Reform Bill Is Good Legislation and Merits Quick Passage

Banking reform is an economic imperative that, like most political initiatives, is highly charged, contradictory, and confusing.

What Congress decides will determine not only the state of the U.S. banking industry, but the nature and condition of the U.S. economy for many years.

It is important that certain key concepts be kept clearly in focus, and that reform not be hampered by political manipulation, legislative tinkering, and/or congressional infighting.

The House Banking Committee wrapped up its look at President Bush's banking reform package on June 28.

The committee, led by its chairman, Henry Gonzalez, D-Tex., pleasantly surprised many observers by adopting most of the structural reforms initiatives in the administration's proposal.

Nod to Interstate Banking

Most significantly, the committee approved of full interstate banking and bank entry into new financial businesses, especially securities underwriting and insurance.

The committee also accepted, in principle, the concept of allowing industrial corporations to own banks that meet certain criteria for safety and soundness. Strict guidelines would prevent banks from using federally insured deposits for non-banking activities.

The committee improved on the administration's proposal by limiting the Federal Deposit Insurance Corp.'s ability to reimburse uninsured depositors and by limiting the Federal Reserve's ability to lend to failing banks over long periods - policies that have proven unnecessarily costly and inequitable.

Since leaving the House Banking Committee, the reform package has been assigned to four other House committees, each of which must examine those parts relevant under its jurisdiction and file recommendations by Sept. 27.

Congressional Infighting

Though all four committee chairmen have their differences with the version reported by the House Banking Committee, clearly John Dingell, the powerful chairman of the House Energy and Commerce Committee, is spoiling for a fight.

In a highly unusual move, the Michigan Democrat requested that the General Accounting Office audit the banking reform legislation to identify all "special-interest" amendments added by members of Rep. Gonzalez's committee. The request is "still pending," according to his press spokesman.

Unnecessary Fears

What's really going on here? Though Rep. Dingell is well known for engaging the General Accounting Office in numerous, reputable studies, this shocker was his attempt, as a strident opponent of deregulation, to gain advantage and stop the momentum of the reform process.

Rep. Dingell mistakenly perceives the banking reform legislation as a repeat of the misguided deregulation that led to the S&L debacle.

He apparently has nightmares of aggressively run corporations taking over banks and plunging them into risky ventures that could lead to billion-dollar bailouts.

His fears, fortunately, are unfounded. Therefore, it is very important that all committee chairmen with a claim on the banking reform package proceed quickly.

In this endeavor, three key concepts might be borne in mind:

International Competitiveness

First, the banking industry in the United States - in order to compete internationally - must be able to meet domestic and foreign financial needs.

In 1982, the largest U.S. banking organization, Citicorp, was also the largest bank in the world. In 1990, it was No. 18 in the world and falling. Seven of the 10 largest global banks are based in Japan (the other three are French).

In order to compete effectively, the United States needs large, efficient financial intermediaries that can provide a full array of products and services.

Impediments to cost savings through consolidation and the shedding of excess capacity are self-defeating, as are proposed linkages between structural reform and deposit insurance reform.

The so-called core bank, an entity that would invest only in government securities or limited commercial loans, and alone receive federal deposit insurance, would be a nonstarter in the marketplace.

Antitrust authorities that seek to challenge "big" or "dominant" banks would damage the very institutions capable of achieving an international presence.

The Risks of Banking

The second concept to remember is that banking is an inherently risky business. However, activities that are individually risky can offset each other so as to reduce overall portfolio risk. Diversification of banking activities, both in regard to services and location, would enable banks to increase earnings stability.

Of course, banks must be subject to government supervision and examination that regulates compliance with financial safeguards. Confusion between supervision and deregulation has been a serious problem in recent years, much to the detriment of taxpayers.

In fact, deregulation of banking, meaning the removal of constraints on permissible activities, requires additional supervision due to the potential for abuse.

As many experts have noted, banks are "special" because they are the repositories of the public's trust, and their success or failure affects the economic environment in toto. Deregulation needs to be accompanied by more stringent oversight and sufficient regulatory discretion to deal with diverse situations.

For a Stable Economy

The third thing to keep in mind is that the financial system must be supported by a governmental safety net that protects the aggregate economy from financial turbulence.

We have in the United States an elaborate yet inefficient safety net consisting of a tangle of regulators, federal and state deposit insurers, and central bankers performing the "lender of last resort" function.

Clearly, the safety net is a necessity, but the overlapping roles of various governmental entities detract from market discipline and have proven costly to taxpayers.

Tightening Up

The safety net can be strengthened, while its costs are lowered, by combining federal deposit insurance coverage (at current levels), risk-based capital guidelines for financial intermediaries, and strict adherence to a single set of emergency lending and closure principles.

Big-bank bailouts are neither necessary nor desirable except in the case of an immediate systemic threat and, then, a single regulator should set the rules and bear the costs.

The reform package reported out of the House Banking Committee succeeded in recognizing these principles and including them in the banking bill. Let's hope the other congressional committees have the good sense to keep the reform package intact, and that Congress enacts this important legislation in the fall.

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