Yesterday, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled, “Strengthening and Streamlining Prudential Bank Supervision.” This hearing was a continuation of the Committee’s August 4, 2009 hearing on the same topic. The witnesses providing testimony at yesterday’s hearing were:

  • Eugene Ludwig, CEO, Promontory Financial Group LLC;
  • Martin Baily, Senior Fellow in Economic Studies, The Brookings Institution;
  • Richard Carnell, Associate Professor, Fordham University School of Law; and
  • Richard Hillman, Managing Director of Financial Markets and Community Investment, U.S. Government Accountability Office (GAO).

Committee Chairman Christopher Dodd (D-CT) began the hearing by discussing the importance of enacting financial regulatory reform in a careful and deliberative manner. He suggested that any proposed reform should target the overlaps and redundancies of the current system that have developed over the past 60-plus years. In order to streamline prudential supervision of insured depository institutions and their affiliates, he proposes to consolidate supervision and regulation of depository institutions and their holding companies into a single federal agency.

Mr. Ludwig’s testimony supported the formation of a new, consolidated federal regulator with authority to oversee the functions of insured depository institutions and their affiliates. He noted that regulatory arbitrage and a lack of regulatory experience with new and innovative products offered by insured depository institutions have contributed to the current problems faced by the market. Mr. Ludwig also noted that the new agency would need authority to oversee all aspects of regulated organizations and any reform legislation would need to remove jurisdictional obstacles for oversight and supervision.

Mr. Baily endorsed consolidation of the respective oversight and supervision responsibilities of the Federal Reserve, FDIC, OCC and OTS be consolidated into a single agency. He suggested that removing supervisory responsibilities from the Federal Reserve and FDIC would enable those agencies to focus on their primary or core functions. Mr. Baily also noted that the historical formation and regulation of bank holding companies creates a situation where decisions regarding financial products, services and initiatives are made at the corporate level and then “shipped to the legal entity” within the holding company’s affiliates in which the product or service would receive the most favorable tax and regulatory treatment. He suggested that the consolidated regulator would be able to prevent this form of regulatory arbitrage by ensuring that all of the organization’s products and services would be subject to uniform oversight and regulation.

Mr. Carnell also addressed the need to combine the regulatory functions of the Federal Reserve, FDIC, OCC and OTS into a single federal regulatory agency. He stated that the new agency should focus on the regulation of the entire banking organization and its affiliates, rather than focusing specifically on an insured depository institution or the holding company.

Mr. Hillman began his testimony by noting that the current regulatory system has not kept pace with changes in the market. He discussed the need for the creation of an independent consumer protection agency to ensure that “consumers are better protected from unscrupulous sales practices” regarding financial products. He also noted that funding the federal regulators through an assessment-based system compromises the effectiveness of the agency by making them dependent on the institutions they are supposed to be regulating. Finally, he noted that Congress should mandate GAO oversight of any regulatory reforms to ensure the transparent and efficient implementation of the measures.

Questions by the Committee focused on few primary issues. The first was concern on the part of the FDIC and the Federal Reserve that removal of their supervisory and regulatory authority would inhibit their ability to perform their primary functions. Messrs. Ludwig and Baily both rejected this concern and emphasized that the new agency they envisioned would share information from its reviews with both the FDIC and Federal Reserve as needed. Mr. Ludwig also noted that the Federal Reserve, as regulator of monetary policy and lender of last resort for financial institutions, did not need to be troubled with regulatory authority over consumer credit cards and bank holding companies to achieve those objectives. Both agreed, however, that the FDIC should still have the authority to have its examiners on the ground at institutions or to accompany the new agency’s examiners in order to meet its objective of protecting depositors and safeguarding the deposit insurance fund.

Other questions addressed the impact that consolidated regulation would have on small, community banks and the need for a resolution mechanism for large, troubled financial companies. With respect to the community banks, all of the panelists concurred that existing regulators have special departments or divisions for supervising institutions of varying sizes. They suggested that the new agency should be no different. Mr. Ludwig noted that it “makes sense to enact protections for community banks [and to create a] specialized regulatory approach to suit their needs.” He also noted that any concern that all the “good” agency employees would be focused on large institutions, to the detriment of oversight of community banks, was overblown, noting that a difference in size between large and small institutions does not necessarily imply a difference in the complexity of the institutions and their products and services. Thus, he concluded, experienced supervisors would be needed for small institutions as well as large institutions – but that the key would be to ensure that sufficient resources were provided to the new agency to attract and retain qualified supervisory staff.

With respect to the resolution of large, troubled institutions, Mr. Carnell noted that the resolution authority granted to the FDIC for troubled banks is a model for resolution that should be expanded to include such entities. He added that the current bankruptcy scheme should be “tweaked” to permit for the orderly resolution of large holding companies and that such bankruptcy proceedings should be overseen by specialists with knowledge of the banking and financial system. It was generally agreed among the panelists that the concept of “too-big-to-fail” and the practice of “propping up” troubled, systemically-significant institutions were untenable and unworkable.