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Statements to Congress.

Statement by Laurence H. Meyer, Member, Board of Governors of the Federal Reserve System, before the Committee on the Judiciary, U.S. House of Representatives, June 3, 1998

I am pleased to appear before this committee on behalf of the Federal Reserve Board to discuss antitrust issues related to mergers and acquisitions between U.S. banks and between banking organizations and other financial services firms. Under U.S. law, when considering the competitive effects of a proposed bank merger or acquisition, the Board is required to apply the competitive standards contained in the Sherman and Clayton antitrust acts. Under these standards, the Board may not approve a proposal that would result in a monopoly or that may substantially lessen competition or tend to create a monopoly in a particular market. In the case of proposals that involve the acquisition of a nonbanking company by a bank holding company, the Board must consider whether the acquisition can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects. My statement today will discuss how the Federal Reserve implements these requirements. I will also try to provide some broad perspective on the ongoing consolidation of the U.S. banking system and the potential effects of bank mergers.

It is important to understand that the Bank Holding Company Act does not give the Board unfettered discretion in acting on merger and acquisition proposals and that competition is not the only criterion that the Board must consider when assessing such a proposal. Other factors that the Bank Holding Company Act requires that the Board consider include the financial and managerial resources and future prospects of the companies and banks involved in the proposal and the effects of the proposal on the convenience and needs of the community to be served, including the performance record of the depository institutions involved under the Community Reinvestment Act. The Bank Holding Company Act also establishes nationwide and individual state deposit limits for interstate bank acquisitions and consolidated home country supervision standards for foreign banks. In my testimony before the Committee on Banking and Financial Services on April 29, I discussed each of these topics in some detail.(1) Lastly, if a bank holding company proposes to acquire a firm that is engaging in an activity not previously approved for bank holding companies, the Board must determine whether such activities are so closely related to banking or to managing or controlling banks as to be a "proper incident" to banking.


It is useful to begin a discussion of the Board's antitrust policy toward bank mergers with a brief description of recent trends in merger activity and overall U.S. banking structure. The statistical tables at the end of my statement provide some detail that may be of interest to the committee.


There have been more than 7,000 bank mergers since 1980. The pace accelerated from 190 mergers with $10.2 billion in acquired assets in 1980 to 649 with $123.3 billion in acquired assets in 1987. In the 1990s, the pace of both the number and dollar volume of bank mergers has remained high. So far this year, the rapid rate of merger activity has continued. For example, if only the five largest mergers or acquisitions approved or announced since December are completed, a total of more than $500 billion in banking assets will have been acquired.

The incidence of "megamergers," or mergers among very large banking organizations, is a truly remarkable aspect of current bank merger activity. But it is useful to recall that very large mergers began to occur with growing frequency after 1980. In 1980, there were no mergers or acquisitions of commercial banking organizations in which both parties had $1.0 billion in total assets. The years 1987 through 1997 brought growing numbers of such acquisitions and, reflecting changes in state and federal laws, an increasing number of these involved interstate acquisitions by bank holding companies. The largest mergers in U.S. banking history took place or were approved during the 1990s--including Chase-Chemical, Wells Fargo-First Interstate, NationsBank-Barnett, and First Union-CoreStates. And while these mergers set size precedents, the recently proposed mergers of Citicorp and Travelers, and NationsBank and BankAmerica, if consummated, would set a new standard for sheer size in U.S. banking organizations.

National Banking Structure

The high level of merger activity since 1980, along with a large number of bank failures, is reflected in a steady decline in the number of U.S. banking organizations from 1980 through 1997. In 1980, there were more than 12,000 banking organizations, defined as bank holding companies plus independent banks; banks (independent banks plus banks owned by holding companies) in total numbered nearly 14,500. By 1997, the number of organizations had fallen to about 7,100 and the number of banks to just more than 9,000. The number of organizations had declined more than 40 percent and the number of banks by more than one-third.

The trends I have just described must be placed in perspective because taken by themselves they hide some of the key dynamics of the banking industry. There are some other important characteristics of U.S. banking. While there were about 1,450 commercial bank failures and more than 7,000 bank acquisitions between 1980 and 1997, some 3,600 new banks were formed. Similarly, while more than 18,000 bank branches were closed, the same period saw the opening of nearly 35,000 new branches. Perhaps even more important, the total number of banking offices increased sharply from about 53,000 in 1980 to more than 71,000 in 1997, a 35 percent rise, and the population per banking office declined. This includes former thrift offices that were acquired by banking organizations. Fewer banking organizations clearly has not meant fewer banking offices serving the public.

These trends have been accompanied by a substantial increase in the share of total banking assets controlled by the largest banking organizations. For example, the proportion of domestic banking assets accounted for by the 100 largest banking organizations went from just more than one-half in 1980, to nearly three-quarters in 1997. The increase in nationwide concentration reflects, to a large degree, a response by the larger banking organizations to the removal of state and federal restrictions on geographic expansion both within and across states. The industry is moving from many separate state banking structures toward a nationwide banking structure that would have existed already had legal restrictions not stood in the way. The increased opportunities for interstate banking are allowing many banking organizations to reach for the twin goals of geographic risk diversification and new sources of "core" deposits.

As I will discuss shortly, it may well be that the retail banking industry is moving toward a structure more like that of some other local market industries such as clothing and department store retailing. As in retail banking, clothing and department store customers tend to rely on stores located near their home or workplace. These stores may be entirely local or may be part of regional or national organizations. Thus, it should perhaps not be surprising that banks, now freed of barriers to geographic expansion, are taking advantage of the opportunity to operate in local markets throughout the country as have firms in other retail industries.

But it would be a mistake to think that adjustment to a new statutory environment--and the increased opportunities for geographic diversification--were the only reasons for the current volume of bank merger activity. Each merger is somewhat unique and likely reflects more than one motivation. For example, a recent study of scale economies in banking suggests that efficiencies associated with larger size may be achieved up to a bank size of about $10 billion to $25 billion in assets. In addition, some lines of business, such as securities underwriting and market making, require quite large levels of activity to be viable.

Increased competitive pressures caused by rapid technological change and the resulting blurring of distinctions between banks and other types of financial firms, lower barriers to entry due to deregulation, and increased globalization also contribute to merger activity. Global competition appears to be especially important for banks that specialize in corporate customers and wholesale services, especially among the very largest institutions. Today, for example, almost 40 percent of the U.S. domestic commercial and industrial bank loan market is accounted for by foreign-owned banks.

More generally, greater competition has forced inefficient banks to become more efficient, accept lower profits, close up shop, or--in order to exit a market in which they cannot survive--merge with another bank. Other possible motives for mergers include the simple desire to achieve market power or the desire by management to build empires and enhance compensation. Some mergers probably occur as an effort to prevent the acquiring bank itself from being acquired, or, alternatively, to enhance a bank's attractiveness to other buyers.

Many of these factors are also motivating mergers between bank and nonbank financial firms. However, in these cases, a key causal factor is the ongoing blurring of distinctions between what were, not very long ago, quite different financial services. Today, as the Board has testified on many occasions, and despite the fact that banks continue to offer a unique bundle of services for retail customers, it is increasingly difficult to differentiate between many products and services offered by commercial banks, investment banks, and insurance companies. Thus, we should not find it surprising that firms in each of these industries should seek partners in the others.

Local Market Banking Structure

Given the Board's statutory responsibility to apply the antitrust laws so as to ensure competitive banking markets, it is critical to understand that nationwide concentration statistics are generally not the appropriate metric for assessing the competitive effects of mergers. Moreover, the extent to which mergers can increase national concentration is limited by the provisions in the Riegle-Neal Act of 1994, which amended the Bank Holding Company Act and established national (10 percent) and state-by-state (30 percent) deposit concentration limits for interstate bank acquisitions. States may establish a higher or lower limit, and initial entry into a state by acquisition is not subject to the Riegle-Neal statewide 30 percent limit.

Beyond this, the Board has a statutory responsibility to apply the antitrust laws so as to ensure competitive local banking markets. Evidence indicates that in the vast majority of cases the relevant concern for competition analysis is competition in local banking markets. This is based partly on survey findings that indicate that households and small businesses obtain most of their financial services in a very local area. In addition, it is based on empirical research that shows deposit rates tend to be lower and some loan rates, particularly those on loans to small businesses, are higher in local markets with relatively high levels of concentration.

While concentration has increased in some local markets, it has decreased in others, from 1980 through 1997, in both urban and rural markets, so that the average percentage of bank deposits accounted for by the three largest firms has remained steady or actually declined slightly, even as nationwide concentration has increased substantially. Essentially similar trends are apparent when local market bank concentration is measured by the-Herfindahl-Hirschman Index (HHI), defined as the sum of the squares of the market shares. Because of the importance of local banking markets, I would like to provide somewhat more detail on the implications of bank mergers for local market concentration.

Metropolitan Statistical Areas (MSAs) and nonMSA counties are often used as proxies for urban and rural banking markets. The average three-firm deposit concentration ratio for urban markets decreased 3 percentage points between 1980 and 1997. Average concentration in rural counties declined 1.7 percentage points. Similarly, the average bank-deposit-based HHI for both urban and rural markets fell between 1980 and 1997. When thrift deposits are given a 50 percent weight in these calculations, average HHIs are sharply lower than the bank-only HHIs in a given year, but the HHIs trend slightly upward since 1984. On balance, the three-firm concentration ratios and the HHI data indicate that, despite the fact that there were more than 7,000 bank mergers between 1980 and 1997, local banking market concentration has remained about the same.

Why haven't all of these mergers increased average local market concentration? There are a number of reasons. First, many mergers are between firms operating primarily in different local banking markets. While these mergers may increase national or state concentration, they do not tend to increase concentration in local banking markets and thus do not reduce competition.

Second, as I have already pointed out, there is new entry into banking markets. In most markets, new banks can be formed fairly easily, and some key regulatory barriers, such as restrictions on interstate banking, have been all but eliminated.

Third, the evidence overwhelmingly shows that banks from outside a market usually do not increase their market share after entering a new market by acquisition. Studies indicate that when a local bank is acquired by a large out-of-market bank, there is normally some loss of market share. The new owners are not able to retain all of the customers of the acquired bank. Anecdotal evidence suggests that some other banks in the market mount aggressive campaigns to lure away customers of the bank being acquired.

Fourth, it is important to emphasize that small banks have been, and continue to be, able to retain their market share and profitability in competition with larger banks. Our staff has done repeated studies of small banks; all of these studies indicate that small banks continue to perform as well as, or better than, their large counterparts, even in the banking markets dominated by the major banks. This may be due, in part, to more personalized service. But whatever the reason, based on this experience, we expect that there will continue to be a large number of banks remaining in the future.

Despite a continued high level of merger activity, studies based on historical experience suggest that in about a decade there may still be about 3,000 to 4,000 banking organizations, down from about 7,000 today. Although the top ten or so banking organizations will almost certainly account for a larger share of banking assets than they do today, the basic size distribution of the industry will probably remain about the same. That is, there will be a few very large organizations and an increasing number of smaller organizations as we move down the size scale. It seems reasonable to expect that a large number of small, locally oriented banking organizations will remain. Moreover, size does not appear to be an important determining factor even for international competition. Only very recently have U.S. banks begun to appear, once again, among the world's twenty largest in terms of assets. Yet those U.S. banks that compete in world markets are consistently among the most profitable and best capitalized in the world, as well as being ranked as the most innovative.

Finally, administration of the antitrust laws has almost surely played a role in restricting local market concentration. At a minimum, banking organizations have been deterred from proposing seriously anti-competitive mergers. And in some cases, to obtain merger approval, applicants have divested banking offices with their assets and deposits in certain local markets where the merger would have otherwise resulted in excessive concentration.

Overall, then, the picture that emerges is that of a dynamic U.S. banking structure adjusting to the removal of long-standing legal restrictions on geographic expansion, technological change, and greatly increased domestic and international competition. Even as the number of banking organizations has declined, the number of banking offices has continued to increase in response to the demands of consumers, and measures of local banking concentration have remained quite stable. In such an environment, it is potentially very misleading to make broad generalizations without looking more deeply into what lies below the surface. In part for the same reasons that make generalizations difficult, the Federal Reserve devotes considerable care and substantial resources to analyzing individual merger applications.


The Federal Reserve Board is required by the Bank Holding Company Act (1956) and the Bank Merger Act (1960) to review specific statutory factors arising from a transaction when (1) a holding company acquires a bank or a nonbank firm or merges with another holding company, or (2) the bank resulting from a merger of two banks is a state-chartered member bank. The Board must evaluate, among other things, the likely effects of such mergers on competition. This section of my statement discusses in some detail the methodology the Board uses in assessing the competitive effects of a proposed merger.

Competitive Criteria

In considering the competitive effects of a proposed bank acquisition, the Board is required to apply the same competitive standards contained in the Sherman and Clayton antitrust acts. The Bank Holding Company (BHC) Act and the Bank Merger Act do contain a special provision, used primarily in troubled-bank cases, that permits the Board to balance public benefits from proposed mergers against potential adverse competitive effects. The law also requires that the Board consider the potential effects on competition in the relevant market when bank holding companies acquire nonbank firms, as will be discussed later.

The Board's analysis of competition begins with defining the geographic areas that are likely to be affected by a merger. Under procedures established by the Board, these areas are defined by staff at the local Reserve Bank in whose District the merger would occur, with oversight by staff in Washington. In mergers where one or both parties are in two Federal Reserve Districts, the Reserve Banks cooperate, as necessary. To ensure that market definition criteria remain current, and in an effort to better understand the dynamics of the banking industry, the Board has recently sponsored several surveys, including national Surveys of Small Business Finances, a triennial national Survey of Consumer Finances, and telephone surveys in specific merger cases, to assist it in defining geographic markets in banking. These surveys are particularly useful because electronic technology and banks with widespread branch networks are becoming more prevalent. The surveys and other evidence continue to suggest that small businesses and households most often obtain their banking services in their local area. This implies using a local geographic market definition for analyzing competition. Local markets would, of course, be less important for the financial services obtained by large businesses.

With this basic local market orientation of households and small businesses in mind, the staff constructs a local market index of concentration, the HHI, which is widely accepted as a useful measure of market concentration, in order to conduct a preliminary screen of a proposed merger. The HHI is calculated based on local bank and thrift deposits. The merger would generally not be regarded as anticompetitive if the resulting market share, the HHI, and the change in that index do not exceed the criteria in the Justice Department's merger guidelines for banking. However, while the HHI is an important indicator of competition, it is not a comprehensive one. In addition to statistics on market share and bank concentration, economic theory and evidence suggest that other factors, such as potential competition, the strength of the target firm, and the market environment, may have important influences on bank behavior. These other factors have become increasingly important as a result of many recent procompetitive changes in the financial sector. Thus, if the resulting market share and the level and change in the HHI are within Justice Department guidelines, there is a presumption that the merger is acceptable, but if they are not, a more thorough economic analysis is required.

To conduct such an analysis of competition, the Board uses information from its own major national surveys noted above, from telephone surveys of households and small businesses in the market being studied, from on-site investigations by staff, and from various standard databases with information on market income, population, deposits, and other variables. These data, along with results of general empirical research by Federal Reserve System staff, academics, and others, are used to assess the importance of various factors that may affect competition. To provide the committee with an indication of the range of other factors the Board may consider in evaluating competition in local markets, I shall outline these factors.

Potential competition, or the possibility that other firms may enter the market, may be regarded as a significant procompetitive factor. It is most relevant in markets that are attractive for entry and where barriers to entry, legal or otherwise, are low. Thus, for example, potential competition is of relatively little importance in markets where entry is unlikely for economic reasons.

Thrift institution deposits are now typically accorded 50 percent weight in calculating statistical measures of the impact of a merger on market structure for the Board's analysis of competition. In some instances, however, a higher percentage may be included if thrift institutions in the relevant market look very much like banks, as indicated by the substantial exercise of their transactions account, commercial lending, and consumer lending powers.

While the merger guidelines provide a significant allowance for nonbank competition, competition from other depository and nonbank financial institutions may be given some additional consideration if such entities clearly provide substitutes for the basic banking services used by most households and small businesses. In this context, credit unions and finance companies may be particularly important.

The competitive significance of the target firm can be a factor in some cases. For example, if the bank being acquired is not a reasonably active competitor in a market, the loss of competition would not be considered to be as severe as would otherwise be the case.

Adverse structural effects may be offset somewhat if the firm to be acquired is located in a declining market. This factor would apply where a weak or declining market is clearly a fundamental and long-term trend, and there are indications that exit by merger would be appropriate because exit by closing offices is not desirable, and shrinkage would lead to diseconomies of scale. This factor is most likely to be relevant in rural markets.

Competitive issues may be reduced in importance if the bank to be acquired has failed or is about to fail. In such a case, it may be desirable to allow some adverse competitive effects if this means that banking services will continue to be made available to local customers rather than be severely restricted or perhaps eliminated.

A very high level of the HHI could raise questions about the competitive effects of a merger even if the change in the HHI is less than the Justice Department criteria. This factor would be given additional weight if there has been a clear trend toward increasing concentration in the market. The possibility of efficiency gains, especially via scale economies, is considered when appropriate, although this has generally not been a significant factor.

Finally, other factors unique to a market or firm would be considered if they are relevant to the analysis of competition. These factors might include evidence on the nature and degree of competition in a market, information on pricing behavior, and the quality of services provided.

Some merger applications are approved only after the applicant proposes the divestiture of offices in local markets and when the merger cannot be justified using any of the criteria I have just discussed. We believe that such divestitures have provided a useful vehicle for eliminating the potentially anticompetitive effects of a merger in specific local markets while allowing the bulk of the merger to proceed.

Remedies: Divestitures and Denials

The Board makes a concerted effort to provide the industry and other market participants with clear competition standards in order to make the regulatory process as efficient as possible. This is accomplished especially through published Board Orders on individual merger decisions. Furthermore, staff at the Reserve Banks and the Board often provide guidance to banks and bank holding companies that are considering a merger even before the filing of a formal application as well as after an application is filed. In this way, applicants learn very early in the process whether their application is likely to raise antitrust concerns. In fact, because this information regarding the principles applied by the Board in its competitive analysis is so readily available, applicants are able to structure proposals so that few merger applications are denied on competitive grounds.

Some potential applicants choose not to file an application after having been advised of the Board's policy and standards. Other potential applicants, who recognize that their application raises serious concerns about competition, choose to make divestitures of offices to remedy the competition problem. As I indicated above, divestitures have proven to be an effective way for applicants to resolve a competition problem without jeopardizing the entire deal. Indeed, the Board has approved forty-eight merger applications involving divestitures during the 1990s.

Board denials of applications on competitive grounds are rare. Nevertheless, despite the Board's efforts to inform the industry of its antitrust policy and standards, the Board has denied four applications because of adverse competitive effects during the 1990s.

Reviews of Policies and Procedures

Given the rapid pace of change in the U.S. banking and financial system, the Board and its staff review policies and procedures for assessing competition on a nearly continuous basis. Periodically, more formal reviews are conducted, the most recent of which was completed by Board staff early last year. This review essentially confirmed the continued appropriateness of our existing methodology. I would like to highlight five aspects of that review that might be of particular interest to the committee.

Since at least the mid-1960s, the cluster of products and services that constitutes commercial banking has been used, and reaffirmed by the courts, as the relevant product line for bank merger analysis. The cluster is meant to encompass the set of products and services that is purchased primarily from banks, a set that technological and other market developments have clearly changed over time. However, extensive review of available data, including our practical experience in analyzing cases, indicated that there still exists a core of such activities for both households and small businesses. Such activities certainly include federally insured deposits and, for small businesses, likely encompass certain credit products and services as well. Thus, the cluster continues to be the product line used by the Board for bank merger analysis.

The staff's review also indicated very strong support for the continued use of local geographic markets for the cluster of bank services as the primary concern of competition analysis. Survey data indicate, for example, that 98 percent of households and 92 percent of small businesses use a local depository institution. In addition, it is estimated that almost 90 percent of services consumed at depositories by households and 95 percent of services consumed by small business are provided by local depositories. On a closely related issue, our staff considered whether it might be appropriate to use somewhat different competition standards in urban and rural markets. This question was motivated by the fact that, because rural markets tend to be more concentrated than urban markets, it is frequently more difficult for banks in a given rural market to merge with each other than it is for banks in an urban market. However, no objective basis was discovered for treating urban and rural markets fundamentally differently in the analysis of potential competitive effects of a merger. Thus, all proposals continue to be evaluated on a case-by-case basis using common standards.

Our staff also reviewed whether continued use of the Department of Justice's merger guidelines was appropriate or whether, in light of institutional and technological changes, a more liberal initial screen should be applied. While the market for banking services certainly has become more competitive since the existing guidelines were established in 1984, the current guidelines continue to provide a useful initial screen for deciding whether a proposed merger is likely to have anticompetitive effects. In particular, the more generous allowance in the guidelines for the effects of nonbank competition were deemed to remain sufficient for the vast majority of cases. Exceptions can be dealt with on an individual basis. Moreover, there is considerable virtue in having both the Federal Reserve and the Department of Justice use the same initial screen. In the end, there appears to be no substitute for a careful case-by-case analysis, of the type that I discussed above, of proposals that violate the Board's and the Department of Justice's initial guidelines.

Lastly, in light of a substantial body of evidence accumulated over the 1980s, economies of scale are considered as a potential mitigating factor in our analysis of merger proposals. Many studies using data from the 1970s and 1980s indicated only small economies of scale in banking, economies that were exhausted at about $100 million in total assets. However, recent research using data from the 1990s suggests that significant scale economies may exist for much larger firms, perhaps for banks as large as $10 billion to $25 billion in assets. If these results hold up to additional scrutiny, we will clearly need to evaluate once again the weight given to economies of scale in competition analysis.

Coordination with Department of Justice

The Federal Reserve and the Department of Justice (DOJ) coordinate their antitrust analysis of banking consolidations through a combination of formal and informal procedures. These procedures have two objectives. First, they ensure that the two agencies share information that is relevant to the competition analysis of all bank merger proposals that raise a serious competitive issue. Second, they ensure that the analysis of each agency is known to the other.

A number of procedures have been developed at various stages of the application process. Largely, they entail the exchange or sharing of documents. The DOJ, for example, is provided a copy of all bank applications made to the Federal Reserve. The geographic markets used to conduct the competitive analysis are provided by the Federal Reserve to the DOJ. Also, the DOJ regularly (about every two weeks) sends the Federal Reserve and other banking agencies a document listing those mergers that the DOJ believes are not likely to have significantly adverse competitive effects. Finally, in cases involving DO J-required divestitures, the DOJ typically sends the Federal Reserve a copy of the "letter of agreement" that identifies the terms of the required divestitures.

A significant amount of information is also shared on an ad hoc basis. Direct staff-to-staff communications, including conversations and meetings, play an important role in the resolution of difficult competitive issues. Communications between the staffs of the DOJ and the Federal Reserve can be frequent and may occur without limit at any stage of the application process, including pre-application and postapproval. In the past, a range of issues has been discussed and resolved informally, including both geographic and product market definitions and divestiture requirements. Such informal interactions occur routinely in both banking and nonbanking cases and are probably the single most important means by which the Federal Reserve and the DOJ coordinate their competitive analyses.

The DOJ places substantial weight on the potential effect of a merger on lending to small businesses. The Board also considers small business lending but in the context of the more general analysis of the cluster of banking services. Because of these differences in emphasis, the Board and DOJ may, in occasional cases, reach different conclusions regarding the competitive effects of a merger.

Recent Cases

As I noted earlier, the Board has always believed that it is important to make its antitrust policy clear to the industry and other members of the public. One way it attempts to accomplish this is by providing a detailed analysis of competitive issues in its public Order on each case. In a number of recent large and complex cases, the Board has reinforced its policy and methodology for analyzing competition and reminded applicants of the need for noticeable and possibly increasing, "mitigators" in cases that exceed the DOJ screening guidelines. This was done because during the past couple of years an increasing number of applicants came very close to the Board's limits, in terms of structural effects and strength of mitigating factors, for approving bank mergers. It appeared as though some applicants had concluded that the Board had relaxed its competition standards. That conclusion is incorrect.

For example, in one recent Order the Board noted,

As the Board has indicated in previous cases, in a market in which the competitive effects of a proposal as measured by market indexes and market share exceed the DOJ Guidelines, the Board will consider whether other factors tend to mitigate the effects of the proposal. The number and strength of factors necessary to mitigate the competitive effects of a proposal depend on the level of market concentration and size of the increase in market concentration.(2)

The Board has recently also considered cases in which Department of Justice guidelines were exceeded in a large number of local markets. In those cases as well, the Board indicated that mitigating factors should exist in each local market being affected. There, the Board stated,

In these cases, the Board believes that it is important to give increased attention to the size of the change in market concentration as measured by the HHI in highly concentrated markets, the resulting market share of the acquiror and the pro forma HHIs in these markets, the strength and nature of competitors that remain in the market, and the strength of additional positive and negative factors that may affect competition for financial services in each market.(3)

In summary, at a time when the banking industry is undergoing an unprecedented merger movement that is likely to continue for a considerable period, it is particularly important to have a public policy that will maintain a competitive banking marketplace and that is well understood by all market participants. The Board seeks to accomplish these public policy objectives in an efficient and effective manner by maintaining a relevant and up-to-date policy, cooperating closely with the Department of Justice, keeping the industry and other members of the public well informed, and providing information and guidance through staff at the Board and Reserve Banks.

Nonbank Acquisitions

The ability of bank holding companies to engage in a wide range of nonbanking activities was made possible by the 1970 amendments to the Bank Holding Company Act. Permissible nonbanking activities are those that satisfy a two-part test delineated in section 4(c)(8) of the Bank Holding Company Act. This test first requires the Board to find that a nonbanking activity is "closely related to banking." Second, the Board must determine that the performance of the activity "can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices."

The Board has determined that nonbanking activities are closely related to banking if they meet any one of three criteria: (1) Banks generally have in fact provided the proposed services; (2) banks generally provide services that are operationally or functionally so similar to the proposed services as to equip them particularly well to provide the proposed services; or, (3) banks generally provide services that are so integrally related to the proposed services as to require their provision in a specialized form.

The competitive effects of a proposal must be reviewed as part of the "net public benefits" test that governs nonbanking acquisitions. Unlike the case in banking acquisitions, however, in every nonbanking acquisition, the Board must also weigh other possible effects--such as undue concentration of resources and the existence of unfair competition--against public benefits and find that public benefits are predominant in order to approve the proposal.

Generally, the Board's competitive analysis of nonbanking acquisitions is very similar to that used in banking mergers. In particular, the economic analysis begins with determining the product market in question and then the relevant geographic area for assessing competition. The relevant market area may be local, regional, national, or international, depending on the product under review and the exact nature of the marketplace. Then, proposed changes in market structure are examined along with other factors, such as potential competition, to determine the extent to which competition may be reduced. Over the years, nonbanking acquisitions generally have raised fewer competitive concerns than banking mergers. This is because nonbanking activities have generally been conducted in markets where industry concentration was low or moderate and where numerous competitors existed (for example, consumer finance and mortgage banking).


The Federal Reserve is required by law to assess the competitive implications of proposed bank mergers and acquisitions. In order to fulfill its statutory responsibilities, the Federal Reserve devotes considerable resources to the case-by-case evaluation of merger proposals. The Board normally focuses its analysis on a proposed merger's potential impact on competitive conditions in local markets for banking services. In some cases, particularly those involving the acquisition of nonbank firms, broader geographic areas are used. The Federal Reserve's (along with the Department of Justice's) administration of the antitrust laws in banking has helped to maintain competitive banking markets in the midst of the most significant consolidation of the banking industry in U.S. history. It is the Board's intention and expectation that this will continue to be the case in the future.

Note. The attachments to this statement are available from Publications Services, Mail Stop 127, Board of Governors of the Federal Reserve System, Washington, DC 20551, and on the Board's site on the World Wide Web (

(1) See Federal Reserve Bulletin, vol. 84 (June 1998), pp. 438-51.

(2.) "First Union Corporation." Federal Reserve Bulletin, vol. 84 (June 1998), p. 494.

(3.) "NationsBank Corporation," Federal Reserve Bulletin, vol. 84 (February 1998), pp. 134-35.

Statement by Edward M. Gramlich, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Social Security of the Committee on Ways and Means, U.S. House of Representatives, June 3, 1998

I am pleased to appear before the committee to testify on social security reform. I speak for myself, as past chair of the 1994-96 Quadrennial Advisory Council on Social Security, and not in my current status as a member of the Federal Reserve Board.

Let me first engage in some retrospection. At the time I and other members of the Advisory Council spoke before your committee last year, our report was just out and there was much publicity about the fact that we couldn't agree on a single plan but had three separate approaches. Since that time, it strikes me that there has been a coalescence around the middle-ground approach I advocated. After our report, both the Committee for Economic Development (CED) and Senator Moynihan came out with plans that adopted some of the features of my plan. Two weeks ago the National Commission on Retirement Policy (NCRP) came out with a similar plan, again adopting some features of my plan. In political terms the center seems to be holding--since our report, there has been increased interest in sensible middle-ground approaches, and I would encourage this committee to work in that direction.

In trying to reform social security, the middle-ground approach has two goals. The first is to make affordable the important social protections of this program that have greatly reduced aged poverty and the human costs of work disabilities. The second is to add new national saving for retirement both to help individuals maintain their own standard of living in retirement and to build up the nation's capital stock in advance of the baby boom retirement crunch.

My compromise plan, called the Individual Accounts (IA) Plan, achieves both goals. It preserves the important social protections of social security and still achieves long-term financial balance in the system by what might be called kind and gentle benefit cuts. Most of the cuts would be felt by high wage workers, with disabled and low wage workers being largely protected from cuts. Unlike the other two plans proposed in the Advisory Council report, there would be no reliance at all on the stock market to finance social security benefits and no worsening of the finances of the Health Insurance Trust Fund.

The IA plan includes some technical changes such as including all state and local new hires in social security and applying consistent income tax treatment to social security benefits. These changes go some way to eliminating social security's actuarial deficit.

Then, beginning in the twenty-first century, two other measures would take effect. There would be a slight increase in the normal retirement age for all workers, in line with the expected growth in overall life expectancy (also proposed by the CED, Senator Moynihan, and the NCRP). There would also be a slight change in the benefit formula to reduce the growth of social security benefits for high wage workers (also proposed by the CED and NCRP). Both of these changes would be phased in very gradually to avoid actual benefit cuts for present retirees and "notches" in the benefit schedule (instances when younger workers with the same earnings records get lower real benefits than older workers). The result of all these changes would be a modest reduction in the overall real growth of social security benefits. When combined with the rising number of retirees, the share of the nation's output devoted to social security spending would be approximately the same as at present, eliminating this part of the impending explosion in future entitlement spending.

These benefit cuts alone would mean that high wage workers would not experience rising real benefits as their real wages grow, so I would supplement these changes with another measure to raise overall retirement (and national) saving. Workers would be required to contribute an extra 1.6 percent of their pay to newly created individual accounts. These accounts would be owned by workers but centrally managed. Workers would be able to allocate their funds among five to ten broad mutual or index funds covering stocks and bonds. Central management of the funds would cut down the risk that funds would be invested unwisely, would cut administrative costs, and would mean that Wall Street firms would not find these individual accounts a financial bonanza. The funds would be converted to real annuities on retirement, to protect against inflation and the chance that retirees would overspend in their early retirement years.

Some observers have objected to mandating new retirement contributions now, when there is a welcome prospect of federal budget surpluses. The NCRP, for example, uses both the surpluses and the Health Insurance Fund to help finance individual accounts. I see some problems with that approach, though it does lessen the political difficulty of mandating additional pension coverage. Another option might be to rely on the already extensive private pension system to fill gaps in the existing pension coverage of workers. Tax qualification rules might be changed to include a provision that requires the full participation of all corporate employees in order to qualify for favorable tax treatment.

The social security and pension changes together would mean that approximately the presently scheduled level of benefits would be paid to all wage classes of workers, of all ages. The difference between the outcome and present law is that under this plan these benefits would be affordable, as they are not under present law. The changes would eliminate social security's long-run financial deficit while still holding together the important retirement safety net provided by social security. They would reduce the growth of entitlement spending. They would significantly raise the return on invested contributions for younger workers. And the changes would move beyond the present pay-as-you-go financing scheme by providing new saving to build up the nation's capital stock in advance of the baby boom retirement crunch.

As the Congress debates social security reform, I hope it will keep these goals in mind and consider these types of changes in this very important program.

Statement by Roger W. Ferguson, Jr., Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Finance and Hazardous Materials of the Committee on Commerce, U.S. House of Representatives, June 4, 1998

It is a pleasure to be here today to discuss the Federal Reserve's perspective on the implications of developments in electronic commerce generally and electronic payments specifically. In my testimony, I will focus on addressing the questions posed in Chairman Bliley's letter of April 9 to Chairman Greenspan.

In the past several years, an unprecedented variety of new electronic banking and payment services have been developed. The Federal Reserve has been following these developments closely, meeting a number of times with industry participants to learn more about the products and technologies that may be offered to banking customers. Of course, many of these new products and technologies are still in the very early phases of development and implementation, and they are likely to change considerably over the coming years as the market evolves.


It is important to recognize that many of what are described as new forms of money or payment simply involve delivering or gaining access to existing retail banking products and services in new ways. The ability to send an electronic message from a personal computer that instructs a bank to pay a bill from the consumer's checking account using traditional payment systems is one example. A protocol for sending encrypted messages containing credit card instructions--the most common means of payment on the Internet today--is another. Many of these services can also be viewed as similar, in concept, to communications and payment arrangements that have been available to banks and large corporations for many years. Increasingly, this technology is becoming cost effective at the consumer level, as personal computer prices have fallen and widespread access to the Internet has opened the way for low-cost electronic data communications between individuals and their financial institutions.

Emerging payment products that have been the subject of considerable publicity in recent years include stored-value cards and "electronic cash" for use on the Internet. These new forms of payment have been referred to collectively as "electronic money" in a number of different studies, including those conducted over the past few years by the Group of Ten countries,(1) Although electronic money products have some novel features, they are generally based on the prepaid payment concept familiar from travelers checks and money orders. With many of these products, a prepaid balance of funds available to the consumer (a liability of the issuing institution) is recorded on a magnetic strip, smart card chip, or the consumer's personal computer. A wide range of potential operational forms, product features, financial and legal structures, and intended usage and markets have been proposed for these products, however.

Certain types of stored-value cards are marketed as alternatives to cash in making small-value payments, such as at parking meters, public transport, and fast food restaurants. Other new payment technologies have been developed specifically for making "micropayments," or very small-value purchases of articles, games, or other electronic information, over the Internet. Federal and state governments are testing different types of stored-value cards for making electronic payments to food stamp recipients, for example, and for other purposes.

It is already becoming clear that many consumers and businesses, particularly those that are technologically sophisticated, find the new electronic delivery methods an attractive option for gaining access to familiar banking and payment services. Growing numbers of financial institutions are offering services over the Internet, and transactions initiated over the Internet are widely reported to be on the increase. At the same time, most would agree that the growth of wholly new payment technologies, such as electronic money, has been slower than many observers anticipated several years ago. This should not be surprising. It is important to keep in mind that these new payment products are designed to substitute for existing payment methods, such as cash, checks, and debit and credit cards, and so must offer consumers and businesses materially improved features in terms of cost and convenience in order to gain their acceptance. In addition, for some of these products, new technical infrastructure must be put in place. While these technologies are thus likely to spread only gradually, for the nation's central bank, issues of importance include the potential implications for monetary policy, for the banking and payment system, and for consumers.


As with financial innovations in the past, the Federal Reserve expects to be able to adjust to future changing circumstances. We do not anticipate that the emergence of electronic money will impair our ability to pursue legislated objectives for the performance of the economy.

New forms of money, such as those held as stored-value card balances, are expected to make up a very small portion of the money supply and are unlikely to influence aggregate payment flows materially, particularly in the near-to-medium term. The Federal Reserve has been monitoring these flows in the larger stored-value card pilots involving banks. We might also need to consider establishing other monitoring channels if amounts issued by nondepository institutions were to become significant in the future.

Moreover, it is unlikely, as some have suggested, that alternative currencies will emerge in the United States along with the introduction of new forms of electronic money. The U.S. dollar is supported by a well-established operational, legal, and economic foundation in this country, and it is very likely that electronic payments made between U.S. residents and businesses will continue to be denominated in U.S. dollars.

Similarly, because the usage of electronic money is likely to grow relatively slowly, its introduction is unlikely to affect materially the seigniorage revenues received by the Treasury Department in the near term. "Seigniorage" is a term often used to describe the direct and indirect revenue the Treasury receives on U.S. currency and coin. The most significant portion of this revenue is received indirectly via the Federal Reserve's annual earnings. The Federal Reserve is required to hold collateral, typically government securities, in an amount at least adequate to cover its outstanding currency obligations. In 1997, the Federal Reserve transferred approximately $21 billion in earnings to the Treasury, largely attributable to interest on these government securities holdings. If the usage of electronic money were to reduce the outstanding amounts of currency, and the Federal Reserve's holdings of securities were correspondingly reduced, the Federal Reserve's annual earnings remitted to the Treasury would fall. The other, much smaller, source of seigniorage revenue--the issuance of coins--could be similarly affected. Of course, it should be recognized that the increasing use of electronic retail payment methods more generally might be expected to have an effect on the use of bank notes and coin over time.


We also do not expect the development of electronic money and electronic commerce more broadly to necessitate significant changes in the nation's payments and settlement systems. Many transactions initiated on the Internet, for example, are likely to flow through existing interbank clearing and settlement channels. In fact, credit card payments over the Internet, as well as certain types of stored-value card transactions, are now routinely cleared and settled through the existing facilities operated by the credit card associations. Likewise, most Internet bill-payment systems plan to utilize the existing automated clearing house (ACH) system for clearing and settlement of individual payments. As you may know, the ACH is an electronic payment system that supports direct deposit of payroll and numerous other types of routine payments. The Federal Reserve clears and settles the majority of these transactions.

In addition, the Federal Reserve Banks provide interbank settlement services for a number of retail payment clearinghouses, including private check and ACH clearinghouses, as well as several bank card clearing arrangements. We are currently upgrading these services to make them more efficient and secure. These settlement services could become useful for a range of emerging electronic payment methods in the future.

In the longer term, it is possible that new clearing and settlement methods will need to be developed. Development of new interbank systems typically requires substantial initial investments, planning, and organization among a large group of financial institutions. The financial industry has considerable experience in this regard, having developed clearing and settlement systems for credit card, ATM, and ACH transactions. The private-sector New York Clearing House Association also operates the Clearing House Interbank Payments System (CHIPS). CHIPS, like the Federal Reserve's Fedwire system, is used primarily for large-value funds transfers. In fact, CHIPS is now the largest U.S. dollar payment system in terms of dollar volume, handling $1.4 trillion in payments per day.

The Federal Reserve believes that private-sector innovation and competition that has the potential to shift retail payment users to potentially more efficient and secure electronic alternatives is beneficial, regardless of the impact on Federal Reserve payment services. The use of electronic payment services provided by the private sector is likely to continue to lead to relatively slower growth, or even a decline, in retail payment services in which the Federal Reserve System is involved operationally, notably check clearing. As discussed in the recent report by the System's Committee on the Federal Reserve in the Payments Mechanism, we are exploring how the Federal Reserve can play a more active role in encouraging innovation in and usage of electronic payment methods.(2) These efforts may include helping to reduce regulatory or legal barriers, encouraging the development of open technical standards, promoting consumer education, and providing efficient interbank settlement services, as I noted earlier.

To a large extent, the impetus for the development of new payment systems will originate in the private sector, where consumer and business needs can most readily be addressed. Consistent with this view, the Federal Reserve has no plans to issue electronic money at this time. Direct competition in this area between the government and the private sector could well stifle the current environment of experimentation and innovation. Moreover, the public benefits and acceptance of these types of payment instruments, as well as the evolution of their underlying technologies, are highly uncertain.


I would like to turn to recent developments in the area of consumer protection issues as they relate to new electronic payment and banking technologies. Competitive market forces should create incentives for financial institutions and other suppliers of new electronic payment products to provide protections to consumers in order to promote confidence and encourage usage and acceptance of their products. Moreover, the existing legal framework provides considerable incentives to disclose the terms of these products and to avoid unconscionable or unfair terms. Although we cannot predict whether these incentives will address all potential problems, industry efforts in this area are likely to be more effective than premature and potentially costly new regulations at this time. This is consistent with the approach advocated in the recently released report of an interagency task force, on which my colleague, Governor Kelley, was a member, which recommended limiting government action to monitoring of industry developments and providing consumer financial education where appropriate.(3) In any case, we believe that the desirability of any potential new statutory consumer protections should be based on a demonstrated need to address specific problems or abuses, rather than on an attempt to promote the future growth of any particular form of payment or other service.

It is evident, however, that certain existing regulations need to be updated to avoid unintended barriers to the provision of new electronic products and services to consumers. Federal Reserve Regulation E provides a prime example in this regard. One requirement of Regulation E is that authorizations for recurring electronic payments must be signed by the consumer. To eliminate the delay and expense of paper-based authorization, the Federal Reserve amended Regulation E in 1996 to allow preauthorized transfers in an electronic system to be authenticated by an electronic method that provides the same assurance as a signature in a paper-based system. Similarly, in March 1998, the Board adopted an interim rule that amended Regulation E to allow financial institutions to provide disclosures and other information required by the regulation electronically, rather than in paper form, if the consumer agrees.

The Federal Reserve and the Congress have also been weighing the more difficult issue of how the Electronic Fund Transfer Act (EFTA), and its implementing Regulation E, should apply to stored-value products, if at all. The EFTA includes elements of both disclosures and substantive requirements regarding product terms and conditions, such as liability for unauthorized transactions. In April 1996, the Board issued proposed amendments to Regulation E that would apply selected provisions of the regulation, such as disclosures, to certain types of electronic stored-value cards. In September 1996, the Congress imposed a nine-month moratorium on the issuance of final regulations affecting stored-value products and directed the Federal Reserve to conduct a study of these products.

The Board's resulting March 1997 report to the Congress evaluated whether the EFTA could be applied to stored-value products without adversely impacting their cost, development, and operation.(4) At the request of the Congress, the Board also considered whether alternatives to regulation--such as allowing competitive market forces to shape the development and operation of the products--could more efficiently achieve the objectives of the EFTA. The report did not recommend any specific course of action but did consider at length the benefits and risks of regulatory action in a rapidly changing environment. For example, the disclosure model is often seen as the least intrusive form of government intervention. However, given the variety of existing and planned stored-value products and the rapid evolution of this industry, it seems unlikely that one set of disclosures or other consumer protection requirements would be appropriate for all such products.

The Federal Deposit Insurance Corporation has determined that most types of stored-value cards, even if issued by federally insured depository institutions, do not meet the definition of a deposit under the Federal Deposit Insurance Act, for purposes of inclusion within federal deposit insurance coverage.(5) From the point of view of the government, this determination would have the effect of limiting the extension of the federal safety net to these new products. The FDIC expects banks to disclose to consumers whether or not their cards are federally insured, however.


One of the most sensitive issues raised during discussions of electronic money and banking is the privacy of consumers' financial information. The issue of privacy in a world of ever-growing access to information through computer and telecommunications technology is by no means limited to financial information, but it is increasingly cited as a concern with respect to the security of retail transactions. Although we have no recommendations to make at this time, I would like to make a few observations that may be helpful for discussions on this important issue.

Last year, in response to a congressional directive, the Board conducted a study concerning the availability to the public of sensitive information about consumers. This study was narrowly focused on the potential for financial fraud that could flow from the use of sensitive information and the associated risks to depository institutions. The report concluded that the losses attributable to "identity theft" did not, at that time, pose a significant risk to the banking industry.(6) Given the pace of technological change and the relatively widespread access to personal information, however, this risk appears to be a growing concern for consumers and financial institutions. More broadly, the report highlighted the importance of balancing individuals' important privacy interests with the legitimate needs for information by law enforcement agencies, businesses, and others in both the public and private sectors.

This study highlighted the fact that many consider the issues of privacy and security to be closely related. Although some surveys indicate that security concerns are still a barrier to the growth of electronic commerce, there has been a considerable amount of promising private-sector activity with respect to addressing the security and reliability of payment transactions transmitted over the Internet. Several technologies are already available for protecting transaction information against unauthorized disclosure while in transit. Some new payment methods have specifically incorporated technologies to safeguard the privacy of consumers' transaction information. Of course, consumers and businesses will need to select the technologies and payment arrangements that are most appropriate, given their preferences and the risks in different types of transactions.

Security is likely to remain a primary concern of financial institutions, which most often bear the losses associated with fraudulent transactions. The Federal Reserve and the other federal banking agencies have been actively reviewing and upgrading our supervisory policies and procedures in the area of electronic banking and information security to help ensure that risks to banks in providing services that support electronic commerce are appropriately managed. The Federal Reserve recently participated in an international effort under the Basle Supervisors Committee to provide preliminary supervisory guidance on risk management for electronic banking activities, resulting in a study published earlier this year. Going forward, information security risk management will continue to increase in importance as banks' reliance on information technology grows and greater attention is focused on the need to safeguard customer information.


Finally, it is important to note that the potential impact of increasingly linked global communications on financial services offered in this country and abroad in the coming years is very difficult to predict. However, it is possible that significant changes could occur in the way that products and services are marketed and delivered. In general, these developments should be positive for users of financial services, offering them greater flexibility and the potential to obtain financial services at the lowest cost, regardless of location or provider.

A significant expansion of the solicitation and provision of financial services across jurisdictional boundaries could raise cross-border legal and regulatory issues. Of course, such activities also occur with current technology, including via telephones and paper-based communications. The resulting jurisdictional and enforcement issues relating to legal uncertainties, compliance with different national laws and regulations, or abusive practices by offshore entities, have arisen in the past in many different contexts. Although new technologies could spur greater activity in this regard, it would appear premature at this time to predict that wholesale changes in legal or regulatory approaches will be needed.


In summary, the Federal Reserve anticipates minimal impact in the near term from emerging electronic payments, and from electronic commerce more broadly, on our core central banking responsibilities, including our ability to implement monetary policy, our supervisory responsibilities, and our operational role in the clearing and settlement of payments. Nevertheless, technological change and the growth of electronic commerce could raise complex policy issues that may require careful monitoring and study over the coming years by the Federal Reserve, the Congress, and the private sector. We look forward to working with you to assess the implications of these important developments.

(1.) See, for example, Group of Ten, Electronic Money: Consumer protection, law enforcement, supervisory and cross border issues (Bank for International Settlements, 1997); Committee on Payment and Settlement Systems and the Group of Computer Experts, Security of Electronic Money (Bank for International Settlements, 1996).

(2.) Board of Governors of the Federal Reserve System, Committee on the Federal Reserve in the Payments Mechanism, The Federal Reserve in the Payments Mechanism (Board of Governors, 1998).

(3.) Consumer Electronic Payments Task Force, Report of the Consumer Electronic Payments Task Force, April 1998.

(4.) Board of Governors of the Federal Reserve System, Report to Congress on the Application of the Electronic Fund Transfer Act to Electronic Stored-Value Products (Board of Governors, 1997).

(5.) Federal Deposit Insurance Corporation, "General Counsel's Opinion No. 8; Stored Value Cards," 61 FR 40490, August 2, 1996.

(6.) Board of Governors of the Federal Reserve System, Report to Congress Concerning the Availability of Consumer Identifying Information and Financial Fraud (Board of Governors, 1997).

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Joint Economic Committee, U.S. Congress, June 10, 1998

I am pleased to have the opportunity to present an update on economic conditions in the United States.

Such an assessment cannot be made in isolation but rather depends critically on what is happening in the rest of the world and how those developments affect the performance of the American economy. In my previous appearance before this committee last October, my remarks focused mainly on the turbulence that was then evident in world financial markets and, in particular, on the problems that had emerged in a number of Asian economies. The tentative assessment offered then was that the economies of Asia were in for some trying times but that the situation did not seem likely to threaten the expansion of this country's economy.

That assessment, I believe, still is essentially correct, although uncertainties about the degree of restraint that will be coming from abroad remain substantial. Earlier this year, the situations in most of the Asian countries seemed to be stabilizing in some respects, but, as the events of the past few weeks have demonstrated, the restoration of normally functioning economies will not necessarily go smoothly. In some cases, the adjustments that are needed to improve external balances and to correct existing misallocations of resources have been accompanied by sharp increases in inflation, rising unemployment, abrupt cutbacks in living standards, and increases in uncertainty and insecurity. The heightened social and political pressures that can develop in such circumstances not only introduce added complications into economic policymaking but also make it even more difficult to foresee how the processes of adjustment will play out across the afflicted economies.

That the American economy would be affected to some degree by spillover from the problems in Asia was never in doubt, even though the timing and magnitude of the impact have been difficult to predict with much confidence. Many months ago, businesses in this country began anticipating a worsening of our trade balance with the Asian countries, and incoming economic data have since confirmed those expectations. Meanwhile, other influences on trade--such as the strength of demand growth in the United States and a dollar that has been strong against a wide array of currencies--have persisted. In total, U.S. exports of goods and services turned down in real terms in the first quarter of 1998, the first such decline in four years, and real imports of goods and services continued to rise very rapidly. The combined effect of these changes exerted a drag of 2 1/2 percentage points on the annual growth rate of real gross domestic product last quarter. Weaknesses in Asia appear to account for approximately one-half of that deterioration. Not only have export volumes been affected, but producers in both industry and agriculture also are having to adjust to the lower product prices that have come with slower economic growth abroad and the increase in the competitiveness of foreign producers induced largely by depreciations of their currencies.

But even with substantial drag from the external sector, the U.S. economy has continued to expand at a robust pace. In the first quarter, real GDP grew even faster than it had in 1997. Employment has continued to increase rapidly this year, and the unemployment rate has fallen further, reaching its lowest level since 1970. Incomes have continued to climb, and gains in household and business expenditures have been exceptionally strong. Although the data on hours worked suggest that growth of the economy has likely slowed this quarter from the first quarter's torrid pace, the degree of slowdown remains in question. Evidence to date of a moderation in underlying domestic spending still is sparse.

The strength of domestic spending has been fueled, in part, by conditions in financial markets. Although real short-term interest rates have been rising, equity prices have moved still higher, credit has been readily available at slender margins over Treasury interest rates, and nominal long-term interest rates have remained near the lowest levels of recent decades. Rapid growth of money this year is a further indication that financial conditions are accommodating strong domestic spending, although we still are uncertain how reliable that relationship will prove to be over time.

In short, our economy is still enjoying a virtuous cycle, in which, in the context of subdued inflation and generally supportive credit conditions, rising equity values are providing impetus for spending and, in turn, the expansion of output, employment, and productivity-enhancing capital investment. The hopes for accelerated productivity growth have been bolstering expectations of future corporate earnings and thereby fueling still further increases in equity values.

The essential precondition for the emergence, and persistence, of this virtuous cycle is arguably the decline in the rate of inflation to near price stability. Continued low product price inflation and expectations that it will persist have brought increasing stability to financial markets and fostered perceptions that the degree of risk in the financial outlook has been moving ever lower. These perceptions, in turn, have reduced the extra compensation that investors require for making loans to, or taking ownership positions in, private firms.

To a considerable extent, investors seem to be expecting that low inflation and stronger productivity growth will allow the extraordinary growth of profits to be extended into the distant future. Indeed, expectations of per share earnings growth over the longer term have been undergoing continuous upward revision by security analysts since 1994. These rising expectations have, in turn, driven stock prices sharply higher and credit spreads lower, perhaps to levels that will be difficult to sustain unless economic conditions remain exceptionally favorable--more so than might be anticipated from historical relationships. In any event, primarily because of the rise in stock prices, about $12 trillion has been added to the value of household assets since the end of 1994. Probably only a few percent of these largely unrealized capital gains have been transformed into the purchase of goods and services in consumer markets. But that increment to spending, combined with the sharp increase in equipment investment, which has stemmed from the low cost of both equity and debt relative to expected profits on capital, has propelled the economy forward. The current economic performance, with its combination of strong growth and low inflation, is as impressive as any I have witnessed in my near half century of daily observation of the American economy.

The consequences for the American worker have been dramatic and, for the most part, highly favorable. A great many chronically underemployed people have been given the opportunity to work, and many others have been able to upgrade their skills as a result of work experience, extensive increases in on-the-job training, or increased enrollment in technical programs. Welfare recipients appear to have been absorbed into the work force in significant numbers.

Government finances have improved as well. The taxes paid on huge realized capital gains and other incomes related to the stock market, coupled with taxes on markedly higher corporate profits, have joined with restraint on spending to produce a unified federal budget surplus for the first time in nearly three decades. April's budget surplus of $125 billion was the largest monthly surplus on record. Widespread improvement also has been evident in the financial positions of state and local governments.

The fact that economic performance strengthened as inflation subsided should not have been surprising, given that risk premiums and economic disincentives to invest in productive capital diminish as product prices become more stable. But the extent to which strong growth and high resource utilization have been joined with low inflation over an extended period is nevertheless extraordinary. Indeed, the broadest measures of price change indicate that the inflation rate moved down further in the first quarter of this year, even as the economy strengthened. Although declining oil prices contributed to this result, pricing leverage in the goods-producing sector more generally was held in check by rising industrial capacity; reduced demand in Asia, which, among other things, has led to a softening of commodity prices; and a strong dollar, which has contributed to bargain prices on many imports. Some elements in this mix clearly were transitory, and the very recent price data suggest that consumer price inflation has moved up in the second quarter. But, even so, the rate of rise remains quite moderate overall. At this point, at least, the adverse wage-price interactions that played so central a role in pushing inflation higher in many past business expansions--eventually bringing those expansions to an end--do not appear to have gained a significant toehold in the current expansion.

There are many reasons why the wage-price interactions have been so well contained in this expansion. For one thing, increases `in hourly compensation have been slower to pick up than in most other recent expansions, although, to be sure, wages have started to accelerate in the past couple of years as the labor market has become tighter and tighter.

In the first few years of the expansion, the subdued rate of rise in hourly compensation seemed to be, in part, a reflection of greater concerns among workers about job security. We now seem to have moved beyond that period of especially acute concern, though the flux of technology may still leave many workers with fears of job skill obsolescence and a willingness to trade wage gains for job security. This may explain why, despite the recent acceleration of wages, the resulting level of compensation has fallen short of what the experience of previous expansions would have led us to anticipate given the current degree of labor market tightness. In the past couple of years, of course, workers have not had to press especially hard for nominal pay gains to realize sizable increases in their real wages. In contrast to the pattern that developed in several previous business expansions, when workers required substantial increases in pay just to cover increases in the cost of living, consumer prices have been generally well behaved in the current expansion. Changes this past year in prices of both goods and services have been among the smallest of recent decades.

In addition, the rate of rise in the cost of benefits that employers provide to workers has been remarkably subdued over the past few years, although a gradual upward tilt has become evident of late. A variety of factors--including the strength of the economy and rising equity values, which have reduced the need for payments into unemployment trust funds and pension plans, and the restructuring of the health care sector--have been working to keep benefit costs in check in this expansion. But, in the medical area at least, the most recent developments suggest that the favorable trend may have run its course. The slowing of price increases for medical services seems to have come to a halt, at least for a time, and, with the cost-saving shift to managed care having been largely completed, the potential for businesses to achieve further savings in that regard appears to be rather limited at this point. There have been a few striking instances this past year of employers boosting outlays for health benefits by substantial amounts.

A couple of years ago--almost at the same time that increases in total hourly compensation began trending up in nominal terms--evidence of a long-awaited pickup in the growth of labor productivity began to show through more strongly in the data; and this accelerated increase in output per hour has enabled firms to meet workers' real wage demands while holding the line on price increases. Gains in productivity usually vary with the strength of the economy, and the favorable results that we have observed during the past two years or so, when the economy has been growing more rapidly, surely overstate the degree of pickup that can be sustained. But evidence continues to mount that the trend has picked up, even if the extent of that improvement is as yet unclear. Signs of a major technological transformation of the economy are all around us, and the benefits are evident not only in high tech industries but also in production processes that have long been part of our industrial economy.

Notwithstanding a reasonably optimistic interpretation of the recent productivity numbers, it would not be prudent to assume that rising productivity, by itself, can ensure a noninflationary future. Certainly wage increases, per se, are not inflationary. To be avoided are those that exceed productivity growth, thereby creating pressure for inflationary price increases that can eventually undermine economic growth and employment. Because the level of productivity is tied to an important degree to the physical stock of capital, which turns over only gradually, increases in the trend growth of productivity probably also occur rather gradually. By contrast, the potential for abrupt acceleration of nominal hourly compensation is surely greater. Still, a strong signal of inflation pressures building because of compensation increases markedly in excess of productivity gains has not yet clearly emerged in this expansion. Among nonfinancial corporations, our most reliable source of consolidated costs, trends in costs seem to have accelerated from their lows, but the rates of increase in both unit labor costs and total unit costs are still quite low.

Nonetheless, as I have noted in previous appearances before the Congress, I remain concerned that economic growth will run into constraints as the reservoir of unemployed people available to work is drawn down. The annual increase in the working age population (from 16 to 64 years of age), including immigrants, has been approximately 1 percent a year in recent years. Yet employment, measured by the count of persons who are working rather than by the count of jobs, has been rising 2 percent a year since 1995 despite the acceleration in the growth of output per hour. The gap between employment growth and population growth, amounting to about 1.2 million a year on average, has been made up, in part, by a decline in the number of individuals who are counted as unemployed--those persons who are actively seeking work--of approximately 700,000 a year, on average, since the end of 1995. The remainder of the gap has reflected a rise in labor force participation that can be traced to a decline of more than 500,000 a year in the number of individuals (age 16 to 64) wanting a job but not actively seeking one. Presumably, many of the persons who once were in this group have more recently become active and successful job seekers as the economy has strengthened, thereby preventing a still sharper drop in the official unemployment rate. In May, the number of persons aged 16 to 64 who wanted to work but who did not have jobs was 9.7 million on a seasonally adjusted basis, slightly more than 5 1/2 percent of the working age population. This percentage is a record low for the series, which first became available in 1970.

The gap between the growth in employment and that of the working age population will inevitably close. What is crucial to sustaining this unprecedented period of prosperity is whether that closing occurs in a disruptive or gradual, balanced manner. The effects of the crisis in Asia will almost certainly damp net exports further, potentially moderating the growth of domestic production and hence employment. The strength of domestic spending that has been bolstering output growth and the demand for labor also could ebb if recent indications of a narrowing in domestic profit margins were to prove to be the forerunner of a reassessment of the expected rates of return on plant and equipment. Reduced prospects for the return to capital would not only affect investment directly but could also affect consumption as stock prices adjusted to a less optimistic view of earnings prospects. Finally, the clearly unsustainable rise of inventories that has been evident in recent quarters will be slowing at some point, perhaps abruptly. An easing of the demand for labor would be an expected consequence of a slowdown in either final sales or inventory accumulation. Of course, the demand for labor that is consistent with a particular rate of output growth also could be lowered if productivity were to continue to accelerate. And, on the supply side of the labor market, faster growth of the labor force could emerge as the result of delayed retirements or increased immigration.

If developments such as these do not bring labor demand into line with its sustainable supply, tighter economic policy may be necessary to help guard against a buildup of pressures that could derail the current prosperity. Fortunately, fiscal policy has been moving toward restraint to some degree, although recent budgetary discussions do not appear to be focused on extending that tendency. Monetary policy might need to tighten if demand were to continue to exhibit few signs of abating noticeably, thereby threatening to place still further strains on our labor markets. We at the Federal Reserve, recognizing the powerful forces of productivity growth and global restraint on inflation, have not perceived to date the need to tighten policy in response to strong demand beyond what has occurred through falling inflation's upward pressure on the real federal funds rate and the modest increase in the nominal rate that we initiated in March of 1997. But we are monitoring the evolving forces very closely to determine whether the recent acceleration of costs, albeit moderate, is likely to prove transitory or the start of a more worrisome pattern that may well require a response.

In summary, our economy has remained strong this year despite evidence of substantial drag from Asia, and, at the same time, inflation has remained low. As I have indicated, this set of circumstances is not what historical relationships would have led us to expect at this point in the business expansion, and while it is possible that we have, in a sense, moved "beyond history," we also have to be alert to the possibility that less favorable historical relationships will eventually reassert themselves. That is why we are remaining watchful for signs of potential inflationary imbalances, even as the economy continues to perform more impressively than it has in a very long time.

Statement submitted by the Board of Governors of the Federal Reserve System, to the Subcommittee on Risk Management and Specialty Crops of the Committee on Agriculture, U.S. House of Representatives, June 10, 1998

The Board appreciates the opportunity to submit its views on issues relating to the potential application of the Commodity Exchange Act (CEA) to over-the-counter (OTC) derivatives transactions. The Board has been participating actively in discussions of these issues for the past ten years. As the subcommittee is aware, the markets for OTC derivatives have grown enormously during this period and are now large and globally significant. For this reason, the legal and regulatory framework for these markets is unquestionably important. The Board is deeply concerned about any legal or regulatory development that calls into question the enforceability of a significant volume of such transactions.

A particular concern for many years has been the potential application of the CEA to OTC derivatives. Because the CEA generally requires instruments covered by the act to be traded on an exchange, if OTC derivatives were covered, they might be illegal and unenforceable. The Futures Trading Practices Act (FTPA) of 1992 tried to address this concern by authorizing the Commodity Futures Trading Commission (CFTC) to exempt OTC derivatives from most provisions of the CEA, to the extent that the act might apply. Nonetheless, concerns have persisted that the CEA could jeopardize the enforceability of certain OTC derivatives transactions.

These concerns have been heightened by the CFTC's recent concept release on regulation of OTC derivatives. In particular, the underlying premise of the release is that such transactions are subject to the CEA unless clearly and explicitly excluded or exempted. This marks an important departure from precedent. Neither the Congress nor the CFTC has to date made a determination that OTC derivatives are subject to the CEA. Indeed, in early 1993, when the commission used the FTPA authority to exempt many OTC transactions from most provisions of the CEA, it stated explicitly that its action should not be construed as reflecting any determination that the instruments covered by the exemption were subject to the act.

The reason the Board has been keenly interested in these issues is because of the potential consequences if significant volumes of OTC derivatives were determined to be illegal and unenforceable under the CEA. In those circumstances, the potential losses to counterparties, including those large U.S. banks that are leading derivatives dealers, could be so large as to pose a threat to the financial condition of the counterparties themselves and to provide a significant shock to the financial system as a whole. The Board is also dismayed by the prospect that legal uncertainties or unnecessary regulatory burdens could undermine the position of U.S. institutions in what are intensely competitive global markets. We see no social benefits and clear social costs from pushing OTC derivatives activity offshore.

Some may characterize the issues under consideration as nothing more than regulatory turf fights. We believe this misses the point. The issues under consideration really are not so much issues of which government agency should regulate these transactions as they are issues of whether government regulation is necessary and, if so, what types of regulations are appropriate. Moreover, as we have indicated, considerably more is at stake--the safety and soundness of banks, the competitiveness of U.S. markets and institutions, and possibly even the stability of the financial system--than would be the case if the issues were limited solely or even primarily to regulatory turf.


Governor Phillips presented the Board's views on the potential application of the CEA to OTC derivatives in testimony to this subcommittee in April 1997. Since then the Board's views have not changed. Indeed, subsequent developments have reinforced our earlier position.

The Board believes that application of the CEA to institutional transactions in OTC derivatives is unnecessary to achieve public policy objectives with respect to these transactions. The public policy objectives of the CEA are to ensure the integrity of commodity markets, especially to deter market manipulation, and to protect market participants from losses resulting from fraud or the insolvency of contract counterparties. In the case of institutional OTC derivatives transactions, private market discipline appears to achieve these objectives quite effectively and efficiently.

Counterparties to privately negotiated transactions have limited their activity to contracts that are very difficult to manipulate. The vast majority of privately negotiated contracts are settled in cash rather than through delivery. Cash settlement typically is based on a rate or price in a highly liquid market with a very large or virtually unlimited deliverable supply, for example, LIBOR or the spot dollar yen exchange rate. Furthermore, the costs of default or of failing to deliver typically are limited to actual damages. Thus, attempts to corner a market, even if successful, could not induce sellers in privately negotiated transactions to pay significantly higher prices to offset their contracts or to purchase the underlying assets. Most important, prices established in privately negotiated transactions are not used directly or indiscriminately as the basis for pricing other transactions, so any price distortions would not affect other buyers or sellers of the underlying asset. In these respects, privately negotiated contracts have different characteristics than exchange-traded contracts generally and agricultural futures in particular.

Institutional counterparties to privately negotiated contracts also have demonstrated their ability to protect themselves from losses from fraud and counterparty insolvencies. They have insisted that dealers have financial strength sufficient to warrant a credit rating of A or higher. Consequently, dealers are established institutions with substantial assets and significant investments in their reputations. When such dealers have engaged in deceptive practices, institutions that have been victimized have been able to obtain redress by going to court or directly negotiating a settlement with the dealer. The threat of legal damage awards provides dealers with incentives to avoid misconduct. A far more powerful incentive, however, is the fear of loss of the dealer's good reputation, without which it cannot compete effectively, regardless of its financial strength or financial engineering capabilities. Institutional counterparties to privately negotiated transactions also have demonstrated their ability to manage credit risks quite effectively through careful evaluation of counterparties, the setting of internal credit limits, and the judicious use of netting agreements and collateral.

Although an October 1997 report by the General Accounting Office (GAO) suggested that there have been substantial losses to end-users of OTC derivatives, a careful inspection of the report's data reveals that the vast majority of those losses were in investments in mortgage-backed securities and structured notes, for which federal sales practices regulations either were in place or have since been implemented. Indeed, we feel the most revealing data in the GAO's report were the results of its survey of end-users. When asked if they were satisfied with derivatives dealers' sales practices, 85 percent of users of plain vanilla derivatives and 79 percent of users of more complex derivatives indicated satisfaction. The great majority of the remainder responded neutrally rather than indicating that they were dissatisfied. In the Board's view, these results call into question the need for additional government regulation of sales practices of OTC derivatives dealers.

In the future, counterparties to OTC derivatives transactions may seek to establish new facilities for centralized clearing of such transactions. Such facilities potentially could make management of counterparty credit risks and liquidity risks even more effective. At the same time, however, clearing facilities often concentrate and mutualize risk. The Board believes that if counterparties were to choose to develop such facilities, some type of government oversight generally may be appropriate to supplement the private self-regulation that the counterparties would provide. However, it is not obvious that regulation of such clearing facilities under the CEA would be the best approach. For example, the Board sees no reason why a clearing agency regulated by the Securities and Exchange Commission should not be allowed to clear OTC derivatives transactions, especially if it already clears the instruments underlying the derivatives. More generally, the Board believes that in many circumstances, regulation of OTC clearing might best be conducted by the Securites and Exchange Commission (SEC), or by one of the federal banking agencies, rather than by the CFTC. Furthermore, if a clearing facility is located abroad and regulated effectively by a home country regulator, U.S. regulators should rely primarily on the home country regulator to address U.S. public policy concerns, rather than attempting to force the clearing facility to conform to the rules of multiple jurisdictions, which may well conflict.

In general, even in those cases in which regulation of OTC derivatives may be necessary, the Board sees serious problems with applying the CEA to such transactions. By far the most significant problem is the uncertainty created by the act's exchange trading requirement. To be sure, there are some specific exclusions of OTC transactions from the act, and CFTC policy statements and exemptions have been intended to create legal certainty for other OTC transactions. Experience has repeatedly demonstrated, however, that these exclusions and exemptions have not provided legal certainty for OTC derivatives. In every case, the exclusions and exemptions include terms or conditions that are ambiguous or that, even if seemingly unambiguous, have been made the sport of litigators. The CFTC's recent issuance of a concept release on regulation of OTC derivatives has made matters worse by presuming that such transactions are covered unless specifically excluded or exempted and by underscoring that, whatever the terms of various existing policy statements and exemptions, these can be altered or reinterpreted by the commission.

As things stand, some interpret the language of the existing exclusions and exemptions in ways that, if accepted by the courts, could call into question the enforceability of at least some, and perhaps a significant share of, outstanding OTC transactions. In the Board's view, the potential that such interpretations might be accepted places the financial system at risk and therefore is an unacceptable state of affairs. The Board continues to believe that the only way to achieve legal certainty is through a broad statutory exclusion of institutional OTC derivatives transactions, perhaps using the definitions of a "swap agreement" and an "eligible swap participant" that the CFTC currently uses in its exemption.

While the legal uncertainty associated with the potential application of the CEA for OTC derivatives is the Board's most serious concern, it is also troubled by the potential implications of a provision of the CEA that provides the CFTC with exclusive jurisdiction over instruments subject to the act. Recently, the CFTC has claimed that this 'provision may impose restrictions on the SEC's ability to impose regulations, including capital regulations on the activities of a new class of broker-dealers, on instruments or transactions that the CFTC asserts are subject to the CEA. Banking regulators apply capital requirements to a wide variety of instruments that either are unquestionably subject to the CEA (futures traded on U.S. commodity exchanges) or that the CFTC has asserted are subject to the act (many OTC derivatives). The Board cannot believe that the Congress intended the exclusivity provision of the CEA to preclude other federal regulators from imposing safety and soundness regulations on activities of institutions over which they have authority, even if those activities involve transactions subject to the CEA.


The Board believes that the issues relating to government regulation of OTC derivatives, including the potential application of the CEA to those transactions, deserve further study and ultimately should be revisited by the Congress. In the interim, however, the Congress should do as much as possible to remove the legal clouds hanging over the OTC derivatives markets.

Accordingly, the Board supports the proposal for immediate but temporary legislation that was recently transmitted to Speaker Gingrich by Chairman Greenspan, Secretary Rubin, and Chairman Levitt. The proposal calls for the President's Working Group on Financial Markets to study the markets for OTC derivatives and for hybrid debt instruments (whose potential regulation under the CEA raises broadly similar issues and concerns), to make recommendations for changes to statutes and regulations, and to submit a report to the Congress containing its results and recommendations within one year. Such a study by the Working Group undoubtedly would produce a thorough airing of the issues that would be quite useful to the Congress in deciding how best to resolve the existing legal and regulatory uncertainties.

The proposal would enhance legal certainty in two ways. First, it includes a standstill provision that would temporarily eliminate the risk that changes in CFTC regulations, policies, or interpretations could raise new questions about the enforceability of any OTC derivatives transaction (or hybrid debt instrument) that was exempt from the CEA under the CFTC's existing exemptions as of January 1, 1998. This standstill provision would also temporarily preclude the CFTC from unilaterally imposing a new, comprehensive regulatory regime for the OTC derivatives markets without the explicit consent of the Congress and before the Congress has had a chance to consider carefully the potential ramifications. Second, the proposal would remove the legal cloud over certain securities-indexed transactions (including equity swaps and equity-indexed hybrid debt instruments). These securities-indexed transactions are subject to additional legal uncertainty because of a provision that prohibits the CFTC from exempting such transactions from the CEA to the extent that they might be considered to be covered. The proposal would, in effect, extend the CFTC's existing exemption for OTC derivatives to cover these securities-indexed transactions, thereby reducing legal uncertainty.


In summary, the Board believes that application of the CEA to institutional transactions in OTC derivatives would be inappropriate. It is unnecessary to achieve public policy objectives with respect to such transactions. Moreover, if the CEA is applied to such transactions, as assumed by the CFTC in its recent concept release, it would call into question the legal enforceability of at least some, and perhaps many, of those transactions. This threat undermines the competitiveness of U.S. firms and markets and could place the stability of the financial system at risk. For these reasons, the Board supports the proposal for immediate but temporary legislation that was recently transmitted to the Congress.

Statement by Herbert A. Biern, Associate Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, before the Committee on Banking and Financial Services, U.S. House of Representatives, June 11, 1998

I am pleased to appear before the Committee on Banking and Financial Services to discuss the Federal Reserve's role in the government's anti-money-laundering efforts and our interagency efforts to develop and issue effective "Know Your Customer" rules for the banking industry. As you requested, I will also describe in general terms the Federal Reserve's participation in Operation Casablanca and the issuance of enforcement orders against the foreign banking organizations with U.S. offices identified in the operation. Finally, I will provide some comments on proposed anti-money-laundering legislation that you and the members of the committee are considering.

First, I want to emphasize that the Federal Reserve places a high priority on participating in the government's programs designed to attack the laundering of proceeds of illegal activities through our nation's financial institutions. As a result, over the past several years Federal Reserve staff has engaged extensively in anti-money-laundering endeavors on its own and in coordination with U.S. and international bank supervisory agencies and law enforcement authorities.

As bank supervisors, the Federal Reserve believes that it is necessary to take reasonable and prudent steps to ensure that banking organizations do not knowingly engage in money laundering. For this reason, and to support our law enforcement agencies in their efforts to combat money laundering, the Federal Reserve's efforts to attack the money laundering problem continue to be one of our highest bank supervisory priorities. As I will describe in more detail, the Federal Reserve has played, and will continue to play, a prominent role in the federal government's program to reduce and we hope eliminate money laundering activities through U.S. financial institutions.


Banking organizations and their employees are the first and strongest line of defense against financial crimes and, in particular, money laundering. It is for this reason that the Federal Reserve emphasizes the importance of financial institutions putting in place controls to protect themselves and their customers from illicit activities. A banking organization's best protection against criminal activities is its own policies and procedures designed to identify and understand with whom it is conducting business and having the capability to identify and then reject potentially illegal or damaging transactions. For this reason, the Federal Reserve and the other regulators have implemented various directives for banking organizations to establish internal controls and procedures designed to detect unusual or suspicious transactions that, if unchecked, could lead to criminal misconduct, including money laundering.

To understand and properly evaluate the effectiveness of a banking organization's controls and procedures, Federal Reserve staff has developed comprehensive examination procedures and manuals. In November 1997, the Federal Reserve issued its newly revised risk-focused Bank Secrecy Act examination procedures. These enhanced examination procedures specifically address anti-money-laundering compliance. For example, the examination procedures direct examiners to review written policies of an institution to assess whether senior management has included anti-money-laundering procedures in all of the institution's operational areas, including retail operations, credit, private banking, and trust. Examiners are also directed to review existing Know Your Customer policies as a preventive measure and as a means to detect and report suspicious money-laundering-related activities. In addition, specific examination procedures direct the examiner to determine the effectiveness of systems used by the institution to identify unusual or suspicious activities with regard to cash transactions, exemptions, the sale of monetary instruments, and funds transfers. Examiners are also directed to review audit testing procedures to determine if audits are being used to detect, deter, and report money laundering activities. Training programs for relevant bank staff in the areas of Bank Secrecy Act compliance and anti-money-laundering controls are also evaluated.

Federal Reserve examiners are provided with comprehensive training to assist them in identifying appropriate bank policies and procedures. We also provide training to our examiners on the latest trends in money laundering, as well as techniques for identifying suspicious or unusual transactions. Examiners evaluate the viability of a bank's anti-money-laundering policies and procedures designed to enable the bank to, among other things, detect and report unusual or suspicious transactions. However, even with appropriate training, it is still difficult for even the most experienced examiners to detect sophisticated money laundering schemes during the course of an examination. In this regard, I must emphasize that we do not expect our examiners to act as criminal investigators. As a federal bank supervisory agency, we view the Federal Reserve's role as auxiliary to the legitimate law enforcement duties of criminal justice agencies. Our examiners do not, nor should they, possess the necessary tools required to fully investigate and prosecute criminal conduct. If money laundering transactions are identified or strongly suspected during the course of an examination, we immediately notify our law enforcement colleagues.

Having said this, however, in recent years the Federal Reserve has determined that in some instances it is necessary to go, beyond the scope of an ordinary bank examination to determine if violations of law have occurred. For this reason, in 1993 the Special Investigations Section was created in the Board's bank supervision division. This unit's function, in part, continues to be that of reviewing information developed during the course of an examination and conducting a specialized inquiry to determine what, if any, laws have been violated through activity conducted at a banking organization. Section staff notifies the appropriate law enforcement agency when apparent criminal violations are detected and provides support and technical assistance whenever requested. Recent undertakings of this section include uncovering information that led to the conviction for criminal activity related to money laundering and fraud of the Bangkok Metropolitan Bank, a foreign banking organization that subsequently was ordered by the Federal Reserve to cease all operations in the United States, and coordinating the Federal Reserve's recent involvement in Operation Casablanca.


In addition to the Federal Reserve's efforts to develop appropriate anti-money-laundering-related policies and procedures for the domestic and foreign financial institutions that we supervise and our examination for compliance with those policies and procedures, staff of the Federal Reserve has taken an active role among federal bank supervisors in the law enforcement community's battle to deter money laundering by providing expertise for law enforcement initiatives and training to various government agencies.

The Federal Reserve routinely coordinates with federal law enforcement agencies with regard to potential criminal matters, including anti-money-laundering activities. The scope of this coordination ranges from our significant work on the development and implementation of the new interagency Suspicious Activity Reporting system to the referral of illicit activities on a case-by-case basis to law enforcement agencies resulting from examinations of banking organizations.

Training provided by Federal Reserve staff to law enforcement agencies continues to include programs at the U.S. Department of the Treasury's Federal Law Enforcement Training Center and at the FBI Academy, as well as training for the U.S. Secret Service and the U.S. Customs Service. Additionally, Federal Reserve staff has provided training in anti-money-laundering procedures to foreign law enforcement officials and central bank supervisory personnel in such countries as Russia, Poland, Hungary, the Czech Republic, and a number of the emerging Baltic states, as well as Brazil, Ecuador, Argentina, China, and several other countries in the Middle East and Far East.

The Federal Reserve's foreign initiatives also include our staff's active participation in the Financial Action Task Force (FATF), which was established by the Group of Seven (G-7) countries. Board staff has contributed significantly to the FATF's mission of educating countries around the world in anti-money-laundering and fraud prevention efforts. The Federal Reserve also participated in the development of guidance related to serious financial crimes, including money laundering, that was adopted at the recently concluded G-7 ministerial meeting at Birmingham, England.

In addition, the Federal Reserve is a founding member and an active participant in the well-regarded interagency Bank Fraud Working Group, which consists of representatives of thirteen federal law enforcement and bank and securities supervisory agencies. Among other things, this group, which has been meeting on a monthly basis since the mid-1980s, has coordinated the dissemination of relevant and timely information concerning criminal misconduct involving various banking organizations and their officials.


The Federal Reserve believes that the most prudent and effective means by which banking organizations can protect themselves from allowing criminal transactions to be conducted at, or through, their institutions are for the institutions to adopt what has become known as Know Your Customer policies and procedures. Illicit activities, such as money laundering, fraud, and other transactions designed to assist criminals in their illegal ventures, pose a serious threat to the integrity and reputation of financial institutions. When transactions at financial institutions involving illicit funds, such as money laundering activities, are revealed, such transactions invariably damage the reputation of the institution involved. While it is practically impossible to identify every transaction at a financial institution that is potentially illegal or is being conducted to assist criminals in the movement of illegally derived funds, it is fundamental for safe and sound operations that financial institutions take reasonable measures to identify adequately who they conduct business with, understand the legitimate transactions to be conducted by those customers, and, consequently, identify those transactions conducted by their customers that are unusual or suspicious in nature.

In February 1996, Governor Kelley directed Federal Reserve staff to begin the development of a Know Your Customer regulation. The first step in this process was an extensive Federal Reserve effort in 1996 and 1997 to gain a comprehensive understanding of the current Know Your Customer policies and procedures of banking organizations operating in the United States and abroad, including the private banking activities of large domestic and foreign banking organizations. Among the actions taken by Federal Reserve staff during this period were the examinations of several private banking operations in order to determine, among other things, how they have implemented their own Know Your Customer policies and procedures. As a result of the yearlong private banking review, the Federal Reserve developed and issued a "sound practices" paper on private banking in July 1997. Information gathered from the private banking examinations provided staff with some basic information that was necessary before draft regulations covering banking organizations' relationships with their customers could be prepared.

In the late summer of 1997, the staff of the Federal Reserve prepared a preliminary draft regulation, and then began discussions with the other federal bank regulators in an effort to design a coordinated regulation that would address the Know Your Customer activities of all federally supervised banks, thrift institutions, and credit unions. Representatives of the five federal bank supervisory agencies, along with a representative from Treasury's Financial Crimes Enforcement Network (FinCEN), have been meeting over the past year. It is hoped that we are nearing the end of what has been a complex process. Barring any unforseen complications, we expect that the regulators should be able to issue coordinated notices of proposed rulemaking for Know Your Customer regulations that would be applicable to bank as well as nonbank financial institutions within the next few months.

The objective of the Know Your Customer regulation will be quite simple. The regulation is designed to protect the reputation of the bank, facilitate the bank's compliance with all applicable statutes and regulations and with safe and sound banking practices, and protect the bank from becoming a vehicle for, or a victim of, illegal activities perpetrated by its customers. One of the benefits of developing and implementing a Know Your Customer program is that having an effective program should enhance the relationship between the bank and its legitimate customers.

As the regulators' staff now envisions the requirements of the regulation, banking organizations would be required to develop a Know Your Customer program that would allow them to identify their customers at the inception of the customer relationship, and understand the source of funds and the normal and expected transactions of their customers. The program should also be designed to allow banking organizations to monitor the transactions of their customers to ensure that they are consistent with their expected transactions and identify and report, as necessary, those transactions that are unusual or suspicious.

The requirements of the Know Your Customer program are expected to be set out in general terms, reflecting the view that a Know Your Customer program that is appropriate for one institution may not be appropriate for another. Under the proposed regulation, we would expect each banking organization to design a program that is appropriate to that organization, given its size and complexity, the nature and extent of its activities, its customer base, and the levels of risk associated with its various customers and their transactions. The Federal Reserve has long advocated this approach as opposed to a detailed regulation that imposes the same list of requirements on every organization regardless of its specific circumstances and the scope of its business activities.


As the members of the committee are aware, Operation Casablanca was recently made public with the announcement of criminal indictments that included charges of money laundering being brought against numerous bankers, as well as three Mexican banks--two of which operate offices in the United States. As I am sure the committee will understand, I cannot provide specific operational information about Operation Casablanca because the law enforcement agencies responsible for the operation are still working on various aspects of the case. Similarly, confidentiality requirements preclude me from discussing supervisory information about the banking organizations that allegedly may have been involved in improper activities identified during Operation Casablanca. Within these parameters, I would like to describe briefly the Federal Reserve's involvement in the operation.

The Federal Reserve was first made aware of Operation Casablanca in late 1995 when staff members were approached by Special Agents of the U.S. Customs Service, the lead agency for Operation Casablanca. The agents requested technical assistance with regard to certain banking aspects of an undercover money laundering sting operation. From that time on, Federal Reserve staff members have provided, and continue to provide, assistance to the U.S. Customs Service and the Department of Justice as they complete the investigation and as they now prepare for the various prosecutions resulting from the recently announced indictments. Some of the assistance that we provided included verification as to the existence of banking organizations and the geographic location of their operations, explanations of procedures for the movement of currency between banking organizations and within the Federal Reserve System, training on check clearing and funds transfer procedures, describing the various procedures banks follow in complying with regulatory reporting requirements such as the filing of Suspicious Activity Reports and Currency Transaction Reports, and providing assistance in the post arrest interviews of the bankers who were arrested in the United States.

On May 18--when the Departments of Justice and Treasury jointly announced the indictments of several banks and bankers resulting from Operation Casablanca--the Board issued enforcement actions, in this case temporary cease and desist orders, against four Mexican banks and one Spanish bank with a Mexican bank subsidiary. Two days later, when several Venezuelan bankers and alleged money launderers were arrested, the Board took a similar enforcement action against a Venezuelan bank with U.S. operations. In total, the Board issued six temporary cease and desist orders resulting from Operation Casablanca.

Specifically, the Board ordered each of the financial institutions to provide a detailed description of the anti-money-laundering policies and procedures that it had in place, as well as a detailed description of its understandings regarding the deficiencies in such policies and procedures that could have given rise to the apparent illegal actions taken by its employees. Additionally, the Board ordered each institution to submit an acceptable plan detailing the steps that have been and will be implemented to ensure that conduct, such as that which has already occurred, is not occurring and will not occur in the future. In conjunction with the responses expected from the six banking organizations, the Federal Reserve has begun in-depth targeted reviews of their anti-money-laundering policies and procedures, and staff continues to monitor each of the implicated banks with U.S. operations.


Finally, you have asked us to comment on legislation you proposed, entitled the "Money Laundering Deterrence Act of 1998," as well as legislation proposed by Congresswoman Velazquez, entitled the "Money Laundering and Financial Crimes Strategy Act of 1998." While the Board has not had an opportunity to review either proposal, as a general proposition the Federal Reserve has always supported constructive efforts to better and more efficiently attack money laundering activities. From the staff's review of the proposals, it appears that the legislation, among other things, would increase the tools available to law enforcement authorities to combat money laundering on the one hand and establish a coordinated government-wide effort against money laundering on the other.

With specific regard to the "Money Laundering Deterrence Act of 1998," the staff is particularly pleased with the clarification of some issues related to the disclosure of Suspicious Activity Reports. The filing of Suspicious Activity Reports by banking organizations is a vital tool for the government's anti-money-laundering efforts, and your legislative proposal enhances the organizations' ability to communicate with law enforcement and bank supervisors in a timely and effective manner without the threat of inappropriate legal challenges. We also appreciate the importance that the proposed legislation places on Know Your Customer regulations as an integral component of an effective government anti-money-laundering program.

With respect to the Money Laundering and Financial Crimes Strategy Act of 1998, we believe that coordination already exists among and between the various governmental bodies that participate in anti-money-laundering efforts. If the Congress were to determine that the development of a national strategy in this area is appropriate, then we would welcome the opportunity to participate in such an initiative.


Over the past several years, the Federal Reserve has undertaken extensive efforts to develop programs, procedures, and systems to better detect and deter illegal money laundering activities at individual banking organizations as well as address systemic issues related to financial institutions' compliance with applicable anti-money-laundering laws and regulations, including the Bank Secrecy Act. The Federal Reserve has also provided training and technical assistance to law enforcement agencies participating in the government's anti-money-laundering efforts and to international banking and law enforcement authorities.

These actions underscore the Federal Reserve's significant commitment to the bank regulatory community's anti-money-laundering mission. The Federal Reserve has a vital interest in protecting the banking system from criminal elements. Consequently, we will continue our cooperative efforts with other bank supervisors and the law enforcement community to develop and implement effective anti-money-laundering programs addressing the ever-changing strategies of criminals who attempt to launder their illicit funds through banking organizations here and abroad.

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on the Judiciary, U.S. Senate, June 16, 1998

It is my pleasure to appear today to discuss the current merger wave that is affecting a wide range of industries in the American economy. This nation has always viewed concentrations of power, whether in government or the private sector, as a threat to individual political freedoms and the equality of opportunity. In the public sector we seek democratic institutions and a rule of law to tether excessive political power. In the private sector we encourage competition as the perceived most effective way to contain the undue concentration of power. Such power is presumed to thwart individual initiative and to prevent the efficient allocation of resources, which would interfere with the creation of wealth and its wide distribution. The acceleration of megamergers in recent months across a broad range of industries has once again stirred these latent concerns.

Waves of mergers are, of course, not new. The current one is the fifth in this country during the past century. Previous waves occurred at the turn of the century, in the late 1920s, the late 1960s, and, most recently, in the early 1980s. The first two almost certainly did produce significant increases in economic concentration in manufacturing as industrialization accelerated with the shift of resources out of agriculture into many new budding industries. The more recent merger waves, however, do not appear to have materially altered industry structure, perhaps owing, in large part, to the increased adaptability of our more mature and competitive industrialized economy. Other countries have also experienced merger waves in recent decades with no perceptible increase in concentration overall.

The effects of the present merger wave on concentration have yet to be determined, but there is little reason to expect their influence will differ substantially from the merger wave of the early 1980s, which produced at most a slight increase in manufacturing concentration.

To be sure, recent bank mergers have led to a substantial rise in national concentration measures. Nonetheless, they have had little or no evident impact on average concentration measured at the more relevant local market level. This stability of local market concentration owes, in part, to the dynamic nature of American banking, with substantial entry of new firms as well as exit of others. In any event, on balance, while the average number of competitors within local banking markets has not materially changed in recent years, they tend to be the same competitors in an increasing number of markets. Beyond banking, useful studies on the effects of mergers on concentration in other nonmanufacturing segments of our economy are regrettably few.

Evidence concerning the effects of mergers on economic efficiency is mixed. While some studies find no evidence of profit and efficiency improvements following mergers, others indicate that, on average, mergers have led to significant productivity gains. In the banking industry, the data suggest that while some mergers have engendered improved operations, others have not. Thus, there are no clearcut findings that suggest bank mergers uniformly lead to efficiency gains. However, the evidence suggests that there are considerable differences in the cost efficiencies of banks within all bank size classes, implying that there is substantial potential for many banks to improve the efficiency of their operations, perhaps through mergers.

Numerous empirical studies, nonetheless, have found a statistically significant positive relationship between market concentration and profits, which, upon closer examination, appears to derive from a link between market share and profits. Economists have differed in their interpretations of this finding. While one group argues that high levels of concentration allow firms to exercise market power, resulting in above-normal profitability, another group argues that high concentration levels and high profits are both the consequence of greater efficiency. Studies of the relationship between concentration and prices tend to support the market power interpretation, but the magnitudes of the positive, statistically significant coefficients relating prices to concentration measures tend to be fairly small.

Some empirical studies also suggest that high concentration and presumed lack of competitive pressure may also be associated with the failure of firms to produce efficiently.

More generally, it is concern over the lack of the leveling force of competition in highly concentrated markets that has fostered the fear of bigness. But unless a relationship between bigness and market concentration can be more firmly rooted in anticompetitive behavior, bigness, per se, does not appear to be an issue for national economic policy. Rather, it appears that bigness should be primarily the concern of shareholders, whose returns could be muted by large company inefficiencies, and their customers, who may face bureaucratic inflexibility.

There is an evident general consensus in this country that competition, in the abstract, is good for the consumer, for economic growth, and standards of living. This notion is buttressed by studies that suggest the more open to competitive forces, the greater the growth of an economy. Much more immediately and directly, the areas of greatest growth in output and productivity in this country--Silicon Valley and its counterparts around the country--are extremely competitive judging from the turnover of business and the evidence of a high degree of what Joseph Schumpeter many decades ago called creative destruction. Many new products emerge with great fanfare and soaring stock prices only to flare out when confronted with a still newer competitive innovation.

There are, nonetheless, differences at the margin (some would go further) of what constitutes appropriate competitive behavior and what the role of government in this country should be in enforcing it. At root, what differences exist stem from varying views of precisely how our economy functions and which activities are wealth producing and which are not.

The notion of what we mean by competition is not altogether without dispute. Most would agree that producers try to emphasize their new products or the comparative advantages of existing products. When they sense that improved quality will enhance sales more than costs, they will direct resources to quality improvement and try to differentiate their product, often through brand name advertising. All seek, or at least hope, to achieve market dominance. When they cannot differentiate their product from others because they choose to produce, for example, electrolytic copper or any other so-called commodity, they will endeavor to improve their market share and spread overhead through innovative improvements in service. Other producers may turn to mergers and acquisitions to increase market share. Acquirers may seek to enhance efficiency, but they may also seek to increase their market power, and hence their profits, through practices that are often considered less than sportsmanlike, to use an analogy to another prominent arena of competition. When producers cannot achieve a profitable market niche, some, but fortunately few, will seek political protection from markets through subsidies, tariffs, quotas, or outright government franchised monopolies.

Through skill, perseverance, luck, or political connections, competitors have always pressed for market dominance. It is free, open markets that act to thwart achievement of such dominance and in the process direct the competitive drive, which seeks economic survival, toward the improvement of products, greater productivity, and the amassing and distribution of wealth. Adam Smith's invisible hand does apparently work.

To be sure, markets do not always work fully to the standards of our abstract notions of perfection, which in turn rest on particular notions of the way human beings do, or should, behave in the marketplace. There appears to be general agreement among economists that the test of success of economic activity is whether, by directing an economy's scarce resources to their most productive purposes, it makes consumers as well off as is possible. Moreover, it is generally agreed that the chances of achieving these goals are greatest if prices are determined in competitive markets and reflect, to the fullest extent that is feasible, the costs in real resources of producing goods and services. While relatively straightforward to state in theory, how such a standard should be applied in practice is often subject to dispute.

The focus of much debate in recent years is just what constitutes a "market failure," or the tendency for market prices not to reflect appropriately all relevant production costs. In addition, what constitutes the interest of consumers in the abstract is, of course, by no means self-evident in a large number of cases. As a result of certain transactions, some consumers will benefit; others will not. Moreover, conditions can differ with respect to whether it is the short- or long-term interest of consumers that is at stake.

Any notion of market failure, of course, presupposes a concept of market perfection. In that sense, perhaps the only market that achieves this standard of unequivocal benefit to consumers is the outcome of an auction market with very tight bid-ask spreads. Such markets represent a very small share of bilateral transactions.

In one sense, markets generally are always in some state of imperfection in their businesses never fully exploit, perhaps can never fully exploit, all opportunities for profitable, productive, investment. Consumers do not always seek out the lowest prices or the best quality, owing to the costs of searching across sellers. Rationally acting individuals may choose not to exert the additional effort that they perceive will only marginally enhance their state of well-being. Then, of course, people do not always act rationally.

In addition, market effectiveness is clearly a function of the degree of market participants' state of knowledge. The critical signals that make markets function--product and asset prices, interest rates, bid-ask spreads, and so on--depend on market participants' perceptions of the state of demand and supply and future prospects, to the extent they are discernable. There is inevitably considerable asymmetry of information among producers and consumers, and buyers and sellers. Moreover, any voluntary transaction comprises not only a good or a service but a representation, explicit or otherwise, of the nature of the product being transferred. Misrepresentation to induce an exchange is theft, in that the transaction was not voluntary. Laws against fraud are demonstrably a necessary fixture of any free market economy.

But what information is a seller obligated to convey to a buyer in an exchange? Misrepresenting a lead brick for a gold one is unambiguous. But are producers required to divulge information about potential new products that would make obsolete an offered product and depreciate its value? More generally, how far does protection of intellectual property rights go in protecting what is, or what is not, divulgable to a counterparty to a transaction? Clearly, this dilemma is only one of many such conundrums resulting from the awesome complexity of the operations of free markets. In this case, too heavy a hand of government regulation will surely stifle innovation and wealth creation. Too little will infringe the legal property rights of counterparties.

Still more difficult is the relevance of the effects on third parties from the actions of two individuals acting voluntarily, with or without conspiratorial intent, in their mutual interest through exchange. In the most general sense, all bilateral transactions, to a greater or lesser extent, affect the markets with which third parties deal for good or ill. Some actions open new markets for unrelated third parties. Other actions increase competitive pressure. Indeed, that is an inevitable consequence of the division of labor in a society. But it is almost impossible in the vast majority of cases to judge with any confidence that one act creates wealth or another destroys it. Nonetheless, while certain aggressive, competitive behaviors may, as the evidence suggests, enhance wealth creation, our society has, in addition to taking actions against presumed failings in the marketplace, chosen to set noneconomic limits to competitive behavior. In effect, we have established a set of Marquis of Queensberry rules for the marketplace, that is, noneconomic criteria for the types of behavior that are judged tolerable in business relationships. We may in the process, of course, be losing some wealth creation, but the value of market civility, at various times in our history, appears to have tempered our drive for maximum efficiency. Nonetheless, that markets, however faulted, are a productive means to coordinate human behavior for most remains beyond doubt.

Markets enforce a degree of trust among participants that may not be so prevalent in other aspects of life. People cannot be untruthful without cost in a market context where credibility has distinct commercial value. A reputation for an inferior product might not be damaging in a centrally planned economy but has heavy consequences in markets where choice is available. But above all, by constructing institutions that enable the value preferences of consumers to be reflected in prices and other market signals, a society can produce far greater wealth than any of the nonmarket alternatives.

One of those essential institutions is a rule of law that protects property rights, both real and intellectual, against force or fraud, enforces contracts, and adjudicates the bankrupt. More controversial are the laws that endeavor to improve the workings of the marketplace, the Sherman and Clayton acts being the most prominent.

While no one, I presume, is against improving markets, the issue is clearly what constitutes improvement and by what means, if any, it can be achieved. How this issue has been addressed since the passage of the Sherman Antitrust Act of 1890 has ebbed and flowed with evolving theories and empirical evidence about how markets function and the degree of acceptance in our society of free markets to determine the distributions of income and wealth.

In the 1970s and 1980s, there was a significant shift in emphasis from a relatively deterministic antitrust enforcement policy to one based on the belief (under the aegis of the so-called Chicago School) that those market imperfections that are not the result of government subsidies, quotas, or franchises would be assuaged by heightened competition. Antitrust initiatives were not seen as a generally successful remedy. More recently, limited avenues for antitrust policy are perceived by policymakers to enhance market efficiencies.

That markets, on occasion, can be shown to be behaving in a manner presumed inferior to some presubscribed optimum is not a difficult task. For example, suboptimal product or operational standards are seen by some to persist because, once in place, they are difficult to dislodge. Often cited is the wordprocessor keyboard whose key placement still reflects the manual typewriter's need to prevent its keys from sticking rather than convenience to the typist. A more recent example pointed to by some is the universal adoption of VHS-based VCR technology. The more general proposition is that the success of competing technologies depends more on the relative size of their initial adoptions than on the inherent superiority of one over the other (what economists term "path dependence"). I should point out, however, that these examples, and the more general proposition, are not without challenges.

To demonstrate that a particular antitrust remedy will improve the functioning of a market is also often fraught with difficulties. For implicit in any remedy is a forecast of how markets, products, and companies will develop.

Forecasting how technology, in particular, will evolve has been especially daunting. The problem is that the various synergies of existing technologies that account for much of our innovation have been exceptionally difficult to discern in advance. For example, according to Charles Townes, a Nobel Prize winner for his work on the laser, the attorneys for Bell Labs initially refused, in the 1960s, to patent the laser because they believed it had no applications in the field of telecommunications. Only in the 1980s, after extensive improvements in fiber optics technology, did the laser's importance for telecommunications become apparent.

Moreover, almost by definition, antitrust remedies are applied mainly to firms dominant in their industries. Yet the evidence of sustained dominance where markets are generally open are few. There has been a tendency for one firm to dominate in the early development of many of our industries where economies of scale enabled significant reductions in unit costs and hence prices. U.S. Steel, General Motors, and IBM are only the more prominent cases of market share erosion after early virtual dominance of their industries was achieved. One wonders how long the Standard Oil Trust's near monopoly of refining would have prevailed, even without the landmark antitrust breakup in 1911, as upstart competitors Royal Dutch Shell, British Petroleum, Gulf, and the Texas Company (Texaco) undercut Standard.

I am not saying that dominant positions in industries cannot be maintained for extended periods, but I suspect in free competitive markets that it is possible only if dominance is maintained through cost efficiencies and low prices that competitors have difficulty matching. By the measure of what benefits consumers, such enterprises should not be discouraged. Natural monopolies are an exception, but technology is increasingly reducing the areas of our economy where such monopolies can prevail. Banking and other regulated industries are of course a further exception.

The possibility of economies of scale leading to very large firms relative to any one nation's economy illustrates and emphasizes the importance of international free trade policies in maintaining domestic competition. In some industries, free trade may be essentially the only way to maintain truly competitive markets to the benefit of consumers in all of the nations involved. Nevertheless, it is also interesting to note that some, such as Professor Michael Porter at Harvard, have found that the most successful exporters have evolved out of domestically competitive industries.

In any event, we have come a long way in attitudes about market power and antitrust enforcement from the days, more than a half century ago, when a Federal Appeals Court opined in the Alcoa case, that "we can think of no more effective exclusion [of competitors] than progressively to embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization, having the advantage of experience, trade connections and the elite of personnel."

If competitors are excluded because of a company's excellence in addressing consumer needs, should such activity be constrained by law? Such a standard, if generally applied to business initiatives, would have chilled the type of competitive aggressiveness that brings efficiencies and innovation to the marketplace. Fortunately, that principle was subsequently abandoned by the Supreme Court. More important, antitrust actions of recent years have sought to enhance efficiencies and innovations. I leave it to others to judge their degree of success. But the regulatory climate in antitrust, indeed throughout government, has moved in a more market-oriented direction. I believe that is good for consumers and the nation.

In conclusion, the United States is currently experiencing its fifth major corporate consolidation of this century. When trying to understand and deciding how to react to this development, I would hope that we appropriately account for the complexity and dynamism of modern free markets. Foremost on the agenda of policymakers, in my judgment, should be to enhance conditions in our market system that will foster the competition and innovation so vital to a prosperous economy.

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, June 17, 1998

It is a pleasure to appear before this committee to present the views of the Federal Reserve on the need to enact legislation to modernize the U.S. financial system and to express the Board's strong support for H.R. 10, which achieves this objective.


U.S. financial institutions are today among the most innovative and efficient providers of financial services in the world. They compete, however, in a marketplace that is undergoing major and fundamental changes driven by a revolution in technology, by dramatic innovations in the capital markets, and by the globalization of the financial markets and the financial services industry.

The Federal Reserve believes that it is essential that the nation act promptly to modernize the rules that govern our financial institutions in order to ensure their continued competitiveness and to foster their ability to innovate, to operate efficiently, and to provide the best and broadest possible services to consumers as well as to maintain this nation's role as the preeminent world financial center. We believe that it is important for the Congress to set the rules for this industry, which is so important to our nation's health and prosperity. Only the Congress has the ability to fashion rules that are comprehensive and equitable to all participants and that guard the public interest.

That is why the Federal Reserve strongly supports H.R. 10 and urges the Senate to consider and pass this legislation as soon as feasible.

The market will continue to force change whether or not the Congress acts. The strength and viability of our financial institutions, the effectiveness of our regulatory structure, and the role and status of our financial services industry in the international system are in play as a result of the aforementioned market forces as well as regulatory actions. Without congressional action, changes will occur through exploitation of loopholes and marginal interpretations of the law that courts feel obliged to sanction. This type of response to market forces leads to inefficiencies, expansion of the federal safety net, potentially increased risk exposure to the federal deposit insurance funds, and a system that will undermine the competitiveness and innovative edge of major segments of the financial services industry. Delay in acting on financial modernization legislation would only limit the Congress's options as these developments proliferate and complicate, increase the difficulty of enacting protections included in H.R. 10 to protect safety and soundness and the public interest, and deny to consumers the benefits that immediate changes in our outdated banking laws will surely bring.

Of course, financial modernization involves complicated and sometimes divisive issues because it requires easing rules and opening options for some while increasing competition for others, redrawing lines that create new limits, and applying some pre-existing regulatory structures to new institutions. However, these issues are not new to the Senate.

The Senate Banking Committee has on three previous occasions led the way in developing financial modernization legislation, and the full Senate has twice followed this committee's recommendation in adopting such legislation. (A summary of these financial modernization proposals is provided at attachment 1.) In 1991, the committee passed S. 543, which repealed the Glass-Steagall Act and allowed banks to affiliate with securities firms using the holding company structure to ensure safety and soundness, a level competitive playing field, and protection of the taxpayer. H.R. 10 uses that same holding company framework from S. 543 but expands the range of permissible financial affiliations to include insurance underwriting and merchant banking. Senate action at this time to enact H.R. 10 would be a historic achievement that would establish a sound and much-needed framework for launching our financial services industry into the twenty-first century.

There has been much--perhaps too much--arguing over details contained in H.R. 10. H.R. 10 is a comprehensive approach to the issues of financial modernization, and it is fundamentally a sound bill. No legislation that endeavors to address financial modernization will be considered ideal by all, but time will allow its rough spots to be worked out.

What is most important is that for the first time there is an extraordinary amount of agreement on nearly all of the key principles in the bill. There is no disagreement--and there has been no disagreement for many years--that the Glass-Steagall Act must be repealed. There is now finally no disagreement that insurance companies and banks should be permitted to affiliate, and virtual unanimity that banks should be permitted to sell insurance. There is no disagreement that financial holding companies should be permitted to engage in a broad range of other activities that are financial in nature, including merchant banking. And there is no disagreement that new affiliations must be permitted on a level playing field and in a manner that permits a realistic two-way street between banking organizations that seek to affiliate with insurance and securities firms, and between insurance and securities firms that seek to acquire banks. Moreover, there is no disagreement that financial modernization must not place insurance and securities firms that choose to remain independent at a disadvantage in competing against those firms that choose to affiliate with banks.

In addition, there is strong agreement that new affiliations must be permitted within a framework that maintains the safety and soundness of our financial system in general and the banking system in particular without imposing unnecessary regulatory burden or intrusion. That means strong functional regulation and reasonable, but not banklike, umbrella oversight of financial holding companies.

A consensus has also developed that banking and commerce should not be mixed at this time beyond the limited level needed to allow a realistic two-way street for financial firms that are predominantly securities and insurance companies to acquire banks. There is also agreement that the new law must provide regulators with adequate means to protect the consumer and ensure that consumers are carefully informed about the differences between products that are backed by federal deposit insurance and those that are not.

These are the fundamental principles embodied in H.R. 10, save one. There are some details surrounding these aforementioned principles that are still under discussion. These surrounding details are important, but not so important that they should be allowed to defeat the consensus that has developed around these principles themselves. It would be a disservice to the public and the nation if, in the fruitless search for a bill that pleases everyone, the benefits of this vital legislation are lost or delayed.

There is, however, as I indicated, one fundamental principle embodied in H.R. 10 upon which there is disagreement between the Federal Reserve and the current Treasury Department, although there is agreement among the Federal Reserve and many in the affected industries as well as earlier Treasury Departments. That is the considered decision of the House to use the holding company structure, and not the universal bank, as the appropriate structure to allow the new securities and insurance affiliations. That decision, which is fundamental to the way in which the financial services industry will develop, is critical because it provides better protection for our banking and financial system without damaging the national or state bank charters or limiting in any way the benefits of financial modernization. Importantly, that decision also prevents the spread of the safety net and the accompanying moral hazard to the securities and insurance industries and ensures a level playing field within the financial services industry and thus full, open, and fair competition as we enter the next century. The other route toward universal banking for national banks will, in our view, lead to greater risk for the deposit insurance funds and the taxpayer. It will also inevitably lead to a weakening of the competitive strength of our financial services industry as independent securities, insurance, and other financial services providers operate at a disadvantage to those owned by banks. It is for these reasons that the Federal Reserve, the Securities and Exchange Commission (SEC), many state functional regulators, and many in the affected industries support the holding company framework and have opposed the universal bank approach.

In virtually every other industry, the Congress would not be asked to address issues such as these, which are associated with technological and market developments; the market would force the necessary institutional adjustments. Why is it so different for the financial system? I believe the difference reflects the painful experience that has taught us that developments in our financial system--especially, but not solely, in our banking system--can have profound effects on the stability of our whole economy, rather than the limited impact we perceive from difficulties in individual nonfinancial industries.

Moreover, as a society we have made the choice to create a safety net for depository institutions, not only to protect the public's deposits but also to minimize the impact of adverse developments in financial markets on our economy. Although we have clearly been successful in doing so, the safety net has predictably created a moral hazard: The banks determine the level of risk-taking and receive the gains therefrom but do not bear the full cost of that risk; the remainder is borne by the government. Because the sovereign credit of the United States ultimately guarantees the stability of the banking system and the claims of insured depositors; bank creditors do not apply the same self-interest monitoring of banks to protect their own position as they would without discount window access and deposit insurance. Instead, this moral hazard requires that the guarantor, the U.S. government, supervise and regulate entities with access to the safety net to protect its own, that is the taxpayers', interest--the cost of making good on the guarantee.

Put another way, the safety net requires that the government replace with law, regulation, and supervision much of the disciplinary role that the market plays for other businesses. Our experience in the 1980s with insured thrift institutions illustrates the necessity of avoiding expanding risks to the deposit insurance funds and lax supervisory policies and rules. But this necessity has an obvious downside: These same rules limit innovative responses and the ability to take the risks so necessary for economic growth. The last thing we should want, therefore, is to widen or spread this unintended but nevertheless corrosive dimension of the safety net to other financial and business entities and markets. It is clear that to do so would not only spread a subsidy to new forms of risk-taking but ultimately require the expansion of banklike supervision as well.

In our judgment, the holding company approach upon which H.R. 10 is premised avoids this pitfall; the universal bank approach does not.

While financial modernization represents a much needed reform, we should not forget that this modernization will, by itself, introduce dramatic changes in our financial services industry. We feel confident that the risks of this type of reform are manageable within the holding company framework set out in H.R. 10. We believe that the magnitude of the reform to our financial system represented by allowing new and broad affiliations counsels that this is not the time to experiment with these broad new affiliations through operating subsidiaries, an approach that has failed the taxpayer in other contexts and has other serious consequences. Instead, we believe the Congress is best advised to retain the existing holding company structure, which achieves the full benefits sought by financial modernization and has a proven track record of protecting safety and soundness, insulating the federal safety net, and providing competitive equality among companies that choose to affiliate with banks and those that choose to remain independent.

There are two final points I want to make because they appear to drive Treasury's opposition to H.R. 10. First, as I will discuss in more detail later, H.R. 10 would not diminish--but would in fact enhance--the national bank charter.

Second, H.R. 10 would not diminish the ability of the executive branch to continue to play its meaningful role in the development of banking or economic policy. Currently, the executive branch influences such policy primarily through its supervision of national banks and federal savings associations. H.R. 10 would not alter the executive branch's supervisory authority for national banks or federal savings associations, nor would it result in any reduction in the predominant and growing share of this nation's banking assets controlled by national banks and federal savings associations.

Furthermore, the Congress for sound public policy reasons has purposefully apportioned responsibility for this nation's financial institutions among the elected executive branch and independent regulatory agencies. H.R. 10 retains this balance, and the Federal Reserve does not believe it would be appropriate to alter this balance in favor of increased executive control of financial institution policy. Such action would be contrary to the deliberate steps that the Congress has taken to ensure independence in the regulation of this nation's financial institutions, both banking and nonbanking.


Although H.R. 10 is almost 300 pages in length, its objective is simple and can be stated concisely--H.R. 10 removes outdated restrictions that currently limit the ability of U.S. financial service providers, including banks, insurance companies, and securities firms, to affiliate with each other and enter each other's markets,(1) This objective--permitting the affiliation of financial service providers and thereby allowing open and free competition in the financial services industry--is supported by the banking, insurance, and securities industries as well as the three federal banking agencies, the Treasury Department, and the Securities and Exchange Commission.

For the most part, the remaining provisions of H.R. 10 are designed to implement and complement this change and to ensure that these new affiliations occur in a manner that is consistent with the safety and soundness of the banking and financial system and the protection of investors and other consumers of financial services. H.R. 10 requires that these new affiliations occur within a holding company structure, which the Federal Reserve believes is sound policy because it best protects the federal deposit insurance funds by limiting the additional risks permitted to insured depository institutions. Arguably of even greater importance, the holding company structure limits the spread of the federal safety net and its related subsidy and moral hazard to entities or activities beyond the insured depository institutions it was intended originally to support. H.R. 10 builds on the protection afforded by the holding company structure by relying on strong functional regulation of the securities, insurance, and banking components of the holding company. It also provides flexibility to authorize restrictions on transactions between depository institutions and their newly authorized affiliates when necessary to protect the safety and soundness of affiliated depository institutions and the federal deposit insurance funds. H.R. 10 grants access to these new affiliations only to those organizations that have and maintain well-capitalized and well-managed subsidiary depository institutions.

H.R. 10 also includes provisions designed to ensure that these new affiliations occur in a manner that is consistent with the protection of consumers. For example, the bill requires that the federal banking agencies issue consumer protection regulations governing the retail sale of securities and insurance products by depository institutions. And H.R. 10 emphasizes the obligation of depository institutions to help meet the credit needs of their entire community by limiting the new affiliations to only depository institutions that have at least a satisfactory performance record under the Community Reinvestment Act.

Umbrella Supervision and Functionally Regulated Entities

H.R. 10 for the first time would permit broad affiliations among financial service providers that are currently supervised by different agencies. As a result, H.R. 10 builds on the principle of functional regulation and includes important provisions that encourage and facilitate cooperation among the functional regulators. It also reduces overlap between the various regulators and clearly allocates responsibility and accountability for supervising the different parts of new financial holding companies. At the same time, H.R. 10 retains a meaningful, albeit streamlined, level of umbrella oversight of the entire organization to ensure that some agency has a complete view of, and accountability for, new financial holding companies and can serve a facilitating role in relationships among functional regulators.

The Federal Reserve believes that H.R. 10 has constructed a good balance that provides the various regulators, including the umbrella supervisor, with the tools needed to supervise financial holding companies adequately. In addition, H.R. 10 is helpful in enhancing the ability of the relevant state and federal supervisory agencies to share information on a confidential basis.

The focus of H.R. 10 on functional regulation is perhaps best illustrated through an example. Under H.R. 10, responsibility would be allocated for supervising a new financial holding company composed of an insurance company, a securities firm, several financial companies such as a mortgage lender and a financial data processing company, and an insured bank. H.R. 10 contemplates that responsibility for supervising and regulating the insurance company, securities firm, and insured bank would, as under current law, rest respectively with the relevant state insurance authorities, with the Securities and Exchange Commission and the securities self-regulating organizations, and with the appropriate state and federal bank supervisory agencies. Each of these agencies would retain the full authority that it currently has to examine firms under its jurisdiction and to interpret and enforce the law applicable to the type of company that the agency is charged with supervising.

The Federal Reserve, as umbrella supervisor, would be required to the fullest extent possible to rely on regulatory reports required and examinations conducted by, using our example, the state insurance commissioner, the SEC (and appropriate securities self-regulatory agencies), and the appropriate state or federal banking agency. In a problem bank situation, the Federal Reserve also would be prohibited from requiring that the insurance company or securities firm provide financial resources to the bank if the functional regulator determines that such action would have a materially adverse effect on the financial condition of the insurance company or securities firm. Instead, the Federal Reserve could order divestiture of the bank or affiliate in order to recapitalize the bank.

At the same time, H.R. 10 preserves the important authority of the umbrella supervisor to apply consolidated capital standards to the financial holding company, to examine the holding company and--under specified circumstances--any subsidiary that poses a material risk to the insured bank, and to enforce compliance by the organization with the federal banking laws. This ensures that, while the functional regulators are supervising various parts of the organization, someone is overseeing the organization as a whole as well as subsidiaries that are not subject to other functional regulation.

Enhanced Functional Regulation of Financial Products

Consistent with the bill's emphasis on functional regulation, H.R. 10 also would repeal the blanket exemptions provided banks from the definitions of "broker" and "dealer" in the Securities Exchange Act of 1934, requiring banks to register with the SEC if their securities activities fall outside specified categories of transactions. These categories are broad and would permit banks to continue engaging in securities activities in connection with their traditional trust, custody, safekeeping, and derivatives operations and in a limited amount of retail securities transactions without registering as a broker or dealer.

The bill also establishes procedures for determining which functional regulator would have primary responsibility for supervising the provision of new or hybrid financial products that may be developed in the future. In the securities area, for example, H.R. 10 would authorize banks, to the extent consistent with applicable banking law, to offer and sell new or hybrid products that are developed in the future unless the SEC determines, after a formal rulemaking process and after consultation with the federal banking agencies, that the new or hybrid product is a security for purposes of the securities laws. If the SEC makes such a determination, the bill would require that the product be sold by an SEC-registered entity, such as a subsidiary of the bank, subject to functional regulation as a security product.

The bill establishes a similar, although more complex, procedure for determining whether future products that are classified as insurance by a state may be underwritten by a bank within the framework of bank regulation or only by a functionally regulated insurance underwriting affiliate. This process seeks to ensure that banks will continue to have the ability to provide any product banks are providing today. In addition, it ensures that banks may, as principal, provide any new form of a traditional banking product that may in the future be characterized as insurance by state law unless the product is treated as insurance for purposes of the federal Internal Revenue Code. There is also a procedure to resolve disputes between insurance and banking regulators over future products with final decisions by the courts "without unequal deference" to either the relevant federal or state regulators and after having reviewed the history of the regulation of the product.

Although any attempt to devise rules for the classification and regulation of future products is bound to encounter difficulties and improvements could be made in some marginal provisions, the substantive provisions of H.R. 10 governing the division of regulatory responsibility for future products are carefully balanced in our judgment.

Competitive Flexibility

Importantly, H.R. 10 provides banking organizations-both large and small--substantial flexibility in determining how to respond to the market forces so rapidly changing the industry. Many large banking organizations that meet applicable criteria may elect to affiliate with full-service insurance and securities underwriting firms and thereby become comprehensive providers or "manufacturers" of financial products. Similarly, small banking organizations would remain free to engage in currently authorized activities or to expand into newly authorized principal activities at the pace most consistent with the organization's competitive strategy. Small banking organizations also would be tree to focus their efforts in an area in which they have a demonstrable competitive advantage--the sale of any type of financial product as agent.

One of the areas of great interest to banks--and one likely to increase consumer options and benefits greatly--is insurance sales. Importantly, H.R. 10 would expand the insurance sales opportunities for banks by authorizing subsidiaries of national banks to sell virtually any type of insurance product, whether underwritten by an affiliate or a third party, from any location on a nationwide basis. National banks also would retain their current ability to sell insurance as agent in any place with a population of 5,000 or less. One detail in this area that we do not support is the provision in H.R. 10 that requires a national bank, for the next five years, to expand its insurance activities in additional states only by buying an existing insurance agency.

H.R. 10 would also provide depository institutions important protections against state laws that might conflict with the ability of these institutions to sell financial products as authorized by federal law. Some confusion and controversy, however, have arisen in this area, particularly as to whether H.R. 10 would scale back the Supreme Court's decision in the Barnett case concerning the ability of states to regulate the sale by national banks of insurance as agent. It is my understanding that H.R. 10, in fact, seeks to codify the Barnett decision by incorporating the phraseology used by the Supreme Court and a specific citation to the Supreme Court's opinion in Barnett into a new federal statute that would preempt any state law that "prevents or significantly interferes" with the ability of any national bank or other depository institution to engage in insurance sales activities authorized by federal law.

H.R. 10 does provide that a state law will not be preempted under the Barnett standard if the law is no more restrictive than an existing Illinois statute that governs insurance sales by banks. This statute, among other things, requires the licensing of agents and the disclosure that insurance products sold by the bank are not guaranteed or insured by the Federal Deposit Insurance Corporation (FDIC). This provision also prohibits the tying of insurance products to credit products, the payment of commissions to unlicensed persons, and the unauthorized disclosure of customer information. The statute's requirements are not onerous, and the Comptroller of the Currency has recognized that the statute's requirements do not on their face conflict with the Barnett decision.

In short, the controversy in this area appears to stem largely from confusion concerning the bill's intent, which can be addressed through clarifying amendments designed to make plain that the bill does not scale back, and is fully consistent with, the Barnett decision.


There has been some concern that H.R. 10 may damage the national bank charter. The Federal Reserve believes that it is important that the national bank charter not be impaired or diminished in view of its significance to the nation's financial system. On the other hand, we do not believe the national bank charter should be fundamentally transformed and enlarged into a universal bank charter by allowing national banks directly or indirectly to engage in underwriting life and property and casualty insurance, underwriting and dealing in securities, merchant banking and direct equity investing, or real estate investment and development. For the reasons laid out in this testimony, we believe such an expansion of the national bank charter would be a mistake for bank safety and soundness, the deposit insurance funds and safety net, the financial services industry (consumers and businesses alike), and the taxpayer.

In the Federal Reserve's view, the concern about H.R. 10's effect on the national bank charter appears based on a misunderstanding of the bill. Our review of H.R. 10 indicates that it preserves the existing benefits of the national bank charter and includes significant provisions that actually enhance the powers of national banks. First, H.R. 10 does not reduce the current powers of national banks to conduct banking activities or indeed limit the present activities conducted by national banks. In fact, H.R. 10 contains several provisions that specifically preserve these powers. Moreover, there is nothing in H.R. 10 that limits the authority of the Office of the Comptroller of the Currency (OCC) to authorize new powers for national banks as within the business of banking or incidental to a banking business under the National Bank Act other than those activities prohibited for national banks and future, as yet unauthorized, insurance underwriting activities.

As I mentioned earlier, H.R. 10 contains, as has every prior version of financial modernization legislation for the past fifteen years including the recent Treasury proposal, provisions that encourage all banks to conduct securities activities through an affiliate or, where authorized, a subsidiary of the bank, rather than in the bank. These provisions, however, include significant exceptions that allow banks to continue to conduct in the bank securities activities that are part of or incidental to traditional banking services or that are conducted in limited numbers. And, as in the Treasury's recent modernization proposal, the provisions of H.R. 10 apply equally to all national and state banks.

Second, H.R. 10 improves the national bank charter. H.R. 10 empowers national banks to conduct any financial activity as agent through an operating subsidiary. Under this provision, national banks may, through a subsidiary, sell any type of insurance at any location (including in cities with a population over 5,000). This provision also allows a subsidiary of a national bank to sell any financial product as agent, and to engage in any financial agency activity that is permitted for a financial holding company. Such activity, as best we can judge, because it is rarely asset intensive and hence requires minimal equity, transfers little subsidy to the bank subsidiary.

H.R. 10 also authorizes national banks for the first time to underwrite any type of municipal security, including municipal revenue bonds, directly or through a subsidiary. At the same time, H.R. 10 removes the current advantage that state banks have over national banks in the securities area. H.R. 10 prohibits state banks from engaging in underwriting or dealing in securities, either directly or through an operating subsidiary, to the same extent that a national bank is prohibited from underwriting and dealing in securities.

H.R. 10 would clarify that national banks should not in the future underwrite life or property and casualty insurance beyond that currently permissible for national banks. State banks are already prohibited by the Federal Deposit Insurance Corporation Improvement Act of 1991 from commencing insurance underwriting activities or making equity investments. Thus, under H.R. 10, the only financial activity of which we are aware that state banks in some states could conduct, either directly or in an operating subsidiary, that national banks cannot is real estate investment and development. Treasury's recent bill, however, would wisely, in our view, also have prohibited that activity to national banks and their subsidiaries.

As I explained earlier, H.R. 10 also includes provisions that guarantee national banks the right to affiliate--through holding companies--with securities firms, insurance companies, and other financial services providers, and to sell and market the products of those affiliates notwithstanding any state law. In addition, H.R. 10 preserves the rule of law established in Barnett.

Together, these provisions allow national banks to remain strong and vibrant competitors. H.R. 10 also does nothing to encourage national banks to convert to state charters. Nor does H.R. 10 tarnish in any way the appeal that many see in the national bank charter, particularly as a vehicle for conducting interstate branching. Indeed, nearly 90 percent of all interstate branches are operated by national banks, which operate under one set of rules and with one regulator at all their locations--the OCC.

The heart of the concern about H.R. 10's applicability to national banks does not appear to be that it fails to enhance the national bank charter but that it fails to enhance the national bank charter enough for some. However, the record does not demonstrate that the national bank charter is in decline. In fact, the opposite is true. In the postwar years, national banks have controlled more than 50 percent of total bank assets. In fact, the share of assets controlled by national banks rose sharply last year and early in 1998, reflecting the increased attractiveness of the national charter as interstate branching has been authorized, and assets held by national banks are at the highest level this decade and near the postwar high relative to state banks. Attachment 3 provides additional data on the relative strength of the national bank charter.

In any event, the issue that is facing the Congress is not whether we need to provide an edge to a particular type of bank charter. The record is replete with evidence that what is really needed is reform of the laws that prevent the affiliation of banks of all types with securities firms, insurance companies, and other financial services providers, and thereby allow the financial services industry to adjust to a rapidly changing market. That is the deficiency that H.R. 10 is designed to address and does address very well. If the future finds, contrary to the past and present, that further adjustments are needed to the national bank charter to allow it to remain competitive and viable, those concerns can, and should, be addressed more clearly once an actual deficiency is shown.


One area in which some have argued that H.R. 10 does not go far enough is in authorizing national banks to own so-called operating subsidiaries, which are subsidiaries of the bank that engage in activities that national banks are forbidden by federal law to conduct directly. This is not a detail or a technical issue, but one that we believe is critical to determining the shape, soundness, and competitive fairness of our financial system as it develops into the twenty-first century and will have profound ramifications for our federal safety net.

There are two reasons why the Board believes that it is not wise or necessary to expand the ability of banks to engage in new principal activities through operating subsidiaries that are prohibited to the bank. These are (1) extension of the safety net subsidy to activities beyond what the Congress originally intended and resultant harm to the vibrancy of competition in our financial services industry and (2) the safety and soundness implications for banks and risk exposure of the deposit insurance funds.

Extension of the Safety Net

In my introductory remarks, I noted that a major reason the Congress is called upon to involve itself in a legislative response to technical innovation in financial markets is the safety net. Institutions covered by it receive a subsidy because insured depositors correctly perceive their risk exposure as virtually zero. These depositors--and other creditors who benefit from the stability brought to the banking system by the safety net--are willing therefore to provide funds to banks at much lower rates than are available to competing institutions. Moreover, the insured creditors--and many of the uninsured ones as well--do not feel the necessity to monitor their credit exposure because of the government guarantee and the other implications of the safety net. As a result, the government is required to monitor the risk-taking--to put itself in the shoes of the creditors--in order to protect the taxpayers and maintain financial market stability.

The existence of this subsidy is clear in debt ratings--which are virtually always higher at banks than at their parent holding company. It is clear in the higher capital ratios required of nonbanking financial firms, even those that receive the same debt rating as banks. It is clear in the tendency for banking organizations, when geographic restrictions were eased, to shift back to the bank and its subsidiaries those activities that, while authorized for banks, had been conducted in holding companies. Bank holding companies, the owners of most banks, have no doubt also gained by the higher debt ratings and lower cost of capital that comes from having as their major asset an entity--the bank--with access to the safety net. But holding companies also own nonsubsidized entities that have no direct access to the safety net. Accordingly, both bank holding companies and their nonbank subsidiaries have a higher cost of capital than banks that cannot be credibly explained by the holding companies' responsibilities to their insured depository institutions. Moreover, any benefit that holding companies might currently be experiencing from ownership of an insured bank can be expected to decline as the holding company's ability to expand its affiliations causes the insured bank to become a smaller part of the total organization.

Virtually all nonbank subsidiaries of bank holding companies, with the exception of section 20 securities affiliates, were historically put in the holding company, not because the holding company could conduct broader activities than the bank, but for other reasons, such as geographic restrictions on the bank. As these restrictions have been eased over the past decade, the share of consolidated assets of bank holding companies associated with nonbank activities--other than section 20s, whose purpose is to conduct a business that is not permissible for the bank itself--has declined about 50 percent. Bank holding companies tell us that the primary reason for shifting back to banks those operations that can be shifted is to obtain cheaper funding and avoid limitations on funding transactions contained in sections 23A and B of the Federal Reserve Act. Activities that have stayed in holding company subsidiaries, we are told, remain there for tax reasons, inertia, and established names separate from the bank. In time, inertia will fade.

It is critical that the subsidy implicit in the federal safety net be limited to those activities that a bank can conduct directly. The Federal Reserve is concerned that operating subsidiaries would be a funnel for transferring the sovereign credit subsidy directly from the bank to finance any new principal activities authorized by either the Congress or by OCC regulatory action--imparting a competitive advantage to such entities. We approve of new principal activities, but we believe they should be financed competitively in the marketplace. Moreover, we do not believe that it is possible to bring to bear the separation of an operating subsidiary from its parent bank that one can introduce between a bank and its sister affiliates.

Rules can be devised to limit the aggregate equity investment made by banks in their subsidiaries. But one cannot eliminate the fact that the equity invested in subsidiaries is funded by the sum of insured deposits and other bank borrowings that directly benefit from the subsidy of the safety net. Thus, inevitably, a bank subsidiary must have lower costs of capital than an independent entity and even a subsidiary of the bank's parent. Indeed, one would expect that a rational banking organization would, as much as possible, shift its nonbank activity from the bank holding company structure to the bank subsidiary structure. Such a shift from affiliates to bank subsidiaries would increase the subsidy and the competitive advantage of the entire banking organization relative to its nonbank competitors.

I am aware that these are often viewed as only highly technical issues, and hence ones that are in the end of lesser significance. I do not think so. The issue of the use of the sovereign credit is central to how our financial system will allocate credit, and hence real resources, the kinds of risk it takes, and the degree of supervision it requires. If the use of the sovereign credit is to be extended, that decision ought to be made by the Congress in full recognition of the consequences of the subsidy on the financial system. But it should not, in the name of some technical change, or in search of some minor efficiency, inadvertently expand significantly the use of the sovereign credit.

This issue would not be so important were we not in the process of addressing what must surely be a watershed in the revamping of our financial structure. But we are at such a watershed, and the Federal Reserve believes that we must avoid inadvertently extending the safety net and its associated subsidy without a thorough understanding of the implications of such an extension on the competitive balance and systemic risks of our financial system.

The safety net subsidy is difficult to measure, and several observers have doubted its existence net of regulatory costs. Subsidy values--net or gross--vary from bank to bank; riskier banks clearly get a larger subsidy from the safety net than safer banks. In addition, the value of the subsidy varies over time. In good times, such as now, markets demand a low risk premium, and it is difficult to discern the safety net subsidy. But when markets turn weak, financial asset holders demand to be compensated by higher yields for holding claims on riskier entities. It is at this time that subsidy values are the most noticeable, as spreads open up between bank and nonbank claims. What was it worth in the late 1980s and early 1990s for a bank with a troubled loan portfolio to have deposit liabilities guaranteed by the FDIC, to be assured that it could turn illiquid to liquid assets at once through the Federal Reserve discount window, and to tell its customers that payment transfers would be settled on a riskless Federal Reserve Bank? For many, it was worth not basis points but percentage points. For some, it meant the difference between survival and failure.

The Federal Reserve has no doubt that the costs of regulation are large, too large in our judgment, and we wish to reduce the degree of regulatory burden. But no bank has turned in its charter in order to operate without the cost of banking regulation, which would require that it operate also without deposit insurance or access to the discount window or payments system. To do so would require both higher deposit and other funding costs and higher capital. It is also instructive that there are no private deposit insurers competing with the FDIC. For the same product offered by the FDIC, private insurers would have to charge premiums far higher than those of government insurance and still not be able to match the certainty of unlimited payments in the event of default, the hallmark of a government insurer backed by the sovereign credit of the United States.

The Federal Reserve has a similar status with respect to the availability of the discount window and riskless final settlement during a period of national economic stress. Providing such services is out of the reach of all private institutions. The markets place substantial values on these safety net subsidies, clearly in excess of the cost of regulation. To repeat, were it otherwise, some banks would be dropping their charters.

Safety and Soundness

Even if there were no subsidy issue, engaging in principal activities in an operating subsidiary exposes the bank--and hence the safety net--to greater risks. I am not arguing that the new financial activities that financial modernization would permit to banking organizations are unusually risky. But they do present additional risk as principal and any losses associated with these activities would have to be absorbed. If such losses were suffered by a bank holding company subsidiary, the loss would be consolidated into the holding company parent--an entity without direct access to the safety net. In contrast, if the loss occurred at a subsidiary of a bank, the loss would fall directly on the bank parent, increasing the risk exposure of the deposit insurance funds and the safety net. This difference is neither small nor technical. It lies at the heart of the matter.

The Treasury, as you know, has proposed and supported new principal activities in the operating subsidiary. It argues that potential losses in the operating subsidiary could be capped in such a way as to eliminate the exposure of the safety net. Under the Treasury plan, investment by a bank in its operating sub must be deducted from the regulatory capital of the bank, after which the bank's regulatory capital position must still be deemed "well capitalized." Moreover, the bank would be prohibited from making good any of the debts of the failed subsidiary.

I should note that it is necessary that all of these prohibitions be statutory, since generally accepted accounting principles--GAAP--require that the subsidiaries' operations be consolidated with its parent and that courts determine if a parent is responsible for the claims on its failed subsidiaries. I should further note that what may be viewed as a regulatory matter as excess capital--the maximum amount that is to be invested in the subsidiary under this proposal--may or may not be excess in an economic or real sense. Regulatory accounting principles--RAP--are not often designed to reflect economic realities, as we saw last in the savings and loan crisis of the 1980s. Moreover, as I understand it, the RAP capital deduction for purposes of computing the level of a bank's investment in its operating subsidiaries would not be mirrored by a capital deduction for other regulatory purposes--like loans-to-one-borrower or dividend limit purposes.

And I can assure you it will not be deducted for the GAAP bank statements that uninsured creditors and large loan customers will insist on reviewing before they conduct business with the bank. Thus, a capital deduction may matter for the regulators for some purposes, but it is not the way the market will view the organization.

In addition to being inconsistent with sound accounting standards (GAAP), the proposed deduction treatment also runs counter to the way that banks manage their subsidiaries, the way regulators have supervised subsidiaries, and the way financial markets are likely to perceive the bank as a whole. Historically, both bank management and supervisors have considered subsidiaries of the bank to be an integral part of the bank (in fact they have been treated as departments of the bank) whose operations, if material, could have a significant impact on the bank's risk profile. Bank managers have invariably sought to support their subsidiaries in the past, and supervisors have carefully examined the operations of material subsidiaries in view of the difficulty in insulating the parent bank from problems in its subsidiaries.

Even if statutory barriers are erected that attempt to limit the impact of subsidiary losses on the parent bank, substantial losses in a subsidiary will likely erode the market's confidence in the management and health of the bank. This would be a critical development in the case of a bank whose stability--and whose level of risk to the federal deposit insurance funds--depends in large measure on its reputation and standing in the financial markets. A law may endeavor to mandate accounting and regulatory treatment, but it is not so easy to alter perceptions of counterparties or the reality of financial markets.

It is worth noting that a dividend payment by a bank to its holding company results in a real decline in bank capital. This is a genuine constraint on the subsidy transfer from banks to their holding company affiliates and helps explain the reality that bank dividends historically have not chronically exceeded the dividends paid out by holding company parents plus debt service. The use of bank dividends to fund holding company expansion would, of course, incorporate a modest safety net subsidy because bank earnings are higher than they otherwise would be because of the safety net. But the capital constraint--plus the supervisor's natural tendency to guard against significant capital reductions--has limited such transfers. It is unlikely that a capital adjustment for regulatory purposes that is in conflict with GAAP would be as effective a constraint on the investments that a bank may make in its subsidiary.

Moreover, losses in, for example, securities dealing or fire and casualty insurance underwriting conducted in an operating subsidiary could occur so rapidly that they could overwhelm the bank parent before actions could be taken by the regulator. Put differently, losses in an operating subsidiary can easily far exceed a bank's original equity investment long before the supervisor has any such knowledge. The resulting bank safety and soundness concerns are only deepened by the extent to which past retained earnings of the operating subsidiary would have strengthened the capital of the parent bank--an ostensible reason for operating subsidiaries. Such a buildup in capital could be used to support other bank activities and then eliminated by subsequent losses in the operating subsidiary, leaving the bank in an undercapitalized position.

The argument that operating subsidiaries are desirable because of the organizational flexibility they provide to bank management seems less than compelling. Having two options is better than one. But there is no real choice here. From the purview of banking organization profitability, the operating subsidiary is far superior to a holding company affiliate because of the funding advantage gained from access to the safety net. Hence, if profitability is the gauge, there is no increase in managerial flexibility. Rational management will always select the operating subsidiary.

Some observers have argued that operating subsidiaries should be allowed to conduct broad activities as principal in the United States because Edge corporations, which are congressionally authorized corporations chartered to conduct a banking business outside the United States and are largely owned by banks, have conducted a broader range of activities as principal outside the United States without damage to banks. As an initial matter, it is important to realize that there are only a handful of banks that engage to any significant extent through Edge corporations in activities not permissible to their parent bank, and these banks engage primarily in various securities activities. Importantly, the Congress authorized the Edge corporation as a means to allow our banks to be competitive abroad. In order to do so, Edge corporations had to be able to conduct outside the United States activities that are somewhat broader than those permitted domestically, provided the activities are usual in connection with the conduct of banking in the country in which the Edge corporation operated. The Edge corporation, therefore, conducts broader activities not because the Congress believed that it was, as a general matter, prudent to permit subsidiaries of banks to conduct broad powers. Instead, Edge corporations may conduct broader activities because they must be allowed to be as competitive as possible in the arena in which they compete--which is in foreign markets where the rules governing the activities of banks and other financial service providers differ from the rules in the United States.

This same principle--allowing competitive equity--argues against authorizing operating subsidiaries to conduct broad activities within the United States. As discussed above, the universal bank approach would allow banks and their subsidiaries a competitive advantage over U.S. securities and insurance firms that remain independent of banks--thereby inevitably impairing their competitive strength. Thus, given the structure of the financial services industry inside the United States, the principle of competitive equity that gave rise to the Edge corporation as a vehicle for conducting a banking business outside the United States argues against a similar vehicle within the United States.

Others have concluded that the Federal Reserve's objection to operating subsidiaries is solely jurisdictional--solely turf. If by such comments, these critics believe that our concern is simply to maintain our status or prerogatives, they are mistaken. This has certainly not been our approach to bank powers. The Board was an early and strong supporter of interstate banking, knowing that it would induce shifts from state to national bank charters, reducing the Federal Reserve's supervisory role. Interstate banking was right for the economy, and we supported it. Operating subsidiaries are not, and that is why we oppose them.


It has also been argued that H.R. 10 damages the Community Reinvestment Act (CRA). The Board believes that this argument is incorrect. In fact, enactment of H.R. 10 would strengthen the CRA in very material ways.

The Board believes that the CRA has played an important role in encouraging banks to identify lending markets that may be underserved and to develop credit products and services in response to identified needs of their communities. H.R. 10 provides a compelling incentive for financial holding companies to continue these efforts by requiring as a prerequisite to the expanded powers and affiliations authorized by the bill that all of the subsidiary depository institutions have at least a "satisfactory" CRA rating.

Moreover, H.R. 10 adds teeth to the CRA. Currently, the CRA is enforced through the application process. But there is no current requirement that a depository institution divest a bank once a merger is approved if the bank fails to maintain adequate CRA performance levels after the merger. H.R. 10, however, requires that satisfactory CRA ratings be maintained as a condition for continued affiliation with companies authorized under the bill. Thus, a financial holding company has a strong incentive to ensure that its depository institution subsidiaries continue to meet their CRA obligations. H.R. 10 also would expand the CRA to wholesale financial institutions, a new form of depository institution authorized by the bill.

There exists some confusion, however, as to whether the CRA would be further benefited if banks were permitted to engage, either directly or through a subsidiary, in securities and insurance activities as principal. The CRA by its terms requires that the federal banking agencies assess the record of depository institutions in meeting the credit needs of their entire community, including low- and moderate-income communities. While the CRA relates to the lending activities of depository institutions, it does not apply to securities or insurance underwriting activities--whether conducted by a bank, a subsidiary of a bank, or an affiliate of a bank. Accordingly, authorizing a bank to directly or indirectly conduct the securities and insurance underwriting activities authorized by H.R. 10 for financial holding companies would not increase a bank's obligations under the CRA, although it would expose the bank and its CRA-related lending activities to the earnings fluctuations and possible losses associated with such principal activities.

Under H.R. 10, banks would remain free to develop and offer the type of innovative or targeted lending products, either directly or through a subsidiary, that are designed to meet the identified credit needs of their communities and that are relevant to the bank's CRA assessment. Moreover, if a banking organization elected to engage in CRA-related activities through a holding company subsidiary, the organization would remain free under the CRA regulations issued by all of the federal banking agencies to have the activities of the holding company subsidiary count toward the CRA performance of an affiliated bank.


Last year, the Board, in testimony before the House Banking and Commerce Committees, recommended caution about authorizing banking and commerce affiliations. We noted that technology was already in the process of eroding any bright line between commerce and banking. Nonetheless, we concluded that the free and open legal association of banking and commerce would be a profound and surely irreversible structural change that should best wait while we absorbed the significant changes called for by financial modernization.

Recent events have, if anything, strengthened our view on the desirability for caution in this area. The Asia crisis has highlighted some of the risks that can arise if relationships between banks and commercial firms are too close. It is not so much that U.S. entities would face structures like those in Indonesia, Thailand, or Korea. Rather it is the experience that interactions of complex structures can make it extremely difficult to monitor, analyze, and manage financial exposures. In short, the Board would prefer more experience with financial change as a prelude to considering further and more profound structural changes. We thus support the H.R. 10 provisions on commerce and banking.

H.R. 10, as passed by the House, prohibits the affiliation of banking and commerce, with three exceptions. Companies, such as securities and insurance firms, that engage predominantly in financial activities and that acquire an insured depository institution may continue to own commercial firms but must divest them within ten years (with the possibility of a further five-year extension). Financial holding companies that own only uninsured wholesale financial institutions also are permitted to retain limited grandfathered investments made as of the date of enactment of the bill but are not required to divest them at the end of a specified period.

Unitary thrift holding companies--holding companies with only one thrift subsidiary--now may be affiliated with commercial entities. Only a few are, but H.R. 10 would grandfather the ability of all unitary thrift holding companies to establish commercial affiliations. For securities firms and insurance companies that acquire banks, however, H.R. 10 would not permit new commercial affiliations.

In light of the dangers of mixing banking and commerce, the Board supports elimination of the unitary thrift loophole, which currently allows any type of commercial firm to control a federally insured depository institution. Failure to close this loophole now would allow the conflicts inherent in banking and commerce combinations to further develop in our economy and complicate efforts to create a fair and level playing field for all financial service providers.

Accordingly, the Federal Reserve strongly supports the provisions of H.R. 10 that would prohibit new unitary thrift holding companies from having nonfinancial affiliations on a prospective basis. However, H.R. 10 would also permit existing unitary thrift holding companies to retain their current commercial affiliations, to expand those commercial affiliations, and to sell those rights to do so. Equity and fairness do not justify providing these grandfathered organizations such unique economic benefits. The Board, therefore, strongly supports an amendment to H.R. 10 that would at least prohibit or significantly restrict the ability of grandfathered unitary thrift holding companies to transfer their legislatively created grandfather rights to another commercial organization through mergers or acquisitions.


The markets are demanding that we change outdated statutory limitations that stand in the way of more efficiently and effectively delivering financial services to the public. Many of these changes will occur even if the Congress does not act, but only the Congress can establish the ground rules designed to ensure the maximum net public benefits and a fair and level playing field for all participants and to ensure the continued primacy of U.S. financial markets.

The Senate has a historic opportunity to modernize our financial system by passing a bill that creates an unusually desirable framework. The Federal Reserve urges the committee to establish a wider scope for the delivery of financial services through the holding company vehicle. This is the best way to minimize the spread of the safety net subsidy and its resulting competitive inequities, to minimize risks for depository entities and their insurance funds, and to facilitate a safe and sound banking and financial system that is able to serve the American public and maintain the leadership role of the American financial system in the global economy.

Note: The attachments to this statement are available from Publications Services, Mail Stop 127, Board of Governors of the Federal Reserve System, Washington, DC 20551, and on the Board's site on the World Wide Web (

(1.) For the committee's assistance, attachment 2 to this testimony provides an executive summary of H.R. 10.

Statement by Ernest T. Patrikis, First Vice President, Federal Reserve Bank of New York, before the Committee on Banking and Financial Services, U.S. House of Representatives, June 23, 1998

I am pleased to appear before the committee today to discuss the implications of the Year 2000 (Y2K) computer problem for international banking and finance. I am appearing in my capacity as chairman of the Joint Year 2000 Council, which is sponsored jointly by the Basle Committee on Banking Supervision, the Group of Ten (G-10) central bank governors' Committee on Payment and Settlement Systems, the International Association of Insurance Supervisors, and the International Organization of Securities Commissions (collectively referred to as the Sponsoring Organizations).

The international financial community has much work to do to prepare itself for the challenges posed by the Year 2000 problem. While much good work is being done and progress in many areas is evident, more needs doing. The Sponsoring Organizations believe that mutual cooperation and information sharing can play a key role in helping individual market participants carry out these preparations and limit the scope of Y2K-related disruptions. Our major concern, of course, will be the possible impact of the Y2K problem on the functioning of the international financial system as a whole.

Federal Reserve Governor Edward W. Kelley, Jr., has recently elaborated on the activities of the Federal Reserve System in connection with the Y2K problem as well as on possible macroeconomic implications.(1) I will not attempt to cover those topics again here. Instead, this morning I will begin with some background on the possible implications of the Y2K problem for international banking and finance. Second, I will describe how various supervisory initiatives led to the formation of the Joint Year 2000 Council a little more than two months ago. Third, I will discuss the actions being taken by the Joint Year 2000 Council, particularly in the areas of raising awareness, improving preparedness, and contingency planning.


The Y2K bug potentially affects all organizations that are dependent on computer software applications or on embedded computer chips. In other words, nearly all financial organizations worldwide are potentially at risk. Even those whose own operations remain strictly paper-based are likely to be dependent on power, water, and telecommunications utilities that must themselves address possible Y2K problems. Also, many nonfinancial customers have dependencies on technology.

All countries of the world, therefore, need to address the Y2K problem and its potential effects on their domestic financial markets. In some cases, it is said that computer systems in particular countries are not much affected because their national calendars are not based on the conventional Gregorian calendar used in the United States and many other countries. I do not derive much comfort from these statements because in most cases operating systems and the software applications running on them count internally with a conventional date system that may not be Y2K-compliant. These systems typically also need to connect and interact with other systems that use conventional dates, and so these interfaces must be tested for Y2K-compliance. More broadly, mere assertions that computer applications are unaffected cannot be seen as a substitute for the rigorous assessment, remediation, and testing efforts that should be undertaken by financial market participants worldwide.

The increasing extent of cross-border, financial-market activity has been much remarked on in recent years. Perhaps less well known is the fact that this activity is dependent on a large, geographically diverse, and highly computer-intensive global infrastructure for each of the key phases of this activity--from trade execution through to payment and settlement.

As an example, consider the daily financial market activities of a hypothetical U.S.-based mutual fund holding stocks and bonds in a number of foreign jurisdictions. Such a mutual fund would likely execute trades via relationships with a set of securities dealers, who themselves might make use of other securities brokers and dealers, including some outside the United States. The operational integrity of the major securities dealers in each national securities market is critical to the smooth functioning of those markets. In addition, securities trading in most countries is reliant on the proper functioning of the respective exchanges, brokerage networks, or electronic trading systems and the national telecommunications infrastructure on which these all depend. Financial markets today are also highly dependent on the availability of real-time price and trade quotations provided by financial information services.

For recordkeeping, administration, and trade settlement purposes, our hypothetical mutual fund would also likely maintain a relationship with one or more global custodians (banks or brokerage firms), who themselves would typically maintain relationships with a network of subcustodians located in various domestic markets around the world. Actual settlement of securities transactions typically occurs over the books of a domestic securities depository, such as the Depository Trust Company or the Fedwire National Book-Entry System in the United States, or at one of the two major international securities depositories, Euroclear or Cedel. Additional clearing firms, such as the National Securities Clearing Corporation and the Government Securities Clearing Corporation in the United States, may also occupy central roles in the trade clearance and settlement process.

Payments and foreign exchange transactions on behalf of the mutual fund would involve the use of correspondent banks, both for the U.S. dollar and for other relevant currencies. These transactions would typically settle over the books of domestic wholesale payment systems, such as the Clearing House Interbank Payments System (CHIPS) or Fedwire in the United States, and the new TARGET system for the euro. Correspondent banks are also heavily dependent on the use of cross-border payments messaging through the network maintained by the Society for Worldwide Interbank Financial Telecommunications (S.W.I.F.T.) to advise and confirm payments. To provide some sense of the magnitudes involved here, consider that the Fedwire and CHIPS systems process a combined $3 trillion in funds transfers on an average day (split roughly evenly between the two systems). While S.W.I.F.T. itself does not transfer funds, its messaging network carries more than 3 million messages per day relating to financial transactions worldwide.

The many interconnections of the global financial market infrastructure imply that financial market participants in the United States could be affected by Y2K-related disruptions in other financial markets. In assessing the scope of any such potential problems, we should be realistic in accepting that some disruptions are inevitable, while also recognizing that not all countries confront Y2K problems of similar magnitudes. The problem simply affects too many organizations and too many systems to expect that 100 percent readiness will be achieved throughout the world. Nor are the best efforts of supervisors and regulators capable of completely eradicating the risk of disruption. Ultimately, the work of fixing the Y2K problem rests with firms themselves, and even some of the most determined and well-funded Year 2000 efforts may miss something.


Recognizing the global nature of the issues surrounding the Y2K problem, each of the Sponsoring Organizations undertook initiatives in 1997 to raise awareness, enhance disclosure, and prompt appropriate action within the financial industry. Their decision last fall to organize a Global Year 2000 Round Table was motivated by a growing sense of the seriousness of the Y2K challenges posed in many countries and of the potentially severe consequences for financial markets that fail to meet these challenges. The Global Year 2000 Round Table was held at the Bank for International Settlements on April 8, 1998. It was attended by more than 200 senior executives from fifty-two countries, representing a variety of private and public organizations in the financial, information technology, telecommunications, and business communities around the world.(2)

The discussions at the Round Table confirmed that the Y2K issue must be a top priority for directors and senior management and that the public and private sectors should increase efforts to share information. The importance of thorough testing, both internally and with counterparties, was emphasized as the most effective way to ensure that Y2K problems are minimized. Round Table participants identified the need to continue the widening and strengthening of external testing programs in many countries.

The communique issued by the four Sponsoring Organizations at the close of the Round Table recommended that market participants from regions that have not yet vigorously tackled the problem should consider the need to invest significant resources in the short time that remains. The Sponsoring Organizations further recommended that external testing programs be developed and expanded and that all financial market supervisors worldwide should implement programs that enable them to assess the Y2K readiness of the firms and market infrastructures that they supervise. The Sponsoring Organizations urged telecommunications and electricity providers to share information on the state of their own preparations and encouraged market participants and supervisors and regulators to consider the need to develop appropriate contingency procedures.

At the Round Table, a new private-sector initiative known as the Global 2000 Coordinating Group was announced. The aims of the Global 2000 effort are to identify and support coordinated initiatives by the global financial community to improve the Y2K readiness of financial markets worldwide. For example, current Global 2000 projects include the development of recommendations for financial infrastructure testing and guidelines for addressing Y2K compliance issues related to vendors and service providers. The Global 2000 Coordinating Group, which includes representatives from more than seventy-five financial institutions in eighteen countries, represents an extremely valuable private-sector attempt at cooperation on this important issue. At the same time, however, the international financial supervisory community recognized that it would be useful to establish a public sector group, called the Joint Year 2000 Council, that would work with the private sector and also maintain a high level of attention on the Y2K problem among financial market supervisors and regulators worldwide.


The formation of the Joint Year 2000 Council was announced at the end of the Global Year 2000 Round Table on April 8, 1998. The Joint Year 2000 Council consists of senior members of the four Sponsoring Organizations. Every continent is represented by at least one member on the council. The Secretariat of the Council is provided by the Bank for International Settlements. I am honored to serve as the chairman of the Joint Year 2000 Council.

The mission of the Joint Year 2000 Council has four parts: first, to ensure a high level of attention on the Y2K computer challenge within the global financial supervisory community; second, to share information on regulatory and supervisory strategies and approaches; third, to discuss possible contingency measures; and fourth, to serve as a point of contact with national and international private-sector initiatives. After their meetings on May 8-9, 1998, the Group of Seven finance ministers called on the Joint Year 2000 Council and its Sponsoring Organizations to monitor the Y2K-related work in the financial industry worldwide and to take all possible steps to encourage readiness.

The council has met twice since being formed in early April and plans to meet frequently, almost monthly, between now and January 2000. At our first meeting, we organized our work projects and approved our mission statement. At our second meeting, we met for the first time with an External Consultative Committee consisting of international public-sector and private-sector organizations. Meeting with this External Consultative Committee is intended to enhance the degree of information sharing and the raising of awareness on different aspects of the Year 2000 problem by both public and private sectors within the global financial markets.

The External Consultative Committee includes representatives from international payment and settlement mechanisms (such as S.W.I.F.T., Euroclear, Cedel, and VISA), from international financial market associations (such as the International Swaps and Derivatives Association, the International Institute of Finance, and the Global 2000 Coordinating Group), from multilateral organizations (such as the International Monetary Fund, the Organization for Economic Cooperation and Development, and the World Bank), from the financial rating agencies (such as Moody's and Standard & Poor's), and from a number of other international organizations (such as the International Telecommunications Union, Reuters, the International Federation of Accountants, and the International Chamber of Commerce). This diversity of perspectives led to an extremely valuable discussion with the Joint Year 2000 Council and stimulated work on several projects to be taken forward with input from both the public and private sectors, for example, the initiatives on Y2K testing and self-assessment that I will describe shortly. Further sessions with the External Consultative Committee are planned on a quarterly basis.

It is important at the outset for me to be clear that the Joint Year 2000 Council is not intended to become a global Y2K regulatory authority, with sweeping powers to coordinate international action or to take responsibility for ensuring Y2K readiness in every financial market worldwide. Through our ability to serve as a clearinghouse for Y2K information, however, I believe that the Joint Year 2000 Council will play a positive role in three areas: (1) raising awareness, (2) improving preparedness, and (3) contingency planning. In the next portion of my remarks, I would like to address each of these roles in turn.


The Joint Year 2000 Council is undertaking a series of initiatives that may be described under the heading of promoting awareness. By this term, I do not mean to include only those initiatives aimed at raising general awareness, although that too is still needed in some cases. I mean to include efforts to promote better awareness of the many efforts currently under way to tackle the Y2K problem. I have found that, while many organizations are working hard on various aspects of the Y2K challenge, in many cases these efforts would be enhanced by a greater degree of information sharing with others. For example, at the Federal Reserve Bank of New York, we have been holding quarterly Y2K forums with a diverse set of financial organizations in the area. Participants have requested that we continue to hold these meetings--in fact, to hold them even more frequently--because they believe that the contacts and the exchange of views are broadly beneficial. We hope to use the Joint Year 2000 Council to achieve similar goals.

Each of the members of the Joint Year 2000 Council has committed to help play a leading role in promoting awareness of Y2K initiatives within their region. Each of us will help in coordinating regional Y2K forums or conferences and will publicly promote the goals of the Joint Year 2000 Council in speeches and on conference programs.

The Joint Year 2000 Council will also maintain extensive World Wide Web pages that can be accessed freely over the Internet.(3) These pages are being maintained through the support the council has received from the Bank for International Settlements, in particular from the General Manager, Andrew Crockett. These web pages will maintain current information on the activities of the Joint Year 2000 Council.

The most extensive aspect of the council's web site will be a series of country pages, one for each country in the world. For each country, the page will contain contact information for government entities (including national coordinators), financial industry supervisors and regulators (including central banks, banking supervisors, insurance supervisors, and securities regulators), financial industry associations, payment, settlement, and trading systems, chambers of commerce, and major utility associations or supervisors. For each of these organizations, a name, address, phone number, fax number, electronic mail, and web site address will be provided. Other relevant information on an organization's Y2K preparations may also be included, for example, whether it has a dedicated Y2K contact or has taken specific action with respect to the Y2K problem.

The motivation for developing these country pages is to increase awareness of the work that is being done to address the Y2K problem and to enable market participants to easily find out more information about the state of preparations worldwide. Establishing these national contacts will also help to develop the informal networks and arrangements that may be needed in addressing other Y2K-related issues, for example, in formulating contingency measures. Finally, of course, the presence of the country pages may exert pressure on those countries in which more vigorous action is needed. A blank or uninformative country listing would probably not be seen as a good sign by some financial market participants.

In addition, the web pages of the Joint Year 2000 Council will also provide summaries of the efforts being undertaken by its Sponsoring Organizations as well as links to the relevant web sites. For example, reports on Y2K surveys of supervisors and regulators being undertaken by the Basle Committee on Banking Supervision and by the International Organization of Securities Commissions are planned to be made available on the Joint Year 2000 Council web site. Public papers produced by the Joint Year 2000 Council will also be available on the web site. A listing of international conferences and seminars related to Y2K will be posted on the web site, together with links to other Y2K web sites and documents.

At this stage, each member of the Joint Year 2000 Council is in the process of finalizing the country page for its respective country. Last week, I wrote to every contact provided by the four Sponsoring Organizations (almost 600 contacts in more than 170 countries), asking for assistance in coordinating the development of their country page. This also provided a further opportunity to raise the awareness of the Year 2000 problem at the most senior levels of financial market authorities and supervisors in countries around the world. Through the effort to develop this web site and other similar efforts by the Joint Year 2000 Council, I believe we can succeed at keeping the awareness of the issue at a very high level within the global financial supervisory community.


Of course, awareness of the Year 2000 problem is only the first step in addressing it. Global efforts to prepare for Year 2000 vary widely, and many countries believe that more coordinated national action will be necessary to tackle the problem as effectively as possible. At our second meeting of the Joint Year 2000 Council, a strong consensus emerged that a national government body in each country could play a helpful role in coordinating preparations for Y2K. While the council did not have a strong view on what particular form or what specific authority such a body would require in each specific country, the council members felt strongly that involvement in some fashion by the national government could be beneficial.

Accordingly, the Joint Year 2000 Council plans to issue a statement in the near future providing general support for the concept of a national-level coordinating body for the Y2K problem. In the United States, of course, the White House has established the President's Council on Year 2000 Conversion, headed by John Koskinen. This effort, as well as those of this committee under the leadership of Chairman Leach, and of the other congressional committees that have addressed the Y2K problem, has shown that national government bodies have a very important and useful role to play in encouraging progress in addressing the Y2K problem.

Turning now to the question of how financial supervisors can implement effective Y2K programs, the Joint Year 2000 Council intends to promote the sharing of strategies and approaches. For example, the Basle Committee on Banking Supervision has prepared a paper containing "Supervisory Guidance on Independent Assessment of Bank Year 2000 Preparations." This document is aimed at moving supervisors worldwide from a level of general awareness to a specific, concrete program of action for overseeing Y2K preparations, both on an individual bank basis and on a system-wide basis.

The Joint Year 2000 Council intends to adapt this paper for use by financial market regulators and supervisors more broadly and to issue it as rapidly as possible with the endorsement of all four Sponsoring Organizations. The goal will be to provide guidance in developing specific Year 2000 action plans for all types of financial market authorities. Supervisors in countries that have gotten a head start on the issue can thereby provide the benefit of their experience to those who are starting later. Those supervisors getting a late start have a need for tools of this type.

The Joint Year 2000 Council will also be working with the members of our External Consultative Committee, particularly the Global 2000 Coordinating Group, to build on this effort and develop a Y2K self-assessment tool that could be used broadly by the financial industry in countries around the world. We also intend to develop additional papers on a variety of Y2K topics that might be of interest to the global financial supervisory community.

At this point, I am sure that members of the committee have questions regarding the state of Y2K preparations in various parts of the world. I think that it is fair to say that most believe a spectrum exists, with the United States at one end of the spectrum, and emerging market and undeveloped countries at the other end. There are likely exceptions of course; some developed countries are probably less far along than they should be. Some emerging market countries, on the other hand, appear to be quite advanced in their preparations.

Overall, however, there is still not nearly enough concrete, comparable information on the preparations of individual institutions to be able to make any confident statements about the state of global preparations in any detail. Over the time remaining until January 2000, we hope to use the Joint Year 2000 Council as a means of gathering a better picture of the state of global preparations and to help direct resources and attention to those regions that appear to be faltering in their efforts. We will use the information provided for our web site and the discussions with members of our External Consultative Committee as our primary resources in seeking to identify "hot spots" where more urgent efforts are needed.

If we identify regions in which more needs to be done, our first step will be to work through the relevant national financial supervisors and regulators to increase the urgency of efforts in their jurisdiction. We may also involve multilateral institutions, such as the World Bank, to help increase national attention on the issue. I do not believe that calling public attention to problems in specific countries would be a constructive step for us to take at this stage, as we are still trying to build cooperation and our current information is incomplete. In this context, I would also point out that the market itself will begin to bring strong pressures to bear on specific firms and markets that exhibit signs of being ill-prepared during the course of 1999.

In conjunction with preparations for Y2K, the recent discussion of the Joint Year 2000 Council with the External Consultative Committee raised several important issues. First, in every national market there is the question of the dependence of the banking and financial sectors on core infrastructure such as telecommunications, power, water, sewer, and transportation. In all cases, it seems that it is not an everyday occurrence for representatives of these differing sectors to get together with financial sector representatives and discuss their mutual concerns. Yet, this must be made a priority if financial firms and their counterparties are to achieve comfort that their own efforts to prepare for Year 2000 will not be compromised by the failures of systems beyond their control.

A representative of the International Telecommunications Union is a member of our External Consultative Committee. At our meeting earlier this month, he provided useful factual information on the preparations being undertaken by telecommunications firms and indicated that a further global survey and report on this topic is due to be completed soon. This is the type of information sharing that helps all parties understand the scope of the problem as well as the efforts that others are undertaking. We intend to encourage further information sharing between the financial sector and core infrastructure providers at future meetings of the Joint Year 2000 Council and the External Consultative Committee. I would also strongly encourage such mutual cooperation on Y2K preparations within each national jurisdiction.

Another issue that some participants in our Joint Year 2000 Council are concerned about in regard to preparations in their countries relates to the availability of human resources. In some regions, the supply of available information technology professionals may be hard pressed to meet the challenges posed by Y2K. For each organization facing resource constraints, this situation clearly indicates the need to develop action plans for Y2K that set clear priorities among systems and projects.

More broadly, we must also recognize that the lack of available programming resources will be a significant overall constraint on the scale of Y2K remediation efforts globally. As a result, the cost of hiring computer professionals capable of addressing the problem will continue to rise. Wealthy countries are undoubtedly in a better position to bear these increasing costs than are poor countries.

A number of participants from our External Consultative Committee cited the recent grant of 10 million [pounds sterling] sterling by the British government to the World Bank as a positive development. Among other projects, the World Bank intends to use this grant to fund a variety of educational and awareness-raising events related to Y2K over the next several months. Given the potential consequences of a failure to prepare for Y2K, the World Bank indicated to the Joint Year 2000 Council that it intends to take on an aggressive role in promoting and assisting Y2K efforts in countries around the world. The Joint Year 2000 Council intends to work closely with the World Bank to enhance our mutual efforts on the Y2K problem.

The subject of appropriate Y2K disclosure was also discussed by members of the External Consultative Committee. Many of those present agreed that greater disclosures would be helpful. However, there was skepticism that a standardized disclosure format would be effective in eliciting meaningful information for a wide class of financial firms, given the complexity and variety of Y2K issues facing these firms worldwide. It was also noted that disclosure which relies primarily on a firm's own subjective assessments of its Y2K problems inevitably will suffer from an optimistic bias.

In addition, most Y2K efforts will not reach the serious testing phase until 1999. The purpose of the testing will be to uncover areas in which additional work is required, so that the first round of tests can be expected to encounter problems. In this environment, it may be difficult for firms themselves to assess the true state of their Y2K preparations. Also, firms that believe that they are going to be ready will be directed by legal counsel not to make too strong a statement to avoid liability claims in case of unforeseen problems. On the other hand, firms that do not believe they can get ready in time will seek to avoid stating this clearly to protect their activities during 1999. For all of these reasons, I am doubtful that specific, reliable information on the state of Y2K preparations by individual firms worldwide will become publicly available.

Finally, in the area of improving preparedness, I have saved the most important topic for last--namely, testing. Testing programs, particularly external testing programs, are universally regarded as the most critical element of serious Y2K preparations in the financial sector. The Joint Year 2000 Council encourages all firms and institutions active in the financial markets to engage in internal and external testing of their important applications and interfaces. To this end, many major payment and settlement systems around the world have developed extensive testing programs and procedures for their participants. In the United States, for example, Fedwire, CHIPS, and S.W.I.F.T. have coordinated shared testing days for the purpose of testing the major international wholesale payments infrastructure for the U.S. dollar. The Securities Industry Association (SIA) has been at the forefront of an ambitious program to develop a coordinated industrywide test of all aspects of the trading and settlement infrastructure for the U.S. stock market. The FFIEC's efforts have also been extremely beneficial in stressing the importance of testing within the banking sector generally.

Yet, external testing programs globally need to be dramatically extended and expanded. To that end, the G-10 Committee on Payment and Settlement Systems last year started to collect information on the state of preparedness and testing of payment and settlement systems worldwide. To date, more than 150 systems in forty-seven countries have responded to the framework and posted such plans.(4) The Joint Year 2000 Council intends to expand the coverage of this framework to exchanges and trading systems, as well as to major financial information services providers, and hopes to expand the number of countries and systems that are included. We will also collate and present the information graphically to help highlight anomalies in testing schedules and to facilitate the efforts of systems to coordinate test scheduling when feasible.

Primarily, I see this as an exercise in peer pressure. If we list every country in the world on our web site and the public can see that some countries have scheduled mandatory external tests of their major trading and settlement systems, while other countries do not provide any information, that second country may come under greater pressure to organize an external testing program. This is our stated goal. We will simply have blanks for those countries that do not respond to our requests for information.

Of course, if the Joint Year 2000 Council is going to encourage testing to such an extent, then it is only appropriate that we also help provide some tools for those countries trying to get a serious testing effort under way in a short amount of time. This is another of our high priority projects. We will be working with members of the External Consultative Committee--including representatives of the Global 2000 Coordinating Group, S.W.I.F.T., and the World Bank--to rapidly develop a series of documents that help countries set up testing programs and overcome common obstacles. We intend to issue these documents broadly by the end of the summer, and some parts well before that.

In closing this section of my statement, I do not think it is possible to overemphasize the importance of testing to help improve readiness. To illustrate this point, I would like to draw on our experiences with Fedwire, the Federal Reserve's wholesale interbank payments system. Much of the current Fedwire software application was written in the past five years, with the Y2K problem in mind. Nevertheless, some of the older software code that was carried over into the new application was not Y2K-compliant. Without the rigorous internal Y2K testing program that the Federal Reserve adopted, our Y2K remediation efforts might, therefore, have been incomplete. I think of this experience whenever I hear it said that some countries are immune to Y2K because they have only recently introduced information technology and that recent software programs are less affected by Y2K. I ask whether those programs have truly been thoroughly tested for Y2K compliance.


The third major role of the Joint Year 2000 Council will relate to contingency planning. In this context, I should note that contingency planning is something that most financial market authorities, particularly central banks, undertake regularly with regard to a wide variety of potential market disruptions. Most private-sector financial firms, as well, have well developed contingency and business continuity plans in place for their operations.

Nevertheless, it is clear that contingency planning for Y2K problems has a number of unique characteristics. First, of course, is the fact that one cannot rely on a backup computer site for Y2K contingency if that site also uses the same software that is the cause of the Y2K problem at the main site. In some cases, it is impractical to build a duplicate software system from scratch simply to provide for Y2K contingency. In these cases, as a senior banker explained at one of our New York Y2K forums, contingency planning amounts to, "Testing, testing, and more testing."

Contingency planning can also be separated into components that are firm-specific and those that are marketwide. Each individual firm will need to develop its own contingency plans designed to maintain the integrity of its operations during the changeover to the Year 2000. The FFIEC has recently issued guidance to banks in the United States regarding the core elements of their own contingency planning.(5) The Joint Year 2000 Council will also be developing a paper on contingency planning for the benefit of the global financial supervisory community. This paper will seek to address firm-level contingency as well as issues of marketwide contingency.

Marketwide contingency refers to the planning by participants and supervisors done to ensure that individual disruptions can be managed in ways that will prevent them from causing disruptions to critical market infrastructures. For instance, we at the Federal Reserve have gone to great lengths to ensure that barriers are in place to prevent Y2K problems with a Fedwire participant from causing problems on the Fedwire system itself. We are also now actively researching additional steps that the Federal Reserve could take to better prepare the financial markets as a whole to function in spite of disruptions at individual firms.

It is also important to realize that contingency planning for Y2K is not solely an operational issue. Financial firms may seek to adopt a defensive posture in the marketplace well ahead of Monday, January 3, 2000 (the first business day of the new year in the United States). For example, market participants may seek to minimize the number of transactions that would be scheduled for settlement on January 3 or January 4 or that would require open positions to be maintained over the century date change weekend.

Contingency planning involves a series of elements, many of which must be put in place well before January 2000. For example, we must consider many possible sources of disruption and determine what approaches could be available to limit the impact of each possible disruption. The sooner such thinking occurs, the more opportunity we have to plan around the possible disruptions. In this context, members of our External Consultative Committee noted that one of the key obstacles to effective contingency planning is the inability to list and consider all possible disruption scenarios. Several of these participants noted that their firms were engaging consultants or other procedures to expand the number of scenarios for inclusion in their Y2K contingency planning.

In New York, we will be using our Y2K forum next month to discuss contingency planning with a diverse set of market participants. These local market participants will provide helpful insights for the Joint Year 2000 Council. Clearly, more work is needed on contingency planning for Y2K, especially at the international level. Once we get beyond the early fall of this year, I believe that these efforts will begin to receive much greater focus and attention and--together with testing--will dominate our discussions of Y2K during 1999.


In closing, I would like to thank the committee for the opportunity to appear and submit a statement on this important issue. I hope that the efforts of the Joint Year 2000 Council will help to make a difference in improving the state of Y2K preparations in the international financial community. Realistically, however, I believe that it is important to understand the limits of what financial market supervisors can accomplish, either individually or collectively. Only firms themselves have the ability to address the Year 2000 problems that exist within their own organizations. Only firms working together can ensure that local markets will function normally. Supervisors and regulators cannot guarantee that disruptions will not occur.

Given the sheer number of organizations that are potentially at risk, it is inevitable that Y2K-related disruptions will occur. Today it would be impossible to predict the precise nature of these disruptions. However, we do know that financial markets have in the past survived many other serious disruptions, including blackouts, snow storms, ice storms, and floods. We will also have a very interesting case at the end of this year with the changeover to monetary union in Europe. We will all be watching carefully to see whether the extent of operational problems related to this event is greater or less than expected.

I would also like to say at this point that my discussions with other members of the Joint Year 2000 Council and with members of the External Consultative Committee have convinced me that successful efforts to address the Y2K problem will be dependent on the credibility of those calling for action. Those of us--such as members of this committee as well as others in the Congress--who are seriously engaged and concerned need to be able to persuade others of the need to take appropriate actions promptly. It would be unfortunate if general perceptions of the Y2K problem are driven primarily by unofficial commentators whose rhetoric is seen to exceed the facts on which it is based, and therefore easily dismissed.

As a central banker and bank supervisor, my major concern must be with the system as a whole. At this point, I believe that we are doing everything possible to limit the possibility that Y2K disruptions will have systemic consequences in our markets. However, we must all continue to work hard--both individually and cooperatively--in the time that remains to ensure that this threat does not become more concrete.

In that spirit, I would like to end my remarks by commending the committee for organizing these hearings on the implications of the Year 2000 computer problem for international banking and finance.

(1.) See Statement by Edward W. Kelley, Jr., Member, Board of Governors of the Federal Reserve System, before the Committee on Commerce, Science and Transportation, U.S. Senate, April 28, 1998, Federal Reserve Bulletin, vol. 84 (June 1998), pp. 433-38.

(2.) A videotape containing highlights of the Global Year 2000 Round Table is available free of charge from the Bank for International Settlements. Please contact the Joint Year 2000 Council Secretariat at the Bank for International Settlements, Centralbahnplatz 2, CH-4002 Basle, Switzerland (telephone: 41 61 2808432, fax: 41 61 280 9100, email:

The Federal Financial Institutions Examinations Council (FFIEC) has also placed the entirety of this video tape on its web site, where it is available for downloading in whole or in part. Please see 19980408.

(3.) The web pages of the Joint Year 2000 Council can be reached at the web site of the Bank for International Settlements ( These pages will also be registered under the name in the near future.

(4.) The relevant information can now be found on the pages of the Joint Year 2000 Council.

(5.) See
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Publication:Federal Reserve Bulletin
Date:Aug 1, 1998
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