WASHINGTON — Banking’s age-old bugaboo is dying, thanks in large part to the Gramm-Leach-Bliley Act of 1999.

Fears that a mammoth commercial company like General Motors might take over a financial giant like Citigroup Inc. are giving way to a more likely scenario in which technology gradually redefines what policymakers consider “financial.”

“The line between banking and commerce is blurring, and e-commerce is driving it,” said a senior federal regulator. “This law has tremendous flexibility built in for innovation and experimentation.”

For instance, if a nonfinancial company such as Microsoft comes up with a product that steals business from banks, federal regulators have the authority to let banks sell it, too. That is how the financial reform law, whose first anniversary is Sunday, envisions evolution in the definition of banking.

Even House Banking Committee Chairman Jim Leach — the lawmaker most devoted to protecting banks from takeovers by commercial companies — agreed. “From here out, it is a principally regulatory, rather than legislative, issue,” he said in an interview. “That line between finance and commercial is a very difficult one to draw; it is a line that moves.”

The law’s other main sponsor, Senate Banking Committee Chairman Phil Gramm, predicted at passage: “This bill is a pause, and it is only a pause, and it is not going to last very long.” The Texas Republican said, just before the Senate gave its final approval, “In 10 years we will have widespread commerce and banking in America.”


The law includes a list of products and services considered “financial,” which means they may be offered without any sort of regulatory approval. This cuts costs and speeds entry to markets. The list includes three products that had been limited or banned: organizing, sponsoring, and managing a mutual fund; running a travel agency; and offering general management consulting.

The law said certain services — merchant banking, insurance underwriting, and real estate development — must be conducted in a holding company affiliate. All other products on the list may be offered by a bank’s own subsidiaries.

To add a product or service in the past, a banking company had to persuade the government that it was “incidental to banking.” Gramm-Leach-Bliley broadened that definition to “financial in nature.” More importantly, it gave the Federal Reserve Board and the Treasury Department authority to define what is financial in nature and what is incidental to it. Each agency can block a decision made by the other.

The Fed also won sole power to approve a product or service by deeming it “complementary” to financial business — a move widely seen as a side door to commercial activities.

Congress gave the two agencies plenty of room to maneuver. The law sets out broad criteria for approving financial activities. For instance, a product may be deemed “financial” to keep pace with “changes or reasonably expected changes” in the market or in the technology for delivering financial services. Regulators are also supposed to consider whether a product would help a financial holding company compete.


Making these calls will be Fed Governor Laurence Meyer who, together with his colleagues at the Fed, is standing at the crossroads of banking and commerce.

In the law’s first year, the Fed has not approved any wholly new product or service, and experts are not surprised.

“It’s hard to move all that marble fast,” said Karen Shaw Petrou, president of ISD/Shaw Inc. “The Fed is really calling the shots, and the Fed is nothing if not cautious.”

Many other people interviewed for this series echoed Ms. Petrou.

“A lot does depend on how the regulators interpret their authority, which is really flexible,” said Bill Sweet, a partner in Skadden, Arps, Slate, Meagher & Flom. “Simply because it’s there doesn’t mean that it is going to be used.”

Fed officials insist that the central bank understands the reform law’s goal: freeing financial companies to innovate, compete, and adapt to changing market conditions. “Gramm-Leach-Bliley made a very substantial break” with past law, Mr. Meyer said in an interview. “You don’t want to see that change thwarted by overly conservative regulations that impede the direction that Congress wanted the country to move in. We’re quite aware of that.”

But before uncorking the Champagne, Mr. Meyer also said that the Fed plans to start cautiously and develop experience. Asked to describe how fast it will approve new powers, he said: “We want to go as fast as we can while giving appropriate consideration, and primary consideration, to doing it in a safe and sound fashion. Every bit as fast as is prudent to go.”

The Fed, he said, is likely to soon approve a proposal to let financial holding companies bring buyers and sellers together, or serve as “finders.” But this would be anticlimactic because the Office of the Comptroller of the Currency has already given national banks that power. “You can go to Chase Manhattan’s Web site and buy any damn thing you want,” one federal regulator said.


Various requests for new authority have been made, including a March letter from the American Bankers Association asking that five products be added to the list of approved “financial” activities. Of these, full management consulting — meaning not limited to financial consulting — was approved because banks could already do it overseas. Acting as a finder soon will be, though the Fed is expected to impose some onerous limits. A third product the ABA requested is data processing without limitation, meaning for third parties having no connection to the bank or to financial services. That power is not controversial either because banking companies are already authorized to do it, but revenues may not exceed 30% of total data processing revenues.

The last two powers requested by ABA are real estate brokerage and management. The group sent a second request in July, focusing on these two, but neither the Fed nor Treasury has responded — though both agencies have pledged to rule within 60 days on requests for new powers.

So far, the ABA remains patient. “As in everything, the first couple of steps are going to be learning steps,” said James D. McLaughlin, the ABA’s director of regulatory affairs. “But I am expecting that once they get comfortable with the new law they will be able to move along the pace.”

But seven states, including Massachusetts and Wisconsin, already authorize their banks to act as real estate brokers, so it is possible this power, too, could be approved for national banks by the Comptroller’s Office.


Some sources said the Comptroller’s Office could return to its historical role as the advocate for a broader banking system if the process of gaining new powers logjams at the Fed and Treasury.

“The OCC is going to push the envelope,” particularly in the electronic commerce arena, predicted Ronald R. Glancz, a partner in the Venable law firm here. “They are going to allow a product that certainly smells like commercial. The lines have always been blurred, and they are more blurred today.”

Under the law, the Comptroller’s Office retained its authority to define “the business of banking” and activities that are “incidental to banking.” National banks may open “financial subsidiaries” to use these new powers. To date, 68 financial subsidiaries have been started, most to sell insurance.

Goldman Sachs Group and a handful of other nonbanks are also using an opportunity presented by Gramm-Leach-Bliley to charter national trust banks. Because these are limited-purpose charters, mainly to offer asset management services, nonbanks do not have to form financial holding companies.

Because Gramm-Leach-Bliley lets banks, insurers, and brokers own one other, observers said the OCC moves may be subject to less scrutiny than in the past when it was sued nearly every time it expanded banking powers.

In an interview, Comptroller John D. Hawke Jr. would not discuss specific new products or his agency’s game plan. But he did say the OCC would approve new services when it could justify them. If a number of states let their banks do something, “it won’t be a big leap for us to find it’s part of the business of banking,” Mr. Hawke said.

“The business of banking is changing all the time. With the advent of new technology it’s going to keep changing,” he said. “It’s an evolving concept.”


But no matter how liberal the OCC may be, its decisions affect only banks. The 435 companies that have created financial holding companies — and the ones that presumably will follow — will need the Fed to broaden its conception of what is “financial in nature” and incidental to it.

Down the road, how the Fed defines a “complementary” power will be even more important. Everyone, including Mr. Meyer, said these complementary powers are the avenue Congress chose to allow some mixing of banking and commerce.

Many observers worry that turf battles will slow the process. Of course, all the principals insist they are cooperating.

Treasury Under Secretary Gary Gensler said that, taken together, Gramm-Leach-Bliley and this year’s digital signatures law have paved the way for technology to transform financial services.

“Ten years from now many of the leading players in the financial industry will have different business models, will deliver services to their customers in a wholly different way than we see today, and in fact,” he said, “I think many of the industry players today will not be in business. It is as radical a shift in an industry as we’ve seen, whether it’s when the automobile was introduced or when electricity was invented.”

But even the law’s strongest proponents admit that giving the Fed and Treasury the power to veto each other’s decisions could lead to gridlock.

It is too soon to know, however, and the Fed and Treasury still have time to make the new “financial in nature” definition system work. But if it bogs down, and the list of approved activities does not grow, expect another legislative battle.


In fact, some experts are already convinced the new system will need tweaking.

Mr. Sweet, the Skadden Arps partner, predicted that Congress will be forced to revisit the law because technology companies such as Yahoo are offering an increasingly larger share of financial services directly to consumers.

“Five to 10 years from now it may be a little more difficult to distinguish among the players,” he said. “I think the financial holding companies themselves will look quite a bit different. The law will be revisited because the world will be a much different place.”

The one-stop-shopping trend may also fall out of favor, forcing Congress to “create a different model.”

Randall S. Kroszner, an economics professor in the Graduate School of Business at the University of Chicago, agreed.

As technology companies offer more financial products, banking companies will complain and push the government to expand the notion of what is financial. “Institutions that are regulated as banks are going to get hot under the collar and start pressuring Congress,” he said. “The Yahoos, the Microsofts, they could be the next credit unions — the outsiders nudging in on banking’s turf.”

As with so many people interviewed for this series, Mr. Kroszner said policymakers should not have tried to separate financial from nonfinancial activities.

“We’ll be scratching our heads, wondering why we were even making these distinctions in the first place,” he predicted.

Straddling the worlds of banking and commerce are the unitary thrift holding companies. Gramm-Leach-Bliley closed the loophole that let nonfinancial companies such as Nordstrom’s charter a single thrift. But the 200 existing unitary thrift companies with commercial operations were grandfathered in (though they may only sell their thrifts to financial companies).

Under the law, any power bestowed on financial holding companies is automatically granted to the unitaries. What’s more, these thrift companies are overseen by the Office of Thrift Supervision, so they escape Fed supervision.

Denis O’Toole, a veteran financial services lobbyist who is vice president of federal government relations at Household International, a Chicago-based unitary, said he expects to see a sequel to Gramm-Leach-Bliley within five years.

“The issue of commerce and banking will be reopened,” he said. “America is out of step with the rest of the banking world. I don’t think we’ll ever see the day when GM buys Citigroup, but at least Citi can have a basket of commercial-type activities.”

From Our Archive:

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.