THE CHANGING REALM OF FINANCIAL
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.
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
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.
WHAT S. 900 WOULD DO
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.
Establish a New Financial Services
important changes S. 900 would make to the current system include
provisions that would put into place a new financial services
system. Specifically, S. 900 would:
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
Change the Regulatory Structure
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
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.
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.
Improve the Community Reinvestment
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
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.
Despite Senate Banking Committee Chairman
Phil Gramm's best efforts, S. 900's significant changes to the CRA
will not go far enough. It would:
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
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
Protect Consumer Privacy
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.
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.
John is Senior Policy Analyst at The Heritage