Hearing on Financial Services Modernization

Prepared Testimony of Ms. E. Lee Beard
First Federal Bank of Hazelton, PA

10:00 a.m., Thursday, February 25, 1999

Mr. Chairman and Members of the Committee, I am E. Lee Beard, President of First Federal Bank in Hazleton, Pennsylvania. First Federal Bank is a $520 million asset institution held by a unitary savings and loan holding company. Until recently, our institution ­ like hundreds of others ­ was in mutual form.

I am here today in my capacity as chair of America's Community Bankers, which represents progressive community bankers across the nation. ACB is the national trade association for 2,000 savings and community financial institutions and related business firms. We represent institutions with more than $1 trillion in assets, 250,000 employees, and 15,000 offices. ACB members have diverse business strategies based on consumer financial services, housing finance, small business lending, and community development, and operate under several charter types and holding company structures.

ACB appreciates this opportunity to testify on this committee's priority issue, financial modernization. Mr. Chairman, you set a positive tone when you said during your recent press conference: "My objective in our financial services modernization bill is to make financial services more available to American consumers and cheaper than they have ever been." In a written statement released that same day, you recognized that, "The same forces that brought the banking, insurance, and securities industries together last year are still at work this year. They are the market forces and technological changes that are already breaking down the barriers between these industries." This statement recognizes that it is not government that will be modernizing the financial system. It is the system itself, businesses, consumers, and communities that are adapting to new circumstances. ACB believes that the government should allow that process to continue through truly progressive legislation.

ACB urges that this legislation give consumers and the financial industry the greatest possible range of choices. The 105th Congress made substantial progress toward meaningful financial modernization and we appreciate your willingness to continue that work. Recognizing that you are building on an existing system, not starting from scratch, ACB believes that your legislation should seek to improve existing charters and holding company structures without reducing any competitive options and consumer choices.

ACB is pleased to state today that the Committee's draft legislation, released on February 17, meets this criterion. You have drafted a financial modernization bill that greatly improves competitive opportunities for banks and bank holding companies and avoids taking steps backward for either banks or savings institutions. We are particularly pleased that your legislation leaves in place a truly modern feature of the financial system ­ the thrift charter and the unitary thrift holding company structure.

ACB's diverse membership makes full use of all the choices already available. We represent institutions with a long operating history under both state and federal charters; hundreds are owned by stockholders; and hundreds are in mutual form. ACB is also proud to represent nationally known new corporate entrants from the insurance and securities industries. At the same time, we are assisting newly converted mutuals coming over from the credit union industry. My own institution recently converted to stock ownership and changed its name from First Federal Savings and Loan Association to First Federal Bank. We also organized a unitary thrift holding company at the time of our conversion to expand our business options. Our board decided to adopt this ownership and corporate structure after carefully evaluating our market and our customers' needs, and deciding that a new direction would be the best way to continue to grow and serve our community. Many of my customers bought stock in our initial public offering, and we remain dedicated to serving our local market in all the ways we can find that make business and service sense.

Our bank's choice to convert to stock form and adopt the unitary holding company structure is not necessarily the right one for all savings institutions; each should have a full range of choices to meet the needs of their customers and communities. That is why ACB urges Congress to expand choices for the financial industry, not reduce them. Much of the value of our bank ­ or any bank ­ is based on its assets, capital, and current structure, but another component is what our charter allows it to do. This value is there whether or not we are actually engaged in a particular activity. Eliminating even a potential activity would adversely affect our value. When we chose to convert from mutual to a unitary holding company structure, we based our decision on what was best for our business, our customers, and our community. We could have chosen to remain in mutual form, convert to a national or state bank or take the route we selected. Financial modernization legislation should not limit in any way the options available to any of us in the financial services industry.

The following expresses these views in another way:

Financial modernization should provide the flexibility for institutions to adapt to the rapidly changing marketplace and to structure the delivery of financial services to their customers in the best possible way. Why different banking firms choose a particular structure is not what is important. What is important is that they have the flexibility to choose the structure best suited to their business, market, and customers. Freedom to choose the most efficient organizational structure is the best way to assure that customers will have access to low-cost, high-quality products and services.

While ACB supports this view of financial modernization, I must give credit where credit is due. These words come from the testimony of the American Bankers Association before the House Banking Committee two weeks ago in promoting operating subsidiary activities. We agree with the ABA on the need for operating subsidiary flexibility and support the substantial improvements made to the bank charter by the Committee draft. However, it is curious that the ABA opposes similar freedom of choice for the unitary holding company structure. Fortunately, the Committee draft consistently protects freedom of choice for all institutions.

We Are Moving Toward a Financial Services Industry

By increasing choices available to financial firms and avoiding cutbacks in existing options, the Committee's draft legislation implicitly acknowledges that we are dealing with one industry ­ the financial industry ­ not a host of imperfectly walled-off competing industries that must be protected from one another. By starting from this premise, Congress can avoid the thankless task of being a referee between segments of the industry. Instead, Congress can focus on making sound public policy decisions and setting essential rules of the road, such as safety and soundness requirements and investor protections. Businesses and customers can determine for themselves what services they will offer and buy.

My customers already understand that there is a single financial industry. They never ask if we are a thrift or a bank. They simply ask what products and services we provide, at what cost, at what level of risk (such as, are the products insured or not), and do we offer good service. If First Federal Bank can provide the full range of services and meet the needs of our customers, we and our community can prosper together. This committee's goal should be to let all of us keep the flexibility we already have and increase it as much as possible, then let the market, rather than government, be the arbiter

Fortunately, there are already examples in today's financial system that provide a road map for positive legislation. The first example is provided from my own part of the industry: thrifts and the thrift holding company structure. The second example is the nation's mutual funds. Each of these financial delivery structures can be used by a diverse array of firms to serve their customers.

Let me explain how this works in practice. For years, securities, insurance, and non-financial holding companies and bank holding companies have owned savings associations. These thrifts ­ generally operated as traditional housing and consumer lenders ­ have given their holding companies the ability to offer an important array of financial services to their customers.

Recently, a number of additional firms have applied for thrift charters. The intentions of these diversified firms are consistent with long-standing precedent, although their relative numbers and their public profile are now higher. The Office of Thrift Supervision (OTS) has carefully reviewed each of these applications to satisfy itself that they present viable business plans and that the thrifts will comply with all applicable safety and soundness, consumer, and community reinvestment laws. Where these applications are approved, the OTS will carefully supervise the transactions between the thrift and its holding company to ensure that the they are on an appropriate arms-length basis.

The OTS does not generally seek to regulate the capital and activities of the holding companies themselves. Regulated firms, such as securities and insurance companies, are already regulated by their functional regulators. Publicly held holding companies are also regulated by maybe the toughest financial regulator of all: the marketplace. Every day, these firms must demonstrate to their owners that their earnings and business prospects justify their continued confidence.

Mutual funds provide another example for a more flexible financial system. In recent years, many types of financial firms, including banks and thrifts, have become involved in the mutual fund sector. It is neither a question of a bank, thrift or some other company "getting into" the mutual fund business, nor one of a mutual fund "getting into" banking or "getting into" insurance. Mutual funds, like thrift deposit and loan products, are simply another financial service and delivery channel a firm may offer to its customers. Of course, every mutual fund, like every thrift, must meet strict statutory and regulatory requirements, regardless of its affiliation. Like those parts of the thrift industry affiliated with diverse firms, mutual funds with connections to other types of firms have compiled an exemplary record of service to the public.

The Need for Financial Modernization

While parts of the financial industry ­ thrifts and mutual funds, for example ­ can already participate in the evolving modernized structure, commercial banks and bank holding companies (BHCs) have been left behind in some respects. They face significant limitations on their ability to offer financial services beyond what has traditionally been called banking. The Glass-Steagall Act hampers affiliations between the banking and securities industries. Although the Federal Reserve has loosened Glass-Steagall substantially via Section 20 subsidiaries, the law remains an anti-competitive anachronism. Bank holding companies may only acquire securities firms that fit within arbitrary size limits, while major securities firms are unable to acquire banks.

In a similar vein, the Bank Holding Company (BHC) Act does not permit banks to affiliate with insurance underwriting companies. Beyond that, the BHC Act limits banks to affiliations with firms "closely related" to banking. Banks that wish to sell insurance products face a patchwork of state and federal statutes, as well as court and agency interpretations that sometimes permit and sometimes prohibit insurance activities.

Congress should not change these laws merely for the convenience and profit of the banking sector or that of the financial industry as a whole. It should change them to improve economic efficiency and competition. Despite their loss of market share, depository institutions remain a vital source of credit to businesses and consumers. The Federal Reserve conducts the nation's monetary policy through its links to major commercial banks. An inefficient commercial banking sector is bad for business, consumers, and the economy. Congress can eliminate the inefficiency caused by outdated statutory restrictions by adding options to the bank charter and bank holding company structure.

The committee draft would make substantial improvements, particularly by permitting banks to freely affiliate with securities and insurance firms at the holding company level. It demonstrates that financial modernization legislation need not ­ as it should not ­ damage those features of the bank charter that are already modernized. For example, the Comptroller of the Currency's (OCC) Part 5 rule gives national banks the opportunity to apply to offer a full range of financial services through operating subsidiaries. Due to legal uncertainty, this rule has been utilized by only a few institutions. The committee draft would ratify this rule for national banks with total assets under $1 billion that operate without a holding company. While ACB believes the asset and holding company limitations are not necessary, this legislation would clearly permit community banks to take greater advantage of the operating subsidiary option. That provides a useful, but limited, opportunity to strengthen the national banking system.

The Federal Reserve and others are concerned that, if banks are permitted to offer new financial services through their subsidiaries they will use that form of organization exclusively. My own bank's experience demonstrates that these fears are not well founded. We elected to operate within a unitary thrift holding company for a variety of reasons, including the opportunity to establish holding company affiliates which can provide services outside of the bank's customer base, with no risk to the bank's capital, and with a different name from the bank. For instance, our holding company operates a title insurance affiliate that serves customers of our bank and those of other lenders. On the other hand, we have a subsidiary of the bank (FIDACO) which has an investment in the Hazleton Community Development Corporation (HCDC). HCDC was established in 1991 as a for-profit community development organization designed to promote economic improvements within the city of Hazleton, Pennsylvania.

The key point is, we made these choices ­ holding company affiliate or bank subsidiary ­ for business reasons, not to comply with arbitrary regulatory requirements. I am sure that national banks and their holding companies would make the same mix of choices under the OCC's Part 5 and the committee draft.

The OCC has also successfully increased the ability of national banks to offer insurance services and annuities to their customers. Fortunately, the committee draft draws lines between state and federal control over banks' insurance sales without adopting a host of confusing new legal standards. The insurance language in H.R. 10 dramatically increased in scope and complexity as it moved through the 105th Congress. ACB is concerned that these provisions ­ now included in the current House version of H.R. 10 ­ are internally inconsistent, rather than being carefully balanced. It could take years of litigation to sort them out. In the meantime, consumers could be denied competitive and efficient insurance services.

This language, inherited and adapted from the work of the last Congress, is apparently intended to diminish fears that the OCC will engage in a wave of unwarranted preemptions of state insurance laws. Based on the history of the OCC since the 1860s, such fears are groundless. The limited preemptions approved by the OCC have been upheld by the Supreme Court in a series of 9 to 0 decisions. The OCC's actions have increased competition and customer service and have harmed no one. The committee draft recognizes that the current system of OCC regulations is not broken. Current law has achieved a balance of state and federal jurisdiction that best protects and advances consumer interests.

A few ACB members operate with a national bank charter, and its health is important to us for a number of additional reasons. Most directly, Federal thrifts and state-chartered banks may generally only offer as principal those products and services permissible for national banks (agency activities are not covered by this limitation). More broadly, as national banks gained the flexibility to offer insurance services, states have extended that flexibility to their own state-chartered commercial banks and removed restrictions on state chartered savings banks. Finally, a strong national bank charter could benefit many firms, including holding companies that chose to operate both a bank and a thrift. For example, Citigroup operates both a national bank and a federal savings bank, using those charters where they make the most business sense. Congress should allow both charters to retain their flexibility and enhance them wherever possible.

The Value of the Thrift Charter Unitary Holding Company Structure

Just as the Committee draft increases the competitive flexibility of banks and bank holding companies in various dimensions, it retains the current options for thrifts and their holding companies. This benefits all thrifts and, indeed, the entire financial industry and its customers.

This is most certainly not an issue that concerns just a handful of big companies trying to "get into banking" through the thrift charter. My own bank is a prime example. We determined that organizing as a unitary thrift holding company was our best business option. That is why First Federal joined the list of about 875 unitaries in the financial industry. We do not know all of the services our customers and communities will need in the future; market needs cannot be predicted. But, without the flexibility and adaptability of the unitary structure it might well be impossible for First Federal and the other unitaries to serve changing customer needs without coming to Washington every time we want to offer a new product.

Our holding company already operates a title insurance agency that provides title searches and real estate settlement services in northeast Pennsylvania. The firm, Abstractors Inc., provides services for customers of First Federal Bank and receives customer referrals from other banks and finance companies. We are also seeking a state license to offer trust services through another holding company subsidiary, Hazleton Bancorp. It is very important to my bank and its community to retain the flexibility that we have under current law.

Another key element of the thrift charter is that it is available to any firm that has the financial and managerial strength to qualify. As we have seen, a diverse array of firms have applied for and obtained thrift charters. But, a bank holding company may also operate a thrift, and, a bank itself may convert to a thrift charter. For example, Citigroup does much of its "banking" outside of New York through a thrift. Similarly, a commercial bank in Iowa converted to a thrift and is now opening branches in its parent holding company's grocery stores.

In exercising these choices, there are logical tradeoffs involved. As a trade-off for the unlimited commercial lending authority provided by the banking charter, an institution cannot affiliate with commercial firms. For the affiliation rights provided by the thrift charter, an institution must strictly limit its commercial lending, among other limitations of the Qualified Thrift Lender Test. The decision is theirs to make. Consumers, businesses, and communities all benefit from the diversity of services that results from these individual business decisions.

Homebuyers are one major beneficiary. Thrifts maintain a high percentage of their assets in mortgage loans and related securities ­ 73.7% for thrifts owned by non-banking companies, 70.6% for thrifts as a whole. By contrast, banks have only 32.6% of their assets in mortgage loans and related securities. The National Association of Home Builders and the National Association of Realtors have pointed out that, "thrifts have demonstrated a pattern of serving low- and moderate-income borrowers. In many markets, thrifts are the leading source of residential construction and development loans." (joint letter, June 12, 1997)

The recent applications from diverse financial firms provide a marketplace validation of the value of the thrift charter and holding company structure. The financial strength of today's thrift industry, reflected by record profits, record capital levels, and a fully funded deposit insurance fund, is a testament to the flexibility and effective business options the thrift charter provides.

Proposals to Harm the Thrift Charter and Holding Company

Given the record of the thrift charter and holding company structure, Congress should hold it up as a model for modernization. Unfortunately, some have proposed to take away many of the unitary thrift holding company affiliation rights for companies that had not applied for a charter by a certain date ­ October 7, 1998 in last year's Senate bill and the new H.R. 10. Some of those firms might be satisfied with the improvements in the bank holding company structure provided in financial modernization legislation. Others might not, and some of the applicants would still not qualify for a bank charter. There is no reason to cut off this successful, market-tested business option as of October 7, 1998 or any other arbitrary date.

Some have also proposed that existing thrift holding companies with non-financial affiliates be prohibited from being acquired by other firms. These artificial constraints on mergers, acquisitions, and divestitures would clearly decrease the franchise value of existing holding companies and reduce economic efficiency without any substantive public policy justification. Prospective thrift holding companies would also lose business options because of newly imposed limitations.

Critics justify these limits by citing their concerns about mixing banking and commerce. We do not share these concerns. But, regardless of one's position on this issue, policy makers should understand that unitary thrift holding companies do not mix banking and commerce in any meaningful manner. Thrifts may not lend to commercial affiliates under any circumstances. And, thrifts' permissible commercial lending is strictly limited to 20 percent of assets, half of which must be small business loans. The unitary thrift structure is a flexible platform for consumer banking, not large-scale corporate lending.

Thrifts and Thrift Holding Companies Already Subject to Strict Regulation

Congress can be confident that that if it leaves the thrift charter, unitary holding company structure, and regulatory system in place, thrifts will continue to be vigorously regulated. The OTS and the Federal Deposit Insurance Corporation impose the same or even tougher capital and examination standards on thrifts as those imposed on commercial banks. Protection of thrifts and banks operating in holding company structures is equally vigorous. In some cases, thrift regulation imposes special requirements; for example, thrifts may not make any loan to an affiliate engaged in activities prohibited for bank holding companies.

While undergoing vigorous supervision, combinations of thrifts and commercial firms have added demonstrably to the stability of the thrifts involved. They have compiled an exemplary safety and soundness record. The OTS reported that only 0.3 percent of enforcement actions against thrifts and thrift holding companies from January 1, 1993 through June 30, 1997 were against holding companies engaged in non-banking activities. In short, the industry's experience with well segregated commercial affiliates has been the opposite of what the critics contend.

Indeed, major firms have injected billions of dollars in capital into the thrift industry, providing an added level of stability. The OTS is careful to ensure that all transactions between thrifts and their diversified holding companies comply fully with the law ­ primarily sections 23A and 23B of the Federal Reserve Act ­ and otherwise do no harm to the thrift itself.

SAIF Special Reserve

ACB is pleased to support legislative language in the Committee draft that would repeal the SAIF special reserve. This language is similar to language introduced separately by Senators Enzi and Johnson. ACB appreciates their leadership on this issue. We note that similar language was included in the Committee's regulatory relief bill this year and this Committee's version of H.R. 10 last year. Repealing the special reserve is the FDIC's top legislative priority and will give the agency needed flexibility in administering the Savings Association Insurance Fund. Mr. Chairman, ACB strongly urges you and your colleagues to do whatever you can to ensure that this provision is enacted this year.

FHLBank Modernization

ACB also strongly supports Federal Home Loan Bank modernization legislation proposed by Senators Hagel and Bayh. This proposal was listed as an "undecided issue" in the committee draft released on February 17. We hope that the committee will decide to include it in the financial modernization bill, or find another appropriate way to enact it into law. The FHLBank System has been an unsung hero in providing housing opportunities through the private sector. This legislation would enable the System to continue to meet housing and community development financing needs into the twenty first century.

The Hagel/Bayh bill provides constructive approaches to governance and regulation of the System. It addresses the issues that must be part of System modernization, including: voluntary and equal membership requirements, an appropriate risk-based capital structure, and improved access to the System for small, community based depository institution. The bill also balances the System's mission and capacity by acknowledging its finite risk capacity, as well as the need to assure both the stability of the System's capital base and the fulfillment of its housing and community development finance responsibilities.

Financing Corporation Funding

ACB vigorously opposes the proposal to extend the unequal FICO funding for three years beyond January 1, 2000. This "undecided issue" threatens to recreate a problem that Congress resolved just two and a half years ago. We cannot understand why anyone in Congress would propose to reopen the BIF/SAIF debate. In the fall of 1996 Congress faced and resolved a dangerous disparity between the FDIC's two deposit insurance funds, BIF (Bank Insurance Fund) and SAIF (Savings Association Insurance Fund). SAIF-insured institutions were paying deposit insurance payments of 23 cents per $100 of deposits (23 basis points). BIF-insured institutions were paying almost nothing. Institutions with SAIF deposits were taking vigorous steps to transfer to BIF coverage, and market forces were causing other transfers.

At the urging of the FDIC, the Federal Reserve, Treasury, and the Office of Thrift Supervision, Congress resolved this problem. First, SAIF-insured institutions were required to make an extraordinary, one-time payment of $4.5 billion to capitalize the SAIF. That equalized the reserve positions of BIF and SAIF. Second, Congress reallocated the FICO interest payment so that BIF and SAIF institutions shared the burden. Until then, SAIF-insured institutions paid all of the interest on FICO bonds (issued to pay depositors in failed institutions). Those payments had diverted premium dollars that otherwise would have gone to capitalize SAIF. Both of the steps Congress took in 1996 resolved the massive premium disparity that threatened to destabilize the deposit insurance system by keeping SAIF weak and diluting BIF through deposit shifting.

To address concerns of BIF members, Congress decided to require SAIF-insured institutions pay ­ for three years ­ a FICO premium at a rate 5 times the rate for BIF institutions. Extending this inequity for an additional three years would reopen the wounds of the BIF/SAIF debate from the late-eighties and mid-nineties. It would risk recreating the premium disparity and give SAIF institutions a renewed incentive to revive their deposit-shifting plans.

Taking these risks is certainly not needed to redress any inequity between SAIF and BIF institutions. In fact, since 1996, SAIF-insured institutions have paid FDIC assessments totaling 83 basis points on their deposit base, or about $6 billion. In contrast, BIF members have paid a total of 2.5 basis points, totaling less than $700 million. Finally, this Committee should consider the fact that a well-capitalized SAIF-insured institution with $100 million in deposits has paid $830,000 for FDIC insurance since 1996, while the same-sized BIF member has purchased the same federal insurance for only $25,000.

Frankly, none of the institutions ­ BIF or SAIF ­ that are paying FICO interest until 2019 were responsible for the crisis of the 1980s. Those institutions responsible were closed long ago and their stockholders rightly lost their investments. Resolving the BIF/SAIF/FICO problem in 1996 was handled in the most even-handed way Congress could devise and the solution has proved manageable for the industry. Both BIF and SAIF are now healthy, as are virtually all the members of each fund. Assessments should be equalized for all FDIC-insured institutions starting in January, 2000, as provided for under current law.


ACB urges the Committee to act promptly on its financial modernization proposal that would provide new competitive options for financial firms without reducing or eliminating firms' ability to provide competitive products and services. I hope that as this debate moves forward, all elements of the financial industry will view what flexibility you find in current law as an opportunity, rather than a threat. This approach will help Congress make a major step forward for the financial system and, more importantly, for the customers and communities it serves.

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