The just-finalized operating-subsidiary, or op-sub, rule from the Office of the Comptroller of the Currency may dynamite the legislative logjam that has blocked financial services modernization for years.
Technically procedural in nature, the op-sub regulation could unleash a wave of applications from national banks that will trigger vast structural change throughout the financial services industry. In effect, this regulation could topple numerous dominos in the next Congress, even though many prefer slow, incremental change.
In particular, the op-sub regulation will permit the "universal bank" to emerge. That is, national banks, either directly or through operating subsidiaries, could offer a full range of financial services, including insurance and securities, without being saddled with the inefficiencies of a bank holding company.
In effect, the op-sub regulation gives banks a one-way street to enter all other financial services activities.
If the op-sub regulation is the first domino, then the reaction of nonbanks (insurance companies, securities firms, mutual fund managers, and the rest) is the second.
Nonbanks already have begun to seek structural parity with banks. Specifically, they want a two-way street into banking; that is, the right to own banks directly rather than through a holding company.
Congress could provide structural parity by authorizing the "universal financial services firm." For example, as such a firm an insurance company could operate a bank as a subsidiary; it would not have to establish a holding company that operated its bank and insurance company as affiliates of each other.
The push by nonbanks to enter banking directly will knock over other dominos.
First, the financial services holding company concept will lose its appeal, because most financial services firms will prefer the more efficient form of direct ownership and operation of a bank.
Second, previously hot issues, specifically Glass-Steagall reform and merging the bank and thrift charters, will cool. The creation of the universal financial services firm, accompanied by the enhancement of the national bank charter, will largely resolve those issues.
Third, the nonbanks' desire for a two-way street raises a host of safety-net issues - access to the payment system and the Federal Reserve's discount window, consolidated supervision, and deposit insurance.
Payment system access centers on the daylight overdraft problem - that is, which institutions can incur overdrafts or net debit positions on the Fed Wire as they make wire transfers during the business day with finality of payment provided by the Fed (or in effect, the taxpayer).
The great fear of all central bankers is that a bank cannot cover its end-of-day overdraft because it has suddenly become insolvent. This is the so-called Herstatt risk, named after a German bank that failed in 1974 owing substantial amounts to other banks.
Presently, only highly regulated depository institutions can directly access the Fed Wire and thus obtain the Fed's guarantee of payment finality.
Additionally, the Fed subjects bank holding companies, whose banks now dominate the payments system, to safety-and-soundness regulation and the Fed's implied source-of-strength doctrine. That is, the holding company will bail out an insolvent subsidiary bank, if necessary.
Permitting an insurance company, for example, to own a bank raises the question of its obligations if its bank cannot cover a Fed Wire overdraft at the end of the day. Although the Fed has become more aggressive in limiting daylight overdrafts, any such overdraft poses a risk to taxpayers.
Consolidated supervision is provided by the regulator empowered to ensure the overall safety and soundness of a large, diversified financial services firm that has different regulators for its component businesses. This is called functional regulation.
The question of who will be the top regulator of diversified financial services firms will trigger a major turf war between the Fed, the Securities and Exchange Commission, and the Comptroller's Office. The Federal Deposit Insurance Corp. and the Office of Thrift Supervision will be losers in this battle.
Many believe, though, that the financial markets are the best supervisor of large, diversified firms. Few want the Fed to assume that job.
Deposit insurance is the thorniest safety-net issue Congress will face when authorizing the universal financial services firm.
Lawmakers will consider isolating the insured bank from losses elsewhere in the universal financial services firm by legislating the so-called narrow, or essentially riskless, bank.
However, that attempt would run counter to the integrating nature of electronic technology, which is why banking and nonbanking financial services are coming together in the first place. Hence, the final domino that the OCC's op-sub regulation will topple is deposit insurance as we know it.
Once Congress reforms deposit insurance and other features of the federal safety net, the remaining structural barriers in the financial services industry can safely be repealed. Market forces, not politics, will then shape the structure of the financial services industry.
Fundamental, almost unbelievable, reform can come quickly after years or decades of frustration. Witness the recent telecommunications, welfare, and agricultural reform bills. Fundamental reform could come just as quickly in financial services.
Mr. Ely, the principal in Ely & Co., is a financial institutions consultant in Alexandria, Va.