Statements to the Congress.

Statements to the Congress

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Task Force on the International Competitiveness of U.S. Financial Institutions, Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, April 4, 1990.

I am pleased to appear before the Task Force this afternoon. The issues you are raising are both wide-ranging and of immense importance to the evolution of the financial system. I could not possibly do justice to all of them this afternoon. What I will attempt to do, and what I hope will be useful to you, is first to describe the global environment in which U.S. financial firms are likely to be operating over the foreseeable future. Against this background, I will comment on the effectiveness of U.S. banks' competition today and will then discuss some policy implications.

GLOBALIZATION OF FINANCIAL MARKETS

Globalization and interdependence are becoming the dominant elements of world finance. Foreign-based financial intermediaries play an increasingly prominent role in U.S. financial markets, and foreign investors are adding to their already significant holdings of U.S. financial and other assets. The volume of transactions by foreigners in U.S. securities markets has increased even more dramatically than foreign holdings. For example, foreign purchases and sales of U.S. Treasury securities surpassed $4 trillion on a gross basis in 1989, up from $100 billion to $200 billion early in the decade. Similarly, foreign purchases and sales of U.S. corporate stocks and bonds have been running dramatically above rates early in the decade. U.S. purchases and sales of foreign stocks and bonds also increased sharply during the 1980s, as did the activities abroad of U.S. financial intermediaries. This surge in cross-border financial transactions has paralleled a large advance in the magnitude of cross-border trade of goods and services.

A key factor behind these trends in international trade and securities transactions is a process that I have described elsewhere as the "downsizing of economic output." By this I mean that the creation of economic value has shifted increasingly toward conceptual values with decidedly less reliance on physical volumes. Today, for example, major new insights have led to thin fiber optics replacing vast tonnages of copper in communications. Financial transactions historically buttressed with reams of paper are being progressively reduced to electronic charges. Such advances not only reduce the amount of human physical effort required in making and completing financial transactions across national borders, but also facilitate more accuracy, speed, and ease in execution.

Underlying this process have been quantum advances in technology, spurred by economic forces. In recent years, the explosive growth in information-gathering and processing techniques has greatly extended our analytic capabilities of substituting ideas for physical volume. The purpose of production of economic value has not changed and will not change. It will continue, as before, to serve human needs and values. But the form of output increasingly will be less tangible and hence more easily traded across international borders. It should not come as a surprise, therefore, that in recent decades the growth in world trade has far outstripped the growth in domestic demand for goods and services. This development, of necessity, implies that on average the share of imports as a percentage of gross domestic product has grown dramatically worldwide. Since irreversible conceptual gains are propelling the downsizing process, these trends almost surely will continue into the twenty-first century and beyond.

New technology--especially computer and telecommunications technology--is boosting gross financial transactions across national borders at an even faster pace than the net transactions supporting the increase in trade in goods and services. Rapidly expanding data processing capabilities and virtually instantaneous information transmission are facilitating the development of a broad spectrum of complex financial instruments that can be tailored to the hedging, funding, and investment needs of a growing array of market participants. These types of instruments were simply not feasible a decade or two ago. Some of this activity has involved an unbundling of financial risk to meet the increasingly specialized risk management requirements of market participants. Exchange rate and interest rate swaps, together with financial futures and options, have become important means by which currency and interest rate risks are shifted to those more willing to take them on. The proliferation of financial instruments, in turn, implies an increasing number of arbitrage opportunities, which tend to boost further the volume of gross financial transactions in relation to output and trade. Moreover, these technological advances and innovations have reduced the costs of managing operations around the globe and have facilitated international investment.

Investment considerations also are playing an important role in the globalization of securities markets. As the economy of the United States becomes increasingly intertwined with foreign economies, it is to be expected that both individual investors and institutions will raise the share of foreign securities in their investment portfolios. Such diversification provides investors a means of protecting against the prospect of depreciation of the local currency on foreign exchange markets and against domestic economic disturbances affecting asset values on local markets. As international trade continues to expand more rapidly than global output and as domestic economies become even more closely linked to those abroad, the objective of diversifying portfolios of international securities will become increasingly important. Moreover, since the U.S. dollar is still the key international currency, such diversification has been, and may continue to be, disproportionately into assets denominated in the dollar. For the same reason, many foreign financial institutions find it beneficial to be represented by banking offices in this country so that they can play an intermediary role based in dollars.

Another factor facilitating the globalization of capital markets and the growth of foreign investments in the United States has been deregulation here and abroad. Technological change and innovations that have tied international economies more closely together have increased opportunities for arbitrage around domestic regulations, controls, and taxes, undermining the effectiveness of these policies. Many governments have responded by dismantling increasingly less effective domestic regulations designed to allocate credit and by removing controls on international capital flows, relying more heavily instead on market forces to allocate capital.

The globalization of capital markets offers many benefits in terms of increased competition, reduced costs of financial intermediation benefiting both savers and borrowers, more efficient allocation of capital, and the more rapid spread of innovations.

COMPETITIVE POSITION OF U.S. BANKS

A proper assessment of how well U.S. banks are competing today in the new globally competitive setting must recognize several points. First, U.S. banks are not all alike. In particular, only a very small subset of U.S. banks is active internationally. Second, among those internationally active banks, the extent to which they are competitive varies across products and over time. Third, particularly with the considerable intermediation involving foreign lenders and borrowers in this country and U.S. lenders and borrowers abroad, it follows that simple measures of competitiveness based on gross assets of national banking systems must be interpreted with care. Let me elaborate on these points.

We have nearly 10,000 banking organizations in this country--treating a multibank holding company as one firm. They vary significantly in terms of size, the nature of their business, and the areas they serve.

The great bulk of U.S. banking organizations, by number, are fairly small, functioning as intermediaries largely between local savers and local household and business borrowers. However, some of these local banks have become quite large and have evolved into sizable regional banks. The regional, or superregional, banks draw on a large base of core retail deposits and serve needs of retail borrowers in their regions, but they also do a large and growing corporate business. These banks generally are strongly capitalized and so can support growth in their portfolios. It is these banks that have experienced the fastest growth in the United States over the past decade, benefiting importantly from existing interstate banking compacts.

International banking--that is, involving transactions that extend across geographic borders--has not been an important business for regional banks. International assets typically have been less than 5 percent of a regional bank's total assets. Instead, international banking is, and has been, concentrated in a small number of U.S. banks. Four out of the 10,000 U.S. banking organizations account for roughly half of international assets; ten of them account for a little more than 80 percent.

For those banks involved in it, the nature of the international business has changed. As I noted previously, technological innovations, as well as the need for large investors and borrowers to protect themselves against the increased volatility in asset prices that we experienced in the 1980s, have led to an unbundling of financial products. With this unbundling and the more efficient dissemination of information, the value of the banking franchise--to the extent that it was based on a unique role in evaluating credit risks--has eroded. The international role of the banks has changed from one of simply extending credit to one of facilitating transactions. Partly for this reason, and partly also to economize on costly equity capital, U.S. banks have tended to cut back on those activities that result in assets that must be booked on a balance sheet. For example, they have chosen to reduce drastically their interbank lending business, which is essentially a high-volume, low-spread business. U.S. banks have devoted their resources instead to banking services that often do not result in assets held by the bank. These activities, such as risk management involving relatively high-tech, sophisticated products, are also the areas in which U.S. banks remain among the world's leaders.

It has become commonplace to express concern about the increasing share of U.S. banking markets that is controlled by foreign banks, or the declining standing of major U.S. banks in international rankings of the world's largest banks. However, measures of total assets, or market shares related to particular national markets, can be very misleading as measures of international competitiveness, partly for reasons I have already mentioned: Only a handful of U.S. banks are internationally active, and a significant element of their international business does not show up on their balance sheets. Moreover, banks' operations can be booked at locations throughout the world, and the large businesses that borrow from foreign banks in the United States themselves operate around the world and can, and do, borrow from the same lenders at many spots on the globe.

Nevertheless, some have argued that U.S. banks are becoming less competitive as a result of the increasing relative size of their foreign bank rivals. While it is important to make sure that we understand why foreign banks have grown relatively quickly, there is no evidence in the professional literature that the size of an internationally active bank by itself has a significant bearing on a bank's costs or efficiency. To be sure, that literature has not specifically addressed the possibility that some economies of super scale could be realized by extremely large banks. But even if so-called economies of super scale exist, such economies would need to be of significant magnitude to draw inferences about competitiveness among major internationally active banks. Our research suggests that cost controls and differences in management across banks of the same size are more relevant for competitiveness than any economies of super scale are likely to be.

Having said that, I hasten to confess that I cannot offer you satisfactory alternative measures of competitiveness. Conceptually, I believe that profitability, as measured by rates of return on equity or assets, is a proper measure of competitiveness. In practice, it is difficult to obtain comparable, up-to-date data on banks from various countries, or to adjust the data that we do have for differences in tax or accounting systems. It would be necessary also to adjust realized rates of return for risk; banks can realize higher rates of return at least over some period of time by engaging in riskier activities, but of course those returns are likely to be more volatile.

However, rather than dwell on comparing the competitiveness of U.S. banks versus foreign banks, I suggest that it is more important to focus on the performance of U.S. banks themselves. From the perspective of the U.S. financial system, of shareholders of U.S. banks, and most importantly of U.S. consumers of financial services, it is desirable that U.S. banks be operated in as low cost and efficient a manner as possible, subject to concerns about their safety and soundness. This would be true even if U.S. banks already were the most competitive banks in the world. If we get bogged down in struggling to make comparisons of competitiveness, policy-makers risk losing sight of the fundamental need to ensure that government policy does not hinder, but rather enhances, in an absolute sense the competitiveness of U.S. banks and financial firms.

POLICY IMPLICATIONS

What, then, can the government do to enhance the competitiveness of U.S. banks? Perhaps the most important thing to do is to reduce the cost of capital to U.S. banks. By the cost of capital, I mean broadly the cost to a bank of raising equity and debt, or more precisely the real pretax rate of return it must pay to attract debt and equity funds to finance its portfolio of assets. It is often argued that U.S. banks are at a competitive disadvantage because their cost of capital is more than that of their foreign rivals.

For example, the Japanese stock market places very high price-earnings ratios on Japanese equities, and some have argued that the resulting lower cost of equity capital gives Japanese firms a competitive edge over U.S. firms. However, the use of different accounting conventions in Japan tends to understate Japanese firms' earnings relative to earnings of U.S. firms and hence to overstate price-earnings ratios in Japan. Minority interests are not completely consolidated in Japanese financial statements. Japanese firms issue the same report for tax purposes and for stockholders so that their financial statements fully reflect the maximum deductions from earnings for such items as depreciation that can be taken for tax purposes; in contrast, U.S. firms issue different reports for tax purposes and for stockholders. Japanese share prices also reflect considerable cross-holdings of equities and of land, both of which have risen sharply in value in recent years without contributing commensurately to reported earnings. It remains to be seen whether the recent weakening in Japanese stock markets is signalling an end to such increases, but in any event the benefits of such holdings will not be captured in earnings unless the assets are sold.

However, even after adjusting for accounting differences, one is left with real economic differences. Besides Japanese firms' holdings of equities and land, analysts point to the high Japanese savings rate, an expectation of strong growth of earnings, and more generally, the overall macroeconomic performance of Japan. These latter economic differences are under the influence of the policymakers. I, among many others, refer often to the substantial decline in the national savings rate in the United States. All other things being equal, our lower savings causes a higher real interest rate, raising the cost of capital in the United States and lowering private investment. Although higher real interest rates themselves may encourage more private savings, reducing our fiscal deficit would be a more certain way to add to savings available for private investment, lower the cost of capital, and thereby increase the potential competitiveness of U.S. financial and nonfinancial firms.

Government policy also has a constructive role to play in avoiding macroeconomic instability. If investors think that U.S. banks, for example, face a more risky macroeconomic environment, they will expect lower or less stable earnings and, therefore, will be willing to pay less for each dollar of such earnings.

Beyond changing the macroeconomic environment, the government should consider structural policies that could also help the competitiveness of U.S. banks. For example, there is reason to believe that the opportunity for a bank to diversify the products or services it offers or to diversify geographically may, in some cases, raise its rate of return and lower its risk. In addition, our laws greatly inhibit the ability of U.S. banks to evolve along with technological and other changes and to achieve the synergies that come from producing multiple, but similar, products and services. Particularly burdensome in this regard is the Glass-Steagall Act. There has been some liberalization in recent years both in geographic restrictions, through regional banking compacts, and in securities activities, through section 20 securities subsidiaries. But the ad hoc nature of this process of liberalization is not a desirable way of approaching significant structural reform. The Federal Reserve has supported, and continues to support, congressional efforts to address these matters in a more systematic way.

Other areas to consider involve those rules and regulations that can impinge on banks' costs. Examples include non-interest-bearing reserve requirements, deposit insurance premiums, capital standards, antitrust laws, consumer protection laws, and laws to deal with money laundering. I am not suggesting that they be abandoned simply because they impose costs on banks. What I am suggesting, however, is that we be cognizant of such costs when we weigh the benefits of our policies in terms of our other objectives. Social and regulatory policies are not free, no matter how desirable they may be perceived to be.

On the supervisory side, we are proceeding with the implementation of the risk-based capital standards that were negotiated in Basle. Efforts also are under way to coordinate other aspects of supervisory policy, with respect to both banking and other financial services. As banking and other financial services become increasingly indistinct, banking and securities supervisors must work more closely together. The aims of such coordination are basically twofold. One is to monitor and ultimately guard against risks to the financial system--risks that are becoming increasingly global and complex in nature. The other is to minimize the extent to which legitimate prudential concerns distort the opportunities for different kinds of financial firms, from different countries, to compete fairly with one another.

That leads me to my final point. We should continue our informal and formal, bilateral and multilateral, efforts to open domestic markets abroad to U.S. and other foreign banks, both in terms of access and scope of activities. Much progress has been made in this area over recent years, in large part, I believe, because the worldwide process of financial integration that I discussed earlier is forcing a liberalization of markets. In some instances, diplomatic initiatives on our part may also have affected the nature of that progress or its timing; such efforts should continue.

In this regard, however, it would clearly be counterproductive to close our own markets to foreign competition merely because foreign markets are less open than we would like. Such an action would invite retaliation and would not be very effective in any case. The globalization of financial markets means that most of the business that foreign banks do with U.S. customers could alternatively be done offshore. To the limited extent that closing of our markets to foreigners was effective, and that U.S. firms were thereby protected from foreign competition, the result would be reduced pressure on U.S. banks and on U.S. policymakers to implement the policies and management procedures necessary to improve the underlying competitiveness of U.S. banks. In the long run, this result would clearly be harmful to the best interests of both U.S. consumers and U.S. producers of financial services.

Statement by Manuel H. Johnson, Vice Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, April 4, 1990.

I appreciate the opportunity to be here today to present the views of the Federal Reserve Board on the implications of the decision of the U.S. Court of Appeals upholding the Board's order in the Merchants National case. The decision is important for two reasons: the legal conclusion reached regarding the applicability of the Bank Holding Company Act to the direct activities of banks owned by bank holding companies, as well as the potential significance of the case for the regulation and supervision of the activities of federally insured banks and for the resources of the federal safety net.

The Merchants National case involved a proposal by Merchants National Corporation, an Indiana bank holding company, to acquire and retain two Indiana state banks that engaged directly in certain general insurance agency activities that were permitted state banks under Indiana law. One of these banks had conducted the insurance agency activities since its founding in 1916.

As required by the Bank Holding Company Act, Merchants National filed applications with the Board for prior approval to acquire the banks. Various insurance industry trade groups protested the applications, urging the Board to prohibit the banks from selling insurance after their acquisition by Merchants National. The protest turned on whether the nonbanking provisions of the Bank Holding Company Act apply to the direct activities of banks owned by a bank holding company in the same manner that these provisions apply to the bank holding company itself and to its nonbank subsidiaries.

Section 4 of the Bank Holding Company Act generally provides, with certain exceptions, that a bank holding company may not directly, or indirectly, acquire or retain the voting shares of any company that is not a bank or engage in any activity other than those authorized under the act. The most significant exception to this prohibition is for companies whose activities the Board has determined to be closely related to banking. In 1982, the Congress specifically legislated, however, that insurance activities, with certain specified exceptions, are not closely related to banking. As a result, the Congress removed the Board's discretion to permit these activities for bank holding companies and their nonbank subsidiaries as an exception to the general nonbanking prohibition in the Bank Holding Company Act. The Congress has not, however, separately prohibited insurance activities for institutions not subject to the nonbanking restrictions of the act.

The nonbanking restrictions of the Bank Holding Company Act do not, by their terms, apply to the acquisition of shares of banks or to the activities conducted directly by banks owned by bank holding companies. The Board has so interpreted the provisions of section 4 of the Bank Holding Company Act since the act's passage in 1956, and it reaffirmed that interpretation in the Merchants National decision. Thus, insofar as the nonbanking restrictions of the Bank Holding Company Act are concerned, state banks may conduct directly those activities that are authorized by state law, including the insurance agency activities at issue in Merchants National.

There is one caveat to this Board interpretation. When the record indicates that a bank holding company is attempting to evade the restrictions of the act by conducting activities directly in the bank, the Board has applied the restrictions of section 4 of the act to the proposed activities. The Board took such action on a 1985 application by Citicorp to acquire a bank in South Dakota when the bank's principal purpose was to market insurance services throughout the United States--except in South Dakota.

The Board found, based on the structure of the South Dakota law and the fact that the South Dakota bank would serve almost exclusively as an insurance subsidiary of Citicorp and conduct only insignificant banking activities, that the acquisition of the bank was primarily, if not solely, for the purpose of enabling Citicorp to engage through the bank in various insurance activities. Accordingly, the Board determined that it was precluded from approving Citicorp's application because the acquisition was simply a device to allow Citicorp to engage in insurance activities prohibited for bank holding companies under section 4 of the Bank Holding Company Act. In contrast, in the Merchants National case, the acquired banks were conducting a full banking business and the banks' insurance agency activities were a small part of the bank's business and were to be conducted entirely within Indiana.

I would also emphasize that the Board's Merchants National interpretation pertains only when the nonbanking activities are conducted directly by a holding company bank. The Merchants National decision does not address the situation in which activities are conducted by a nonbank company whose shares are controlled by a holding company bank. The Board has consistently taken the position, in accordance with the explicit terms of the act, that shares of a nonbank company owned by a holding company bank are indirectly controlled by the parent holding company and, thus, a nonbank company controlled by a holding company bank would be an indirect subsidiary of the parent holding company. As such, the ownership of the shares of the company by the bank holding company, as well as the activities of the company, must qualify under the closely related to banking exception, or one of the other exceptions to the nonbanking provisions in the act.

In a 1971 regulation, however, the Board recognized a limited exception to this requirement for the acquisition of so-called operation subsidiaries by holding company banks. The regulation authorizes a state bank owned by a bank holding company to acquire and retain, without Board approval under the act, all of the voting shares of a company so long as the company engages solely in activities the parent bank could conduct directly and only at a location at which the bank could conduct the activities. The purpose of this regulation was to permit holding company state banks to compete on an equal footing with state banks that are not in a holding company system. The Board recognized that the regulation could potentially become the focus for evasion of the nonbanking restrictions of the act over time, and therefore stated that it would review the merits of its decision from time to time in light of its experience in administering the act.

In December 1988, in light of the increase in the conduct of nontraditional activities, such as real estate development, by state bank operating subsidiaries, the Board asked for comment on whether the 1971 regulation should be modified. The Board held a hearing on its proposal in April 1989 and has not taken further action on the proposal.

Besides its significance for interpreting the scope of the Bank Holding Company Act, the Merchants National decision also has important implications for the regulation and supervision of the direct activities of holding company banks. Had the court decided the Merchants National case the other way and determined that the direct activities of holding company banks are subject to the nonbanking restrictions of the Bank Holding Company Act, the activities of these banks would be limited to those that the Board has determined by regulation or order to be closely related to banking.

The fact that the Court held that the direct activities of holding company banks are not subject to the nonbanking restrictions of the act does not mean, however, that their activities are unregulated. The activities of national banks are determined by the Comptroller of the Currency under the provisions of the National Bank Act, and the activities of state-chartered banks are determined by the state banking laws under the supervision of the state banking commissioner. The activities of state banks are further regulated at the federal level--by the Federal Deposit Insurance Corporation (FDIC), in the case of insured state nonmember banks, and by the Board, in the case of state banks that are members of the Federal Reserve System.

In exercising its supervisory authority over state member banks, the Board has recognized the interest of the states in regulating banking within their borders. The dual banking system has contributed, on balance, to the flexibility and resiliency of the banking system and has helped make it more responsive to the needs of both business and consumers. Nevertheless, a serious question must be raised about any state action that might have the potential of posing undue risk to the resources of the federal safety net. The framework in place for regulating and supervising state banks ensures that the federal interest is taken into account. While the states, as the chartering authority, establish in the first instance those activities that are permissible for state banks, limitations may be placed on these activities by the Board, in the case of state member banks, and by the FDIC, with respect to nonmember federally insured banks.

The Board has ample statutory authority, under the Federal Reserve Act and related statutes, to ensure that the activities of a state member bank are consistent with safe and sound banking practices and do not pose an undue risk of loss to the federal safety net. Furthermore, as reinforced by the International Lending Supervision Act, these statutes enable the Board to require state member banks to maintain capital that is adequate in relation to the character and condition of its assets and liabilities. The Board also has authority, under the Financial Institutions Supervisory Act, as further amended and strengthened by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), to prevent, by order or rule, state member banks from engaging in activities that are unsafe or unsound.

In granting applications by state banks to become members of the Federal Reserve System, the Board takes into consideration whether the conduct of certain activities directly by banks could have a seriously adverse effect on the safety and soundness of the institution and on the nation's banking system. The Board has required that banks applying for membership in the Federal Reserve System not engage in activities that the Board views as posing an undue risk for an institution with access to the federal safety net. In addition, a state member bank may not, without obtaining the approval of the Board, cause or permit any change to be made in the general character of its business or in the scope of its corporate power exercised at the time of its admission to membership.

For example, the Board has, as a general condition of membership, not permitted state member banks to engage in real estate development activities, even though approximately twenty-five states permit banks to engage in such activities. Similarly, state member banks may not make direct investments in securities of less than investment grade, even when they are permitted to do so under their state charters. On the other hand, the Board has not found state authorization of insurance agency activities that could be comparable to those conducted by Merchant National's subsidiary banks or of similar agency activities to be inconsistent with Federal Reserve membership. Agency activities do not raise the risk-related and competitive concerns that would justify placing restrictions on the state-authorized powers.

Under the Federal Deposit Insurance Act and related statutes, the FDIC possesses authority that parallels that of the Board. Just as the Board considers corporate powers of a state bank when it acts on a bank membership application, the FDIC may take into consideration whether the corporate powers of a nonmember state bank are consistent with the purposes of the Federal Deposit Insurance Act when it acts on an application for deposit insurance.

In enacting some of the key reform provisions of the FIRREA, the Congress recognized the risk to the federal safety net that can be caused when federally insured state-chartered thrift institutions are allowed to engage in a broad range of activities without adequate regard for the federal interest. In that statute, the Congress prohibited a state thrift institution from engaging as principal in any type of activity that is not permissible for a federal thrift institution unless both parts of a two-part test are satisfied: (1) The FDIC has determined that the activity in question would pose no significant risk of loss to the deposit insurance fund, and (2) the thrift institution has sufficient capital to meet the fully phased-in capital standards prescribed in that statute. It should be noted that the legislative history of the FIRREA made it clear that the test of a "significant risk" of loss to the deposit insurance fund is not the relative or absolute size of the potential loss, but whether there is significant risk that the insurance fund will suffer a loss if a state thrift institution engages in the activity.

The FIRREA also prohibits a state thrift institution from acquiring or retaining any equity investment of a type or in an amount that is not permissible for a federal thrift institution to acquire and retain directly. This prohibition would apply to investments in real estate and equity securities. There is an exception for service corporations, when the FDIC determines that the investment would not pose any significant risk of loss to the deposit insurance fund and when the thrift institution meets applicable capital standards on a fully phased-in basis.

The Board does not believe that legislative provisions similar to those discussed above are necessary to limit the activities of state-chartered banks, since a system similar to that adopted by the Congress is already in place. As I have discussed, the activities of state banks are currently subject to the oversight of the FDIC or the Federal Reserve, as the case may be. In the case of state member banks, the Board has exercised its authority to prevent activities or investments considered to be too risky for a depository institution with access to the federal safety net.

In conclusion, the Board believes that it has correctly interpreted the Bank Holding Company Act in the Merchants National case in determining that the nonbanking restrictions of that act do not apply to the direct activities of holding company subsidiary banks. While the conduct of nonbanking activities by depository institutions that have access to the federal safety net requires close attention, the Board also believes that the current regulatory scheme, which includes federal supervision and regulation of state-chartered federally insured institutions, is adequate to ensure the appropriate degree of supervisory oversight.