Abstract
From the earliest days of banking in the United States, legislators have imposed activity limits on banking firms by crafting legal phrases intended to describe what banks could and could not do. Even before these limits were aimed at the prevention of excessive risk-taking, they were seen as promoting competition in a free market economy. In passing GLB, Congress clearly intended to permit a wider range of banking activities than permitted under earlier legislation. The new Act provides for activity expansion that is reminiscent in scope of the expansion that developed, largely outside legislative limits, in the first 30 years of the twentieth century. Not only are all “financial” activities allowed, including merchant banking, but also some commercial activities. At the same time, Congress also expressed an intention to sustain the traditional separation of banking and commerce. This paper examines the impact of the Financial Services Modernization Act of 1999 (also known as the Gramm-Leach-Bliley Act (GLBA)) on banking industry, domestically and internationally. It also examines the factors that led to enactment of this important regulation.
Introduction
On November 12, 1999, President Clinton signed the GLBA into law. This law officially ends the Depression era Glass-Steagall Act of 1933, that prohibits commercial banks from entering investment banking, and ends the Bank Holding Company Act of 1956, which prohibits commercial banks from insurance underwriting. It allows banks, brokerage firms, and insurance companies to merge. In addition, newly created Financial Holding Companies (FHC) may engage in a wider range of activities, including insurance underwriting, securities activity, merchant banking, and real estate development. Existing banks can extend insurance and investment activity using their subsidiaries. (Shull)
The GLBA is the most sweeping deregulation of the U.S. financial services industry in the last century. To comprehend the impact, one should look at the major change brought in by the major provisions. Since the passage of law, a lot of FHC were created. The FHC is the centerpiece of the GLBA. Once a financial firm obtains the FHC designation, it can house a complete family of financial activities. The Glass-Steagall Act is said to have limited the financial institutions’ ability to pursue economies of scope, while it is argued that GLBA has created opportunities for domestic as well as international financial intermediaries. (Gup)
Overview
The Gramm-Leach-Bliley Financial Modernization Act of 1999 (the Act) removes longstanding previous activity limits for U.S. banks, by allowing “financial holding companies” and “financial subsidiaries” to embrace all three sectors of the financial world: banking, dealing in securities and offering insurance. (Shull 77) Moreover, the Act empowers the Board of Governors of the Federal Reserve System, in consultation with the Secretary of the Treasury, to expand the list of permitted activities with new ones, if the new activities are “financial in nature or incidental to a financial activity”. Interestingly enough, the Act does not authorize the still very controversial mixing of banking and commerce. This boundary thus avoids the introduction in the United States of “real” universal banks as they have long existed in Germany for example or in other countries of Europe. Gramm-Leach-Bliley nonetheless permits Financial Holding Companies to enter into some commercial activities if considered by the Board as “complementary to financial activities”. (Shull 77-8)
The main purpose of the 1999 Act is to foster competition within the financial industry by suppressing the longstanding barriers that insulated banks, securities firms and insurance services providers in the United States. As stated by Congressman James A. Leach in an address to the Symposium “Future of Law and Financial Services” held at Fordham University School of Law in 2001,
the legislative approach we took was that of a three-way street. That is, banks were given securities and insurance powers. Insurance companies were given banking and securities powers and securities companies were given banking and insurance powers. The approach taken was a very competitive approach that I believe is good for consumers and America’s financial position in the world. By allowing each of the American companies to offer a wider variety of products, I think we are going to see America’s position in financial services become much stronger. This is important because some of our European competitors have broader rights; but it is also important in and of itself. (Leach 12)
The Gramm-Leach-Bliley Act constitutes a fundamental step since it ends a period of more than sixty years of restrictive regulation and two decades of intense debate about a potential reform of the U.S. financial industry. In effect, several proposals for reforming the financial sector by eliminating existing restrictions had been raised under the Reagan and Bush administrations particularly, but also afterwards. (UNCTAD 7)
Accordingly, the repeal of the Glass-Steagall Act is a major feature of the symbolic change embodied by this Act. However, the future of banking in the United States might be determined -or at least affected- even more by the Federal Reserve Board’s use of its new powers in determining what the permissible banking activities are. Though the Act is divided into seven titles, most of the provisions dealing with the new activities allowed to financial holding companies and financial subsidiaries are contained in Title 1.
Repeals and New Activities
The legal barriers erected by the Glass-Steagall Act were based on four crucial provisions. The Gramm-Leach-Bliley Act repeals two of them. It repeals section 20, which prohibited banks from owning affiliates principally engaged in dealing in securities. It also repeals section 32, which prevented securities firms and commercial banks from sharing staff, directors and officers. (Title 1 Section 101) However, the Act leaves unimpaired the two other provisions from 1933. In effect, Gramm-Leach-Bliley Act does not repeal section 16, which prohibits banks from selling, dealing in and underwriting securities. (O’Neal) Neither does it suppress section 21, which bans securities firms from traditional commercial banking activities such as deposit-taking. As a matter of fact, there is still no direct integration of the securities business into a banking entity itself. Indeed, Congress rather chose to permit banks to exercise financial activities through distinct corporate entities like separate affiliates of holding companies or banks’ subsidiaries. (Title 1 Section 102)
Gramm-Leach-Bliley amends Section 4 of the Bank Holding Company Act of 1956 by adding a series of new subsections which allow a set of new activities. In effect, under a new section 4(k) added to section 4(c) 8 of the 1956 Act, bank holding companies which qualify can turn into “financial holding companies”, thus being given the possibility to engage in a wider range of activities. (Title 1 Section 103) The new activities permitted by the Act in its Title 1 deal with the insurance or securities business, but also with merchant banking. Moreover, financial holding companies are allowed to engage in activities defined by the Board as “financial in nature or incidental to a financial activity” or “complementary” to financial activities. (Shull 81)
This constitutes a very important provision. The list of financial activities contained in section 4(k) includes “lending, exchanging, transferring, investing for others, or safeguarding money or securities, insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker for purposes of the foregoing in any State.” These activities also include “providing any device or other instrumentality for transferring money or other financial assets” and “arranging, effecting, or facilitating financial transactions for the account of third parties.” (Shull 82)
Generally speaking, the new list of permissible activities includes securities underwriting, any activity that would have been considered permissible by the Board under section 4(c) (8), merchant banking, insurance company portfolio investments and also health insurance. Activities undertaken abroad are also concerned since section 103 of Gramm-Leach-Bliley considers as “financial in nature” activities that a bank holding company may embrace outside of the United States and that the Board has determined under section 4(c) (13) as being “usual” in connection with the business of banking abroad. (Shull 83)
Finally, it is worth noting that section 4(k) (H) allows insurance companies and securities firms to have equity stakes in businesses which are engaged in “commercial activities” that the Act still does not authorize to carry on themselves. In effect, the Act permits financial holding companies to acquire or control entities engaged in any non-authorized activity as long as the shares, assets or ownership are not acquired or held by a depository institution. (O’Neal)
Expectations, Impact and Significance of GLBA
The enactment of Gramm-Leach-Bliley led to great expectations within the financial sector. Many felt that firms in different sectors of the financial sector would swoop down and buy each other up, others would launch into new lines of business, the Federal Reserve and the Treasury Department would approve reams of new “financial” activities, and the structure and configuration of the financial services industry would change forever. Well, not a lot of this has come to pass. There was no wholesale consolidation within the financial sectors, banks are not lining up to underwrite insurance (and insurance companies and securities firms certainly don’t seem to be lining up to buy banks), and now Citigroup, the firm that may have lit the final Gramm-Leach-Bliley legislative fuse with its combination with the Travelers Group in 1997, has sold its Travelers life and annuity underwriting businesses to a third party. (Anonymous 10) Worse, say others, the federal regulators have been too timid or too conservative in approving (or not approving) new financial activities. (Hogan 32)
As a result, it was declared Gramm-Leach-Bliley a disappointment that has failed to live up to its billing. Certainly, if the only purpose of GLB was to create excitement and drama, then it certainly has fallen short. Fortunately, these are not the benchmarks of good legislation, whether in financial services or other areas, so perhaps a slightly more modulated examination of Gramm-Leach-Bliley’s impact, seven years later, may tell a less exciting but nonetheless important story. (Mamun et al. 361-2)
It is true that the financial services consolidation that many predicted would follow GLB has not come to pass in a significant manner. While there has been some activity here and there, simply telling banks, securities firms, and insurance companies that they can merge or get into each other’s lines of business does not mean that they should do so if the proper business case cannot be made. As matters have turned out, many financial firms have concluded for various reasons that the commercial justification for a cross-sector transaction just isn’t there (whether it be inadequate market capitalization or depressed price valuations, a disinclination to expand beyond core business lines, concerns over business culture differences, and the like). (Horn 9)
It is also true that the Federal Reserve Board and Treasury Department have not approved a lot of new financial activities, and that those that have been approved (finder activities, expanded data processing activities) have been largely incremental in nature rather than an entirely new authority. It is possible that the agencies have been scared off from approving more controversial financial activities, such as real estate brokerage, by political pressures. (Hogan 33)
This does not mean, however, that GLB has not had a significant beneficial impact on the financial services industry. A cursory review of the list of almost 650 banking organizations that have elected financial holding company status shows that a diverse number of banking organizations, including not only virtually every one of the larger US and international banks active in the United States but also a broad array of smaller banking organizations, have elected financial holding company status. (Horn 8)
They have done so for a variety of specific business reasons, such as wanting to free their securities affiliates from the old “section 20” revenue restrictions and firewalls (large US and foreign banks), offer insurance agency services to their customers (smaller banks, in particular), or increase their ability to make private equity or venture capital investments. In most cases, however, banking organizations have viewed their financial holding company powers as supportive of their existing lines of business, rather than the opportunity to jump into something completely new. (Government Finance Officers Association)
A principal avenue for activity expansion under GLB is the new powers it grants financial holding companies and financial subsidiaries to engage in activities that are “financial in nature or incidental to a financial activity.” (Shull 92) The early regulatory decisions of the Federal Reserve Board, in consultation with the Treasury Department, have helped clarify the likely impact of the new standard. Examination of recent proposals and determinations suggests a regulatory approach that will potentially accommodate a progressive expansion of permissible new activities into areas that are currently perceived as “commercial.” (Hogan 34)
The intention of Congress to sustain the traditional separation of banking and commerce notwithstanding, early pronouncements by the Federal Reserve Board and the Treasury suggest that GLB provides no obvious limits to activity expansion. Although the regulatory process of making the law operational is still at an early stage, it appears that, “after a 70-year hiatus, GLB has created an opportunity for the bank-centered financial organizations to expand significantly into areas that today are perceived as commercial.” (Shull 93)
Conclusion
By providing a redesigned framework for the affiliation of banks, securities firms and insurance companies, Gramm-Leach-Bliley represents a symbolic and substantial legislative initiative. It is worth noting that another important example of the liberalization trend affecting banking affairs had already occurred a few years before Gramm-Leach-Bliley was passed. Indeed, by enacting the Riegle-Neal Interstate Banking and Branching Efficiency Act in 1994, Congress repealed the McFadden Act of 1927 and thus caused the suppression of longstanding geographical limits that prevented national expansion for U.S. banks. Since 1994, all fifty states have allowed banks to expand on an interstate basis by purchasing another bank. (Olson)
These two landmark events can be seen jointly as the latest legal interventions that have, in a significant modernization effort, characterized the deregulation of the U.S. financial services industry. As a matter of fact, Congress has allowed financial players to enter into the twenty-first century within a liberalized, open environment, in order to permit a higher level of competition. Even so, several traditional American specificities remain in this modernized framework. After having analyzed what the Act has done, it is important to state, even briefly, what the Act has not done.
In effect, the progress embodied by the adoption of Gramm-Leach-Bliley can be considered to be limited with respect to some crucial points or expected evolutions that it has not settled. Some of these remaining questions are the following. Although the 1999 Act slightly modifies the traditional segregation between banking and commerce, it still formally precludes the intermingling of these two sectors. The American system thus keeps it own specificity to that extent, while other countries like Germany or Japan have long had a tradition of merging comprehensively commerce with banking. (Ferran)
Second, even after the modernization bill has been passed, the regulatory framework of the U.S. banking world still seems as complex and seemingly potentially unsafe as it used to. (Ferran) In effect, in the past decades, many criticisms have been directed toward the American banking regulatory structure for being broken up into too many different bodies. In the United States, according to the dual structure of the banking system (which constitutes one of its most prominent features), the banking sector is regulated at a federal level -for all nationally chartered banks and for state-chartered banks that are members of the Federal reserve System- and at a state level for state-chartered banks. (Mamun et al. 366-8)
In addition to this, regulation at the sole federal level belongs to several banking agencies. Three federal regulators share responsibility for banks. The Federal Reserve Board, which is independent, regulates state-chartered banks that are members of the Federal Reserve System, and also regulates companies which own banks, i.e. bank holding companies and, now, financial holding companies. The Office of the Comptroller of the Currency (OTC), which is part of the Department of the Treasury, regulates national banks. National banks usually correspond to the largest banks in the country. The Federal Deposit Insurance Corporation (FDIC), an independent agency, whose main function is to insure deposits in almost all banks and savings associations (formerly savings and loans associations, also called “thrifts”), also regulates state-chartered banks that do not belong to the Federal Reserve System. The Office of Thrift Supervision (OTS), an agency of the Treasury Department, regulates savings associations. (Shull)
Things become more complicated under a holding company structure since under such a structure, the holding company is regulated by a certain body but the banks or banks are placed under the control of other regulators. As a matter of fact, the U.S. banking industry is subject to on an incredibly complex regulatory framework. The Gramm-Leach-Bliley Act has done little to clarify the existing complexity of the situation. The only significant contribution was in fact that of the introduction by the Act of “functional regulation” to banking matters. (UNCTAD 13) This new approach nevertheless does not really enhance cooperation between the agencies, nor does it reduce the potential risks of inefficiency of a regulatory system shared by too many agencies.
Finally, Gramm-Leach-Bliley legislation does not really provide any remedy to the hazards inherent in the “too-big-to-fail” policy. In effect, by boosting bank’s ability to grow faster and by facilitating cross-industry consolidation, the Act increases risks which can derive from the attitude of authorities toward financial giants. It is obvious now that as a result of GLBA, banking and other classes of financial services organizations across the board are enjoying the benefits of greater regulatory freedom and the ability to make better business decisions on their own merits.
In turn, GLB may just deserve as an unexciting but useful blow for a more rational financial services legal and regulatory environment. In perspective, GLB has placed commercial banking organizations, particularly large ones, back on the road they had begun to travel before the Glass-Steagall Act of 1933 and the Bank Holding Company Act of 1956 terminated the movement toward an American form of universal banking. The future of American banking, then, can be seen as a continuation of the course that had emerged prior to 1933 and that had been held up for nearly 70 years.
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Appendix.
Supervisory Structure of FHCs under GLBA.
