Summary

GAO examined the objectives, costs, and benefits of solvency regulation of financial institutions. It focused on the relationship of solvency regulation to the existing system of deposit insurance. It discussed the benefits and costs of various rules and regulations imposed to maintain bank solvency and reviewed possible alterations in the current regulatory and insurance systems.

Federal agencies control entry into the banking industry and the maximum interest rates that banks, savings and loan associations, and mutual savings banks may pay on deposits. Federal laws prohibit banks from buying certain kinds of assets and from engaging in various activities. Types of assets which nonbank depository institutions are permitted to hold are even more circumscribed. The laws that created banking regulation were enacted in response to financial crises with inadequate consideration of their relation to existing laws and regulations. The purpose of solvency regulation for financial institutions is to maintain the supply of money and the smooth functioning of the credit system and to safeguard the assets of certain classes of depositors. Existing bank performance is enhanced by competition from new entrants or branch banking. However, regulations may be required to insure the smooth functioning of the deposit insurance system, prevent conflicts of interest, and prevent concentrations of conglomerate power. Federal deposit insurance protects the public against the failure of small or medium sized banks, but not of giant banks. The Federal Deposit Insurance Corporation is required only to protect insured depositors to the extent of its resources. Handling the failure of a giant bank may be made more difficult by the statutory division of responsibility. Charging uniform premiums encourages banks to undertake risky activities and minimize their capital. A variable premium deposit insurance system would be preferable.