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Answering the Call for Banking Supervision

August 1, 1988

Answering the Call for Banking Supervision

One responsibility of the evolving Federal Reserve System was to regularly examine member banks to ensure that the banks were being operated properly. The following vignettes provide insight into a Minneapolis Fed examiner's "life on the road."

During World War II, plane travel was limited and Fed examiners from Minneapolis had to travel by train and car. That wasn't so bad for trips in Minnesota, but the Ninth District extends about 1,500 miles east-to-west and 600 miles north-to-south. Minneapolis examiners were also auditing Montana banks at that time, and often the trip would be more grueling than the exam.

One Fed examiner of the '30s and '40s likened the occupation to that of a traveling salesman because of all the time spent on the road. Likewise, the examiner said, the job was probably best suited for the young and single. Later, a policy was adopted at the Minneapolis Fed to allow examiners to return home on weekends, whenever possible, during long trips (some Montana trips could last six weeks, though most lengthy trips averaged from two to four weeks).

Cribbage was the game of choice during idle time for one group of examiners in the '30s and '40s who spent many hours in trains and hotel rooms, although occasionally a small-ante poker game was introduced for a little variety.

Winter storms would sometimes delay exams. Once, two examiners were trapped in their car for half a day in western Minnesota during a Red River Valley blizzard. Also, sickness once canceled a planned exam to western Montana in the 1950s. Diphtheria had overtaken the town, and the examiners, both with families, had little desire to expose themselves to the illness.

At times events tended to be a little off-center, for example:

  • One morning, sometime in the early 1960s, a group of dark-suited Fed examiners was waiting for a bank to open in a small southern Minnesota town. Upon noticing the well-dressed men standing in the town's Main Street, the local mortician asked if they would do him the favor of serving as pallbearers for an early-morning funeral. The examiners obliged.

  • In Belle Fourche, S.D., at about the same time, examiners were also asked to aid the community, although in a decidedly less formal manner. A celebration was taking place in the town and contestants were needed for a Main Street bed race that evening. The town banker, a strong local booster, asked the Fed examiners if they would participate. Once again, the examiners obliged (no word on how the examiners finished, but the banker was reportedly pleased with their effort).

  • About 10 years later, in Ashland, Mont., Fed examiners were also caught up in a peculiar situation: when they entered the bank's lobby they discovered a bank robbery in progress. The robbers ordered them to the floor with the rest of the employees and customers, where they remained until the robbers fled and the situation was safe.

Prior to the dawning of the computer age, examiners arriving back in Minneapolis from a trip were greeted by piles of reports to prepare—with the "modern" conveniences of paper, pencils and carbon copies. Today, examiners use computers, the Helena branch examines all Montana banks and modern transportation is the only way to go. Together, the Helena and Minneapolis banks employ 60 examiners (including in-house examiners who review bank holding company applications, among other things) and in 1987 they conducted 323 various exams and inspections.

While their lives on the road may not always be the stuff of adventure movies, Fed examiners perform an important function. Although banks are independent businesses operated for profit, banking in the United States has always been a guarded privilege—treated as a matter of public interest—hence, the historical concern for effective supervision of the banking industry. Indeed, the call for strong bank supervision is one of the cornerstones of the Federal Reserve Act: "... to establish a more effective supervision of banking in the United States . .." An ambitious goal, to be sure, and one that is still sought today.

As in other matters of concern to the banking industry, the Federal Reserve Act was not the final word on bank supervision. Legislation throughout the past 75 years, including the formation and involvement of additional government agencies, helped shape the existing nature of the Fed. Since the 1930s, banking supervision on a federal level has included three regulators: the Fed, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC). In addition each state has its own supervisory department, and similar agencies also exist for the regulation of other financial institutions like credit unions and savings and loans.

The need for more effective bank supervision was urgent in 1913. In testimony before the House that year, the comptroller of the currency said bluntly: "The whole question of bank examination is illogical, unscientific, and simply impossible under the present laws." National bank examiners, clearing-house examiners and state examiners were all clamoring for the same information, sharing some with their counterparts and jealously guarding other bits of information. The split in regulatory functions was one of the results of the country's firmly entrenched dual banking system. That banking system, which recognized the sovereignty of both national and state charters, affected all subsequent legislation aimed at regulating the banking industry and frustrated attempts to unify bank supervision. Indeed, an unrealized goal of the Federal Reserve Act was to bring all banks under one supervisory blanket.

While the Fed was required under the Federal Reserve Act to supervise state member banks, its role has expanded through the years. The Banking Acts of 1933 and 1935, which gave additional supervisory powers to the Fed, were spawned by the Great Depression and the apparent inability of the existing financial structure—including the Federal Reserve System—to prevent such an event from occurring. About 10,000 banks failed during the Great Depression, and along, with repairing a damaged banking system Congress also had to mend consumers confidence in the banking industry. It went a long way toward meeting that goal and easing bank depositors' fears by creating the Federal Deposit Insurance Corp. The FDIC established, for the first time, insurance on bank deposits.

But the bill that had, perhaps, an even greater impact on the operations of the central bank was the Bank Holding Company Act of 1956 (bank holding companies are legal entities that own one or more banks). By circumventing geographic and business restrictions normally applied to individual banks, bank holding companies were becoming large, multifaceted institutions with little regulation. The Bank Holding Company Act not only put the Federal Reserve System in charge of supervising multibank holding companies, but also required the Fed to regulate the formation of the companies and their acquisitions.

The key word in that 1956 act was "multi-bank"—it wasn't until 1970 that Congress amended the act to include one-bank holding companies. By 1970, one-third of all commercial bank deposits were held by one-bank holding companies. Still further, bank holding companies of all kinds held 89 percent of all bank deposits by 1984. Clearly, the Fed's supervisory umbrella was expanding.

In addition to industry regulation, the Federal Reserve has also been called upon to regulate consumer legislation. For example, the Fed is the primary regulator of the Truth in Lending Act of 1968, which requires the Fed to ensure that lending institutions properly disclose interest rates and other information on consumer credit. That Act was followed by a number of laws in the 1970s that regulated consumer credit. Most recently, in 1987, Congress passed the Competitive Equality Banking Act which, among other things, requires banks to reduce the float time normally applied to deposited checks.

In large part, the Fed's supervisory role has mirrored the growth of the financial services industry. As the banking industry has evolved to meet consumer demands and business challenges, so has the Fed accommodated those changes. Other legislation has helped shape the Fed's role in supervising the banking industry, and more legislation will surely pass in the future. The latter half of the 1980s found the financial services industry engaged in a bitter debate over interstate banking—allowing bank holding companies to purchase banks out of their home state—and the proposed expansion of banking powers. Many of the expansion proposals, for example, allowing banks to get into the real estate and insurance business, include the Federal Reserve in an even larger supervisory role. While the bank powers debate was far from settled at the time of this writing, the issue provided another example of how far the Fed has evolved as a bank supervisor—and as a central bank—since 1913.