In the turf war between the Federal Reserve Board and Treasury Department that hung up the financial reform bill for more than a year, the Fed seems to have emerged the winner.
The battle centered on how banks would be allowed to take advantage of new powers. The Fed wanted them to be offered through subsidiaries of holding companies, which it supervises. The Treasury argued that new powers could be safely housed in subsidiaries owned directly by banks, which it indirectly oversees through the Office of the Comptroller of the Currency.
The two sides came to an eleventh-hour compromise last month that helped move the legislation toward the verge of enactment.
"My impression is that the Fed did get most of what it wanted," said Princeton University economics professor Alan Blinder, a former vice chairman of the central bank. "There are many cleaner solutions that could have been reached, such as writing the Treasury out altogether, but that clearly wasn't in the cards."
Richard M. Whiting, executive director of the Financial Services Roundtable, said Congress has ensured that new banking services will be delivered through holding companies -- rejecting the European tradition of permitting banks to directly enter new businesses. "The holding company format will continue to be the primary way to deliver financial services," he said.
Under the bill, approved by the House/Senate conference committee Tuesday, all banks would be allowed to underwrite securities in direct subsidiaries, to be called "financial subsidiaries." What has been known under OCC rules as an "operating subsidiary" will still exist, but these units will not be barred from doing anything the parent bank may not do. (Under the bill, state banks may not do more than national banks, which are OCC-regulated.)
However, insurance underwriting and real estate investment and development could be conducted only in a holding company unit.
Only holding company units could conduct merchant banking. Five years after enactment, the Treasury and the Fed would be free, but not required, to agree to allow it for bank subsidiaries.
All other "financial" activities could be conducted in either bank subsidiaries or holding company units.
It is for new products and services that things could get tricky.
Lawmakers left it to the Fed and Treasury to decide whether new activities belong within a holding company or a bank structure -- and they gave each side the power to veto decisions made by the other.
For example, the Comptroller's Office might define some new product as "financial" and permissible for national bank subsidiaries, but the Fed could block the decision. The OCC could do the same thing to the Fed, but the central bank has an escape. Under the law, holding company units are not as confined as bank subsidiaries and may conduct activities considered "complementary" to banking.
Many people consider the Fed the winner because the three areas that regulators view as posing the greatest risks -- insurance underwriting, real estate development, and merchant banking -- fell under the Fed's purview.
"This gave Treasury a fig leaf to hide behind, but the Fed got everything that it wanted," said one industry observer. This source spoke on condition of anonymity, as did most others contacted for this article, including senior officials at the Fed and the OCC.
Still, some experts insist, the national bank charter survived this process unscathed.
"With the exception of a few activities, the bank subsidiary is just as attractive, if not more so, than a holding company affiliate," said James C. Sivon, a banking lawyer and secretary for the Support Group for Modern National Banking.
OCC officials contend the agency never wanted national bank subsidiaries to be able to engage in real estate investment and development, and did not consider it worthwhile to battle over insurance underwriting. The five-year delay on merchant banking is a disappointment, but not regarded as a complete defeat. The OCC also retains the authority to determine what national banks do, which includes anything the agency defines as part of the business of banking.
Karen Shaw Petrou, president of the Washington-based consulting firm ISD/Shaw Inc., is in a neutral corner and summed it up this way: "In terms of the value of the operating subsidiary as a venue for nontraditional powers, its relative attractiveness has been reduced."
Within the bill are many other details of what is referred to as the "op-sub" compromise.
For instance, banks that want to establish financial subsidiaries will have to meet certain ratings requirements depending on their size.
The 50 largest insured national banks will be required to have an outstanding issue of long-term unsecured debt with one of the top three ratings issued by an independent ratings agency. The next 50 largest banks would have to either meet that standard or pass a comparable test to be established jointly by the Fed and Treasury.
In the event that a bank's debt rating falls below the required minimum, it would be barred from making further equity investments in its subsidiaries and prevented from establishing any new ones. It would not be required to divest existing subsidiaries.
The total assets of a financial subsidiary would not be allowed to exceed 45% of the bank's consolidated assets, or $50 billion, whichever is less.
A bank that controls a financial subsidiary would be required to remain well capitalized and well managed. If it fails to do so, it could be required to divest subsidiaries.
Lending to financial subsidiaries would be capped at no more than 20% of the bank's capital. Any investments in the subsidiaries by a bank's holding company affiliates would count toward that 20% limit.
A parent bank's regulatory capital compliance would be determined after the deduction from capital of its equity investment in any operating subsidiaries and the "de-consolidation" of the subsidiaries' assets and liabilities from the bank's balance sheet. Public financial statements would be required to present the subsidiaries' assets and liabilities as separate from the bank's.
If a bank's holding company were involved in merchant banking, it would face certain restrictions on lending to firms in which the merchant banking operation holds a stake of 15% or more. Sections 23A and 23B of the Federal Reserve Act, which limit the total amount a bank may loan to its affiliates, would count loans to such "controlled portfolio companies" against that limit.
