By Richard Neiman
In the debate on regulatory reform, there has been much discussion of how best to prevent regulatory arbitrage, where banks “shop” for the laxest regulator. Eliminating arbitrage opportunities is very important, but we need to distinguish this kind of negative maneuvering from banks’ legitimate ability to select the charter and regulator that is the best fit for their business model.
The Obama administration’s plan for regulatory reform includes partial consolidation at the federal level, through merger of the Office of Thrift Supervision (OTS) with the Office of Comptroller of the Currency (OCC). Although New York State continues to offer the state thrift charter, I support that change at the federal level, as it should bring greater efficiency. But some suggest that we should go beyond this, and propose the creation of a single overarching federal regulator. That is a bridge too far.
Creating one big regulator would have profound implications for supervision at both the state and the federal levels, and would overlook three critical benefits of our current system. We can have the efficiency of a more centralized model without losing what is best in our partially decentralized approach, namely: quality of supervision, effectiveness of consumer protection and responsiveness to community banking.
Quality of supervision
Multiple regulators yield better results, much like multiple judges at the Olympics are needed to reach a fair score. A timely example relates to the leverage ratio. The Federal Reserve Board (FRB) would have likely eliminated this requirement as part of U.S. implementation of Basel II. The Federal Deposit Insurance Corporation (FDIC), however, argued forcefully to retain the leverage ratio and the financial crisis demonstrated the wisdom of that decision.
There is a place for horizontal checks and balances at the federal level, in addition to the vertical checks and balances between the states and the federal government. For instance, the FDIC and the FRB should retain exam authority. The FDIC does a better job of safeguarding deposit insurance and the FRB of monitoring markets and developing monetary policy if they are informed by first-hand information and experience.
A move toward complete centralization would also undermine the effectiveness of consumer protection efforts. In a complex financial services landscape, we need more cops on the beat, not fewer. The states took an early lead on subprime and predatory lending issues, despite being thwarted by the OCC and the OTS with aggressive claims of federal preemption. But one national regulator would undermine the states’ consumer protection role by shifting all federal power to one entity that would nationally charter banks, thus creating a strong disincentive for obtaining a state charter.
It was critical for the states to challenge the status quo on subprime and predatory lending, and the problem was not the so-called patchwork of state anti-predatory lending laws. The problem was the lack of an appropriate federal response to the smoldering issues that states had identified in the mortgage market. Without multiple regulators, there would be no such early warning system by regulators on the ground, and there would be inadequate consumer protection in times when federal standards are too lax.
One national entity with a monopoly on regulatory power only sets the stage for the more intractable problem of regulatory capture – which is, ironically, the very outcome of regulatory arbitrage that single regulator proposals are seeking to avoid. Proposals to create an overarching regulator carry the very risks to consumer protection which we are working to safeguard against. We could find ourselves worse off than where we started, but this time without the checks and balances of federalism to restore order.
Diversity of regulators also supports diversity of institution types. States are accessible regulators who understand local conditions and economies, and community banks in particular are supported by state supervision. These smaller institutions are reliable sources of hometown credit – they have lower risk profiles and were not caught up in subprime excesses. It is critical to safety and soundness and the nation’s economy that deposits reside in a mix of banks with different risk appetites. The thousands of institutions in the state banking system also provide an incubator where ideas can be tested first in local market, and then applied nationally.
I appreciate the appeal of a completely centralized regulatory system, but the ideal structure defies simple engineering. We need to retain the flexibility and accountability of complementary oversight by multiple regulators. New York is famous for the Garment District, as well as for Wall Street. And whether it is fashion or finance, a custom fit is always better than an off-the-rack solution. One size never fits all.
Richard H. Neiman is the superintendent of New York State Banking Department. He writes on regulatory issues for Banking New York.