The regulation in its current form permits a bank to establish an Op Sub that conducts activities as agent, and that is, without having to deduct the bank's equity investment in the subsidiary from the bank's capital; and, two, without requiring that the bank be well-capitalized after deducting the capital necessary to capitalize the subsidiary; and three, without any limit on the bank's investments and loans in this subsidiary. The most troublesome aspect of the Op Sub regulation's firewall structure is the lack of application of the firewalls of Sections 23A and 23B of the Federal Reserve Act to agency activities. Section 23A requires a Federally-insured depository institution not to extend credit to an affiliate greater than 10 percent of its capital. Section 23B requires that loans to affiliates must be on no better terms and conditions than offered to nonaffiliate companies. I am concerned that the lack of these firewalls for agency activities raises the specter of biased credit allocation, with the bank being able to provide below-market-rate loans to its own subsidiaries to gain market share over its nonbank competitors. Now with that being said, I would like to commend the Comptroller on his efforts to enhance the national bank charter. As you know, I strongly support financial modernization. I believe that the affiliation and cross-marketing restrictions of the Glass-Steagall Act and Bank Holding Company Act artificially segregate the three types of financial services-banking, securities, and insurance. These laws create artificial barriers to competition that hurt consumers by making financial services more costly and less convenient. I think that there is a common thread between the topic of this Subcommittee hearing today and the prior one that we had regarding the Federal Reserve's proposed reduction in the firewalls of Section 20, Securities Affiliates. Our financial services industries have outgrown their antiquated legal framework. The Fed and the OCC are merely being responsive to the technological changes that have been occurring in the banking industry. My hope is that the actions of these regulators will spur this Subcommittee to hold more hearings this year to carefully review the issue of financial modernization. Financial modernization is not just about the expansion of bank powers; it is about creating a comprehensive financial services structure that provides competitive equality to all financial services providers, while preserving consumer protections and the safety and soundness of the Federal deposit insurance system. No regulator can do this for us. Congress should step in and take the action. Mr. Chairman, again, I want to commend you for holding this important oversight hearing. I look forward to hearing the views of the Comptroller on these very important issues. Thank you. Senator FAIRCLOTH. Thank you, Senator Grams. Senator Mack. OPENING COMMENTS OF SENATOR CONNIE MACK Senator MACK. Thank you, Mr. Chairman. Welcome, Mr. Ludwig. I appreciate the opportunity we had to chat yesterday. The only comment that I have would be picking up on what Senator Shelby said a moment ago. It ought to come from here and not from you. In essence, that is what he said. I would make the case that, frankly, the Senate did move, and the Senate is prepared to move on modernization, but we do have some difficulty on the other side of the Capitol. The reality is that the world has changed and Congress has not, and you are attempting to allow the banking industry to change with that new world. I think this is an important hearing, and I welcome you and look forward to your testimony. The CHAIRMAN (Presiding]. Senator Hagel. OPENING COMMENTS OF SENATOR CHUCK HAGEL Senator HAGEL. Mr. Chairman, thank you. Welcome, Mr. Comptroller. One of the advantages of being on the end is that you are allowed an opportunity to be brief. [Laughter.] I do look forward to your testimony and the questions. The CHAIRMAN. Senator Bennett. OPENING COMMENT OF SENATOR ROBERT F. BENNETT Senator BENNETT. I will be even briefer. Welcome, Mr. Ludwig. (Laughter.] The CHAIRMAN. Comptroller Ludwig. OPENING STATEMENT OF EUGENE A. LUDWIG Mr. LUDWIG. Mr. Chairman and Members of the Subcommittee, I want to commend you for holding this oversight hearing on the OCC's supervision and regulatory activities, and in particular, the recent revision to Part 5 which governs corporate applications from national banks. In light of the significant changes in the banking industry today, this is a particularly appropriate time to focus on these important issues. I welcome this opportunity to answer your questions, and I have a detailed written statement for the record. I would like to briefly summarize the key points in that statement. Since the mid-1970's, banks have increasingly faced numerous changes that have challenged the long-term health of the industry. Increased competition from market participants operating under a different regulatory structure, changing consumer needs, globalization of financial markets, and, most significantly, increasing technological change all have irrevocably altered the competitive environment in which banks operate today. In this environment, the status quo is no longer an option for ensuring a safe and sound banking system to serve the American economy. Both the industry and our supervision must keep pace with the changing environment. That has been a guiding principle of OCC supervision over the past 4 years, and the results speak for themselves. When I took office in 1993, there were numerous bank failures. Small businesses, consumers, and the Members of Congress were complaining about a credit crunch, and banks and Congress were concerned about excessive regulatory burden. Community organiza tions raised concerns about fair lending compliance, and everyone agreed that the Community Reinvestment Act regulations were not getting the job done. Today, the banking system is healthy, profitable, and far better capitalized than at any time in recent memory. Bank failures in 1996 were at a 20-year low. Credit is flowing smoothly, and small business loans have increased 31 percent over the 3 years ending June 1996. To make sure the performance of national banks continues to be healthy and strong, we have strengthened our supervision of highrisk areas, and focused on getting the most from our historic strength-hands-on, in-the-bank examinations. For example, we now have dedicated examination teams assigned full-time to each of the 30 largest national banks. We have pioneered supervision guidance on issues such as bank derivatives activities that have become the standard for other regulators, both in the United States and overseas. The OCC has also stepped up its enforcement of fair lending laws. To date, we have completed more than 3,000 fair lending examinations with revised, state-of-the-art procedures. Before my arrival at the OCC, they had referred only one fair lending case to the Department of Justice. Since 1993, we have referred 23 cases. We also spearheaded the interagency effort to revise the CRA regulations to focus less on process and more on the actual loans, investments, and services. One result is a dramatic increase in mortgage lending to low- to moderate-income households. In the past 20 years, banks have made $140 billion in loan commitments for community reinvestment. Fully 70 percent of that amount, $100 billion, was committed in the last 3 years alone. Before 1993, national banks had invested less than $1 billion in community development projects. Since then, national banks and their community development partners, have invested more than $4 billion. Although the situation clearly has improved, we cannot be complacent. Now while the industry is strong, we are keeping a vigilant watch for emerging risks and working with national banks to make sure they manage these risks appropriately. In my written statement, I have detailed the OCC's actions to carry out its mission: to charter, regulate, and supervise national banks to ensure a safe, sound, and competitive National Banking System that supports the citizens, communities, and economy of the United States. While these actions are important, by themselves they are not enough. In today's changed and changing financial environment, banking cannot stand still. If we deny banks the chance to pursue opportunities in evolving financial activities that they can undertake safely, they will be pressured into moving further out on the risk curve-to squeeze more profit out of their traditional activities and to reduce costs by cutting internal control systems. Indeed, that is precisely what led to bank losses from loans to LDC's and highly leveraged transactions in the 1980's. And losses such as those have a direct impact on banks' ability to meet the needs of their customers and the Nation's economy. By contrast, creating a process through which banks can prudently meet new market demands will enable banks to achieve greater balance in their operations, diversify their sources of earnings, offset downturns in their traditional lines of business, and expand their ability to meet the financial needs of business, consumers, and our national economy. Part 5 is one step in that direction. We did not rush headlong into revising this regulation. We first proposed changes to Part 5 in November 1994, and over the next 2 years, we thoroughly reviewed the many comments we received on the proposal. Only after long deliberation did we issue our final rule in late November 1996. Part 5 lays out procedures for filing and processing the full range of national bank corporate applications. The part of the regulation that has generated the greatest controversy deals with the new process under which the OCC considers an operating subsidiary application for activities different from those permitted for the parent bank itself. Because there has been some confusion about this provision, I want to be absolutely clear about what the regulation does and does not do. First, the revised Part 5 does not authorize any new activity. Instead, it lays out a public process under which banks can apply, one at a time, to set up operating subsidiaries to engage in activities that are part of or incidental to the business of banking. Second, activities in a national bank operating subsidiary must be part of or incidental to the business of banking. Part 5 does not breach any separation between banking and commerce. Third, Part 5 lays out explicit firewalls to ensure that any new activities are conducted safely and soundly, to protect the interests of America's consumers and communities. In addition, the OCC can and will impose additional safeguards that may be warranted by a particular activity a subsidiary proposes to conduct. Let me assure you, taxpayer funds will not be put at risk. Fourth, because these activities are being conducted in a bank subsidiary, the earnings from these activities will strengthen the bank itself, and increase its ability to provide greater access to financial services. As FDIC Chairman Ricki Helfer said in recent testimony, allowing a bank to put new activities in a bank subsidiary, "lowers the probability of failure and provides greater protection to the insurance funds." Fifth, in many cases, activities in an operating subsidiary will be regulated on a functional basis by another regulator, as well as by the OCC. For example, today, most national banks sell securities through operating subsidiaries that must be registered broker-dealers, and are subject to SEC regulation, in addition to oversight by the OCC. Finally, despite assertions to the contrary, there is no evidence of a net subsidy from the Federal safety net that would provide an unfair competitive advantage to activities conducted in a bank operating subsidiary as opposed to a holding company affiliate. At my confirmation hearing in 1993, I said that focusing on the structure and function of the banking system over the long term was critical to ensuring a truly safe and sound banking system. Everything I have learned since that time has only strengthened my belief in that statement. The OCC has changed significantly over the past 4 years. We have implemented many improvements to maintain bank safety and soundness, and to increase access to banking services. I am proud of OCC employees for their hard work and dedication in effecting these changes. My goal for the remainder of my term is to ensure that the National Banking System remains healthy, stable, and able to serve the diverse needs of American businesses, consumers, and communities. Part 5 is one step toward achieving that goal. Congress in its wisdom created a National Banking Act that was carefully designed to allow the National Banking System to evolve prudently over time. The Supreme Court has affirmed this Congressional intention 4 times in just the last 3 years. The banking system did evolve throughout the 19th century and has continued to do so to this day. Given the rapid changes in the financial services industry today, changes that will certainly continue into the next century, not to allow this evolution to continue would be unwise, unsafe, and unsound. I assure you that, in making decisions under Part 5 or any other area of my responsibility, we will act with the greatest prudence and care to assure the continued safety and soundness of the National Banking System. Thank you very much. Senator FAIRCLOTH. Thank you, Mr. Ludwig. We have been joined by Senator Moseley-Braun. Do you have an opening statement? OPENING COMMENTS OF SENATOR CAROL MOSELEY-BRAUN Senator MOSELEY-BRAUN. Thank you, Mr. Chairman. I do have a statement and ask that it be placed in the record. I would like to say at this point that I believe that in this situation the Comptroller's action was brought upon, in large part, by our failure to act on this area of financial modernization across the board. We asked Treasury a couple of years ago to provide a report on financial modernization. It is long overdue. We have been pressing the Treasury Department to try to come up with it, but they have not. In the absence of Congress taking a comprehensive and sensible look at this whole area, we wind up with piecemeal decisions having to be made by virtue of the changes in the industry. The Comptroller's action with this rulemaking has been modest, I believe, and cautious. I want to say to the extent that it is controversial, that this controversy has been brought upon us as much by our inaction as anything else. I look forward to the questions. Senator FAIRCLOTH. You statement will be placed in the record. Thank you. Mr. Ludwig, the Part 5 proposal is very new, but I would like to know if a bank were to underwrite securities-and they will be or engage in real estate development-and under this proposal they can-in a direct subsidiary of the bank, what safeguards are going to be in place to protect against losses to the bank itself? Mr. LUDWIG. Senator, the Part 5 regulation sets out a series of strong firewalls that must apply in every case. In addition, in an individual case-and we would only approve applications on a caseby-case basis-we can add to those firewalls. The history of our Office in terms of approving applications has shown that, in fact, |