Rethinking split of banking and commerce: Noreika makes his case

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Acting Comptroller of the Currency Keith Noreika jokes that his embossed business cards are limited editions.

Though his term in office is quickly drawing to a close, with President Trump’s nominee Joseph Otting awaiting confirmation, Noreika has already found the time to publicly feud with his peers in other financial agencies on issues such as mandatory arbitration, the deposit insurance application process, and even a cornerstone of financial law — the separation of banking and commerce.

The principle was first codified in the 1956 Bank Holding Company Act, which restricted the nonbanking activities of multiple-bank holding companies. Ever since, it has been the subject of numerous legal and policy debates. Community banks have long felt that their survival depends on it.

Tensions came to a head when Walmart in 2005 sought permission from regulators to open an industrial loan company, a type of financial institution that is not subject to the same type of activities restrictions as traditional banks. The retail giant’s controversial application was stalled by a Federal Deposit Insurance Corp. moratorium on ILCs until it ultimately dropped its bid.

The issue was revived again in June when online lender Social Finance sought its own ILC charter. Though SoFi is itself a financial institution, its application sparked opposition from community bankers, who feared it could open the door for companies like Amazon or Google to seek a similar charter, and once again tear up the dividing line between banking and commerce.

In an interview with American Banker, Noreika argued there should be no sacred cows in financial policy, including separation of banking and commerce. The following transcript has been edited for length and clarity.

Why do you think we should reconsider the principle of separating banking and commerce?

KEITH NOREIKA: What I don't like is everyone just assuming the separation of banking and commerce is holy writ, without having an intellectual understanding about why that's the case. That's why as a lawyer, I'm going to push holes in that argument so that people can justify it to me. If they can't, maybe there need to be some changes.

It seems like we're just on autopilot. Certainly a little bit less now that I’m here — but certainly in the last administration, from Dodd-Frank on it's like, “Get rid of the ILCs, get rid of the trust companies.”

When we're regulating a business that manages risks, part of risk management is diversification. We have a uniquely American system of bank regulation. But the notion of separation of banking and commerce is quite late to that debate. The Bank Holding Company Act was only enacted in 1956.

One story is it was meant to put out of business Bank of America and [its founder] Mr. [Amadeo] Giannini, who owned a bunch of different banks. As we moved on in the timeline, it was always a chit that was given to some group not to oppose a regulation. And that chit was protection from competition. So that's not the best story to tell.

Maybe there are other very valid reasons to have separation of banking and commerce. Maybe it involves safety and soundness. But somebody has to prove that to me empirically through data.

Should Walmart be allowed to have a banking charter?

My issue at that time was, I'm not sure the FDIC acted in a legal manner. What was their basis? First, they never acted on their application. They imposed an extralegal moratorium on the transfer and control of ILCs that was not mandated by Congress.

Really, if you want to get down to it, an agency acting like that is the type of activity that gave rise to the president getting elected, right? You have agencies that decide not to follow the law and do their own thing.

That's the criticism. I don't know that it's valid or not, but I think if somebody files an application to acquire an ILC, then they should get a yes or a no just like de novos and be able to go to court and get that reviewed.

Some in the industry are worried that if companies tied to tech giants are allowed to obtain bank charters, they will have an unfair advantage in the market.

We already have a competitive advantage; we have four banks that are thirty-four times larger than even the littlest banks. We already have a very segmented economy and do you want anybody to be able to compete with Bank of America?

I'm not sure it really hurts the community banks. Maybe it's better if we can have some competition for larger banks to make them smaller, to make them less risky. But that's the way markets work; they work themselves out if we let them, if we let there be competition.

What are your views on Glass-Steagall?
If a depository institution is federally insured its activities should be limited. And they can be limited not to have risky securities activities as section 16 of the Glass-Steagall Act does, which is still in place today.

I'm not sure if we need a new Glass-Steagall, because you already have the old one.

Community banks particularly are worried about their long-term competitiveness if fintechs get to obtain bank charters.

People want to use the law to shield themselves from competition. And that to me is not forward-looking.

To me, community banks have so many advantages in the current environment, and what has to be the basis of taking advantage of those opportunities is a real recognition that the marketplace is dramatically changing.

Fintech is an incredible opportunity for the community banks. Because they are unburdened with this large infrastructure of the megabanks or the medium-sized banks or the bigger banks. These smaller banks with the right ideas and the right partnerships or vision could really have a dramatic outsized investment in the marketplace that they may not have been able to have 10 or 20 years ago.

But it's also scary, I get that. I mean, I don't like change, but change is coming regardless.

Why do you think there’s such fundamental opposition to revisiting the separation of banking and commerce?

There are still exceptions [like ILCs, trust companies or credit card banks] to the banking and commerce written into the law, and the idea that any company might take advantage of those is controversial.

The [Competitive Equality Banking Act of 1987] just sort of codified that, and frankly people like the chairman of the FDIC were not on the winning side of that.

What a lot of what you've seen play out since 1986 through the previous administration, is people just didn't like the legislative argument that Congress and [President Reagan] agreed to, and they decided, through the exercise of their regulatory authority, not to do it.

There are laws we may not agree with that we have to enforce — that's our duty as executive agents. And I think there's a different school of thought that we may have seen where people didn’t want to enforce laws they didn’t agree with.

Some people wanted a strict separation. To me, if you’re headed that way you have to justify why.

How do you deal with the risk of a commercial company giving itself preferential rates through a bank it owns?

The Federal Reserve Act prevents that. Section 23a and 23b have arms-length requirements so it would be illegal to have a preferential agreement from a bank to an affiliate, and also there are quantitative limits to how much you could do. So then the question becomes why isn't that enough?

Do you think the separation of banking and commerce poses actual risks today?

What I worry about most is, you may find yourself in a very difficult situation later, when there's some crisis situation, and you can’t have the [right] type of rescue operation.

If Glass-Steagall had been in place in 2007, 2008, 2009, what would have happened to Bear Stearns what would have happened to Merrill Lynch? You basically outlawed the fire department at that point.

The separation of banking and commerce can also have the effect of restricting some banks’ access to funding.

Before I came here, I did help to recapitalize small community banks. And the amount of time and energy and resources spent on people like me, and frankly on people in the government, to decide whether you own 33% or 34% of a community bank that was tiny?

I realize that you’ve got to draw the line somewhere, but these are little banks and a lot of resources are being spent. How many banks had to fail because we had this very strict, rigidly enforced separation of banking and commerce at very low levels of control under the Bank Holding Company Act?

You likely won’t be in office for much longer, and this is a question that requires congressional action. Why bring this up now?

I bring up the debate because it's a fundamental tenet of everything I've done in my life every day, and it will be after I leave here. I'm not necessarily doing anything in my job differently than what I usually do. It's just that a lot more people get to see it and comment on it. There's a platform here.

Are we headed in one direction? Why don't we give some thought into whether that's the right direction?

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Law and regulation Glass-Steagall Banks, thrifts and holding companies ILCs Keith Noreika OCC