To Save Banking, Heal the Congress

Legislators on Capitol Hill are not arguing whether comprehensive restructuring of the banking industry is critical. Congress is more concerned about who would win what turf if reform is enacted.

Congress is captive to the parochialism of special-interest-group lobbying from every side on every particle of every issue.

Fractionalized legislative oversight has contributed to a fractionalized financial services industry and is now one of the biggest barriers to saving the banking system.

Broadening the Approach

To start reforming the banking industry, Congress needs to reform itself through a new committee structure that can hear and do what is best for the financial services industry as a whole.

Banking is essential to today's economy, but banks are not. When other institutions can perform the functions of banking better -- cheaper, faster, more conveniently, or more profitably -- they replace banks. This is precisely what has been happening for nearly three decades.

Aftermath of 1929

When we faced the same kind of financial crisis 60 years ago, the political solution was:

* Save the banks by separating commercial and investment banking.

* Protect small savers through deposit insurance.

* Preserve bank profitability by continuing to limit geographic competition through banking restrictions.

Banks were saved -- but only superficially and temporarily. Bankers soon became intent on getting out of their little boxes. And nonbanks started to dip into the honeypot of banking functions.

Segregation of banking functions loses its meaning when technology makes industrial and geographic boundaries artificial.

The solution of 60 years ago made little sense for the crisis then and even less for the crisis we face today.

Regulators cannot now hold back nonbank erosion of what were hitherto exclusive franchises of the banks. They cannot regulate banks back into prosperity, especially if legislators continue fencing them out of profitable businesses.

Banks are failing not because they have been naughty but because their profits have been declining for two decades.

Profits depend on managing the cost of doing business, particularly the risks. Under current ground rules, banks simply cannot make enough money to cover those risks.

Recipe for a Potion

The proposals of yesteryear splintered the system and disadvantaged banks against the competition. Today, we need the following ingredients to restore profitability:

* An environment that allows consolidation to proceed on a rational basis, to reduce industry overcapacity. This could be accomplished by intervening early to force the acquisition of weak players, encouraging mergers that eliminate excess capacity, or allowing mitigating circumstances to offset antitrust concerns.

* Economies of scale in manufacturing and distribution, through interstate branching.

* Economies of scope, by granting expanded powers. This means restoring all banking functions to banks.

Banks must be allowed to sell insurance and mutual funds and to underwrite securities, with appropriate oversight, so they can meet nonbank competition head to head.

Customers Indispensable

Banks must have the flexibility to meet the full spectrum of consumer and business needs so that customers do not shop elsewhere.

Banks must be treated like private businesses, rather than public utilities, and allowed to meet new competition as it arises.

If regulators and legislators want more capital in banking to hedge taxpayers from the cost of failures, they must make banks a place in which investors want to put their money.

The only successful reform is one that permits banks to generate earnings consistent with risk, at a yield that will attract capital.

If the solution is so obvious, why hasn't Congress gone as far as required? One reason is that Congress does not understand the seamlessness of banking functions and how, given modern technology, they can be performed by nearly any institution.

What's Holding Back Congress

Congress is also excessively preoccupied with treating past illnesses -- with retribution, punishment, and regulation that micromanages banks.

But the largest trust is that Congress is not organized properly to deal with overall financial industry reform. It lacks the will to fight the special-interest groups it set on a roll 60 years ago.

Instead, Congress continues to act like the barber-physicians of old who bled their patients in the hope they would get well. It must shift the focus from treating illness to providing a rational structure for the future.

Umbrella of Protection

A joint committee on financial services is just one organizational structure that would enable Congress to deal with truly comprehensive reform. The committee would provide an umbrella of protection against the torrent of special-interest considerations.

Without such reform of Congress itself, all that congressional proposals can accomplish is to take banks out of their old boxes and put them in slightly larger ones.

Cautionary Note

Even with the right laws and regulators, banks will have to work hard to demonstrate the management capability to run the larger institutions that are emerging through consolidation.

They will have to convince Congress that they can take advantage of broader geographic and product opportunities without getting into trouble.

A prudent alliance between banks and regulators can husband the industry through the current crisis, in cooperation rather than confrontation.

Better no reform than reform that continues to restrict along interest-group lines. The goal of Congress should be to encourage the requisite combination of competitive freedom with effective supervision of safety and soundness.

If reform is inadequate, businesses and consumers and the economy will suffer and the American definition of a bank will be "that which a river has two of." The solution for saving banks is up to Congress.

Mr. Furash is president of Furash & Co., a Washington-based consulting firm.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.