The United States has the largest economy in the world. We have more than 10 times as many commercial banks as any other nation. But they cannot compete effectively and efficiently at home.

Internationally, the United States is second to Japan in assets held by commercial banks. During the past decade, the U.S. share of international banking assets fell to 14% from 27%. It is little wonder, then, that the biggest U.S. commercial bank is in 21st place in world ranking.

Why is it that the United States does not have a single bank among the top 20? While there is no easy answer, much of the explanation lies in overcapacity and overregulation brought on through outdated laws. The U.S. banks operate under 1930s - that is, Depression Era - laws.

Our capital markets may be the envy of the world but, today, our banking system is not world class. It does not reflect our competence, our wealth, our influence on international markets, or the innovative capability of our capitalist system.

Outer Limits of Diversity

As in other international industrial nations, there are several kinds of depository institutions in the United States. But we have taken this diversification to the extreme.

On the one hand, the United States has too many financial insitutions, too many branches, and too many loan officers, pursuing too few decent credits. On the othe rhand, American banks face fierce competition from regulated and nonregulated entities. As a result, the banking system has been weakened.

There are nearly 4,000 national banks with almost $2 trillion in assets. The 1,000 state-charactered member banks of the Federal Reserved system have $560 million in assets. An additional 7,300 state-chartered banks have $836 billion in assets. All of these institutions provide checking and savings accounts, as well as personal and commercial loans.

The 2,216 federally insured S&Ls have a little less than $1 trillion in assets. They offer savings accounts and housing finance, principally for home mortgages.

Add to that 13,000 credit unions, with $200 billion in assets. Located in offices and factories, they offer many consumer services that banks offer, though on a much smaller scale.

The Big Picture

Altogether, the United States has 28,000 financial institutions with $4.5 trillion in assets. They report to five federal regulators and, in many cases, 50 state regulators.

The United States has excess capacity - redundancy - without even mentioning the explosion of nonbank providers of financial services such as American Express, General Electric Credit, the securities firms, mutual funds, insurance and leasing companies, and auto credit companies. Some of these also offer home mortgages.

The American Automobile Association, a not-for-profit company which once provided onlymaps and roadside assistance to motorists, now offers credit cards and auto loans. Even AT&T, the long-distance telephone company, recently entered the credit card business - with extraordinary success.

There are also enterprises sponsored by the American government: the Federal National Mortgage Association - Fanny Mae - and the Federal Home Loan Mortgage Corp. - Freddy Mac - which pool and then securitize home mortgages. Thus, they compete directly with banks and S&Ls.

These institutions often compete without the restraints imposed on depository institutions by state and federal regulators. And, unlike foreign institutions, U.S. banks cannot freely compete nationwide.

Within the United States, a commercial bank cannot expand into another state unless it creates a new bank - with all of the overhead required.

The Winds of Change

Treasury Secretary Nicholas Brady has stated: "Banks in California, Michigan, and Utah can open branches in Birmingham, England, but not in Birmingham, Alabama." That is just one of our very big problems.

In this environment, change is inevitable. Since 1985, 5,500 financial institutions have dissappeared in the United States through voluntary and involuntary mergers, acquisitions, or failure.

American taxpayers are painfully paying for much of the S&L problem - up to $130 billion on a present-value basis.

Despite the costs, consolidation is moving us in the right direction. Money-market funds and global bank trading were the hallmark of our financial system in the 1970s; securitization, currency, and equity trading were the sign of the '80s; cost control and consolidation will be the symbols of the 1990s.

Consolidation is the most important and most benficial trend in the U.S. financial industry. The most recent example of major bank mergers reflects the nationwide trend: BankAmerica and Security Pacific in the West; in the East, Chemical and Manufacturers Hanover; in the South, NCNB and C&S/Sovran.

Pulses and Minuses

Mergers on this scale hold the potential for substantially reducing payrolls. They can eliminate duplication and redundant capacity. Mergers create stronger institutions with a larger, more diversified asset base and they bring fresh opportunities to seek new markets, expand market share, and introduce new products.

Why has the U.S. financial industry lost its competitive advantage? Can it recapture the edge? Our friends in Japan and the European Community are asking this same question. They want to know what has worked in the United States - and what has failed.

Our present system was created in the aftermath of the great Depression, when some $30 billion was lost in the collapse of the stock market, followed by bank failures and massive unemployment. To provide stability and confidence to our financial system, a series of reforms were undertaken, including the development of federal deposit insurance.

The banking structure created in the 1930s survived for more than 40 years, with few changes and few problems. But this smoothly functioning system began to break apart in the 1960s and '70s under the force of external and internal shocks: the Vietnam War, budget deficits, inflation, dramatic escalations in the price of crude oil.

Internally, fixed exchange rates were abandoned. The Federal Reserve turned its focus on controlling the money supply rather than interest rates. As a result, interest rate volatility increased - leading to the development of money-market funds.

Alternative credit intermediaries expanded depository and borrowing choices. The prime rate topped 20%. And massive disintermediation took place. Funds were withdrawn from depository institutions for redeposit into money-market instruments, at higher rates.

Grim Omens for S&Ls

In the 1980s, new competitors permanently changed the market for S&Ls. The origination and funding spreads of thrifts were adversely affected, driving down the profitability of their primary business.

The initial regulatory and legislative response to these changes was halting and inconsistent. S&L balance sheets were deregulated one side at a time.

The federal ceiling was removed on interest rates paid on deposits. But it was not until later that federal restrictions on loans were lifted. For many institutions, the negative spread was a mortal wound.

The industry and the regulators expected institutions to grow out of the problems. Revisions to the federal and state laws in the mid-1980s allowed S&Ls to seek assets and fund themselves in almost any way they chose.

A savings association could even loan an amount equal to 100% of its capital to one single borrower. In some states - California, Texas, and Florida are good examples - they went even further, lifting virtually all restrictions on S&Ls.

Taxes and Real Estate

The 1980 Tax Act created substantial tax incentives for investment in real estate. These incentives, coupled with a tremendous increase in real estate values generated by the rampant inflation of the 1970s, led to a building boom. Many thought it would continue forever.

In 1986, while that building boom was still in progress, the government took back those tax advantages. But the momentum was not stopped.

Banks and S&Ls continued to make loans based on the profits real estate promised. Commercial banks and S&Ls became major participants, as lenders and then as equity investors, in real estate ventures.

Many S&Ls abandoned their traditional business, lending for residential housing; they tried to take advantage of the commercial real estate building boom. They were a little late

Too many directors and officers paid less and less attention to loan risk, because they were using federally insured deposits. Between 1981 and 1991, commercial banks in the United States almost doubled the percentage of their assets in real estate lending, to 25% from 14%.

Developers overbuilt and the supply of office space far exceeded the demands. As L. William Seidman, the recently retired chairman of the Federal Deposit Insurance Corp., described it: "We built 1993 buildings in 1989."

As a result of massive, reckless of rbuilding, especially in the central business districts, the office vacancy rates increased fourfold, to 20% in 1990 from 5% in 1980.

In the aftermath of this glut, it was discovered that several hundred thrifts and S&Ls were the subject of fraud and illegality during these 1980s. This has meant a tremendous cost to taxpayers and a major loss of confidence in the U.S. financial system.

Shared Guilt

There was no one culprit; a confluence of events caused our problems. In the midst of a new surge of competition the industry experienced bad management, bad judgment, and bad regulation. We had understaffed, undertrained examiners. There was massive overbuilding and - quite frankly - greed.

Regulators were too close to the industry and some legislators became the advocates of individual institutions. Even legislation that was meant to help often did more to harm.

We did not address our S&L problems while they still could be solved for a fraction of the ultimate cost. We waited too long and acted too late. The U.S. experience should be a warning to other nations.

The federal government and the taxpayers were forced to recognize the problems that left us with the twin tasks of repairing the damage and making certain it could not happen again.

The U.S. system must be changed. We all know that. But there are competing and conflicting interests that requires stability. Confusion and uncertainty discourage capital markets and harm the financial industry.

How does the U.S. stabilize the banking environment while we eliminate its antiquated rules, recapitalize it, reinvigorate it, and level the playing fields? Our goal is for banks and S&Ls, securities firms, mutual funds, the government-sponsored enterprises like Fanny Mae, to complete fully and fairly.

The view of the Bush administration is to renovate and restructure the regulatory framework, the supervisory structure, and the deposit insurance system.

Under the leadership of Treasury Secretary Nicholas Brady, the Bush administration is working with Congress and I am confident that we will make the changes that must be made.

The Bush administration proposal would preserve deposit insurance for small savers while protecting taxpayers by reducting the overextended deposit insurance system. The Bank Insurance Fund would be recapitalized by almost $30 billion.

Greater Role for Capital

The role of capital would be intensified by attracting new capital to the banking industry, an effort that has already achieved some success. Supervision and deposit insurance premiums would be capital-based.

The proposal would make banks more competitive by modernizing laws to allow banks to offer a broader range of financial services and to operate nationwide. Banks with expertise in other financial services would be allowed to provide them to consumers. And financial service companies would be allowed to invest in banks. This would add new capital and promote well capitalized banks.

Commercial companies would be allowed to form bank holding companies under these conditions:

* The banks involved are well capitalized.

* Strick regulations are in place.

* Financial affiliates are separately capitalized.

* Walls separate funding and disclosure activities.

* There is comprehensive oversight.

The Bush administration also proposes an end of the Glass-Steagall Act separations of banking and securities firms. (A similar prohibition adopted in Japan is known as Article 65.)

News for Foreign Banks

We believe that the administration's banking reform proposal will be beneficial to the 727 foreign banks operating in the United States, as well as to American banks.

Foreign banks hold 20% of all banking assets in the United States and more than 30% of all commercial and industrial loans.

Under the Bush administration proposal, foreign banks would receive national treatment. Those that engage only in banking will have new opportunities to branch nationwide without setting up subsidiaries and holding companies.

In short, foreign banks would be able to do exactly what U.S. banks could do in the U.S. market and would be regulated the same way.

Where the OTS Fits In

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 created the Office of Thrift Supervision, the agency I run. Its purpose is to remove failed savings associations from the private sector.

We enforce the same new, risk-based capital standards that the Bank for International Settlements applies to banks throughout the world. We also tighten regulation of the industry and enforce the laws; we are reasonable, but tough.

In September, I reported in Washington that the S&L industry made a profit of $387 million in second-quarter 1991. That's not a lot of money, but this is the second consecutive profit the industry has reported.

It's the first time the industry has had back-to-back quarterly profits since 1986. Today, 85% of the savings and loans in the United States are profitable.

The industry set the pattern for dramatic restructuring through merger, acquisition, and failure.

The number of private-sector savings associations has declined to 2,216 at the end of second-quarter '91 from 3,252 in first-quarter 1986 - a reduction of more than 1,000 S&Ls, nearly one-third of the industry, in five years. And there is a direct relationship between the number of institutions going down and the tangible capital going up.

A second reason for S&L profits over the first six months of 1991 is a very favorable spread on interest rates. In June, the cost of funds for the industry was the lowest it has been in nearly four years.

Capital Standards of Track

During this period of consolidation, the industry's ratio of tangible capitals has increased, on average, to 4.5% currently from 0.5%. Accordingly, the vast majority of the S&Ls in the United States are now in full compliance with the BIS capital standards. Our goal is a consolidated, stronger, safer, profitable industry that will serve its market and protect depositors and taxpayers alike.

When this consolidation trend in the S&L industry is finished, in the next year or two, we will have something like 1,500 to 2,000 S&Ls remaining in the United States. And their role of serving the housing market will continue. Hopefully, they will prosper, since consolidation will mean fewer providers to the community.

I am confident the Bush administration's banking bill will achieve the necessary reforms in the S&L industry. Everybody knows what's required: Republicans and Democrats, the executive branch, members of Congress. We all know what's required, we all understand the issues, and we all know that timing is crucial.

Insurance Underpinning

Deposit insurance is the foundation of the American banking and S&L system. One thing that we've learned over the past four years in the S&L cleanup: The insurance system works.

Deposit insurance has made it possible for U.S. financial regulators to close or merge failing institutions, some 1,200 banks and S&Ls over the past three years, without causing any devastating runs on those institutions.

In some other countries, civil disturbances accompanied the closing of branches of the Bank of Commerce and Credit International. But Americans know they can rely on the government's absolute promise to protect federally insured deposits up to $100,000.

By the end of September 1991, we had protected nearly 20 million S&L accounts with an average balance of just over $9,000.

The United States has, quite frankly, swallowed a very bitter pill. It is paying a high price for its mistakes. But it is many years ahead of the rest of the world in recognizing that changes must be made in financial institutions and in how this industry - which is so important to the world - is regulated.

The United States has successfully identified the causes of our present situation and just as successfully identified the remedies. I am confident that the changes we are making will strengthen the U.S. system and make it competitive worldwide.

The United States and Japan lead the world in production of goods and services. Our combined GNP is almost twice that of all the other leading industrial nations. We have a special relationship, a special responsibility and a unique opportunity. As Japan and the United States reform our financial institutions, our two countries will strengthen our ability to lead the world toward a new era of economic growth and stability.


Director Office of Thrift Supervision

Timothy Ryan has been director of the Office of Thrift Supervision since April 9, 1990, when he was sworn in by Treasury Secretary Nicholas Brady.

Mr. Ryan oversees the regulation and supervision of the nationa's thrift industry, some 2,300 institutions with nearly $1 trillion in assets, including all federally chartered and federally insured savings associations.

As the nation's thrift regulator, Mr. Ryan is a member of the board of directors of the Federal Deposit Insurance Corp. and the Resolution Trust Corporation.

Mr. Ryan's tenure at the OTS has been marked by the continuing consolidation of the thrift industry. Under his leadership, the OTS has provided tough, straightforward supervision and enforcement policies to ensure appropriate capital standards while encouraging creative solutions to a changing financial system.

The OTS is the lead agency in pursuing those who defraud savings and loans, and works closely with the Department of Justice to prosecute those who violate criminal laws.

Before joining the OTS, Mr. Ryan was a partner and a member of the executive committee of the law firm of Reed Smith Shaw and McClay. He served as solicitor of labor at the U.S. Department of Labor from 1981 to 1983.

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