Hearing on Financial Services Modernization

Prepared Testimony of Mr. Hjalma Johnson
Chairman and CEO
East Coast Bank Corporation
Dade City, Florida

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

Mr. Chairman, I am Hjalma Johnson, Chairman and CEO of East Coast Bank Corp, Dade City, Florida, and President-Elect of the American Bankers Association (ABA). I am pleased to be here today to present the views of the ABA on modernizing the structure of our financial system. The ABA brings together all categories of banking institutions to best represent the interests of this rapidly changing industry. Its membership ­ which includes community, regional and money center banks and holding companies, as well as savings associations, trust companies and savings banks ­ makes ABA the largest banking trade association in the country.

Mr. Chairman, we thank you for the fast start in considering financial modernization legislation this year, and for holding hearings early in this new session. As we all know, the path towards the enactment of financial modernization has been long and difficult, but real progress has been made.

This year, proponents of financial modernization have reason to be encouraged. The fast start in your Committee, coupled with the hearings and scheduled mark up in the House Banking Committee, gives this legislation a significant boost. At the end of last year there was a growing consensus among many interested parties, including the various sectors of the financial services industry, on the need for financial modernization. It is clearly time to move forward.

We recognize that changes will be made in this legislation during the Congressional process. However, we know that no party ­ including ABA ­ will get everything it wants in the final legislation. All parties must be willing to compromise in the interest of enacting financial modernization; we pledge to work with this Committee to achieve that goal.

In my statement today, I would like to first discuss the need for financial modernization. Second, I will detail ABA's position on some of the elements in the Staff Discussion Draft of February 16, 1999. Further details on the securities and insurance provisions will be submitted for the record by the ABA Securities Association and the ABA Insurance Association. These subsidiaries of the ABA follow these issues in detail and have worked closely with members of this Committee and others over the last Congress to help develop a workable framework for reform.

Third, I will discuss an issue critical to ABA which is not in the Discussion Draft ­ the unitary thrift holding company issue. We strongly urge the Committee to address this issue. Finally, I would like to discuss the need to resolve the debate regarding operating subsidiary authorities.

I. The Need for Financial Modernization

The virtually unanimous agreement among financial service providers that the time has come to modernize our financial structure is perhaps the most obvious evidence of the need for reform. Revolutionary improvements in technology and escalating competition are redefining the financial services business. The lines between different types of financial service firms have been blurred beyond recognition.

Today, my customers have the option to write a check on a money-market mutual fund to pay their bills; they can have a credit card issued by a phone company; and they can get a home mortgage from an automobile manufacturer. The list of non-traditional suppliers of financial services competing for my customers gets longer every day. Even defining the term "financial service" is becoming difficult in today's market.

As dramatic as the recent changes have been, they will surely be dwarfed by those that will occur over the next few years. In this dynamic market, the ability to quickly and efficiently respond to changing customer needs is critical. Successful firms must be flexible, innovative, and able to offer a broad range of financial services. As a banker, I can tell you that finding ways to compete successfully in these rapidly evolving markets without tripping over the outdated regulatory banking framework is no easy task ­ and it is absorbing a considerable amount of time, energy, and resources of large and small banks across the country.

Under the current regulatory regime, banks have lost traditional market share to other financial service providers. In fact, the market share of total assets held by banks and thrifts has fallen steadily over the past two decades, from almost 60 percent to 25 percent. On the other hand, securities and insurance firms like Merrill Lynch and Prudential offer everything from consumer and commercial loans to credit cards, securities, insurance and real estate products without having to jump through a series of regulatory hoops. Not only can these firms affiliate with each other, but many also own FDIC-insured savings institutions or "non-bank" banks.

Bankers are working to offer the products our customers want, although in many cases the current framework makes this process more difficult and expensive than it would otherwise be. For example, Section 20 subsidiaries allow some large bank holding companies to offer securities underwriting services, but this is not a practical structure for small banks or even for most mid-sized banks.

Simply put, the bank regulatory structure needs to be modernized to allow all institutions the option to enter lines of financial business without having to jump through costly regulatory hoops. Not all banks will choose to offer all services. But the decision of what products and services to offer should be a business judgment that each individual institution is free to make. It simply makes no sense to perpetuate a system that limits free and fair competition. Doing so means that customers will not be well served.

Ensuring that consumers are well served should, of course, be a primary focus of the Committee. The costs and lost efficiencies of the current system are ultimately borne in large part by the consumers of financial services.

This legislation is also important to our country's international competitiveness. Despite our archaic laws, this country is the international leader in financial services ­ to the great benefit of our economy. However, we cannot maintain that leadership unless our laws are brought up-to-date.

ABA's Position on Key Provisions of the Staff Discussion Draft

Basic structure: The ABA strongly supports the basic underlying structure for financial modernization contained in the Discussion Draft. It provides a clean framework for the affiliation of all financial firms without some of the unnecessary regulatory provisions that have been contained in bills considered over the last few years. We believe this core part of the bill provides a solid basis from which the Committee can proceed.

Securities provisions: Mr. Chairman, as you and members of the Committee know, the ABA ­ through its affiliate, the ABA Securities Association (ABASA) ­ worked long and hard to contribute to many of the capital markets and securities provisions in the bill reported from this Committee last Congress. ABASA had many constructive dialogues on these issues with members and staff of this Committee and the House Banking and Commerce committees. In addition, numerous discussions with the federal banking regulators, the Department of the Treasury, the SEC and various industry trade groups were held.

ABASA will submit a more detailed statement for the record in support of the capital markets and securities provisions of the Discussion Draft. However, in summary, the ABA and ABASA support the provisions in the Discussion Draft. ABA had agreed to support the language in last year's Committee product, but the new language is far preferable in a number of ways that will be detailed in ABASA's submission.

Insurance provisions: The treatment of insurance has for many years been one of the most troublesome aspects of financial modernization legislation. The Discussion Draft contains a new approach to the insurance issues. Again, ABA had agreed to support the compromise provisions contained in last year's Senate Banking Committee approved version of financial services reform legislation. However, the Discussion Draft, as released, contains a preferable approach, which is cleaner and less complex. ABA supports it.

A more complete discussion in support of the insurance provisions in the Discussion Draft will be provided in a statement to the Committee prepared by our affiliate organization, the American Bankers Association Insurance Association (ABAIA).

Subchapter S provision: We support the provision providing for a study of expansion of the Subchapter S treatment of small banks. We greatly appreciate the interest of several members of this Committee in this important topic, and particularly the efforts of Senator Allard. The ABA strongly supports changes to Subchapter S along the lines of those that have been advocated by Senator Allard and others. Of course, this ultimately is a matter within the jurisdiction of the Finance Committee. We sincerely hope that members of this committee who also serve on the Finance Committee will take the lead in pushing Subchapter S modernization within that committee.

Elimination of SAIF special reserve: The ABA supports the provision to eliminate the SAIF special reserve. In truth, this artificial reserve was created for Congressional budget reasons which, as we understand it, no longer apply. Thus, it really is a matter of good accounting to repeal the special reserve provision.

CRA provisions: We appreciate the fact that CRA is potentially one of the most controversial aspects of this legislation. In general, bankers across the country strongly support the purpose of CRA, and indeed there is no industry more involved in developing and serving their communities than the banking industry. On the other hand, it is no secret that bankers have had problems with both the implementation of CRA and the fact that it does not apply to our competitors. On page 3 of this statement, there is a graph of market share of assets held by various types of financial institutions. It clearly shows the incredible decline of market shares held by banks and thrifts. Looked at another way, it also shows how the assets within the financial industry subject to CRA have shrunk rapidly. During this same period of time, CRA requirements on banks have been increased. Thus, increasing requirements are being placed on an ever smaller relative base.

The ABA, therefore, would support a Congressional review of CRA, which we would suggest include a number of issues, such as:

the paperwork burden;

competitive implications of applying CRA to banks and not direct competitors, many of which are taking funds out of communities that would have traditionally gone to local banks;

the practical impact of the CRA evaluation system, under which banks with satisfactory or outstanding ratings can still have their applications challenged and delayed despite those ratings; and

the issue of how CRA protests are handled by regulators, community groups, and banks, and whose interests are being served.

While we know there are strong feelings on this Committee, it is our hope that the potential controversy over CRA would not delay action on financial services modernization. We note that you, Mr. Chairman, have indicated that you would be open to working out some agreement on CRA in the context of this financial modernization bill, and then proceeding to a more thorough review of CRA later this year. If Committee members wish to address the issue in this fashion, we would pledge to work with all Committee members to reach an agreement on CRA within the context of this bill and to participate in any later review that may take place.

Commercial basket provision: Since the beginning of the last Congress, we have indicated that we could support a limited basket, although we did not have to have a basket to support a bill. The ABA believes a limited basket could be valuable for community development in certain situations. For example, in many small towns, there is a crying need for credit and for investment capital in main street businesses. I am aware of instances where a local businessperson is retiring and would like to sell a critical business in a community. The problem is that often the purchaser needs some small help in terms of capital investment in addition to credit. For want of such a capital investment, this critical business may be closed, triggering even greater problems for businesses and residents of the community. Allowing a bank holding company to make such investments, even on a limited basis and only with excess capital above the well-capitalized regulatory standard, would help ease this problem and help local economies.

We would like to make sure, however, that the commercial basket does not become so large that it becomes a back door way to co-mingling banking and commerce in a general sense. In that regard, we have generally supported commercial baskets in the five to ten percent range, and ABA, therefore, believes that a 25 percent basket is too large.

Home Loan Bank System reform provisions: The ABA strongly supports the proposed provisions on Home Loan Bank System reform, which have been put forth previously by Senator Hagel and others. We particularly want to compliment Senator Hagel for his strong leadership on this issue, and we appreciate Senator Bayh's interest this year. As Senator Hagel has stated on a number of occasions, many smaller communities, particularly rural communities, are suffering from a lack of available credit. The problem is that local banks in many of these communities are fully "loaned up." As mutual funds, securities firms, and insurance companies have expanded, some of the funds that previously had been available in those communities have been "sent to Wall Street." At the same time, it is extremely difficult for smaller banks to tap the national capital markets.

While the proposals on Home Loan Bank reform contain a number of important provisions that we support to modernize the System, we want to especially emphasize a very important provision permitting more flexibility for community banks to use the System to directly address this critical issue of bank liquidity. We strongly urge the Committee to include the Home Loan Bank System reforms in the financial modernization bill. These reforms are of great interest to community banks, and would be very helpful in gaining community banks support for the legislation.

Unitary bank holding company provision: Under this proposed provision, commercial companies could enter the banking business by gaining control, either through a de novo charter or by acquisition, of a national bank. The revenues and assets of that bank would be limited to a percentage of the bank holding company's total revenues and assets. The ABA is strongly opposed to this provision because of our basic concerns about mixing banking and commerce. Under this provision, it appears that a large commercial company could own a bank of significant size. While there are clearly differences of opinion among Senators on this Committee about the appropriateness of mingling banking and commerce, it is the position of the ABA that ­ with the exception of a limited basket ­ the intermingling of banking and commerce should not be further expanded.

Extending for three years the BIF-member FICO assessment rate: When Congress enacted the so-called BIF/SAIF legislation in 1996, it transferred a significant proportion of the obligation to pay interest on FICO bonds from SAIF-insured institutions to BIF-insured institutions. (FICO bonds are bonds that were used to fund a portion of the thrift rescue in the 1980s.) As the legislative history ­ indeed, the legislative language ­ clearly indicates, it was the intention of the Congress at that time to come back and address issues relating to the thrift charter and unitary thrift holding companies in the next Congress.

In that next Congress, 1997 and 1998, the House of Representatives had an extensive debate on thrift charter and unitary thrift holding companies. Different approaches were contained in versions of the House legislation. Ultimately, the House settled on a provision which, basically, prevented commercial firms from buying or chartering a thrift going forward, while maintaining the current thrift charter as is and grandfathering existing unitary holding companies. This same provision was adopted by the Senate Banking Committee, although no final Senate action was taken.

In the 1996 BIF/SAIF legislation, the Congress provided a two-step timetable for having BIF-institutions assume part of the FICO obligations from SAIF-institutions. For the first three years, BIF institutions were to pay at a rate of roughly 1.30 basis points of domestic deposits, while SAIF institutions paid at a rate of 6.50 basis points. (Note that because there are more BIF-insured deposits than SAIF-insured deposits, BIF institutions are paying considerably more than the one-fifth of the FICO obligation that this rate differential would seem to imply ­ in fact, BIF-institutions pay two-thirds of the total FICO obligation.)

Under the 1996 law, as of January 1, 2000, both BIF and SAIF members will pay slightly over 2 basis points for FICO. The legislative history clearly shows that this three-year phase-in was designed to give Congress time to address issues relating to the thrift charter and unitary thrift holding companies. In fact, it was the stated intention of key Members of Congress to seek a merger of the two charters into a new, expanded charter, and to merge the deposit insurance funds.

As is discussed further below, the strong preference of the ABA would be to proceed to address the unitary thrift issue as part of financial modernization this year. We are very concerned that if it is not addressed this year, it may prove to be too late to address it in the future. In fact, many banks have told us this is the most important issue to them. However, if this Committee decides that it does not wish to address the unitary thrift issue at this time ­ by preventing both the chartering and sale of thrifts to commercial firms in the future ­ then a three-year extension of the second step in the FICO assessment rate would be appropriate. This would give Congress additional time to address issues relating to the thrift charter and unitary thrift holding company.

Although we recognize there are differences of opinion about the banking and commerce issue, from talking with Senators on this Committee, it is our belief that there is a desire to address these issues at some point. Extending the timetable for FICO would send a signal to, and provide an incentive for, industry groups to work with this Committee to resolve these issues once and for all. The provision would also carry forward the clear Congressional intent, at the time of the enactment of the BIF/SAIF legislation, that parity was to be achieved after these issues had been addressed.

III. The Unitary Thrift Holding Company Issue Needs To Be Addressed

ABA believes that the unitary thrift holding company issue should be directly addressed in the financial modernization bill. We would strongly support an amendment to the Discussion Draft to address the unitary thrift issue. This is an issue of critical importance to bankers, particularly community bankers.

Again, to many bankers it is the most important issue in this debate.

At the heart of the unitary thrift issue is whether it is appropriate to mix commerce and banking. Mr. Chairman, we recognize that you and others on this Committee may disagree with our views on this issue. However, we believe that commerce and banking should not be allowed to mix in the wholesale fashion permitted under the unitary thrift concept. It is noteworthy that both Federal Reserve Chairman Greenspan and Treasury Secretary Rubin have now testified in support of prohibiting the chartering or purchase of thrifts by commercial companies going forward.

If the current unitary thrift situation ­ which allows any commercial firm to enter the banking business merely by buying a thrift ­ is not addressed soon, commerce and banking will certainly be mixed. For example, Microsoft or General Motors could buy a small thrift with what would amount to them as spare change. Note also that such a small thrift could then be merged with a very large bank, as long as the resulting institution were run as a unitary thrift.

This is a critical point ­ there is almost no difference between a thrift and a bank today. The tax incentive for thrifts to engage in housing finance has been eliminated, and the Qualified Thrift Lender test has been steadily eroded to the point where the great majority of commercial banks in the country qualify, or could easily qualify with minor asset adjustments, as thrifts. The only real difference is the ability to hold large commercial loans; but even this can be circumvented by selling off those loans or by setting up a commercial finance affiliate.

Thus, if Congress passes financial modernization without addressing the unitary thrift issue, it is highly likely that our country will have permanently crossed the bridge to full banking and commerce. In a very short time, we will almost certainly see large commercial firms owning large banks. These banks will technically have thrift charters, but for all practical economic purposes, they will be banks.

In fact, since discussions in Congress began regarding the possibility of closing the unitary thrift option, interest in acquiring and chartering unitary thrifts has intensified. Seventy non-depository firms ­ including some large manufacturing companies ­ either have an application pending or have already been granted a thrift charter. (See Table 1 for more details).

The Parallel Banking System

The unitary thrift issue raises concerns even beyond the mixing of banking and commerce. As I noted above, there is little practical difference between a bank and a thrift. Yet there is a big difference in how their holding companies are regulated. In particular, the Office of Thrift Supervision (OTS) focuses its supervision on the subsidiary thrift, while the Federal Reserve imposes supervision at the holding company level. Most importantly, the Fed imposes capital requirements on bank holding companies, while there is no such requirement on thrift holding companies.

Failure to deal with the unitary thrift holding company issue would mean that Congress will have blessed two parallel banking systems, one with much stricter regulatory standards than the other. Economic theory tells us that resources will flow into firms with more regulatory advantages and out of those with less regulatory flexibility. Some day soon, the OTS could even supplant the Federal Reserve as the principal "umbrella" regulator of our banking system.

In the past, the unitary thrift holding company had not been used much because the thrift crisis and the deposit insurance premium differential tarnished the thrift charter. However, this is no longer the case, in large part as a result of thrifts recapitalizing the Savings Association Insurance Fund (SAIF) and commercial banks assuming a large share of the FICO obligations. Moreover, liberalization of the Qualified Thrift Lender test has also enhanced the usefulness of the charter by permitting thrifts to engage in a wider variety of banking services. The applications from non-depository institutions (noted in Table 1) clearly show the renewed interest in unitary thrift holding company charters. Over time, particularly with commercial interests taking advantage of the unitary thrift approach, billions of dollars will flow to that side of the parallel banking system.

Table 1

Unitary Thrift Charter Applications

as of December 31, 1998

Securities Brokerage/Investment

Paine Webber Group, Inc.

Legg Mason Inc.

Advest Group*

A.G. Edwards, Inc.*

Merrill Lynch & Co., Inc*

The Capital Group Companies, Inc.

T. Rowe Price Associates

Franklin Resources Inc.

Morgan Keegan Inc.

Fidelity Investments

Everen Capital Corporation

SMR Corporation

Manufacturing & Other Companies

Ford Motor Company (Manufacturing: Auto)

Archer-Daniels-Midland (Manufacturing: Agriculture)*

Hillenbrand Industries, Inc. (Manufacturing: Coffins, Urns)*

Temple-Inland, Inc. (Manufacturing: Paper and Forest Products)

Farm Bureau (Trade Group for Farmers and Agricultural Interests)

General Motors Corporation (Manufacturing: Auto)

Excel Communications, Inc. (Telecommunications)*

B.A.T. Industries/Imasco (Tobacco)*

UKROP's Super Markets, Inc. (Supermarkets)*

Deere, Co. (Manufacturing: Ag Equipment)

AGI (Miscellaneous/Marketing)

Other Nonbank Financial Companies

First Alliance Mortgage Company (Mortgage Co.)*

Partners First Holdings, LLC (Credit Card)

American Express Company (Diversified Financial)

First American Financial Company (Finance Company)

Insurance Companies

State Farm Mutual Auto Insurance Co.*

American International Group

The Hartford Group

Aid Association of Lutherans*

Sun America, Inc.

CCC Holdings, Inc.*

Equitable Companies Inc.

American General Corporation

TIAA Board of Overseers*

Allstate Insurance Company*

AmerUs Group Company

Grange Mutual Casualty Co.


New Jersey Mfg. Insurance Co.

CNA Financial Corporation

First American Trust

Lumbermens Mutual Casualty Co.

Metropolitan Life Insurance Co.

ReliaStar Financial Corp.*


Aetna, Inc.

GUARD Insurance Group, Inc.

Guardian Life Insurance Co.

INA Holdings Corporation

Washington Mutual, Inc. *

Peyton Financial Service Corp.

National Association of Mutual Ins. Co.

Nationwide Insurance Enterprises*

New York Life Insurance Co.

Shelter Mutual Insurance*

AAA/Auto Club Services, Inc.

Massachusetts Mutual Life Insurance Co.

Polish National Alliance

American Sterling Corporation

Greentree Financial Services

Some unitary thrifts have argued that to prohibit sales of thrifts to commercial companies deprives them of franchise value. However, to allow sales, even if new charters are prohibited, means that any commercial company can enter the banking business by purchasing a small existing thrift. Subsequently, that thrift can then be expanded via acquisition of other banks or thrifts. In other words, a prohibition on sales is necessary to make any unitary restriction meaningful.

Furthermore, existing thrifts could still be sold to any bank, thrift, securities firm, insurance company, or other financial firm. There would be thousands of potential buyers. Finally, the reason that the thrift charter has become of such great interest to commercial firms is largely because Congress acted in 1996 to greatly reduce thrifts' SAIF and FICO premiums in the future and to liberalize the thrift charter to closely resemble a bank charter. Note that almost every commercial firm that has chartered or bought a thrift plans to run it as a bank, not a traditional mortgage-focused thrift. Yet, that same 1996 legislation contained a trade-off ­ a commitment that the thrift charter and unitary issue would be addressed in the next Congress. These are the two sides of the same coin. Some unitary thrifts, however, want to just keep the benefits of the BIF/SAIF legislation ­ which made the charter attractive to commercial companies ­ while ignoring the other side of the coin ­ a commitment to addressing the unitary issue.

IV. Operating Subsidiaries

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.

This principle of "freedom to choose" has led us to historically support the operating subsidiary approach. The choice of organizational structure will clearly vary from company to company. Some banking firms will choose to offer some products and services through holding company affiliates; others may find it more efficient to use an operating subsidiary of the bank; and some others may choose to provide some products, where permissible, directly through the bank. Why different banking firms choose a particular structure is not what is important. What is important is that they have 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. In addition to these benefits, there are some important public policy benefits of allowing banks to conduct new activities in an operating subsidiary. For example, the bank subsidiary structure creates stronger and more stable institutions; is less costly and less complex; is more user-friendly for most community banks; will make U.S. banks more competitive in world markets; and, as community groups have pointed out, will keep resources in the bank for purposes of the Community Reinvestment Act (CRA).

I would like to elaborate a bit on the very important issue of safety and soundness. Under an operating subsidiary structure, the earnings of the subsidiary flow directly to the bank. This means that conducting new activities in an operating subsidiary will help to diversify the bank's income stream. This diversification will lower the risk profile of the bank, reducing the probability of failure and the potential risk to the deposit insurance fund.

The importance of an operating subsidiary for bank safety and soundness was articulated in a joint article by former FDIC Chairmen Helfer, Isaac, and Seidman. The article (which is attached to my testimony) states:

The big difference between the [operating subsidiary and holding company affiliate] comes when the activity is successful, which presumably will be most of the time. If the successful activity is conducted in a subsidiary of the bank, the profits will accrue to the bank.

Should the bank get into difficulty, it will be able to sell the subsidiary to raise funds to shore up the bank's capital. Should the bank fail, the FDIC will own the subsidiary and can reduce its losses from the failure by selling the subsidiary.

If the company is instead owned by the bank's parent, the profits of the company will not directly benefit the bank. Moreover, should the bank fail, the FDIC will not be entitled to sell the company to reduce its losses.

Requiring that bank related activities be conducted in holding company affiliates will place insured banks in the worst possible position. They'll be exposed to the risk that the affiliates will fail without reaping the benefits of the affiliates' successes.

Moreover, offering nontraditional financial products and services does not increase the risk profile of the bank, regardless of whether these activities are conducted in an operating subsidiary or a holding company affiliate. Let me cite a few examples. First, banks already engage in a variety of securities and insurance activities, some within the bank or operating subsidiary and some through the holding company. None of these activities has led to safety and soundness problems.

Second, U.S. banks have successfully offered a variety of financial services (including securities and insurance underwriting) in foreign markets through branches or bank subsidiaries for many years. These activities have not led to safety and soundness problems.

Third, strong safeguards are already in place. There are strict regulatory limits on capital investment, terms and conditions of credit extensions, and other transactions between banks and their subsidiaries. In addition, FDIC can impose additional capital requirements for institutions engaging in non-traditional activities. The SEC, the security exchanges, and the security industry self-regulatory organizations also impose financial adequacy regulations, affiliate transaction requirements, standards of conduct, and reporting and examination requirements on securities firms.

As you are well aware, Mr. Chairman, the issue of operating subsidiaries was a major stumbling block to efforts to reform our financial system in the last Congress. We would not want this to impede the process this year, and we hope that a reasonable approach can be found that will bridge the gap in this area. We note that Treasury Secretary Rubin recently took an important step in bridging the gap when he indicated support for provisions on this issue in a bill put forth by Representative LaFalce. Mr. Chairman, you have also made a valuable contribution to the debate by putting forth the concept of additional flexibility for banks under $1 billion in assets. This approach could be helpful to small banks wishing to engage in joint ventures. We pledge to work to achieve an agreeable approach that can help move this legislation forward.

One concept that may not have received adequate consideration is a proposal originally advanced by the Treasury Department in its 1997 draft legislation. This proposal, as amended in the House Banking Committee, would impose certain financial requirements on banks wishing to engage in underwriting activity in an operating subsidiary. For example, the bank must be well-capitalized (e.g., 10 percent risk-based capital-to-assets ratio) after deducting its capital investment in the operating subsidiary. This imposes a capital restriction on all banking institutions regarding the size of the underwriting subsidiary they can operate. In many cases, these requirements make it a practical necessity to use a holding company structure rather than an operating subsidiary when the underwriting entity is large relative to the bank.

If one runs the numbers on the larger banks, securities firms, and insurance companies, the practical result of these requirements is that no bank ­ no matter how big ­ will be able to acquire a significant underwriting entity through an operating subsidiary, but rather would have to run it through the holding company.

V. Conclusion

Mr. Chairman, the goals of financial modernization are to strengthen our entire financial system and to promote more competition to the benefit of consumers. Whatever financial modernization bill is finally enacted will form the framework for our financial system for decades to come. And history has shown us that once new rules are in place, they are very difficult to change. Simply put, the financial structure that is ultimately put in place here must be done carefully and correctly, or it can have severe long-term consequences.

As a banker, I understand the importance of financial modernization. I need the ability to offer new products and services in order to meet the needs of my customers. At the same time, we strongly urge the Committee to address the unitary thrift issue as part of this legislation.

Last year, remarkable progress was made. Industry groups, which have debated modernization for so long, even reached a consensus on key issues. We are so close that we should move forward now, as this Committee is doing. While contentious issues remain, we believe we can work with the leadership of the insurance and securities industries, and with the Congress, the regulators and Treasury to achieve a balanced product with broad support. The ABA pledges to work to that end.

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