Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before the

38^th^ Annual Conference on Bank Structure and Competition

Chicago, Illinois

May 9, 2002

The independence of bank supervision is not likely to find its way on to
the list of America\'s great contributions to popular government. But
given what we increasingly know about the vital role that independent
supervision plays in maintaining financial stability, it may be time for
a new list. The importance of supervisory independence \-- and what we
must do to [keep]{.underline} U.S. supervision effective and independent
\-- are the subjects I\'d like to discuss with you this afternoon.

Certainly the subject has a long history. In 1829, when New York State
legislators created the nation\'s first truly professional bank
supervisory agency, they took steps to ensure that it would be able to
operate free of political influences and pressures. So did the
legislators who created the national banking system in the 1860s. They
created the Office of the Comptroller of the Currency as a \"separate
bureau\" within the Treasury Department. They provided the Comptroller
with a five-year term and protections against premature removal from
office. The first bill that passed Congress forbade the Comptroller\'s
removal except with the approval of the Senate \-- an extraordinary
requirement. But in amended legislation, that \"advice and consent\"
requirement was dropped \-- not because of second thoughts about the
importance of protecting the Comptroller\'s independence, but in
recognition of the practical difficulty of reassembling a recessed
Senate \-- in those days, the Senate was not in virtually continuous
session, as it is today \-- to deal with a Comptroller whose conduct
merited removal. Indeed, the Senate recognized \"the force of the
argument that \[the Comptroller\] ought to be in a great degree
independent.\"

Congress even contemplated moving the OCC to New York or Philadelphia,
so the Comptroller would not have to contend with the bleating and
pleading of the lobbyist crowd. And the founders of the national banking
system expressed their commitment to supervisory independence when they
chose to fund the examination of national banks from fees and
assessments on the banks themselves, rather than entangling the OCC\'s
performance of bank supervision in the political give-and-take of the
federal budget and appropriations process.

The legislative debate on the National Bank Act of 1864 may have been
brief, but supervisory independence \-- and how best to safeguard it \--
was central to it. And the authors of that legislation took great pride
in the success they believed they had achieved in promoting it.

It\'s important to note, moreover, that the independence of supervision
is not simply an interesting bit of historical trivia. It has been
reinforced repeatedly by Congress, even up to recent years. Within the
past decade, for example, Congress has passed additional measures
forbidding the Treasury Department from intervening in any matter or
proceeding before the OCC, or from delaying or preventing the issuance
of any rule or regulation by the OCC, and it has expressly permitted the
agency to submit legislative recommendations and testimony to Congress
without prior approval or review in the Executive Branch.

It\'s also important to note that this is not an issue of purely
domestic relevance. Experience in other countries, where the tradition
of supervisory independence may be weak or nonexistent, reminds us that
there\'s a steep price to be paid when supervisors are unable or
unwilling to conduct their business independently.

Indeed, the absence of supervisory independence has been implicated in
almost every national financial crisis the world has recently seen. In
Argentina, South Korea, Thailand, Japan, Turkey, and Indonesia, bank
supervisors were unable to operate with the independence their
responsibilities demanded. In each case, supervisors became instruments
of government or central bank policies that subordinated the safety and
soundness of financial institutions to other goals. In each case, banks
were permitted \-- or even encouraged \-- to make loans in defiance of
good credit practices in order to promote certain policy objectives,
such as protecting inefficient industries. Moreover, in each case, the
result was the same: supervision was discredited; the condition of the
banking system deteriorated; the national economy suffered; and the
process of recovery was seriously impeded by a crippled banking system.
Some countries are still struggling with the consequences of such
ill-advised supervisory policies.

These experiences help explain why, when the Basel Committee on Banking
Supervision adopted its core principles for effective supervision in
1997, \"operational independence and adequate resources\" headed the
list. And the experiences of other countries remind us of the importance
of vigilance in defending supervisory independence here at home.

Supervisory independence in this country has also seen its share of
challenges. During the Great Depression of the 1930s, for example, there
was strong sentiment that federal bank supervisors should align
themselves behind the monetary and macroeconomic policies of the
Treasury Department and the Federal Reserve. Many people thought that
the Comptroller of the Currency should encourage national banks to make
loans to good borrowers and bad borrowers alike, and to look the other
way as credit quality deteriorated. This view was frequently expressed
in terms of countercyclicality \-- that bank examiners ought to promote
the cause of growth and easy credit when the economy was in a slump and
enforce credit restraint when the economy was in danger of overheating.

Fortunately, the firewalls erected by Congress in the 1860s and
buttressed over the years thereafter held strong during the banking
crisis of the Great Depression. The OCC was able to continue supervising
national banks objectively and independently, and the banking system
subsequently regained its strength.

That experience was not lost on a generation of bank supervisors, who
came away convinced that combining monetary policy and supervision would
undermine both. For people like J.L. Robertson, who served as a bank
supervisor for 30 years, first as a Deputy Comptroller of the Currency
and then as a Governor of the Federal Reserve System, it became an
article of faith that \"bank examiners should never be obliged to switch
from rose-colored glasses to black ones, and bank and forth again, in an
effort to implement the monetary policy of the moment.\"

However, the notion that federal bank examiners might be pressed into
service of some larger political or economic agenda lived on \-- and it
lives on today, after a fashion. For evidence one need look no further
than the introduction to our own conference program, where, sure enough,
you'll find the question whether \"regulation and supervision \[should\]
attempt to smooth the business cycle\" on the list of current
supervisory issues.

I believe it\'s a matter of considerable significance, however, that
while we may still debate the idea of using bank supervision as a
macroeconomic tool in forums like this one, the question has essentially
been laid to rest in government circles. Indeed, it has never come up in
any official discussion in which I have participated, either as Under
Secretary of the Treasury for Domestic Finance or as Comptroller of the
Currency. The statutory constraints that limit the ability of Treasury
to become involved in matters at the OCC have been well understood and
scrupulously respected during my experience in the Department. As a
practical matter, I believe, the principle of operational independence
for bank supervisors in this country is no longer open to question.

There\'s another dimension of supervisory independence \-- independence
from the institutions we supervise. In this regard, the chartering and
regulatory choices available to U.S. banks \-- the dual banking system
and the tripartite division of federal regulatory responsibility \--
create certain tensions. The problem was highlighted over 30 years ago
by Federal Reserve Chairman Arthur Burns, who decried what he saw as a
dangerous \"competition in laxity,\" not only between state and national
bank supervisors, but among the various federal regulators as well, each
having an incentive to pursue supervisory and regulatory strategies that
would attract constituents to their particular jurisdictions.

In the game of regulatory competition, a gain to one supervisor usually
means a loss to another, with varying consequences. While it is true,
for example, that a wholesale exodus of banks away from the national
charter could decimate the OCC, a threat equally if not more imposing
might face the Federal Reserve System if there were to be a wholesale
exodus away from state member status. In such an event the Federal
Reserve Banks \-- already facing competitive pressures in other aspects
of their operations \-- could face the need to downsize significantly
their role in supervision. Not only would this have implications for the
Fed\'s monetary policy and discount window functions, but, as the
Reserve Banks were forced to shrink and become less substantial
participants in the financial system, it would have implications for an
important foundation stone of the Fed\'s independence.

We have been willing for many years, in the name of federalism, to
accept whatever implications the mere existence of the dual banking
system might have for supervisory independence, and I am a supporter of
the dual system. But there is an aspect of the dual system \-- the way
in which the costs of supervision are allocated \-- that presents an
even greater threat to the independence of bank supervisors than dual
banking in and of itself \-- a threat that has disproportionately
serious implications for the OCC.

No one would ever accuse the United States of not taking literally the
Basel principle that bank supervisors should have adequate resources at
their disposal. In 2001, the total of supervisory expenditures in this
country amounted to nearly two [billion]{.underline} dollars \-- a
substantial sum by any standard. That covers the supervisory expenses of
the OCC (for national banks), the Federal Reserve (for bank holding
companies and state member banks), and FDIC (for state nonmembers), as
well as the expenses of the 50 state banking authorities.

It\'s how we raise and allocate that vast sum that introduces
irrationality into our system, that potentially undermines its safety
and soundness, and that destabilizes our dual banking system. There\'s
nothing terribly complicated about it. National banks must bear the
entire cost of their supervision, in the form of assessments paid to the
OCC. State banks, by contrast, receive the federal portion of their
supervision \-- far and away the largest component of state bank
supervision \-- at no cost.

To be sure, state banks pay relatively modest fees to their state
supervisors, reflecting the comparatively modest role that many states
play in the supervision of federally insured state banks, compared to
the pervasive roles played by the Fed and the FDIC. As a consequence,
national banks pay on average two and a quarter times more in
supervisory fees than do state banks. While national banks fully
shoulder their costs of supervision, state banks pay only about 22
percent of the costs of their supervision.

That\'s not all. National banks actually subsidize the supervision of
their state-chartered competitors. The FDIC draws on the insurance fund
to cover the expenses of supervising state nonmember banks, yet 55
percent of the balance in the fund reflects insurance premiums paid by
national banks. Thus, 55 percent of the subsidy that the FDIC affords
state banks by absorbing their cost of supervision is, in effect,
provided by national banks. A similar subsidy is delivered by the
Federal Reserve to state member banks, since the costs of Fed
supervision are not passed on to the banks they supervise. In this case,
however, it is taxpayers that bear the cost of the subsidy, since the
funds that the Federal Reserve draws on to absorb the costs of
supervision would otherwise be returned to the Treasury.

Operating in tandem, the freedom that banks have to choose a state or
national charter and to choose their federal regulator,
[and]{.underline} the disparity in the allocation of the costs of
supervision caused by the federal subsidization of state banks, create a
system in which financial institutions have a potential influence in
their relationships with their supervisors.

This influence can be exercised overtly or tacitly \-- and, I hasten to
say, it is not an influence that may be directed only at the OCC. Fee
disparity simply becomes a cost factor for banks to weigh in the
balance. If a bank feels \"oppressed\" by the OCC to the point that the
combined cost of the higher fees and the supervisory \"oppression\"
outweigh the advantages of the national charter, the bank has an
incentive to convert. By the same token, if a state bank feels
\"oppressed,\" either because state law or its federal regulator limits
its flexibility to conduct its business in the manner it desires, the
incremental cost of higher assessments might be outweighed by the appeal
of the national charter.

Fee disparity can have a particularly insidious impact on the OCC,
however, because, unlike our self-funded sister agencies, we must tax
our bankers to maintain our agency. Thus, to the extent fee disparity
encourages conversions to state charter, there is a direct impact on the
OCC\'s budget. In times of severe stress in the economy, this impact
could have serious consequences. As a deteriorating economy translated
into increased problems for banks, supervisors would be confronted with
the need to expand their resources to cope with worsening conditions. At
the OCC this would likely create a need for increased assessments \--
with a commensurate increase in the financial burden on national banks.
Those national banks in the best condition, facing the prospect of
larger assessments needed to deal with problem institutions, would thus
have a strong incentive to convert to the subsidized state charter,
leaving a diminishing number of national banks to bear the costs of an
increasing OCC workload. And of course such conversions do not change at
all the systemic costs of supervision, since the agencies assuming
jurisdiction must pick up the costs of expanding their own supervisory
resources to deal with the converted banks. Conversions thus simply
transfer those costs from the national banks to either taxpayers
generally or to all insured banks. The implications for the independence
of the OCC in such a scenario are self-evident, I believe.

I\'m encouraged to see that there\'s a growing understanding of these
issues, and a consensus that the problems I\'ve been discussing are
problems that must be fixed. The question, of course, is how we should
do that. Any solution we propose must meet several basic criteria. First
and foremost, it should protect and preserve the independence of bank
supervisors. It must also make our system of supervisory funding fairer,
more secure, and more predictable. National banks should not be forced
to subsidize their state-chartered competitors and taxpayers should not
be expected to defray the cost of supervising one favored class of
banks, as is now the case with state member banks that receive free
supervision from the Federal Reserve.

Both state supervisors and the OCC must be freed from the uncertainty
that currently surrounds their funding. At present, we are subject not
only to fluctuations in the economy, but to changes in the structure of
the banking system. Declining on-balance sheet assets mean declining
revenues. And industry consolidation means an increasing reliance on a
shrinking number of institutions. In half the states, a single bank
accounts for 25 percent or more of the asset base on which state
supervisors assess fees. The loss of such a large bank, through either
failure or conversion, could have a crippling effect on a state
supervisor\'s ability to provide quality supervision. Of course, the OCC
could find itself in the same fix.

One suggestion made recently was that the OCC\'s funding concerns should
be addressed through the use of appropriated funds. But if this means
subjecting the supervision of national banks to the budget and
appropriations process, it would clearly be a step in the wrong
direction.

As I described earlier, since the very inception of the national banking
system Congress has scrupulously insulated bank supervision from the
political process \-- just as it has the formulation and execution of
monetary policy. Injecting political considerations into supervision
through the appropriations process would clearly run the risk of
bringing to bear pressures that could undermine the objectivity and
integrity of the critically important work that supervisors perform, and
would make the direction and strength of supervision subject to the
varying priorities of partisan politics. That would be no more desirable
in the area of bank supervision than in respect of monetary policy.

Certainly, if there were any serious case for subjecting bank
supervision to the kind of political oversight involved in the budget
and appropriations process \-- and I see none whatsoever \-- it would be
impossible to rationalize treating [only]{.underline} national banks in
this fashion, while leaving federal supervision of state banks to be
self-funded through the use of the Federal Reserve\'s earnings and the
FDIC insurance fund, with no outside oversight whatsoever.

Of course, the funding of supervision could be rationalized in the
context of legislation reforming the entire structure of federal
supervision of financial institutions \-- a challenge that has
repeatedly been taken up over the past three or four decades. Experience
in the United Kingdom and other countries that have altered their
supervisory structures suggests that serious structural change is not an
impossible goal. Nonetheless, past efforts in the United States have
foundered for at least four reasons:

-   First, the states have always felt that if there were a monolithic
    federal regulator for all banks, the attractiveness of the state
    charter would diminish. Now state banks can choose between the Fed
    and the FDIC as their federal regulator, or they can choose to go to
    a national charter. Those options would be lost under any proposal
    that sought to unify supervision.

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-   Second, a key element of past proposals has generally been to take
    the Fed out of bank supervision. This aspect of restructuring has
    had to confront two major objections: the explicit objection that
    removing the Fed from supervision would deprive it of a \"window
    into the banking system,\" and thus impair its effectiveness in
    implementing monetary policy; and the implicit objection that taking
    the Fed out of supervision would decimate the Reserve Banks and thus
    undermine an important pillar of the Fed\'s independence.

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-   Third, there has never been any appreciable public constituency for
    such change. The banking industry and other interest groups have
    learned to live with \-- and take advantage of \-- the existing
    system, and they have not been anxious to change things. One does
    not even hear a clamor from public interest or consumer groups for
    such change.

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-   Finally, as illogical as it might be, the present system works
    pretty well, and enhanced cooperation and coordination in recent
    years has made it work even better.

While the challenge of addressing the funding problem in the context of
regulatory restructuring is a formidable one, there are alternative
approaches that should be considered \-- measured steps targeted to the
problem that would avoid the difficulties presented by more far-reaching
proposals to dismantle and reassemble the current supervisory structure.

I have proposed that we replace the system under which the OCC and state
supervisors fund themselves through direct assessments, with a system
that would draw on the earnings of the insurance fund. Such an approach
would have multiple advantages:

-   First, it would be supremely logical. After all, protection of the
    insurance fund is a major purpose of bank supervision. Charging the
    costs of supervision to the fund would place supervision on a
    sounder and fairer footing, relieving national banks of the unique
    and discriminatory burden of directly funding the costs of their own
    supervision \-- and of the grossly unfair burden of subsidizing the
    cost of supervision of their state bank competitors.

-   Second, it would promote the equitable and efficient allocation of
    the costs and benefits of deposit insurance, and ensure that all
    supervisors have the resources necessary to provide effective bank
    supervision, regardless of changes in the economy or the structure
    of the banking system.

-   Finally, it would revitalize the dual banking system by eliminating
    the distorting effects of a selective subsidy, while retaining the
    element of charter choice that has long been its hallmark.

Under our proposal, federal and state agencies would jointly formulate
an allocation formula initially calibrated to provide the OCC and state
agencies with resources equivalent to their current levels. This
\"baseline\" allocation would be adjusted annually under the formula to
take account of changes in the composition and condition of each
agency\'s constituent banks, so that allocations from the fund would be
automatic and nondiscretionary. The great benefit of this proposal is
that it would significantly reduce, if not eliminate, reliance on the
federal subsidy to state banks as a major determinant of charter choice.
Banks would then make charter decisions based on such considerations as
the quality of supervision and the suitability of the charter for their
business objectives \-- a far healthier environment for the dual banking
system than at present. It would provide the basis for restoration of
salutary competition among the regulators \-- a \"competition in
excellence,\" that would restore the focus to the qualitative aspects of
charter choice, rather than competition based on subsidized pricing.

There are some who believe that the national charter is so far superior
to the state charter that an equitable allocation of the costs of
supervision would result in a massive outflow of banks from state
systems, and on this ground they oppose our suggested solution. But
while I bow to no one in my enthusiasm for the national charter, the
state charter has significant attributes of its own. Many states have
been very innovative in granting powers to their banks that national
banks do not yet have, and many states have adopted \"wild card\" laws
that allow their banks to exercise many powers permissible for national
banks. No comparable \"reverse wild card\" law affords reciprocal
benefits for national banks. In the area of interstate branching, state
supervisors have been very resourceful in reducing the burdens of
duplicative regulation on banks operating in multiple states, and
Congress has enacted \"equalization\" provisions giving state banks with
interstate branches many of the benefits that national banks have in
that connection.

Whatever one\'s view might be of the relative merits of the two
charters, however, I think it\'s fair to say that the state charter is
not in such a state of decrepitude that it needs almost a billion
dollars a year in federal subsidies to shore it up \-- particularly
subsidies that are delivered not pursuant to congressional mandate, but
through the discretionary decisions of those federal regulators who have
a self-interest in maintaining these banks as their constituents. If,
indeed, an elimination of these subsidies would result in a major
outflow of state banks to the national charter, we should all be
alarmed, and we should focus on more fundamental concerns about state
systems. Similarly, maintenance of a subsidy that is intended to protect
the role of the Federal Reserve Banks in supervision diverts attention
from what may be more significant structural issues in the Federal
Reserve System. If there [is]{.underline} reason to have such concerns,
we should address them more forthrightly, and we should not obscure them
with subsidy practices that have the purpose or effect of maintaining a
particular regulatory share of market.

But I do not for a minute think that elimination of the subsidy would
cause an exodus of state banks. Supervisory costs are naturally a
concern for all banks, but I don\'t believe that major banking
organizations make their charter choice simply on the basis of
supervisory fees. I see no reason, to put a somewhat finer point on it,
why the Federal Reserve should be concerned that its perfectly
legitimate interest in being meaningfully involved with the banking
system would be undermined if the discriminatory cost burden now borne
by national banks were eliminated.

When we began to talk about the fee disparity issue in public nearly two
years ago, it was the target of a fair amount of derision. Predictably,
those who derided it most were many of the same people who were
benefiting most from the subsidies I\'ve been discussing.

Now I think it\'s widely acknowledged that we do need to revisit the way
we fund bank supervision. But the changes needn\'t \-- and shouldn\'t
\-- be radical ones. Ungainly though it is, our system of supervision
has been too successful to scuttle. Indeed, our goal should be to
strengthen our supervisory system by preserving and enhancing
independence.

I believe that the proposal I have sketched today meets that standard. I
commend it to your attention \-- and look forward to continuing the
dialogue well underway with everyone who has a stake in the issue.