Principles of Financial Modernization
There are four principles that we believe should guide financial modernizations
Preserving Community-Based Lending Institutions and Protecting Housing Finance
Financial modernization should preserve the vitality and strength of America's community-based
lending institutions. In addition, any proposal to modernize financial services must also ensure
that institutions are not discouraged or precluded from continuing to concentrate in mortgage
Given their traditional focus on residential mortgage lending, many thrifts over the years have
developed strong ties to their local communities. In addition to traditional mortgage lending,
many of the smaller, community-oriented thrifts we regulate fill niches not addressed by the
conventional mortgage market or larger financial institutions. We should not force institutions
that focus on housing finance to curtail or abandon a business that not only is profitable but also
fulfills a very important public purpose.
The Unitary Savings and Loan Holding Company Structure
Many have suggested that the unitary savings and loan holding company ("SLHC") structure is a
"loophole" for mixing banking and commerce. The legislative history of the Savings and Loan
Holding Company Act and restrictions on the thrift charter, however, refute the "loophole"
notion. Congress made a deliberate distinction in the treatment of banks and thrifts and their
holding companies based on the fact that thrifts cannot engage in the traditional type of banking
activity--unlimited commercial lending--that raises concerns with the mixing of banking and
Whereas Congress chose to restrict bank holding company ("BHC") activities and thereby
enforce a separation between banking and commerce in the BHC structure, the focus in the
SLHC context was to place limits on the subsidiary thrift. In exchange for permitting a unitary
SLHC to engage in any legitimate business activity, the commercial lending activities of its
subsidiary thrift are limited and the institution must maintain a focus on mortgage and other
consumer lending activities, as required by the qualified thrift lender ("QTL") test. Pertinent
Since enactment of the FIRREA affiliate transaction restrictions, unitary SLHCs have not as a
class presented special supervisory problems. There is little evidence to suggest that, in the 30
years it has been in existence, the unitary SLHC has created systemic problems or undue
concentrations of economic power that could threaten the stability of our financial system. With
respect to the recent increase in unitary SLHC applications, a substantial majority of the
applicants are engaged in activities that are financial in nature---entities that could acquire a bank
if H.R. IO were enacted.
The Federal Deposit Insurance Funds
With respect to the federal deposit insurance funds and financial modernization, from a public
policy perspective, the insurance funds should be merged. We should eliminate the economic
and managerial inefficiencies of a two-fund structure for what is essentially one product-insured
deposits. Now is the ideal economic climate to do this. In addition, with or without a fund
merger, it is extremely important for Congress to take action soon to eliminate the SAIF special
reserve. Failure to do so before the reserve is funded on January 1, 1999, would eliminate the
capital cushion currently available to the SAM (or to a combined BIF-SAIF in the event of a
fund merger) and would raise the possibility of increased SAIF assessments where a substantial
reserve has already been built up with SAM premiums.
Mr. Chairman and members of the Committee, I appreciate the opportunity to discuss the Office
of Thrift Supervision's views on the ongoing efforts to modernize America's financial services
Last month, the House passed H.R. 10, which represents the most recent proposal to update our
financial services system. Even with the tremendous efforts of those in the House who
championed this difficult undertaking, it remains unclear whether H.R. 10 truly moves our
financial system into the twenty-first century. Several provisions of the bill are particularly
contentious, with many of the players in the financial services industry and the public sector still
at odds about how best to proceed.
The issues we are confronted with are large and have far-reaching implications. Advancing
technology, financial globalization and continuing consolidation have been driving the evolution
of our Nation's financial services sector for a generation. The dynamics of the banking industry
have changed more dramatically in the last decade than in the five previous decades. Regardless
of government's response to these changes, the market will continue to evolve.
In my statement, I will first highlight what we are seeing in this changing world of financial
services. Next, I will articulate the principles that we believe must be part of financial
modernization, regardless of how legislation is ultimately structured. I will then discuss the
issues that we believe are among the most important in this debate. These include ensuring
marketplace incentives and regulatory authority to protect the safety and soundness of existing
insured institutions, maintaining and promoting the viability of community-based lending
institutions, ensuring the continued availability of housing finance, and preserving operational
and charter flexibility for insured institutions.
What makes the current debate on financial modernization different from those past is that
current market dynamics have propelled the discussion to a new level. We no longer have to
speculate about the potential implications of legislation; we need only open the business section
of the newspaper to read about what is on the line--and to realize that the stakes are already very
In contrast to most prior legislative efforts involving restructuring of our financial system, we are
not now compelled to act by a crisis. Instead, we are confronted with examining the
government's role in a rapidly changing financial world in, what is for now, a relatively stable
Many questions must be answered. Will community-based financial institutions survive, or will
these institutions be absorbed by larger regional and national banking concerns? Is a specialized
federal charter oriented toward home lending still appropriate? Will there continue to be a
significant role in our financial system for federally insured depository institutions? What is the
appropriate regulatory and supervisory framework for monitoring modernized financial services
activities conducted both inside and outside the insured depository institution? How should the
various financial regulators (state and federal) interrelate? These are just some of the questions
we must consider.
We are also seeing substantial consolidation and integration among the various sectors of the
financial services industry. The idea of offering consumers one-stop financial services shopping
has become one of the foremost goals of financial modernization, although the jury is still out on
whether consumers truly value this. And it is becoming increasingly difficult to classify
companies as either "financial" or "commercial." The fundamental elements of our financial
services marketplace, such as the nature of the competitors and the corporate structures they take,
Regardless of what new structures government puts in place, the market and new technologies
will continue to alter our financial system. Our failure to recognize and respond to this change
could result in government rules that impede, rather than advance, the ongoing evolution of our
financial markets, and this, in turn, could harm consumers and the communities that rely on these
financial institutions. If we intend to keep up in the global marketplace, we must adapt our rules
and laws to today's-and tomorrow's-developing marketplace.
This is not an easy task. It requires us to address events that we cannot predict. We must move forward carefully and purposefully to craft legislation that accommodates change and flexibility, yet retains adequate structural and supervisory safeguards to mitigate harm when trouble arises.
There are four elements that we believe must be incorporated in developing and implementing
legislative reforms affecting the future of our financial services industry.
First, financial modernization legislation should include marketplace incentives and adequate
regulatory authority to protect the safety and soundness of existing insured institutions and the
federal deposit insurance funds.
Second, financial modernization legislation should foster a structure that facilitates the ability of
institutions to continue to provide consumer- and community-based financial services to all
Americans, in all our communities.
Third, financial modernization legislation should preserve flexibility for insured depository institutions to compete effectively in today's marketplace.
Fourth, financial modernization legislation should minimize regulatory burdens imposed on
existing institutions, consistent with safety and soundness, while ensuring that a full range of
financial services are available to all.
The proper balance must be struck between flexibility for institutions---so that marketplace innovations that benefit customers, communities and the financial system are not impeded-and appropriate regulatory safeguards. We believe the thrift charter represents one model of a modem charter with a community and consumer-based focus. It also offers substantial flexibility in that it affords benefits and advantages both to small community-based institutions and larger regional and national providers of financial services.
Certain aspects of H.R. 10 remain very controversial, with federal policy makers, interest groups, and industry representatives continuing to wrestle over various provisions. From our perspective, several reform issues stand out from the others.
The debate on financial modernization and H.R. 10 has raised many significant public policy
issues, yet many of these discussions appear to have glossed over what should be the key issue
and fundamental objective of reform-preserving our financial system by protecting the safety and
soundness of our insured depository institutions. Until we clearly set this as the overriding
objective of financial modernization, it is difficult sometimes to muddle through and establish
priorities with respect to the other outstanding issues in the debate.
As we proceed with this debate in the Senate, we must be vigilant that the reforms proposed and debated do not destroy existing regulatory safety and soundness tools and incentives that protect existing (and future) insured institutions and the federal deposit insurance funds. Equally important, we must avoid perverse market incentives that result from well-meaning, but short-sighted reforms. Market forces should reinforce the regulatory objective of promoting the safety and soundness of insured depository institutions-and the stability of the federal deposit insurance system.
Financial services in the United States have traditionally been delivered through a decentralized
system of smaller, community-oriented financial institutions. Even in this time of mega-bank
mergers, over 8,900 insured depository institutions, including 72 percent of the approximately
1,200 OTS regulated thrifts, have less than $250 million in assets. And recent charter activity
suggests that small institutions continue to thrive. Between 1994 and 1997, over 540 new banks
and thrifts were chartered. -Of these, over 70 percent of the new banks had $25 million or less in
assets, and over 85 percent of the new thrifts had assets of $100 million or less. Overall, almost
97 percent of newly chartered depository institutions over the last three years had $500 million or
less in assets.
As articulated in our second principle of financial modernization, any plan to modernize our
financial services industry should preserve the vitality and strength of America's community-based lending institutions. Particularly in this age of ever-growing and consolidating mega-regional, national and international banking organizations, many consumers prefer banking at a
local community based institution. There are thousands of insured institutions, banks as well as
thrifts, whose primary business focus is meeting the lending and credit needs of their local
communities. Institutions that operate in this manner--by choice and at a profit--should not be
forced to alter their focus on community lending simply to conform to new rules and regulations
aimed at allowing for larger financial institutions to compete more effectively nationwide and
Moreover, any proposal to modernize financial services must ensure that institutions are not
discouraged or precluded from continuing to concentrate in mortgage lending. Public policy in
this country has consistently recognized the value of promoting home ownership. Many of the
institutions we regulate have found residential lending a profitable line of business, with
numerous thrifts far exceeding the levels of residential lending required under the qualified thrift
lender ("QTL") test. On the whole, one-to-four family mortgages comprise over half of the
industry's assets, with other mortgage-related products representing almost another quarter of
thrift industry assets. With home ownership at an all time high of 65.9 percent as of March 31,
1998-in part due to the considerable efforts of thrifts to serve those previously underserved-it
would be a shame to do anything to discourage lenders from continuing to serve this market.
The interagency risk-based capital requirements recognize that residential mortgage loans present
a much lower credit risk to institutions than commercial loans. With effective supervision,
constant monitoring of interest-rate risk, and maintenance of adequate capital levels, a
concentration in residential mortgage lending presents substantially lower risk than some more
diversified portfolios. We should not force institutions that focus on housing finance to cut back
on or abandon a business that not only is profitable but also fullfills a very important public
Given their traditional focus on residential mortgage lending, many thrifts over the years have
developed strong ties to their local communities. In fact, two years ago Congress modified the
QTL test to allow federal thrifts to more adequately and effectively meet the lending needs of
their local communities. This reform permitted thrifts to include other consumer lending, such as
educational loans and credit card loans, in calculating their QTL compliance. In addition,
Congress allowed thrifts to devote up to 20 percent of their portfolio to small business lending,
the backbone of any community lending program. These new lending powers enable thrifts to
better serve their communities.
Thrifts have an historic commitment to affordable housing and community development and
therefore are positioned to meet unique, unmet credit needs. In addition to traditional mortgage
lending, many of the smaller, community-oriented thrifts we regulate fill niches not addressed by the conventional mortgage market or larger financial institutions. Let me give you several
examples of local thriftslocated in communities that include many low- and moderate-income
borrowers--that serve their communities prudently and profitably.
Sunshine State Federal Savings, a $135 million thrift in Plant City, Florida, operates in an
assessment area that has a population that includes approximately 33 percent low- and moderate-income families. During its last review period, Sunshine State originated 45 percent of its
mortgage loans to low and moderate-income borrowers. Sunshine State is well-capitalized and
well-managed, posting a return on assets of over 90 basis points and a return on equity of almost
9 percent last year, while receiving an "outstanding" CRA rating in its most recent review by the
Another community institution, Financial Federal Trust and Savings Bank, is a well capitalized
and well managed $1.24 billion Chicago area thrift. Although somewhat larger in size than the
typical community institution, Financial Federal has within its market area Chicago's south and
southwestern suburbs, which include some of the most economically disadvantaged communities
in Chicago. In addition to providing basic financial services to these communities, Financial
Federal builds and rehabilitates affordable housing through several subsidiaries, Financial
Properties and Financial Community Development, a community development corporation.
These activities have catalyzed the transformation of blighted neighborhoods into restored and
thriving communities. For example, in six neighborhoods in the Dixmoor area of south Chicago,
the 52 houses constructed by Financial Properties in 1995 represented the first new housing in
that community in 40 years. Recently, Financial Federal has expanded into communities in
Detroit, Michigan, and Gary, Indiana, where there is heavy demand for new, affordable housing.
Thrifts were also among the original partners and investors in many locally-oriented community
lending organizations that support affordable housing. These include many of the Neighborhood
Housing Services organizations across the country, the Neighborhood Housing Services of
America ("NHSA"), and the Savings Associations Mortgage Company, or "SAMCO," a
consortium of community-based lending institutions that concentrate their support in multi-family housing projects. Thrifts of all sizes continue to support these important community
lending programs. For example, one of the largest thrifts in the country, World Savings, in
Oakland, California, is also the largest investor in the NHSA. Thrifts continue to play an integral
role in the affordable housing initiatives of these organizations.
These are a few examples of thrifts serving low- and moderate-income communities and borrowers. Failing to maintain these groups' access to credit and financial services at a fair price would not only be a fundamental failure of the modernization process and detrimental to the American economy, but a betrayal of what we have told underserved communities they should expect of financial institutions.
Providing sufficient operational flexibility for insured institutions to compete more effectively is
another key element in the financial modernization debate. As I previously stated, this is one of
the principles of financial modernization to which we believe any legislative reform must adhere.
1. -- Depository Institution Holding Company Activities
There has been considerable discussion throughout the consideration of H.R. 10 about the so-called "unitary" savings and loan holding company ("SLHC") structure. Many have suggested
that it is a "loophole" through which banking and commerce may be mixed. A review of the
legislative history of the Savings and Loan Holding Company Act and examination of existing
restrictions on the thrift charter, however, appear to refute the "loophole" notion. In fact, what
emerges is a deliberate distinction in the treatment of banks and thrifts and their holding
companies based on the fact that thrifts cannot engage in the traditional type of banking activity-unlimited commercial lending--that raises concerns about the mixing of banking and commerce.
a) Overview of Unitary Savings and Loan Holding Company Structure
The evolution of the unitary SLHC as a structure with different regulatory treatment than a bank
holding company ("BHC") structure reflects a number of public policy decisions made by
Congress over the last forty years.
Modem federal regulation of BHCs began in 1956 when Congress identified two areas of
concern: (1) the geographic concentration of commonly controlled commercial banking facilities
in a particular geographic area, and (2) the combination of banking and nonbanking enterprises
under a common ownership structure. Initially, Congress directed the Federal Reserve Board
("FRB"), pursuant to the Bank Holding Company Act of 1956 ("BHCA"), to impose acquisition
standards and activities limitations only on multiple BHCs (i.e., BHCs owning two or more
banks). At the time, the prevailing view was that one-bank BHCs were generally small and
presented no serious supervisory concerns. By 1970, however, this perception had changed-with
the six largest banks in the country owned by unitary BHCs-and Congress extended the BHCA
acquisition and activities restrictions to one-bank BHCs.
While Congress extended the so-called "banking and commerce" restrictions to multiple BHCs in
1956, concerns related to the growing number of SLHC acquisitions of thrifts in the late 1950s
were addressed in a very different manner. In 1959, pursuant to the Spence Act, Congress
prohibited existing SLHCs from acquiring any additional thrift institutions; and limited
prospective holding company acquirers to the acquisition of one thrift. In addition, Congress
directed the thrift regulator, the Federal Home Loan Bank Board ("FHLBB"), to submit
recommendations to Congress regarding the overall regulation of SLHCs. Although the FHLBB
proposed restricting SLHC activities as early as May 1960, Congress did not act on the SLHC
issue until 1967.
Congress chose to disregard the FHLBB's restrictive recommendations. Rather, pursuant to the
Savings and Loan Holding Company Act of 1967 (SLHCA), Congress provided a framework for
the registration and supervision of all SLHCs and imposed activities restrictions on multiple
SLHCs, but did not restrict the ownership and operation of nonthrift-related businesses by
unitary SLHCs. Given the FHLBB's recommendations to the contrary, this appears to have been
a deliberate decision.
Subsequent legislation, that was not aimed at curbing the unrelated business activities of unitary
SLHCs but rather at reinforcing the historical mortgage and consumer lending focus of thrifts,
implicitly recognized the tradeoff struck in the unitary SLHC structure. Congress' authorization
in the SLHCA for unitary SLHCs to engage in any legitimate business enterprise that does not
pose a safety and soundness risk to their thrift subsidiaries was subsequently folded into the
Home Owners' Loan Act (HOLA) pursuant to the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA).
The legislative history of the SLHCA demonstrates that Congress intentionally sought a different
route than it took with BHCs to address the mixing of banking and commerce in the unitary
SLHC structure. Whereas Congress chose to restrict BHC activities and thereby enforce a
separation between banking and commerce in the BHC structure, the focus in the SLHC context
was not to limit the holding company's activities, but rather to place limits on the activities of its
subsidiary savings association. Thus, in exchange for permitting a unitary SLHC to engage in
any legitimate business activity, the commercial lending activities of its subsidiary thrift are
limited and the institution must maintain a focus on mortgage and other consumer lending
activities, as set forth in the QTL test.
Although the unitary SLHC model has received a lot of recent attention and has been around for
a long time, very few SLHCs, in fact, engage in commercial businesses. Currently, of a total of
554 SLHC structures regulated by the OTS, only 71 SLHC structures (owning 73 thrifts) were
engaged in nonbanking activities. In fact, of the 71, only 21 SLHC structures (owning 21 thrifts)
are engaged in truly commercial activities. Of the remaining 71, 26 (owning 25 thrifts) are
engaged in only financial activities such as insurance sales and underwriting, investments,
mutual fund management and investor services, and broker-dealer operations. The other 24
SLHC structures (owning 27 thrifts) do business in areas that, while nonfinancial in nature, are
closely related to the thrift business, predominantly real estate and related services.
From an operational standpoint, based on a recent OTS survey of existing unitary SLHCs, it
appears that the thrift in a SLHC usually contributes either a minimal amount to holding
company revenue (less than 10 percent of revenue in 41 percent of the cases) or a very significant
amount (over 80 percent of revenue in 46 percent of the companies surveyed) of a holding
company's consolidated income.
Although unitary SLHCs may engage freely in a variety of commercial and financial activities, a
SLHC cannot operate a subsidiary savings association for the purpose of financing the activities
within the holding company structure. Both Congress and the OTS have imposed a variety of
requirements on unitary (and multiple) SLHCs that are designed to protect the safety and
soundness of the subsidiary thrift and enable the thrift to perform its core functions, and to
significantly restrict interactions between the thrift and its parent holding company and affiliates.
Perhaps the most significant statutory protection for a subsidiary thrift is set forth at § II (a) (1)
(A) of the HOLA, which establishes an absolute prohibition on loans and extensions of credit by
a thrift to affiliates that are not engaged in activities permissible for a BHC. This provision, part
of the broader thrift affiliate transaction provisions of FIRREA (described below), bars a thrift
from lending to a commercial affiliate. Thus, although a thrift may affiliate with a commercial
entity in a SLHC structure, the institution may not engage in any financing of the commercial
activities of an affiliate-which limits the thrift's exposure to commercial activities.
The commercial lending limits imposed on thrifts and the QTL test, both statutory requirements,
also limit the ability of a thrift in a commercial SLHC structure to make selective lending or
pricing decisions. The statutory lending authority limits federal thrifts' commercial loans to 20
percent of assets-and any amount in excess of 10 percent of assets must be in small business
loans. The QTL test restricts commercial lending by requiring that 65 % of a thrift's portfolio
assets be in mortgage- and consumer-related assets. These two provisions sharply limit a thrift's
ability to do commercial lending.
In addition to the bar on thrift loans to an affiliate not engaged solely in permissible BHC
activities, transactions between a thrift and its other affiliates are subject to the restrictions of §§
23A and 23B of the Federal Reserve Act. These require, among other things, that a thrift's
transactions with any one affiliate may not exceed 10% of the thrift's capital stock and surplus,
and transactions with all affiliates may not exceed 20% of capital stock and surplus. These
provisions also impose an independent dealing requirement to prevent preferential pricing and
other preferential terms by an institution in transactions with its affiliates.
Sections 5(q) and 10(n) of the HOLA impose anti-tying restrictions on thrifts that prohibit them
from conditioning extensions of credit or the furnishing of services to a customer by requiring
the customer to obtain certain other services from an affiliate of the thrift, including a
commercial holding company. These anti-tying restrictions help prevent the unfair use of market
power to coerce banking consumers to purchase non-banking products and services, which not
only protects consumers but mitigates concern about the unfair use of the SLHC structure to
disadvantage competitors. OTS regulations also prohibit the sale of holding company securities
on the premises of the subsidiary thrift.
Finally, § 10 of the HOLA prohibits a holding company from undertaking an activity for the
purpose of evading the restraints on the activities of the subsidiary thrift. This section also
provides the OTS the authority to impose certain restrictions on a SLHC or any of its subsidiaries
if there is reasonable cause to believe that an activity by a thrift affiliate constitutes a serious risk
to the financial safety, soundness, or stability of the subsidiary thrift institution.
From the perspective of financial risk to a subsidiary thrift, several statutory and regulatory
provisions prevent a SLHC from undermining the capital position of the thrift, whether through
dividend payments, tax-sharing arrangements or other means by which income or capital could
be upstreamed from a thrift to its holding company. First, the thrift itself is subject to capital
requirements that the OTS has developed (in conjunction with the other federal banking
agencies) under the so-called "prompt corrective action" provisions of the Federal Deposit
Insurance Act. Generally, a subsidiary thrift must maintain a total risk-based capital ratio of 8
percent and Tier 1 risk-based capital and leverage ratios of 4 percent to remain adequately
capitalized. On an industrywide basis, as of March 31, 1998, thrifts currently maintain ratios of
14.6 percent and 7.6 percent, respectively.
Thrift capital levels are carefully monitored through annual on-site examinations and off-site
monitoring by the OTS. If capital drops below statutorily designated levels, then the holding
company must guarantee the thrift's compliance with a capital restoration plan and provide
adequate assurances of performance by the thrift. If the holding company fails to provide
adequate guarantees and assurances of performance, the OTS may, among other things, require
the holding company to divest itself of the thrift.
Further protection is provided by OTS's capital distribution rule, which predates the prompt
corrective provisions of FDICIA. That rule requires OTS approval of any dividend that would
cause a thrift to fall below any of its capital requirements. Dividends that would not cause a
capital failure are also subject to limitations based on the thrift's net income. Further, tax sharing
agreements between a thrift and its holding companies must conform with several OTS
guidelines designed to ensure that the thrift bears only its proportional tax liability, not that of the
holding company or affiliates.
When we review any holding company application to acquire a thrift institution, we routinely
impose conditions on applicants intending to establish non-traditional branch network thrift
operations in order to protect the safety and soundness of the thrift, as well as to protect
consumers. An overview of our application process and a description of the types of conditions
that we have imposed on unitary SLHC applicants is set forth in our letter to the Conference of
State Banking Supervisors, dated April 27, 1998, which responds to questions raised about these
issues. (The letter is attached to this statement.) And, of course, we monitor approved
applications to ensure compliance with imposed conditions as well as to determine that adequate
supervisory controls are in place.
Since enactment of the FIRREA affiliate transaction restrictions in 1989, unitary SLHCs have
not as a class presented special supervisory problems. Although this experience is limited, it
does offer valuable insights on how our system may accommodate, from both a capital
standpoint and an operational perspective, a limited intermingling of commerce and depository
OTS has commenced an internal review of our existing procedures with respect to holding
company oversight to look at how we supervise thrift holding companies. The primary focus of
this review is to determine the sufficiency of our existing procedures for non-traditional
structures, what we can do to improve our current oversight activities, and whether there are
specific adjustments to our examination and supervisory approach that should be implemented.
For now, we note that most of the recently approved applications have involved either de novo
thrifts that plan a slow "roll-out" of their operations or the conversion to a thrift charter of
existing institutions with good track records. We will continue to use the case-by-case approach
to address specific issues of concern that arise in connection with pending applications. We
expect the type and scope of conditions imposed on applicants to continue to evolve, as well as
our overall supervisory approach and strategy in tackling difficult issues.
b) Concerns With H.R. 10
H.R. 10 as it is currently drafted eliminates the ability of an existing company engaged in
otherwise legitimate business activities to acquire or charter a savings association. As I have
already described, there are numerous statutory and regulatory restrictions already in place that
guard against the concerns that appear to form the basis for eliminating this existing structural
option. Moreover, there is little evidence to suggest that, in the more than 30 years that the unitary SLHC
has been in existence, it has created systemic problems or undue concentrations of economic
power that could threaten the stability of our financial system. In addition, as I have already
stated, with respect to concerns expressed about the recent increase in unitary SLHC
applications, a substantial majority of the applicants are engaged in activities that are financial in
nature--entities that could acquire a bank if H.R. 10 were enacted.
In recent years, we have seen a gradual lowering of the traditional barriers among the various
sectors of the financial services industry. During this time, we have gained a better
understanding of the risks involved in these activities, and have become more comfortable with
the ability of institutions to address the specific risks posed by these activities. As a result of our
experience, we have continued to refine our regulatory approach to monitoring these risks and
evaluating the appropriateness of various activities of insured institutions and their affiliates.
Risk-focused supervisory approaches, including the adoption of risk-based capital requirements
and risk-focused examinations, enable us to adapt our supervision to focus on safety and
soundness risks to a thrift arising from the activities of the thrift or its affiliates.
Unique in the financial institutions industry, the OTS is the consolidated federal regulator for all
insured savings associations, their subsidiaries and their holding companies, unless the holding
company also includes a bank. This approach has worked well. We have access to information
on all aspects of the institution's operations and provide the institutions with "one-stop"
Thrifts also have experience with functional regulation. Thrifts may only conduct insurance and
securities activities through a subsidiary service corporation (although SLHCs may also provide
these services through a holding company subsidiary). Thrift and SLHC subsidiaries engaged in
insurance activities must be licensed and regulated by the appropriate state insurance regulator,
and thrift subsidiaries engaged in securities activities must register with the SEC. Primary
oversight of insurance and securities activities remains with the functional regulator (i.e., state
insurance commissioners and the Securities and Exchange Commission, respectively).
Financial modernization should be structured to preserve these unique attributes of the thrift regulatory system--combining the best aspects of consolidated regulatory oversight and functional regulation. This approach not only benefits OTS-regulated thrifts by reducing excessive regulatory overlap, it embraces a common-sense regulatory division of labor while maintaining the ability of the OTS to monitor all aspects of a structure to protect the safety and soundness of the thrift.
As I have stated before, we believe that, from a public policy perspective, the insurance funds should be merged. We need to eliminate the economic and managerial inefficiencies of a two-fund structure for what is essentially one product-insured deposits.
Indeed, market forces have already begun this process. It is becoming increasingly anachronistic
to refer to a "bank fund" and a "thrift fund." The overlap between the two funds has been an open
secret for some time. As of March 31, 1998, almost 33 percent of total SAIF-insured deposits
($227 billion) were held by commercial banks and 28 percent of savings institution insured
deposits ($183 billion) were insured by the BIF.
Now is the ideal time to do what sound public policy clearly tells us must be done. Both industries are sound and healthy, and both funds are well capitalized.
Although the issue of the SAM special reserve does not pertain directly to the subject of financial modernization, it highlights the need for public policy makers to be attentive to outdated and burdensome laws that no longer serve a valid public purpose.
The SAIF Secondary Reserve was established pursuant to the 1996 SAIF recapitalization
legislation as a budget-scoring mechanism. The recapitalization legislation required any excess
SAIF reserves (I.E., above the 1.25 percent required reserve ratio) on January 1, 1999 (or at the
time of a BIF-SAIF fund merger before January 1, 1999), to be transferred to the Secondary
Because the legislation did not provide the FDIC with rebate authority for SAIF excess reserves
(and since economic projections indicated low SAIF losses), a buildup in the SAIF was deemed
to be a budget certainty and, thus, was accorded favorable budget-scoring to offset other,
unrelated programs. These projections have proven accurate and, based on the current buildup in
the SAIF, relatively conservative. Currently, the FDIC staff estimates that SAIF reserves on
January 1, 1999, may approach 1.45 percent, which could result in the funding of the SAIF
Secondary Reserve in an amount equal to $1.35 billion.
Other than budgetary considerations, there was no public policy reason for creation of the SAIF
Secondary Reserve. As structured, the legislation provided that the Secondary Reserve would be
available to the SAIF (or the combined BIFSAIF, in the event of a merger) in the event that the
SAIF (or the combined BIFSAIF) reserve ratio falls below 50 percent of the statutorily required
1.25 percent SAIF (or the combined BIF-SAIF) reserve ratio, and is expected to remain below
that level for the following four quarters.
Given that the FDIC is required to maintain the SAIF (or the combined BIFSAIF) at a 1.25
percent reserve ratio and must raise deposit premiums (up to 23 basis points annually) to do so, it
is highly unlikely that the Secondary Reserve will ever be utilized. In addition, funding of the
Secondary Reserve would have two very troublesome outcomes. First, absent a fund merger, the
transfer of the SAIF excess reserve would result in the SAIF reserve ratio being pared to 1.25
percent. This would eliminate the capital cushion now available to the SAIF to absorb even
incremental insurance losses - Existing SAIF institutions would be placed in a position, after
already substantially overcapitalizing the SAIF, of being exposed to increased premiums and,
once again, a BIF-SAIF premium differential.
Second, as noted above, it is highly unlikely that the Secondary Reserve would ever be utilized.
Yet, once it is funded, any legislative efforts to transfer the money back into the SAIF, or the
combined BIF-SAIF, would likely have a negative budget scoring impact since such funds would
be used in lieu of increasing SAIF premiums to fund any SAIF shortfall.
The only way to resolve this problem without a negative budget scoring consequence is to eliminate the SAIF Secondary Reserve before it is funded. This would preserve the capital cushion currently available to the SAIF (or that would be available to a combined fund in the event of a merger) and would avoid the possibility of increased SAIF assessments where a substantial reserve has already been built up with existing SAIF premiums. We support legislation that achieves this result.
The financial modernization debate over the last several months has resulted in serious, thoughtful discussion about many issues that are fundamental to the strength and stability of America's financial markets, the most expansive, durable, and creative in the world. It has also had the result (perhaps unintended) of directing attention to certain aspects of the thrift charter and the SLHC structure that have been discussed without the benefit of a full understanding of the trade-offs inherent in the charter.
In many respects, the thrift charter offers the organizational flexibility and broad affiliation
powers now being sought by some financial institutions from different branches of the financial
sector. It is not a panacea, however, for those seeking unrestricted affiliations of banking and
commerce. In fact, traditional commercial banking authority is severely restricted. Institutions
seeking the affiliation authority permissible in a unitary SLHC structure must accept significant
restrictions on their commercial lending authority and structure their portfolio to satisfy the QTL
test. In addition to being subject to various other provisions intended to protect the safety and
soundness of the thrift, in no event may a thrift be used to finance the activities or operations of a
The current attributes of the thrift charter make it an excellent vehicle
through which to offer a full range of locally-focused, consumer-oriented financial services.
For institutions that wish to focus their business operations in this manner, the thrift charter
provides one model of the modem charter. At the very least, financial modernization should
preserve the freedom of institutions to choose whether the attributes and limitations of the thrift
charter suit their particular business goals and needs.
Although we are not in a crisis mode, we should not overlook the opportunity to strengthen and
modernize our financial system. The competitive pressures and technological advances I
discussed earlier make change inexorable. Our depository institutions must have the flexibility
and the tools to continue to compete and to thrive; and our regulators must have both the
responsibility and the authority to make certain the system continues to operate in a safe and
sound manner to serve all Americans and all communities.
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