October 28, 1999 | Backgrounder on Regulation
Congress may soon have an opportunity to officially recognize that America's financial services industry has changed over the past 66 years. It will consider the conference report to a bill, known as the Gramm-Leach-Bliley Act (S. 900), which would repeal obsolete Depression-era laws that still govern financial transactions today. Significantly, this means banks, securities firms, and other types of financial institutions could join together to offer their customers a more complete range of services. In addition, this bill takes steps to correct some of the worst abuses of the 1977 Community Reinvestment Act (CRA)--a misguided effort that forced banks to invest in disadvantaged neighborhoods even when it was not financially feasible--and to provide consumers with significant new protections of personal financial data. Although it is still not a perfect combination of possible financial services reforms, this legislation represents the most significant deregulation of the financial services industry in over half a century.
Since 1933, federal law has effectively divided the U.S. financial services industry into separate and distinct types of institutions, such as banks, mutual funds managers, insurance companies, and securities firms. For the most part, the separate types of financial services companies were strictly prohibited from merging and from offering their products. Thus, banks were not allowed to own securities firms or to underwrite or sell most stocks and bonds. Similarly, insurance companies were prohibited from owning banks or taking deposits. Each type of firm had its own regulatory agency that jealously guarded its authority over the companies it supervised. And because deposits are federally insured, strict limitations were placed on the activities of banks.
This artificial division worked for some time but, over the past 20 years, the distinctions between these types of transactions have blurred. Innovative managers and technological advances allowed some firms to offer services that closely resembled those offered by competitors. At the same time, seemingly minor loopholes in the laws were exploited to allow banks to increase their securities activities and permit securities houses and other types of firms to buy or open companies--known as non-bank banks--that offered credit cards and other banking products. Federal courts ruled that these new activities were legal, but because they were conducted indirectly through legal loopholes, they often became less efficient and more expensive than necessary.
Adding to these changes is the tremendous impact of the Internet and electronic transactions. As financial services companies continue to deliver more services through electronic means, customers may never physically visit their bank or broker. In addition, loan approvals that once took weeks are being made almost instantaneously. This new technology has added a new level to an already fierce competitive market, and companies that delay joining this revolution may find that their customers will disappear.
As the old distinctions became harder to apply, the American public and the financial services industry began pressing Congress to change federal law. Now many Members of Congress recognize that a new financial system would more effectively meet the needs of American consumers and corporations in an expanding and more global economy. To that end, Senator Phil Gramm (R-TX) and Representatives Jim Leach (R-IA) and Thomas Bliley (R-VA) developed S. 900.
S. 900 would make major changes in the way that the financial services industry has been organized. By eliminating obsolete distinctions between different types of financial institutions and allowing them to merge, the bill would enable one company to meet all of its consumers' financial needs, and at a vastly lower cost. One estimate suggests that consumers would save $15 billion a year in fees levied on financial services thanks to greater competition and a more efficient financial services system.1
Allow banks and securities
firms to own the other.
Over the past two decades, the products offered by banks and securities firms have gradually come to resemble each other. Both types of firms offer checking accounts in which idle balances are invested in stocks or bonds and credit cards. Products for companies are even more closely related. As a result, S. 900 would repeal portions of the 1933 Glass-Steagall Act (P.L. 48-162) that prohibit banks and securities firms from owning each other.
Establish a new financial
services holding company with expanded powers.
In order to allow one company to offer a wide variety of financial services, S. 900 would create a new financial services holding company that could own separate banking, securities, and insurance subsidiaries. These subsidiaries could operate on both a retail level, offering products to individual consumers, and a wholesale level, underwriting insurance and securities for sale through other companies. Individual subsidiaries would be allowed to sell their products to customers of the other subsidiaries. This ability would mean consumers could meet all of their financial needs at a single source. Since each subsidiary would have its own capital and management, those that ran into trouble could fail without endangering the holding company.
Prohibit FDIC assistance to
affiliates and subsidiaries of banks.
In the past, the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits up to $100,000, has used federal dollars to prop up the subsidiaries of troubled banks. The agency reasoned that if the subsidiary failed, public confidence in the underlying bank would fall, which, in turn, could cause the entire bank to fail. In order to prevent federal dollars from being used to support subsidiaries conducting risky activities, S. 900 would prohibit the FDIC from assisting them in this way. Instead, subsidiaries and affiliates would need to have enough capital available to finance their activities. In the event of trouble, the FDIC would only be able to help the bank.
Allow nationally chartered
banks to expand their activities.
Some national banks find it less expensive to conduct financial activities through a subsidiary than through an entirely separate company owned by a holding company. However, there was concern that if these subsidiaries got into trouble, their losses could endanger the bank itself. S. 900 would allow certain types of activities to be conducted through a bank subsidiary as long as the bank is well capitalized and managed. The total assets of the subsidiaries of each bank would be limited to a maximum size of 45 percent of the parent bank's assets or $50 billion, whichever is less.
Require an antitrust review of
any combinations allowed by this law.
For years, opponents of bank reform claimed that expanding banks' powers would result in a few mega-banks with so much financial strength that they would unduly control the entire U.S. economy. S. 900 requires financial regulators to conduct an antitrust review in order to prevent one financial institution from having too great an influence over the country or over any specific geographic area.
For over 60 years, regulation of financial institutions has been divided among several different agencies, each of which had similar power over a specific type of company. This division of power meant each regulator had a thorough knowledge of the specific circumstances of the firms it regulated, but jealousy of each other made it difficult for anyone to agree on any plan that would allow financial firms to offer new services.
Although S. 900 would not abolish the regulators, it would give the Securities and Exchange Commission (SEC) and the Federal Reserve Board dominant roles in the new system. In addition, the Office of the Comptroller of the Currency (OCC), a part of the U.S. Treasury Department, would maintain significant oversight of national banks. Individual states would continue to regulate the insurance industry. An October 15 agreement between the OCC and the Federal Reserve over the corporate changes needed for a bank to offer new services to customers preserved some of the OCC's powers but, in the long run, the Federal Reserve will most likely eclipse the Treasury agency in regulatory control.
At the same time, S. 900 would abolish the practice of having bank regulators oversee the securities activities of banks while the SEC oversees the same activities at other types of firms. Instead, the SEC would oversee virtually all securities activities. The SEC and the Federal Reserve would have to agree on how to regulate any new products that combine bank and securities activities.
This enhancement of the SEC's role is likely to place it in direct conflict with the Federal Reserve as banking and securities activities increasingly resemble each other. As a result, Congress may be called upon in the future to either referee or merge various financial regulators into one large agency.
The 1977 Community Reinvestment Act attempts to force banks and savings and loan institutions to lend to individuals and businesses in low-income communities. It requires banks to establish a service area for each branch and to prove it is lending to all segments of a community. Every three years, banks have faced burdensome examinations to see if they comply with CRA's confusing paperwork requirements and vague compliance standards.
Under existing law, a bank seeking to merge with another bank or begin a new activity must have a satisfactory CRA rating. However, self-styled community groups can challenge the application and seriously delay the approval process. Such delays can cost banks millions of dollars in extra legal fees and lost business opportunities, so they sometimes submit to agreements that require a certain level of lending and also include "finders fees" and direct cash payoffs to the community organizations.
Today, technological changes are making CRA increasingly irrelevant. Since the law is based on the geographic location of bank units, it will apply to an increasingly small segment of the financial services community as banks move to online activities and freestanding automated teller machines instead of branches.
Require public disclosure of
payments to community groups.
S. 900 requires all CRA agreements to be made public. In addition, it requires banks and community groups to annually disclose any payments or loans over a certain amount that were made to community groups because of a CRA agreement. This important provision would reduce the ability of self-styled organizations to fund themselves through agreements that are supposed to benefit low-income communities.
Reduce the regulatory burden of
Banks with under $250 million in assets that have an "outstanding" or "satisfactory" CRA rating would be examined less frequently than they are under current law. Banks with "outstanding" ratings would be examined once every five years instead of every three years. Those with "satisfactory" ratings would be examined every four years. This change represents a significant reduction in the regulatory burden CRA would impose on smaller banks.
Require continued compliance
for new activities.
In a less positive change, S. 900's provisions would actually expand CRA requirements for bank affiliates of financial services holding companies. It would require that all bank affiliates receive at least a "satisfactory" rating before the holding company can be formed. In addition, those banks must maintain that rating in order for the financial services holding company to begin any of the new activities S. 900 authorizes. This requirement would also apply to banks that are not part of a financial services holding company.
For the first time, under S. 900 banks and other financial services firms would be required to develop privacy standards regarding sharing a customer's confidential data with corporate affiliates and other companies. This policy would have be explained to every new customer and provided annually to existing customers. This section of the bill has several major benefits. It would:
Allow customers to know how
confidential information will be treated.
Instead of hoping a financial services company will treat their personal data as confidential, consumers will receive an explicit disclosure of how such information will be used by the firm. The stated policy must specify how and under what circumstances confidential information, that is not available from other public sources, would be disclosed among the firm's affiliates and other firms. Customers who object to any portion of this policy would be able to take their business to another firm.
Allow consumers to control how
their personal information is shared.
S. 900 would give customers the explicit right to prohibit financial services companies from sharing their personal confidential information with other non-affiliated firms. Once a consumer makes that decision, financial companies would be prohibited from violating their instructions. Anyone attempting to obtain this information fraudulently by pretending to be the consumer or any similar action could be sent to a federal prison for up to five years.
Protect both account numbers
and access codes.
Under S. 900, financial services firms would be completely prohibited from disclosing either customer account numbers or access codes to any telemarketer or direct marketing firm.
Give customers the benefit of
full-service financial firms.
A major benefit of these new financial services supermarkets would be the consumer's ability to obtain traditional products, such as loans, securities, and insurance and any new products from the same source. Since the financial firm already would know each customer's financial history, it would be able to make more rapid decisions on loan applications and other requests.
Establish protections that are
realistic and cost-effective.
Although some groups have been attempting to scare workers into believing their personal data would be at risk under S. 900, this is simply not true. Its privacy protections are carefully balanced to benefit both workers and companies. Workers receive explicit knowledge about how their information will be used, while companies gain the opportunity to offer a full range of products to customers who qualify for them.
S. 900 is an important step toward bringing America's financial services industry firms into the new realm of telemarketing and electronic commerce. The distinctions between their products have blurred to the extent that each financial services firm could offer better services, at a lower cost, to customers if the 66-year-old firewalls were taken down. At the same time, S. 900 would allow these firms to better compete in an increasingly global economy. Although the Gramm-Leach-Bliley Act is not a perfect bill, it represents an important step in deregulating the financial services industry and enhancing America's financial future.
David C. John is Senior Policy Analyst at The Heritage Foundation.