The House Banking Committee has approved a bill championed by Chairman Jim Leach to reform the Glass-Steagall Act. The bill represents a good beginning on the road to financial reform, though bankers will have problems with some of its specifics.
The bill would allow commercial banks and investment banks to affiliate for the first time in more than 50 years. Potentially more important for most banks is a provision that would modify the "closely related to banking" test in the Bank Holding Company Act.
This test was included in the 1970 amendments to the act at the request of the Federal Reserve to assuage the concerns of banks about the restrictive nature of that law. It was intended to liberalize the range of activities in which bank holding companies were permitted to engage.
In reality, the language did no such thing. The Federal Reserve has consistently refused to allow holding companies to do anything more than banks themselves could do. One hopes the Fed will turn over a new leaf when it comes to the "financial in nature" test in the Leach bill.
Whether the Leach bill will result in legislation acceptable to banking will depend on whether its troublesome features can be modified and whether it can be kept free of additional negative provisions. I would not bet the ranch on the outcome.
A significant problem with the Leach bill is its insistence that most securities underwriting activities be conducted in bank holding company subsidiaries rather than directly in banks or their subsidiaries. The limited securities activities that are allowed to remain in any bank must, in many cases, be segregated into a separately identifiable department of the bank, subject to overlapping regulation by the bank regulators and the Securities and Exchange Commission.
There are many unanswered questions regarding the content and meaning of the Leach bill. But it appears that as the price for establishing a securities affiliate:
*Banks may not securitize commercial mortgages and commercial loans.
*Banks may not deal in options on U.S. government or other securities.
*Banks may not underwrite and deal in bonds collateralized by U.S. government obligations.
*Banks may not deal in options on foreign currencies and exchange.
*Banks may not underwrite and deal in new securities products unless the Federal Reserve determines the activity is a "traditional banking product."
Moreover, all banks would be subject to greater regulation by the Federal Reserve. The Fed would be authorized to define products, including insurance products such as credit life, offered by any depository institution or affiliate as a "nonbanking product." The Fed would then prescribe disclosures a bank or thrift must make before it could recommend purchase of the product.
These are but a few of the many issues in the Leach bill that the banking industry will need to examine carefully. Banks will need to use the legislative process to change what they can and then decide if what remains is demonstrably better than the status quo.
It is exceedingly difficult, as a matter of public policy, to justify stripping from banks or their direct subsidiaries profitable securities activities. The requirement would give banks the worst of all worlds. They would be affiliated with securities firms and their attendant risks, yet they would not participate in their profits.
Imagine the reaction of bank regulators if an individual owner of a bank decided to transfer to himself, without compensation to the bank, the bank's mortgage loan department. Yet that is exactly what the Leach bill requires in order to satisfy the Federal Reserve's appetite for turf.
There are plenty of other potential trouble spots for the industry as the bill wends its way through Congress. The Leach bill contains no authorization for banks to expand their insurance activities. Indeed, Rep. Thomas Bliley has promised that when the bill gets to the Commerce Committee he will attempt to roll back the existing authorities.
There is always the possibility that additional regulatory burdens will be imposed along the way. At some point, if that point has not already been reached, the bill could gather enough weight to sink it.
Finally, there is the matter of the premium disparity between banks insured by the Bank Insurance Fund and thrifts insured by the Savings Association Insurance Fund. If that issue is joined with the Glass-Steagall bill, it's easy to envision the banking industry pulling the plug on the whole package.
Mr. Isaac, a former chairman of the Federal Deposit Insurance Corp., is chairman and chief executive officer of Secura Group, a financial services consulting firm based in Washington.