Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before the

University of North Carolina School of Law

Center for Banking and Finance

Charlotte, North Carolina

April 5, 2001

It's a pleasure once again to be a participant in the University of
North Carolina School of Law's Banking Institute, being offered for the
first time under the auspices of the new Center for Banking and Finance.
The Center's commitment to teaching, scholarship, and service to the
banking and law communities will be of immense value \-- and a source of
immense pride \-- to North Carolina and the whole nation in the coming
years. I congratulate the faculty and staff who have worked so hard to
transform the Center from a vision into a reality.

The last time I was with the Institute was in Chapel Hill, and I spoke
to you then about financial modernization and the legislation that went
on to become the Gramm- Leach-Bliley Act of 1999. Since we have decamped
to Charlotte for this program, it seems fitting to turn to a subject
that, for many, virtually defines this great city. That subject is
consolidation in the financial services industry \-- a trend that gave
impetus to GLBA, and that has, in turn, been given impetus by it.

The FDIC recently released its "Quarterly Bank Profile," covering the
last three months of 2000, and that report reminded us again of how far
industry consolidation has come. In 1985, there were no fewer than
14,400 insured commercial banks in the United States. That number has
shrunk every year since then, leaving us with around 8300 banks today.
And of course this shrinkage understates the true level of merger and
acquisition activity, for the aggregates include the new charters that
are added to the system each year.

Closer inspection of the FDIC's latest numbers actually reveals some
slowdown in the rate of consolidation from the frenetic pace of earlier
years, and that trend also seems likely to continue for some time. It
may be related to the slowdown in the economy or it may simply indicate
that the industry is still busy digesting earlier acquisitions \-- or
both. But I have not heard anyone suggest that we've finally reached
critical mass, and, with more than 8000 independent banks still on the
scene, there seems to be ample opportunity for further consolidation to
occur.

If history is a guide, North Carolina will be in the forefront of
whatever innovations are in the industry's future. This is a safe
prediction now, but who would have predicted 15 or 20 years ago that
Charlotte would become one of the world's great banking centers \-- or,
indeed, that the structure of banking in the United States would look
like it does today? So much has changed over that time that it's easy to
forget what the banking landscape looked like before the leaders of
Charlotte's banking community set out to transform it.

Twenty years ago, banking was essentially a local business. Indeed, a
guiding principle for antitrust analysis of bank mergers, first
articulated by the Supreme Court in the mid-1960s, was that banking
markets are primarily local in character. That principle was buttressed
by pervasive legal constraints designed to prevent the geographic
expansion of banks \-- constraints that protected competitors, but
deprived banking customers of the efficiencies of open markets and real
competition. During the 1980s, those barriers started to fall as leaders
like Hugh McColl and Ed Crutchfield brought their intellect,
imagination, and energy to bear on the business. Because of their vision
\-- and their relentless pursuit of a competitive marketplace \-- we
have today a genuinely national, and enormously competitive, banking
system. Charlotte has become one of its capitals.

Those who opposed these efforts and sought to retain the insulation from
competition that banks had traditionally enjoyed argued that a more
consolidated industry would be unresponsive to local needs and
impossible to supervise. But neither concern has been borne out. Changes
of name and ownership involve adjustments on all sides, but most
customers have found that they now enjoy the best of both worlds \--
personalized, highly responsive service [and]{.underline} access to a
comprehensive range of financial products. For example, the evidence
suggests that small business loans and financing for community
development projects are [more]{.underline} readily available now than
they ever have been. And where there was any basis for believing that a
merger might result in less responsiveness to local needs, new
entrepreneurs have been quick to enter the market with newly chartered
institutions.

For our part, I believe that regulators have demonstrated over time that
we're fully capable of adapting to the supervisory challenges presented
by a restructuring industry. Today large bank supervision has become a
continuous process rather than an episodic event. In our large bank
program, which covers almost 30 of the country's largest banks, we now
maintain full-time teams of resident examiners, who cover not only basic
safety and soundness supervision, but all of the other specialties, as
well \-- capital markets, compliance, asset management, MIS, and so on.
More than 350 dedicated OCC examiners and support staff \-- men and
women specifically trained to identify and address the existing and
emerging risks associated with complex banking organizations \-- staff
our large bank program, which has been widely studied and emulated by
other U.S. and many foreign bank supervisory agencies. With this
experience in supervising Iarge, complex banking institutions, I'm
confident that our capabilities are equal to whatever supervisory
challenges a consolidating industry poses in the years ahead \-- just as
they have been in the past.

However, there is an Achilles heel in our supervisory system, and it's a
vulnerability that's grown increasingly troublesome as the industry
confronts a possible turn in the economy, and that is the way in which
supervision is funded. It was considered quite a significant reform
when, back in the early twentieth century, the country converted from an
arrangement under which banks paid a flat fee for their examinations to
one that assessed banks on a sliding scale based initially on their
total capital and then on their assets. That reform eliminated the
incentive for examiners to cram as many exams as possible into a
workweek in order to maximize their income.

This change also introduced other, less desirable incentives. For a long
time, higher supervisory assessments were considered a small price to
pay for growth, and banks paid them, for the most part, without a second
thought. But two recent developments changed that. First, a more
competitive financial marketplace and intensifying cost pressures have
made bankers more attuned even to relatively small opportunities for
savings. Second, and more important, we have seen a change in the nature
of the competition for membership that lies at the heart of our dual
banking system. Traditionally, a banker's choice between a national or
state charter centered on such qualities as supervisory philosophy and
responsiveness, examination quality, permissible activities, and cost.
But with the narrowing of differences between the powers available to
state and national banks, in large part due to state wild-card statutes,
and with the lessening of burdens on state banks' interstate operations
brought about by parity legislation and by agreements among the states,
that competition has focused more and more on assessments and the cost
of supervision.

This has had both positive and negative consequences. On one hand,
sensitivity to supervisory costs has encouraged the OCC and state
supervisors to be extremely careful about their spending. Efficiency has
long been heralded as a major advantage of the dual banking system, and
there's little doubt that the burdens of supervision, financial and
otherwise, might be greater but for the responsiveness of the OCC and
state supervisors to the need to be more efficient. Of course, the most
substantial portion of the costs of supervising state banks are those of
the Federal Reserve and the FDIC, who perform for state-chartered banks
exactly the same functions that OCC performs for national banks, but
without imposing any charge for their services, as must the OCC. Because
those agencies are essentially self-funded \-- unlike the OCC, which is
almost totally dependent on the assessment revenue it collects from
national banks \-- they are not subject to the external pressures for
efficiency that work alike on state supervisors and the OCC.

Still, it has to be recognized that the effectiveness of supervision can
suffer, and serious inequities can result, if these pressures get out of
hand. Consider, for example, what happened during the wave of large bank
failures in the late 1980s and early 1990s \-- a period of stress in the
banking system that had not been seen since the Great Depression.
Excruciating demands were placed on supervisors to staff up in order to
manage the exigencies of a banking system under severe pressures. Yet
just as these demands were being felt, the system was contracting as
banks failed, thereby reducing the base on which fees could be increased
to support the increased costs. At the OCC this meant significant
increases in assessments \-- 14 percent in 1989, another 11 percent in
1991, and a whopping 30 percent in 1992. To be sure, there was a series
of reductions in subsequent years, but one conclusion is inescapable:
well-managed banks \-- the survivors \-- were forced to bear significant
additional costs to support the supervisory resources needed to deal
with problem institutions. This is a perversity in the system that must
be addressed before we experience any repeat of the conditions that
created such pressures.

Even in good times there are perversities in an assessment-based system
of funding supervision. The restructuring of the industry over the past
15 years, for example, has had adverse effects on both the OCC and state
bank regulators. Every time there is a merger between a state bank and a
national bank, one or the other system will lose a member \-- and the
larger the bank, the larger the loss of revenue. Even apart from
mergers, where a large multibank holding company with banks in several
states "rolls up" its subsidiaries into a single bank with an interstate
branch network \-- something that's happening ever more frequently since
the passage of the Riegle - Neal Interstate Banking and Branching
Efficiency Act of 1994 \-- there will be a loss to either system. The
OCC's assessments will be diminished because marginal assessment rates
decline as the size of the consolidated bank increases. And in the case
of a state bank "roll up," each state in which a separate charter
previously existed other than the home state of the consolidated bank
will lose dues-paying members.

The effect of these changes on state banking systems, which already
spread their expenses over a smaller base of institutions, can be very
significant. In 24 of the 50 states, a single large state-chartered
institution accounts for 25 percent or more of all state chartered
assets \-- and, presumably, more than 25 percent of the total assessment
revenues of the state banking authority. Thus, the loss of a large state
bank in those states has the potential for significantly weakening the
support for state bank supervision.

A healthy system of state bank supervision is very much in the national
interest \-- not only to maintain a vigorous and dynamic dual banking
system, but also to protect important federal interests, for the federal
"safety net" stands behind all insured banks, irrespective of charter.
Thus, to paraphrase John Donne, don't ask for whom the bell tolls when a
large state bank exits the state system: it tolls for all of us.

The question, of course, is what to do about this. I have already stated
publicly that the direct imposition of new federal fees on state banks
is not a politically viable approach \-- even though there is no basis
for justifying the federal subsidy that is presently delivered by the
Fed and the FDIC. I believe we must come up with a new method of funding
bank supervision \-- a method that will strengthen both the federal and
state supervisory processes, protect them from the impact of random
structural changes, and ensure that all supervisors, state and national,
have adequate, predictable resources available to carry out effective
supervisory programs.

There are a number of alternative approaches that one might consider,
and I believe that now is the ideal time to do so, as the whole topic of
the role of deposit insurance is being reexamined. An idea that I think
has considerable appeal would draw on the earnings of the FDIC's
insurance funds to defray the costs of both state and national bank
supervision. Today, with the funds aggregating about \$41 billion, and
generating earnings of more than \$2 billion per year, there would be
considerably more funds available to defray the costs of FDIC, OCC, and
state supervision than those agencies today spend in total. Working
together, and using the present costs of supervision as a baseline,
state and federal supervisors could develop an allocation formula that
would reflect not only the breadth of responsibilities of the agencies,
but the condition, risk profile, size, and operating environment of the
banks they supervise. All agencies would remain free to impose
supplemental assessments if they chose, but competitive pressures would
presumably work to keep these charges at a minimum.

This arrangement would offer several meaningful advantages. First, it
would remedy the inequity to national banks that exists today, resulting
from the fact that the FDIC already funds its supervision of state banks
out of the earnings of the deposit insurance funds, to which
[all]{.underline} banks have contributed. We estimate that national
banks account for 52 percent of the contributions to the bank insurance
fund since the resources of that fund were exhausted in 1991.
Considering that the FDIC spent about \$590 million on state nonmember
bank supervision in 1999, national banks can be viewed as having
contributed about \$300 million to the FDIC's costs of supervision \--
this in addition to the \$384 million in assessments they paid to the
OCC for their own supervision.

Of course, there are other roads we might take to placing our
supervisory funding on a sounder and fairer basis. The inequity of
requiring national banks to pay a share of the cost of supervising
state-chartered banks could be remedied by having the FDIC return to
national banks \-- or to the OCC, for pass-through to national banks \--
that portion of their insurance premium that is currently diverted to
supervision. Such an approach would get national banks out of the
business of subsidizing their competitors, with relatively minor impact
on FDIC resources.

But ending this anomaly is not just a matter of fairness to national
banks. The very constructive debate now taking place on the future of
deposit insurance, and the role that a truly risk-based system of
insurance can play in bank supervision, has stressed the importance of
allocating the costs and benefits of insurance in an equitable and
efficient manner. Separating the actual costs of the FDIC's supervisory
functions from the costs of providing deposit insurance is an essential
step toward efficient and rational pricing of both.

There's a second major advantage of a system under which the OCC and the
state supervisory agencies would be funded out of the earnings on the
insurance funds. I believe it would reinvigorate the dual banking
system. Although there has always been an assessment differential
between state and national charters \-- and, given the federal subsidy
to state banks, it has often been substantial \-- most banks are likely
to choose their charters more on the basis of such non-financial factors
as regulatory philosophy, access, and the perceived quality of
supervision. Indeed, the size and health of the national banking system
is testimony to this conclusion. Banks would still be free to choose
under the system I've described, but those factors would almost
certainly loom larger in a regime that was more equitable with regard to
supervisory charges, and that encouraged competition in those qualities
that are more relevant to a safe and sound banking system.

The devil is always in the details, of course, and obviously the
approach I've suggested this evening is little more than that \-- a
concept that requires a full airing and fleshing out. That's what I'm
proposing to begin today. I would like to stimulate a broad dialogue
among all of the interested parties and policy makers. Through such a
dialogue, I believe we can develop concrete proposals to overhaul the
current system, and replace it with one that supports rather than
undermines our ability to achieve common goals.

There's no doubt in my mind that we have the tools and the expertise to
effectively supervise the banking industry of today and tomorrow,
whatever form it takes. That's especially true if all who play a role in
our supervisory system work and compete constructively and not at
cross-purposes. The time to start is now.