Core Bank Concept Is Recipe for Disaster
I have four general concerns about the core bank concept and specific problems with the two key components of the concept -- the interest rate ceiling and a lending limitation.
My principal concern is that the proposal now before us was not unveiled until the day before this committee [began] marking up the bill for which this amendment is proposed.
Clearly this is far too late in the game to allow proper analysis of the impact of sweeping new regulations that would significantly affect the operations of lending institutions with total assets of almost $5 trillion.
My second concern is that we do not really know what the core bank proposal is. Congress cannot legislate from a book or magazine article. It has to legislate from properly crafted legislative language that can be scrutinized thoroughly to ferret out undesirable side effects and unintended consequences. Where is the core bank amendment about which this hearing is being held this morning?
Although my association received a draft of a Schumer amendment, which includes a core bank concept, we have no way of knowing if this is the amendment that will be offered during the markup.
My third concern goes to the heart of the issue before us: Is the core bank concept a remedy for what ails federal deposit insurance?
Until today, this committee has not held one hearing on the core bank concept, nor has it otherwise been given reason to link the two key precepts of core banking -- deposit interest rate controls and a lower legal lending limit -- to the causes of the current problems in deposit insurance.
In fact, almost no one has argued that this linkage exists.
The Competitiveness Issue
My final overall concern is that the core bank's proponents have ignored the impact of their proposal on the domestic and international competitiveness of American banks and thrifts.
No other country is moving toward the core bank concept. Indeed, other nations are following the advice of the Bank for International Settlements and consolidating and integrating their financial systems, not deconsolidating and fragmenting them, which the core bank concept certainly would do.
Banking does not operate in a vacuum. If Congress continues to impose unrealistic requirements that further strangle banking, then deposit insurance losses will soar as a shrunken banking system is less and less able to serve America.
Interest Rate Cap Unworkable
On the proposed interest rate cap: We believe deposit interest controls are essentially unworkable.
Price fixing of any kind creates distortions. Surely we learned the dangers of interest rate price fixing when the extension of Regulation Q to S&Ls in 1966 effectively perpetuated an inherently unsound financial structure for another 15 years.
I believe that the committee will find that capping deposit interest rates nationally at 105% of comparable Treasury securities will prove to be unworkable for at least three reasons.
First, the difference between the interest rate on Treasury bills and bank and thrift CDs varies greatly over time, in large part because different forces drive these interest rates. They certainly do not move in lockstep.
These fluctuating differences mean that sometimes the rate cap would be meaningless. At other times, it would drive deposits out of banks and thrifts. This is the disintermediation process that periodically plagued S&Ls before Reg Q was phased out.
Factoring In Income Tax Rates
A second and perhaps more serious problem with a national rate cap tied to Treasuries is that it is unworkable because the interest rate spread between Treasuries and CDs must vary from state to state to accommodate differences in state and local income tax rates.
Interest on Treasury debt is exempt from state and local taxation. Interest on CDs is taxable. Therefore, CDs in states with high income tax rates must carry higher rates than CDs offered by banks and thrifts in states with low rates or no state income tax.
The only way this tax effect, as well as other regional interest rate influences, could be accommodated in the core bank price-fixing regime would be to establish a massive national rate-setting bureaucracy akin to a public utilities commission. How would this remedy the problems of federal deposit insurance?
The third problem with a rate cap is that it will interfere with prudent interest rate management by banks and thrifts.
For example, if a bank thinks that interest rates are moving up, it would be sound management for it to boost its deposit rates to attract more funds.
It would be bad public policy to substantially impair the ability of banks and thrifts to exercise wise interest rate management. We believe the floating deposit interest rate cap inherent in the core bank concept will do just that.
With respect to the proposed lending limit, no testimony or any other evidence has been offered at any time or in any forum which demonstrates that the present legal lending limit has caused problems for the Bank Insurance Fund.
To be sure, the legal lending limit for S&Ls caused losses for the the Federal Savings and Loan Insurance Corp. But that limit was almost seven times higher than the legal limit for banks.
Again, there is no evidence that the present legal lending limit has caused problems.
In reality, a lower legal lending limit could be very detrimental for banks and thrifts and for the economy by impairing the ability of midsize banks to fully meet the borrowing needs of companies far below the size cutoff for the Fortune 500. Thus, a lower legal lending limit will force some lending into larger banks.
Ironically, however, a lower legal lending limit will not prevent overlending by many banks and thrifts in certain areas of the economy, as happened in the 1980s with commercial real estate.
In their most recent version, core bank advocates are now proposing to exempt banks with capital under $100 million. This leaves only larger banks - $1.2 to $1.5 billion in assets and up - to bear the impact of a lower limit on lending to one borrower.
Where is the analysis to substantiate the $100 million cut-off? What led to this decision, which suddenly exempted some 12,000 banks from the lending limits contained in earlier versions of the core bank proposal?
Shrinkage of the Industry
Taken together, the interest rate cap and the lower legal lending limit will force a substantial contraction in the size as well as the operation of America's banks and thrifts.
Core bank advocate Lowell Bryan estimates a shrinkage of as much as $1.5 trillion, or almost one-third of all bank and thrift assets.
What the core bank advocates have yet to discuss is the inevitable credit crunch that would ensue with the curtailment of bank lending as capital and assets massively shift from banks to nonbank banks.
In the new environment mandated by the core bank amendment, many borrowers would pay more for their loans. Others would lose all access to reasonably priced credit.
Just as the core bank will force bank and thrift shrinkage, so too will it trigger branch closings. America today has about 90,000 banking offices. How many thousands or tens of thousands of branches will be eliminated? Where will the closures take place? Who will be impacted?
What other unforeseen consequences will be the legacy of this untried concept?