FDIC: The Future of Banking: The Structure and Role of Commercial Affiliations

Symposium hosted by the Federal Deposit Insurance Corporation

Terry J. Jorde
President and CEO, CountryBank USA, Cando, ND
National Press Club

July 16, 2003

Good morning. My name is Terry Jorde, and I'm pleased to be here to present a community banker's perspective on the issue of mixing banking and commerce.

I am president and CEO of CountryBank USA, a community bank with two offices in Cando and Devils Lake, North Dakota. I also have the honor and privilege of being the only active banker to sit on the FDIC's Advisory Committee on Banking Policy. I'd like to thank the FDIC and especially Chairman Powell for inviting me to participate today.

At the Advisory Committee's last meeting, I offered my comments on the issue of mixing banking and commerce generally, and particularly on the issue of whether it is good public policy for a commercial firm to own a bank. My reward for speaking up was to be invited to sit on this panel today to present my views a little more formally-surrounded by others whose views likely differ from mine.

It will come as no surprise to most in this audience that I, like nearly all community bankers, oppose the mixing of banking and commerce. We have been accused of holding this view because we are afraid of competition. Now, I have just as much interest in self-preservation as the next person, and I think I'm a pretty good community banker, but if the competition overwhelmed me, I like to think that I'm probably still employable. Therefore, I would like to use my time this morning to consider the issue from a public policy standpoint, not from the point of view of a competitor, but from the point of view of consumers of banking services, both businesses and households alike.

U.S. law generally prohibits affiliations or combinations between banks and commercial firms. The historical reasons for separating banking and commerce are well known, and in my view are probably more valid today than in the past. They include:

Let's put this into context by considering a bank or industrial loan company owned by Wal-Mart. Now, I really have nothing against Wal-Mart and a year ago I may have used Enron as an example, but I'm going to pick on Wal-Mart today since they are the largest company in the WORLD, and it's no secret that they really, really, really want to own a bank.

Now, imagine that you are a small business retailer in a town with a Wal-Mart SuperCenter (assuming that you haven't already been run out of business by Wal-Mart). And you need an operating loan or a loan to expand your business. You are a hardware store owner, a Jiffy-Lube franchise owner, a pharmacist, a grocer, a florist, an optometrist, a used car dealer, or any one of a number of other small businesses that may compete with Wal-Mart. Would a Wal-Mart owned bank agree to lend you the money if you were creditworthy? Would you want to share your confidential business plans and information with this bank?

Well, you say, I would just seek credit elsewhere. But, what if there are no other local credit providers in your community because the Wal-Mart bank has underpriced them out of existence? You could try to get credit from outside your local market, but those banks and lenders don't know you and your business, and you don't fit their cookie cutter mold to qualify for a credit-scored small business loan, so they will not lend you money either.

Imagine you are a supplier to Wal-Mart. What if Wal-Mart tells you it won't do business with you anymore unless you obtain your banking and credit services at the Wal-Mart bank?

These are examples of how commercial and banking affiliations can interfere with a bank's role as an impartial financial intermediary-one whose credit decisions should be based on merit, and not competitive concerns. These affiliations would undermine one of the key strengths of the U.S. financial and economic system-the efficient and unbiased allocation of credit among competing borrowers. In my view, commercial and banking affiliations, such as a Wal-Mart owned bank, would be particularly harmful in smaller communities where there are fewer alternative sources of credit.

Small business financing is not just important in and of itself. Small business financing is key to economic development in local communities. Local banks that fund local businesses, and that can provide relationship banking that is so important to small business, are particularly attuned to this issue, and are uniquely equipped to facilitate the local economic development process, which can be time-consuming and resource intensive.

Community bankers provide tremendous leadership in their communities, which is critical to economic development and community revitalization. Last week alone, I spent six hours in a hospital board meeting, four hours in an economic development corporation meeting, and another four hours working with other local community bankers to develop a financial incentive package for a potential new business in our community.

You could argue that this was not an efficient and cost-effective way to spend my time, and in fact, Wal-mart might agree with you, as not one of their 1.3 million employees were at any of these meetings (and Wal-mart is in my community). But the difference is that, unlike Wal-mart, the survival of CountryBank USA depends on the economic vitality of Cando and Devils Lake, North Dakota, and I have a very real incentive to work to assure their success.

Let's consider consumers. Wal-Mart says 20% of its customers don't have bank accounts. The answer isn't letting Wal-Mart own a bank, but figuring out why the 20 percent are unbanked. It isn't because of a lack of banks available to those customers. My local community of Cando has 1,300 people and is served by 3 community banks. Our branch location in Devils Lake has 7,500 people and is served by 8 banks, all of which have low or no-cost deposit and checking products that are affordable for customers of all income levels.

My bank offers one consumer checking account and it's free. And our checks are free, our debit card is free, out Internet banking is free, our ATM card is free and thanks to the Fed, our loans are almost free!

But what will happen to banking services for consumers and households in a world where Wal-Mart owns a bank? If the past is prologue, local banks, just like local retailers in towns where Wal-Mart has located, will no longer be able to compete. While the initial effect may be cheaper services at the Wal-Mart bank, the long-term effect will be reduced choices for consumers as the number of financial services providers shrinks, and as the products become more commoditized.

A Wal-Mart owned bank will not be able to look past a consumer's credit score to understand the customer's individual circumstances and can't make the customer a loan based on a long-standing relationship and personal knowledge of the customer… something my bank does every day.

Our country was founded on the ideals of separation and dispersion of political and economic power. A hallmark of our strong economy, which is the envy of the world, is our diversified economic system, with both a diversified financial sector and a strong and robust small and middle market business sector. Bank and commercial affiliations would undermine this strength, and enable huge conglomerates to dominate the American economy.

We have already seen alarming consolidation in the banking industry, and in a number of other industry sectors. The number of banks continues to decline while the market share of the largest banks continues to grow. In 1995, there were 10,168 commercial banks in this country. By the end of 2002, this number had dropped 27%, down to 7,482. Only 405 (or 6%) of the nation's banks are greater than $1 billion in assets, yet they control 85% of the total commercial banking assets in the United States. The 80 banks with more than $10 billion in assets control 72% of industry assets, up from 52% in 1995.

When you consider that banks with only 15% of the banking assets provide nearly 40% of the small business loans, you understand that a policy that supports a strong system of community banks provides essential fuel to the economic engine of the United States. Allowing commercial and bank affiliations would only serve to undermine our cultural heritage and the financial and economic diversity essential to our nation's well being.

Mixing banking and commerce also presents the danger of extending the safety net protecting depositors of federally insured institutions. Commercial affiliates of banks may seek to shift losses to the bank, or financial difficulties at an affiliate could lead to loss of confidence in the bank, even where it does not try to tap the bank's resources. While firewalls between the bank and its affiliates are important to help mitigate these dangers, firewalls tend to melt when there is a really hot fire.

Imagine if Enron or WorldCom had owned a large insured bank or ILC. Even if the Enron Bank were run safely and soundly, what would have happened to that bank upon news of its parent's spectacular demise?

All of these banking and commerce issues were considered again by the Congress when it passed the Gramm-Leach-Bliley Act, which reaffirmed our nation's long-standing policy against mixing banking and commerce. Congress specifically considered and rejected the notion of allowing financial holding companies to have a 15% "basket" of commercial activities.

In addition, Congress closed the unitary thrift loophole, which allowed a commercial company to own a single FDIC-insured savings institution. Congress was spurred to action to close the loophole, in fact, by an eleventh hour application by Wal-Mart to buy a unitary thrift-the specter of which Congress found unacceptable.

I would like to close with a few thoughts about industrial loan companies. These hybrid FDIC-insured bank charters, available in a few states, have been the focus of a renewed debate about banking and commerce, as the Congress considers legislation that would expand ILC powers.

Because of an exemption in the Bank Holding Company Act, ILCs can be owned by any commercial company, and their owners are not subject to the same supervision and oversight by the Federal Reserve that applies to other bank holding companies. ILCs were granted this loophole in 1987, on the condition that the ILC either refrain from offering demand deposits withdrawable by check, or remain below $100 million in assets.

In 1987, there were a number of small ILCs that functioned as local institutions. Many converted to state bank or savings association charters. Today, however, deposits in a number of ILCs have grown into the billions of dollars, and ILCs have been acquired by a number of large corporations. In 1995, Utah's loan companies had combined assets of $2.9 billion, but by the end of last year had more than $100 billion. The largest, owned by Merrill Lynch, has assets of $65 billion and would rank 17th on a list of the country's largest banks. Other ILC owners include General Motors Corp., BMW, GE Capital, Sears, Volvo, and Morgan Stanley Dean Witter.

Wal-Mart applied to acquire a California industrial bank last year, but was thwarted when the state legislature passed end-of-session legislation allowing only financial companies to own ILCs. California now applies the activities restrictions of the Bank Holding Company Act to ILC owners.

Pending federal legislation would effectively remove the conditions for Bank Holding Company Act exemption imposed on ILCs in 1987. Interest on business checking legislation would allow ILCs that cannot currently offer demand deposits to offer their functional equivalent, Business NOW Accounts. This, in essence, makes ILCs full service banks, but outside the scope of the Bank Holding Company Act.

To make matters worse, pending regulatory relief legislation would permit ILCs (and other banks) to branch de novo across state lines regardless of existing state laws.

The combination of these two measures would allow large corporations to use the ILC charter to offer full service banking, nationwide, by setting up branches in each of their locations, and not be subject to the same laws and regulations as owners of FDIC-insured banks and thrifts.

ILCs have said it would be unfair to deny them these expanded powers as they are only asking for parity with other banking institutions.

If parity is appropriate, then why not parity of holding company supervision and holding company activities restrictions?

If it is appropriate to restrict ownership of banks to financial companies and subject bank holding companies to certain rules and oversight, then it is appropriate to do so for an ILC that is the functional equivalent of a commercial bank.

And then there is the subject of supervision. The FDIC does have limited authority to examine bank affiliates in order to police transactions between the affiliate and the bank, but it pales in comparison to the oversight and supervision of bank holding companies provided for under the Bank Holding Company Act-including general examination authority, consolidated umbrella supervision, capital requirements and enforcement authority for unsafe and unsound activities at the parent or affiliate.

Chairman Powell has argued that the FDIC and the State supervisory agencies are perfectly capable of supervising and examining ILC's. I couldn't agree more. My bank has been examined by the FDIC and our state-banking department for all of the 24 years of my banking career and the quality of their supervision is outstanding. I have had the unique opportunity to serve on the FDIC's Advisory Committee as well as the Board of the North Dakota Department of Financial Institutions. I have seen firsthand that their commitment to safety and soundness is beyond reproach.

But the capability of the FDIC is not the question that we are here to discuss today. Rather, the question is whether the FDIC, or the Federal Reserve, or any regulatory agency for that matter, has the ability to prevent a meltdown from occurring if the parent company implodes. Back where I come from, if the dog that wags the tail gets sick, the whole dog is sick. If the dog dies, you can't save the tail!

It is important to recognize that the policy issue here is not about which regulatory agency gets to be in charge. That's irrelevant. The question is whether there is any regulatory agency that can prevent the systemic risk that will result from large commercial companies owning or controlling banks.

The U.S. policy of separating banking and commerce has served our nation and its economy very well. We are the envy of the world and our banking system is stronger than ever. The arguments for change are not compelling. The risks of getting it wrong are enormous.


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