Viewpoints : Examining Bush’s Banking Reform Package

As regulators struggle to sweep up the remains of the savings and loan debacle--and taxpayers prepare to file the returns that will help pay for the industry’s multibillion-dollar bailout--the Bush Administration is lobbying Congress to dramatically reduce regulations governing the nation’s banks.

A bill drafted by the Treasury Department under Secretary Nicholas F. Brady calls for repeal of the Glass-Steagall Act, introduced in 1933 to prevent banks from losing depositors’ money in risky non-banking businesses such as underwriting securities. It also removes prohibitions on interstate banking, a move that is widely expected to stimulate consolidation of the crowded industry.

Sharon Bernstein interviewed Larry Kurmel , executive director of the California Bankers Assn.; Claude Hutchison , chairman and chief executive of Oakland-based CivicBank of Commerce; Lenny Mendonca , banking consultant for McKinsey & Co.; Robert Litan , banking analyst for the Brookings Institution, and Peg Miller , banking representative for the Consumer Federation of America, about the proposed reforms.

Why do banks want to expand their powers?

Hutchison: We’re an industry that has to attract additional capital. The interests of the economy and the people and the banking industry are served by creating an environment where banks can legitimately compete.

The industry is holding its own, but if we’re going to have globally competitive banks, we have to look to ways to enhance earnings by offering a broader base of services. If we don’t, we’re going to lose out internationally. And by losing out internationally, our own domestic economy is going to continue to erode vis a vis the other economies that we are competing with in a global sense. The United States does not have a bank in the top 10 in the world anymore.

Is the Treasury Department’s proposal an appropriate response to the needs of consumers and the industry?

Kurmel: What’s important in that Treasury (plan) is its reliance on capital, which is very different from what we saw with the savings and loans. Savings and loans were deregulated, and their capital requirements were reduced. The minimum capital requirement for banks right now is 6% (of assets), and the proposal will increase that. The extent to which you go into riskier kinds of investments is the extent to which you have to increase capital. So if you’re going to go do different stuff than you did before, you have to put more of your stockholders’ money on the line. That’s the first line of defense for the consumer.

Litan: It’s a reasonably good start. There are a number of areas that I would like to see handled differently. With broader powers, I would have liked to see more safety requirements. I think that if a bank wants to affiliate with an insurance company or securities outfit or commercial firm, then the bank part of your operation has to have very safe assets, highly rated corporate and government securities. It could accept deposits, but the bank itself should not be allowed to make regular loans--they would have to be made out of a finance company.

Miller: The supervisory section, which deals with things like early intervention in the case of a failing bank, and other tools for the regulators, we support. Otherwise, particularly in the areas of commercial purchase of banks, broadening securities powers and getting involved in further expansion along interstate branching issues, we strongly oppose.

The Treasury bill would allow banks to issue and put forward securities if they set up an affiliated company. But there will be very little way the regulators can stop affiliates from tapping into the insured funds.

The way they drafted it, you could use bank overhead and bank labor to develop and run the new securities affiliate. This drives the cost of your current bank products up.

Is it dangerous to broaden bank powers? The laws restricting banks were passed in the wake of the Great Depression, when large numbers of financial institutions failed.

Hutchison: I find it very hard to draw a parallel between the Depression of the ‘30s and the United States as we enter the ‘90s. Because of the expansion of the economy and the strength that has been built into it since that point in time, and the strength of the reserve system and the liquidity built into the system, times are really very different. And today the communication between banks and regulators is very different, the techniques used to analyze credit are different.

Also, the banking industry and the savings and loan industry are very, very different. The capital structure of the nations’ banks is substantively sounder than was the case at the point that fiasco developed. Secondly, regulation has been much stricter and much more professional in the banking industry than in the thrifts.

Miller: They’re saying that times have changed. We would only like to point to the last decade. Even though times have changed, it does not appear that greed or desire for market control or (manipulation) or abuse of the system in any way has been eliminated. We in fact have seen gross abuses of the system. The regulatory tools are stretched to their utmost at the present. They’re barely staying on top of the closures. They tell us they have absolutely no tools to stay on top of securities transactions and the types of risks that could occur. They go into a bank once a year.

Could deregulation of banks invite a repeat of the savings and loan fiasco?

Kurmel: First of all, I don’t like to call this deregulation. There would still be regulation of banks. Under the Treasury Department proposal, banks would be required to increase their capital reserves, and any securities or risky ventures would have to be funded out of completely separate companies.

When the savings and loans were deregulated, there was no increase in capitalization requirements, nor was there an increase in oversight. The savings and loans had a whole host of new things they could do, and there was no increase in the criteria used to examine them or the staff used to examine them. In this proposal, oversight is increased. It both requires additional capital and provides for a system of early warnings in cases where banks appear to be ailing.

Litan: Without the right protections, it could be an S&L; rerun. You could get abuse of the protections offered by deposit insurance.

I think we need more safeguards for expanded (banking) powers than are included in the Treasury proposal. I don’t think they went far enough.

The Treasury proposal would allow nationally chartered banks to expand across state lines. Is this a good idea?

Hutchison: We believe very strongly that restrictions on interstate banking and branching are archaic and ought to come down. It is ludicrous for the Bank of America or any other bank to be forced to operate independent banking structures in every state where they want to do business.

Miller: Consumers could definitely be hurt by interstate branching. The primary way is through reduction in credit availability. The bigger banks will buy up small local banks, and branch managers will have to adhere to headquarters policy. Headquarters policy tends to be to reduce consumer loans and small business loans. They tend to want to concentrate more on larger loans. That has a spiral effect right into the community.

Mendonca: The banking industry needs mergers. We have far too many banks and bank branches. The United States has over 12,000 banks, which is 50 banks per million people. The United Kingdom and West Germany have six banks per million people. The banking industry spends over $113 billion a year on things like people and branches and systems. And it’s been growing at 10% a year for the past decade.

If the industry consolidated, competition would be increased. Even a small-scale consolidation could take $10 billion to $15 billion out of the industry’s expenses, and you would still have two to three major banks and hundreds of small ones in an area, and they would still be competing as aggressively for deposits, with lower costs.