Community banking won two major victories in GLB. First, the new law closes the unitary thrift loophole through which some commercial firms were acquiring S&Ls. Second, community bankers also fought hard for and won provisions in the new law to reform the Federal Home Loan Bank (FHLB) system. Another bonus in GLB will give most community banks welcome relief from Community Reinvestment Act (CRA) examinations.
When I assumed the presidency of the Independent Community Bankers of America (ICBA) last March, I might have bet against financial modernization legislation, then just reintroduced in Congress, being enacted by the end of 1999. After all, there was a fairly long history in Washington of financial modernization bills failing to move forward, whether due to internecine warfare in the financial services industry or political maneuvering on Capitol Hill. But somehow the pieces fell into place, and the result was the Gramm-Leach-Bliley Act of 1999 (GLB), signed last November by President Clinton. The new law has far-reaching impact on community bankers. Like many things in life, some of it is good and some of it is bad.
What changed in the political and competitive landscape that enabled this legislation to succeed where earlier versions failed? First, the Federal Reserve and Treasury Department settled their longstanding differences over the appropriate Fed and Office of the Comptroller of the Currency supervisory role. Second, all elements of the financial industry found enough common interests to pull together finally behind a hybrid bill. Third, there was a determined push by the Republican Party leadership in Washington to find a legislative trophy to brandish during the 2000 election season. And, the Clinton White House was eager to support a politically acceptable financial reform bill.
Community banking's gains
Community banking won two major victories in GLB. First, the new law closes the unitary thrift loophole through which some commercial firms were acquiring S&Ls. This will prevent Wal-Mart and other commercial firms from breaching the wall historically separating banking and commerce in this country. True, there will still be some 75 grandfathered unitaries with commercial ties, but had this loophole stayed open the remaining 500 to 600 unitaries without commercial links could have been bought by the likes of Wal-Mart.
Second, community bankers also fought hard for and won provisions in the new law to reform the Federal Home Loan Bank (FHLB) system. Beset by an outflow of core deposits to mutual funds and other competitors, community banks under $500 million in assets will now be able to become FLHB members (regardless of the percentage of housing finance assets they have in their portfolio) and use small business- and agricultural-loan collateral to secure advances. I cannot underestimate the importance of these provisions to community bankers in providing needed access to a valuable source of fixed-rate, long-term funding.
Another bonus in GLB will give most community banks welcome relief from Community Reinvestment Act (CRA) examinations. Any bank under $250 million in assets that received a "satisfactory" rating on its most recent CRA exam, will now be examined for CRA no more frequently than once every four years. If that bank received an "outstanding" rating, it will not have a CRA exam more than once every five years. While this relief is somewhat limited in scope, it should be an improvement over current regulation if implemented appropriately (that is, without a new set of regulatory burdens).
The new financial services industry structure
You have undoubtedly heard that the new law repeals the Depression-era Glass-Steagall Act. In fact, GLB not only tears down this barrier to the common ownership of banks and securities firms, it also changes the Bank Holding Company Act of 1956 to allow similar affiliations with insurance companies. Under a new entity called a financial holding company (FHC), banks can sell and underwrite insurance and securities through affiliates, and insurance and securities companies can engage in banking activities through their affiliates. Above all, banks, insurance companies and securities firms can come under common ownership.
Stated most bluntly, the affiliation provisions in GLB were the ultimate ratification of the Citibank-Travelers merger, which was based on a clever Federal Reserve interpretation of the Bank Holding Company Act. Will similar deals follow? I strongly, if reluctantly, assume so. As a result, community bankers will face enhanced competition from larger financial conglomerates cross-marketing a wide array of financial products.
One of the most contentious issues lawmakers faced was resolving sharp disagreement between the Fed and Treasury over what activities could be conducted in operating subsidiaries of banks, and what would have to be pushed out to holding company affiliates. In the end, Chairman Greenspan and Secretary Summers worked out a compromise allowing all permissible financial activities to be conducted in financial subsidiaries of a bank (with certain asset limitations)except for insurance underwriting, real estate development and merchant banking, all of which could be conducted in holding company affiliates.
The new law also establishes the Federal Reserve as the umbrella regulator over financial holding companies, giving the nation's central bank a heretofore unseen level of authority in financial supervision and regulation. At the same time, GLB also embraces the concept of functional regulation, meaning state insurance commissioners will regulate bank insurance operations, the Securities and Exchange Commission will regulate most bank securities activities and bank regulators will oversee banking activities.
Insurance sales and privacy
For community bankers, one of the anomalies in GLB is that while it prescribes new rules for insurance sales, it does not repeal the "place of 5,000" rule under section 92 of the National Bank Act. This means that in order to sell insurance directly, a bank would have to be located in a place of 5,000 people or fewer. However, a bank may sell insurance through a financial subsidiary or an FHC without regard to geographic location, provided it follows state licensing laws. The new law calls on states to enact uniform state insurance licensing standards and does open the door for some potential mischief from state insurance commissioners. If a majority of states fail to enact such laws within three years, GLB provides for the establishment of a new self-regulatory body, the National Association of Registered Agents and Brokers, to write uniform standards.
Having said all this about GLB, what else should community bankers be on the lookout for? To begin with, although a regulatory regime for dealing with too-big-to-fail (TBTF) banks was codified by 1991's Federal Deposit Insurance Corp. Improvement Act, the reality of this situation has been truly driven home by enactment of financial modernization. Not only is the new law the ultimate ratification of the Citibank-Travelers merger and its future kin, but the absolute guarantor that these behemoths would be kept alive no matter what trouble they might get themselves into.
This point was underscored in a mid-January speech by Fed Governor Laurence Meyer, who said that "the growing scale and complexity of our largest banking organizations . . . raises as never before the potential for systemic risk from a significant disruption in, let alone failure of, one of these institutions." He also said that the Fed has developed a separate supervisory arrangement for these 30-odd entities, designated large complex banking organizations (LCBOs), which control about 60 percent of U.S. bank assets.
Governor Meyer went on to note that this new regime "covers the [LCBOs] that engage in capital arbitrage and often operate at the edge of the envelope in risk-return trade-offs and in the creation of new instruments and strategies." For most other U.S. banks, he said, the "existing system works just fine with only minor modifications and will continue to do so for the foreseeable future." For community bankers, this is a critical distinction to keep in place. A system of differential regulation based on size should increasingly be the order of the day, so community bankers can ensure that they do not become ensnared in a supervisory and regulatory regime that is not appropriate for their noncomplex, less-risky nature. Having been a banker before, during and after the S&L crisis, I can honestly say I am tired of cleaning up other people's messes.
Increasing deposit insurance coverage
Deposit insurance issues surrounding TBTF banks also have top-tier significance for community bankers. From time to time, some heads of TBTF banks have urged elimination or privatization of deposit insurance. Well, when you have the luxury of offering your depositors protection via a systemic risk guarantee, you can afford to make such statements. But I can't do that, because as neither TBTF nor an LCBO, my bank must operate under the existing deposit insurance system. And this depositor protection is how community bankers bring in and maintain the core deposits they use to fund local lending, a more challenging task every day given stiff competition from mutual funds, online brokerages and sprawling TBTF branch networks.
While the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) are in their best financial shape ever, with reserves well above their statutory minimums, there are some coverage-related concerns. The current $100,000 coverage limit has not been increased since 1980 and is now only worth about $55,000 in constant dollars. My successor as ICBA president, and a fellow Midwesterner, Tom Sheehan of Grafton, Wis., recently testified to Congress that the coverage limit should be doubled to $200,000 and indexed for inflation going forward. This increase would make up for the inflation erosion in coverage since 1980, and indexing the limit for inflation in the future would ensure that deposit insurance coverage kept pace with economic reality. Importantly, the ICBA has also strongly urged 100 percent insurance coverage for municipal deposits-the people's money, so to speak.
At this time, disappointingly, there is not unified support among the bank trade associations for increasing the coverage limit. There are those who are asking for rebates on excess BIF and SAIF reservesa plan strongly opposed by the U.S. Treasury. Of course, such a rebate would be nice, but it would be better to use these funds for doubling coverage to $200,000 with future indexing. This increase would promote the role of community banks as financial intermediaries and help ensure that they have lendable funds for economic development in their market areas. I'm not interested in short-term economic fixes like rebates on excess reserves. What I want are the economic tools to keep my bank healthy and competitive for the long haul.
Unfortunately, Merrill Lynch plans to start sweeping cash management account balances into FDIC-insured accounts at two BIF-insured banks the securities firm owns. This is deeply troubling, as it means a Merrill Lynch customer with noninsured funds could automatically receive up to $200,000 in deposit insurance coverage, rather than the usual $100,000 limit. To make matters worse, since Merrill's banks currently qualify for the highest rating (1A) under the FDIC's risk-based premium system, and hence do not pay deposit insurance premiums, the BIF fund wouldn't increase by even a penny for the heightened liability. The FDIC has already calculated that if Merrill were to add $100 billion of insured deposits, the BIF's current reserve ratio would fall 6 basis points to 1.32 percent of insured deposits. This Merrill Lynch gambit underscores the imperative of increasing deposit insurance coverage levels if community banks are to remain competitive. We will continue to carry this important message to Congress and Washington policymakers.
Robert Barsness is president and chairman of Prior Lake State Bank, Prior Lake, Minn. Barsness is immediate-past president of the Independent Community Bankers of America, and is a member of the boards of ICBA and ICBA Mortgage Corp. He was charter president of the Bank Holding Company Association and is a member of the Fannie Mae National Advisory Council.