Speech

JJXLUD IN RECORDS SECTION I i o im j For release on delivery NOV 9:30 AM E.S.T. October 29, 1981 ^ / • V // ' V , Pou^JC ft ' Statement by Paul A. Volcker Chairman, Board of Governors of the Federal Reserve System before the Committee on Banking, Housing, and Urban Affairs United States Senate October 29, 1981 JLAr! • I am happy to appear before the Banking Committee this morning to discuss the legislation now before you. As you well know, the proposed legislation ranges over a wide field. While some of its provisions are technical, taken as a whole the proposals could have profound implications for our financial system. The discussion engendered by the bill is timely, for we are obviously in the midst of a period of enormous financial change. Those changes are forced by developments in the market place, and change will take place whatever the Congress decides with respect to this legislation, or whatever the approach of the regulatory agencies. What is at issue — and what we can influence — is the speed and direction of that change; the legislative proposals before you challenge all of us to consider more explicitly the kind of a financial structure we would like to see in the years ahead. In providing a focus for that consideration — not just in concept or theory, but in terms of concrete legislation — you have provided a signal public service, and we welcome the opportunity to participate in these hearings. In their specifics, the bills before you are, of. course, both complex and controversial. Moreover, broad as they are, some of their provisions inevitably raise further pressing questions, including the appropriateness of geographic re- strictions on the operation of depository institutions, the relationship between commerce, and banking, and the validity of remaining legal "compartmentalization" in the provision of — 2— financial services. My understanding is that you intend to consider some or all of those issues next year; except to note their relationship to some of the provisions of the legislation, I will not attempt to deal with them this morning. I would like to preface the more particular comments of the Federal Reserve Board with some comments on the forces at work in the market place bearing on our financial structure and then to suggest the general framework within which we have approached the specific issues. The statement will then sum- marize our position on the specific provisions of the bills. The appendices provide further detailed analysis. The efforts of individuals, businesses, financial institutions, and markets to adapt to inflation, and to the extraordinarily high current level of interest rates that has accompanied inflation, are among the most potent factors pushing toward change in financial structures and behavior. The stresses on thrift institutions, the competitive inroads made by money market mutual funds, and the controversy over the phasing out of interest rate ceilings on depository institutions are only some of the most obvious examples of the forces at work tending to alter — and even undermine — the established institutional structure. Regulators and the Congress alike have the respon- sibility for responding to these pressures in a constructive way. We can and should ease those strains that arise from elements in the legal or regulatory system that are truly outmoded. - 3- When appropriate, we can provide transitional financial^ assistance. We can also accelerate consideration of more fundamental reforms- to minimize current .—, and potentially recurrent — problems. At the same time, let us also recognize that no legis- lative or regulatory changes can assure a sound and efficient financial system in the face of accelerating inflation, and that we need not, and should not, plan on inflation as, a way of life. As we are.successful in bringing inflation under control, some of the forces and pressures for change so evident today in our financial system will subside. In appraising particular proposals for structural change — changes likely to be with.us for many years — we need to look beyond the present transitional and market problems to a vision of what is appropriate for the longer run. There can be little doubt^that structural change is. inevitable and desirable, whether the current exceptional, stresses quickly abate or not, whether interest rates.are high or low, or fluctuate widely in between, or whether "transitional" or "emergency" measures are adopted to ease current strains. Irreversible technological change is fundamentally altering the financial environment; modern data processing capabilities, instantaneous and cheap communications, and relatively inexpensive and fast travel are all breaking down the traditional geographic or institutional barriers to competition and contributing.to the rapid growth of new institutions able to exploit new technology. Old concepts of what is banking and what is not are blurred. Even national borders are losing their significance. We have an array of financial institutions and instruments that were simply unknown a decade or two ago. The typical customer — business or individual —- no longer feels so dependent on his local bank or savings and loan for financial services. Even the distinction between commerce and finance — embodied in law and tradition — has been eroded. In the circumstances, many institutions are under- standably concerned not only about the strains arising from current market conditions but about the prospects for their industries over the years ahead, and whether they, as individual J institutions, will have the ability to compete fairly and. effectively in the future. To be sure, some of those concerns may be exaggerated or inconsistent; banks, thrift institutions, and investment houses have long perceived strong competitive thrusts from each other, yet all have survived and roughly maintained or even enhanced their share in the provision of credit as more of the total market for credit has become institutionalized. (See Appendix E) But the pervasive air of uncertainty about the future role of financial institutions itself calls for reexamination of the legal framework, and building a new consensus about the desired institutional structure. -5- Given the national responsibilities for monetary policy and for maintaining the safety and efficiency of our financial system, we — and you -- must be sensitive to unreasonable or unnecessary regulatory structures and to threats to the stability and growth of depository institutions that have long been the backbone of our credit markets and are the transmission channel for monetary policy. We should also consider whether, in some instances, when regulation of depository institutions remains essential, it may not be necessary for reasons of equity, safety, or monetary policy, to bring newer institutions within the regulatory framework. The bills before you address some of these long-term issues, as well as the more pressing immediate needs.' The testimony you have already heard reflects th6 fact that proposals affecting the competitive position of particular industries are bound to be contentious and difficult to resolve Nevertheless, they must be dealt with, recognizing that the intramural disputes of regulated institutions need to be placed in the broader context of aggressive competition from newer institutions and from the open market itself. It is against that background that we have assessed the implications of the specific changes proposed in S. 1720 for our financial structure, and its evolution in the years ahead. At the same time, we would strongly urge that the debate on longer-term structural issues not deter your immediate attention to the provisions of the bill needed to help deal with the current situation in the distressed thrift industry — specifically those provisions common to the so- called "Regulators' Bill" adopted yesterday in the House. - 6- A Frame of Reference The objective of reform of banking and financial regulation is, in essence, simple enough. We, as a nation, want to preserve and nurture the strong competitive forces that assure that our financial system remains the most efficient and innovative in the world. We also want to maintain the discipline necessary for the strength and solidity of our depository institutions -- institutions that are the essential nucleus of a stable financial system. And, we must also preserve our ability to conduct an effective monetary policy. The difficulties and complexities arise in effectively blending the objectives, all of which are important, but in application may conflict. Certainly, the existing legal . and regulatory structure is rife with such conflicts, and the temptation is strong to dismantle it wholesale and start afresh. Certainly, a structure put in place in quite different circum- stances in the early 19301s is outdated in important respects by technology and by the growth of competitive nonbanking institutions. But in approaching change, our conviction in the Federal Reserve is that some basic building blocks of the present system should be preserved, and the presumption is that needed change can be fit into that framework. Specifically, the laws and traditions of this country embodying a separation of banking and commerce still seem to us valid. That tradition rests on concepts that concentration of economic power can be dangerous, that the potential for conflicts of interest in a service so vital as the extension of capital and credit should be minimized, and that there is a special public' interest in the safety and soundness of our depository institutions -- an interest that does not, and should, not, extend in the same way to other businesses. In some respects, our concerns about preserving a broad dividing line between banking and commerce are reinforced by techno- logical change. For example, advances in communications and data analysis could potentially enhance the capacity and reach of financial-commercial conglomerates raising the risk of dangerous concentration of power and conflicts of interest. ' ' - The case for separation is less clear with respect to banking and investment banking, and in practice, the line between banking and other financial services has become increasingly blurred. Banks, investment banks, and business firms have all long been involved in extending credit to both consumers and businesses, and some substantial overlapping in the provision of services by different types of institutions -- bank and rionbank -- is both inevitable and useful in enhancing competition without damage to other essential functions. How- ever, at the margin,' we believe distinctions can and should be made. For instance", the risks and uncertainties, as well as the greater potential for 'conflict* of interest, in handling equity "8- financing suggests that function should remain outside commercial banking (or depository institutions). Under- writing and marketing of corporate securities to the general public by banks raises questions of risk, self-dealing, and conflict of interest. Conversely, there are strong advantages in lodging transactions balances and responsibility for the payments system within the regulated (and insured) "banking" sector. A large variety of services often thought of as financial fall between these extremes. S. 1720 touches upon insurance, some securities activities, and mutual funds. Some services related to finance -- including management consulting, travel services, and data processing and trans- mission, in particular -- deserve consideration as well as possible areas where banking might reasonably overlap commerce with benefits for competition and convenience. In considering these and existing areas of overlap, a second element in our framework is relevant, to the extent regulation is necessary at all, institutions providing the same services should be subject to substantially the same regulation in providing these services regardless of their form of organization. A number of the distortions and in- equities in financial markets today result from failure to adhere to this principle. An obvious case in point is the absence of reserve requirements on money market mutual funds even when those funds have the essential attributes of trans- actions balances in depository institutions. -9- Obviously, consistency in regulatory treatment should be achieved by removing unnecessary regulatory constraints as well as by closing loopholes in* the application of those regulations deemed essential. For example, one of the most powerful arguments for eliminating ceilings on interest rates paid by depository institutions is the competition from non- regulated institutions and from the open market itself. The third element in our thinking has implications for assessing several provisions of S. 1720: our regulatory system should encourage a degree of diversity among institutions, large and small, specialized and generalized-, "retail" or "wholesale" oriented. Traditionally in the United States, this concern has provided much of the rationale for geographic limits on banking, and for a separate legal and regulatory structure for banking and thrifts. Both technology and market incentives are breaking down geographic and functional distinctions. Like it or not, in the market place we obviously have interstate banking and active competition between banks and thrifts in very large measure. Moreover, depository institutions are competing every day with other, nonbank, providers of similar financial services. The only realistic question can be how the strong forces for further overlap and "homogenization" can be channeled most constructively. In some cases, time is needed for adaptation. Some elements of diversity in the provision of financial services that have served us well can reasonably be preserved. Regulatory policies can be more sensitive to the particular problems and needs of the smallest institutions. -10- The fourth and last general point I would like to make is that public policy must attach particular importance to maintaining the safety and soundness of depository institutions. Depository institutions handle the great bulk of the payments of services and transaction settlements in our economy -- and indeed much of the enormous volume of dollar transactions abroad. They are the principal repository of the financial assets of most households and businesses. In recognition of the importance of maintaining confidence in the system and assuring its stability, deposit insurance has been provided banking and thrift institutions; At the same time, those institutions are subjected to substantial supervision and regulation with respect to capital, to lending policies and to other operations significant for their safety and soundness. As a result, they have certain competitive advantages and constraints; in those respects, depository institutions are, and should remain, different from other financial enterprises. In other words, there are limits on the degree to which competition of depository institutions with other institutions can be unfettered. In commenting on the specific provisions of S. 1720, reference when appropriate will be made to this general framework. As will be apparent in our comments, we consider a few provisions of the bill of urgent importance. Other positions may be relatively non-controversial. Those sections dealing with "Glass-Steagall" issues and the powers of thrifts -- because of their particularly important implications for the evolution of the system -- in our -11- judgment deserve particularly close scrutiny but have fewer implications for the immediate problems facing depository institutions. Immediate Needs - "The Regulators' Bill" S. 1720 incorporates in Title I the main provisions of the so-called "Regulators' Bill" adopted by the House. We would strongly urge that, whatever action is taken with respect to the remainder of the bill, and without prejudice to the remaining provisions, these sections be enacted immediately. These provisions are in no sense a fundamental solution to the problems of the thrift industry or a substitute for structural reform. They may, however, be of critical importance in providing the regulatory agencies with the flexibility and authority needed to deal with transitional problems posed by the thrift industry by the extraordinarily high level of market rates. Title I has two main elements. The first recognizes that, in circumstances like the present, otherwise viable thrift institutions may face depletion of existing capital as they work toward restoring their earnings position. The FDIC and the FSLIC would be provided clear authority to temporarily supply capital to such institutions' -- capital that should be repaid from future earnings -- so that their operating capability can be maintained during a transitional period, and at the same time reducing the potential loss to the insurance funds from an avoidable failure. Under present law, the powers of the FDIC, in particular, are so closely circumscribed as to make it -12- difficult or impossible to exercise such an option except in the case of "assisted" mergers, thus unnecessarily raising questions about the ability of some we11-managed, basically sound institutions to remain viable as an independent entity. The second element in the bill would facilitate orderly mergers of failing thrifts with healthy out-of-state thrift institutions, or, as a last resort, bank holding companies in instances where such mergers are not practicable with thrift institutions within a state. Authority for acquisition in state or out-of-state of thrifts by bank holding companies already exists in other statutes. As a matter of policy, that authority has not been exercised. The purpose of the new authority would be to provide clear and specific guidance by the Congress as to the circumstances in which such acquisition might be permitted and to cut across obstacles in the law of some states to the conversion of mutual institutions into stock form, a necessary prerequisite to acquisitions by bank holding companies. As I have indicated to'the Committee before, without this legislation the Federal Reserve, faced with an emergency situation, may well find it necessary to act under existing authority to allow a bank holding company to acquire a thrift. Should that authority be used, it is not clear that such acquisitions would subsequently be confined to emergency situations. Moreover, state law in some instances could -13- frustrate the objective. In these circumstances, action within the framework of the new limited and defined authority would appear far preferable at this time. Other Provisions Ready for Prompt Action While not of the same degree.of urgency as Title I, S. 1720 contains a number of more technical provisions that the Board considers both a distinct improvement in regulatory practice and relatively non-controversial. Section 210 of the bill would amend Section 23A of the Federal Reserve Act governing bank relationships to,its affiliates, to simplify its administration while improving its effectiveness. Sections 221-233 would amend the Financial Institutions Regulatory and Interest Rate Control Act of 1978 ("FIRA") to reduce burdensome operating requirements and remove some restrictions necessary to its purpose. Indeed, we believe further steps could be taken to that end, and we would be glad to work with the Committee. The Federal Reserve also supports Sec. 702, which would exempt deposits at international banking facilities from Federal deposit insurance assessments, placing them on a parity -with deposits at overseas branches of United States banks. We believe such parity is important to the effective operation of the international banking facilities authorized by the Board, and which are to begin operation in December. -14- Should the Congress not wish to foreclose the possibility of the FDIC assessing both IBF and foreign branch deposits at some future time, the basic purpose of assessing parity in treatment could be achieved by requiring that IBF deposits be treated in the same manner as foreign branch deposits rather than by permanent exemption. While we strongly doubt assess- ments on such deposits are appropriate now, the alternative approach would permit the FDIC to reconsider that question in the future if it so desired. Preemption of State Laws -- Usury Ceilings. "Due-on-sale Clauses," and Truth-in-Lending. Several provisions of S. 1720 provide for Federal pre-emption of state law, in each case permitting states to override the preemption by new legislation within three years after the effective date of the provision. In approaching questions of this kind, the Board is reluctant to support preemption of state law, but that may be necessary when a clear national interest is at stake. In earlier testimony, we have recognized the adverse impact that usury laws can have on the availability of credit in local markets and have urged the removal of such ceilings. But we have also suggested that further action in that respect might reasonably be left to individual states. That preference was expressed in the knowledge that action by the Congress last year already pre- empted state usury ceilings for the bulk of bank lending: remaining binding state usury laws affect mainly local consumer lending, where the national interest is less clear. -15- Should Congress wish to act in this area, the Board would strongly endorse the provision in Sec. 401-404 that would permit states, by new action, to reestablish usury ceilings, and we would also urge that any new ceilings adopted in Federal or state legislation not be tied to the Federal Reserve discount rate. That rate is an instrument of monetary policy and not appropriately a benchmark for appropriate usury rates in the market. Section 141 would permit depository institutions, state law notwithstanding, to enforce due-on-sale clauses in mortgage instruments. For the majority of Board Members, the reluctance to preempt state law is in this instance more than offset by a sense of urgency growing out of the strongly adverse effects of failure to enforce due-on-sale clauses on the soundness of thrift institutions. Inability to enforce contractual due-on-sale provisions, agreed by the borrower in undertaking the mortgage commitment, has slowed the turnover of low-yielding mortgages in institutional portfolios precisely at the time when earnings pressures are so strong as to threaten the viability of many thrift institutions. Indeed, the net result of failure to enforce due-on-sale clauses may be to restrain the provision of new fixed-rate mortgages more than would otherwise be the case in today's markets. As the legislation is presently drafted, existing state law prohibitions on due-on-sale would be preempted. However, in -16- the twenty states where either state legislatures or the courts have taken recent action to prohibit due-on-sale provisions, borrowers could reasonably have interpreted that, whatever the contractual terms, due-on-sale could not be enforced. We believe that as a matter of equity the bill should be amended so that it does not permit enforcement of due-on-sale provisions with respect to sales occurring in the period between the time state legislatures or the courts have acted and the passage of preemption legislation. Section 704 of the bill would preempt "any state law that is similar in purpose, scope, requirement or content" to the national truth in lending laws. The broadened test for preemption -- current law only preempts "inconsistent state laws -- is clearly aimed at the important objective of simplifying compliance by lenders, without loss of the basic consumer protection provided by Federal law. The Board agrees with that objective, but has substantial doubts about the administrative feasibility of applying so vague a test as "similarity" to the multiplicity of specific state provisions. Moreover, we note that the possibility of states overriding the Federal preemption would, as drafted, appear to extend to the possibility of repeal of any truth-in-lending protection -- State or Federal -- within a state. Alternatively, • a state might adopt a very different system of disclosure, adding . to creditor burdens and confusion. We question whether such results are intended. In the light of these complications, I would hope that our staff might work further with yours toward the desired objective. -17- Apart from the, preemption issue, S, 172,0 would attempt to provide further simplification of the administration of the Truth-in-Lending law, and to reduce litigation, by limiting creditor liability to "substantial non-compliance" and exempting "arrangers" from disclosures. The approach proposed to. limit litigation appears to have substantial legal and technical ambiguities, discussed at greater length in an appendix. Exemption of "arrangers" does offer substantial simplification, but at the expense of exempting a large category of mortgage financing in today's market — so-called creative financing provided by the seller or by other non- professional lenders with the assistance or guidance of a realtor. The appropriate balance between simplification and potential loss of consumer protection is difficult to draw, and the Board welcomes efforts of the Congress to provide guidance. In accordance with present law, which contemplates coverage of those regularly "arranging" mortgage finance, we have recently invited public comment on certain proposals. We would be glad to make those comments available to you as they are received. The Board would have no objection to delaying the effective date of new Truth-in-Lending requirements scheduled, - - •' under existing law, to become effective April 1, 1982. -18- Banking and Other Financial Services Several provisions of S. 1720 deal with the question of what kind of other financial services banks or other depository institutions might properly provide. In practice, a substantial and growing overlap already exists between commercial and investment banking, and the bill would extend that direct competition into the area of municipal revenue bonds and the sponsorship of investment companies (i.e., mutual funds) and the sale of their shares. In evaluating proposals of this kind, the Board believes a number of concerns cited in the past by the Congress and the courts needs to be taken into account. One of those concerns is the possibility of conflicts of interest arising between management of the bank's loan and security portfolio and non-banking investment activities. The potential riskiness of the non-banking activity is also relevant, given the inevitable linking of a bank's reputation to that of its affiliates; our own experience in supervising bank holding companies suggests the extreme difficulty, at best, of insulating banks from the fortunes of other holding company affiliates. In the case of the largest institutions, safeguards against the undue concentration of economic power may be appropriate. Concerns of this kind can be and have been addressed in supervisory and regulatory policies; the mere possibility -19- of conflicts or abuse or risks cannot justify sweeping prohibitions on particular types of activity, particularly in areas where competition and public convenience would be appreciably improved by bank entry. In the end, it is a matter of balancing potential dangers against advantages in particular instances. Indeed, a step-by-step evolutionary \ approach toward expanded powers for banks and bank holding companies has much to commend it, permitting all of us to observe experience as it develops. While we do not support at this time all of the proposals contained in S. 1720, we would note that other service areas -- such as travel services, data processing, and the sale of commercial paper (which is presently in dispute in the courts) -- might well be considered for inclusion in the legislation. In that connection, the Board considers the additional restrictions on the already limited provision of credit-related insurance services by bank holding companies as proposed in Sec. 601 of the bill, un- desirable. Those services seem to us helpful in promoting competition and public convenience without substantial risk or conflict of interest with banking. The Board has long supported extension of the ability of commercial banks to underwrite municipal revenue bonds, as well as general obligations, as would be provided by Sec. 301. Revenue bonds have become a much more prominent feature of municipal finance in recent years, and commercial bank authority to participate in this area of municipal finance appears a logical extension of power that they have exercised for -20- many years. The provisions of the bill to protect against conflicts of interest and unsound banking practices are desirable and should reasonably be extended to the existing authority to deal in general obligations. A more cautious approach toward depository institution sponsorship of investment companies and the sale of mutual fund shares seems appropriate. In particular, participation in money market mutual funds could importantly aggravate current pressures on thrift institutions and other market distortions. The intent of some depository institutions in sponsoring such funds is related to their inability to compete without interest rate restrictions in the deposit market. The process of deregulation of deposit instruments has, as you know, been highly controversial because competing considerations cannot be fully reconciled. A rapid lifting of deposit rate ceilings would have the advantage of enabling depository institutions to compete on a more equal footing with users of short-term funds, would offer benefits to the consumer, and help maintain a flow of credit to local communities served by depository institutions. At the same time, however, the higher interest costs resulting from the more rapid liberalization of deposit ceilings would bring still heavier pressure on the earnings of thrift institutions' and many banks locked into longer term lower yielding assets. Providing authority to banks to sell their own money market mutual funds may, on the -21- surface, appear an attractive means of cutting through- the dilemma -- on the one hand, permitting the banks to compete more fully, while on the other, retaining deposit rate ceilings. But the dilemma cannot be escaped so easily. The result inevitably would be to attract more funds from traditional deposits; potentially adding liquidity pressures to the current earnings problems of thrifts. Without SEC specific waivers of provisions of the ( Investment Company Act enforcing diversification of fund assets and restricting transactions among affiliated institutions, the funds attracted into the bank-sponsored money market funds could not be employed ,in lending by the sponsoring institution. Indeed, the nature of lending and investing by depository institutions could imply major shifts in the avilability of credit, to particular regions of the country and to. some categories of borrowers. However, should present law be changed so that the funds could vbe funnelled back into the sponsoring bank, potential conflict of interest becomes of more concern. Further inducements to-the growth of money market,funds, particularly if sponsored by banks and operated alongside regular transactions accounts, would also raise serious questions for the conduct of.monetary policy. Money market fund shares carry no reserve requirement. They can be withdrawn by check and upon demand, and - arrangements can be developed for automatic transfer to and from deposit accounts (including "zero balance" accounts); in other words, they can be the functional equivalent of. interest- \ 1 bearing demand deposits. The implication is that both the meaning of money supply statistics, and our ability to control the money stock, could be gravely impaired by major shifts from deposit transaction accounts to money market funds. -22- For these reasons, the Board feels strongly that authority to permit banks to sponsor and sell money market mutual funds should not be provided at this time, and that such authority would in fact weaken both our institutional structure and monetary control. Instead, we would urge that the very real problems of equity and competition be approached in other ways. The process of deregulation of deposit instruments should proceed as rapidly as circumstances permit. At the same time, we would suggest that money market funds, to the extent they in fact provide transaction balance services, be brought within the framework of reserve requirements and that those funds that do not wish to provide such transactions services be required to insist upon a short -- say, seven day -- notice before withdrawal. The net effect would be to move toward competitive equality and to improve the arrangements for monetary control. With these changes in place and interest rate ceilings phased out, the. question of providing authority for depository institutions with money market fund powers could be reexamined. Depository institution participation in more traditional stock, bond, or diversified mutual funds would not have the same adverse consequences for either the safety and soundness of depository institutions or for monetary policy. Some potential does exist for conflicts of interest, for confusion -23- on the part of the public about the bank's responsibility for the value of the shares, and for adversely reflecting on the reputation of the bank itself. While different in legal basis and in asset composition, the difficulties arising some years ago when banks became active in sponsoring Real Estate Investment Trusts may be suggestive of possible problems. The potential for abuse and misunderstanding is certainly limited by existing banking and investment company law and regulation. Moreover, few problems have arisen in the trust and agency activities of banks, which resemble the proposed mutual fund powers!. Based on this record, the Board believes banks should have broader powers for providing investment management services, but with certain added safe- guards. . As a first step in that direction, we would suggest banks now be permitted to operate, as part of their trust departments, commingled investment accounts on an agency basis. The effect would be to encourage joint management of individual accounts top small to be profitably serviced individually -- essentially the same service as provided by. mutual funds. We would also suggest that regulatory guide- lines be established,. to restrict advertising to the general public, to minimize the. possibility of confusion with liabilities of the bank itself, and to protect against conflicts of interest. -24- Should Congress wish to go further than our proposal and permit banks at this time to sponsor investment companies —— that is to enter the mutual fund business directly -- we believe the activity should be segregated into a separate holding company subsidiary, that use of the bank's name be prohibited, that sales commissions not be charged (i.e., only "no-load" funds be per- mitted) , and that further guidelines be developed by the regulatory agencies to avoid conflicts of interest and self- dealing. Broadened Thrift Powers The most sweeping changes in the present institutional structure are implied by the provision of S. 1720 greatly expanding the lending and deposit powers of thrift institutions. As we read the proposed legislation -- and detailed section- by-section analysis is provided in the appendix -- thrifts would be provided with virtually the full range of commercial banking asset and liability powers, at least so far as domestic banking is concerned, and in some cases without limitations (such as single borrower limits) long applicable to commercial banks. In addition, new or expanded powers for real estate development -- including sizable equity positions through subsidiaries -- would be provided. I believe it is generally accepted that the new powers are of little relevance in relieving the existing earnings pressure on thrift institutions -- indeed, incautiously used -25- by institutions without present experience and expertise in commercial lending, the new powers could precipitate greater difficulties. Rather, the apparent purpose would be to enhance the competitive position of the thrift institutions over time, and to provide greater flexibility to cope with swings in interest rates or other market conditions in the future. Those are understandable and worthy objectives. Yet, in evaluating the provisions as a whole, insistent questions arise. We would be left with a seemingly anomalous situation of two sets of institutions -- commercial banks and thrifts -- with comparable asset and liability powers, yet with different regulatory structures, branching powers, access to government- sponsored credit, and (for a transitional period) interest rate ceiling differentials. For one set of depository institutions -- the thrifts -- the separation of commerce from banking and the prohibition on interstate banking could, in some circumstances, be breeched; for the other -- commercial banks -- the present restrictions could remain in full force. To put the point another way, if thrift powers are to be broadened to the extent envisaged, the logic would point to the need for substantial further changes in law very promptly. Decisions will need to be made, for instance, about whether commercial bank or thrift branching powers should be the norm, whether we find it acceptable that industrial or commercial firms should operate subsidiaries with full banking powers, and whether banks, too, should be able — 26- to become real estate developers. Decisions on such issues could affect the safety, soundness, anu efficiency of our financial institutions. Moreover, the point is not just theoretical; for many banks S. 1720 would seem to provide a strong inducement to convert to thrift charters to take advantage of the broader branching powers, greater flexibility in real estate activity and non-banking activities, and incidentally take advantage of remaining interest rate ceiling differentials and the ability to borrow from the Home Loan Bank System. Those anomalies could be rectified, now or later. But looked at from another vantage point, the proposals raise the further, and more basic, question of whether our vision of the future financial system is evolving toward fully "homogenized," multi-purpose institutions. I recognize traditions in the thrift industry have been strongly oriented toward the housing industry and the individual, and some provisions in the tax law would, at least for the present, continue to provide incentives for that specialization. However, we would anticipate that competitive forces would strongly dilute the separate institutional traditions under the"framework proposed by S. 1720. A related question is whether the full range of commercial banking powers is really necessary to assure the competitive strength of thrifts. Historically, the answer has been no, as reflected in the relative earnings and growth performance of the industry. But today, with the competitive advantage of interest rate differentials being phased out, with differences in tax treatment less significant, and with markets more volatile, the historical record may not provide a full answer. -27- It is, of course, concern on this score that has motivated the'legislative proposals. At the same time, we should recognize that thrifts have already been provided substantial added flexibility in the Monetary Control Act last year and by regulatory action given the limited time available and the current pressures on the industry, few institutions have yet geared up to full use of this new authority. Clearly, there are a number of possibilities for providing still more flexible authority to the thrifts. We would urge, however, that any further steps at this point be taken within the broad framework of a concept of community, family-oriented institutions. Such an approach, for instance, would be compatible with full consumer credit and individual deposit-taking powers. Limited commercial loan powers -- viewed as meeting the needs of local, smaller businesses -- would help fill a niche in the credit market, and would be consistent with a community orientation. Thrift institutions and their affiliates could logically provide insurance and trust services for individuals, and deal with real estate and construction -- the existing areas of expertise -- within this concept. That evolutionary approach seems to us more fully in the traditions of our financial system -- a system that has served us well and can continue to do so. We do not perceive an absence of competition, or large new competitive opportunities, -28- in the national, regional, or foreign markets for commercial lending; indeed, there could be danger in looking toward those markets as a "quick fix" for depressed earnings. Those thrift institutions that, in fact, wish to operate as full commercial banks, should be able to convert to commercial bank charters -- and impediments to such con- versions could be removed. Questions of appropriate branching and other powers for banks and thrifts would, of course, remain. However, we believe those issues could and should be dealt with on their merits, rather than as a by-product of fully yielding the lending and deposit powers of banks and thrifts. Miscellaneous Provisions S. 1720 also includes a number of miscellaneous provisions that I have some concern about and would like to touch on very briefly. Once again the Federal Reserve's views on these provisions are described in more detail in the accompanying appendix. Limits on National Bank Loans to One Entity Under existing law, national banks are constrained in the amount of lending they can do to any one entity to 10 percent of their capital and surplus. The Federal Reserve strongly opposes the provision of S. 1720 which would raise that limit to 25 percent. Risk diversification has long been a key element of sound financial practice, and in my view, one that may be even more important than ever in light of the -29- longer term decline in the capital ratios of most of our largest banks. Accordingly, the Board opposes any general increase in the current limits on lending to any one entity. The Board does understand that current law may hinder i small banks in their attempts to serve the needs of their larger customers. At the same time, small banks tend to have relatively strong capital positions. Congress may thus want to consider an alternative approach, contemplating raising the lending limit to 15 percent of capital and surplus for banks with a relatively high capital ratio of, say, more than 7 or 8 percent. Limit on Loans of Certain Types and in Real Estate Lending The Federal Reserve supports the provision of the bill removing statutory limitations on certain types of loans as a share of a bank's assets. The Board is also not opposed to providing banks with greater flexibility in real,estate leading. The Board believes potential problems in this area can be best dealt with by regulation and through the bank . , examination process. Exemptions from Reserve Requirements S. 1720 and the accompanying S. 1686 would exempt depository institutions below a certain size as well as the deposits of state and local governments from reserve require- ments. The Federal Reserve strongly opposes the provision of -30- S. 1686 exempting state and local deposits from reserve requirements. Those deposits, from the standpoint of monetary control, have the characteristics of transactions balances, and should be treated in the same manner as other components of the money supply. However, the Board has no objection to the provision of S. 1686 which would extend NOW account eligibility to state and local governments. S. 1720 would exempt from reserve requirements depository institutions with total deposits of less than $5 million. The Federal Reserve is in favor of efforts to relieve burdens on smaller institutions if it can be done without significantly affecting our ability to conduct monetary policy, or damage to other objectives. Consequently, the Board would support exempting institutions below $5 million. We would point out, however, that that approach raises certain technical problems as well as questions of equity, discussed in the appendix, that may merit further consideration. As an alternative, the Congress may want to consider exempting the first $2 million in reservable deposits for all institutions. The effect on small institutions would be virtually the same, and some of the potential problems would be alleviated, although the cost to the Treasury would be somewhat higher. Increased Deposit Insurance on IRA-Keogh Accounts While we are mindful of the desirability of secure retirement funds, the Federal Reserve is concerned by the -31- trend toward higher insurance limits on all types of accounts. This trend increases the risk to the insurance funds and diminishes the sense of discipline implicit in the need for larger depositors to consider the soundness of their depository institutions. Consolidation of Insurance Funds The last issue I would like to touch on is the potential consolidation of the FDIC, FSLIC and the NCUA deposit insurance funds accomplished by expanding the FDIC's authority. The Board has serious reservations about such a consolidation at this time. It raises a number of important regulatory questions that have not been adequately addressed The Board recommends that the Congress postpone consideration of this issue pending fuller assessment of the financial and regulatory implications. Mr. Chairman, that completes my formal statement, and I would be pleased to answer any questions the Committee may have. * * * * * ** REC'D IN RECORDS SECTION I * • -- APPENDICES TO THE TESTIMONY OF > PAUL A. VOLCKER CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BEFORE THE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS UNITED STATES SENATE OCTOBER 29, 19 81 f j] -i— TABLE OF CONTENTS Pages Appendix A — Section by Section Commentary S. 1720 — Financial Institutions Restructuring and Services Act of 1981 Title I Parts A and B — Expanded Powers For Thrifts 1-5 Part C — Preemption of Due on Sale Prohibition 6-7 Part D — Extraordinary Authority Relating to Thrifts 8-12 Title II — Provisions Relating to National and Member Banks Section 201 — Expanded National Bank Authorities 13-14 Section 209 — Bankers' Acceptances 15-16 Section 210 — Loans to Affiliates 16-17 Section 211 — Reserve Requirement Exemption 17-18 Section 221-223 — FIRA Amendments 19 Title III — Securities Activities Section 301 — Municipal Revenue Bonds 20 Section 302 — Mutual Fund Activities 20-28 Title IV — Usury Preemption 29-30 Title V — Credit Union Amendments 31 Title VI — Bank Holding Company Insurance Activities 32-34 Title VII — Miscellaneous Provisions Section 701 — IRA-Keogh Account Deposit Insurance 35 Section 702 — IBF Deposit Insurance Assessment Exemption 35-36 Sections 703-705 — Truth in Lending Act Amendments 36-40 -ii- S. 1721 — Consolidation of Insurance Funds S. 1686 — Reserve Requirements and Interest on State and Local Government Deposits Appendix B — Comparison of National Bank and Federal S&L Powers Appendix C — Activity Restrictions on Depository Institutions Holding Companies Under S. 1720 Appendix D — Banks Meeting the IRS Qualifying Assets Test for S&Ls Appendix E — Banks in the Financial System APPENDIX A f . ' •- SECTION BY SECTION COMMENTARY S. 1720 — FINANCIAL INSTITUTIONS RESTRUCTURING AND SERVICES ACT OF 1981 TITLE I, PARTS A AND B — EXPANDED POWERS FOR THRIFTS The Depository Institutions Insurance and Services Act of 1981 New Authorities — The provisions of Parts A and B of this Title deal with expanded powers for thrift institutions, including chartering of new institutions and conversions of existing ones? new asset, liability and investment powers and authority for regulating branching by thrifts and activities of SSL holding companies. On the liability side, the new law would allow thrift institutions to offer demand deposits. On the asset side, it would eliminate existing quantitative limits on their ability to make consumer loans and invest in commercial paper, corporate debt securities, and municipal securities, as well as allow them for the first time to make commercial and industrial loans, offer mutual funds, and engage in equipment leasing. Disincentives on Use of' New Powers — It has been suggested in testimony before this Committee that thrift institutions would not, for the most part, have the expertise to use these new powers, and that the learning process might be- both time consuming and costly. However, there is an additional perspective in the form of existing structural disincentives on this use of new powers by thrift institutions, principally resulting from provisions of the tax law. I ! »• —2— Tax Provisions — The Internal Revenue Code provides that S&Ls and mutual savings banks may allocate up to 40 per cent of their taxable net income as noncash additions to their bad debt reserves. For the full 40 per cent to be taken, S&Ls must have 82 per cent, and mutual savings banks 72 per cent, of their assets invested in qualifying assets—mainly residential mortgages, cash, and U.S. Government securities. The Interagency Task Force on Thrift Institutions reported that for an S&L to be indifferent between, a portfolio of qualifying assets of 82 per cent as compared with 81 per cent, its net pretax yield on nonqualifying assets would have, to be 52 per cent greater than on qualifying assets. Effect of Tax Incentives — For example, for an S&L with 82 per cent of its assets in qualifying form and with mortgage rates at 18 per cent, the net yield on nonqualifying assets would have to be at least 27 per cent before diversification would be profitable. This net yield would probably have to be even greater since the 27 per cent yield does not take into account the high start-up costs of entering new credit markets. Additionally, if qualifying assets fall below 60 per cent—the minimum ratio in the Internal Revenue Code for a "qualified" S&L—an S&L would lose the authority to branch interstate; and if it were a subsidiary of a unitary S&L holding company, the holding company would become subject to the activity restrictions applicable to multi-S&L holding companies. Level Playing Field Objective — The paradox of Title I is that while S&Ls might find it unattractive to use their new powers because of tax and operational disadvantages, commercial banks might find these new powers, and the present ability to branch statewide, to be highly valuable. -3- As a result, many banks might be induced to switch to a savings and loan charter without changing the nature of the their commercial activities. The drafters of this legislation apparently intended to remove existing restrictions on thrift institutions in order to make them similar to commercial banks. Unfortunately, many disparities in powers would still exist. Attached is a table which compares the powers of national banks and thrift institutions after the passage of S. 1720 (Appendix B) and a second table comparing the powers of S&L and bank holding companies (Appendix C). Advantages of Thrift Institutions — These tables indicate that in many important respects' federal thrift institutions, after the passage of • S. 1720, would have significantly more desirable powers than the commercial banks. To list only a few examples, thrift institutions could pay interest on demand deposits, benefit from the interest rate differential, have access to Federal Home Loan Bank credit, engage in insurance activities without restriction, and would have the benefit of a regulator charged with advancing the the interests of the thrift industry. Qualifying federal thrift institutions would be permitted to branch intrastate regardless of state branching laws concerning branching by commercial banks, and would not be prohibited from branching interstate; a unitary S&L holding company with a qualifying subsidiary S&L would, in addition, have no limitations on its activities, in sharp contrast to the limited authorities of bank holding companies. In fact, the present situation in which major steel companies and retailers own S&Ls would be continued under the new law, an incursion across the line between commerce and banking that is not allowed by banking organizations. Thus, taken to the extreme, the drafters, in their efforts to give S&Ls the same powers as commercial banks, may have created incentives for bank holding companies to restructure their banking subsidiaries into qualifying S&Ls in order to become unitary S&L holding companies, and thus escape the present restrictions on permissible nonbanking activities in the Bank Holding Company Act. Possible Conversions by Banks — Only those unitary S&L holding companies whose S&L subsidiary meets the Internal Revenue Code test of having at least 60 per cent of its assets in qualifying instruments, including home mortgages, cash, and government securities, may continue to maintain this preferred status of not being subject to regulatory restrictions on its activities. However, this may not be a serious impediment to bank qualification. Appendix D illustrates that nearly 1,200 commercial banks presently would meet the 60 per cent asset test in the Internal Revenue Code to be a qualified S&L if they converted their charters. (Most of these would also probably meet the additional IRS test that 75 per cent of income come from qualifying assets.) The table also shows that by merely spinning off their C&I loans and loans to individuals into affiliates, nearly 6,200 banks could meet the qualifying asset test if they were to change their charters. Advantages of Conversion — If these banks converted to S&L status, they would be able essentially to keep their present asset powers, but would in addition have unrestricted intrastate branching privileges, would not be statutorily prohibited from branching interstate, would have higher deposit rate ceilings available on their small denomination deposits and would have access to both Home Loan Bank and Federal Reserve -5- discount window resources. In addition, they could elect to transfer a minimum of 23.5 per cent of before-tax earnings to bad debt reserves tax free, and could become a subsidiary of a unitary S&L holding company with no restrictions- on expansion into nonbanking activities and with no limits on the business of their parent organizations. In short, as presently drafted the Bill could create a whole new class of hybrid S&L-banks "with a significant competitive-advantage over commercial banks. Other Advantages — The new powers provisions also create a new regulatory structure involving the FHLBB as the primary regulator for these essentially commercial banking institutions.. Moreover, to the extent that existing banking organizations are able to restructure their activities into. special purpose/national banks.and S&Ls, they.could escape the jurisdiction and limitations of. the Bank Holding Company Act entirely. Competitive Consequences — Such consequences may be unintended, but have far-reaching implications for competitive equity, financial structure • v f - - - , , , , - - and the evolution of depository institutions and the credit markets they serve that deserve careful study and consideration. Rather than adopt provisions whose consequences may not be fully known, a practical alternative might be to facilitate thrift conversions to commercial . bank charters for those thrifts wishing to have wider asset and liability powers. This would, of course, raise knotty problems with regard to mutual commercial .banks.and expedited procedures to convert a mutual thrift into a stock commercial bank. However, such conversions would not raise-the problems contained in the Bill with respect .to competitive equity, interstate banking, regulatory structure, and the efficacy of the existing bank holding company and Glass-Steagall restrictions separating- banking and commerce. TITLE I, PART C—PREEMPTION OF DUE ON SALE PROHIBITION General Scope — Section 141 would preempt state law by permitting depository institutions to enforce due-on-sale provisions contained in mortgage instruments, although the states could override this preemption by enacting new legislation within three years. State laws and court decisions that prohibit enforcement of due-on-sale provisions have had the effect of reducing the asset flexibility of depository institutions, particularly thrifts. Effect on Thrifts — The prohibition against enforcement of due on sale clauses has exacerbated the greatest problem currently faced by thrifts, their large portfolio of low-rate mortgages. The prohibition of due- on-sale provisions has limited the ability of thrifts to increase their average portfolio returns as the underlying property is sold. By weakening earnings, the prohibition of due-on-sale clauses may even restrict the availability of mortgage credit and is likely to increase the impetus for lenders to emphasize variable rate mortgages whose rates are adjusted frequently. Board Position — Normally, the Board would prefer to see the states themselves deal with problems of this kind. In the current situation, however, the Board believes there are compelling reasons for federal intervention, which could provide immediate benefits, particularly to the earnings of thrift institutions, establish a uniform rule for all lenders and encourage the availability of long-term funds for the mortgage market. —7— Retroactive Enforcement — Under section 141, however, institutions could enforce due-on-sale provisions retroactively to property sales occurring before the date of enactment. That result seems inequitable. Additional consideration should also be given to exempting from preemption, mortgages made after the rendering of Court decisions or the effective date of state laws prohibiting enforcement of due-on- sale clauses, but before the effective date of Section 141. Consequently, the Board recommends that the legislation be amended to permit enforcement of due-on-sale provisions only for sales occurring after the date of enactment. Support for State Override — In addition, consistent with prior federal preemption in the financial area, the Board supports the provision allowing states to override the federal preemption of due-on-sale prohibitions. Such an alternative would enable state legislatures to review this matter over the longer term in order to determine at the local level whether it is desirable public policy to permit the enforcement of those clauses. TITLE I, PART D—EXTRAORDINARY AUTHORITY RELATING TO THRIFTS (THE REGULATORS BILL) General Scope — Title I and Title V of S. 1720 would enhance the ability of the Federal supervisory authorities to deal with distressed depository institutions. Economic Environment — There is a keen awareness that the nation's thrift institutions are under severe earnings pressure. Fortunately, most of these institutions entered this period of strain with a sizeable capital cushion. Their assets remain sound and the aggregate liquidity of the industry — both in a portfolio and cash flow sense — is adequate. But inflation and the related extraordinary levels of interest rates have created particular problems for institutions whose portfolios are dominated by long-term, fixed-rate assets, such as residential mortgages. As the costs of deposits have escalated, the earnings of such institutions have vanished, with the result that the capital position of virtually all of them is being eroded. The basic solution to this problem must be found in success in the fight against inflation, bringing lower and more stable interest rates. But, as progress is made toward that end, the supervisory authorities must also be prepared to deal with the possibility that an increasing number of thrifts, basically with sound assets and with satisfactory prospects, could find their capital depleted to the point of technical insolvency or failure, and seme will face a need for reorganization and merger. The great mass of their deposits are, of course, insured, maintaining customer confidence. But it has also become clear that -9- the insuring and regulatory agencies need clarification and strengthening of certain of their powers to deal with the situation in an orderly way. Temporary Nature of Problem — The current acute problems of the thrift industry are transitional in nature. Although no one can predict the duration with certainty, the earnings squeeze facing thrift institutions will be temporary in nature. As older assets mature and are replaced by new ones, thrift institutions portfolio returns will rise? just in the last three years, for example, average portfolio returns have increased over 1-1/2 percentage points at S&Ls and over 1 percentage point at MSBs. New asset powers provided by the Depository Institutions Deregulation and Monetary Control Act and more flexible mortgage instruments recently authorized by the Federal Home Loan Bank Board and in an increasing number of States, will also enhance the ability of thrift institutions to acquire assets with returns more closely related to market rates. Need for Assistance — At the same time, there are a number of institutions that will require assistance during this difficult period, or will need to seek merger partners or other solutions. Part of the approach should be to provide reasonable support to those institutions that can and should survive problems not of their own making. Essentially, that is the long-established mission of the supervisory and regulatory authorities. Titles I and V drafted largely by the supervisory agencies, provide no fundamental change in the authority or role of those agencies. Rather, they simply provide the PDIC and FSLIC, and the NCUA, under specified conditions, with more flexibility either to provide transitional assistance -10- to thrift institutions that can survive during a period of financial stress or to broaden merger possibilities. Capital Infusion — One provision of the bill would provide for the temporary infusion of capital to affected institutions through insurance fund acquisitions of subordinated securities of the Institution being assisted, which will be repaid from future earnings. Such authority already exists in limited form, but the language of the existing statutes, particularly with respect to the FDIC, does not really contemplate a situation like the present affecting the thrift industry so generally. Specifically, at present, the FDIC can provide such assistance when it finds that the particular institution to be assisted is "essential™ to its community. In foreseeable circumstances, with a number of thrifts in a given area subject to severe pressures, no single such institution in the area may be "essential" to the community, but it seems clear that the community or region does have a clear stake in the maintenance of an effective presence of a number of thrift institutions. The bill would assure that the Federal Deposit Insurance Corporation could provide assistance when "severe financial conditions exist which threaten the stability of a significant number of" insured institutions, if such assistance will "substantially reduce the risk of loss or avert a threatened loss" to the insurance fund. Thus, sound, and soundly- managed institutions could be assisted without the difficult finding that a particular institution is "essential," but only when the difficulties are general and arise from developments external to the institution, and when the insurance fund risks can be minimized. -11- Th is approach envisages repayment over time and is designed to ultimately save, not cost, the taxpayer money. The assistance would be provided only in circumstances in which it would, in fact, avoid large potential drains on the insurance funds themselves that would arise in the event otherwise sound institutions needed to be merged or liquidated. More Flexible Merger and Acquisition Authority for Supervisory Agencies — There will inevitably be institutions whose prospects would be such that their long-term viability is questionable, even under more favorable economic circumstances. Consequently, this legislation would also specify guidelines under which the agencies would be given more flexible authority to arrange supervisory mergers. This includes expanded powers to facilitate conversion of mutual organizations to stock form as a prelude to mergers with stock organizations, and in specified circumstances and as a "last resort," would permit acquisition of thrifts by healthy out-of-state thrift institutions, or alternatively, banks or bank holding companies. The bill sets clear and specific groundr ules for such mergers. Priority would be given first to institutions of the same type within the same state? second, to institutions of the same type in different states; third, to institutions of different types in the same states; and fourth, to different types in different states. The Federal Reserve already has broad authority under existing law to approve bank holding company acquisition of thrifts. As a matter of policy and in the circumstances of recent years, the Federal Reserve -12- recognizes the close Congressional interest in this subject, and recently submitted to the Congress a staff study examining the issue anew. In transmitting that study, the Federal Reserve indicated that in the absence of legislation providing specific direction concerning possible bank holding company takeovers of ailing thrifts, the Board might well find it necessary in the public interest to act under its . existing broader authority. The advantages of the "Regulators' Bill" in these circumstances seen clear. The capital infusion provisions of the bill may help reduce the number of cases in which supervisory mergers are necessary — but, when they are, the supervisory authorities would be provided with the necessary flexibility and criteria to deal with the situation. TITLE II — PROVISIONS RELATING TO NATIONAL AND MEMBER BANKS Section 201 — Expanded National Bank Authority General Scope — Section 201 would both expand the existing quantitative limits on the total amount of loans a national bank could make to any one entity and ease limitations on the share of different types of loans in a bank's portfolio. Limits on Loans to One Entity — The Board opposes an expansion of lending limits from 10 per cent to 25 per cent of capital because this could lead to excessive concentrations of credit and risk for a bank. At the same time, the Board recognizes that current lending limits hinder seme national banks, particularly the smaller ones that are most affected, in fully meeting the credit needs of their larger borrowers. Accordingly, if lending limits are liberalized, the Board would recommend raising the limits to 15 per cent of capital for those banks with relatively high capital to asset ratios of 7 or 8 per cent. These banks are the ones that can best support a larger concentration of credit. Moreover, tying higher lending limits to strong capital positions has the desirable effect of creating an incentive for banks to build up their capital. Section 202 — Borrowing Limits The Federal Reserve supports removing existing statutory quantitative limitations on certain types of national bank liabilities and, instead, giving the Comptroller of the Currency the authority to establish limits by rule or regulation as appropriate. ' The Board believes that statutory quantitative limits such as these are not necessary and in seme cases could be counterproductive. Problems with inappropriate liability structures can best be dealt with on a case-by-case basis through the examination process. Section 203 — Flexibility in Real Estate Lending Section 203 would amend the Federal Reserve Act to provide national banks with more flexibility in real estate lending. Certain limitations such as maximum loan to value ratios and maximum debt retirement provisions would be eliminated. Instead, the Comptroller of the Currency would be authorized to impose terms, conditions or limitations on real estate lending by rule or regulation. The Board supports the provisions of section 203 providing national banks with greater flexibility in real estate lending. In the cases in which seme constraints still seem necessary, the terms and conditions would be specified by regulation and monitored through the examination process. Section 205 — Bankers' Banks Section 205 would authorize the Comptroller of the Currency to issue national bank charters to bankers' banks. It also would permit national banks to invest up to 10 per cent of capital in a bankers' bank, but a national bank could not obtain more than 5 per cent of any class of voting stock of the bankers' bank. Bankers' banks would have to be owned exclusively by depository institutions. The Board supports the provisions of Section 205 and also believes that such institutions should be given access to the discount window in order to enable member banks to maintain a reasonable amount on deposit with bankers' banks. -15- Section 209 — Bankers' Acceptances Description of Rra&ision — Section 209 would amend the Federal Reserve Act to increase the aggregate limitation on the amount of eligible bankers' acceptances that may be issued by a member bank from 50 per cent to 200 per cent of capital and surplus, and to 300 per cent with the permission of the Board. The proposal would also exclude fully secured acceptances and those eligible acceptances participated out to other banks from these percentage limitations. Board Proposal — The Board supports a revision of the limitations on eligible acceptance limits, but believe that an increase in aggregate limitations of the size proposed in Section 209 would be too large. A more modest adjustment would be appropriate in order to avoid an excessive expansion of credit on a reserve free basis, and, accordingly, it is proposed that an eligible acceptance limit of 150 per cent of capital and surplus, increasing to 200 per cent with the permission of the Board be adopted. Moreover, for the same reasons, in applying this limitation, no distinction should be made between secured and unsecured acceptances. Equal Applicability — To assure that all institutions are subject to the same rules, we also recommend that the same limitations apply to nonmember banks and to U.S. branches and agencies of foreign banks. Participation — Finally, with respect to the issue of whether participations of bankers' acceptances are counted towards the aggregate limits, the Board believes that this issue is best handled through the development of supervisory policies by the bank regulatory agencies and that there is no need for legislation on the matter. -16- Section 210 — Banking Affiliates Act (Amendment of Section 23A of the Federal Reserve Act) Section 210, the Banking Affiliates Act, would amend Section 23A of the Federal Reserve Act to simplify and reduce regulatory burdens. The Federal Reserve supports the proposed revisions which are based upon a proposal submitted to Congress by the Board. The revisions will increase the overall effectiveness of Section 23A by closing seme potentially dangerous loopholes, while freeing banks within a bank holding company system from unnecessary restrictions. We believe that similar restrictions should apply to transactions between thrift institutions and their affiliates. In addition, we would suggest the following technical amendments be made to section 210 (except as otherwise indicated, all section numbers refer to Section 23A as revised by the Banking Affiliates Act — language to be added is underlined; language to be deleted is canceled): (1) to continue the current application of Section 23A to all member banks, section (b)(7) should be stricken in full and the following language should be substituted: "(7) the term "bank" includes State bank. National bank, banking association, and trust company."; (2) to continue the current coverage of section 18(j) of the Federal Deposit Insurance Act, strike out section (d) of the Banking Affiliates Act; (3) to indicate that the prohibition on the purchase by a member bank and it subsidiaries of low quality assets applies only to transactions with affiliates, the following underlined language should be added to section (a)(2): "(2) a member bank and its subsidiaries may not purchase a low-quality asset from an affiliate."; —17— (4) to correct an erroneous cross-reference, the following revision should be made to section (b)(5)(B): "(B) notwith- * standing any other provision of this subsection, no company shall be deemed to own or control another company by virtue of its ownership or control of shares in a fiduciary capacity, except as provided in paragrpah (3HBHC) • • •"; (5) to clarify the application of section (d) (3) it should be revised to read as follows: "(3) a low-quality asset shall•not be acceptable as collateral for a loan or extension of credit to, or guarantee, acceptance, or letter of - credit issued to, or on behalf of, affiliate of any other affiliate of the member bank.". " Section 211 — Exemption from Reserve Requirements for Small Institutions General Scope — Section 211 would exempt from reserve requirements institutions with total deposits of under $5 million. The Federal Reserve is in favor of efforts to relieve burdens on smaller depository institutions if it can be done without significantly affecting the system's ability to conduct monetary policy. Consequently the Board supports this section; however, it notes that there are other alternatives that achieve this objective that the Congress may want to consider. Effect of $5 Million Exemption — If institutions below $5,000,000 are exempted from reserve requirements—but are subject to full reserve requirements on all reservable deposits once that threshold is exceeded— the marginal reserve requirement on the deposits that take an institution above the cutoff is very high. Exempting institutions below a fixed i • -18- size from reserve requirements could also be considered somewhat inequitable since the reserve burden on all depository institutions would no longer be proportional. Edge and Agreement Corporations, and U.S. Branches and Agencies of Foreign Banks — In any event, these banking organizations should not be exempted from reserve requirements based upon their deposits because of their ability to engage in transactions of sizeable amounts on reporting dates with their parent banking organizations or other affiliates in order to avoid reserve requirements. Alternative- Approach — An'alternative approach, having the effect of exempting small institutions from reserve requirements but avoiding some.of the. above, problems, would be to provide a reserve-free tranche of $2 million in reservable deposits for all depository institutions. (The average institution with $2 million of reservable deposits has about $5 million of total deposits.) This alternative would effectively exempt small institutions from reserve requirements, avoid the problem of high marginal reserve requirements on deposits immediately above the cutoff point, and treat all depository institutions in a similar fashion. This approach would cost somewhat more, however, in terms of lost revenue to the Treasury. . A reserve-free tranche above $2 million could result in monetary control problems. Date for Determining Exemption — If the Congress should elect to exempt all institutions below $5 million from reserve requirements, the" Federal Reserve would suggest that rather than determining exemption by deposits on a fixed date, such as the end of an institution's fiscal year, an institution be exempt unless deposits exceed the cutoff for two successive calendar quarters. This would eliminate the possibility of an institution losing its exemption because of a temporary deposit increase. -19- TITLE II, PART B — FINANCIAL INSTITUTIONS REGULATORY ACT AMENDMENTS Sections 221-223 — FIRA Amendments Sections 221-223 contain amendments to the Financial Institutions Regulatory and Interest Rate Control Act of 1978 ("FIRA") aimed at lessening unnecessary restrictions and burdensome reporting requirements. These amendments would clarify existing laws and ease some of the restrictions and reporting burdens with respect to loans to executive officers, directors and principal shareholders. The amendments were recommended to the Congress by the Financial Institutions Examination Council and we believe that they are a good first step in reforming FIRA. The Examination Council is in the process of preparing additional amendments to reduce the regulatory burden particularly on small institutions and they will be forwarded to Congress separately. -20- TITLE III — SECURITIES ACTIVITIES Section 301 — Municipal Revenue Bonds Section 301 of S. 1720 would permit banks to underwrite and deal in most municipal revenue bonds. The Federal Reserve has long supported the entry of banks into this activity as a logical extension of their current ability to participate in the market for municipal general obligations, particularly since revenue bonds have accounted for an increasing portion of all municipal securities. Banks underwriting of municipal revenue bonds would enhance competition in the revenue bond market, and should reduce costs to tax exempt borrowers. Moreover, the legislation contains desirable provisions to protect against conflicts of interest or unsound banking practices. The Board would like to have substantially all of these provisions apply not only to the new authority on municipal revenue bonds but also to existing authority to deal in municipal general obligation bonds. Section 302 — Authority to Offer Mutual Funds Distinction Between Money Funds and Other Mutual Funds — Section 302 of Title III authorizes depository institutions or their affiliates to sponsor or operate mutual funds registered under the Investment Company Act of 1940, and to underwrite and distribute their shares. The bill would permit depository institutions to offer shares of both traditional mutual funds investing in stocks and bonds and money market mutual funds. This proposal raises many issues of vital concern to the Federal Reserve. Bank and thrift sales of mutual funds could affect the conduct of monetary policy, public confidence in the financial system, the safety and soundness of our depository institutions, the protection of savers' —21— dollars, and the distribution of credit throughout the economy. A number of these issues are associated most directly with the offering of money market funds, and as a consequence these will be discussed separately front the more traditional stock and bond funds. MONEY FUNDS — Money market funds resemble deposits in several important ways, and are generally superior in yield and liquidity to deposits offered by banks and thrifts. These characteristics have resulted in the phenomenal growth of money funds in recent years, largely at the expense of deposits, but they also mean that the increase in money fund assets has some very special implications for depository institutions, our financial system, and the conduct of monetary policy. It would not be too broad of a generalization to say that money market funds are in large part an outgrowth of the restrictions of Regulation Q. As interest rates rose and Regulation Q became more of a constraint on the attractiveness of insured deposits, mutual funds expanded as a nonregulated alternative that was able to offer customers a market return on a highly liquid instrument with a high degree of financial security. This instrument has been the opening wedge for a variety of nondepository institutions to enter the market for what would otherwise be deposit funds. Impact of Deregulation — Because Regulation Q was the principal cause for this development, the deregulation of interest rate ceilings should have an opposite effect of freeing banks to compete more effectively with nondepository institutions. The Congress, in the Monetary Control Act of 1980, has begun the process of deregulating deposit rate ceilings -22- and, in establishing this process, has carefully weighed the competing public policy considerations. In this process the Congress has taken into account the competitive needs of financial institutions, in particular, the situation of the thrifts, while at the same time establishing as the ultimate objective, the provision to consumers of a market rate of return on insured deposits, to be achieved as soon as feasible. Problems of Money Funds — The process of deregulation has not been smooth or easy, but it is bound to be this way when sharply conflicting interests are at stake. In this context, allowing banks to offer money market mutual funds could severely impair the deregulation process which Congress created last year by greatly accelerating the diversion of deposits to money market funds. Moreover, the offering of money market funds by depository institutions would result in a major strain on the present deposit structure, and would have a sharp adverse effect on earnings, particularly at thrift institutions. Alternative Solutions — Depository institutions need to be able to offer to all of their customers services that are capable of competing more effectively against the expanded services of their securities industry competitors. To that end, proposals are now before the Deregulation Committee allowing depository institutions to offer short-term instruments with ceilings tied to market rates or without interest rate ceilings, perhaps subject to substantial minimum deposits and minimum maturities. In considering this issue, the DIDC will be weighing the effect such an action may have upon the viability of various depository institutions and the benefits to the public. Movement in this direction would provide -23- an effective competitive answer to the challenges of the marketplace for depository institutions without creating new, potentially damaging strains on the financial system. Other Money Fund Issues — In addition, to the potential impact on institu- tions, there are other serious problems with the money market funds approach. The expansion of money funds is likely to complicate the tasks of formulating and implementing monetary policy. By permitting the public to economize on holdings of traditional transaction account balances currently included in the narrow definition of the money stock, Ml-B, money funds raise serious questions about the relationship of targeted growth rates of this aggregate to inflation and economic activity. More generally, money funds have contributed to the progressive blurring of the distinction between transaction and nontransaction accounts that has made expansion of Ml-B so difficult to interpret. The combination of transaction and money fund accounts that will be encouraged by this legislation will greatly aggravate this problem, especially when excess funds in a NOW or other Ml-B account are automatically invested in money funds; in this event, any given money stock could be consistent with widely varying levels of spending and the basic premises of Federal Reserve monetary aggregate targeting would be open to question. The Federal Reserve could redefine narrow money to include money fund shares. But it is not known what proportion of these holdings are properly classified as transaction balances. Moreover, an expanded narrow money stock could be difficult to control using bank reserves given the nonreservability of money fund shares and the relatively low —24— or nonexistent reserve requirements on the assets they purchase, and. attempts to control money fund growth through the application of the traditional tools of monetary policy could prove difficult. In recognition of the potential problems in this regard, last spring the Federal Reserve proposed that the Monetary Control Act be extended to permit the Federal Reserve to impose reserve requirements on the shares of money market funds that could be used as transaction balances; we continue to believe that this step is necessary. And, it may be necessary to take additional steps—such as enforced minimum notice requirements on nonreservable deposit and money fund shares—to establish a distinct transactions aggregate that would be predictably related to the public's desires to spend. Purchase of CD's — A major reason for financial institutions wanting to be able to offer money market funds is the ability to use funds . arising from share sales to buy their own certificates of deposits. . Flows of funds to money funds distort the distribution of credit in the financial system, at least initially, by concentrating resources in the wholesale money markets, where they are most readily accessed by large banks and corporate borrowers. Small- or medium-sized banks thus have a special interest in overcoming this problem by sponsoring money funds that purchase their own CDs. However, such an investment strategy creates serious concentrations of risk in the fund and potential conflicts of interest for bank officers who are also advising the money fund. In addition, the CDs of small-or medium-sized banks generally are not readily marketable and difficulties could arise if large-scale redemptions were requested. -25- Moreover, this approach is inconsistent with the basic diversification objectives of the Investment Company Act and can only be accomplished through a waiver granted by the SBC. It is reasonable to anticipate that such waivers would become the subject of litigation and there could be a long delay in the implementation of the authority contained in this bill. Major Risks of Money Funds — For all of these reasons the Board believes that the money fund proposal poses major risks for the short-term stability of major, components of the financial industry and raises major questions about the future ability to conduct monetary policy. If the Congress believes that events require that depository institutions be permitted to compete more effectively for the liquid assets of the public, the Board believes that the Congress should direct the DIDC to accelerate the elimination of deposit rate ceilings and permit interest to be paid on all transactions accounts, including demand deposits. Such an approach would minimize difficulties for monetary policy, sustain the flow of funds to depository institutions to lend and invest and would also assure that more,of the public's liquid asset holdings are in insured form. However, the Board is not recommending a major acceleration at this time because of the fact that elimination of rate ceilings would threaten the continued viability of many thrifts. . , STOCK AND BOND FUNDS — Many of the concerns associated with money market funds do not arise, or are considerably less intense with respect to bank and thrift sponsorship and sales of stock and bond funds. Because of the obvious differences between the longer-term securities such funds -26- may hold and deposits, growth of these funds is unlikely to be at the expense of deposits and hence to affect monetary policy or the earnings of depository institutions. Judicial interpretations of the Glass-Steagall Act have stood in the way of offerings of stock and bond funds by banks. The courts and investment company competitors of banks have been greatly concerned about the effect of commingled agency accounts on concentration of resources, on conflicts of interest, and on the safety and soundness . of banks. Problems of Stock and Bond Funds — These considerations have been explained in detail in the context of the present hearings. The Board-is,' of course, concerned about potential problems such as conflicts between • serving the interests of the bank arid those of the shareholders of a bank-sponsored mutual fund. For example, it has been suggested-that - attempts might be made to use a bank to bolster the performance of its mutual fund"by purchasing poor quality securities from it or by making unsound loans to troubled firms whose shares were held by the' mutual1 fund, and that the soundness of a bank could be impaired if its mutual- fund were performing poorly and bank management was concerned that the] reputation of the bank might be compromised in the process. Moreover, the argument is made that it may be difficult to separate in the public's mind the fortunes of the related mutual fund from those of the bank or thrift itself, especially if bank sponsorship and sales tended to spread mutual fund ownership to less sophisticated investors. Such circumstances, it is suggested, could also lead to intensive efforts by banks or thrifts to step up sales of mutual fund shares if declining values were leading to redemptions. The pressure for such efforts could -27- interfere with the delivery of sound and impartial investment advice to customers. Trust Fund Administration — On the other hand, banks in their trust functions have been the largest institutional holders of common stock and other securities. Trust assets as to which banks have investment discretion amount to $571 billion in 1980. Our overall experience gives no indication that the potential problems described above are serious and provides a substantial basis for concluding that securities holdings by banks in a fiduciary capacity are consistent with safety and soundness, with fair competition, and with a healthy climate for investors. Regulatory Framework — Moreover, the provisions of the bill would provide further tools to assure that these objectives are not compromised. Numerous existing laws and regulations designed to protect the investing public would apply to this activity under the bill, and would guard against difficulties especially those involving conflicts of interest. Establishment of mutual funds would be subject to the provisions of the Investment Company Act, which among other things, greatly restrict transactions between mutual funds and affiliated entities. In addition, section 23A of the Federal Reserve Act, as amended by the bill, and other federal banking regulations govern transactions between insured banks and related entities. Finally, the bill would provide authority to set standards and qualifications for depository institutions broker- dealers in mutual funds. Alternative Proposal — In view of these protections and the generally favorable experience of banks with commingled agency trust accounts, 28- we see benefits to the banks from being able to use their trust department expertise more intensively, and to the public from having additional sources of investment management services. We believe that many of these benefits can be realized, and potential difficulties minimized, if banks were allowed to offer commingled agency accounts through use of their trust departments as investment advisors, but subject to tight restrictions on advertising for business with the public at large. This would enable banks to service customers who request investment assistance, but whose accounts are not sufficiently large to warrant separate, individual handling on an agency basis. Banks would be unable to sell these services to a much wider audience and would avoid strong public identification of the fund with the fortunes of the bank. Exploratory Objective — This new authority for commingled agency accounts should be considered a testing ground for the idea of depository institutions offering mutual funds. Congress could then evaluate this experience with the commingled agency accounts if it wished to reconsider extending the authority to encompass all traditional mutual funds. To help develop this experience we believe the Federal Reserve should be empowered under the legislation to set the rules governing the operation of commingled agency accounts, with enforcement left to the primary regulators. This regulatory structure would also ensure that parallel regulation would prevail for different types of financial institutions. -29- TITLE IV — USURY PROVISION ,v Sections 401-4Q4 The "Credit Deregulation and Availability Act of 0 ir.rjcc/i':- r B General Scope — The-usury provisions in Title IV broaden the coverage of preemptive actions taken with respect to state usury laws in the Depository Institutions Deregulation and Monetary Control Act of 1980. Title IV removes state usury ceilings on business, agricultural, and consumer loans, while permitting states to establish their own ceilings by enacting overriding legislation within three years. The DIDMCA presently sets a ceiling of 5 per cent above the Federal Reserve discount rate on 90-day commercial paper and affects only loans above $1,000. Business and agricultural loans below that amount are subject to state usury provisions. Consumer„loans are subject to a ceiling of 1 per cent over the discount rate. Under the proposed legislation, state limits would be removed without imposition of a federal rate ceiling or amount restrictions. In addition, the bill would recognize the binding character of state override actions taken since adoption of the DIDMCA, but before the effective date of Title IV. Preference for State Action — The Board has frequently noted the adverse impact that usury laws can have upon the availability of credit in local markets, and has recommended the complete removal of such ceilings— rather than establishment of different ceilings—as the most appropriate solution. The Board's preference, however, is for corrective action by the states themselves rather than by federal preemption. If Congress decides to act on this matter, the Board endorses the provisions in —30— Title IV to provide the states with a means to reestablish their ceilings. The Board also believes that, if ceilings ar^nclfe-to~tie--Liftedilerihir.ely, any ceilings should not be tied to the Federal Reserve discount rate* as is now the case under the provisions of DIDJCA. -ufj? cif;' MO vjs o) c.yoi : •_ih -31- TITLE V — CREDIT UNIONS Covered as part of analysis of Regulators Bill. -32- TITLE VI — SECTION 601T-.- ; BANK HOLDING COMPANY INSURANCE ACTIVITIES General Scope — Title .-VI makes significant changes in the authority of bank holding companies to engage in insurance activities. The bill sharply limits the insurance activities of larger bank holding companies (over $50 million of assets) and broadens the scope of these functions for smaller bank holding companies (under $50 million of assets). Impact on Larger Bank Holding Companies — Larger bank holding companies would be grandfathered with respect to existing activities. However, under section 601, no large bank holding company that had not received Board approval before June 12, 1980 (or thereafter if the application were filed before April 29, 1980) could sell property and casualty insurance to protect collateral on which the bank holding company had extended credit unless the loan in question were made (a) by a finance company subsidiary and (b) for not more than $10,000 ($25,000 for mobile homes). At present, bank holding companies can sell property and casualty insurance to protect collateral without regard to the size of the loan or the nature of the lending subsidiary. Impact on Small Bank Holding Companies — The liberalization for smaller bank holding companies is significant. Section 601 would allow the sale of any type of insurance (except for life insurance and annuities) by bank holding companies with less than $50,000,000 in total assets. In addition, there would be no restrictions on the insurance agency activities of bank holding companies that (a) are located in communities with populations of 5,000 or less or that (b) are located in places with inadequate insurance facilities. At present, only the town of -33- under 5,000 exemption exists for general insurance activities and the addition of the new exemption to some extent is redundant. Overall Effect — The bill thus has two major impacts: (a) new large bank holding company entrants into insurance activities would continue to be able to sell credit accident, health, and life insurance, but credit-related property and casualty insurance would be limited to. small ($10,000) loans by finance company subsidiaries, and (b) small bank holding companies ($50 million or under) would be free front all existing insurance agency restrictions including the restriction that the insurance be credit related. The bill does not affect the scope of underwriting activities of bank holding companies, regardless of size, which are now limited to underwriting credit life, accident and health insurance. Board Position — As the Board has indicated in previous testimony, it believes that the proposed prohibitions would have an adverse impact on the public interest. The Board's view continues to be that banking organizations should be allowed to sell credit-related insurance, including property and casualty insurance, and that the benefits of such activity generally outweigh the possible adverse effects. Permitting bank holding companies to provide this service is pro-competitive and would promote the public welfare. Sales of insurance by banking organizations have provided a useful and convenient service to the public in the past, including sales at locations that were poorly served by others. Limiting this activity for banking organizations would adversely affect at least some part of the public, namely those borrowers who would prefer to —34— purchase their credit-related insurance from the lender and under the proposed legislation could not do so. The bill can only be characterized as inconsistent. On one hand, it severely restricts the insurance activities of larger bank holding companies, (particularly, property and casualty insurance sales) while, on the other hand, it arbitrarily frees smaller bank holding companies to expand into the sale of any insurance. In addition, it establishes a new criterion for determining what are appropriate activities for bank holding companies unrelated to the economic and financial characteristics of the activities. Section 601 also singles out bank holding companies among financial institutions and nonregulated lenders for special restriction and, for example, imposes no limitations on savings and loan associations and savings and loan holding companies. As a whole, the proposal appears to foster distinctions between financial institutions that are not warranted by their nature—an effect this legislation as a whole seems designed to eliminate. -35- TITLE VII — MISCELLANEOUS PROVISIONS -• - - r , . Section 701 — Deposit Insurance on IRA-Keogh Accounts r - General Scope — Section 701 would increase the level"of deposit insurance coverage on IRA-Keogh accounts from $100,000 to$250/000;^ The Board " is of course aware of the desirability of securing the safety of retirement funds. However, this does not appear to be the major factor in this. proposal because of the ready alternatives available to individuals : 1 .„v; V- " who wish to maintain insured deposits for accounts of this size. Opposition To Increase —A second objective of this proposal—to encourage an inflow of funds to depository institutions has already been encouraged by DIDC action to deregulate rate ceilings that institutions may pay t on IRA-Keogh deposits. Moreover, the Board is very'much:, concerned about the trend toward higher insurance levels, which,both increase, the risk to the insurance funds, and, at the same time, lessen sane, parti of ••management's responsibility for the safety of deposit, funds.- Similarly,--.the Board, believes it- desirable to increase the incentives.for large depositors to exercise appropriate discretion and care in the placing of the investments. j ; t' L;. H." Accordingly, the Board does not support this section of the Bill. ' - f-: Section 702 — Exemption of IBF From Insurance Assessments •, ;: General Scope —r Section 702 would exempt deposits at international banking facilities from federal deposit insurance assessments,and,reaffirms the exemption of deposits at United States banks overseasfrom these assessments. Since IBFs were created solely.to, accept deposits in the United States of foreign customers, the Board believes,they should be —36— treated the same as deposits" at foreign branches of U.S. banks, which are exempt from insurance assessments. The FDIC believes that they svi-.-canntit^exempt' IBF rdeposi.ts from insurance assessments without legislation. The> .iegl slat ion Cwould give * the same treatment for FDIC purposes to IBF jrs:^deposits as^torthe. deposits taken by foreign offices of United States banks, u io;te.r:> t i -- s s ?)r-• \ • ' Equality of Treatment — To assure this equality of treatment for both e ~ My ? v.:., IBF and deposits at foreign branches of U.S. banks, we believe it would tv-ft^iberdesirablecto.draft'?the proposed legislation so as not to provide •>?i..a "ipermanentdexemption;for deposits at foreign branches and to provide the]rsamer treatment:;for IBF.rdeposits that is established for foreign ^:branchfdepositsv .f This will allow continuing evaluation of the -insurance t:fiatmerit:of^depositsrtat^foreign .branches and facilitate the submission »' moo-ofBTproposalscfor Congressional consideration should it be recommended thatoa change-beimade in:the insurance assessment treatment, of overseas deposits-jtaken"zby U:S. :banks.v Section 703 — Definition of Creditor General Scope — The Truth in Lending Act requires "creditors" to give Truth in Lending^isclqsures, and a "creditor" is defined as a person who<reither-"extends1 or- arranges credit. Prior to the Truth in Lending ^amendments',"an" arranger of credit was considered a creditor only if the-person1actually extending the credit was also a creditor—that is, bne who- in!'th'e->ordinary- course of business regularly extends credit. The amendment's' chang^d-the def inition to cover instead those arrangers -37- who regularly arrange credit to be extended by persons who do not meet the creditor definition. This raised the possibility that real estate brokers who arrange seller-financed transactions may, for the first time, have Truth in Lending disclosure responsibilities. Board Request for Comment— Because of ambiguity on the question, the Board recently issued for public comment a proposed amendment to its Truth .in Lending regulation. It would clarify the definition of "arranger" in a way that would-cover most mortgage loan brokers, as well as real estate brokers who arrange seller-financed transactions. By contrast, the proposed bill would entirely delete the concept of arranging from the definition of creditor, with the result that Truth in Lending disclosures would not be required in seller-financed transactions, and even professional loan brokers would have no disclosure responsibilities. Policy Considerations — The Board understands that conflicting policy implications surround this issue. Those in favor of covering real estate brokers point out the growing popularity of seller financing in the mortgage market, with seller-financed mortgages occurring in more than 50 per cent of home sales. These sales transactions involve large amounts of money and substantial risks to consumers, and Truth in Lending disclosures, particularly of the large final balloon payments normally involved in such transactions, may help consumers to understand these risks. The disclosures required are likely to be relatively straightforward, and in most instances would probably .not call for complex numerical calculations. -38- Despite these concerns, however, there are good reasons advanced by others that argue against coverage of this group. It appears inconsistent with the general thrust of Truth in Lending simplification to now bring within the scope of the act an entirely new class of creditors, as would occur if real estate brokers are considered arrangers of credit. Subjecting brokers for the first time to those requirements unquestionably adds to the expense and difficulty of their operations, and could complicate the contract process. Given the current state of the housing industry, it may be unwise to require the industry to shoulder an additional burden at this time. Moreover, in the final analysis, the Board cannot state with any certainty that requiring Truth in Lending disclosures for these transactions will measurably decrease their risks for consumers. Section 704 — Preemption of State Consumer Credit Laws General Scope — Under current federal law, only state laws that are. , '"inconsistent" with the Truth in Lending, Consumer Leasing and Fair- Credit Billing Acts are preempted. This narrow preemptive standard has left in place many overlapping state laws and this has contributed to the costs of compliance. Section 704 of the bill expands this preemption to include any state law that is "similar" to the federal law. This represents a bold approach to the problem, and is attractive from the point of view of reducing regulatory burdens. However, the application of section 704 to the multitude of specific state provisions is very unclear—and no easy solution is apparent to the problem of identifying specific state provisions that should be superseded. -39- Difficulties of Applying Concept of Similarity — The concept of "similarity" is a subjective one that does not provide much real guidance on how the preemption provision would apply to individual state laws. The problem lies not so much with state "mini-Truth in Lending laws," which would likely be preempted by this standard, but with the numerous provisions that are buried in state laws or regulations not otherwise related to Truth in Lending, such as usury laws, contract formation laws, insurance laws, and sales acts. It is unclear, for example, how the "similar" standard would apply to the following relatively common state law provisions: 1. prohibitions against false or misleading credit advertising; 2. requirements that contracts contain various notices such as "Do not sign this agreement before reading it;" 3. requirements that credit information.be given to parties not covered by federal law. Given these difficulties, and the Board's general view that federal preemption should be limited to only the most compelling circumstances, the Board does not support this proposal. Problem with Overriding State Law — The state override of the federal preemption, which is intended to balance the sweeping preemption provision, is also troubling to the Board. The override appears to be so broad that it allows every state not only to substitute its own rules, but to determine that no rights or disclosures are required for consumer credit transactions that would have been subject to Truth in Lending under federal law. This may effectively frustrate legitimate national policy enunciated by Congress in enacting the Truth in Lending Act. —40— If Congress, nevertheless, decides to proceed with this concept, it may wish to consider narrowing the scope of the override. One obvious alternative could be based on the current exemption process, by which a state can substitute its own requirements, provided they are "substantially similar" to the federal law. Section 705 — Civil Liability General Scope — Section 705 addresses the potential liability of institutions under Truth in Lending for technical and isolated violations by providing that a creditor is not liable unless its actions reflect "substantial noncompliance." Over the years there has been a considerable amount of civil litigation under Truth in Lending. Creditors were often held liable for technical violations, whether or not the consumer suffered any damages. This large volume of litigation is one major reason for the complexity of Regulation Z, as creditors tried to protect themselves against a variety of sometimes conflicting court decisions by obtaining large numbers of interpretations from the Board. In the Truth in Lending amendments passed last year, Congress sought to deal with the litigation problem by limiting statutory damages to certain essential disclosures. Discussions with attorneys practicing in the field suggest that this change may well curtail the technical litigation that occurred in the past—although only further experience under the act will verify that prediction. The idea of limiting liability to cases of "substantial non- compliance" has a good deal of appeal. By its nature, however, the standard is unclear despite the efforts in the bill to provide courts —41— with some guidance. Any new statutory scheme for the prosecution of Truth in Lending claims brings with it a host of ambiguities, with the risk that it will stimulate new forms of complex litigation. Practitioners representing both the consumer and creditor bar indicate that the effect of the proposal may be to turn relatively simple individual actions into far more complicated and costly litigation, as plaintiffs seek to prove substantial noncompliance by searching throughout the creditor's records of other transactions. The new civil liability provisions of the Simplification and Reform Act generally will not become effective until next April. These reform proposals may well accomplish the goal of reducing litigation. With this prospect, the Board believes that further change in the civil liability provisions at this time would be premature. Extension of the Effective Date — The new Truth in Lending requirements are scheduled to go into effect next April. The bill would extend this effective date for an additional six months. The Board has no objection to the proposed extension since it will provide the industry with additional time in which to implement the changes. —4 2- S. 1721 — CONSOLIDATION OF INSURANCE FUNDS General Scope — A separate bill, S. 1721, the Federal Deposit Insurance Consolidation Act of 1981, proposes to consolidate the deposit insurance funds of the Federal Deposit Insurance Corproation, the Federal Savings and Loan Insurance Corporation and the National Credit Union Administration. The consolidation is to be achieved by restructuring the Federal Deposit Insurance Corporation and expanding its authority to insure the deposits of commercial banks to include the deposits of thrifts and credit unions. The bill would also merge the Corporation's insurance fund with the primary and secondary reserves of the Federal Savings and Loan Insurance Corporation and the National Credit Union Share Insurance Fund.- This expansion of the Corporation's insurance authority would also require an expansion of its role and authority as an examiner of insured institutions and as a regulator of problem institutions and closed institutions. Major Issues — The Board has identified several major issues concerning the operation and organization of a consolidated insurance fund as proposed under S. 1721 and is concerned about the potential.risks the consolidation would have upon the security of the insurance fund. Consolidation of the funds would clearly increase the risk to the FDIC insurance fund from current levels and would, in effect, require commercial banks to underwrite losses arising from other depository institutions. Consideration must also be given to the equities and the complex task of determining whether appropriate terms and conditions could be established for shifting —43— the risk of the FSLIC and the NCUSIF to a fund established in major. portion from assessments on FDIC member institutions. i ' Board Position — Because this consolidation will mandate vast structural changes in the present federal deposit insurance system, the Board recommends that the consideration of this proposal by Congress be postponed until a thorough analysis of the changes proposed under the bill and an assessment of the current financial status of the three funds has been prepared for Congressional review. -44- S. 1686 — RESERVE REQUIREMENTS AND INTEREST ON STATE AND LOCAL GOVERNMENT DEPOSITS The Board has been asked to comment on S. 1686, proposed by Senator Lugar, which would exempt state and local government and U.S. Treasury demand deposits from reserve requirements and permit the payment of interest on state and local transactions balances—either by establishing a program similar to the Treasury note balance program or by granting eligibility for NOW accounts. The Board opposes exempting state and local government demand deposits from reserve requirements on monetary control grounds. These transactions balances are included in our narrow measure of the money stock, Ml-B. To promote control of this aggregate, reserve requirements on its deposit components ideally should be uniform and universal, a prime objective of the Monetary Control Act of 1980. Reserve requirements are the link between reserves, over which the Federal Reserve has direct control, and the monetary aggregates. Exempting from reserve requirements select components of the money stock—such as state and local government demand deposits, which amounted to $16-1/2 billion in mid-1981—necessarily loosens this link between reserves and money. Moreover, an exemption for state and local government deposits would establish a precedent for exemption for demand deposits of other money-stock holders. Additional exemptions would further impair monetary control. Any exemptions would reduce Treasury revenues, as the decrease in required reserves would involve a commensurate reduction in Federal -45- Reserve holdings of U.S. Treasury securities, offset only-partly by : additional taxes .on the increase in bank earnings that would result from• holdings a smaller quantity of noninterest-bearing reserves. - . . < The payment of interest on state and local government demand deposits would further reduce Treasury revenues by shifting income from banks, which are subject to federal income tax, to untaxed government units. The reserve requirements exemption for state and local governments combined with a program for providing interest on their transaction accounts would involve a long-run annual revenue loss to the Treasury estimated at about $1.1 billion, based on mid-1981 deposit levels, recent interest rates and current reserve requirements and tax rates. This sum is half of the revenue gain to state and local governments, estimated at $2.2 billion. Alternatively, the reserve requirement exemption coupled with NOW accounts for state and local governments would involve an annual loss of revenue to the Treasury estimated at nearly $500 million, well over half the revenue gain to state and local governments. If state and local NOW accounts were reservable as other NOWs, the Treasury's loss of revenue would be about $410 million, about 45 per cent of the - revenue gain to state and local governments. It should be noted that large nonfederal government units already have access to devices for efficient cash management and to market-determined yields on money market assets. Smaller governments can obtain competitive yields by purchasing small-denomination RPs, -46- which are subject to neither reserve requirements nor interest rate ceilings. Moreover, important questions of equity would arise if NOW account eligibility were extended to state and local governments, but not to businesses. Treasury Revenue Loss Implied — The attached tables detail estimates of the annual loss of revenue to the Treasury that would result from proposals contained in S. 1686. The estimates assume that if state and local governments were made eligible for NOW accounts, then they •' - would shift all demand deposits to NCWs, whereas if they were to participate in a program like the Treasury note balance program, then they would shift to interest-earning note balances a fraction of their demand deposits equal to the average ratio over the first nine months of 1981 between Treasury note balances and combined Treasury note balances and demand deposits at commercial banks. The estimates also assume that after a period of adjustment, federal income tax would recover 45 per cent of any earnings gain at banks or drop by a like percentage of any reduction in earnings; this tax recovery rate corresponds to that agreed upon by Board staff and the Treasury for use in earlier studies concerning , the Monetary Control Act of 1980. —47— TABLE 1 Annual Treasury Revenue Loss from Exempting State and Local Government Demand Deposits from Reserve Requirements 1. State and local government demand deposits 1/ $ 16.66 billion 2. Times: Average required reserve ratio against such deposits 2/ x .0859 3. Equals: Required reserves on state and local government demand deposits $ 1.43 billion 4. Times: September 3-month Treasury bill rate, average fiscal 1981 yields con- verted to an annual effective yield x .16408 5. Equals: Reduction in Federal Reserve earnings remitted to Treasury $234.63 million 6. Minus: Tax recovered from bank earnings on reserves shifted to earnings assets -143.41 million 7. Equals: Net revenue loss to Treasury $ 91.22 million MEMO: 3. Required reserves on state and local government demand deposits $ 1.43 billion 8. Times: September average prevailing prime rate, converted to annual effective yield x .22285 9. Equals: Bank earnings on reserves shifted to earnings assets $318.68 million 10. Times: Long-run tax rate on additional bank earnings x .45 11. Equals: Line 6 $143.41 million JL/ Demand deposits as of June 30, 1981, comprising $11.5 billion in deposits at member banks and $5.51 billion in deposits at nonmember banks. 2j As of September 1981, the average required reserve ratio on state and local government demand deposits was .1169 at member banks and .0154 at nonmember banks. Line 2 equals a weighted average of these ratios, with weights equal to the proportions of state and local government demand deposits located at member and nonmember banks, respectively, as of June 30, 1981. -48- TABLE 2 Annual Treasury Revenue Loss from a Note Balance Program and Reserve Requirement Exemption for State and Local Governments 1. State and local government demand deposits If $ 16.66.billion 2. Times: Fraction of such deposits that would be placed in note balances If x .70 3. Equals: State and local government demand deposits shifted to interest-earning note balances $ 11.66 billion 4. Times: 1981:HI average yield on Treasury note balances 3/ x .1871 5. Equals: Annual interest paid to state and local governments on note balances (reduction in bank earnings) $ 2.18 billion 6. Times: Long-run tax rate on bank earnings x .45 7. Equals: Treasury revenue loss due to bank earnings reduction associated with added interest payments on note balances $ 0.98 billion 8. Plus: Treasury revenue loss due to reserve requirement exemption for state and local government demand deposits 4/ $ .091 billion 9. Equals: Total Treasury revenue loss due to note balance program and reserve requirement exemption $ 1.07 billion If As of June 30, 1981. 2/ Assumed to be the average ratio over the first nine months of 1981 between Treasury note balances and combined Treasury note balances and demand deposits at commercial banks. 3/ 1981:HI average federal funds rate minus 25 basis points, converted to an annual effective yield. 4/ See Table 1. -49- TABLE 3 Annual Treasury Revenue Loss from NOW Account Eligibility and a Reserve Requirement Exemption for State and Local Governments 1. State and local government demand deposits V $ 16.66 billion 2. Times: Annual effective yield on NOW accounts at commercial banks 2/ x .0547 3. Equals: Interest paid to state and local governments (reduction in bank earnings) $911.30 million 4. Times: Long-run tax rate on bank earnings x .45 5. Equals: Treasury revenue loss due to bank earnings reduction associated with added interest payments on state and local government NOW accounts $410.09 million 6. Plus: Treasury revenue loss due to reserve requirement exemption for state and local government NOW accounts 3/ $ 91.22 million 7. Equals: Total Treasury revenue loss due to NOW account eligibility and reserve require- ment exemption. 4/ $501.31 million 17 As of June 30, 1981. 2j Assumes that state and local governments would shift all demand deposits to NOW accounts. 3/ See Table 1. 4/ If NOW accounts of state and local governments were made reservable at the ratios specified in the Monetary Control Act of 1980 for other NOW accounts, then required reserves at banks would increase by $40 million. An equal increase in the Federal Reserve's holdings of securities would raise Federal Reserve earnings by $6.56 million, based on the September average 3-month Treasury bill rate converted to annual effective yield. The $40 million shift of bank funds from earning assets to reserves would reduce bank earn- ings by $8.9 million and thereby depress Treasury tax revenues by $4.0 million, assuming a 45 percent tax recovery rate. Thus, on net making state and local government NOWs reservable would raise Treasury revenues by $2.56 million and lowere the total Treasury revenue loss associated with authorization of such NOWs to $407.5 million. B-1 APPENDIX B COMPARISON OF NATIONAL BANK AND FEDERAL S&L POWERS CURRENTLY AND AFTER PASSAGE OF S. 1720 AND S. 1721 National. Bank Federal S&L National Bank Federal S&L Asset Powers Currently Currently After Passage After Passage Deposits in other insured depository institutions A. Demand deposits Unlimited Permitted in FDlC-in- Unlimited Permitted in FDIC and FSLIC- sured institutions insured institutions B. Time deposits Unlimited Unlimited C. Savings deposits Unlimited Unlimited Deposits in foreign Unlimited Not permitted Unlimited Not permitted institutions Investments A. U.S. government Unlimited Unlimited Unlimited Unlimited and agency securi- ties B. State and local obligations (1) General obliga- Unlimited Unlimited Unlimited Unlimited tions (2) Revenue bonds Not permitted Not permitted 10% of capital to one Unlimited obligor (3) Other obliga- tions B-2 National Bank Federal S&L National Bank Federal S&L Asset Powers Currently Currently After Passage After Passage C. Corporate securi- ties (1) Commercial 10% of capital to one limited to 20% of 15% of capital to one Same as national bank: paper obligor assets obligor 15% of capital to one obligor (2) Other corporate 10% of capital to one 10% of capital to one Same as national bank: debt obligor obligor 10% of capital to one obligor D: Stock (1) Open-end mutual Not permitted Permitted if invest- Not permitted Permitted if investment funds ment company's port- company's portfolio is folio is restricted to restricted to assets an assets an S&L can it- S&L can itself sell or self sell or invest in invest in directly directly (2) Operations sub- Must be 80% owned and Not prohibited or per- Must be 80% owned and Not prohibited or per- sidiaries can only engage in mitted by statute can only engage in mitted by statute activities bank is activities bank is permitted to engage in permitted to engage in (3) Small business Up to 5% of capital Not permitted Up to 5% of capital Up to 1% of total assets investment com- panies (4) Service corpora- Limit of 10% of capi- Limit of 3% of assets Limit of 10% of capi- Limit of 5% of assets tions tal; service corpora- but at least one- tal; service corpora- tion limited to per- half the investment in tion limited to per- forming operational excess of 1% of assets forming operational services for banks must be used for com- services for banks munity development purposes (5) Other Generally not per- Generally not per- Generally not per- Generally not permitted mitted permitted permitted B-3 National Bank Federal SSL National Bank Federal S&L Asset Powers Currently Currently After Passage After Passage Federal funds sales Unlimited Unlimited Unlimited Unlimited Loans Real estate loans (secured) (1) Construction Total real estate loans Limited to the greater Total limited to total Unlimited and land devel- limited to the greater of the sum of reserves time and sayings de- opment of total time and surplus, and undivided posits; limited to 25% savings deposits or profits or 5% of of capital to one of total capital and assets obligor surplus; loan princi- pal limited to a per- centage of assessed value depending on type of property; sub- ject to 10% of capital to one obligor U) Secured by " Not specifically stated: farmland Limited to 5% of assets unless loan qualifies under another loan category (3) 1-4 family re- [In addition, residen- Up to 90% of appraised sidential tial loans must be value if Federally in- amortized within 30 sured or guaranteed years] more than 90% (4) Multi-family residential (5) Nonfarm nonre- Commercial real estate residential loans are limited to 20% of assets; other- wise, limited to 5% of assets unless loan qualifies under an- other loan category B-4 National Bank Federal SSL National Bank Federal S&L Asset Powers Currently Currently After Passage After Passage B. Loans to purchase 10% of capital to one Limited to 5% of assets 25%.of capital to one Unlimited; subject to or carry securi- obligor; subject to unless loan qualifies obligor;.subject to less onerous restric- ties (margin cred- Regulation D under another loan Regulation U tions of Regulation G; it) category however, Board is cur- rently considering changes to Regulation G C. Agricultural loans 10% of capital to one Unsecured 15% of capi- Same as national bank: obligor tal to one obligor Unsecured 15% of capital plus secured 10% of to one obligor plus capital to one obli- secured 10% of capital gor to one obligor D. Commercial & agri- cultural loans (except those se- cured by real estate) E. Consumer loans (1) Secured Limited to 20% of as- Unlimited sets (2) Credit card Unlimited (3) Other unsecured Limited to 20% of as- sets F. Other Loans (1) Leasing Not prohibited by Total may not exceed 10% statute of total assets (2) Educational Total may not exceed 5% Total may not exceed 5% loans of total assets of total assets B-5 National Bank Federal S&L National Bank Federal S&L Liability Powers Currently Currenty After Passage After Passage 1. Deposit taking A. Demand, NOW, time Yes Demand deposits not Yes Yes & savings permitted , Bi Restriction on Yes N/A Yes No payment of interest on demand deposits C. Interest rate dif- No Yes No Yes ferential D. Acceptance of pub- Yes Yes Yes Yes lie deposits E. Pledge assets to secure deposits (1) Public Yes Yes Yes Yes (2) Private No Not specifically re- No Not specifically re- stricted or permitted stricted or permitted F. Issue officers and Yes Yes Yes Yes certified checks 6. Restrictions from No restrictions (ex- No restrictions (ex- No restrictions (ex- No restrictions (except whom deposits can cept NOW accounts) cept NOW accounts) cept NOW accounts) NOW accounts) be accepted 2. Borrowing authority A. General Total indebtedness No statutory limits, No statutory limits, No statutory limits, but limited to 100% capi- but limits may be im-r but limits may be im- limits may be imposed by tal stock and 50% of posed by FHLBB posed by Comptroller FHLBB surplus, subject to certain exceptions B-6 National Bank Federal S&L National Bank Federal S&L Liability Powers Currently Currenty After Passage After Passage B. Federal Reserve Yes Yes Yes , Yes discount window / C. Federal Home Loan No authority to borrow 12 times FHLB stock No authority to borrow 20 times FHLB stock held Banks held 3. Bankers acceptances Eligible acceptances No specific authority Eligible acceptance No specific authority or limited to 50% of cap- or prohibition limited to 200% of cap- prohibition ital and surplus, ital and surplus. (300% (100% with Board's with Board's permission) permission) B-7 National Bank Federal S&L National Bank Federal S&L Capital Currently Currently After Passage After Passage 1. Minimum requirement A. Establishment $50,000 to $200,000 No statutory require- $50,000 to $200,000 No statutory requirements required depending on ments; subject to required depending on subject to FHLBB regula- location FHLBB regulations location tions B. Branches $50,000 to $200,000 $50,00 to $200,000 for for each branch depen- each branch depending ding on location on location 2. Impairment of capital Capital may not be Capital may not be withdrawn; no dividend withdrawn; no dividend is permitted if losses is permitted if losses exceed undivided pro- exceed undivided pro- fits; dividends can- fits; dividends cannot not exceed net pro- exceed net profits fits 3. Liquidity require- None 4-10% of withdrawable None 4-10% of withdrawable ments accounts and borrowings accounts and borrowings payable on demand or payable on demand or with remaining maturi- with remaining maturi- ties of less than one ties of less than one year year B-8 Other Powers National Bank Federal S&L National Bank Federal S&L and Restrictions Currently Currently After Passage After Passage 1. Branching Subject to McFadden— Not governed by Federal Subject to McFadden— No restrictions on restrictions on inter- statute restrictions on inter- interstate or intrastate state and intrastate state and intrastate branching as long as branching branching 60% of its assets are composed of U.S. govern- ment, agency taxable state and municipal obligations, real estate loans or certain other assets. Otherwise pro- hibits interstate branch- ing Mergers Can't merge interstate; Subject to FSLIC; no Can't merge interstate; No statutory prohibition can only merge when Federal statutory can only merge when against interstate mergers State branching law restriction State branching law or intrastate mergers permits permits Applicability of Yes No Yes Yes of Bank Merger Act Insurance activities May act as general No statutory restric- May act as general No statutory restrictions; agent only in towns tions; may do a general agent only in towns of may do a general insurance of under 5,000; can insurance business under 5,000; can sell business sell credit life and credit life and acci- accident insurance, dent insurance, gen- generally erally Membership in Federal Required Not eligible Required Not eligible Reserve 6. Automated tellers Considered to be bran- No statutory or regu- Considered to be bran- No statutory or regula- ches and subject to latory limits on num- ches and subject to tory limits on number or branching restrictions ber or location; can branching restrictions location; can be located be located interstate; interstate; not considered not considered branches branches B-9 Other Powers National Bank Federal S&L National Bank Federal S&L and Restrictions Currently Currently After Passage After Passage 7. Taxes Taxed as a commercial Can be taxed as a Taxed as a commercial Can be taxed as a build- bank ' building and loan or bank ing and loan or a com- a commercial bank mercial bank 8. Loans to affiliate Subject to applicable FSLIC insured subsid- Subject to applicable FSLIC insured subsidiaries limits of § 23A of iaries of S&L holding limits of § 23A of of S&L holding companies Federal Reserve Act companies are restric- Federal Reserve Act are restricted by 12 U.S.C. ted by 12 U.S.C. § 1730(a)(d) in affiliate § 1730a(d) in affili- transactions similar to ate transactions simi- § 23A; independent S&Ls lar to § 23A; indepen- are not dent S&Ls are not 9. Regulator Comptroller of the FHLBB or FSLIC Comptroller of the FHLBB or FSLIC Currency Currency 10. Glass-Steagall § 21 (Prohibition § 21 may apply § 21 (Prohibition § 21 may apply against issuing securi- against issuing securi- ties and receiving ties and receiving deposits); deposits); § 32 (Prohibition on § 32 not applicable § 32 (Prohibition on § 32 not applicable Interlocks with securi- Interlocks with securi- ties companies); and ties companies); and § 20 (Prohibition on § 20 not applicable § 20 (Prohibition on § 20 not applicable affiliation with securi- affiliation with securi- ty companies) apply ty companies) apply 11. Mutual funds (spon- Not permitted Not prohibited Permitted Permitted sor, organize operate, control, or advise an investment company or under- write, distribute, sell or issue securi- ties shares of any investment company) •v" B-10 Other Powers National Bank Federal S&L National Bank Federal S&L and Restrictions Currently Currently After Passage After Passage 12. Trust powers A. Personal Authorized, subject to Authorized, subject to Authorized, subject to Authorized, subject to State law to conduct State law to conduct State law to conduct State law to conduct trust business to the trust business to trust business to the trust business to the same extent as State the same extent as same extent as State same extent as State banks and trust com- State banks and trust banks and trust com- banks and trust companies panies companies panies B. Corporate Not specifically per- Not specifically per- mitted mitted 13. Holding company re- BHC restrictions apply No limitations on BHC restrictions apply No limitations on parent strictions to all parent holding parent holding company to all parent holding holding company if it is: companies if it is unitary hold- companies (1) unitary holding ing company; multiple company; and S&L holding company (2) subsidiary S&L is subject to substan- qualifies as a build- tial restrictions on ing and loan under non S&L activities IRC Otherwise holding company is subject to multiple S&L holding company re- strictions on non S&L activities 14. Foreign activities A. Foreign branches Yes No statutory provision Yes NO statutory provision B—11 Other Powers National Bank Federal S&L National Bank Federal S&L and Restrictions Currently Currently After Passage After Passage B. Invest in stock Up to aggregate of Only if FHLBB finds Up to aggregate of 10% Only if FHLBB finds it of Edge and Agree- 10% of capital and it is incidental to of capital and sur- is incidental to S&L ment Corporations surplus S&L activities; sub- plus activities; subject to (inter-state offices ject to approval of approval of Federal and accept deposits' Federal Reserve Reserve Board and invest in Board financial concerns doing business abroad} - C. Invest in stock No limit Not permitted No limit Not permitted of foreign banks 15. Incidental powers A national bank may A multi-S&L HC and A national bank may A Federal S&L may engage exercise such inci- any insured subsidiary exercise such inciden- in any activity the . dental powers as are thereof may engage tal powers as are FHLBB determines to be necessary to carry in any activity the necessary to carry on incidental to the exer- on the business of FSLIC determines to the business of bank- cise of an S&L business banking be incidental to the ing operation of the institution C-l APPENDIX C Activity Restrictions on Depository Institution Holding Companies Under S. 1720 BHC's Multiple S&LHC's Unitary S&LHC's* 1. extensions of credit yes yes yes (but limited to noncommercial loans, except for commercial real estate loans) 2. operating an industrial yes no yes bank or loan company 3. servicing loans and yes yes yes other extensions of (but only permissible credit extensions of credit) 4. trust company activities yes no yes (but may act as trustee under deeds of trust) 5. investment advisory yes no yes activities 6. leasing personal property yes no yes 7. leasing real property yes yes yes 8. investments in community yes yes yes welfare projects 9. bookkeeping and yes yes yes data processing * Unitary S&L holding companies whosevS&L subsidiaries do not engage primarily in home lending (at least 60 percent of assets in mortgages) would be subject to the activity restrictions applicable to multiple S&L holding companies. c 2 BHC'a Multiple S&LHC's Unitary S&LHC's 10. acting as agent for sale of insurance related to extensions of credit by subsidiaries: credit life, accident and health insurance yes yes yes property.and casualty no yes yes insurance 11. underwriting credit life, accident, and health insurance: for subsidiaries yes yes yes for other depository , organizations no yes yes 12. general insurance no yes yes . agency activities (yes in towns under 5,000 pop.) 13. courier activities yes no yes 14. management consulting to depository organizations of same type as subsidiaries of parent holding company yes yes yes 15. sale of money orders under $1,000 and travelers checks yes no yes 16. real estate development no yes yes 17. acquisition of property for sale, rehabilitation, or rental ho yes yes 18. property management n«% yes yes 19. preparation of tax returns no yes yes 1A -foul aonraisals yes yes yea D-1 APPENDIX D Banks Meeting the IRS Qualifying Assets Test for S&Ls (Size Class ($ millions) Under 25 25-50 50-100 100-300 300-500 500-1,000 Over 1,000 Total Ratio of qualifying assets to total assets .4309 .4097 .4065 .4009 .3985 .3989 .3440 .4183 Number of Banks ' with ratio of qualifying assets to total assets in excess of 607. 758 226 104 58 1157 Ratio of qualifying assets to total assets (less loans to individuals and C&I loans) .5690 .5601 .5734 .5854 .5785 .5827 .5030 .5681 Number of banks with ' modified ratio of qualifying assets to total assets in excess of 60 7. , .3047 1477 861 563 93 75 37 6153 s Total number of banks in size class 7018 3645 2026 1206 198 158 192 14,443 Appendix E Banks in the Financial System LOANS AND INVESTMENTS OF U.S. BANKS1 AS A PERCENT OF TOTAL DEBT IN THE U.S. Percent 40 35 30 25 I I I M I I I I I I I I I I I II I I I I I I I HI I I I 20 LOANS AND INVESTMENTS OF U.S. BANKS AS A PERCENT OF FINANCIAL ASSETS OF PRIVATE FINANCIAL INTERMEDIARIES Percent 65 60 55 45 35 I I I I I I I I I I I I II II I I I I I I I I I I I I I I I I I I 30 45 '50 '55 •60 '65 '70 '75 '80 1 Includes all U.S. chartered banks: excludes branches and agencies of foreign banks In the U S BANK BUSINESS LOANS AS A PERCENT OF DEBT OF NONFINANCIAL BUSINESS • Percent 130 28 U.S". BANKS PLUS BANK-AFFILIATED FINANCE COMPANIES 26 24 22 U.S. BANKS 20 '45 '50 55 •60 •70 '75 '80 E-3 BANK CONSUMER INSTALLMENT LOANS AS A PERCENT OF HOUSEHOLD INSTALLMENT DEBT Percent 56 U.S. BANKS PLUS 52 BANK-AFFILIATED FINANCE COMPANIES 48 44 40 U.S. BANKS 36 32 BANK MORTGAGE LOANS AS A PERCENT OF TOTAL MORTGAGE CREDIT Percent 22 '45 '50 '55 '60 '65 '70 '75 '80 E-4 HOUSEHOLD DEPOSITS AT COMMERCIAL BANKS AS A PERCENT OF FINANCIAL ASSETS OF HOUSEHOLDS1 Percent 40 35 30 25 20 '45 '50 '55 '60 '65 '70 ' '75 '80 1 Checkable deposits plus small time and savings deposits; also includes currency holdings Financial assets exclude equities. Selected Assets and Liabilities of ($ billions) (As percent of all domestic banking offices) Standard - Standard Total Banking Total Business Total Total Banking Total Business Total Assets Assets Loans Loans Deposits Assets Assets Loans Loans Deposits December 1973 25.2 18.6 - 13.5 10.2 5.8 2.9 2.4 2.9 6.0 0.8 December 1974 34.0 26.4 20.3 15.0 7 6 3.6 3.1 3.9 7.5 1<0 December 1975 38.2 29.7 22.0 15.5 11.0 3.9 3.3 4.2 8.1 1.4 December 1976 45.7 35.3 27.0 15.5 13.7 4.3 3.7 4 9 8.0 1.6 December 1977 59.1 44.5 32.2 17.6 19.7 5.0 4.2 5.1 8.2 2.1 December 1978 86.8 69.4 53.4 26.9 28.5 6.4 5.8 7.2 10.8 2.7 December 1979 113.5 90.8 70.9 38.4 35.4 7.5 6.8 8.4 13.0 3.2 December 1980 147.2 118 4 90.9 45 6 41.5 8.8 8.0 10.0 13.9 3.4 June 1981 171 1 126.0 94 1 47.0 57.1 10.1 8.5 10.4 14.2 4.6 1. U.S. offices of Puerto Rican banks are not included. Sources' FFIEC 002 FFIEC 010, FFIEC 012, FFIEC 014, FR 886a, and FR 105.

Paul A. Volcker (1981, October 28). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19811029_volcker

@misc{wtfs_speech_19811029_volcker,
  author = {Paul A. Volcker},
  title = {Speech},
  year = {1981},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19811029_volcker},
  note = {Retrieved via When the Fed Speaks corpus}
}