LARGER, MORE COMPLEX, FINANCIAL ENTITIES E. HEAVILY INTERTWINED - SEPARABILITY 1. CAN LARGE, COMPLEX FINANCIAL ENTITIES BE COMPARTMENTALIZED 2. CAN THEIR VARIOUS DIVERSE ACTIVITIES BE EFFECTIVELY ISOLATED ONE FROM ANOTHER ~J ~ ,4 .. Se.c.. -:2..3 A _ ~7'..Jitt - ~~ s . 3 ADAM SMITM 1S FIRE WALL ~XAMPLf A. WHEN THINGS ARE GOING WELL, SEPARABILITY IS PROBABLY A REASONABLE EXPECTATION B. BUT WHEN THE SITUATION DETERIORATES - AND WHEN A SIGNIFICANT PART OF A LARGE ENTITY EXPERIENCES VERY SEVERE FINANCIAL PROBLEMS C. SEPARABILITY BECOMES DIFFICULT TO MAINTAIN - CONTAMINATION 4. VERY DIFFICULT ISSUE - WIDE SPECTRUM OF THINKING Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 11 A. INDIVIDUALLY AND AS A SYSTEM FAR FROM CONCLUSION F. SEPARATION OF COMMERCE AND FINANCE 1. VERY MUCH A PART OF THE SEPARABILITY QUESTION 2. ACCESS TO THE DISCOUNT WINDOW - PAYMENTS MECHANISM - FDIC A. YET ALSO AFFILIATED WITH NONFINANCIAL COMMERCIAL ACTIVITIES 3. HOW TO PROVIDE ACCESS APPROPRIATELY YET NOT PROVIDE GOVERNMENT SUPPORT FOR THE NONREGULATED "-- ~- _ PART OF THE FINANCIAL ENTITY ~ ~1LJtv:SA:f,~\W~ G. SI ZE~kfrSE NOT AN I S5tJ~ > 1. THE RECENT STATEMENT BY A TREASURY DEPARTMENT OFFICIAL - CREATION OF 5 TO 10 SUPER BANKS - $500 BILLION 2. COMPETE INTERNATIONALLY Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 12 3. PERMIT THE AFFILIATION OF MANUFACTURING ENTITIES (AT LEAST NONFINANCIAL) WITH BANKS 4. ACCESS TO CAPITAL NECESSARY TO PROVIDE FOR GROWTH A. WITHOUT SUCH ACCESS, LARGE ENTITIES CANNOT BE DEVELOPED 5. THE EXAMPLES OF INSTITUTIONS IN EUROPE AND THE FAR EAST INSTRUCTIVE - BUT THESE AFFILIATIONS DIFFERENT - INVESTMENTS - BANK OWNS OTHERS CJD"\.\.\~-~1)\/'~ 6. VERY FUNDAMENTAL ISSUE - INTERESTING DEBATE IN COMING DAYS VII. CONCLUSION - THE ROLE FOR SMALL AND MEDIUM SIZED BANKS A. DESPITE TH IS TREND TOWARD LARGER, MORE COMPLEX, INSTITUTIONS_ ~'~ 1. THERE WILL BE A ROLE FOR SMALLER BANKS 2. VERY LARGE INSTITUTIONS MAY SERVE MONEY CENTERS AND INTERNATIONAL MARKETS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 13 A. BUT THEY MAY NOT EFFECTIVELY DEAL WITH LOCAL/COMMUNITY MARKETS 3 . LOCAL BANKS KN OW TH E I R CU ST OMER S AND TH E I R MARKETS VERY WELL A. EFFECTIVELY RESPOND WITHOUT EXHAUSTIVE REVIEW AND PROCESSING 4. THERE ARE NUMBERS OF EXAMPLES TO SUPPORT MY STATEMENT A. CALIFORNIA - -'1/IM~c(, iJ,~ \~,._JcJ' A-1,t.U\I ~ d.i~~ ~ 6 -~G. \, \l -~ ~ ~. 5. BUT THE WILLINGNESS TO COMPETE IS ESSENTIAL A. THE OLD DAYS OF PROTECTED MARKETS AND ISOLATED OPERAlIONS ARE CLEARLY OVER B. BANKS NOT WILLING TO COMPETE WILL NOT SURVIVE C. THOSE WILLING TO COMPETE THAT HAVE GOOD SKILLS AND TRAINED EMPLOYEES WILL DO JUST FINE Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis VALPARAISO UNIV. 6/25/87 PAGE 14 D. AND BEING AFFILIATED WITH AN INSTITUTION THAT HAS THESE COMP ET I TI VE SK I LL S A1J D" I 1 j! ( RI( ET PLACE ,s.E-NSj ti:::VITY WILL BE A REWARDING EXPERIENCE THANK YOU * * * * * Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Silas Keehn (1987, June 24). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19870625_silas_keehn

@misc{wtfs_regional_speeche_19870625_silas_keehn,
  author = {Silas Keehn},
  title = {Regional President Speech},
  year = {1987},
  month = {Jun},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19870625_silas_keehn},
  note = {Retrieved via When the Fed Speaks corpus}
}