The Big Bad Bank Holding Company Law and the ILC

During my time as chairman of the FDIC, it was my general view that the bank holding company (BHC) structure was an unnecessary intrusion in the free marketplace. Regulated by the Federal Reserve Bank, BHCs were designed to separate commerce and finance, so that GM or Wal-Mart couldn’t own a bank, for instance. Yet I believed this oversight, to the extent it was really necessary, could be accomplished by the FDIC’s talented and diligent supervisory staff. In addition, certain special-purpose banksu00e2u20ac”ILCs (industrial loan corporations)u00e2u20ac”were exempt from this forced separation, and, in my view, appropriately so. I knew that the ILC operations had not caused the FDIC any troubles, and there had never been a failure because of one.

Unfortunately, ILCs broke that shining record after I left the agency. Now Congress is considering extending ILC branching powers nationwide, effectively allowing a Wal-Mart-type company to run an ILC. A branch in every Wal-Mart store? My old view was, why not? Today, after considering the current congressional proposal, I am rethinking that position somewhat.

During the last 10 years I have spent a lot of time in the Far East examining the banking systems of Japan, Korea, Taiwan, and Thailand. In these countries, the mixing of so-called commerce and finance has been legalu00e2u20ac”and it has been a disaster. There’s no doubt that what happened to damage the banking system in the Far East was primarily the result of “crony capitalism”u00e2u20ac”cross ownership between financial institutions and commercial businesses. This system has created huge losses due to bad “crony loans” from which these countries are still trying to recover. This experience has made an impression on me. Maybe the Bank Holding Company Act had some justification after all.

Does the current congressional proposal to allow ILCs to branch really jeopardize the financial system? Are there enough regulatory controls in place? Are we creating something that could become a step toward what happened in the Far East? The Fed says this branching exception is a step toward destroying the separation of banking and commerce and should be opposed as a violation of a basic principle of bank regulation.

One of the things that ought to be asked in this connection is: How do these proposed changes affect the consumer?
Our government systems are there to ensure that banks serve the consumer in a safe and sound manner. Regulatory prohibitions should restrict the marketplace only when needed to keep the financial system safe and sound.

Approached from this point of view, Congress should allow the free marketplace to work and interfere only when it is absolutely necessary for safety and soundness. It is perhaps no surprise that on balance, it is my view that the FDIC has appropriate powers to regulate the relationship between ILCs and their owners safely and soundly. Thus, this new form of branching should be allowable.

The Fed disagrees because, among other reasons, the FDIC does not have the Fed’s power to investigate the commercial owners of ILCs. If that’s the correct analysis, then the Fed should support additional powers for the FDIC as part of the legislation.

You can bet the ranch that won’t happen, and you can also bet that with the Fed opposing it, the ILC branching proposal won’t become law anytime soon. This, of course, will not be a major disappointment to community banks, for obvious reasons.