Statements to the Congress.

Statement by Susan M. Phillips, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions and Regulatory Relief of the Committee on Banking, Housing, and Urban Affairs, US Senate, May 2, 1995

I am pleased to be here today to discuss S.650, the Economic Growth and Regulatory Paperwork Reduction Act of 1995. The Board welcomes its introduction and supports its purpose of relieving costs imposed on our nation's banking system by governmental regulation when those costs are not offset by corresponding benefits to the safety and soundness of our nation's financial institutions, the protection of bank customers, or the availability of credit.

In my testimony today, I will discuss the Board's efforts to reduce the cost of regulation and why we believe that legislation is necessary to continue those efforts. I will then address those portions of the bill that make major changes to laws administered by the Board, particularly in the area of bank and branching applications, where I believe the bill would significantly reduce burden, and in the consumer area. Finally, I will highlight provisions about which the Board does have concerns. Still, I do not wish these objections in any way to detract from the central message of my testimony: that the nation's banking system needs legislation of the type presented by S.650.

Appended to my testimony is a brief summary of the Board's comments on certain provisions that are not discussed directly in my testimony.(1)

THE ROLE OF REGULATION

Banking regulation has clearly defined purposes. They include protecting the federal safety net and thereby the taxpayer, preserving a strong banking system, minimizing the destabilizing effects on the economy caused by any difficulties in the banking system, providing consumer protection, and ensuring that communities are served by our banking system.

Such regulation, however, cannot succeed if it is designed to eliminate at any cost the possibility of any bank failure--either a financial failure or a failure to serve customers. Rather, banking regulation must aim to produce at a reasonable cost the banking system that can best serve our economy and the American people. Each requirement, restriction, application, and report imposed may individually be justified at the time of adoption, but collectively the amount of regulation created over time may become a significant obstacle for the community banker and, equally important, someone hoping to start a community bank.

The aggregate burden on our nation's banks has become substantial, raising the cost of banking services and thereby encouraging customers to seek less costly loans and services or higher yielding investments from other financial intermediaries that are not subject to the same regulatory requirements. Furthermore, our banks must operate in increasingly competitive financial markets, both domestic and global. The United States can ill afford to handicap its banking institutions with unnecessary and dysfunctional regulation. The Board believes the time has come to reexamine each of our banking statutes and regulations and decide whether its benefits are commensurate with its costs. The Board believes that there a're restrictions in current banking law that cannot pass this test. To address this problem, the Board advocates not only burden relief of the type provided by S.650 but also reform of anachronistic statutes such as the Glass-Steagall Act, which needlessly and significantly hinders the ability of U.S. banking organizations to compete in their home market. We encourage the full committee to take up the matter of Glass-Steagall reformn promptly. The recognition that regulatory burden must be reduced is not new at the Board. Since 1978 the Board has maintained a formal program of regulatory review and simplification, and in 1986 the Board established a Regulatory Planning and Review office, charged with ensuring that regulatory proposals minimize the burdens imposed on those that must comply. The Board has long believed that significant reductions can be made in regulatory burden by eliminating requirements that are redundant or have outlived their usefulness.

The Board has redoubled these efforts in recent years. For example, we have streamlined the applications process by shortening processing times, substituting a notice requirement for an application whenever possible, waiving applications for transactions reviewed by other regulators, and reducing the paperwork that must accompany applications and notices. These changes have reduced both the volume of paper that must be filed by notificants and the time required for the Board to review nonbanking proposals. Of the more than 3,500 applications and notices acted on during 1994, 94 percent were completed within the Board's self-imposed sixty-day target, with the average period of review lasting thirty-four days. In other areas, the Board has worked within the limits of its governing statutes to expand the list of permissible nonbanking activities for banking organizations, to remove unnecessary, outdated restrictions on the conduct of these activities, and to eliminate restrictions that prevented banking organizations from providing discounts to their customers on packages of products.

I have attached to my testimony a more complete list of our initiatives to reduce unnecessary regulatory burden over the past three years.

THE NEED FOR LEGISLATIVE CHANGE

There is a limit, however, to how far we or the other banking agencies can go in rationalizing the regulation imposed on our nation's banks. Although we speak of "regulatory" burden, that term is something of a misnomer. The Board must operate within statutory constraints, and all of our regulations are either required by statute or are necessary to explain or implement a statute. Put simply, we have no choice but to regulate, and in some cases to overregulate.

S.650 provides the type of statutory changes that would allow a reduction in regulatory burden in many areas without adversely affecting safety and soundness or other important supervisory and policy concerns.

Applications

One of S.650's important reforms, from the Board's perspective, comes in the applications area, where S.650 would eliminate federal regulatory review for routine bank acquisitions and branch openings by well-capitalized and well-managed banking organizations that are helping to meet the credit needs of their communities. The Board's experience in administering these statutory requirements over the past thirty-nine years leads us to endorse these initiatives very strongly.

Currently, the Bank Holding Company Act requires that all bank holding companies obtain Board approval before acquiring control of another depository institution or merging with another bank holding company. The bill would eliminate this application requirement for proposals that raise no serious competitive issue and are made by bank holding companies that met specified standards for capital, management, and community reinvestment at their previous examination. The vast majority of proposals processed by the Board meet these requirements and are routinely approved. Thus, we believe that the cost of continuing the applications process in such cases is unnecessary from any public policy perspective. The bill not only would make the applications process simpler, less burdensome, and more transparent for qualifying banking organizations but also would provide a powerful incentive for banking organizations to achieve and maintain strong capital positions, solid management, and a commitment to the community.

In a similar vein, S.650 would eliminate branch applications for banks that meet the specified capital, management, and community reinvestment standards. The cost of these applications, which are routinely approved by all the agencies, is not justified when the applicant is well-capitalized, well-managed, and serving its community. Furthermore, S.650 would eliminate branch applications for automatic teller machines (ATMs) in all cases. The law defining a branch to include an ATM for this purpose is simply an anachronism. Together, these two changes would eliminate the need for a substantial number of branch applications filed with the banking agencies.

Finally, S.650 would eliminate or modify other applications requirements whose benefits no longer justify their costs, including applications for investment in bank premises and determinations that a bank holding company does not control shares of stock that it divests to certain companies.

The Board supports these changes and, indeed, believes that the bill should go further still. We believe that the provisions in the bill eliminating the application process for acquisitions by well-managed and well-capitalized banking organizations need to be extended to routine proposals involving nonbanking activities (such as mortgage banking or securities brokerage) that the Board has already determined to be permissible. The application requirement places bank holding companies increasingly at a competitive disadvantage with other companies that face no similar federal review requirement. We estimate that adoption of this proposal could reduce the filing of notices to engage in nonbanking activities by 60 percent or more. The reduction in burden associated with all the changes made by S.650 and recommended by the Board would be substantial.

Lastly, we believe that the bill should be amended to eliminate a hearing provision for nonbanking applications, given the ample opportunity afforded all parties to make written submissions.

CONSUMER REFORMS

S.650 contains numerous amendments to the consumer protection statutes administered by the Board. Although time does not permit me to discuss each of these provisions, I will mention those of particular importance to the Board. First, section 236 of the bill would reduce the number of institutions required to report the Home Mortgage Disclosure Act data by raising the asset level at which reporting is mandatory from $10

million to $50 million. The Board believes that this step would provide important relief to our nation's community banks without undercutting the goal of the act.

Second, the bill makes a variety of changes to the Community Reinvestment Act (CRA) that, collectively, would affect the way the banking agencies administer that act. Some of these changes are directed at concerns the agencies addressed in their recently revised CRA regulations, such as the exemption for small banks. That multiyear effort recognized that the burden imposed on small institutions needed to be reduced and focused on making the CRA evaluation process more objective, performance-based, and predictable. Before changing the rules in this area once again, we believe that the Congress should pause to consider whether the agencies' efforts will achieve the objectives of S.650 in this area. Furthermore, the prohibition on additional reporting would leave the agencies unable to carry out the mandates of the act through their recently adopted regulations. We believe that if an agency is assigned a responsibility, it should also be granted the tools necessary to fulfill its mandate.

S.650 also contains CRA reforms not addressed by the agencies' recent efforts, particularly incentives for CRA performance. Section 133 provides that any institution that receives a "satisfactory" or outstanding" rating is deemed, for purposes of the applications process, to have met the purposes of the CRA in regard to community credit needs. The Board endorses the concept of providing incentives to institutions for good CRA performance. As the Board has previously testified, however, it is important to differentiate in the offering of incentives between institutions whose performance may be barely satisfactory and institutions whose performance is close to outstanding. Accordingly, the Board believes that the Congress should add a new rating category of "high satisfactory" to the current 4-point rating system and then focus benefits, such as the application relief mentioned earlier, on institutions at that and the higher "outstanding" level.

Third, the entire Board believes that the Truth in Savings Act could be amended to make compliance less onerous but is divided on the merits of the approach taken in section 141 of the bill. I and a majority of the Board support the approach of the bill, which would repeal portions of Truth in Savings. Section 141 would leave intact the requirement that a depository institution pay interest on the full principal in a consumer's account, thereby barring the use of the investable and low-balance methods in determining interest payments. This requirement, which is already in place for financial institutions generally, benefits consumers without imposing excessive burdens. In addition, the Congress should prohibit misleading or inaccurate advertising in the promotion of deposit accounts--similar to the approach taken in H.R.1362, which leaves in place the current bar on misleading advertisements. Such a limitation would be valuable in ensuring that consumers are not misled by advertising that, for example, publicizes high "teaser" rates without informing consumers of the limited periods for which they are in effect or of other conditions that will determine the rates actually paid.

Before leaving the consumer area, I would like to make one general observation. Our consumer regulations are quite detailed, more so than one might expect. One reason for this detail, and, ironically, the reason why the industry often demands rather than rejects such detail, is the possibility of civil liability. Because banks can be liable for any misstep, they ask the Board to clarify every rule and validate every practice. It may be time for a serious reexamination of whether all the civil liability provisions in the consumer statutes are truly needed to protect consumers.

OTHER PROVISIONS

Although the Board supports the great majority of the provisions of S.650, there are three that cause us considerable concern: relaxing the standards for foreign banks operating in the United States to the extent proposed, loosening the terms for intraday credit for the Federal Home Loan Banks, and transferring authority for administering the Real Estate Settlement Procedures Act (RESPA) to the Board.

Foreign Banks

As currently drafted, S.650 would amend the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA) to lower the standards under which foreign banks may enter and operate in the United States and to reduce significantly the authority of the Federal Reserve to examine their U.S. operations on a comprehensive basis. The Board strongly opposes these provisions of the bill, as they remove many of the important protections that were considered necessary in the wake of the Banca Nazionale del Lavoro and Bank of Credit and Commerce International (BCCI) affairs and were included in FBSEA. The Board believes that it is too soon to conclude that those protections are no longer necessary and sees no evidence that they are not.

More specifically, the bill would permit the Board to deny entry to foreign banks only on the very narrow ground that establishment of an office by a foreign bank would place at risk the safe and sound operation of the U.S. financial system--a standard that even BCCI probably would not have failed. The bill would also deprive the Board of important examination authority. Because the activities of the various U.S. banking offices of a foreign bank are often highly intertwined, examinations need to be coordinated not only to avoid duplication of effort but also to ensure a complete and comprehensive picture of the organization, reducing the potential for financial manipulation. To this end, in 1994 the Federal Reserve and other state and federal bank regulatory authorities that supervise more than 90 percent of the assets of U.S. branches and agencies of foreign banks announced a joint program to enhance the supervision of foreign banks.

Although the Board believes that these provisions go too far, the Board believes that some provisions of FBSEA should be reevaluated--most notably the inflexible requirement that the Board may not approve an application unless a foreign bank is subject to comprehensive consolidated supervision by home country authorities. This standard has proved a significant barrier to entry for banks from jurisdictions, especially developing countries, that have not yet implemented a policy of consolidated supervision. The Board would recommend adding a provision to S.650 that would allow a foreign bank that meets all other requirements to open a limited office in the United States, subject to appropriate safeguards, if the bank's home country is making progress toward consolidated supervision. This amendment would give well-run foreign banks from developing countries an opportunity to establish a limited presence in the United States, while still providing an incentive for home country authorities to continue to implement reforms for consolidated supervision. Although the Board supports the setting of a deadline for action on applications for foreign bank entry, the deadline in the bill is too restrictive, given the difficult issues raised in many foreign bank cases.

Daylight Overdrafts 

Also of concern to the Board is section 305 of the bill, which Would essentially require that the Federal Reserve make intraday credit, in the form of daylight overdrafts, available to the Federal Home Loan Banks. This would create a nonmarket source of short-term funding for the Federal Home Loan Bank system without the costs incurred by depository institutions in maintaining required reserves. Section 305 would thereby serve as a precedent for government-sponsored enterprises to escape the market discipline inherent in their statutory funding schemes. The Board opposes extending this taxpayer subsidy to the Federal Home Loan Banks.

RESPA

S.650 attempts in a very limited way to improve the administration of the Real Estate Settlement Procedures Act, or RESPA, by transferring regulatory authority from the Department of Housing and Urban Development to the Board. Although such a transfer may have some intuitive appeal because of the Board's Truth in Lending responsibilities, there are important reasons why the Board is concerned about this provision. First, unlike Truth in Lending, certain portions of RESPA are in essence a price-regulation scheme--one that the Board lacks expertise to administer and that is foreign to the Board's central bank responsibilities. Second, even if the Board were better suited to the task, simply transferring responsibility from one agency to another does not achieve substantial reform or, necessarily, burden reduction.

Instead, we offer a different solution for RESPA. The Board believes that an in-depth reassessment by the Congress of RESPAS fundamental requirements is more to the point. We believe that the Congress should set aside the very complex issues raised by RESPA for separate hearings that could focus on the substance of RESPA rather than on administrative jurisdiction. There are serious questions to be considered, including, for example, the suggestion by some parties to real estate transactions that RESPA may be stifling innovation and technological advancement from which the public might benefit.

We urge the Congress to undertake such an assessment rather than simply transfer regulatory authority. We believe that the Board is not the appropriate locus for this responsibility.

CLOSING THOUGHTS

In closing, I would like to expand on one thought I mentioned earlier: that when the Congress or the agencies impose a regulatory burden, there are generally good reasons for doing so at the time. As time passes, however, the reasons for imposing the requirement may subside, but the requirement takes on a life of its own. A good example of this phenomenon is the sixty-year-old Glass-steagall Act, a law that was a response to a time and a financial system that bear little relation to our own.

S.650 addresses half of this problem by requiring that the agencies reexamine each regulation on a regular basis, a provision the Board endorses. However, as S.650 elsewhere recognizes, there are some things that only the Congress can do. For that reason, the Board hopes that the Congress would commit itself to a siniilar reexaniination of the banking statutes themselves-either through the use of sunset provisions when appropriate or, less forrnally, through periodic oversight hearings on existing statutes and regulatory burden.

(1.) The attachments to this statement are available from Publications Services, Mail Stop 127, Board of Governors of the Federal Reserve System, Washington, DC 20551.

Statement by Edward W. Kelley, Jr., Member Board of Governors of the Federal Reserve System, to the Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services, US. House of Representatives, May 3, 1995

The Board of Governors is pleased that the Congress is again considering legislation that would provide for substituting a $1 coin for the $1 bank note now in circulation, and we appreciate the opportunity to present information on several benefits and costs of making such a replacement.

In summary, a $1 coin would produce a substantial budgetary gain for the federal government, provided that the $1 note is withdrawn from circulation. The Board believes, however, that the convenience and needs of the American public, rather than cost savings, should be the main consideration in making this decision. Experience in Canada, where a similar change was made some years ago, suggests that the public will, over time, find a $1 coin more convenient than the $1 note. Finally, we would note that the significance of the U.S. dollar goes beyond the purchasing power it represents or the utility it provides; for Americans, the dollar is a symbol of economic and political stability and a source of national pride; consequently, any change should be made only for the most compelling reasons. If, after taking account of all these considerations, the Congress is inclined toward replacing the $1 note, it should enact legislation with a reasonably delayed effective date so that all those affected can plan adequately for the transition.

The impact on the federal budget of issuing coins and currency notes is not widely understood by the public, so it may be useful to devote a part of this statement to reviewing those fundamentals. The accounting processes and budget presentations are quite different in substance:

* Both issuing coins and issuing currency notes lower the government's effective cost of borrowing from the public, by approximately the value of the coin or currency notes in circulation times the interest rate that the government pays on its debt.

* There is an offsetting cost to the government associated with servicing the outstanding circulating coins or notes, which involves replacing "unfit" coins and notes as they wear out and operating the Federal Reserve currency and coin-processing facilities that provide the public with good-quality, genuine coins and notes.

Let us start with the following assumptions to illustrate the budget and accounting processes: (1) the Treasury's borrowing rate is 5.5 percent; (2) 7 billion $1 notes will already be in circulation at the time of the changeover; (3) $1 notes have a useful life of 1.5 years and cost 3.8 cents each to produce; (4) $1 coins would have a useful life of thirty years and cost 8 cents each to produce; and (5) $1 notes and $1 coins would cost 75 cents and 30 cents per thousand pieces respectively to be processed at the Federal Reserve Banks.

In the issuance of currency notes, the reduction in net governmental borrowing from the public occurs indirectly. The federal government's total borrowing and total interest outlays are not affected, but the Federal Reserve System holds a portfolio of government securities equal to the value of Federal Reserve notes outstanding, and, at the margin, the Federal Reserve returns to the Treasury its full earnings on those securities. These earnings are, from the Treasury's viewpoint, a return of its own interest outlays.(1)

* In our simplified model, the $7 billion of outstanding $1 notes provides a gross benefit to the Treasury of $385 million per year.(2)

* The cost of servicing the $1 note issue is the cost of replacing each note every 1.5 years, or $177 million per year,(3) and of processing it 1.3 times per year at Reserve Banks, or $7 million per year.(4)

Thus the net benefit to the Treasury associated with 7 billion of outstanding $1 notes is $201 million per year.(5)

In the issuance of coins, the reduction in net governmental borrowing from the public occurs directly. When the Treasury deposits newly minted coins at Federal Reserve Banks, it receives credit to its checking account, and thus the government is able to make budgeted expenditures without additional borrowing in the amount of the face value of the newly deposited coins less their production cost (which amount we call "seigniorage").(6)

* Seven billion new $1 coins would reduce the federal government's total borrowing by $6.44 billion(7) and total interest outlays by $354 million per year,(8) a gross benefit not much different from the gross benefit from 7 billion notes.

* But the cost of replacing each coin every thirty years would be only $19 million per year(9) and of processing dollar coins at Reserve Banks 0.3 times only $1 million per year.(10)

Thus the net benefit to the Treasury associated with 7 billion of outstanding $1 coins would be $334 million per year,(11) considerably higher than that for an equal number of currency notes.

At this point in the analysis, replacing $1 notes with $1 coins would have a favorable impact on the governmental budget of $133 million per year.(12) However, such a replacement would have a further--and even more significant--benefit. Based on the experience in virtually every country that has made a comparable substitution, the government can expect to issue at least twice as many $1 coins as it would have issued $1 notes.(13) (This may result partly from the habit of many people to save their pocket change at the end of the day and partly from a tendency for banking and retail establishments to hold larger quantities of coins than of notes of equal value. In our simplified model, doubling the number of $1 coins in circulation would add another $334 million per year to the Treasury's benefit, for a total benefit of $467 million.(14)

The simplified model, of course, does not fully reflect the real world. There are factors that would both increase and decrease the $467 million annual benefit shown above. In particular, growth in the volume of $1 currency pieces outstanding--historically, more than 4 percent per year--would, over time, considerably increase the benefit of substituting coins for notes. So would any numismatic, or sentimental, collecting of $1 notes that might result from the announcement that they soon would no longer be issued (although $1 notes would continue to be legal tender). On the other hand, some increase in the use of $2 notes by the public seems very likely if the $1 note were no longer issued, and any such increase would reduce the budgetary gain. In addition, the production cost for higher denomination notes would rise because fixed costs at the Bureau of Engraving and Printing would be spread over a smaller production volume. ($1 notes account for nearly 50 percent of the total annual currency note production.

Taking account of these additional factors, the Board's staff estimates that, in the first five years of the implementation, the federal government budget position would be improved by a total of $2.28 billion (in nominal terms). The average yearly gain in real present-value terms, over the assumed thirty-year life of a $1 coin is estimated to be $460 million.(15)

These gains are unlikely to be achieved, however, if the $1 note is not withdrawn from circulation. This is because the private sector (notably banking and retail establishments), not knowing how extensively the public will use the $1 coin, will be reluctant to make the infrastructure outlays necessary for the coin to succeed (training employees on new cash-register-drawer procedures, ordering of $1 coin inventories, new arrangements with financial institutions, and the like). Likewise, the public will refrain from using the new coin if the retail sector is not prepared.(16) In the meantime, the public sector (particularly the Bureau of Engraving and Printing, the Bureau of the Mint, and the Federal Reserve System; perhaps also the Postal Service and mass transit systems), not knowing what the respective demands will be for $1 notes and coins, and wanting to be able to meet any likely demand, will inevitably overinvest in production and processing capacity.

As important as the budgetary gains would be, the Board believes that the foremost consideration in this decision should be the convenience and needs of the public. In this regard, opinion surveys indicate that the American public generally is satisfied with the present currency system and may not initially welcome replacing the $1 note. There is evidence in the Canadian experience, however, that over time a $1 coin would come to be recognized as more convenient, cleaner, and more efficient than the $1 note.

If designed properly, a $1 coin may well be able to evoke confidence in the currency system and be a source of national pride to the same extent that the $1 note does now. Market testing, such as with focus groups, can help to achieve this result.

We believe that some legislative proposals, such as H.R.534, would not provide enough preparation time for those most involved--the Nation's banking and retail establishments, the Treasury Bureaus of the mint and of Engraving and Printing, and the Federal Reserve Banks. Preparing for the issuance of new $1 coins will be complex and time-consuming, and the prescribed preparation period--eighteen months--would not be sufficient. The mint will need time to be certain that the design is effective, both mechanically and in terms of public acceptance. There will be substantial changes in resource requirements at the Bureau of Engraving and Printing, the Bureau of the Mint, and the Federal Reserve Banks and branches. And, above all, the Nation's banks and retail establishments will have to plan carefully for the changeover.

Moreover, beginning in 1996, the Treasury and Federal Reserve will begin a multiyear introduction of new designs for Federal Reserve notes that will be completed (with the introduction of a newly designed $5 note) in about 1999. It would be preferable that these important changes not occur contemporaneously with the introduction of a $1 coin.

A reasonable approach may be for the Congress to explore thoroughly the implications-for the federal budget, for the convenience and needs of the public, and for the public's feelings toward the currency--of replacing the $1 note with a coin. If the Congress judges that the balance of considerations weighs in favor of replacing the note, it should adopt legislation as promptly as possible that would establish dates in the future for introducing the new $1 coin, say in about four years to coincide with issuance of the newly designed $5 note, and for no longer issuing $1 notes. In that way, both the public and private sectors would have a sound basis for beginning immediately to plan for the change.

(1.) The federal government budget accounts treat Federal Reserve earnings paid to the Treasury as a miscellaneous receipt. (2.) $7 billion x 5.5 percent. (3.) 7 billion notes / 1.5 x $.038. (4.) 7 billion notes x 1.3 x $.00075. (5.) $385 million - $177 million - $7 million. (6.) The budgetary accounting process for coin production sometimes gives rise to the belief that the booking of seigniorage per se reduces the Treasury's borrowing requirement. This is not so. It is being able to spend the newly minted coins that reduces the Treasury's need to borrow. Such spending seldom occurs directly, of course; the Treasury ordinarily deposits newly minted coins at Federal Reserve Banks for credit to its checking account. Reserve Banks accept only as many new coins as they expect to need to meet the requirements of depository financial institutions in their Districts. (7.) $7 billion face value--$560 million production cost. (8.) $6.44 billion x 5.5 percent. (9.) 7 billion coins [divided by] 30 x $.08. (10.) 7 billion coins x 0.2 x $.00030. Note that $1 notes are typically deposited at Federal Reserve Banks an average of 1.3 times per year. We expect that $1 coins would be deposited only 0.2 times. (11.) $354 million - $20 million. (12.) $334 million - $201 million. (13.) In six countries that replaced a note valued at about $1 with a coin, the General Accounting Office found coin-for-note replacement rates ranging from 1.6 to 1 to 4 to 1. General Accounting Office, National Coinage Proposals, Limited Public Demand for New Dollar Coin or Elimination of Pennies (GAO, May 1990), p. 39. (14.) An attachment to this statement summarizes these effects and is available from Publications Services, Board of Governors of the Federal Reserve System, Washington, DC 20551. (15.) The thirty-year estimate uses an inflation rate of zero, a Treasury borrowing rate of 3 percent, and a rate for discounting future values to the present of 3 percent. The advantage of expressing the longer-run financial impacts in real present-value terms is that it adjusts for inflation and the time value of the magnitudes involved. (16.) For an excellent treatment of "network externalities" in currency systems, see John P. Caskey and Simon St. Laurent, "The Susan B. Anthony Dollar and the Theory of Coin/Note Substitutions," Journal of Money, Credit, and Banking, vol. 26 (August 1994, Part 1), pp. 495-510.

Statement by Susan M. Phillips, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions and Consumer Credit of the Committee on Banking and Financial Services, U.S. House of Representatives, May 18, 1995

I am pleased to be here today to discuss H.R.1362, the Financial Institutions Regulatory Relief Act of 1995. The Board welcomes its introduction and supports its purpose of relieving costs imposed on our nation's banking system by governmental regulation, particularly when those costs are not offset by corresponding benefits to the safety and soundness of our nation's financial institutions, the protection of bank customers, or the availability of credit.

In my testimony today, I will discuss the Board's efforts to reduce the cost of regulation and why we believe that legislation is necessary to continue those efforts. I will then address those portions of the bill that make major changes to laws administered by the Board, particularly in the area of bank and branching applications, where I believe the bill would significantly reduce burden, and in the consumer area. Finally, I will highlight provisions about which the Board does have concerns. Still, I do not wish these objections in any way to detract from the central message of my testimony: that the nation's banking system needs legislation of the type presented by H.R.1362.

Appended to my testimony are the Board's comments on certain provisions that are not discussed directly in my testimony.(1)

THE ROLE OF REGULATION

Banking regulation serves clearly defined purposes. They include protecting the federal safety net and thereby the taxpayer, preserving a strong banking system, minimizing the destabilizing effects on the economy caused by any difficulties in the banking system, providing consumer protection, and ensuring that communities are served by our banking system.

Such regulation, however, cannot succeed if it is designed to eliminate at any cost the possibility of any bank failure-either a financial failure or a failure to serve customers. Rather, banking regulation must aim to produce at a reasonable cost the banking system that can best serve our economy and the American people. Each requirement, restriction, application, and report imposed may individually be justified at the time of adoption, but collectively the amount of regulation created over time can become a significant obstacle for the community banker and, equally important, someone hoping to start a community bank.

As H.R.1362 recognizes, the aggregate regulatory burden on our nation's banks has become substantial, raising the cost of banking services and thereby encouraging customers to seek less costly loans and services or higher yielding investments from other financial intermediaries that are not subject to the same regulatory requirements. Furthermore, our banks must operate in increasingly competitive financial markets, both domestic and global. The United States can ill afford to handicap its banking institutions with unnecessary and dysfunctional regulation.

The Board believes the time has come to reexamine each of our banking statutes and regulations and decide whether its benefits are commensurate with its costs. The Board believes that there are restrictions in current banking law that cannot pass this test. To address this problem, the Board advocates not only burden relief of the type provided by H.R.1362 but also reform of anachronistic statutes such as the Glass-Steagall Act, which needlessly and significantly hinders the ability of U.S. banking organizations to compete. We applaud this committee's recent approval of Glass-Steagall reform and urge the House to pass H.R.1062.

OUR EFFORTS AT THE BOARD

The recognition that regulatory burden must be reduced is not new at the Board. Since 1978, the Board has maintained a formal program of regulatory review and simplification, and in 1986 the Board established a Regulatory Planning and Review office, charged with ensuring that regulatory proposals minimize the burdens imposed on those that must comply. The Board has long believed that significant reductions can be made in regulatory burden by eliminating requirements that are redundant or have outlived their usefulness.

The Board has redoubled these efforts in recent years. For example, we have streamlined the applications process by shortening processing times, substituting a notice requirement for an application whenever possible, waiving applications for transactions reviewed by other regulators, and reducing the paperwork that must accompany applications and notices. These changes have reduced both the volume of paper that must be filed by notificants and the time required for the Board to review nonbanking proposals. Of the more than 3,500 applications and notices acted on during 1994, 94 percent were completed within the Board's self-imposed sixty-day target, with the average period of review lasting thirty-four days. In other areas, the Board has worked within the limits of its governing statutes to expand the list of permissible nonbanking activities for banking organizations, to remove outdated restrictions on the conduct of these activities, and to eliminate restrictions that prevented banking organizations from providing discounts to their customers on packages of products.

I have attached to my testimony a more complete list of our initiatives to reduce unnecessary regulatory burden over the past three years.

THE NEED FOR LEGISLATIVE CHANGE

There is a limit, however, to how far we or the other banking agencies can go in rationalizing the regulation imposed on our nation's banks. Although we speak of "regulatory" burden, that term is something of a misnomer. The Board must operate within statutory constraints, and all of our regulations are either required by statute or are necessary to explain or implement a statute. Put simply, we have no choice but to regulate and in some cases to overregulate.

H.R. 1362 provides the type of statutory changes that would allow a reduction in regulatory burden in many areas without adversely affecting safety and soundness or other important supervisory and policy concerns.

Applications

One of H.R. 1362's most important reforms comes in the applications area, where it would eliminate federal regulatory review for routine bank acquisitions and branch openings by well-capitalized and well-managed banking organizations that are helping to meet the credit needs of their communities. H.R.1362 would also allow well-capitalized and well-managed organizations to commence previously approved nonbanking activities without filing an application. The Board's experience in administering these statutory requirements over the past thirty-nine years leads us to endorse these initiatives very strongly.

Currently, the Bank Holding Company Act requires that all bank holding companies obtain Board approval before acquiring control of another depository institution or merging with another bank holding company. The bill would eliminate this application requirement for proposals that raise no serious competitive issue and are made by bank holding companies that met specified standards for capital, management, and community reinvestment at their previous examination. The vast majority of such proposals processed by the Board meet these requirements and are routinely approved. Thus, we believe that the cost of continuing the applications process in such cases is unnecessary from a public policy perspective. The bill not only would make the applications process simpler, less burdensome, and more transparent for qualifying banking organizations but also would provide a powerful incentive for banking organizations to achieve and maintain strong capital positions, solid management, and a commitment to the community.

The bill would also eliminate the application process for well-managed and well-capitalized banking organizations that wish to engage in nonbanking activities (such as mortgage banking or securities brokerage) that the Board has already determined to be permissible. The application requirement places bank holding companies increasingly at a competitive disadvantage with other companies that face no similar federal review requirement. The bill also eliminates a hearing provision for nonbanking applications, which is an unnecessary burden given the ample opportunity afforded all parties to make written submissions.

In a similar vein, H.R.1362 would eliminate branch applications for banks that meet the specified capital, management, and community reinvestment standards. The cost of these applications, which are routinely approved by all the agencies, is not justified when the applicant is well-capitalized, well-managed, and serving its community. Furthermore, H.R.1362 would eliminate branch applications for automated teller machines (ATMs) in all cases. The law defining a branch to include an ATM for this purpose is simply an anachronism. Together, these two changes would eliminate the need for a substantial number of branch applications filed with the banking agencies.

Finally, H.R. 1362 would eliminate or modify other applications requirements whose benefits no longer justify their costs, including applications for investment in bank premises and determinations that a bank holding company does not control shares of stock that it divests to certain companies.

I wish to stress the practical, bottom-line importance of these reforms. We estimate that adoption of this proposal would reduce the number of applications filed with the Federal Reserve by at least 50 percent--eliminating more than 1,700 applications currently filed with the Board each year and saving the industry untold hours of time and substantial legal expenses.

Consumer Reforms

H.R.1362 also contains numerous amendments to the consumer protection statutes administered by the Board. Although time does not permit me to discuss each of these provisions, I will mention those of particular importance to the Board.

First, section 116 of the bill would reduce the number of institutions required to report Home Mortgage Disclosure Act data by raising the asset level at which reporting is mandatory from $10 million to $50 million. The Board believes that this step would provide important relief to our nation's community banks without undercutting the goal of the act. Second, the bill makes a variety of changes to the Community Reinvestment Act (CRA) that, collectively, would affect the way the banking agencies administer that act. Some of these changes, such as the small bank exemption and self-certification, are directed at concerns the agencies addressed in their recently revised CRA regulations. That multiyear effort recognized that the burden imposed on small institutions needed to be reduced and focused on making the CRA evaluation process more objective, performance-based, and predictable. Before changing the rules in this area once again, we believe that the Congress should pause to consider whether the agencies' efforts will achieve the objectives of H.R.1362 in this area. Furthermore, the prohibition on additional reporting would leave the agencies unable to carry out the mandates of the act through their recently adopted regulations. We believe that if an agency is assigned a responsibility, it should also be granted the tools necessary to fulfill its mandate.

H.R. 1362 also contains CRA reforms not addressed by the agencies' recent efforts, particularly incentives for CRA performance. Section 124 provides that any institution that receives a satisfactory" or "outstanding" rating is deemed to have met the purposes of the CRA in regard to community credit needs for purposes of the applications process. The Board endorses the concept of providing incentives to institutions for good CRA performance. As the Board has previously testified, however, it is important to differentiate in the offering of incentives between institutions whose performance may be barely satisfactory and institutions whose performance is close to outstanding. Accordingly, the Board believes that the Congress should add a new rating category of "high satisfactory" to the current 4-point rating system and then focus benefits, such as the application relief in title 11 of the bill, on institutions at that and the higher "outstanding" level.

Third, the entire Board believes that the Truth in Savings Act could be amended to make compliance less onerous but is divided on the merits of portions of section 131 of the bill. I and a majority of the Board support the general direction of the bill, which would eliminate some provisions of the Truth in Savings Act and revise others. Section 131 would leave intact the requirement that a depository institution pay interest on the full principal in a consumer's account, thereby barring the use of the investable and low-balance methods in determining interest payments. This requirement, which is already in place for financial institutions generally, benefits consumers without imposing excessive burdens. Section 131 would also continue to prohibit misleading or inaccurate advertising in the promotion of deposit accounts. Such a limitation is valuable in ensuring that consumers are not misled by advertising that, for example, publicizes high "teaser" rates without informing consumers of the limited periods for which they are in effect or of other conditions that will determine the rates actually paid.

Before leaving the consumer area, I would like to make one general observation. Our consumer regulations are quite detailed, more so than one might expect. One reason for this detail, and, ironically, the reason why the industry often demands rather than rejects such detail, is the possibility of civil liability. Because banks can be liable for any misstep, they ask the Board to clarify every rule and validate every practice. The amendments to the Truth in Lending Act in title I of the bill, which the Board supports, take an important step toward addressing this problem, but it may also be time for a broader reexamination of whether all the civil liability provisions in the consumer statutes are truly needed to protect consumers.

OTHER PROVISIONS

Although the Board supports the great majority of the provisions of H.R. 1362, there are two that cause us considerable concern: relaxing the standards for foreign banks operating in the United States to the extent proposed and transferring authority for administering the Real Estate Settlement Procedures Act (RESPA) to the Board.

Foreign Banks

As currently drafted, H.R.1362 would amend the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA) to lower the standards under which foreign banks may enter and operate in the United States and to reduce significantly the authority of the Federal Reserve to examine their U.S. operations on a comprehensive basis. The Board opposes these provisions of the bill as drafted.

More specifically, the bill would permit the Board to deny entry to foreign banks only on the very narrow ground that establishment of an office by a foreign bank would place at risk the safe and sound operation of the U.S. financial system--a standard that even the Bank of Credit and Commerce International probably would not have failed. As drafted, the bill would also deprive the Board of important examination authority. Because the activities of the various U.S. banking offices of a foreign bank are often highly intertwined, examinations need to be coordinated not only to avoid duplication of effort but also to ensure a complete and comprehensive picture of the organization, reducing the potential for financial manipulation. To this end, in 1994 the Federal Reserve and other state and federal bank regulatory authorities that supervise more than 90 percent of the assets of U.S. branches and agencies of foreign banks announced a joint program to enhance the supervision of foreign banks.

Although the Board believes that these provisions go too far, the Board believes that some provisions of FBSEA should be reevaluated--most notably the inflexible requirement that the Board not approve an application unless a foreign bank is subject to comprehensive consolidated supervision by home country authorities. This standard has proved a significant barrier to entry for banks from jurisdictions, especially developing countries, that have not yet fully implemented a policy of consolidated supervision. The Board would recommend adding a provision to H.R. 1362 that would allow a foreign bank to open an office in the United States, subject to appropriate safeguards, if the bank's home country is making progress toward consolidated supervision. This amendment would give well-run foreign banks from developing countries an opportunity to establish a presence in the United States under appropriate conditions, while still providing an incentive for home country authorities to continue to implement reforms for consolidated supervision. H.R.1362 also establishes a deadline for the Board to act on foreign bank applications, a concept the Board endorses.

We would be pleased to work with the committee on appropriate changes to the foreign bank provisions.

RESPA

H.R.1362 attempts in a very limited way to improve the administration of the Real Estate Settlement Procedures Act by transferring regulatory authority from the Department of Housing and Urban Development to the Board. Although such a transfer may have some intuitive appeal because of the Board's Truth in Lending responsibilities, there are important reasons why the Board is concerned about this provision. First, unlike Truth in Lending, certain portions of RESPA are in essence a price-regulation scheme--one which the Board lacks expertise to administer and which is foreign to the Board's central bank responsibilities. Second, even if the Board were better suited to the task, simply transferring responsibility from one agency to another does not achieve substantial reform or, necessarily, burden reduction.

Instead, we offer a different solution for RESPA. The Board believes that an in-depth reassessment by the Congress of RESPK's fundamental requirements is more to the point. We believe that the Congress should set aside the very complex issues raised by RESPA for separate hearings that could focus on the substance of RESPA rather than on administrative jurisdiction. There are serious questions to be considered, including, for example, the suggestion by some parties to real estate transactions that RESPA may be stifling innovation and technological advancement from which the public might benefit.

We urge the Congress to undertake such an assessment rather than simply transfer regulatory authority. We believe that the Board is not the appropriate locus for this responsibility.

CLOSING THOUGHTS

In closing, I would like to expand on one thought I mentioned earlier: that when the Congress or the agencies impose a regulatory burden, there are generally good reasons for doing so at the time. As time passes, however, the reasons for imposing the requirement may subside, but the requirement takes on a life of its own. A good example of this phenomenon is the sixty-year-old Glass-Steagall Act, a law that was a response to a time and a financial system that bear little relation to our own.

H.R.1362 addresses half of this problem by requiring the agencies to reexamine each regulation on a regular basis, a provision the Board endorses. However, as H.R.1362 elsewhere recognizes, there are some things that only the Congress can do. For that reason, the Board hopes that the Congress would commit itself to a similar reexamination of the banking statutes themselves--either through the use of sunset provisions when appropriate or, less formally, through periodic oversight hearings on existing statutes and regulatory burden.

(1.) The attachments to this statement are available from Publications Services, Mail Stop 127, Board of Governors of the Federal Reserve System, Washington, DC 20551.