Our proposed bank holding company securities subsidiary would have the same tax treatment as an independent securities firm, the same regulators and the same access to outside financing and outside customers. In contrast, leaving securities activities submerged within the corporate structure of a commercial bank as S. 1720 presently does would afford the bank several advantages in the securities business. The bank's securities activities would have preferential tax treatment, particularly as regards the carrying of securities in inventory; they would be regulated by the Federal bank regulatory agencies for which securities activities are only a limited aspect of bank business; they would have access to financing based on the cost of the bank's insured deposits; and they would have opportunities for the non-arms length linkage of traditional bank services to the securities business of the bank. There are too many inequalities here to satisfy the goal of equal treatment for all financial institutions doing the same kinds of business.

We are prepared to submit legislation to implement our securities subsidiary concept, Mr. Chairman. In addition, we are prepared to make a study, within two years after the effective date of the law, regarding the impact of these new bank securities activities and to determine what additional activities might be appropriate.

BANK HOLDING COMPANIES

Recent events have brought into sharp focus the fact that the financial services market is growing rapidly and that many companies are broadening the range of services they offer to business and the consumer. Increasingly, this is a direct challenge to banks and bank holding companies whose range of possible financial services is restricted by regulation. I believe that the time has come to permit bank holding companies to compete more fully with the many firms which are now entering the financial services market.

One important advantage of offering new financial services through a bank holding company rather than a bank is its ability to separate new functions from the traditional business of banking. This can be important if the new functions have or are perceived to have a greater element of risk. We must recognize, Mr. Chairman, that banks are different from other institutions in that a substantial portion of the funds they receive are deposits insured by a Federal government agency. This gives banks an inherently lower cost of funds and also requires us to be circumspect in permitting banks to take risks which go beyond traditional banking practice. It is not appropriate for depository institutions to be taking on business with substantially

increased risks while enjoying insurance by the Federal government designed for institutions taking much less risk. If new functions are set apart from the bank itself in a holding company subsidiary the bank is insulated from these risks but may still carry on its customary business of accepting deposits and making loans.

Insofar as the greater risks of new activities can be separated from the risks of traditional banking business, we would support additional activities for bank and thrift holding companies beyond those now permitted. For example, Mr. Chairman, the thrift industry would like to make direct investments in real estate, as distinguished from mortgage loans, to make use of its expertise and experience in local real estate. This, of course, would create a quantum of additional and different risks for these insured institutions. We would have no objection if Federally chartered thrift institutions were given this authority, provided that all direct investments in real estate were made through a holding company subsidiary and that commercial banks, through a holding company subsidiary, were given the same authority. In this way, the entity of which the thrift institution or bank is a part could increase its earnings and improve its financial condition, without endangering the safety of the thrift institution or bank or increasing the risks to the Federal deposit insurance fund and uninsured depositors.

This is but one example of a service which could be offered by a holding company--in direct competition with other kinds of enterprises--without subjecting the insured institution which is its subsidiary to risk. In a very real sense this approach will create the "level playing field" on which all institutions that offer financial services can compete while recognizing the uniqueness of depository institutions in our current financial system.

OTHER MATTERS

Now, Mr. Chairman, I would like to comment briefly on S. 1721 and on some other sections of S. 1720.

S. 1721 To Combine the Federal Deposit Insurance Funds

The idea of consolidating the three Federal deposit insurance agencies expressed in S. 1721 has considerable merit, although it seems premature until we have made some progress expanding the powers of thrift institutions. We would like

to work with the Congress in exploring this proposal at a later date. As the powers of all depository institutions

become similar or the same, it seems inappropriate to have three separate insurance agencies. The objectives and financial activities of the three should be the same.

Depository Insurance of Retirement Accounts

We strongly oppose any increase in Federal deposit insurance, including the increase from $100,000 to $250,000 for retirement accounts contained in S. 1720. Deposit insurance coverage for all accounts was raised from $40,000 to $100,000 only last year. That increase extended insurance coverage to all retail deposits (generally defined as those under $100,000). A further increase at this time would, in effect, extend coverage to depositors who should be able to make investment decisions without reliance on deposit insurance and who should, by their actions, influence risk-taking by depository institutions. The discipline uninsured depositors bring to the business of commercial banks and thrift institutions is important.

Preemption of State Usury Ceilings

The Depository Institutions Deregulation and Monetary Control Act of 1980 preempts state usury ceilings on mortgage and commercial loans, if state legislatures do not reinstate the ceilings for their states within three years from the effective date of the Act. We favor preemption of usury ceilings for all loans in the manner prescribed in the Deregulation Act, as proposed in S. 1720. In our opinion, usury ceilings only distort financial markets and credit flows and do not reduce the cost of credit in the economy.

Banking Affiliates

We support the proposed revisions of Section 23A of the Federal Reserve Act so long as they are not expanded to give member organizations of a bank holding company more favorable treatment than organizations outside the holding company. This is a significant issue given our proposed reliance on bank holding companies for arms-length treatment of securities and other subsidiaries.

Exemption from Reserve Requirements

We favor exempting depository institutions with less than $5,000,000 in deposits from reserve requirements, if the dollar amount of deposits necessary to qualify for the exemption is increased by 100% of the percentage increase in

total depository institution deposits, rather than by 80% as contained in the proposed legislation. This change should lift an unnecessary burden from small institutions.

International Banking Facilities

The Administration favors the establishment of domestic international banking facilities free from FDIC deposit insurance and assessment; however, we believe the debate concerning the assessment of foreign deposits for FDIC insurance has merit and should continue.

Insurance Activities of Bank Holding Companies

The Administration opposes the restriction of bank holding company insurance activities as contained in S. 1720. We believe this would be an anticompetitive move contrary to our objective of equal treatment for all financial institutions.

Technical Provisions

There are several provisions of S. 1720 that are more technical in nature and can best be developed by the Congress and the regulatory agencies. Where we have special concerns regarding these provisions we will communicate our views at a later date.

Mr. Chairman, in closing I would like to thank the Committee again for offering me this opportunity to present the Treasury Department's and the Administration's views on issues relating to the financial system, issues about which I feel very strongly. I would also like to thank you, Mr. Chairman, for all of the work you have done in arranging these hearings and preparing this legislation. We would like to work closely with the Congress to secure passage of this legislation.

Mr. Chairman, that concludes my testimony. I will be pleased to answer any questions the Committee may have.

The CHAIRMAN. Thank you, Mr. Secretary.

I welcome your comments as far as going beyond this legislation. To be more specific about that, to a general review of Glass-Steagall and McFadden. That is something that I stated before, that it is not possible to get into that general review this year. I do intend to do that right after the first of the year, at the start of the second session of the 97th Congress. I'm pleased that the administration will be ready at that time to submit their comments and be prepared to testify on a much broader review of Glass-Steagall and McFadden.

So I appreciate your testimony on that.

Mr. Secretary, this past Friday afternoon, you announced that DIDC would consider postponing the half percent increase in the passbook account rates. I welcome that statement by the administration. I am one who participated in the creation of H.R. 4986 and the 6-year phaseout of Reg Q. I was one who favored a faster phaseout than the 6 years that we provided, however, when we did set up DIDC, the statement of the managers and the conversation at that time with regard to safety and as rapidly as economic conditions warrant.

So although I still favor the continued deregulation and as fast a phaseout as possible, I did feel that the timing of the 50 basis point increase was not helpful to the thrift institutions. It increased their cost of money without really giving them any additional competitiveness. A difference between 5 and 6 certainly didn't make them competitive with money market funds.

So I was going to question you at great length on that activity. I am sure you have preempted the entire committee from asking you many questions on that by your statement of Friday. I think I can speak for at least a majority of the committee, that we are pleased with your statement and the activity that you propose to take in that area.

Would you like to make any comments at this point?

CROSS CURRENTS IN THE ALL SAVERS CERTIFICATES

Secretary REGAN. Thank you, Mr. Chairman. I might explain just a little bit my thinking and why the change of mind, at least temporarily. First of all, there are an awful lot of cross currents going on in the market for all savers certificates and other deposits, that I don't think anyone in the country understands at the present moment. I have tried to contact leading thrift institutions as well as commercial banks, and many of their industry organizations. And no one yet has a good handle on how much of this is new money. We were quite surprised that at least initially a lot of this money was not coming out of money market funds. That was contrary to expectations of most of us as to what the source of these funds would be.

Therefore, it seemed prudent to back off on any change in passbook ceiling rates until we find out where the all saver certificates money actually is coming from. If, indeed, a great deal of it is coming from passbook savings, then there is no need for this increase in the ceiling rate, because it will not suffice to accomplish our purpose, which is to make passbook savings more competitive