WASHINGTON — The Obama administration's plan to revamp financial oversight aims to restructure the banking industry, as well.
Gone would be the thrift charter, along with industrial loan companies. All holding company supervision would be handed to the Federal Reserve Board. A new consumer protection agency would examine banks separately.
The proposal, certain to be controversial on Capitol Hill and within the industry, is likely to be adopted only if President Obama personally pushes the changes. He is scheduled to announce details of the proposal Wednesday afternoon.
Observers predicted a fierce battle over the effort to eliminate charters and create a consumer protection agency with power over banks.
"There will be a huge political fight over getting rid of the thrift charter and ILCs," said former Federal Deposit Insurance Corp. Chairman William Isaac. "I'm not sure why they felt that that was important enough to put in this bill. … The ILCs had nothing to do with the creation of these problems. You can argue about the thrifts, but they both have very strong constituencies."
The plan calls for giving the Fed authority to police systemic risks and enhanced authority to set capital standards for all institutions. The Treasury would determine whether a failing systemically important nonbank should be saved.
The Fed would have oversight of all holding companies, including the parents of ILCs and thrifts. Any thrift or ILC would be required to convert to a commercial banking charter within three to five years, according to sources familiar with the administration's plan.
The Office of Thrift Supervision would be eliminated, as expected, but the effort to eliminate the thrift charter is more ambitious than many had predicted. Industry representatives called it a mistake and vowed to oppose it.
"What efficiency does that bring to the system?" asked Diane Casey-Landry, the chief operating officer of the American Bankers Association. "Just because you have a multitude of charters doesn't mean you can't have an efficient charter. As many national banks have failed as thrifts. As many state banks have failed as thrifts. There is as much blame to go all around."
Many blame the OTS for the Washington Mutual, IndyMac and BankUnited failures, but many said that should not translate into eliminating the charter.
"It's not necessarily the case that agency consolidation and the charter go together," said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC. "There are clearly large gaps in regulation that need to be addressed, but those apply to commercial banks as well as thrifts."
At the end of the first quarter there were 801 thrifts but only 49 ILCs. Still, eliminating ILCs may also be a tough sell — especially for Sen. Robert Bennett, the No. 2 Republican on the Senate Banking Committee, whose home state of Utah claims a predominant share of the ILC industry.
The administration is seeking to eliminate a loophole that allows commercial firms to own banks, though through special-purpose ILCs with restrictions.
The issue has faded of late but was at its height in 2005 and 2006, when Wal-Mart Stores Inc. and Home Depot Inc. applied for ILC charters. (Both eventually suspended their bids after fierce opposition from community banks and Congress.)
But observers said the new reforms would still have a sizable effect on the ILC sector. Several commercial firms, including Target Corp. and some automakers, already own ILCs and would not be allowed to apply for commercial bank charters. As a result, observers said, the firms that still own ILCs would be big losers under the administration's plan.
If the administration kept the Fed restrictions that ban all commercial ownership, nonfinancial firms would have to choose between their bank and their standard commercial activities.
"If they change the laws of who can operate some of these institutions, it could have an adverse impact on consumers — if suddenly entities that lawfully engage in consumer credit are now forced to make a decision between consumer credit and their nonbanking activities," said Lawrence Kaplan, a lawyer at Paul, Hastings, Janofsky & Walker LLP. "The question is: is it realistic that you can unwind" them. "Some of these entities are very large, and they're serving a good purpose, and they're probably not the cause of the problem."
The industry — and current federal banking regulators — are also expected to oppose the creation of a dedicated consumer protection agency.
Under the plan, the Treasury is seeking to establish a Consumer Financial Protection Agency that would serve as the "primary" protection for borrowers and other customers, according a summary circulated Tuesday by the Treasury.
The new agency would be able to write rules for banks and nonbank financial companies, supervise and examine banks for compliance and enforce compliance through regulatory orders, including penalizing companies with fines.
As envisioned by the Treasury, the agency would be independent and would work to ensure transparency, simplicity, fairness, accountability and access to protect consumers in the areas of credit, savings and payment markets. It would enforce all fair-lending laws, including the Community Reinvestment Act.
It could ban unfair terms, impose stronger duties of care on financial intermediaries and protect consumers from conflicts of interest related to financial products.
Many of the agency's objectives are open-ended goals for improving the simplicity of disclosures. However, the Treasury's plan would give the new agency the power to mandate that consumers have a chance to opt out of standard financial products and services before being offered alternatives.
It would require "plain-vanilla" loans to be offered with straightforward terms and would require the borrower to reject that offer before considering more complicated loans that are subject to more "stringent protections."
Consumers would have to be "adequately" warned about the risks and benefits of a mortgage product, and they would receive a single, simple federal mortgage disclosure.
The summary is laced with standards subject to interpretation. For example, mortgage brokers would "owe a duty of best execution" among available mortgages to avoid conflicts of interest. They would also have a duty to determine that the mortgages they offer are "affordable."
It calls for a ban on yield-spread premiums and restrictions on prepayment penalties. It also would require originators of securitized loans to retain 5% of a loan's risk.
Though the summary says the agency would have a "stable source of funding," the source of that funding is not identified.