Hearing on Financial Services Modernization

Prepared Testimony of Mr. John Finneran
Senior Vice President and General Counsel
Capital One Financial Corporation

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

Mr. Chairman and Members of this Committee, my name is John Finneran. I am a Senior Vice President and the General Counsel of Capital One Financial Corporation, headquartered in Falls Church, Virginia. I appreciate the opportunity to testify today on behalf of the Association of Financial Services Holding Companies (the "Association"), of which Capital One is a member. The Association is a non-profit organization of approximately 45 member companies with combined assets in excess of $1 trillion. Its members are holding companies that own commercial banks, insurance companies, thrifts, credit card banks, non-bank banks and industrial loan companies as well as a diverse group of non-depository affiliates.

Since we began business as a separate company in 1994, Capital One has been one of the fastest growing, most successful companies in the United States. Through its subsidiary credit card bank and thrift, Capital One has become one of the world's largest issuers of credit cards and a direct marketer of consumer and small business lending products. We are also a pioneer in the direct marketing of wireless telephone service through our subsidiary, America One Communications, Inc.

As of the end of 1998, Capital One had $17.4 billion in managed loans outstanding and nearly 17 million customers in the United States, Canada and the United Kingdom. We have over 10,500 employees based in Virginia, Texas, Florida and the U.K.

In each of the last four years, Capital One surpassed its goals of achieving annual earnings growth and annual return on equity of at least 20%. In 1998 alone, we added nearly 5 million net new customers and are currently adding new customers at an astounding pace of 20,000 net new accounts a day. To support that account growth, our Company hired 4,500 more employees during 1998 and expects to hire at least 3,500 additional employees in 1999 across all of our sites.

On behalf of the Association and Capital One, I want to thank you, Mr. Chairman, for offering your draft proposal. It is a narrowly tailored bill which accomplishes meaningful financial modernization without undermining important existing regulatory safeguards or the ability of an institution to choose the most efficient way to conduct its business and to pursue marketplace innovations that will benefit consumers. I especially want to offer our appreciation and support for the decision to retain the status quo with regard to the unitary thrift holding company structure. Unlike recently introduced legislative proposals from the House and measures from the last Congress, your bill would achieve true modernization, providing for a repeal of Glass-Steagall and other antiquated barriers without imposing unnecessary artificial restrictions on the range of activities engaged in by unitary thrift holding companies. In sum, your bill would enhance flexibility, increase global competitiveness for U.S. financial institutions, and increase innovation and competition for the benefit of consumers in the U.S.


In the last Congress, there was much debate about the ability of unitary thrift holding companies to engage in non-financial activities. Lost in that debate, however, was any appreciation for the regulatory framework that ensures the safety and soundness of thrifts and tightly controls any and all relationships between thrifts and their non-financial affiliates. Also overlooked were the real benefits to consumers that can come from the unitary structure.

When Capital One applied for its thrift charter in 1995, we went through an application process that is substantially identical to the application process necessary to establish a de novo bank. Before granting our application, the Office of Thrift Supervision (the "OTS") had to be satisfied that, among other things: we had a sound business plan; we provided for adequate capital and reserves; we had capable and experienced management; and the thrift's business would be conducted separately from that of its affiliates. Our thrift, like all other thrifts, is prohibited from making any loans or extending any credit to its non-bank affiliates. The OTS has examination and supervisory authority over both our thrift and our holding company. In the annual safety and soundness examination process, the OTS examines not only the thrift, but also each of the affiliates to satisfy itself that the non-bank activities pose no threat to the thrift.

We established the thrift to bring a greater array of financial services to consumers. In addition to consumer credit cards, our thrift presently offers deposit products, unsecured consumer loans, and credit cards to small businesses. Our goal is to build one of America's premier consumer franchises by offering the best products available in the marketplace in each customer segment. We "mass customize" our products to individual needs. We now offer literally thousands of product variations and have created more choice, wider access to credit and lower borrowing costs for many consumers and small businesses. The thrift is an important part of our ability to continue to expand our product offerings and is a vital component of Capital One's future growth.


The history of the affiliation issue is directly tied to the history of the thrift industry itself. In exchange for foregoing a diversified asset base and focusing on residential lending, thrifts received certain benefits such as the bad debt loss reserve incentive and membership in the Federal Home Loan Bank System. Among the benefits conferred by Congress was the right to affiliate with non-bank entities through the thrift holding company structure. Although certain of these benefits have been eliminated over the years, and additional requirements have been applied to thrifts to narrow and strengthen thrifts' consumer finance focus, Congress has steadfastly continued to recognize the benefit of retaining the affiliation rights for thrifts.

The safety and soundness record of unitary thrift holding companies suggests that there is no reason for Congress to deviate from this long-standing position. Specifically, there is no record of any thrift failure that has resulted from the existence of the affiliation authority. In sum, the 35 years of experience with commercial affiliation has not presented any serious safety or soundness concerns.

The strong safety and soundness record no doubt in part results from the extensive requirements imposed by Congress and the OTS on unitary and multiple holding companies. First, federal thrifts are prohibited from making any loans or extending credit to commercial affiliates not engaged in activities permissible for bank holding companies. Second, thrifts are subject to a Q.T.L. requirement that 65% of assets be in mortgages, mortgage-related investments, education and certain consumer and small business loans. The OTS also imposes minimum capital requirements on subsidiary thrifts as well as restrictions on dividends and other capital distributions. There are additional regulations to further ensure the safety and soundness of unitary thrift holding companies and subsidiary thrifts. These include:

Our experience at Capital One offers compelling evidence that the operation of a thrift holding company and its affiliates are subject to extensive regulation. As I mentioned earlier, both our thrift and the holding company are subject to the examination and supervisory authority of the OTS. In addition, our credit card bank is regulated by the Board of Governors of the Federal Reserve System and the State of Virginia's Bureau of Financial Institutions; our credit card bank's U.K. operations are not only regulated by the Federal Reserve and Virginia Bureau but also by the bank regulatory agency in the U.K. -- the Financial Services Authority; and our Canadian operations are subject to a variety of Canadian federal and provincial regulatory schemes. All of these regulatory bodies examine Capital One for safety and soundness as well as compliance with consumer protection laws and regulations.

Notwithstanding the existence of these strong institutional safeguards, in the past several weeks the long-standing opposition to the thrift charter from certain industry groups has resurfaced. In continuing to advocate elimination of what they characterize as the "unitary thrift loophole," these parties have re-asserted that the affiliation authority allows for an unhealthy mix of "banking and commerce." The use of the term "loophole" ignores the extensive legislative debate that took place thirty five years ago which resulted in the carefully crafted grant of affiliation authority for savings and loan holding companies in exchange for a commitment to residential and consumer lending. This structure has since been reaffirmed by the Congress in every major banking bill.

These detractors refuse to acknowledge the long-standing fundamental distinctions between the thrift charter and the commercial bank charter, most notably that thrifts are prohibited from lending to commercial affiliates. As Director Seidman noted in her testimony to the House Banking Committee on February 12, 1999, "this prohibition serves as an absolute limitation on a thrift's ability to engage in the types of affiliate commercial lending that are at the heart of the concern about mixing banking and commerce." In addition, as referenced above, only 20% of a thrift's assets, half of which must be in the form of small business loans, may be applied to commercial lending. The additional requirement that 65% of thrift assets be devoted to mortgages, mortgage-related investments, education, and certain consumer and small business loans, further distinguishes thrifts from traditional commercial bank lending activities. In short, it is entirely unfounded to argue banking and commerce concerns in the same context as commercial affiliation rights of unitary thrift holding companies.

Some critics of financial modernization are concerned that further mixing of financial services and commerce, in any form, could result in a less stable financial structure, one vulnerable to an "Asian" type of banking crisis. In fact, there is little similarity between the banking structures in Asia and the United States. The crisis in some of the Asian countries (and elsewhere) resulted from an unhealthy linkage between government and banking, and unsound bank lending practices undertaken to carry out governmental industrial policies and practices.

Many of these failures are also attributable to the absence of an effective regulatory system, such as bank-level capital requirements, and uniform accounting standards. Perhaps most importantly, many of these financial institutions were not subject to the pervasive safety and soundness requirements and regular careful scrutiny by experienced regulators as all financial institutions are here in the U.S. In sum, the "Asian experience" is in no way relevant to U.S. savings and loan holding companies' operations and activities.


The case for leaving intact the current law governing unitary thrift holding companies does not rest solely on the positive safety and soundness record. During times of economic hardship, the unitary holding company structure has been a valuable source of capital, benefiting the thrift industry and ultimately, taxpayers. In February, 1995, the Association commissioned an independent study of the thrift holding company experience. That study found that the preponderance of evidence suggests that commercial firms should continue to be permitted to acquire control of thrifts. The study further showed that access to capital reduces the likelihood of failure and that a holding company can reduce portfolio risk and reduce sensitivity to similar economic cycles by affiliating with commercial firms. Finally, the study demonstrated that non-bank or commercial activities reduce the likelihood of failure by a holding company.

The conclusion of the study was best illustrated by the thrift industry experience during the 1980's. In the face of dramatic thrift losses, several commercial firms made investments which prevented even larger losses to the thrift insurance fund and expedited the recovery process. Director Seidman, in her recent testimony before the House Banking Committee, noted that over $3 billion was infused into 79 failed thrifts by commercial firms during this period. This investment was especially important because the commercial banking industry was unable or unwilling to provide the capital. The ability of these diversified commercial entities to acquire thrifts substantially benefited the industry, the SAIF, which insures the deposits of its customers, and ultimately the taxpayers.

The unitary thrift holding company model also provides substantial consumer benefits. As Director Seidman noted in her testimony to the House Banking Committee, "competition has been enhanced as existing thrifts and new entrants have provided more choices for consumers through innovative products and new service delivery systems." Furthermore, customers with multiple accounts with holding company affiliates can be treated as a single customer relationship thereby improving operating efficiency, reducing costs and reducing customer information errors. This is particularly important for low and moderate income customers who traditionally have found it more difficult to obtain a full range of financial services from multiple providers.


In conclusion, Mr. Chairman, we are grateful for your recognition that a narrow, focused piece of legislation offers the best model for modernization. Your proposal addresses pressing marketplace needs, and advances the goals of increased efficiency, global competitiveness, and operational flexibility in a regulatory context that assures continued safety and soundness and consumer protection. Your proposal also maintains the current savings and loan holding company structure that has served American consumers for 35 years. Thank you for the opportunity to testify and we look forward to working with you and the other Members of the Committee on this important legislation.

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