At the request of Gary Stern, president of the Federal Reserve Bank of
Minneapolis, I have been asked to revisit the essay"Are
Banks Special?"I wrote almost 20 years ago when I was Gary's
predecessor. While I readily agreed to undertake the revisitation, I must
confess that a microscopic review of one's own writing 20 years after
the fact is somewhat daunting. However, even with the passage of time,
I can still recall with clarity the factors that prompted me to write
the essay in the first place.
In large part, those factors centered around the widely held
perception in the early 1980s that the competitive position of
traditional banks was rapidly eroding, thereby calling into question
how the banking and financial system of the futureincluding
the monetary policy processwould work. In turn, those questions
were prompting a range of other issues relating to the desired
structure of the future banking and financial system, including
specific questions such as the scope of activities that banks
should be permitted to offer, and whether the separation of banking
and commerce should be preserved.
In that time frame, then-Federal Reserve Chairman Paul Volcker
and I often engaged in late-night brainstorming sessions about
these and other issues. During one such session, I remember suggesting
to the chairman that someone should write a "think piece" on these
banking sector issues. In his usual style Chairman Volcker responded
by saying, "Why don't you do it?" So, I did.
However, writing the essay, as Volcker anticipated far better
than I, proved to be more difficult that I suspected. I can still
recall going through what seemed like dozens of drafts in what
became a painful and tedious test of logic and precision. I remain
grateful for the support and help provided to me in that undertaking
by Kathy Erickson, then a colleague at the Minneapolis Federal
While the initial publication of the essay produced a bit of
a stir, it proved to have much more staying power than I would
have imagined at the time. Indeed, eight to 10 years later I was
surprisedand perhaps a bit flatteredto learn that
both of my daughters encountered the essay on reading lists for
courses they were taking in college. As for myself, by the time
the essay was finished I was so sick of the subject that I never
again glanced at it until Gary Stern asked me to write this article.
Clearly, a great deal has changed since 1982. However, in what
I hope is not an overdose of intellectual self-delusion, I still
find the core of the essay highly relevant and I still believe
that banks are special. Further, I would observe that important
parts of the philosophy embodied in the essay continue to command
broad support and are, for example, reflected in the sweeping
new banking legislation enacted in the United States last year.
Finally, in reflecting on the severe banking sector problems that
have been witnessed in so many countriesincluding the United
Statesover the past two decades, I believe that the stress
the essay placed on the critical importance of what I called the
"impartiality of the credit decision making process" was, if anything,
The 1982 essay began with the assertion that there were three
traits that made banks special. Building on those core traits,
a simple, but formal, definition of a "bank" was suggested. A
"bank" was defined as any institution that was authorized to issue
deposits which were "payable on demand at par and readily transferable
to third parties." Given the core traits and the definition of
a bank, the essay went on to stipulate that public interest considerations
associated with banking were such that only banks should have
access to the full-scale public safety net for financial institutions
as defined in the essay.
The three key traits of banks were: First, they offer transaction
accounts as defined; second, they are the backup source of liquidity
for all other institutions; and third, they are the transmission
belt for monetary policy.
Clearly, the world of 2000 is not the same as the world of 1982.
Yet, there remains a core of validity to these key traits of banks.
Allow me to elaborate briefly.
- With regard to transaction accounts, certainly there are many
close substitutes for bank-issued demand deposits, the most
important of which is the "checkable" money market mutual fund
that was rapidly gaining popularity in the early 1980s. However,
these substitutes do not meet the test of being payable on demand
at par. Thus, while the competitive landscape continues to shift,
there remains a critical aspect of the deposit gathering function
which is unique to "banks."
- With regard to banks as the backup source of liquidity, it
is true, as recently observed by Fed Chairman Alan Greenspan,
that the ability of capital markets to mobilize and allocate
capital has changed dramatically and that capital markets and
banks play complementary roles in the credit intermediation
process, especially when one sector is having problems and the
other is not or vice versa. However, it remains highly unlikely
that nonbanks-whether financial or nonfinancial companies-can
provide very large amounts of liquidity on short notice, such
as the surge in bank funding of the securities industry which
occurred at the time of the 1987 stock market crash.
- As to the transmission belt for monetary policy, it is undeniable
that the monetary policy processand its linkages with
the economyhave changed considerably over the past 20
years. Yet it remains largely true that most monetary policy
targets and indicators (the federal funds rate or its equivalent
in other countries and most measures of the "money supply")
remain, to a very considerable degree, uniquely associated with
banking institutions. However, recognizing that interest rates
are the cutting edge for monetary policy, it follows that financial
markets generally, and nonbank financial institutions specifically,
play a much larger role than they once did in the transmission
of monetary policy changes to the economy, even if we do not
fully understand the precise workings of these transmission
channels. In other words, while the monetary policy channels
and linkages have changed, the role of banks remains central
to the monetary policy process even if less so than in the past.
In the 1982 essay, a direct connection was drawn between the
special traits of banks and access to the financial safety net
defined as deposit insurance; the account, credit and payment
facilities of the central bank; and a heightened degree of fully
consolidated official supervision. This, of course, raises the
question of whether so much has changed since 1982 as to either
narrow or broaden the class of institutions having access to the
safety net, or to redesign certain aspects of the safety net,
or both. Directly or indirectly, these questions have been at
the core of the debate about legislative reform of the financial
system for most of the past two decades.
At the time the essay was written it was widely recognized that
the basic statutory framework governing banking and finance in
the United States was in need of reform. However, there were considerable
differences of opinion as to how far that reform should go. For
example, there were many, myself included, who were distinctly
uneasy about the prospect of the full-scale repeal of Glass-Steagall.
Similarly, for many who anticipated the scope and cost of the
savings and loan crisis, there were major questions about the
wisdom of authorizing broad new powersincluding full-fledged
real estate development authorityto S&Ls.
By the mid to late 1980s, the forces of competition and technology
made it clear that "the finger in the dike" approach to Glass-Steagall
was, as a practical matter, unworkable. Nevertheless, several
efforts aimed at legislative reform failed. By the late 1980s
and early 1990s, the focus of attention shifted as major banking
sector problemsincluding the seriously weakened condition
of a number of very large banksgave rise to heightened concerns
about the stability of the system as a whole. In some ways, this
time interval was the high-water mark for those who favored combining
banking and commerce. The argument, in a nutshell, was that only
such a step could provide the huge amount of fresh equity needed
to recapitalize the banking system, especially several of the
nation's largest banks. This environment helped to trigger the
enactment of the Federal Deposit Insurance Corp. Improvement Act
of 1991. This important legislation accomplished some of the needed
redesign of the safety net, but it was essentially silent on issues
relating to banking structure.
Even as the banking system regained its health and the financial
condition of most major banks and nonbank financial institutions
improved dramatically, efforts aimed at legislative reform remained
stymied. Finally, in late 1999 Gramm-Leach-Bliley (GLB) was signed
into law by the president.
By any measure, the provisions of GLB are sweeping, even if
it is true that in important respects it essentially ratified
what markets and regulators had already done. In the debate leading
to the passage of GLB, there were three core issues relating to
the 1982 essay which had to be resolved. They were: first, whether
expanded activities for banks should be conducted through operating
subsidiaries of banks or through subsidiaries of a bank holding
company; second, whether, or to what extent, to alter the doctrine
regarding the separation of banking and commerce; and third, whether
to preserve the narrow linkage between "banks" and full-scale
access to the so-called safety net as defined earlier. The 1982
essay answered these questions by: (1) favoring the bank holding
company model; (2) strongly opposing the breakdown of the separation
of banking and commerce; and (3) preserving the narrow link of
extending the full-scale safety net only to banks.
Relative to these three central issues, GLB stacks up rather
well. It preserves the narrow link between banks and the safety
net, and it rejects the blending of banking and commerce while
providing some added flexibility for merchant banking. With regard
to the bank subsidiary vs. bank holding company question, GLB
incorporates the compromise struck by the Congress, the Treasury
Department and the Federal Reserve. Specifically, GLB permits
certain activities (based primarily on their "closeness" to banking
and their risk characteristics) to be housed in bank subsidiaries
while other activities (including merchant banking) would be housed
in subsidiaries of the bank holding company. Important details
regarding these arrangements have yet to be spelled out in regulations.
The debate between the bank subsidiary vs. bank holding company
models involves several issues, but the central issue relates
to whether one approach is superior to the other in insulating
the safety net from problems that might arise outside the bank
but within the group as a whole. I have never believed, and still
do not believe, that either model can provide fail-safe
insulation. Thus, the question is which approach provides the
greatest assurance that the insulation will survive the test of
severe stress. I, for one, remain firmly of the view that the
holding company provides the greater assurances in this regard.
But, we should not delude ourselves. Fail-safe insulation is an
outright fiction and that is why effective and enlightened consolidated
supervision of banking groups and holding companies is so essential.
In summary, to a very considerable degree, GLB seems to acknowledge
that banks are special. Indeed, the Act is both powerful and progressive
in providing a coherent framework to guide the next phase of the
evolution of banking and finance in the United States. Of course,
GLB will not be the last word on this subject. The still-accelerating
pace of technological advances in banking and finance ensures
In the meanwhile, the pattern of further consolidation in banking
and finance will continue. Hopefully, that process will evolve
in an orderly fashion, including one in which the argument for
combining banking and commerce has been put to rest for a long,
long time to come. Indeed, if there were any lingering doubts
about the potential costs of such arrangements, the havoc produced
by these arrangements in so many countries in recent years should
serve as "Exhibit A" in defense of the separation doctrine.
More broadly, the financial strength, competitive energy and
global leadership of U.S. financial institutions have recovered
sharply from the threatening days of the late 1980s and early
1990s. Yet, the financial system continues to encounter periodic
bouts of severe volatility and instability. And, despite massive
efforts by both the official and private sectors aimed at crisis
prevention and crisis management, the system remains vulnerable.
This underscores the case for enlightened management and supervision
of banking institutions which will encourage a gradual but decisive
shift to greater reliance on market mechanisms and less reliance
on de facto official intervention.
E. Gerald Corrigan is managing director
at Goldman, Sachs & Co., New York. He serves as co-chair of both
the firm's Risk Committee and the Global Compliance and Controls Committee.
Prior to joining Goldman Sachs in 1994, Corrigan was chairman of the
Basle Committee on Banking Supervision, the first American to hold that
post. In addition, he spent 25 years with the Federal Reserve System,
most recently as president and chief executive officer of the New York
Fed, following five years as president of the Minneapolis Fed.
Also see: The 1982 Annual Report essay, "Are
Banks Special" and the
Region interview with E.
Gerald Corrigan, Nov. 1990.