As the Senate Banking Committee completes work on its regulatory reform bill, we anticipate changes that could have long-term consequences for the stability of the banking industry in New York and around the world. Decisions about the extent of agency consolidation are particularly urgent.
In order to sort through the many compelling and competing proposals, we need a framework for evaluation. A helpful way to approach this is through the lens of two fundamental criteria:
Is the proposed reform forward-thinking, or is it merely a reactionary response to yesterday’s crisis?
Will the proposed reform cause negative effects? Like doctors tending a patient, reforms to the regulatory framework should first do no harm.
Addressing regulatory architecture will be an important part of the reform process, but not because there is any one optimal approach. No country was spared from the financial crisis, notwithstanding diverse agency structures. However, we need to eliminate the potential for abuses, especially where there were attempts to avoid oversight through regulatory arbitrage. For example, competition between the Office of Thrift Supervision and the Office of the Comptroller of the Currency for larger institutions became the occasion for destructive charter-shopping. Therefore, I support the Obama administration’s plan to merge these two agencies.
However, some proposals discussed in the Senate would go farther to create a single monolithic bank regulator. This would strip the Federal Reserve and the FDIC of all exam authority. I have serious reservations about such complete consolidation; it undermines the dual banking system and increases the risk of regulatory capture.
Without examinations by the Fed and the FDIC, the quality of bank oversight would also be compromised in three key respects:
1. Dual Banking: Loss of examination authority for these agencies would needlessly sacrifice a successful model of joint supervision with the states. This partnership is integral to the dual banking system which has fostered a diverse and competitive industry with banks of all sizes, including community banking. Potential organizational efficiency is a slim gain compared to what we would lose through a well-intentioned but rash experiment in extreme centralization.
2. Multiple perspectives: We would also lose the safety of having multiple regulatory perspectives on complex issues. The FDIC’s insistence on retention of the leverage ratio in U.S. implementation of Basel II, when other federal regulators might have waived this standard, is a timely case in point. The quality of supervision is enhanced by having more than one agency’s opinion on regulatory standards, much as multiple judges in the Olympics are used to achieve a fair outcome.
3. Regulatory Capture: One issue that consolidation is intended to address is regulatory arbitrage, where institutions seek the most accommodating regulator. But an equally serious and more intractable problem is regulatory capture, where the regulator becomes too closely aligned with the industry, particularly with the interests of the largest market players. A single federal agency greatly increases the risk of capture.
Another aspect of consolidation that may be overlooked, but that is critical for the banking industry in New York, is the future of our model for supervising branches and agencies of non-U.S. banks.
Until the International Banking Act of 1978 gave authority to the OCC, only the states could license branches and agencies of non-U.S. banks. Today, the overwhelming majority of foreign bank licenses remain state licenses. As of June 30, 2010, there were 253 branches and agencies of foreign banks in the U.S. Only 50 of them were licensed by the OCC; the remaining 203 are licensed by the states. These state-licensed branches are supervised in partnership with the Federal Reserve. That oversight model is in jeopardy if the Fed’s exam powers are cut.
There are a number of reasons why I believe we should continue to leverage the Fed’s expertise in its current role with respect to foreign banking organizations.
The Fed’s participation in global monetary and regulatory initiatives gives it unique insights into international banks’ business model. This has practical application in dollar clearing, the payments system and international monetary flows. A continuing role in regulating the U.S. operations of foreign banking institutions also gives the Fed an important window into systemic risks worldwide.
The Banking Department has a long and successful history of working with the Fed to regulate foreign bank branches. New York licenses just over 80 percent of the total assets of all foreign branches and agencies in this country. Based on our extensive collaboration, I can say first-hand that the partnership between the Fed and the states is a model that yields positive results and should be retained.
In other words, while we need change, we don’t need change for change’s sake – we need regulatory reforms that work.
Richard H. Neiman, superintendent of the New York State Banking Department, writes on regulatory issues for Banking New York.