Hearing on Financial Services Modernization

Prepared Testimony of Mr. Jeff Tassey
Senior Vice President
American Financial Services Association

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

The American Financial Services Association (AFSA) appreciates this opportunity to express our views on the modernization of the U.S. financial system. Below is a brief description of the Association and its members followed by the association's views on financial modernization as requested by the Committee.


AFSA members are market funded lenders with over 10,000 offices in the U.S, providing over 20 percent of all U.S. consumer credit. Market funded lenders operate through a wide range of affiliations in a variety of corporate structures. Our members include industrial companies, diversified financial services firms, retailers and bank-owned finance companies.


AFSA strongly supports the Committee's efforts to start a process that will lead to a comprehensive overhaul of the balkanized financial services structure. The goal of these efforts should lead to a system in which markets and consumers will determine what financial services are available and how they are delivered while promoting the substitution of private capital for government regulation.

AFSA urges the Committee to take the broadest, most comprehensive approach to modernization possible, particularly in the areas of holding company regulation and affiliations. Ideally, we urge the Committee to support affiliations between insured institutions and all financial and commercial entities. We feel that these affiliations can safely take place among separately capitalized affiliates in a functionally regulated holding company structure.

The Draft

The Draft removes restrictions imposed almost 70 years ago by Glass-Steagall pertaining to affiliations among financial services firms. While these restrictions have eroded over the years through regulation and court decisions favoring insured institutions, it is nonetheless vital that the last vestiges be removed in order to streamline and fully level the playing field for other financial services providers such as securities and insurance firms.

Additionally, the Draft simplifies affiliations among firms engaged in activities that are financial in nature. Regulators are provided with authority to define activities that are financial in nature to meet changes in technology and the marketplace. This provision alone would open the door to substantial new activities which are today considered commercial in nature. These could include a full range of telecommunications and information services activities. This could also permit the sale and manufacturing of related hardware. While AFSA supports these opportunities for banks and financial firms, reciprocal provisions should be included for commercial firms. These reciprocal provisions are currently included in the undecided portions of the Draft.

In terms of holding company regulation, the Draft makes a genuine effort to provide for functional regulation of the various affiliates of the bank holding company. The draft attempts to limit the ability of the Federal Reserve Board (The Board) to supervise affiliates already adequately or appropriately supervised by such entities as the SEC or state authorities. The Board is required to rely "to the fullest extent possible" on reports filed with other regulators and to limit direct examinations of the affiliates. Nevertheless, in the final analysis, the Federal Reserve has the authority to require any report and conduct any examination deemed necessary. While these provisions are somewhat of an improvement over the current regulatory scheme, AFSA urges the Committee to consider other regulatory models and the experience of the commercial paper markets outlined below.

Undecided Issues

Two of the undecided issues are extremely important to AFSA members. Over a ten-year period, the Draft would gradually permit a bank holding company to increase its non-financial activities to a maximum of 25 percent of its revenues. This provides certainty for AFSA's predominately financial members which either currently do, or may in the future, engage in non-financial activities.

The second undecided issue would permit AFSA's commercial members to acquire a single national bank, thereby becoming a unitary bank holding company. This provision would permit a commercial firm to own a national bank only if the bank's revenues and assets did not exceed 25 percent of those of the commercial firm. This provision restores a limited, but long overdue opportunity for commercial firms that wish to affiliate with a bank. Until 1956, there were no restrictions on bank holding companies and commercial affiliations. Until 1970, a "one bank holding company" with commercial affiliations was permitted. It is time to address these structural imbalances. AFSA does not, however, agree that the Federal Reserve should have regulatory authority over the commercial parent.

The Unitary Thrift

The Draft does not affect the right under current law for a commercial firm to own a single savings association. AFSA strongly supports current law and is strongly opposed to any attempts to curtail this type of affiliation. These institutions have proven successful and are currently the primary means (credit card banks are very limited) through which a commercial firm can affiliate with an insured institution, although the charter is limited to consumer lending.

Competitive Equality Banking Act

AFSA strongly supports the inclusion in this legislation of relief from the restrictions temporarily imposed on limited purpose banks by the Competitive Equality Banking Act of 1987. Relief from these restrictions has been included in every version of modernization considered by the Congress since 1995, and was included in the version of H.R. 10 adopted by the Senate Banking Committee last year. The relief should include lifting the out-dated restrictions on engaging in new banking activities and cross-marketing, and permitting the acquisition of certain loan portfolios. Adoption of this legislation would not permit these institutions to become full-service banks and would not in any way reduce the authority of the regulatory agencies to assure that they are operating in a safe and sound manner.


In general, AFSA supports the Draft with the inclusion of the two undecided issues mentioned above. While the draft's approach to affiliations is clearly significant progress, AFSA respectfully urges the Committee to revisit the issue of holding company regulation as discussed more fully below. The risk assessment model established by the Market Reform Act of 1990 is superior to having the Federal Reserve as an umbrella regulator without regard to the structure of a particular holding company.


The examination and reporting requirements for a diversified financial services holding company pose a particular challenge that is best met through reliance on the principals of functional regulation as opposed to the extension of various forms of current bank regulation to non depository affiliates of the holding company. Using the Market Reform Act of 1990 (the "Act") as a model, AFSA feels that it is possible to protect the insured depository institution from any material risks posed by the activities of other affiliates. The best means of controlling risk to the insured affiliate is both through proper "insulation" between holding company affiliates and by ensuring sufficient capital levels in the bank such that it can remain solvent regardless of the failure of any affiliates. Deference should be given to the reporting and examination requirements of the functional regulators. Duplicate examinations, especially when the examining entity has little expertise in a given activity, and duplicate reporting requirements are serious burdens, which add little to safety and soundness. It is perfectly feasible to mandate cooperation among functional regulators and to provide safeguards in the event that a regulator is somehow unable to examine an entity or obtain appropriate information.

As with the various financial modernization proposals, the Act was ultimately prompted by changes in the financial markets, particularly their internationalization. As part of their efforts to obtain capital and to compete globally, large securities firms under went a variety of structural changes. These included the formation of holding company structures where many activities were distributed into affiliates that prior to the Act were not subject to direct regulatory oversight but carried some potential risk to the regulated broker-dealer. The SEC did not feel that it had adequate information to set broker-dealer capital requirements to ensure that the broker dealer was protected from the failure of an affiliate(s). The Act was a response to these concerns and has worked well to address these concerns while respecting the role of the primary functional regulator of each affiliate and avoiding duplicate examination and information requirements. There is no reason to believe this model cannot work for a holding company that includes an insured institution and AFSA urges the Committee to fully consider and endorse this holding company oversight model.


The affiliation issue is at the root of AFSA's support for financial modernization. As indicated at the beginning of the testimony, AFSA represents an extremely diverse group of lenders, primarily market funded and accordingly subject to intense scrutiny and regulation by the markets. A great many of these entities have a wide range of affiliations which include some type of federally insured institution. Virtually all of these affiliations have been in existence for some time with varying degrees of anticompetitive functional constraints imposed by federal law and regulation. There has never been any evidence that any of these entities pose systemic or deposit insurance risk as they go about their business of providing more than 20 percent of all consumer credit.

AFSA strongly supports the ability of commercial firms to own or otherwise affiliate with such a holding company. The issue of mixing banking and non-financial commerce has become an overblown philosophical issue when it really is at most a competitive inequity susceptible of legislative solution. The prohibition on banking and commerce has always been shot through with exceptions - especially at the small bank level - and none of these exceptions - at least at the level of significant publicly owned corporations - have given rise to any problems, let alone problems that would justify the federal prohibition. Thousands of individuals own banks - large and small - who also own many and varied commercial interests, none of which are subject to the same holding company affiliation restrictions and oversight as banks owned by corporate entities. It is difficult to understand why individuals should not be subject to the same banking and commerce restrictions as corporate owners, if the proximity of banking and commerce truly is a mortal threat to the banking system. If it is harmful for bank and commercial entities owned in the commercial form to affiliate, and AFSA does not think that it is, then the same restrictions should apply to the thousands of wealthy individuals who freely mix banking and commercial enterprises.

The primary argument postulated against banking and commerce is that such a holding company form would result in large concentrations of economic resources, in addition to having the potential for conflicts of interest between the bank and the non-bank entities that would pose undue risk to the bank and the federal deposit insurance funds.

AFSA believes this argument has little merit, especially in the context of the global marketplace in which our financial services industry now competes.

Concentrations of economic resources are far more likely to occur in small towns where, as described above there is only one bank owned by an individual who also owns other major economic units such as the local independent insurance agency, car dealer, feed store, etc. Economic concentration, particularly in today's global market, is not just size but size in relation to the market in which the entity operates. A very large institution, operating nationally and internationally, is subject to competition at every size level, from the smallest independent bank to the largest Japanese bank.

Size alone should not be an indicator of concentration and should not determine holding company activity restrictions. Size in a domestic market is a problem only if that market is protected from competition or if market forces are otherwise weak. The types of domestic financial institutions permitted by the draft and other proposals have the potential to be larger than any heretofore able to exist. In today's global financial services market, at least some larger institutions are a necessity. While AFSA feels that expanding financial affiliations is beneficial to our international competitiveness, we don't feel that the benefits of modernization should stop at this point.


AFSA's expertise is primarily in the area of consumer lending, but from that vantage point, we would like to make some general observations as to how our financial services markets have evolved to their present state.

Our present financial services system is strictly regulated as regards to the banking component. Banking, at least in theory, is tightly compartmentalized from other types of financial and nonfinancial business. The objective of this intensely regulated structure is to control the risk exposure of individual banks so as to protect their safety and soundness, thereby, at least in theory, maximizing the stability of the whole system.

The stability of the system is also substantially predicated on government sponsored deposit insurance, which provides an additional reason for regulatory barriers and tight risk standards. The depression era Glass-Steagall Act and the Bank Holding Company Act are the two statutory components of the risk control structure. The ultimate consequence of these statutory barriers is that almost no corporations other than existing banks or bank holding companies are permitted to purchase a bank or start a new bank. Existing banks are therefore protected from competition with other business corporations. This barrier against corporate entry is designed to reduce specific risks by screening out potential competition.

This comfortable structure began to be rocked by revolutions in financial markets resulting in the bypassing of the banks traditional credit role through the use of securities and commercial paper markets to borrow directly from investors. Additionally, the securitization of assets such as loans also worked to change the functional role of banks, which through Glass-Steagall were excluded from participation in these activities.

The Glass-Steagall and Bank Holding Company Act compartments have always had exceptions, and the changes discussed above increased the erosion of the Glass-Steagall barriers. Additionally, a small number of grandfathered, diversified lenders are not covered by Glass-Steagall and the Bank Holding Company Act. Although they still suffer under significant restrictions imposed by the Competitive Equality Banking Act of 1987. Some grandfathered foreign banks also conduct a wide range of activities. In other words, the securities, nonfinancial commerce and banking compartments have both been breached, but not in any organized or rational manner. Furthermore, the so-called diversifieds and unitaries have breached the commercial compartment. Again, many of the grandfathered foreign banks also have commercial operations.

The practical impact of this compartmentalization is to severely restrict capital mobility. (1)

The capital resources of financial corporations have two main components -- financial capital and organizational capital. Financial capital is usually easily transferable. Overall, our financial markets work well in transferring financial capital from one area of business to another.

If this were the only form of capital of concern in the financial services industry, then we would not have a capital mobility problem.

However, there is also the less tangible but equally vital concept of organizational capital. There is no way to represent this "going concern" value on the balance sheets, but there is no doubt that this is a major factor in the value assigned to publicly held corporations in the equity markets. (2)

When an industry incurs a narrowing of the profit opportunities available to it, such that new capital could earn a better return elsewhere and profitability on existing capital investment is below average, then most businessmen and investors try to shift at least some of their capital into other, more profitable lines of business.

When the capital cannot be shifted, competition becomes more intense, profit declines and less successful firms suffer losses with the result that the value of capital invested in that industry is reduced. there is little doubt that Glass Steagall and the Bank Holding Company Act combined with our whole system of regulation constitute significant barriers to capital mobility and have greatly contributed to the problems in the banking industry over the past decade.

The best example of this concept had its beginning in the 1970's when the commercial paper market grew rapidly, attracting corporate customers whose borrowings had been a major source of stable earnings for the banks. The commercial paper market in turn was made possible by the advent of uninsured money market mutual funds. Banks could neither participate in the commercial paper market, nor could they offer money market mutual funds.

As a result they were forced to replace safe corporate loans that paid a good return with much riskier loans that paid a higher return. We know how this worked out. In 1991 the banking committee was forced to both recapitalize the bank insurance fund and to impose even stricter safety and soundness regulations on insured institutions.

If our system had provided for an orderly exit (3) of organizational capital at that time, banks would have been able to follow their customers to the commercial paper market and some of the problems banking encountered would have been avoided. Capital is not a one way street - once it gets into a particular sector, it must also be able to exit in an orderly manner.

All of the proposals currently under consideration address the specific problem outlined above in terms of permitting banks to be involved in the underwriting of products such as commercial paper while also allowing banks to be involved in insurance and securities activities.

The question is whether to stop at this point, or permit additional affiliations between commercial firms and insured institutions. No proposal currently under consideration addresses the overriding question of deposit insurance, which is the primary reason financial modernization, is a federal legislative issue to begin with.

The problem with stopping at this point is that the system remains compartmentalized; one of the compartments has been enlarged, but there are still legal and regulatory barriers to full capital mobility. No one envisioned or predicted the advent of the commercial paper market; who is to say that the next major advance in financial products will not come from the insurance industry or from a completely nonfinancial lender. It is virtually impossible to legislate ahead of the market. Where there is federal regulation substituted for market discipline, serious distortions in economic behavior will occur.


Fundamental Characteristics of Market Funded Lenders

A review of the commercial paper market (4) and the finance industry may help illustrate why it is necessary to remove all barriers to capital mobility and these affiliations are not only not a systemic risk, but actually contribute to safety and soundness.

The fundamental difference between market funded lenders and banks is the nexus of their relationship with local communities. Banks' relationships with their local communities emanate from their deposit base. Market funded lenders enter local communities through their lending activities, funded by the capital markets.

In the typical banking model, a bank generates funding for its lending activities from deposits gathered by local offices. It then lends these funds locally or, if local demand is not sufficient or the bank elects to focus outside the community, the bank lends in other markets, buys securities, or places the funds in the federal funds markets (i.e., lends to other banks throughout the nation).

Clearly, there are exceptions to this pattern, especially among larger, wholesale oriented banks. (5) Nevertheless, in the context of consumer lending, this model gives a good picture of the funding and lending dynamics of the banking industry.

The model for the typical market funded consumer lender is, in a sense, opposite. These companies raise their funds in global capital markets by issuing commercial paper and medium and long term debt. To reduce their cost, their commercial paper is often backed by bank back-up lines of credit, the same way that non-financial corporations rely on bank back-up lines of credit to enhance their credit ratings; this is really the only way banks can participate in the commercial paper market of the market funded consumer lending industry.

As in the case of the banks, there are exceptions to this model, but again, it is a good representation of the funding and lending dynamics.

What these models show, very simply, is that banks generate funds locally, largely from consumers and small businesses, to lend inside or outside the local market, while market funded lenders raise funds worldwide to lend into local consumer and small business markets. This fundamental difference between the two groups is the basis for many of the institutional distinctions between them.


The performance of publicly traded banks, thrifts, and market funded lenders is followed closely by the capital markets. Their debt securities are rated by the rating agencies such as Moody's, Standard and Poors, and Fitch. However, there is a key difference between depository institutions and market funded lenders. If the markets lose confidence in a bank or thrift, the institution can still operate by raising deposit funds. In the 1980's, numerous banks and thrifts continued to operate even though their market ratings were well below investment grade. In contrast, if the markets lose confidence in a market funded lender, it may no longer have the ability to fund its activities and to grow - it must shrink and ultimately may be forced to close.

Because the maturity of commercial paper is so short, 270 days or less, issuers usually expect to roll it over at maturity rather than pay it off . However, they may obtain a higher rating for their debt by providing additional insurance that they have liquid funds available in the event that conditions change and they must repay their paper otherwise, the issuers may obtain back-up lines of credit for a fee from banks, although this practice is decreasing. It is important to note that the actual risk of loss to banks is extremely low. the bank's role is to be ready to provide liquidity, but may want to restructure in most back-up arrangements they can restructure the debt to secure their interest should the issuer face financial difficulties. Even that is unlikely, since only high grade corporations are accepted commercial paper issuers. In particular, the finance company issuers have high levels of capital which protect the banks against potential losses. Further, many finance company obligations are guaranteed by strong parent companies. Commercial paper defaults have been extremely rare, as have failures of finance companies.

The Westinghouse Credit Corporation is a good example of how the market resolved a potential problem. As a result of large loan write offs in the early 1990s, Westinghouse Credit experienced large losses. The company lost its credit rating and could no longer issue commercial paper; the credit rating of the parent company was impaired and it was forced to downstream capital to the finance company. The company drew down its lines of credit at about 50 foreign and domestic banks. These lines were restructured into secured lines. The liquidation was quick, orderly, and without crisis. Throughout the process, the parent, Westinghouse Electric, stood behind the debt of its subsidiary.

As the Westinghouse example illustrates, it is absolutely critical to market funded lenders that they be well regarded by the market. It is in that sense that the market regulates their financial viability. This regulation of safety and soundness is swift, with no excuses.

The Westinghouse example is one where the subsidiary impaired the parent and the subsidiary was forced to shrink and close. However, market discipline works in the opposite direction as well. There have been several instances where the manufacturing parent of the finance company encountered financial difficulty and received an impaired credit rating. Even though the subsidiary finance companies were doing extremely well, they were forced to shrink significantly. The Federal Reserve has been trying to implement a similar "source of strength" doctrine for banks and the bank holding company for some time. The market is considerably ahead of it, even with all of the bank regulatory improvements that have been made since 1989.

Not mentioned in the above discussion on commercial paper's impact on bank lending is the most interesting part - the fact that consumer and commercial finance companies are the largest issuers of commercial paper with over $392 billion outstanding as of year end 1993 and that these proceeds from the market are used to fund lending. Who are the finance companies, what kind of lending is being funded and why aren't banks doing it?

The modern finance industry consists of a varied group of market funded financial institutions. Ownership is especially diverse, including: industrial and other nonfinancial companies, banks, non bank financial companies as well as independent finance companies. Many companies engage in both commercial and consumer finance. In 1990, the combined assets of the twenty largest firms totaled $426 billion or 82 percent of the industry's overall assets. Of the top twenty companies, twelve do both commercial and consumer finance.

In virtually all cases, finance companies carry significantly heavier capital burdens and do not have deposit insurance. In 1990, capital ratios for the top 20 companies ranged from a low of 8.4 percent to a high of 27.7 percent. Capitalization for finance companies is at least partially dependent upon asset quality and size.

Finance companies traditionally concentrate on loans secured by tangible assets and have the greatest success in niche markets where they are well established and have specialized expertise, whether it is in commercial aircraft leasing or second mortgage lending to consumers.

This is why finance companies are generally not in head to head competition with banks, but instead compete by offering services that substitute for bank credit in markets not served by banks. Banks are not prohibited from engaging in any of these types of lending but they choose not to do so, substantially in part because they are federally insured institutions with a regulatory environment that tries to protect the deposit insurance funds by tightly controlling risks, and hence controlling types of lending.

This is as true for an activity such as equipment leasing as it is for second mortgage loans to individuals. These specialized niche markets place a premium or specialized information and practical experience which place new lenders at a disadvantage short of acquiring a finance company engaged in a particular niche. For an insured institution it is particularly difficult to overcome this lack of knowledge and experience. Federal bank examiners will not tolerate the rate of losses and attendant demands on capital it takes to enter one of these niche markets. Additionally, once in the market, lenders are still exposed to higher risks than regulators of insured depository institutions would deem prudent, especially in light of congressional pressures in recent years.

To summarize the situation, on the one hand, the banks have lost a substantial amount of commercial lending to the commercial paper market while on the other hand, participants in the commercial paper market are using the proceeds obtained from the sale of commercial paper to fund lending that banks are not prohibited from doing, but choose not to do, largely because of their regulatory culture. In other words, on one side there is a structural impediment to bank activities, while on the other side there is a cultural and regulatory impediment to such lending. It should be noted that banks do not have to lend; they can invest their insured deposits in treasury bills and are even rewarded for doing so by risk based capital standards.

Finance companies must lend; otherwise, they cannot provide the rate of return that the commercial markets require. A finance company that is not lending will shrink, and must increase its capital and pay more for funds. Moreover, finance companies carry out this lending with a high degree of safety and soundness despite having affiliations with commercial firms and insurance companies.

AFSA believes that its members, who again are primarily market funded, have a wide range of affiliations and offer an excellent illustration of the effectiveness of market regulation for the commercial ownership of financial institutions. AFSA regrets that the debate on financial modernization has not yet focused on both the issue of how more market regulation can be injected into the federally insured part of the financial system, and who should close weak or failing insured institutions - the markets or the regulators.

AFSA believes that the experience of financial institutions funded in the commercial paper market provides a blueprint for increased competition and availability of financial products. It also provides a rapid, highly effective discipline of unsound risk-taking that combined with an exit mechanism for weak or failing institutions only impacts shareholders and management without significant systemic risk.


The fundamental difference between banks and market funded consumer lenders explains the dramatic difference in incidence and resolution of failures of the two groups of institutions. Banks are funded primarily through deposits. As the experience of the 1980's clearly illustrates, banks can continue to maintain and even increase insured deposits while the quality of their assets is severely deteriorating.

The S&L debacle gave an even clearer picture of how insured depository institutions can grow despite severe asset quality problems. At some point, the bank's liabilities may even exceed the true value of its assets. When this occurs, the regulators must close or merge the bank. The regulators' goal is to protect the deposit insurance fund from losses. Therefore, the regulators primary focus must be on ensuring the safety and soundness of the banks to avoid their failure and potential losses to the insurance fund. If the bank's assets are not sufficient to cover the insured deposits, the difference must be made by the FDIC's bank insurance fund. Insured depositors funds must be protected, by law.

In contrast, the failure of a market funded lender is borne solely by its shareholders and debt holders. Neither its customers, nor the government, nor the tax payers are directly affected.

Second, the market typically requires that the market funded lenders hold more capital relative to assets than banks. As of year end 1993, the medial ratio of equity to assets for bank holding companies with assets of $10 billion or above was 7.95%. The median for the largest 20 publicly held finance companies (ranked by total capital) in 1993 was 11.97%.


A finance company's credit rating depends not so much on its own capitalization as on the existence of a parent and the perceived capital strength of that parent. Some of the strongest parents are commercial or industrial firms. Financial ties to such parents often help raise a finance company's credit ratings and thus lower its borrowing costs, a benefit of ownership that is not institutionally available to commercial banks.

In assigning credit ratings, the rating agencies in effect set capital adequacy guidelines for finance companies. In these guidelines, the agencies take important account of the parents' strength and the financial ties between parents and subsidiaries. When the parent is rated higher than the finance company, rating agencies look for mechanisms that protect the subsidiary in the event of parent stress.

These mechanisms may include attorney's letters and debt covenants limiting the capital a parent may take out of a subsidiary. On average, a subsidiary receives a somewhat higher rating than its parent because the financial ties are designed to enhance the finance company's rating rather than its parent's.


As demonstrated earlier in the testimony, it is the sensitivity to the financial condition of both the parent and financial subsidiary combined with the ability of the market to act quickly, without discretion, that makes market regulation so effective and gives lie to so many of the doomsday scenarios when an insured institution is thrown into the mix. In a financial services structure comprised of separately capitalized affiliates, most of whom are market regulated, it is difficult to see the risk to the insured institution, especially when combined with a well constructed "capital bear down" provision. The rating agencies and markets are going to be well aware of the liability of the holding company and its uninsured affiliates to the insured institution; this will be reflected in the capital ratios and debt ratings for the market funded firms in the holding company. The reaction of the market to any problems in any of the affiliates, particularly the insured affiliate since the market will know that the liability to the insured affiliate is virtually unlimited while the liability of the insured affiliate to the others is nonexistent.

The goal of financial modernization should be to squeeze excess deposit insurance out of the system and replace government regulation with market discipline. To the extent that certain functions must be conducted in insured institutions, ownership of these institutions should not be restricted.

The other reason deposit insurance must be addressed is because it has provided the nexus for a whole host of regulation that has nothing to do with safety and soundness, but instead is designed to fund a host of social programs. As budget funds for new programs are very scarce, and almost no old programs are cut, many interest groups are searching for private income streams that can be nationalized for social purposes. Deposit insurance has provided the basis for all of these. It is important to take advantage of the opportunity the Committee has before it to reduce to the maximum extent of this exposure.


AFSA strongly opposes the termination of the right to form unitary thrift holding companies under the same conditions as permitted for existing unitary thrift holding companies. There is no evidence that the abolition of the current affiliation rights of unitary thrift holding companies serves any public policy. Indeed, AFSA believes that the abolition of the unitary thrift holding company will not lead to any increase in safety or soundness for financial institutions. It simply abolishes a useful alternative form of holding company and creates an artificial market for existing unitary thrift holding companies by arbitrarily abolishing the creation of additional unitary thrift holding companies.


Under current law a unitary thrift holding company (i.e., a holding company which controls only a single savings association) may have separately capitalized affiliates which engage in any form of business or commercial activity. This business or commercial activity may not occur in the thrift itself. The provision was enacted in 1987 as a means of attracting additional capital to the thrift industry.

Unitary Thrifts Are Predominantly Limited to Consumer Lending --
The Type of Ownership is Irrelevant

One of the concerns constantly raised about unitary thrift holding companies is that they "mix banking and commerce". Commercial firms, it is said, will use their power to control the lending process to bend consumers and borrowers to their will. The experience with unitary thrift holding companies does not remotely bear this out. An examination of the actual periods of time during which commercial firms were affiliated with a savings association show that most of the firms held their thrifts for periods ranging from two to five years. If the combination of commerce with thrifts was so powerful and profitable, the affiliations should have not only continued, but grown.

Under current law, a commercial firm could today buy the largest thrift, securities firm, mutual fund and insurance company. None have chosen to do so for the reason that it makes no business sense. Commercial firms that buy a thrift almost invariably already have a market funded lending facility and purchase a thrift because they think that it may assist them in meeting the needs of their customers, who are consumers as opposed to businesses. It is important to remember that thrifts are limited almost entirely to consumer lending and the majority of that lending has to take the form of mortgages. Again, the vast majority of commercial firms that purchase thrifts are already engaged in consumer lending. There is virtually no conceivable systemic or other risk posed by consumer lending, especially given the restrictions that these institutions operate under.

The majority of commercial firms that have purchased thrifts have acquired those with assets under $1 billion, hardly a pattern which will result in commercial financial behemoths. Nor is it the case that the acquired thrifts then grow to excessive size. Nearly all of the affiliated thrifts have either shrunk or remained approximately the same size. Institutions of this size, particularly in an environment of increasing consolidation outside unitary thrift holding companies, present no threat of economic coercion to borrowers.

In addition to all of the restrictions imposed on the affiliate relationships under Sections 23A and 23B of the Federal Reserve Act, unitaries are fully regulated by the Office of Thrift Supervision. Unitary thrifts owned by large commercial firms have not posed any unique, or for that matter, any regulatory problems. During the peak of the Savings and Loan crisis, there were no failures among thrifts owned by large commercial entities. To the contrary, commercial acquisition of failing thrifts saved the government a considerable sum of money. Banking and commerce did not seem to constitute such a problem at that time.

Unitary Thrift Holding Companies Prove that Commercial Ownership Works

AFSA sees unitary thrift holding companies as proof that banking and commerce is not a real issue. In the past eleven years, commercial firms have not come to dominate the thrift industry. This gives lie to the fears that commercial firms will somehow dominate the banking industry if permitted to acquire banks. At a minimum, AFSA supports continuing the experiment by allowing additional firms to obtain unitary thrifts. There is not even a shred of evidence that large scale acquisition of thrifts by commercial firms will occur. The few additional acquisitions that will occur only serves to reinforce the proposition that affiliations between commercial companies and insured depository institutions are beneficial to American taxpayers and consumers.

Consumers Benefit from Unitary Thrift Holding Companies

The Office of Thrift Supervision recognizes the advantages that unitary thrift holding companies provide consumers. According to its background paper, Holding Companies in the Thrift Industry, commercial companies that have purchased healthy thrifts since the last banking crisis have done so because these thrifts "offer some" synergy "between the thrifts' customers and the customers of the commercial firm." Affiliations between thrifts and other companies provide several advantages including financial advantages, managerial advantages and customer service advantages. Some examples of advantages include offering the firms' financial products to the thrifts customers, or allowing thrift customers to conduct financial transactions through the firm's existing distribution systems, such as grocery stores.

Prohibiting the creation of additional unitary thrift holding companies would eliminate any opportunity to expand these services to consumers served by more firms. The result would be to prohibit increased competition for existing unitary thrift holding companies. It is that


AFSA would like to see the removal of all barriers to competition and the free flow of capital combined with intensive market regulation of financial services activities. It is important to take this opportunity to end the substitution of bureaucratic regulation for private capital in insured financial institutions and to remove excess deposit insurance from the system. Some limited form of deposit insurance is useful to protect certain vulnerable classes of individuals and for systemic reasons, but there is no question that there is too much deposit insurance today. Thank you again for this opportunity to express our views.



2. I.D.




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