FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, Senator Sarbanes, Members of the Committee. Thank you for this opportunity to present the Administration's views on S. 1405, the Financial Regulatory Relief and Economic Efficiency Act of 1997.

Mr. Chairman, I would like to commend you, Senators Shelby and Mack, and the other Senators who introduced S. 1405. Your commitment to rationalizing the regulation of our nation's financial institutions is longstanding.

In 1996, the Administration was pleased to support final passage of the Economic Growth and Regulatory Paperwork Reduction Act of 1996. That legislation demonstrated that Congress and the Administration, working together, could achieve meaningful reductions in the regulatory burden on depository institutions without sacrificing the safety and soundness of those institutions or important protections for our nation's consumers and communities. We welcome the opportunity to work with you on additional meaningful reforms.

The Administration is particularly pleased that S. 1405 does not propose to weaken the Community Reinvestment Act. Under CRA, insured depository institutions have become increasingly important sources of capital for the revitalization of our nation's low- and moderate-income neighborhoods, bringing billions of dollars in investments to local economies. As the Committee knows, all the banking agencies have made a determined effort to rework their CRA rules to emphasize performance over paperwork.

In 1996, the Administration urged Congress to allow time for these changes to take effect, and the results have validated Congress's decision to do so. As one ABA official has put it, the new CRA regulations "reduced record keeping, exams went quicker, and banks now know what is required of them." CRA is working.

I should note that the Administration has taken additional steps to reduce regulatory burden. Examples include directing each agency to undertake a line-by-line review of its regulations to streamline procedures, eliminate redundant requirements, and write rules in plain English. In addition, the Administration encouraged the OCC and OTS to streamline their examination process for smaller, well-capitalized, well-managed institutions.

I am attaching to my testimony a section-by-section analysis of the bill setting forth our understanding of each provision and the Administration's position on it. Rather than repeat that discussion in my testimony, I will highlight some areas we believe to be of particular comfort or concern.

A. Removal of Interest Rate Restrictions

Section 102 of the bill would authorize banks and thrifts to offer NOW accounts for businesses and repeal existing prohibitions on their paying interest on demand deposits. Section 102 would thereby eliminate a needless government control on the price banks pay for funding, consistent with earlier elimination of Regulation Q ceilings on rates paid on deposit accounts. The result should be more efficient resource allocation. Moreover, small businesses, including minority-owned businesses, stand to benefit significantly from increasing the rate they earn on deposits from zero to a market rate. Larger firms are better able to earn interest through corporate sweep accounts or price concessions on other bank products in order to offset the below-market rate earned on deposits. The Administration therefore supports permitting depository institutions to pay interest on demand deposits with an appropriate transition period to allow banks to adjust their funding sources to reflect the new market rate.

Section 101 would permit the Federal Reserve to pay interest on reserves that banks are required to hold at the Fed. The Fed would pay a rate or rates not to exceed "the general level of short-term interest rates," thereby eliminating a cost to banks that is not imposed on their non-bank competitors. Banks can reduce this cost, but only if they expend resources to avoid it through sweep accounts and other machinations. In addition, the Federal Reserve believes that the payment of interest on reserves should help to reduce the volatility of the federal funds rate and resulting inefficiencies in short-term credit markets, thereby making monetary policy easier to implement through open market operations.

However, the effect of section 101 is to shift significant revenues from the taxpayers to the banking industry. Given the many high priority claims we and the Congress have on scarce budget resources, and the current high level of earnings in the banking industry, we do not believe that there is sufficient reason to make this change at this time.

B.Reform for Savings Associations

S. 1405 contains several helpful reforms for savings associations. Section 104 would repeal a requirement that the Office of Thrift Supervision (OTS) require 30 days notice of any dividend paid by a savings association that is a subsidiary of a savings and loan holding company. No similar statutory notice requirement applies to savings associations owned by individuals or bank holding companies, though OTS has imposed a notice requirement under other authority. The OTS now would like to waive the notice requirement for adequately capitalized, highly-rated savings associations, regardless of their ownership structure, and section 104 would allow it to do so.

We support this step but note that although section 104 repeals the notice requirement for savings associations, it leaves in place a dividend approval requirement for national banks.

In addition, section 106 would permit the OTS to approve interstate acquisitions of savings associations by savings and loan holding companies on the same basis as intrastate acquisitions. As a result, savings and loan holding companies would not have to comply with certain state laws, such as age and concentration requirements. We support this provision but note that it would continue a disparity in the treatment of interstate acquisitions between bank holding companies acquiring banks and savings and loan holding companies acquiring thrifts.

C.Elimination of Unnecessary Bureaucracy

Section 306 would eliminate the Thrift Depositor Protection Oversight Board and direct the Secretary of the Treasury to assume the Board's remaining responsibilities -- overseeing the Resolution Funding Corporation for the next 30 years, and serving as a nonvoting member of the Affordable Housing Advisory Board until the Advisory Board terminates in October 1998. The Department of the Treasury proposed this change last year.

Terminating the Oversight Board would eliminate the costs associated with preparing mandated agency filings -- such as Privacy Act reports and Federal Managers Financial Integrity Act reports -- over the remaining 33 years of the Board's life. Similar legislation passed both the House and Senate last year and is now awaiting conference on a provision unrelated to elimination of the Board.

D. Federal Home Loan Banks

We have fundamental concerns about the provisions in S.1405 that affect the Federal Home Loan Bank System. Our concerns are two-fold. First, we believe that there must be comprehensive reform of the Federal Home Loan Bank System, and that piecemeal amendments make such reform more difficult both conceptually and politically. Second, we believe that some of the FHLB amendments in S. 1405 would be poor public policy in any context.

The Federal Home Loan Bank System's role in financial markets has changed significantly in recent years. The development of the secondary mortgage market and the authorization of adjustable-rate mortgages have eroded the System's original public purpose. The System's balance sheet, however, has been growing rapidly. At the end of 1997, the System had nearly $360 billion in assets, but only $200 billion of those assets were advances. About $150 billion of the System's assets were investment securities unrelated to the System's mission -- a sort of money market fund for the benefit of System members managed by the System and funded with debt securities subsidized by taxpayers.

In the early 1990s, the Federal Home Loan Banks pointed to the combination of diminished demand for member advances and the fixed $300 million a year REFCorp obligation as a justification for building large investment portfolios. Since that time, there has been a steady increase in the demand for member advances, but the Federal Home Loan Banks have increased rather than decreased their investment portfolios. While the higher dividend rates that result from the investment portfolios may help retain members in the System, these investments do not contribute to the Federal Home Loan Banks' public purpose and are unnecessary to fund a REFCorp obligation that is small in comparison to the overall size of the System. Thus, any meaningful Federal Home Loan Bank legislation must include eliminating investments that do not directly serve the mission or safety and soundness of the system, better ensuring that advances to members are used to further their intended purpose; rationalizing the rules for FHLB membership; and reforming the capital structure of the Banks.

The FHLB provisions of S. 1405 do not serve these goals. For example, section 118 provides the Federal Home Loan Banks exemptions or special treatment with regard to Federal Reserve daylight overdraft regulations. Exemptions from daylight overdraft regulations could give the Federal Home Loan Banks a price advantage with regard to intra-day credit. Such advantage would serve no public purpose, could add risk to the payments system, and would create an unfair advantage for FHLBanks over both depository institutions and other GSEs.

Some of the FHLB provisions in section 119 that devolve decision making from the Finance Board to the Federal Home Loan Banks, such as eliminating Finance Board approval for Federal Home Loan Bank directors' salaries and Federal Home Loan Bank dividends, may be appropriate. However, it is inappropriate to give the FHLBanks greater autonomy absent other changes that would make the system both sounder and more accountable.

E.Consumer Protection Issues

In the Economic Growth and Regulatory Paperwork Reduction Act of 1996, Congress made some progress in the consumer protection area. Reform of the Truth in Lending Act and the Real Estate Settlement Procedures Act (RESPA) required the elimination of duplicative and needlessly burdensome requirements in the home mortgage lending process. These improvements will serve the interests of both consumers and the industry by reducing information overload and the costs of loan originations.

S. 1405, however, proposes several reforms that we believe would tilt the balance against consumers. We have serious concerns about the following provisions that would weaken important consumer protections.

Section 206 would permit a settlement service provider to pay an "affinity group" for a written or oral endorsement in an advertisement or mailing if the service provider clearly disclosed the payment in its first written communication to the consumer.

We have concerns that, under the existing statutory regime, such changes could spawn sham affinity groups seeking to avoid RESPA's anti-kickback provisions. It would be difficult to distinguish between bona fide and sham affinity groups. Moreover, the Committee has requested recommendations on fundamental statutory reform to RESPA and TILA. Any affinity group exemption proposal should be considered in that context.

Section 402 would amend TILA by (1) eliminating the repayment period and number of installments as terms that trigger disclosure requirements (regarding the down payment, terms of repayment, and APR) in closed-end credit advertisements; (2) eliminating disclosure of the highest possible APR in advertisements for open-end, variable-rate, home-secured credit; and (3) providing that instead of including current disclosure requirements, credit advertisements on radio or television in those media could state basic rate information, give a toll free number, and state that further information is available upon request.

We have concerns about section 402. We believe that consumers receive valuable information through advertising disclosures, and that this change would curtail that information. We understand that a nearly 40-organization Mortgage Reform Task Force, formed as a result of Section 2101 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996, is looking into this issue as well as the issues raised in Section 206. We believe the agencies and this working group should be allowed to finish their assignment before legislative language is enacted.

Section 204 would repeal a statute that prohibits banks from "tying" -- that is, requiring a customer to purchase one product in order to receive another or to receive a better price on another. In order to avoid disrupting traditional banking relationships, the anti-tying statute already allows banks to tie traditional bank products -- allowing depositors to receive preferential rates on loans, for example. The statute also authorizes the Federal Reserve to grant further exceptions by regulation or case-by-case. We oppose repealing this prohibition. We are aware of no evidence that it has imposed unreasonable burdens that the Federal Reserve has been unable to address through its exemptive authority.

F. Reform for National Banks

S. 1405 contains several burden-reducing provisions for banks. For example, section 110 expedites the procedure by which a national bank may reorganize to become a subsidiary of a holding company, section 111 provides national banks with the flexibility to stagger the election process of members of their boards of directors, and section 112 provides procedures by which a national bank could merge with nonbank subsidiaries or affiliates.

The Administration also supports section 113 which clarifies that banks can purchase their own stock. Current law prohibits a national bank from owning or holding its own stock except to prevent a loss on a debt previously contracted and sold or disposed of within six months. The OCC has interpreted this language to permit national banks to acquire their own stock for certain legitimate corporate purposes. Legitimate purposes include reducing capital when consistent with safety and soundness and called for by either market conditions or internal operations, or holding stock in order to offer it to employees as part of a stock sharing plan.

Clarifying that banks can purchase their own stock is especially important now, when banks find themselves flush with liquidity. In such circumstances, banks are more likely to make marginal loans. Section 113 would make it easier for banks to choose the alternative of buying back their own stock. Indeed, we further recommend that Congress consider repealing the current restriction altogether.

G. Relief for the Regulators

Two sections of S. 1405 are intended to relieve burdens not on the financial services industry but rather on its regulators. We believe that each provision should be eliminated or modified. The first, section 304, would repeal the requirement that each federal banking regulator submit an annual report to Congress concerning the differences among the regulators' capital and accounting standards. We believe that this reporting requirement is an important means for the regulators to identify and harmonize any differences that develop in their capital rules. We believe that capital regulation is an area where consistency is important. As an alternative, we propose allowing the regulators the option of producing one joint report each year, rather than four separate reports. To the extent that the capital standards become and remain truly consistent, the report should be simple to prepare.

The other provision, section 302, would repeal the requirement that the federal banking regulators develop jointly a method for insured depository institutions to provide, to the extent feasible, supplemental disclosure of the estimated fair market value of assets and liabilities in any financial report. We have concerns about eliminating this requirement. Repeal could be read as a retreat from the current trend toward better disclosure.

CONCLUSION

We look forward to working with the Committee as this bill makes its way through the legislative process. Working together, we can eliminate regulatory burden while maintaining important and necessary public protections.

I would be glad to respond to any questions the Committee may have.

Treasury's complete review of the Financial and Regulatory Relief and Economic Efficiency Act of 1997 is also available on the website.