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it is irrelevant whether nonbanking activities are conducted through affiliates or subsidiaries of banks." 15

Some have also expressed concern that banks benefit from a safety net subsidy that can be transmitted to an operating subsidiary and is best contained by the bank holding company structure. The attached paper addresses these concerns in detail. To summarize, there simply is no evidence of a net subsidy. Any benefit to banks from access to the safety net has declined in value over the past decade. The value of any benefit is offset by regulatory costs. Even when being conservative with respect to cost estimates the net subsidy received by banks is negative. Evidence cited as proof of a subsidy is readily attributed to other factors. Most important, banks do not behave as if they enjoy a subsidy.

Even if there were a subsidy, the appropriate response to contain it would be with carefully constructed regulations-similar to those safeguards we have developed for operating subsidiaries-rather than to impose organizational constraints on banking companies. If a subsidy existed, the transfer could be contained by rules restricting transactions between organizational components. Indeed, where any activity is placed on the organizational chart will not affect the transfer of any alleged subsidy. Under current rules, the bank holding company structure is not superior to the bank subsidiary structure in containing any alleged subsidy; the bank subsidiary structure is actually the superior structure for containing any alleged subsidy. If the safeguards of Sections 23A and 23B are applied to transactions between a bank and its subsidiary and a bank and its affiliates, the subsidy is equally contained from all angles. But a bank can also pay dividends to its holding company-a transfer of funds which is not subject to Sections 23A and 23B. Those funds may then, in turn, be downstreamed to a holding company affiliate.

Moreover, in addition to protecting the interests of taxpayers, the subsidiary structure offers important benefits from a safety and soundness and public policy perspective, as discussed below.

Benefits of Part 5 Revisions

The revised Part 5 regulation provides a broad range of benefits. First, the streamlined application procedures promote safety and soundness because they provide a powerful incentive for banks to ensure that they are well managed and well capitalized so they can take advantage of expedited processing. They enhance competitiveness and efficiency by reducing the paperwork that must be filed in connection with many applications and simplifying the process for charter conversions, consolidations, mergers, and corporate reorganizations.

The revised operating subsidiary framework set forth in Part 5 has long-term safety and soundness benefits. Use of bank operating subsidiaries, for example, allows banking organizations to focus their capital and earnings strength on their banks, or a lead bank, rather than removing capital and channeling earnings away from the bank. Use of operating subsidiaries also allows the benefits of activities diversification to flow to the bank and strengthen it.

Moreover, forcing new lines of business that are responding to the newest customer needs to be conducted in holding company affiliates has troubling long-term ramifications for the health of banks generally. Either the assets and income stream of the bank itself will dwindle away, or the bank will reach farther out on the risk curve. In either case, what will result is a destabilized hollow bank. This hollow bank will be less safe and sound.

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Also, the kind of structure allowed for new bank activities also has profound implications for the application and scope of the Community Reinvestment Act. As Allen Fishbein, General Counsel of the Center for Community Change, recently noted, it is also important to understand that the OCC's new rule provides a potentially important means for increasing the resource base for CRA-related activities." 16 If growth and new lines of business in banking organizations are forced to occur in holding company affiliates and not allowed in bank operating subsidiaries, that growing base of activities and earnings is not available to support a bank's CRA efforts. The source of support for CRA will shrink, and, in the worst case, the CRA may become functionally obsolete.

The subsidiary option should also help banks of all sizes compete more effectively. For large and mid-size banks, competition is increasingly global. Most of the foreign banks with which U.S. banks compete are able to engage in broad securities, insur

15 Hearings before the Senate Committee on Banking, Housing, and Urban Affairs, December 3, 1987.

16 See written testimony, hearing before the Subcommittee on Financial Institutions and Consumer Credit, Committee on Banking and Financial Services, U.S. House of Representatives, February 25, 1997.

ance and other activities, which they provide efficiently and conveniently through operating subsidiaries (or in some cases directly through the bank itself). This structure is particularly notable in the European Community, where many formidable financial conglomerates are taking shape. For U.S. banks that must compete against these firms, the subsidiary option gives them an organizational mode that puts them on more equal competitive footing.

For community banks, use of operating subsidiaries can be a simpler, less costly structure for providing new products and services. Community banks today face multi-faceted competition-ranging from nonbank competitors that have lower regulatory costs, to credit unions with significant tax advantages. Community banks need to be able to choose the organizational form that enables them to compete most effectively to meet these challenges. Diversification_through operating subsidiaries may be their best means of survival in an increasingly competitive marketplace.

Conclusions

In March 1993, when I stood before the Senate Committee on Banking, Housing, and Urban Affairs at my confirmation hearing, I stated that I wanted to focus particular attention on the structure and function of the banking system from a longterm perspective. I also stated that developing this vision of the future direction of the banking industry specifically, and the financial services sector in general, was a critical basis for a truly safe and sound banking system. My actions taken to date as Comptroller, including promulgation of the revised Part 5, demonstrate my commitment to those statements I made 4 years ago.

The OCC has changed significantly over the past 4 years and implemented many improvements in order to maintain safety and soundness in the banking industry. We continue to look for potential sources of problems in the industry and to make changes as needed. I am proud of our efforts and of the OCC's employees for their hard work and dedication in effecting these changes. They are a strong group of highly-skilled professionals who are committed to ensuring the safety and soundness of the National Banking System.

The revisions to Part 5 are only one example of the OCC's actions over the past 4 years, but they epitomize what the OCC is about: chartering, regulating and supervising national banks to ensure a safe, sound, and competitive National Banking System that supports the citizens, communities, and economy of the United States. Certainly, the new Part 5 does not provide answers to all the difficult issues that banks face. Like so many changes, the new Part 5 is a small, but logical, step forward. But it does hold the promise of significant progress, and it can be a powerful tool for business opportunities, greater efficiencies, enhanced safety and soundness, and a broader and less expensive array of financial services for America's communities and consumers-goals that should be shared by all supporters of financial modernization.

My goal for the remainder of my term is to assure that the National Banking System remains healthy, stable, and able to serve the diverse needs of American consumers and communities. We will continue to build on the actions of the four-pillar approach I established to guide OCC supervision of the National Banking System. At the same time, I am committed to making certain that our supervision and our policies meet any new challenges that the future will bring. That is the essence of safety and soundness.

Attachment 1

SIGNIFICANT OCC ACTIONS 1993-1997

ENSURING SAFETY & SOUNDNESS

ENSURING FAIR ACCESS

SIGNIFICANT OCC ACTIONS TO ENSURE BANK SAFETY & SOUNDNESS DATE, EVENT, AND IMPACT

JUNE 1993-OCC Initiates Annual Meetings Between Comptroller and Senior Management of the 25 Largest National Banks, promoting better communication between the agency and its largest banks.

JULY 19, 1993—OCC Issues Guidance on Sales of Bank Investment Products, protecting customers investing in bank mutual funds and other bank investment products.

AUGUST 16, 1993-OCC Issues New Compliance Exam Procedures, improving the quality and frequency of compliance examinations. In response to an OCC survey, the agency overhauled its approach to compliance and created a cadre of compliance specialists to perform consumer/trust exams.

OCTOBER 27, 1993-OCC Issues Guidance on Bank Derivatives Activities (BC277), providing comprehensive guidance on risk management of financial derivatives.

NOVEMBER 29, 1993-OCC Issues Mutual Fund Risk Brochure for bank customers setting forth investment risks.

FEBRUARY 17, 1994-Uniform Guidance on Mutual Fund Sales Issued. The Federal banking agencies issue the Interagency Statement. (I/A)1

APRIL 1994-OCC Charters a Working Group of OCC Examiners, Economists, and Bank Information Systems and Compliance Specialists to Study Concerns Associated with Growth and Competition in the Credit Card Industry. The group devises a plan to review the 15 largest national bank credit card issuers.

APRIL 1994-OCC Initiates Twice Yearly Meetings Among Comptroller and Senior Examiners in Charge (“EIC's”) of 40 largest banks to address potential risks and improve effectiveness of large bank supervision.

MAY 1994-OCC Initiates 6 Yearly Meet the Comptroller Seminars. Comptroller and senior staff meet with thousands of small bank CEO's throughout the country. JULY 8, 1994-OCC Forms Risk Analysis Division, acting to build expertise to support supervision of complex activities.

JULY 21, 1994-OCC Issues Advisory on Structured Notes, after developing risk management guidance for bankers and examiners.

SEPTEMBER 19, 1994-OCC Completes Voluntary Review of Mutual Fund Advertising and Marketing. Over 700 national banks voluntarily submit advertising and marketing materials on mutual funds to OCC for guidance. Comptroller initiates meetings with leaders of bank trade associations to address concerns and establish disclosure standards.

OCTOBER 1994-OCC Expands and Enhances Examiner Training, adding more training programs and enhancing capital markets training.

OCTOBER 12, 1994-OCC Convenes Conference on Bank Lending to Small Business, first in a series of forums on critical banking policy issues held by the OCC. OCTOBER 1994-OCC Creates National Credit Committee, top credit examiners from throughout the country meet regularly to examine and report on credit trends. OCTOBER 24, 1994-OCC Releases Derivatives Exam Procedures, the first thorough examination guidance provided to bank examiners.

DECEMBER 2, 1994-OCC Convenes Conference on Systemic Risk, covering banking, financial markets, and systemic risk.

1 I/A indicates event was part of an interagency effort.

DECEMBER 1994-OCC Commences Program to Use Economists to Provide Expert Assistance in Bank Examinations, with particular focus on interest rate risks and the evaluation of internal models.

JANUARY 3, 1995-NASD and Federal Bank Regulators Agree to Coordinate Mutual Fund Broker-Dealer Compliance Exams, OCC helps bring about agreement between NASD and banking regulators. (I/A)

FEBRUARY 8, 1995—OCC Issues Advisory on Interest Rate Risk, responding to the banks' increasingly complex asset portfolios and increasing volatility of interest

rates.

MARCH 31, 1995—OCC Releases First Quarterly Fact Sheet on National Bank Derivatives Activity, disclosing volumes, risk levels, and trends in derivatives activities.

APRIL 8, 1995-OCC National Credit Committee Warns National Banks About Deteriorating Credit Standards. OCC also surveys loan underwriting standards at the largest 40 national banks and communicates results and issues to bank management.

APRIL 12, 1995-Basle Issues Proposal on Market Risk, with OCC working to formulate international capital standards for trading activities that recognize a role for banks' internal models.

JUNE 7, 1995-OCC Releases Study on Large Bank Derivatives Sales Practices, a review of the largest national bank derivatives dealers, describing how major dealer banks are complying with the appropriateness standards contained in BC277, and identifying best practices.

JUNE 12, 1995—OCC/SEC Announce Agreement on Joint Examinations. Agreement minimizes regulatory burden on bank operations and protects the interests of bank depositors and investors.

JUNE 20, 1995-OCC Issues Additional Guidance on Interest Rate Risk Management. Responses to questions underscore OCC's continued commitment to provide guidance to national banks on the management of interest rate risk. JULY 24, 1995—OCC/SEC Joint Study Finds No Statistical Differences Between Bank and Nonbank Mutual Fund Customer Beliefs about Investment Risks. This study is the only definitive study of investor beliefs about mutual fund investment risk by place of purchase.

SEPTEMBER 26, 1995-OCC Announces Supervision by Risk, a flexible supervisory approach that targets resources at issues and banks that pose the greatest risk for an evolving industry.

NOVEMBER 9, 1995-OCC Issues Derivatives Guidance on Futures Brokerage, containing, in the wake of the Barings failure, detailed guidance and comprehensive examination procedures for futures commission merchants.

DECEMBER 6, 1995-OCC Releases Staff Paper on Trading Activities at Commercial Banks, providing educational background and perspective on trading activities generally, and proprietary trading in particular.

DECEMBER 20, 1995—OCC Issues Guidance on Emerging Market Country Products and Trading Activities, responding to concerns about emerging market products. JANUARY 4, 1996-OCC Issues Large Bank Supervision Handbook, implementing the Supervision by Risk Program for the 40 largest banks.

MARCH 11, 1996-OCC Creates Office of the Deputy Comptroller for Risk Management, to better identify and respond to new and emerging risks arising from the business of banking. Creates a position for a full-time senior official whose sole job is to identify risks to the banking system, consider ways to better supervise risks, and ensure that the agency takes proper action to address risks. APRIL 29, 1996-OCC Completes Release of Four Supervision by Risk Books (Bank Supervision Process, Community Bank Risk Assessment, Community Bank Procedures for Noncomplex Banks, Large Bank Supervision), completing the basic outline of how the OCC will supervise national banks based on its assessment of banking risks.

MAY 1, 1996-OCC Issues Mortgage Banking Handbook, providing comprehensive guidance on mortgage banking activities, including examination procedures.

AUGUST 12, 1996-OCC Issues Guidance on Credit Derivatives, stressing proper control over credit derivatives activities.

SEPTEMBER 10, 1996-OCC Issues Guidance on Smart Card/Stored Value Card Risks, assisting national banks develop appropriate risk management systems if they begin to offer such products and services.

SEPTEMBER 1996-OCC launches Industry Sector Information Service ("ISIS”), a technological innovation for bank examiners, and will soon unveil the Integrated Banking Information System ("IBIS"), offering tremendous statistical power for modeling, data analysis, and retrieval.

SEPTEMBER 20, 1996-OCC Issues Guidance on Bank Purchases of Life Insurance, acting to ensure that such purchases are consistent with safe and sound banking practices.

SEPTEMBER 25, 1996-OCC Issues Asset Securitization Guidelines, focusing on the need for bankers to understand fully the risks involved in securitization and to take steps to manage those risks effectively.

SEPTEMBER 26, 1996-OCC Issues Guidelines on Preapproved Credit Card Solicitations, addressing issues with preapproved solicitations of credit cards by identifying specific steps to deal with weaknesses in bank credit card portfolios. OCTOBER 3, 1996-OCC Issues New Credit Life Insurance Regulations, working to ensure credit life insurance sales are based on customer needs.

OCTOBER 8, 1996-OCC Issues Final Advisory on Insurance and Annuity Sales, working to ensure safe and sound practices and to protect consumers. OCTOBER 22, 1996-OCC Warns Banks Not To Weaken Internal Controls, stressing importance of maintaining strong internal controls and coordinated information systems.

NOVEMBER 19, 1996—OCC Publishes New Credit Card Handbook, focusing on the risks associated with credit card lending, a result of the 1994 initiative. JANUARY 23, 1997-OCC Publishes New Derivatives Handbook, focusing on strong risk management and emphasizing the importance of internal controls. MARCH 11, 1997-Federal Bank Regulators Adopt Sales Practices for Government Securities. The rules are substantively identical to the NASD Business Conduct and Suitability Rules and provide consistent treatment for customers engaging in Government securities transactions, regardless of whether the customer receives a recommendation from a bank or nonbank broker-dealer. (I/A) APRIL 2, 1997-OCC Publishes New Guide for Bank Directors, incorporating the changes in Federal law and court cases affecting directors, and providing guidance to directors on how to meet their responsibilities in the increasingly complex financial services industry.

SIGNIFICANT OCC ACTIONS ENSURING FAIR ACCESS TO

FINANCIAL SERVICES

DATE, EVENT, AND IMPACT

MARCH 10, 1993-OCC Credit Availability Initiative Results in Formation of Interagency Program on Credit Availability. Program addresses: loans to small- and medium-sized businesses; real estate lending and appraisals; agency procedures for handling appeals by bankers and consumer complaints; examination procedures; and paperwork and regulatory burden on banks. (I/A) 1 MARCH 30, 1993—Credit Availability Program Initiates Reforms aimed at eliminating unnecessary documentation of loans to small- and medium-sized businesses and farms, and reducing costs to lending institutions and the time it takes to respond to credit applications. (I/A)

MAY 4, 1993-OCC Issues New Procedures to Detect Lending Discrimination. New approach involving comparative reviews of bank lending decisions results in more effective and efficient examinations. Previously, OCC did not review bank files-relying only on reviews of bank audit results and bank representations. Since implementation, OCC has conducted over 3,000 fair lending examinations under the new procedures.

MAY 18, 1993-OCC/HUD/DOJ Form Working Group on Lending Discrimination, undertaking a comprehensive review of fair lending enforcement.

1 I/A indicates event was part of an interagency effort.

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