FINANCIAL INSTITUTIONS RESTRUCTURING

AND SERVICES ACT OF 1981

TUESDAY, OCTOBER 20, 1981

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,

Washington, D.C.

The committee met at 9:30 a.m., in room 4302 of the Dirksen Senate Office Building, Senator Jake Garn (chairman of the committee) presiding.

Present: Senators Garn, Chafee, Schmitt, Proxmire, and Dixon. The CHAIRMAN. The committee will come to order.

Today we start the second day of hearings on S. 1720 and other bills incorporated in the legislation introduced a couple of weeks ago.

We are happy to have before us Llewellyn Jenkins, president, American Bankers Association, and Robert L. McCormick, first vice president, Independent Bankers Association of America. Mr. Jenkins, would you like to begin.

STATEMENT OF LLEWELLYN JENKINS, PRESIDENT, AMERICAN BANKERS ASSOCIATION, ACCOMPANIED BY LEE GUNDERSON, IMMEDIATE PAST PRESIDENT, AMERICAN BANKERS ASSOCIATION, CURRENT CHAIRMAN, ABA COUNCIL

Mr. JENKINS. I am Llewellyn Jenkins, president of the American Bankers Association and vice chairman of the board of the Manufacturers Hanover Trust Co. of New York City.

I am accompanied by Mr. Lee Gunderson, on my right, immediate past president of the ABA and now chairman of the ABA Council and president of the Bank of Osceola, Wis.

Thank you for placing my full statement in the record. In my brief oral presentation, I will confine myself primarily to comments on title I, parts A and B. These portions of the bill, in effect, would authorize thrift institutions to operate as if they were banks.

We commend the chairman for attempting to resolve a number of seemingly unrelated issues that in most instances clearly do point in the same direction-the opportunity for depository institutions to compete more effectively in the new competitive environment of the financial services industry.

Prior to addressing the issues involved, it is important to mention the overriding issue which if left unresolved will frustrate any attempts to address the items raised in the legislation.

The efforts this committee has put forward in securing recent budget reductions is well known and commendable. Progress has been made. The current signals from the Congress are, however, quite discouraging.

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Further reduction in spending are essential. It is also vital that the Congress live up to its commitments made in the budget resolution adopted in July.

To combat the ever-widening budget deficit, our Nation can either print more money, tax its citizens and businesses ever more, or reduce the rate of spending. The latter answer is the only one that can ever lead to long-term economic stability and growth. We urge the chairman and the members of the committee not to waiver in the determination to win this specific battle on inflation. All other issues pale in significance, and essentially are tied to this fundamental issue.

Further reduction in spending are essential. It is also vital that the Congress live up to its commitments made in the budget resolution adopted in July.

To combat the every-widening budget deficit, our Nation can either print more money, tax its citizens and businesses ever more, or reduce the rate of spending. The latter answer is the only one that can ever lead to long-term economic stability and growth. We urge the Chairman and the members of the committee not to waiver in the determination to win this specific battle on inflation. All other issues pale in significance, and essentially are tied to this fundamental issue.

Our association testified earlier this year on the need for legislation to address many of the items in S. 1720. We are pleased that much of what was identified in the prior hearings as necessary for banks to maintain competitive viability and get costly and unnecessary Government interference out of the middle of every banking transaction is in S. 1720.

The new issues in S. 1720 relate to the matter of dealing with current and perceived future earnings and competitive problems of the specialized thrift institutions. It is our conviction that unless banking gains competitive equity with the near banks of the securities industry, attains broader lending and investment powers, and gets feed of state-imposed usury ceilings and due-on-sale prohibitions, it is of marginal value to give the specialized thrifts more bank-like powers.

Many of these issues have been patiently awaiting resolution for many years. Changing the powers of the specialized thrifts as proposed in S. 1720 is a relatively new matter.

NEW AND CONTROVERSIAL MATTER

Another new and controversial matter, Mr. Chairman, is contained in S. 1721, the bill proposing consolidation of the Federal Deposit Insurance Corporation, the Federal Savings and Loan Insurance Corporation, and the National Credit Union Administration's Share Insurance Fund.

The American Bankers Association cannot support S. 1721 at this time. Similar proposals were made in 1963 and in 1972, and on both occasions the ABA did not agree that consolidation was needed or would be good public policy.

We realize that conditions have changed since 1972, and further changes in the financial environment are occurring daily. We respectfully request, however, that committee action on S. 1721 be deferred until there has been additional opportunity to thoroughly

consider the need for and ramifications of this proposed consolidation. Bankers are concerned about the impact that the consolidation might have on the current FDIC fund created by assessments on banks. More data are needed and justification must be established before this proposal is acted upon.

Title I of S. 1720 would expand substantially the authority of specialized thrift institutions on both the asset and liability sides of the balance sheet. In addition, S. 1720 would facilitate conversion of specialized thrift institutions from State to Federal charter and from mutual to stock form of organization.

It is important to recognize that this proposed expansion of thrift powers will do nothing in the near term to offset earnings problems. It does nothing about the low-yielding mortgages currently held in thrift portfolios.

To utilize many of the additional powers granted in S. 1720, specialized thrifts would have to enter entirely new markets in which they currently have no experience. This would require substantial investments in personnel and customer relationships which will not begin generating profits for some time.

The competitive nature of the markets which specialized thrifts would be allowed to enter, and their lack of expertise in these markets makes it likely that at least some specialized thrifts will initially incur substantial losses.

Thus, expansion of specialized, thrift institution powers will involve a period of negative cashflow for the expanding institutions, further exacerbating their immediate earnings problems. Even if it were concluded that expansion of specialized thrift institution powers might reduce the likelihood of a future recurrence of earnings problems, it would be important to postpone expansion of such powers until specialized thrifts are better able to handle the temporary negative cashflow that is likely to result.

Nevertheless, we believe controlled expansion of specialized thrift institution powers could help solve their problems and deserves further study.

However, because expansion of specialized thrift institution powers as proposed in S. 1720 will not help and, in fact, may aggravate their current earnings problems, there is no need to act on this legislation in a crisis atmosphere.

The broadened authority to offer variable rate mortgages will allow specialized thrift institutions to share interest rate risks with borrowers. Ability to trade financial futures provides the potential for them to reduce their interest rate risk. Thus, legislative action should await study of several serious issues relating to the longrun effect of such an expansion of their powers. These include competitive equity among depository institutions, the safety and soundness of the financial system, and the structure of regulatory agencies. It should also be recognized that an important part of the socalled thrift problem has nothing to do with their competitive position vis-a-vis banks and, hence, will not be changed by altering the laws and regulations that govern that position. I am referring to the competitive problem that all depository institutions have visa-vis nondepository institutions.

Other parts of S. 1720 address some of the restrictions that have created this problem. However, another important aspect of this

problem, a faster and more equitable liberalization of regulation Q ceilings, can only be resolved by the Depository Institutions Deregulation Committee. A faster elimination of longer term ceilings affecting consumer certificates of deposit and a short-term deposit instrument competitive with money market funds are what is needed most.

Any support the Congress could give depository institutions on these issues would be welcome.

An important goal of recent financial institution legislation is competitive equity among financial institutions. It has been recognized that such competitive equity is a prerequisite for the efficient operation of financial markets.

EXAMPLE OF INEQUITY

The expansion of specialized thrift institution powers proposed in S. 1720 is a step away from competitive equity. It would provide specialized thrift institutions with some authority, such as the ability to invest in corporate debt securities, not available to commercial banks. More importantly, it would provide specialized thrift institutions with all the powers of a commercial bank without subjecting them to equivalent restrictions. For instance, specialized thrifts would enjoy more liberal branching privileges in many States than commercial banks offering the same financial services.

A flagrant example of the inequity which would result by enactment of the proposals of Chairman Pratt and the administration is the fact that specialized thrifts would continue to be able to exploit an interest-rate differential on certain types of deposits during the phaseout of interest rate ceilings.

The chairman of the Federal Home Loan Bank Board and the leadership of the thrift industry have done everything in their power to frustrate the scheduled phase out of regulation Qas agreed to in last year's legislation. If interest rate ceiling discrimination ever had a justification, it was based on the theory of specialized financial services pitted agaist full financial services.

In addition to the issue of competitive equality, the expansion of specialized thrift institution powers proposed in S. 1720 raises a serious issue of the safety and soundness of our financial system. An important tool for insuring the safety and soundness of our financial system is the capital requirements imposed on depository institutions.

Banks have higher ratios of capital to assets than specialized thrift institutions of similar size. The level of capital needed to insure the safety and soundness of financial institutions is currently the subject of considerable debate. However, if considerations of safety and soundness require commercial banks to meet certain capital adequacy standards, then other institutions offering the same services should be required to meet the same standards. Moreover, the mutual form of organization used by most specialized thrift institutions eliminates protections offered by the stock form of organization used by commercial banks. Bank regulatory agencies frequently require commerical banks to raise additional equity to bolster the safety and soundness of the institutions and

support asset growth. This regulatory tool is not available to regulators of mutual institutions.

It should also be recognized that the mutual form of organization in certain instances offers definite competitive advantages. Mutual organizations do not have to face the discipline of raising external equity capital and do not have to pay the dividends need to do so. They either pay regulated rates to their depositors or rates determined in competitive markets that also discipline stockholder's institutions.

The balance of their earnings are retained to support the growth of the institutions or the income of their managers. They are subject to none of the disclosure requirements and marketing requirements needed to attract external equity capital. These requirements are important disciplines to managerial performance. We believe the Congress should proceed cautiously before creating a system of institutions with full bank powers without bank responsibilities.

EVALUATING BENEFITS OF EXPANSION

In evaluating the long-term costs and benefits of the expansion of specialized thrift institution powers, an alternative to the approach taken in S. 1720 should be considered-namely, allowing conversion to a commercial bank charter. Our association cannot fully commit to support this option at this time. However, it is an option that would allow for a fair and rational liberalization of the powers restrictions that govern thrift institutions. We are currently involved in a careful exploration of this option will all our policymaking bodies. While this option could create other problems that need additional study, it would insure competitive equity among institutions offering the same services and would prevent the proliferation of bank regulatory agencies.

Some proponents of the expansion of thrift institution powers brush aside considerations of competitive equity, the safety and soundness of the financial system and the structure of regulatory agencies to argue that this legislation should be enacted merely because it will increase earnings of these institutions in the future. Some proponents have even argued that this legislation is needed to deal with their immediate earnings problem.

For reasons described above, immediate expansion of specialized thrift institution powers could lead to any significant improvement in earnings. Moreover, several important steps have already been taken to deal with the long run problem.

Thus, expansion of specialized thrift institution powers, such as included in S., 1720, should not be considered in a crisis atmosphere. Legislative action on this portion of S. 1720 should be postponed pending further analysis of the issues raised above-particularly consideration of the option to qualify for and convert to a national bank charter.

In summary, title 1, parts A and B, of S. 1720, Mr. Chairman, are very controversial-so controversial that, if unchanged, they may arouse opposition from homebuilders, realtors, and large segments of the banking community. It would be most unfortunate if these controversial proposals were to result in defeat or delay of the entire bill.