a

GAO

United States Government Accountability Office

Report to the Chairman, Committee on 

Banking, Housing, and Urban Affairs,

U.S. Senate

October 2004 FINANCIAL 

REGULATION

Industry Changes 

Prompt Need to 

Reconsider U.S. 

Regulatory Structure

GAO-05-61
www.gao.gov/cgi-bin/getrpt?GAO-05-61. 

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Thomas J. 

McCool at (202) 512-8678 or 

mccoolt@gao.gov. 

Highlights of GAO-05-61, a report to the 

Chairman, Committee on Banking, 

Housing, and Urban Affairs, U.S. Senate 

October 2004

FINANCIAL REGULATION 

Industry Changes Prompt Need to 

Reconsider U.S. Regulatory Structure 

The financial services industry has changed significantly over the last several 

decades. Firms are now generally fewer and larger, provide more and varied 

services, offer similar products, and operate in increasingly global markets. 

These developments have both benefits and risks, both for individual 

institutions and for the regulatory system as a whole. Actions that are being 

taken to harmonize regulations across countries, especially the Basel 

Accords and European Union Financial Services Action Plan, are also 

affecting U.S. firms and regulators. While the financial services industry and 

the international regulatory framework have changed, the regulatory 

structure for overseeing the U.S. financial services industry has not. 

Specialized regulators still oversee separate functions—banking, securities, 

futures, and insurance—and while some regulators do oversee complex 

institutions at the holding company level, they generally rely on functional 

regulators for information about the activities of subsidiaries. In addition, 

no one agency or mechanism looks at risks that cross markets or industry 

segments or at the system and its risks as a whole. 

Although a number of proposals for changing the U.S. regulatory system 

have been put forth, the United States has chosen not to consolidate its 

regulatory structure. At the same time, some industrial countries—notably 

the United Kingdom—have consolidated their financial regulatory 

structures, partly in response to industry changes. Absent fundamental 

change in the overall regulatory structure, U.S. regulators have initiated 

some changes in their regulatory approaches. For example, starting with 

large, complex institutions, bank regulators, in the 1990s, sought to make 

their supervision more efficient and effective by focusing on the areas of 

highest risk. And partly in response to changes in European Union 

requirements, SEC has issued rules to provide consolidated supervision of 

certain internationally active securities firms on a voluntary basis. 

Regulators are also making efforts to communicate in national and 

multinational forums, but efforts to cooperate have not fully addressed the 

need to monitor risks across markets, industry segments, and national 

borders. And from time to time regulators engage in jurisdictional disputes 

that can distract them from focusing on their primary missions. 

GAO found that the U.S. regulatory structure worked well on some levels but 

not on others. The strength and vitality of the U.S. financial services 

industry demonstrate that the regulatory structure has not failed. But some 

have questioned whether a fragmented regulatory system is appropriate in 

today’s environment, particularly with large, complex firms managing their 

risks on a consolidated basis. While the structure of the agencies alone 

cannot ensure that regulators achieve their goals—agencies also need the 

right people, tools, and policies and procedures—it can hinder or facilitate 

their efforts to provide consistent, comprehensive regulation that protects 

consumers and enhances the delivery of financial services. 

In light of the passage of the 1999 

Gramm-Leach-Bliley Act and 

increased competition within the 

financial services industry at home 

and abroad, GAO was asked to 

report on the current state of the 

U.S. financial services regulatory 

structure. This report describes 

the changes to the financial 

services industry, focusing on 

banking, securities, futures, and 

insurance; the structure of the U.S. 

and other regulatory systems; 

changes in regulatory and 

supervisory approaches; efforts to 

foster communication and 

cooperation among U.S. and other 

regulators; and the strengths and 

weaknesses of the current 

regulatory structure. 

While GAO is not recommending a 

specific alternative regulatory 

structure, Congress may wish to 

consider ways to improve the 

regulatory structure for financial 

services, especially the oversight of 

complex, internationally active 

firms. Options to consider include 

consolidating within regulatory 

areas and creating an entity 

primarily to oversee complex, 

internationally active firms, while 

leaving the rest of the regulatory 

structure in place. Federal 

financial regulators provided 

comments on these options. 
Page i GAO-05-61 Financial Regulation

Contents

Letter 1

Executive Summary 3

Purpose 3

Background 4

Results in Brief 6

GAO’s Analysis 11

Matter for Congressional Consideration 19

Agency Comments and Our Evaluation 23

Chapter 1

Introduction

25

Traditionally, Financial Institutions Served as Intermediaries and 

Transferred Some Risks 26

The Financial Services Industry Faces Risks at the Institutional 

Level and Systemwide 29

U.S. Financial Services Regulation Has Multiple Goals 30

U.S. Financial Regulatory System Includes a Variety of Regulatory 

Bodies 31

The United States Participates in International Organizations 

Dealing with Regulatory Issues 39

Objectives, Scope, and Methodology 41

Chapter 2

The Financial Services 

Industry Has 

Undergone Dramatic 

Changes

44

Financial Services Have Played an Integral Part in Globalization 44

Large Institutions Have Become Larger through Consolidation and 

Conglomeration 46

Roles of Large Financial Services Firms Have Changed and Financial 

Products Have Converged, but Some Differences Remain 51

As Financial Services Institutions Have Diversified, Introduced New 

Products, and Become More Complex, Risks Have Changed 56
Contents

Page ii GAO-05-61 Financial Regulation

Chapter 3

While Some Countries 

Have Consolidated 

Regulatory Structures, 

the United States Has 

Chosen to Maintain Its 

Structure

62

Some Countries and States Have Consolidated Their Regulatory 

Structures 62

United States Has Chosen to Maintain the Federal Regulatory 

Structure, although Proposals Have Been Made to Change It 73

Chapter 4

Regulators Are 

Adapting Regulatory 

and Supervisory 

Approaches in 

Response to Industry 

Changes 

83

New Basel II Structure and EU Requirements Will Likely Affect 

Oversight of U.S. Financial Institutions 83

U.S. Regulators Have Made or Considered Some Other Changes to 

Their Regulatory and Supervisory Approaches in Response to 

Industry Changes 89

Chapter 5

Regulators 

Communicate and 

Coordinate in Multiple 

Ways, but Concerns 

Remain 

97

U.S. Financial Regulators Communicate and Coordinate with Other 

Regulators in Their Sectors, but Sometimes Find It Difficult to 

Cooperate 97

Financial Services Regulators Also Communicate across Financial 

Sectors, but Do Not Effectively Identify Some Risks, Fraud, and 

Abuse That Cross Sectors 105

Chapter 6

The U.S. Regulatory 

System Has Strengths, 

but Its Structure May 

Hinder Effective 

Regulation 

113

U.S. Financial Services Regulatory System Has Generally Been 

Successful but Lacks Overall Direction 113

Structure of U.S. Financial Services Regulatory System May Not 

Facilitate Oversight of Large, Complex Firms 117

Structure of U.S. Financial Services Regulatory System May Not 

Facilitate Response to Increased Globalization 122
Contents

Page iii GAO-05-61 Financial Regulation

Regulators Provide Some Other Benefits by Specializing in 

Particular Industry Segments or Geographic Units, but 

Specialization Has Costs As Well 123

Chapter 7

Congress May Want to 

Consider Changes to 

the U.S. Regulatory 

Structure 

126

Matter for Congressional Consideration 128

Agency Comments and Our Evaluation 132

Appendixes

Appendix I: Comments from the Board of Governors of the Federal 

Reserve System 137

Appendix II: Comments from the Federal Deposit Insurance 

Corporation 140

Appendix III: Comments from the Office of the Comptroller of the 

Currency 143

Appendix IV: Comments from the Office of Thrift Supervision 146

Appendix V: Comments from the Securities and Exchange Commission 159

Appendix VI: GAO Contacts and Staff Acknowledgments 161

GAO Contacts 161

Staff Acknowledgments 161

Related GAO Products 162

Table Table 1: Selected Retail Products by Financial Institution and 

Function 55

Figures Figure 1: Traditional Role of Financial Intermediaries 26

Figure 2: International Debt Securities, 1987-2004 45

Figure 3: Share of Assets in Each Sector Controlled by 10 Largest 

Firms, 1996-2002 47

Figure 4: Merger Activity among Banking Organizations, January 

1990-June 2004 49

Figure 5: Number of Futures Contracts Traded, 1995-2003 54
Contents

Page iv GAO-05-61 Financial Regulation

Figure 6: Structure of a Hypothetical Financial Holding 

Company 57

Figure 7: The Three Pillars of Basel II 85

Figure 8: United States—EU Regulatory Dialogue 109

Figure 9: Regulators for a Hypothetical Financial Holding 

Company 120

Abbreviations

AFM Netherlands Authority for the Financial Markets

APRA Australian Prudential Regulation Authority

ASIC Australian Securities and Investments Commission

BaFin German Federal Financial Supervisory Authority (Die 

Bundesanstalt für Finanzdienstleistungsaufsicht) 

CESR Committee of European Securities Regulators

CFMA Commodity Futures Modernization Act

CFTC Commodity Futures Trading Commission

CRS Congressional Research Service

CSE consolidated supervised entity

EU European Union

FBIIC Financial and Banking Information Infrastructure

Committee 

FCM futures commission merchant

FDIC Federal Deposit Insurance Corporation

FFIEC Federal Financial Institutions Examination Council

FSF Financial Stability Forum

GLBA Gramm-Leach-Bliley Act

IAIS International Association of Insurance Supervisors

ILC industrial loan companies

IMF International Monetary Fund

IOSCO International Organization of Securities Commissions

ISG Intermarket Surveillance Group

Japan-FSA Financial Services Authority of Japan

LTCM Long-Term Capital Management 

NAIC National Association of Insurance Commissioners

NASDAQ Nasdaq Stock Market Inc.

NCUA National Credit Union Administration

NFA National Futures Association

NYSE New York Stock Exchange

OCC Office of the Comptroller of the Currency
Contents

Page v GAO-05-61 Financial Regulation

OTC over the counter 

OTS Office of Thrift Supervision

SEC Securities and Exchange Commission

SIA Securities Industry Association

SIBHC supervised investment bank holding company

SRO self-regulatory organization

UK-FSA Financial Services Authority of the United Kingdom

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Page 1 GAO-05-61 Financial Regulation

United States Government Accountability Office

Washington, D.C. 20548

A

October 6, 2004 Letr

The Honorable Richard C. Shelby

Chairman

Committee on Banking, Housing, and Urban Affairs

United States Senate

Dear Mr. Chairman:

This report responds to your request that we analyze the present financial 

services regulatory structure. As you requested, this report (1) describes 

the changes in the financial services industry over recent decades, (2) 

describes changes that have occurred in the U.S. regulatory structure and 

those of other industrialized countries, (3) describes major changes in U.S. 

financial market regulation, (4) discusses efforts to communicate, 

coordinate, and cooperate across agencies in the present system, and (5) 

assesses the strengths and weaknesses of the present financial regulatory 

structure. This report includes a Matter for Congressional Consideration.

As agreed with your office, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days from its 

issue date. We will then send copies to the Ranking Minority Member of the 

Committee on Banking, Housing, and Urban Affairs; the Chairman and 

Ranking Minority Member of the House Committee on Financial Services; 

the Secretary of the Department of the Treasury; the Chairman of the Board 

of Governors of the Federal Reserve System; the Chairman of the Federal 

Deposit Insurance Corporation; the Comptroller of the Currency; the 

Director of the Office of Thrift Supervision; the Chairman of the Securities 

and Exchange Commission; the Chairman of the Commodity Futures 

Trading Commission; the President of the National Association of 

Insurance Commissioners; and other interested parties. Copies will also be 

made available to others upon request. In addition, this report will be 

available at no charge on the GAO Web site at http://www.gao.gov. 
Page 2 GAO-05-61 Financial Regulation

This report was prepared under the direction of James M. McDermott, 

Assistant Director. Please contact Mr. McDermott at (202) 512-5373 or me 

at (202) 512-8678 if you or your staff have any questions about this report. 

Major contributors to this report are listed in appendix VI.

Sincerely yours,

Thomas J. McCool

Managing Director, Financial Markets and

 Community Investment
Page 3 GAO-05-61 Financial Regulation

Executive Summary

Purpose It is 5 years since Congress passed the landmark Gramm-Leach-Bliley Act 

(GLBA). In some ways, this act recognized the blurring of distinctions 

among banking, securities, and insurance activities that had already 

happened in the marketplace and codified regulatory decisions that had 

been made to deal with these industry changes. While recognizing industry 

and regulatory changes, that act changed neither the number of regulatory 

agencies nor, in most cases, the primary objectives and responsibilities of 

the existing agencies. The result of the blurring of distinctions among the 

traditional financial services sectors, recognized by GLBA, has enlarged the 

number and types of competitors facing any firm, both domestically and 

internationally. Thus, what is happening abroad from a regulatory 

perspective could impact the competitive position of U.S. financial services 

institutions and the ability of U.S. regulators to achieve their objectives. On 

this front, many other industrialized countries are consolidating their 

financial regulatory structures, and international forums are nearing 

completion of important efforts to harmonize regulation across countries. 

To better understand the effectiveness of the U.S. regulatory system in this 

changing environment, the Chairman of the Committee on Banking, 

Housing, and Urban Affairs requested an analysis of the present regulatory 

structure. In particular, this report

• describes the changes in the financial services industry over recent 

decades;

• describes changes that have occurred in the U.S. regulatory structure 

and those of other industrialized countries;

• describes major changes in U.S. financial market regulation;

• discusses efforts to communicate, coordinate, and cooperate across 

agencies in the present system; and 

• assesses the strengths and weaknesses of the present financial 

regulatory structure.

To meet these objectives GAO drew on its past work, reviewed other 

relevant literature, conducted interviews with officials of federal and state 

regulatory agencies, financial services industry representatives, and other 

experts in the United States, the United Kingdom, Belgium, and Germany 

and collected and analyzed data on industry changes and regulatory 
Executive Summary

Page 4 GAO-05-61 Financial Regulation

activities. We conducted our work between June 2003 and July 2004 in 

accordance with generally accepted government auditing standards in 

Washington, D.C.; Boston; Chicago; New York City; Brussels, Belgium; 

London; and Berlin, Bonn, and Frankfurt, Germany.

Background An efficient and effective financial services sector promotes economic 

growth through the optimum allocation of financial capital. Achieving that 

outcome rests primarily with the industry; however, in some cases the 

market may not produce the most desirable outcomes and some form of 

regulatory intervention is needed. In the United States, laws define the 

roles and missions of the various regulators, which, to some extent, are 

similar across the regulatory bodies. Regulators generally have three 

objectives: (1) ensuring that institutions do not take on excessive risk; (2) 

making sure that institutions conduct themselves in ways that limit 

opportunities for fraud and abuse and provide consumers and investors 

with accurate information and other protections that may not be provided 

by the market; and (3) promoting financial stability by limiting the 

opportunities for problems to spread from one institution to another. 

However, laws and regulatory agency policies can set a greater priority on 

some roles and missions than others. In addition, the goals and objectives 

of the regulatory agencies have developed somewhat differently over time, 

such that bank regulators generally focus on the safety and soundness of 

banks, securities and futures regulators focus on market integrity and 

investor protection, and insurance regulators focus on the ability of 

insurance firms to meet their commitments to the insured. 

Generally, banking and securities activities are regulated at both the state 

and federal levels, while futures are regulated primarily at the federal level 

and insurance at the state level. For banking activities, the Federal Reserve 

System (Federal Reserve)—including the Board of Governors and the 12 

Federal Reserve Banks—the Office of the Comptroller of the Currency 

(OCC), the Office of Thrift Supervision (OTS), the Federal Deposit 

Insurance Corporation (FDIC), and the National Credit Union 

Administration (NCUA) are the primary federal regulators. For securities 

activities, the Securities and Exchange Commission (SEC) is the primary 

federal regulator, and for futures products, the Commodity Futures Trading 

Commission (CFTC) is the primary regulator. In addition, self-regulatory 

organizations under SEC or CFTC jurisdiction provide oversight of 

securities and futures dealers and exchanges. State regulators also provide 

oversight of banking, securities, and insurance. For commercial and 

savings banks with state bank charters, state banking departments charter 
Executive Summary

Page 5 GAO-05-61 Financial Regulation

the entity and have supervisory responsibilities, while the Federal Reserve 

or FDIC serve as the primary federal supervisor for these banks.1

 For 

securities, states generally provide oversight to protect fraud and abuse 

against within their jurisdictions. In contrast to these products or activities, 

which are either regulated primarily at the federal level or through a dual 

system of state and federal regulation, insurance products are regulated 

primarily at the state level. Organizationally, some regulatory agencies 

(OCC and OTS) are part of the Department of the Treasury (Treasury), 

while the others are independent entities or commissions. While OCC and 

OTS are part of Treasury, their heads are appointed by the President and 

approved by the Congress for fixed terms to ensure their independence. 

The U.S. regulatory system for financial services is described as 

“functional,” so that financial products or activities are generally regulated 

according to their function, no matter who offers the product or 

participates in the activity. Broker-dealer activities, for instance, are 

generally subject to SEC’s jurisdiction, whether the broker-dealer is a 

subsidiary of a bank holding company subject to Federal Reserve 

supervision or a subsidiary of an investment bank. The functional regulator 

approach is intended to provide consistency in regulation and avoid the 

potential need for regulatory agencies to develop expertise in all aspects of 

financial regulation. 

Some firms engaged in the provision of banking, insurance, securities, or 

futures products and activities in the United States are also required by 

statute to be regulated at the holding company level. These include bank 

holding and financial holding companies that are regulated by the Federal 

Reserve, and thrift holding companies that are regulated by OTS. In 

addition, SEC has statutory authority to oversee investment bank holding 

companies, if they choose to be overseen in that way. 

U.S. regulators conduct their activities within a broad array of international 

forums and agencies. Some, such as the Basel Committee on Banking 

Supervision (Basel Committee), International Organization of Securities 

Commissions, and International Association of Insurance Supervisors, are 

voluntary organizations of supervisors from a number of countries. In 

addition, activities in the European Union—a treaty-based organization of 

European countries in which those countries cede some of their 

1

OTS is the supervisor for state-chartered saving associations that belong to the Savings 

Association Insurance Fund.
Executive Summary

Page 6 GAO-05-61 Financial Regulation

sovereignty so that decisions on specific matters of joint interest can be 

made democratically at the European level—often impact U.S. firms and 

regulators.

Results in Brief Over the last few decades, the environment in which the financial services 

industry operates and the industry itself have undergone dramatic changes 

that include globalization, consolidation within traditional sectors, 

conglomeration across sectors, and convergence of institutional roles and 

products. As a result of these changes, a relatively small number of very 

large, diversified financial companies now compete globally to meet a 

broad range of customer needs. Moreover, the complexity of these firms 

and the products and services they offer and use are changing the kinds 

and extent of risks in the financial services industry. With regard to some 

risk, such as credit risk, diversification across products, services, and 

markets might be expected to reduce the risk faced by an individual 

institution. However, it may not reduce the extent of risk in the system as a 

whole. The increased sophistication in and interconnections throughout 

the industry now make it difficult to determine the location and extent of 

that risk. In addition, the difficulty of managing these large, complex, 

globally active firms may expose them to greater operational risk in that it 

is more difficult to impose adequate controls to prevent fraud and abuse or 

some other operational problem at home or in some small far-flung 

subsidiary. While there are fewer financial services firms, the U.S. financial 

services industry retains a large number of smaller entities that compete in 

more traditional segmented markets, where they generally offer less 

complex or varied services than the large, consolidated firms and compete 

more locally against institutions in their sector. 

For some time, the United States has chosen not to change its regulatory 

structure substantially; however, since the mid-1990s, several other 

industrialized countries and some U.S. states have consolidated their 

regulatory structures, partially in response to changes in the industry. 

Today, instead of an array of government agencies and self-regulatory 

bodies, the countries GAO studied have one or two supervisory agencies. 

Germany, Japan, and the United Kingdom each have merged their 

regulatory structures into a single agency, while Australia and the 

Netherlands have consolidated their regulatory structures by assigning two 

of the major objectives of regulation—the safety and soundness of 

institutions and conduct-of-business, which includes market conduct, 

market integrity, and some aspects of corporate governance—to different 

regulatory agencies. Within these structures, the attainment of the third 
Executive Summary

Page 7 GAO-05-61 Financial Regulation

major regulatory objective, financial stability, is shared with the central 

bank, which may also share regulatory responsibilities. Those countries 

that have consolidated their regulatory structures differ in some important 

respects from the United States in that their economies and financial 

sectors are smaller and generally less diverse. Several U.S. states have 

similarly consolidated their regulatory agencies to better deal with changes 

in the industry. Officials in the states GAO talked to said that they are better 

able to meet the needs of consumers and to cooperate across traditional 

industry lines; however, they report that they have also sought to maintain 

the specialized knowledge regulators brought from their respective 

agencies. Over the years, proposals have also been made to consolidate 

various aspects of the U.S. regulatory structure, but the United States has 

not chosen to adopt those changes in any substantive way. 

While the U.S. financial services regulatory structure has changed little, 

regulators have modified their regulatory and supervisory approaches to 

respond to market changes. For example, during the 1990s, the bank 

regulatory agencies began risk-focused supervision of large, complex 

banks, focusing supervisory attention on management policies and 

procedures for areas believed to be the highest risk for the banking 

organizations rather than trying to cover all aspects of bank management; 

this risk-focused approach now applies to all banking organizations. 

Somewhat earlier, the National Association of Insurance Commissioners 

(NAIC) began to conduct groupwide financial analyses for nationally 

significant insurance companies—companies that are large or operate in 

several states. Some of the most pronounced changes in regulatory 

approach have or are coming about as a result of efforts to harmonize 

supervision across national boundaries. These efforts include the Basel 

Committee negotiations to update capital requirements for banks, 

generally referred to as Basel II,2

 and the European Union’s Financial 

Services Action Plan, especially the Financial Conglomerates Directive, 

which requires most large, complex firms doing business in European 

Union countries to apply Basel capital standards and become subject to 

consolidated supervision sometime in 2005. These activities are leading to 

changes in the regulation and supervision of some large or complex U.S. 

financial services firms that are active in Europe. For example, SEC has, 

2

The Basel Committee, a group of central bankers and regulators from 13 countries, adopted 

the Basel II capital standards in June 2004. Different countries will implement these 

standards at different times and to varying degrees. In addition, regulatory agencies in the 

United States that oversee different functional areas may implement these standards 

differently. 
Executive Summary

Page 8 GAO-05-61 Financial Regulation

for the first time, adopted rules to provide holding company oversight for 

certain large securities firms on a voluntary basis. These rules incorporate 

some of the Basel II framework for capital adequacy regulation.

Congress and the regulators themselves have recognized the need for 

regulators in the U.S. system to communicate and coordinate activities 

within and across the traditional financial services sectors. Several formal 

and informal mechanisms exist to facilitate communication, both within 

and across sectors, but problems remain. For example, at the federal level, 

bank regulators coordinate examination and supervisory policy, including 

many rule-making initiatives, through the Federal Financial Institutions 

Examination Council and communicate internationally through the Basel 

Committee. Officials serving in the regional offices of the various federal 

bank regulators also reported that they communicate formally and 

informally with each other and with the state banking regulators in their 

region on a regular basis. However, problems between OTS and FDIC and 

between OCC and FDIC hindered a coordinated supervisory approach in 

bank failures in 2001 and 1999, respectively, and questions have arisen 

concerning the efficacy of having several U.S. bank regulators present 

different positions at Basel Committee negotiations. With regard to 

concerns about Basel II, the regulators say that the process was necessarily 

complex, they are required to air any disagreements through a transparent, 

public process and, in the end, all of the provisions the various U.S. bank 

regulators wanted were included in Basel II when it was adopted in June 

2004. Similarly, securities regulators at the state and federal levels say they 

regularly coordinate enforcement actions, but in certain high-profile cases, 

some disagreements have emerged concerning the appropriateness and 

effectiveness of state and federal actions. With regard to coordination 

across sectors, regulators have taken some actions themselves, but have 

often been directed to coordinate by Congress or the President, especially 

in response to crises such as the stock market crash of 1987, the events of 

September 11, 2001, and recent corporate scandals. In a number of reports 

evaluating these cross sector efforts, GAO has noted that no mechanism 

exists for the monitoring of cross market or cross industry risks and that 

information sharing has not been sufficient for identifying and heading off 

potential crises. For example, in our report issued in 2000 on the 

President’s Working Group, which includes the heads of the Federal 

Reserve, Treasury, SEC, and CFTC, GAO reported that although this group 

has served as a mechanism to share information during unfolding crises, its 

activities generally have not included such matters as routine surveillance 

of risks that cross markets or of information sharing that is specific enough 

to help identify potential crises.
Executive Summary

Page 9 GAO-05-61 Financial Regulation

Experts generally agree that the regulatory structure alone does not 

determine whether regulatory objectives are achieved. Having an adequate 

number of people with the right skills, clear objectives, appropriate policies 

and procedures, and independence are probably more important. However, 

the regulatory structure can often facilitate or hinder the attainment of 

regulatory objectives. U.S. regulators and financial market participants 

GAO spoke with generally emphasized that the current regulatory structure 

has contributed to the development of U.S. capital markets and overall 

economic growth and stability. Industry participants also noted that 

regulators are generally of a high quality. With the adoption of holding 

company supervision for a broader segment of firms, some regulators may 

be better able to understand and prepare for the risks that cut across 

functional areas within a given holding company. In addition, in 

conjunction with agency specific strategic planning activities, regulators 

may better monitor risks that cut across the industry segments they 

oversee. However, no agency or mechanism has the responsibility for 

monitoring risks that cut more broadly across functional areas. Further, no 

agency has the responsibility for analyzing the risks to the financial system 

as a whole or planning strategically to address those risks and problems 

that may develop in the future; there also is no mechanism for agencies to 

cooperate effectively to perform these tasks. Some characteristics of the 

U.S. regulatory structure—specialization of and competition among the 

agencies—facilitate the attainment of some regulatory objectives and 

hinder the attainment of others. On the positive side, specialization allows 

regulators to better understand the risks associated with particular 

activities or products and to better represent the views of all segments of 

the industry. And competition among regulators helps to account for 

regulatory innovation and vigilance, by providing businesses with a method 

to move to regulators whose approaches better match the businesses’ 

operations. However, these very characteristics may hinder the effective 

and efficient oversight of large, complex, internationally active firms that 

compete across sectors and national boundaries. In addition, the 

specialized and differential oversight of holding companies in the different 

sectors has the potential to create competitive imbalances among firms in 

those sectors based on regulatory differences alone. Further, competition 

among the regulators may limit the ability to negotiate international 

agreements that would broadly be to the advantage of U.S. firms. Similarly, 

some legal experts and regulators note that because large, complex firms 

are managed centrally, regulators that specialize in understanding risks 

specific to their “functional” sector may not have the ability or authority to 

oversee the complex risks that span financial sectors or the risk 

management methodologies employed by these firms. Moreover, they note 
Executive Summary

Page 10 GAO-05-61 Financial Regulation

that competition among supervisory authorities poses the risk that 

financial firms may well engage in a form of regulatory arbitrage that 

involves the placement of particular financial services or products in that 

part of the financial conglomerate in which supervisory oversight is the 

least intrusive. 

In this report, GAO recognizes that the specifics of a regulatory structure 

may not be the critical determinant in whether a regulatory system is 

successful because skilled regulators with the appropriate policies and 

procedures could potentially overcome any impediments of the structure 

through better communication and coordination across agencies. However, 

because the structure may hinder the attainment of certain regulatory 

goals, GAO suggests that Congress may want to consider ways to 

consolidate the regulatory structure to (1) better address the risks posed by 

large, complex firms and their consolidated risk management approaches, 

(2) promote competition domestically and internationally, and (3) contain 

systemic risk. Some of these ways may require that the lines that now 

define regulatory responsibility change to recognize the changed 

environment of financial services. This could be done in several ways, 

including making relatively small changes such as consolidating the bank 

regulators and, if Congress wishes to provide an optional federal charter 

for insurance, creating a federal insurance regulator, or making more 

dramatic changes such as creating a single regulatory agency. Alternatively, 

a small agency could be created to facilitate the oversight of all large, 

internationally active firms. Each alternative has potential benefits and 

costs. For example, consolidation could facilitate, but won’t necessarily 

ensure, that regulators communicate and coordinate, provide for 

regulatory neutrality, and monitor risks across markets. However, larger 

regulatory agencies could be less accountable to consumers or the 

industry, possibly damaging the diversity that enriches our economy, or 

could lose expertise critical to overseeing certain aspects of the industry. In 

addition, change itself has certain costs, such as the costs of rewriting the 

various laws that support the current regulatory structure and any 

unintended consequences that could result during the movement from the 

current structure to a new structure. 
Executive Summary

Page 11 GAO-05-61 Financial Regulation

GAO’s Analysis

The Financial Services 

Industry Has Undergone 

Dramatic Changes

The environment in which the financial services industry operates and the 

industry itself have undergone dramatic changes. First, globalization has 

become a predominant characteristic of modern economic life and has 

affected and been affected by the financial services sector. Capital moves 

across national boundaries, and many financial services firms operate 

globally. For example, foreign firms increasingly own U.S. life insurers and 

many U.S. banks and securities firms are internationally active. In addition, 

Citigroup has a significant retail banking business in Germany, while ING, a 

Dutch firm, seeks to attract deposits in its U.S. thrift. Second, consolidation 

of firms within the “functional” areas of banking, securities, and insurance 

and conglomeration of firms across these areas have increasingly come to 

characterize the large players in the industry. Since 1995, 40 large banking 

organizations have merged or acquired each other to such an extent that 

today just 6 very large institutions remain. Similarly, the number of 

securities and futures firms and the number of insurance companies have 

also declined while generally the industry has grown. With regard to 

increased conglomeration, a research report by International Monetary 

Fund staff—based on a worldwide sample of the largest 500 financial 

services firms in terms of assets—shows that the percentage of U.S. 

financial institutions in the sample that were engaged to some significant 

degree in at least two of the functional sectors of banking, securities, and 

insurance increased from 42 percent in 1995 to 61.5 percent in 2000, and 

that these conglomerates held 73 percent of the assets of all of the U.S. 

firms included in the sample. Commonly, large firms will seek to use their 

size to meet a wider array of customer demand for different financial 

products and services and to diversify an individual firm’s risk profile. 

Third, the roles of financial institutions and the products and services they 

offer have converged, so that many of these institutions are competing to 

offer similar services to customers. While these changes are occurring, the 

U.S. economy still has a large number of smaller entities that compete in 

more traditional segmented markets, where they generally offer less 

complex or varied services than the large, consolidated firms and compete 

more locally against institutions in their sector.

As a result of changes in the industry, as well as the development of 

complex financial products, the financial services industry has become 

more complex, and thus the kinds and extent of risks the industry faces are 

changing. It is generally agreed that banks can better withstand defaults by 
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segments of their creditors, because they now serve a range of geographic 

markets and types of creditors. In addition, by securitizing assets, certain 

institutions have generally been able to reduce certain kinds of risks within 

an institution by passing them off to other financial institutions or 

investors. However, the overall risk to the industry may not have been 

reduced. Institutions that have purchased securitized assets, for instance, 

may not have risk management systems designed for the acquired risks. 

Further, the relationships between institutions that securitize assets and 

those buying these securitized assets range across regulatory and 

governmental jurisdictions. Changes in the industry, especially the growth 

of large institutions, have also affected the level and management of 

operational and reputation risk. Large, complex firms pose new risks for 

global financial stability because they can be brought down by fraud and 

abuse or some other operational problem in some small far-flung 

subsidiary. For example, the collapse of Barings, a British bank with global 

operations, demonstrates the potential vulnerability of firms to operational 

risk. In this case, management did not effectively supervise a trader in 

Singapore, and his actions brought down the whole bank. 

While Some Countries Have 

Consolidated Regulatory 

Structures, the United 

States Has Chosen to 

Maintain Its Structure 

Partly in response to industry changes, since the mid-1990s several major 

industrial countries have consolidated their regulatory structures. 

Germany, Japan, and the United Kingdom have each consolidated their 

regulatory structures so that they rely primarily on a single agency. The 

United Kingdom’s move from nine regulatory bodies, including selfregulatory organizations (SRO), to a single agency, the Financial Services 

Authority (UK-FSA), is the most dramatic. UK-FSA focuses strategically on 

achieving a small number of statutory objectives—maintaining confidence 

in the financial system, promoting public understanding of the financial 

system, securing the appropriate degree of protection for consumers, and 

reducing the potential for financial services firms to be used for a purpose 

connected with financial crime—across a broad range of financial 

institutions and activities. In pursuing these goals, UK-FSA is required to 

take account of additional obligations, including achieving its goals in the 

most efficient and effective way and not damaging the competitive position 

of the United Kingdom internationally. To achieve its objectives under 

these proscribed constraints, UK-FSA focuses on the largest firms and on 

the needs of retail consumers. In addition, UK-FSA has taken actions to 

break down the traditional industry silos and to ensure that large, complex 

firms are overseen in consistent ways. While UK-FSA has sole 

responsibility for the safety and soundness of financial institutions and 

conduct-of-business, a tripartite group that includes the central bank and 
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Her Majesty’s Treasury pursues the goal of financial stability. The German 

single regulator, which is still quite new, maintains the traditional silos of 

banking, securities, and insurance, adding crosscutting groups to handle 

conglomerate supervision and international issues. In addition, the new 

supervisory body shares some supervisory responsibilities with Germany’s 

central bank. Because of persistent problems in the Japanese economy, 

especially in its banking sector, the Japanese experiment with a single 

regulator illustrates the point that a country’s financial services regulatory 

structure alone is not the determining factor in promoting economic 

growth through the optimum allocation of financial capital.

GAO also reviewed documents for two other countries—Australia and the 

Netherlands—that have consolidated their regulatory structures into two 

agencies that have responsibility for a single regulatory objective. In each 

country, one agency is responsible for prudential regulation of all financial 

institutions and the other for ensuring that financial firms and markets 

conduct their businesses properly. These structures are based on the belief 

that government agencies should have a single focus, so that one objective 

will not take precedence over another. In the Netherlands, the Dutch 

central bank has become the prudential regulator, while in Australia, the 

prudential regulator is independent. In both cases, the central bank has the 

primary responsibility for achieving the objective of financial stability. 

Some U.S. states have consolidated their structures in response to industry 

changes as well. The states GAO spoke with had created a single regulator 

structure, in part, because of the blurring of traditional boundaries in the 

industry. These states said they are better able to share information and 

cooperate across the sectors, but that maintaining expertise in the 

traditional sectors is still important. In addition, state officials said that 

while they did not consolidate to reduce the cost of regulation, 

consolidation had reduced costs. 

The United States, which differs from the other countries that have 

consolidated their structures in significant ways, such as having a much 

larger and more diverse financial sector, has not consolidated its regulatory 

structure. While GLBA substantially removed many of the barriers that had 

previously separated commercial banking from investment banking and 

insurance underwriting, GLBA did not substantially change the U.S. 

regulatory structure. Over the years, however, many proposals have been 

made to change the U.S. regulatory structure, and these proposals 

continued to be made throughout the 1990s and early 2000s. These include 

proposals to consolidate the bank regulators, merge SEC and CFTC, 
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change the self-regulatory organization structure for securities, and create 

a federal insurance regulator to oversee those companies opting for the 

proposed federal insurance charter. Proposals have also been made that 

cut across sectors, including ones for a single federal regulator in each 

area, an oversight board, and a fully consolidated regulator. 

Regulators Are Adapting 

Regulatory and Supervisory 

Approaches in Response to 

Industry Changes

Partly as a response to efforts to harmonize regulation internationally, 

regulators are adapting regulatory and supervisory approaches to industry 

changes. The major international efforts include the culmination of 

negotiations at the Basel Committee to update the framework for capital 

adequacy requirements for banks and bank holding companies, resulting in 

the Basel II framework, and European Union implementation of the 

Financial Conglomerates Directive, which will require most internationally 

active U.S. financial firms be subject to consolidated supervision. U.S. 

regulators will be implementing the Basel II requirements for large banking 

organizations over the next several years. Basel II has three pillars: the first 

concerns setting of minimum capital requirements, the second focuses on 

supervisory review of and action in response to banks’ capital adequacy, 

and the third requires banks to publicly disclose information about their 

risk profile, risk assessment processes, and the adequacy of their capital 

levels to foster greater market discipline. The Financial Conglomerates 

Directive requires that non-European financial conglomerates, certain 

securities firms, and bank and financial holding companies operating in the 

European Union have adequate consolidated supervision, which includes 

application of Basel capital standards. Under the directive, which is 

expected to go into effect in 2005, a non-European financial conglomerate, 

securities firm, or bank or financial holding company that is not considered 

to be supervised on a consolidated basis by an equivalent home country 

supervisor would be subject to additional supervision by regulators in 

European Union member states. As a result, some major U.S. companies 

will need to demonstrate that they have consolidated home country 

supervision. Some companies that own thrift institutions may seek to meet 

these requirements by choosing OTS, which has the authority to oversee 

thrift holding companies, as their home country consolidated supervisor. 

For others, SEC has adopted rules for voluntary oversight of certain 

holding companies with large broker-dealers that are to be called 

Consolidated Supervised Entities. SEC is pursuing some changes to the 

Basel II standards that would make those requirements more relevant to 

securities activities undertaken by U.S. firms. 
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U.S. regulators have adapted other regulatory and supervisory approaches 

in response to industry changes. Beginning in the mid-1990s, OCC and the 

Federal Reserve adopted new supervisory protocols for large, complex 

institutions. Under this approach, examiners are assigned full time to a 

bank (and are often on-site) so that they can continually monitor and 

assess a banking organization’s financial condition and risk management 

systems through the review of a variety of management reports and 

frequent meetings with key bank officials. Examiners focus examinations 

on a bank’s internal control and risk-management systems; this risk-based 

approach is now used for banks of all sizes. Securities regulators had 

repeatedly revised their supervision protocols and had taken other actions 

to better understand derivatives activities of securities firms. The 

Commodity Futures Modernization Act of 2000—which had the primary 

goals of addressing changes in market conditions, such as the introduction 

of a wider variety of products—revamped many of the processes and goals 

of CFTC. And, NAIC adopted risk-based capital requirements and began 

analyzing significant insurance companies that do business in several 

states to identify issues that could affect groups across state lines. 

Regulators Communicate 

and Coordinate in Multiple 

Ways, but Concerns Remain

Most of the communication among U.S. regulators takes place within a 

“functional” area. Within each of the four areas—banking, securities, 

insurance, and futures—federal regulators have established interagency 

groups to facilitate coordination and also communicate informally on a 

variety of issues. Generally, within sectors, these regulators communicate 

with each other, SROs, relevant state regulators, and their international 

counterparts. In insurance, NAIC is the primary vehicle for state regulators 

to communicate with each other and to coordinate with insurance 

regulators abroad. While regulators report frequent and regular meetings 

within their area, coordinated responses are not always reached on some 

major issues. 

Bank regulators coordinate examination and supervisory policy, including 

many rule-making initiatives, through the Federal Financial Institutions 

Examination Council and communicate internationally through the Basel 

Committee. They also hold formal meetings at the national and regional 

levels and communicate informally on a regular basis.

Despite these practices, problems persist. In the 2001 failure of Superior 

Bank, FSB, problems between OTS, the primary supervisor, and FDIC 

hindered a coordinated supervisory approach, especially OTS’s refusal to 

let FDIC participate in examinations. The failure resulted in a substantial 
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Page 16 GAO-05-61 Financial Regulation

loss to the deposit insurance fund. Similarly, problems between OCC and 

FDIC were identified in the failure of the First National Bank of Keystone 

(West Virginia), which failed in 1999. (Regulators note that subsequent 

changes in policies should avoid similar problems in the future.) On the 

international front, several U.S. regulators joined the Basel II negotiations 

or presented their views late in the process. Regulators said that this 

ensured that concerns from all industry sectors were addressed in the 

negotiations, that a transparent process was used, and that the United 

States regulators obtained all of the provisions they wanted in the 

international agreement, reached in June 2004. Critics complain that having 

multiple regulators, particularly at the latest stages of negotiations, 

needlessly complicated the process and could have affected the outcome. 

While SEC and state securities regulators told us that they coordinate 

activities, including enforcement actions, some high-profile cases have 

resulted in disagreements. SEC and state securities regulators have 

brought several enforcement actions together; however, SEC and the states 

have sometimes disagreed on what is an appropriate role for each, and on 

how effective each has been. Similarly, in the insurance area, where NAIC 

is a highly structured forum for communication, some critics have noted 

that NAIC does not have the power to force state regulators to adopt 

similar positions, while other critics have noted that, as a 

quasigovernmental body, NAIC has too much power over state insurance 

regulation.

Regulators themselves have identified the need to communicate across 

sectors. For example, nine securities SROs created the Intermarket 

Surveillance Group in 1983, and since then, futures SROs and foreign 

exchanges have joined as affiliated members. The purpose of this group is 

to coordinate and develop programs and procedures designed to assist in 

identifying possible fraudulent and manipulative acts and practices across 

markets and to share information. SEC and CFTC also jointly developed 

regulations implementing portions of the Commodity Futures 

Modernization Act, which lifted the ban on securities futures, but the 

process was difficult. Prior to the passage of the act, staff of both 

regulators had at times claimed sole jurisdiction over single stock futures, 

necessitating development of a memorandum of understanding that 

clarified joint oversight responsibilities for these instruments. 

Congress and the President have often seen the need to direct regulators to 

communicate across “functional” areas, sometimes in response to crises. 

On a number of occasions, Congress has directed regulators to 
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communicate across “functional” areas. For example, in GLBA, Congress 

directed regulators to communicate to better oversee the risks of 

diversified holding companies; and following recent corporate and 

accounting scandals, Congress directed them to collectively draft guidance 

on complex structured finance transactions. Similarly, the President has 

issued executive orders directing regulators to form the President’s 

Working Group and the Financial and Banking Information Infrastructure 

Committee. The former was created to address issues related to the 1987 

stock market crash and was formally reactivated in 1994 to consider other 

issues, including the 1997 market decline and threats to critical 

infrastructure. The latter was created after the events of September 11, 

2001, to coordinate federal and state financial regulatory efforts to improve 

the reliability and security of the U.S. financial system.

In evaluating these and other efforts of financial regulators to communicate 

and coordinate, GAO has found that these ways do not allow for a 

satisfactory assessment of risks that cross traditional regulatory and 

industry boundaries and therefore may inhibit the ability to detect and 

contain certain financial crises. In addition, the existing ways regulators 

communicate and coordinate do not provide for the systematic sharing of 

information on enforcement actions across sectors, making it more 

difficult for regulators to identify potential fraud and abuse, and for 

consumers to identify the relevant regulator. 

The U.S. Regulatory System 

Has Strengths, but Its 

Structure May Hinder 

Effective Regulation

Financial markets exist to serve the needs of businesses, households, and 

government, and financial regulation is judged, in part, by how well 

markets meet the needs of these users. U.S. regulators and financial market 

participants GAO spoke with generally emphasized that the current 

regulatory structure has contributed to the development of U.S. capital 

markets and overall growth and stability in the U.S. economy. Industry 

participants also noted that regulators are generally of a high quality. With 

the adoption of holding company supervision for a broader segment of 

firms, some regulators may be better able to understand and prepare for 

the risks that cut across functional areas within a given holding company. 

In addition, in conjunction with agency specific strategic planning 

activities, regulators may better monitor risks that cut across the industry 

segments they oversee. However, no agency or mechanism has the 

responsibility for monitoring risks that cut more broadly across functional 

areas. Further, no agency has the responsibility for analyzing the risks to 

the financial system as a whole or planning strategically to address those 

risks and problems that may develop in the future; there also is no 
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mechanism for agencies to cooperate effectively to perform these tasks. 

Agency structure alone does not determine whether regulators do their 

jobs efficiently and effectively, but it can facilitate or hinder achieving 

those goals. Experts outside the regulatory system and some foreign 

regulators have suggested that the U.S. regulatory system does not 

facilitate and may hinder the efficient and effective oversight of large, 

complex, internationally active firms. In particular, critics have noted that 

“functional” regulation—focusing the oversight of different regulators on 

specific activities within a financial services firm—is inconsistent with 

these firms’ centralized risk management. U.S. firms and regulators are also 

likely to be affected by efforts to harmonize regulation internationally. 

Large, internationally active firms say these efforts are critical to providing 

financial services in a cost-effective manner; however, the fragmented 

nature of the U.S. regulatory system may hinder these negotiations. In 

addition, the increasing need for a global perspective in the insurance 

industry where U.S. insurers are increasingly foreign-owned is difficult 

within the state insurance regulatory system.

While large U.S. firms compete across sectors, important differences 

remain among banking, insurance, securities, and futures businesses. In 

addition, many smaller firms operate only in a single sector or single local 

market. As a result, the regulatory system benefits from the specialized 

knowledge regulators acquire within their specialized agencies. Regulatory 

agencies, however, may become “captives” of the industries they are 

supposed to regulate and not be able to benefit from economies of scale 

and scope related to the need for skills that cut across regulatory agencies. 

In addition, the existence of specialized agencies affords firms the 

opportunity to conduct transactions in those parts of its organization with 

the least intrusive regulation.

Congress May Want to 

Consider Changes to the 

U.S. Regulatory Structure 

The financial services industry is critical to the health and vitality of the 

U.S. economy. While the industry itself bears primary responsibility to 

effectively manage its risks, the importance of the industry and the nature 

of those risks have created a need for government regulation as well. While 

the specifics of a regulatory structure, including the number of regulatory 

agencies and the roles assigned to each, may not be the critical determinant 

in whether a regulatory system is successful, the structure can facilitate or 

hinder the attainment of regulatory goals. The skills of the people working 

in the regulatory system, the clarity of its objectives, its independence, and 

its management systems are critical to the success of financial regulation.
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Because our regulatory structure relies on having clear-cut boundaries 

between the “functional” areas, industry changes that have caused those 

boundaries to blur have placed strains on the regulatory framework. While 

diversification across activities and locations may have lowered the risks 

being faced by some large, complex, internationally active firms, 

understanding and overseeing them have also become a much more 

complex undertaking, requiring staff that can evaluate the risk portfolio of 

these institutions and their management systems and performance. 

Regulators must be able to ensure effective risk management without 

needlessly restraining risk taking, which would hinder economic growth. 

Similarly, because firms are taking on similar risks across “functional” 

areas, to understand the risks of a given institution or those that span 

institutions or industries, regulators need a more complete picture of the 

risk portfolio of the financial services industry both in the United States 

and abroad.

Recognizing that regulators could potentially overcome the impediments of 

a fragmented regulatory structure through better communication and 

coordination across agencies, Congress has created mechanisms for 

coordination and on a number of specific issues has directed agencies to 

coordinate their activities. In addition, GAO has repeatedly recommended 

that federal regulators improve communication and coordination. While 

GAO continues to support these recommendations, it recognizes that the 

sheer number of regulatory bodies, their underlying competitive nature, 

and differences in their regulatory philosophies will continue to make the 

sharing of information difficult and true coordination and cooperation in 

the most important or most visible areas problematic as well. Therefore, 

Congress might want to consider some changes to the U.S. financial 

services regulatory structure that address weaknesses and potential 

vulnerabilities in our current system, while maintaining its strengths.

Matter for 

Congressional 

Consideration

While maintaining sector expertise and ensuring that financial institutions 

comply with the law, Congress may want to consider some consolidation or 

modification of the existing regulatory structure to (1) better address the 

risks posed by large, complex, internationally active firms and their 

consolidated risk management approaches; (2) promote competition 

domestically and internationally; and (3) contain systemic risk. If so, our 

work has identified several options that Congress may wish to consider: 

• consolidating the regulatory structure within the “functional” areas;
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• moving to a regulatory structure based on a regulation by objective or 

twin peaks model; 

• combining all financial regulators into a single entity; or

• creating or authorizing a single entity to oversee all large, complex, 

internationally active firms, while leaving the rest of the structure in 

place.

If Congress does wish to consider these or other options, it may want to 

ensure that legislative goals are clearly set out for any changed regulatory 

structure and that the agencies affected by any change are given clear 

direction on the priorities that should be set for achieving these goals. In 

addition, any change in the regulatory structure would entail changing laws 

that currently govern financial services oversight to conform to the new 

structure. 

The first option would be to consolidate the regulatory structure within 

“functional” areas—banking, securities, insurance, and futures—so that at 

the federal level there would be a primary point of contact for each. The 

two major changes to accomplish this at the federal level would be 

consolidation of the bank regulators and, if Congress wishes to provide a 

federal charter option for insurance, the creation of an insurance 

regulatory entity. The bank regulatory consolidation could be achieved 

within an existing banking agency or with the creation of a new agency. In 

1996, we recommended that the number of federal agencies with primary 

responsibilities for bank oversight be reduced. However, we noted that in 

the new structure, FDIC should have the necessary authority to protect the 

deposit insurance fund and that the Federal Reserve and Treasury should 

continue to be involved in bank oversight, with access to supervisory 

information, so that they could carry out their responsibilities for 

promoting financial stability. We have not studied the issue of an optional 

federal charter for insurers, but have through the years noted difficulties 

with efforts to harmonize insurance regulation across states through the 

NAIC-based structure. Having a primary federal entity for each of the 

functional sectors would likely improve communications and coordination 

across sectors because it would reduce the number of entities that would 

need to be consulted on any issue. Similarly, it would provide a central 

point of communication for issues within a sector. Fewer bank regulators 

might reduce the cost of regulation and the opportunities for regulatory 

arbitrage, choosing charters so that transactions have the least amount of 

oversight. In addition, issues related to the independence of a regulator 
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from the firms they oversee with a given kind of charter would be 

alleviated. However, consolidating the banking regulators and establishing 

a federal insurance regulator would raise concerns as well. While improved 

communication and cooperation within sectors would help to achieve the 

objectives outlined above, it would not directly address many of them. In 

addition, some constituencies, such as thrifts, might feel they were not 

getting proper attention for their concerns; and opportunities for 

regulatory experimentation and the other positive aspects of competition 

in banking could be reduced. Further, while this option represents a more 

evolutionary change than some of the others, it might still entail some costs 

associated with change, including unintended consequences that would 

undoubtedly erupt as various banking agencies and their staff jockeyed for 

position within the new banking regulator. Similarly, the establishment of a 

federal insurance regulator might have unintended consequences for state 

regulatory bodies and for insurance firms as well. 

Another option would be consolidating the regulatory structure using a 

regulation by objective, or twin peaks model. The twin peaks model would 

involve setting up one safety and soundness regulatory entity and one 

conduct-of-business regulatory entity. The former would oversee safety and 

soundness issues for insurers, banks, securities, and futures activities, 

while the latter would ensure compliance with the full range of conduct-ofbusiness issues, including consumer and investor protection, disclosure, 

money laundering, and some governance issues. This could be 

accomplished by changing the tasks assigned to existing agencies or by 

restructuring the agencies or creating new ones. On the positive side, this 

option would directly address many of the regulatory objectives related to 

larger, more complex institutions, such as allowing for consolidated 

supervision, competitive neutrality, understanding of the linkages within 

the safety and soundness and conduct-of-business spheres, and regulatory 

independence. In addition, conduct-of-business issues would not become 

subservient to safety and soundness issues, as some fear. On the negative 

side, in addition to the issues raised by any change in the structure, this 

structure would not allow regulators to oversee the linkages between 

safety and soundness and conduct-of-business. As reputational risk has 

become more important, the linkages between these activities have 

become more evident. In addition, if the controls and processes for 

conduct-of-business issues and safety and soundness issues are coming 

from the top of the organization, they are probably closely related. Finally, 

combining regulators into multifunctional units might not allow the 

regulatory system to maintain some of the advantages it now has, including 
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specialized expertise and the benefits of regulatory competition and 

experimentation.

The most radical option would combine all financial regulators into a single 

entity, similar to UK-FSA. The benefits of the single regulator are that one 

body is accountable for all regulatory endeavors. It can more easily 

evaluate the linkages within and across firms, including those between 

conduct-of-business and safety and soundness considerations, plan 

strategically across sectors, and facilitate the allocation of resources to 

their highest priority use. However, achieving these goals would depend on 

having the right people and skills, clear regulatory objectives, effective 

tools, and appropriate policies and procedures. While the UK-FSA model is 

intriguing, this option raises some concerns for the United States. First, 

because of the size of the U.S. economy and the number of financial 

institutions, this entity would have to be very large and, thus, could be 

unwieldy and costly. UK-FSA has about 2,300 employees, while estimates of 

the number of regulators currently in the United States range from about 

30,000 to 40,000. In addition, officials at UK-FSA have commented about 

the difficulty of setting priorities when a large number of issues have to be 

dealt with. Prioritizing these issues for the United States would be 

particularly difficult. Further, an entity with this scope and size might have 

difficulty responding to smaller players and might therefore damage the 

diversity that has enriched the U.S. financial industry. Also, staff at such an 

entity might lose or not develop the specialized skills needed to understand 

both large and small companies and risks that are specific to the different 

“functional” sectors. And, without careful oversight, such a large and allpowerful entity might not be accountable to consumers or the industry.

A more evolutionary change would be to have a single entity with 

responsibility for the oversight of all large, complex, or internationally 

active financial services firms that manage risk centrally, compete with 

each other within and across sectors, and, by their size and presence in a 

wide range of markets, pose systemic risks. Having a single regulatory 

entity for large, complex, or internationally active firms could be 

accomplished by giving this responsibility to an existing regulator or by 

creating a new entity. A new entity might consist of a small staff that would 

rely on the expertise of staff at existing regulatory agencies to accomplish 

supervisory tasks. 

Having a single regulatory entity for large, complex, or internationally 

active firms would have the advantage of addressing industry changes, 

while leaving much of the U.S. regulatory structure unchanged. A single 
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regulatory entity for large, complex holding companies would have 

responsibilities that more closely align with the businesses’ approach to 

risk than the current regulatory structure. In addition, this entity could 

promote competition between these firms by ensuring, to the greatest 

extent possible, that oversight is competitively neutral. A single regulatory 

entity for internationally active firms would also be better positioned to 

help coordinate the views of the United States in international forums, so 

that the U.S. firms are not competitively disadvantaged during negotiations. 

Finally, this entity would be better able to appraise the linkages across 

large, complex, internationally active firms and, thus, with the aid of the 

Federal Reserve and Treasury, could contribute to promoting financial 

stability. These potential improvements could be obtained without losing 

the advantages afforded by our current specialized regulators, who would 

continue to supervise the activities of regulated firms such as brokerdealers or banks. However, this option also has drawbacks. While the 

transition costs might be less than in some of the other options, the 

creation of a new entity or changing the role of an existing regulatory entity 

would still entail costs and likely some unintended consequences. It might 

also be difficult to maintain the appropriate balance between the interests 

of the large or internationally active firms and smaller, more-specialized 

entities. It also could involve creating one more regulatory agency in a 

system that already has many agencies.

Agency Comments and 

Our Evaluation

We received written comments on a draft of this report from the Chairman 

of the Board of Governors of the Federal Reserve System, the Chairman of 

FDIC, the Comptroller of the Currency, and the Director of SEC’s Division 

of Market Regulation. Their comments generally noted that the U.S. 

financial regulatory system had balanced effective regulation and market 

forces to promote a strong and innovative financial system. Where 

appropriate, we have changed the report to clarify this balance. In addition, 

the Chairman of the Federal Reserve Board of Governors and the Chairman 

of FDIC stressed the importance of the insured depository in the regulatory 

scheme. We provided a draft of the report to Treasury, CFTC, and NAIC, for 

possible comments, but no written comments were provided. All of the 

agencies provided technical comments that were incorporated, where 

appropriate.

The Director of the Office of Thrift Supervision provided comments on a 

draft of this report, saying that the report inadequately reflected OTS’s 

authority to supervise thrift holding companies and OTS’s international 

initiatives. While we have made some changes to the report to clarify these 
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topics, we believe that the report does accurately discuss both topics. We 

also disagreed with the Director’s request that we delete references to the 

failure of Superior Bank, FSB, which he thought did not reflect the causes 

of the failure or the significant costs to the insurance funds from other 

failures. We did change the report to make clear that this failure, and 

another commercial bank failure in 1999, were caused by actions of the 

banks themselves. However, these failures did highlight problems in 

coordinating actions by the primary federal bank regulators and FDIC, 

which also has authority to examine the banks it insures. 
Page 25 GAO-05-61 Financial Regulation

Chapter 1

Introduction Chapte1r

The U.S. financial services industry has four sectors—banking, securities, 

insurance, and futures,1

 which together had 5.8 million employees and were 

responsible for almost one-tenth of the U.S. gross domestic product in 

2001. Traditionally, the financial services industry promoted economic 

growth by intermediating between households, businesses, and 

governments seeking to increase their assets through savings and those 

interested in increasing their current spending through borrowing. 

Intermediation differed in specific ways across the major sectors. All 

financial services firms are exposed to a variety of risks, including credit 

and market risk, and the industry as a whole is exposed to systemic risk, 

which is generally defined as the risk that a disruption (at a firm, in a 

market segment, to a settlement system, etc.) could cause widespread 

difficulties at other firms, in other market segments, or in the financial 

system as a whole. 

The U.S. regulatory structure is composed of several agencies that tend to 

specialize in given financial sectors and activities and has a tradition of 

both state and federal regulation of some sectors and activities. Generally, 

banking is regulated by several federal regulators and by state bank 

regulators; securities by the Securities and Exchange Commission (SEC), 

self-regulatory organizations (SROs), and state regulators; futures by the 

Commodity Futures Trading Commission (CFTC) and SROs; and insurance 

by state insurance departments. Federal agencies are charged with 

overseeing particular types of institutions and activities, and state agencies 

exercise a similar function for entities that are not regulated exclusively by 

the federal government. The federal agencies also operate within an 

international framework that includes a variety of entities.

1

Futures are one type of derivatives contract. The market value of a derivatives contract is 

derived from a reference rate, index, or the value of an underlying asset, including stocks, 

bonds, commodities, interest rates, foreign currency exchange rates, and indexes that 

reflect the collective value of underlying financial products. The regulation of derivatives 

generally varies depending on whether they are traded on exchanges (exchange-traded) or 

traded over-the-counter (OTC) and on the nature of the underlying asset, reference rate, or 

index. Futures obligate the holder to buy or sell a specific amount or value of an underlying 

asset, reference rate, or index at a specified price on a specified future date and are often 

traded on exchanges. Options—contracts that grant their purchasers the right but not the 

obligation to buy or sell a specific amount of the underlying asset, reference rate, or index at 

a particular price within a specified period—are also sometimes traded on exchanges. See 

chapter 2 for more information about derivatives.
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Introduction

Page 26 GAO-05-61 Financial Regulation

Traditionally, Financial 

Institutions Served as 

Intermediaries and 

Transferred Some 

Risks

Because those doing the saving in an economy and those doing the 

spending have not always had direct access to each other, financial 

services firms have traditionally served as intermediaries between them. 

Figure 1 illustrates how financial services firms perform this role. Different 

institutions—depositories, securities firms, insurance companies, and 

futures firms—facilitated intermediation differently, using different 

markets and products. In addition, some firms helped households and 

businesses manage risk. 

Figure 1: Traditional Role of Financial Intermediaries

By most measures, depositories—commercial banks, thrifts,2 credit 

unions,3 and industrial loan companies (ILCs)4—make up the largest group 

of financial intermediaries. Traditionally, depositories used the funds they 

received as deposits to make loans directly to businesses and consumers, 

and various types of depositories were set up to serve different 

2

We use the term “thrifts” to refer to savings and loan associations and the term “thrift 

holding companies” to refer to savings and loan holding companies throughout this report.

3

Our report Credit Unions: Financial Condition Has Improved, but Opportunities Exist 

to Enhance Oversight and Share Insurance Management, GAO-04-91 (Washington, D.C.: 

Oct. 27, 2003) discusses the credit union industry and the National Credit Union 

Administration (NCUA). Because credit unions have only about 9 percent of domestic 

deposits, this report does not discuss them in detail.

4

ILCs are state-chartered institutions that may take deposits and offer some banking 

services, but generally are not permitted to offer a full range of bank services. GAO has an 

ongoing engagement looking at certain issues related to ILCs. Because ILC’s have only about 

1 percent of domestic deposits, this report does not discuss them in detail. 

Households

Businesses

Government

Intermediaries

Sources of funds

(including

savers)

Households

Businesses

Government

Financial

markets

Users of funds

(including

spenders)

$

$

$

$

$

Source: The Evolving Role of Commercial Banks in U.S. Credit Markets, FDIC.
Chapter 1

Introduction

Page 27 GAO-05-61 Financial Regulation

constituents. Today, their activities are considerably more diverse. For 

instance, banks and their affiliates are heavily involved in the OTC 

derivatives market, in which transactions involving financial derivatives 

are negotiated off exchanges. Depositories include commercial banks, with 

about 73 percent of domestic deposits at the end of 2003; thrifts, with about 

14 percent of domestic deposits; credit unions, with about 9 percent of 

domestic deposits; and ILCS, with about 1 percent of domestic deposits. 

Although structural differences remain, most powers and services of 

depositories have converged over time, with few practical differences 

remaining in the activities they undertake. Thus, in this report we will 

generally refer to all depositories as banks.

Securities firms are second to banks in the amount of assets held and 

revenue generated. Securities firms facilitate the transfer of funds from 

savers to businesses or government through capital markets by 

underwriting corporate equity securities (stocks) and corporate and 

government debt securities (bonds). In addition, securities firms facilitate 

the buying and selling of existing securities so that funds move from all 

kinds of savers to all kinds of spenders. Several types of securities firms 

participate in this process. Brokers are intermediaries for those who buy 

and sell securities, and dealers are those who buy and sell securities for 

their own accounts. Investment banks underwrite new debt securities and 

equity securities and perform broker-dealer functions. Investment banks 

buy the new issues and, acting as wholesalers, sell them to institutional 

investors such as banks, mutual funds, and pension funds. Investment 

companies, such as mutual funds and hedge funds, gather funds from 

savers and collectively pass them to spenders by purchasing assets in 

capital markets. Investment advisers and transfer agents also play a role in 

this market but do not act directly as intermediaries. By offering savings 

products with varying risks and returns, securities firms also help savers 

manage risk. 

Insurance companies, the third largest sector of the financial services 

industry, serve as intermediaries by taking the insurance premium 

payments of households and businesses in payment for insurance coverage 

and investing in corporate securities. The return on these investments is 

expected to fund insurance companies’ future liabilities. Insurance 

premium payments come from the sale of products that usually fall into 

three categories: property-casualty, life and health, and reinsurance. 

Property-casualty insurance products cover business and household assets 

such as cars, houses, business structures, inventories, and goods in transit, 

as well as areas of liability such as product performance and professional 
Chapter 1

Introduction

Page 28 GAO-05-61 Financial Regulation

misconduct. Life insurance products provide a tax-free sum to the 

beneficiary of the policyholder in the event of the policyholder’s death or 

other insured event. Health insurance, which covers expenses associated 

with medical care and often any financial losses individuals incur from 

injuries or illness, is not directly relevant to this study. Insurance 

companies purchase reinsurance, among other things, to spread risk and 

protect against catastrophic events. Along with their role as financial 

intermediaries, insurance companies have helped households and 

businesses manage risk by allowing them to insure themselves against 

certain contingencies. Agents who are employed by the insurance 

companies or work independently generally distribute insurance products.

While firms that deal in exchange-traded futures (futures firms) facilitate 

the transfer of funds, the primary role of futures markets involves 

transferring risk and providing a mechanism for price discovery. Market 

participants include hedgers, who are managing risks, and speculators, 

who are taking a position on the direction of market movement in hopes of 

making a profit. Futures contracts protect sellers and purchasers of assets, 

such as physical commodities like pork bellies or financial commodities 

like currencies, from changes in value over time and provide opportunities 

for speculators to take varying positions on the future value of these 

commodities in hopes of making a profit. Several types of futures firms 

participate in this process. Futures firms that execute orders and hold 

retail customer accounts are futures commission merchants (FCMs). In 

addition, floor brokers make trades for others and, along with floor traders, 

also make trades for themselves. Commodity pool operators serve a 

function similar to that of investment companies in securities markets in 

that they pool funds for the purpose of trading futures contracts. 

Commodity trading advisers and others also participate in futures 

markets.5

 The markets where exchange-traded futures contracts are traded 

are generally called boards of trade.

5

For example, associated persons who may act on behalf of other futures firms also play a 

role in futures markets.
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Introduction

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The Financial Services 

Industry Faces Risks at 

the Institutional Level 

and Systemwide

 To varying degrees, financial institutions are exposed to the following 

types of risks:6

Credit risk—the potential for financial losses resulting from the failure of a 

borrower or counterparty to perform on an obligation. 

Market risk—the potential for financial losses due to the increase or 

decrease in the value or price of an asset or liability resulting from broad 

movements in prices, such as interest rates, commodity prices, stock 

prices, or the relative value of currencies (foreign exchange).

Liquidity risk—the potential for financial losses due to the inability of a 

firm to meet its obligations because of an inability to liquidate assets or 

obtain adequate funding, such as might occur if most depositors or other 

creditors were to withdraw their funds from a firm. 

Operational risk—the potential for unexpected financial losses due to 

inadequate information systems, operational problems, and breaches in 

internal controls, or fraud. These can include risks associated with clearing 

and settling transactions, either as a principal or as an agent, as well as 

risks associated with custodial functions (e.g., holding securities on behalf 

of others).

Reputational risk—the potential for financial losses that could result from 

negative publicity regarding an institution’s business practices and 

subsequent decline in customers, costly litigation, or revenue reductions.

Legal risk—the potential for financial losses due to breaches of law or 

regulation that may result in heavy penalties or other costs. 

Business/event risk—the potential for financial losses due to events not 

covered above, such as credit rating downgrades (which affect a firm’s 

access to funding), or factors beyond the control of the firm, such as major 

shocks in the firm’s markets. 

Insurance/actuarial risk—the risk of financial losses that an insurance 

underwriter takes on in exchange for premiums, such as the risk of 

premature death.

6

We recognize that there are alternative ways to categorize risks. 
Chapter 1

Introduction

Page 30 GAO-05-61 Financial Regulation

In addition to these risks, the financial system as a whole may be 

vulnerable to systemic risk, which is generally defined as the risk that a 

disruption (at a firm, in a market segment, to a settlement system, etc.) 

could cause widespread difficulties at other firms, in other market 

segments, or in the financial system as a whole. The difficulties may be real 

in that institutions, markets, or settlement systems are linked by 

transactions or may result in customers panicking as a result of believing 

that failure at a given institution will affect similar institutions and taking 

actions such as removing deposits that precipitate systemic crises. 

U.S. Financial Services 

Regulation Has 

Multiple Goals 

Generally, the United States relies on markets to promote the efficient 

allocation of capital throughout the economy so as to best fund the 

activities of households, business, and government. Financial services are 

subject to oversight for several reasons that relate to the inability of the 

market to ensure that the efficient allocation of capital will take place. 

Essentially, markets cannot ensure that certain kinds of misconduct, 

including fraud and abuse or market manipulation, will not occur and that 

consumers/investors will have adequate information to discipline 

institutions with regard to the amount of risk they take on. In addition, 

because of systemic linkages, the system as a whole may be prone to 

instability. While financial services firms are aware of systemic risk, they 

will not likely take steps to minimize it. 

In the United States, laws define the roles and missions of the various 

regulators, and to some extent these are similar across the regulatory 

bodies. However, laws and regulatory agency policies can set a greater 

priority on some roles and missions than others. In addition, the goals and 

objectives of the regulatory agencies have developed somewhat differently 

over time, such that bank regulators generally focus on the safety and 

soundness of banks, securities and futures regulators focus on market 

integrity and investor protection, and insurance regulators focus on the 

ability of insurance firms to meet their commitments to the insured. 

In general, regulators help protect consumers/investors who may not have 

the information or expertise necessary to protect themselves from fraud 

and other deceptive practices, such as predatory lending or insider trading, 

and that the marketplace may not necessarily provide. Through monitoring 

activities, examinations, and inspections, regulators oversee the conduct of 

institutions in an effort to ensure that they do not engage in fraudulent 

activity and do provide consumers/investors with the information they 

need to make appropriate decisions and ultimately discipline the behavior 
Chapter 1

Introduction

Page 31 GAO-05-61 Financial Regulation

of financial institutions in the marketplace. However, in some areas 

providing information through disclosure and assuring compliance with 

laws are still not adequate to allow consumers/investors to influence firm 

behavior. In these cases, regulators oversee how risk is managed and seek 

to restrain excessive risk taking in order to promote the safety and 

soundness of institutions that engage in certain kinds of activities. In 

addition, by providing deposit insurance, overseeing other insurance or 

guarantee funds, or directly intervening in the marketplace, regulators take 

actions to ensure that the types of widespread financial instability that 

could seriously disrupt economic activity do not occur. However, with 

insurance or guarantee funds or the expectation that some firms are too big 

to fail, the normal disciplining of the market is disrupted, creating the 

“moral hazard” that institutions will take on more risk than they would in 

the absence of such insurance or expectations. As a result, the need for 

safety and soundness oversight is intensified. 

U.S. Financial 

Regulatory System 

Includes a Variety of 

Regulatory Bodies

The objectives of U.S. financial services regulation are pursued by a 

complex combination of federal and state government agencies and selfregulatory organizations (SROs). Generally, regulators specialize in the 

oversight of financial entities in the various financial services sectors. This 

specialization stems largely from the laws that established these agencies 

and defined their missions. In addition, some regulators have 

responsibilities to regulate holding companies with subsidiaries that 

engage in various financial services activities. The Federal Reserve7

 and the 

Department of the Treasury (Treasury) play a special role in maintaining 

financial stability. 

Regulators Specialize in the 

Oversight of Financial 

Entities in Various Sectors

Five federal agencies oversee banks, including those chartered and 

overseen by state regulatory agencies. The specific regulatory 

configuration depends on the type of charter the banking institution 

chooses. Banks may be regulated by the federal government alone, if they 

are chartered by a federal regulator such as the Office of the Comptroller of 

the Currency (OCC) or Office of Thrift Supervision (OTS), or by both 

federal and state governments, if they are state-chartered institutions. 

Securities and futures firms are regulated at the federal level by the 

7

We use the term Federal Reserve throughout this report to refer to the Federal Reserve’s 

Board of Governors, the 12 Federal Reserve Banks, or both, unless otherwise specified.
Chapter 1

Introduction

Page 32 GAO-05-61 Financial Regulation

Securities and Exchange Commission (SEC) and Commodity Futures 

Trading Commission (CFTC), respectively, which, in turn, rely on SROs to 

assist with their oversight. State regulators also have oversight and 

enforcement responsibilities for securities. Insurance entities are overseen 

largely at the state level. There are also regulators for government 

sponsored enterprises and pension funds, which lie outside the scope of 

this report.

Multiple Regulators Oversee 

Banking Entities

Banking institutions can generally determine their regulators by choosing a 

particular kind of charter—commercial bank, thrift, credit union, or 

industrial loan company. These charters may be obtained at the state level 

or the national level for all except industrial loan companies, which are 

chartered only at the state level. State regulators charter institutions and 

participate in the oversight of those institutions; however, all of these 

institutions have a primary federal regulator if they have federal deposit 

insurance. State-chartered commercial banks that are members of the 

Federal Reserve are subject to supervision by that institution. Other statechartered banks, such as nonmember state banks, state savings banks, and 

ILCs, with federally insured deposits are subject to Federal Deposit 

Insurance Corporation (FDIC) oversight, while OTS supervises statechartered savings associations that are members of the Savings Association 

Insurance Fund. Federally chartered institutions are subject to oversight by 

their chartering agencies. OCC supervises national banks, OTS supervises 

federally chartered thrifts, and the National Credit Union Administration 

(NCUA) supervises federally chartered credit unions. To the extent that 

OTC derivatives activities take place in these institutions, they are subject 

to oversight by the appropriate regulator. In addition, FDIC has backup 

supervisory authority for those banks that are members of the insurance 

funds it oversees and have a different primary supervisor.

The primary objectives of federal bank regulators include ensuring the safe 

and sound practices and operations of the institutions they oversee and the 

stability of financial markets. To achieve these goals, regulators establish 

capital requirements, conduct on-site examinations and off-site monitoring 

to assess a bank’s financial condition, and monitor compliance with 

banking laws. Regulators also issue regulations, take enforcement actions, 

and close banks they determine to be insolvent. In addition, federal 

regulators oversee and take enforcement actions to ensure compliance 

with many consumer protection laws such as those requiring fair access to 

banking services and privacy protection. 
Chapter 1

Introduction

Page 33 GAO-05-61 Financial Regulation

The current bank regulatory structure evolved over time. OCC was created 

by the National Currency Act of 1863, which was rewritten as the National 

Bank Act of 1864. The Federal Reserve Act of 1913 created the Federal 

Reserve, partly in response to the financial panic of 1907. FDIC was 

established under the Banking Act of 1933. In 1933, Congress also 

authorized the federal chartering of savings and loans by the Federal Home 

Loan Bank Board, and, in 1934, the National Housing Act established the 

Federal Savings and Loan Insurance Corporation to provide for federal 

regulation of federally insured, state-chartered thrifts. In 1989, OTS 

replaced the Federal Home Loan Bank Board as the federal thrift 

institution regulator.8

 Organizationally, OCC and OTS are within the 

Department of the Treasury; however, the Comptroller of the Currency and 

the Director of OTS are appointed by the President and confirmed by the 

Senate for fixed terms, an arrangement intended to help ensure the 

independence of these agencies. The Federal Reserve’s Board of Governors 

and FDIC are independent federal agencies; the Comptroller of the 

Currency and Director of OTS sit on FDIC’s five-person board of directors. 

The three other board members are appointed by the President for fixed 

terms with one appointed as Chairman and another as Vice Chairman. As 

with the Comptroller of the Currency and the Director of OTS, the Federal 

Reserve’s Board of Governors are appointed by the President and 

confirmed by the Senate for fixed terms.

SROs Contribute to Security and 

Futures Regulation

The Securities Exchange Act of 1934 established the regulatory structure of 

U.S. securities markets. These markets are regulated under a combination 

of self-regulation (subject to SEC oversight) and direct SEC regulation. 

This regulatory structure was intended to give SROs responsibility for 

administering their own operations, including most of the daily oversight of 

the securities markets and their participants. One of the SROs—NASD—is 

a national securities association that regulates registered securities brokerdealers.9

 Other SROs include national securities exchanges that operate the 

markets where securities are traded.10 These SROs are primarily 

8

See Financial Institution Reform, Recovery and Enforcement Act of 1989 (FIRREA) § 407, 

103 Stat. 363. 

9

NASD is registered as a national securities association under section 15A of the Securities 

Exchange Act of 1934, 15 U.S.C. § 78o-3, (2000 & Supp. 2004) and is considered an SRO 

pursuant to section 3(a)(26), 15 U.S.C. & 78c(a)(26). 

10These SROs include those dealing in exchange-traded options. SEC shares oversight of 

exchange-traded options with CFTC depending on the nature of the underlying. 
Chapter 1

Introduction

Page 34 GAO-05-61 Financial Regulation

responsible for establishing the standards under which their members 

conduct business; monitoring business conduct; and bringing disciplinary 

actions against their members for violating applicable federal statutes, 

SEC’s rules, and their own rules. SEC oversees the SROs by inspecting their 

operations and reviewing their rule proposals and appeals of final 

disciplinary proceedings.

The Securities Exchange Act also created SEC as an independent agency to 

oversee the securities markets and their participants. SEC has a fivemember commission headed by a chairman who is appointed by the 

President for a 5-year term. In overseeing the SROs’ implementation and 

enforcement of rules, SEC may use its statutory authority to, among other 

things, review and approve SRO-proposed rule changes and abrogate (or 

annul) SRO rules.

The futures market’s regulatory structure consists of federal oversight 

provided by CFTC and industry oversight provided by SROs—the futures 

exchanges and the National Futures Association (NFA). Futures SROs are 

responsible for establishing and enforcing rules governing member 

conduct and trading; providing for the prevention of market manipulation, 

including monitoring trading activity; ensuring that futures industry 

professionals meet qualifications; and examining members for financial 

strength and other regulatory purposes. Their operations are funded by the 

futures industry through transaction fees and other charges. In regulating 

the futures market, CFTC independently monitors, among other things, 

exchange trading activity, large trader positions, and certain market 

participants’ financial condition. CFTC also investigates potential 

violations of the Commodity Exchange Act and CFTC regulations and 

prosecutes alleged violators. Additionally, CFTC oversees the SROs to 

ensure that each has an effective self-regulatory program. In this regard, 

CFTC designates and supervises exchanges as contract markets and NFA 

as a registered futures association, audits SROs for compliance with their 

regulatory responsibilities, and reviews SRO rules and products that are 

traded on designated exchanges. 
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Introduction

Page 35 GAO-05-61 Financial Regulation

States Have Primary 

Responsibility for Regulating 

Insurance Entities

Unlike other financial service sectors, the U.S. insurance industry is 

regulated primarily at the state level.11 To help coordinate their activities, 

state insurance regulators established a central structure, the National 

Association of Insurance Commissioners (NAIC), in 1871. Members of this 

organization are the heads of the insurance departments of 50 states, the 

District of Columbia, and 4 U.S. territories and possessions. NAIC’s basic 

purpose is to encourage consistency and cooperation among the various 

states and territories as they individually regulate the insurance industry. 

To that end, NAIC promulgates model insurance laws and regulations for 

state consideration and provides a framework for multistate examinations 

of insurance companies. State insurance regulators have tended to stress 

safety and soundness issues, but have also taken action in the conduct-ofbusiness area, especially with regard to sales practices. The McCarrenFerguson Act of 1945 generally asserted the view that insurance regulation 

should be undertaken by the states. 

Some U.S. Regulators 

Engage in Holding Company 

Oversight

Many of the largest financial legal entities are part of holding company 

structures—companies that hold stock in one or more subsidiaries. Many 

companies that own or control banks are regulated by the Federal Reserve 

as bank holding companies, and their nonbanking activities generally are 

limited to those that the Federal Reserve has determined to be closely 

related to banking. Under the Gramm-Leach-Bliley Act (GLBA), bank 

holding companies can qualify as financial holding companies and thereby 

engage in a range of financial activities broader than those permitted for 

“traditional” bank holding companies. Savings and loan or thrift holding 

companies (thrift holding companies), which own or control one or more 

savings and loan companies, are subject to supervision by OTS and, 

depending upon the circumstances of the holding company structure, may 

not face the types of activities restrictions imposed on bank holding 

companies. Investment bank holding companies that have a substantial 

presence in the securities markets can elect to be supervised by SEC as a 

supervised investment bank holding company (SIBHC) if the holding 

company does not own or control certain types of banks. Holding 

companies that own large broker-dealers can elect to be supervised by SEC 

11SEC regulates sales of discrete products, such as certain types of annuities considered to 

be securities. Also, banks engage in certain types of insurance activities, such as 

underwriting credit insurance and, under certain circumstances, acting as an insurance 

agent either directly or through a subsidiary. Although these activities are subject to OCC 

regulation, national banks can be subject to nondiscriminatory state laws applicable to 

certain insurance-related activities. 
Chapter 1

Introduction

Page 36 GAO-05-61 Financial Regulation

as consolidated supervised entities (CSE). SEC would provide groupwide 

oversight of these entities unless they are determined to already be subject 

to “comprehensive, consolidated supervision” by another principal 

regulator. While holding company supervisors oversee, to varying degrees, 

the holding company, the appropriate functional regulator, as described 

above, remains primarily responsible for supervising any functionally 

regulated subsidiary within the holding company. 

Bank and Financial Holding 

Companies

The Bank Holding Company Act of 1956, as amended, generally requires 

that holding companies with bank subsidiaries register with the Federal 

Reserve as bank holding companies.12 Among other things, the Bank 

Holding Company Act restricts the activities of bank holding companies to 

those the Federal Reserve determined, as of November 11, 1999, to be 

closely related to banking. However, under amendments to the Bank 

Holding Company Act made in 1999 by GLBA, a bank holding company can 

qualify as a financial holding company that, under GLBA, may engage in a 

broad range of additional financial activities, such as securities and 

insurance underwriting. The Federal Reserve has primary authority to 

examine and supervise a bank holding company, financial holding 

company, and their respective nonbank affiliates, except for those that are 

“functionally regulated” by some other regulator.13 The Federal Reserve’s 

authority to require reports from, examine, or impose capital requirements 

on a functionally regulated affiliate is limited. For example, the Federal 

Reserve has limited authority under GLBA to examine broker-dealer 

affiliates of bank and financial holding companies. These limitations were 

designed to lessen the regulatory burden on and provide for consistent 

regulation of a financial activity, such as securities, regardless of whether 

the entity conducting the activity is affiliated with a commercial bank. In 

this report, we sometimes refer to banks, bank holding companies, and 

financial holding companies as banking organizations.

12The Bank Holding Company Act exempts certain types of depository institutions, such as 

ILCs chartered in certain states, from its definition of “bank,” as well as some grandfathered 

banks. Consequently, a company’s ownership or control of an ILC does not necessarily 

subject the company to supervision by the Federal Reserve. 

13The “functionally regulated” affiliates (and their respective functional regulators) are: 

registered broker-dealers, investment advisers, and investment companies (SEC); stateregulated insurance companies (state insurance authority); and CFTC-regulated firms 

(CFTC).
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Page 37 GAO-05-61 Financial Regulation

Thrift Holding Companies Under the Home Owners’ Loan Act of 1933, as amended, companies that 

own or control a savings association are subject to supervision by OTS. 

Historically, most thrift holding companies were designated as “exempt” 

and permitted to engage in a wide range of activities, including insurance, 

securities, and nonfinancial activities.14 GLBA expanded the activities 

authorized for nonexempt thrift holding companies to include those 

authorized for financial holding companies. However, GLBA curtailed the 

availability of exempt status to only those that meet all of the following 

criteria: the organization was a thrift holding company on May 4, 1999, or 

became a thrift holding company under an application pending with OTS 

on or before that date; the holding company meets and continues to meet 

the requirements for an exempt thrift holding company; and the thrift 

holding company continues to control at least one savings association (or 

successor savings association) that it controlled on May 4, 1999, or that it 

acquired under an application pending with OTS on or before that date. As 

a result, GLBA in effect redefined the requirements for an exempt thrift 

holding company. 

SEC’s Consolidated Supervision Beginning with the Market Reform Act of 1990, SEC has been undertaking 

supervisory activities aimed at assessing the safety and soundness of 

securities activities at a consolidated or holding company level.15 That act 

authorized SEC to collect information from registered broker-dealers about 

the activities and financial condition of their holding companies and 

material unregulated affiliates. In 1992, SEC began receiving riskassessment reports from firms that permitted it to assess the potential risks 

that affiliated organizations might have on broker-dealers. By June 2001, 

SEC was meeting monthly with major securities firms in connection with 

their risk reports. SEC rules regarding more complete oversight of the 

activities of some holding companies—SIBHC and CSE—became effective

14Before the enactment of GLBA, a unitary thrift holding company whose subsidiary thrift 

was a qualified thrift lender generally could operate without activity restrictions. 

Additionally, a multiple thrift holding company that acquired all, or all but one, of its 

subsidiary thrifts as a result of supervisory acquisitions generally could operate without 

activity restrictions if all of the subsidiary thrifts were qualified thrift lenders. These thrift 

holding companies have been referred to as “exempt.” The majority of thrift holding 

companies qualify as exempt. Nonexempt thrift holding companies were permitted to 

engage only in those nonbanking activities that were: specified by the Home Owners’ Loan 

Act; approved by regulation as closely related to banking by the Federal Reserve; or 

authorized by regulation on March 5, 1987.

15Pub. L. No. 101-432§ 4(a), 15 U.S.C. § 78q(h) (providing for, among other things, SEC risk 

assessment of holding company systems).
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Introduction

Page 38 GAO-05-61 Financial Regulation

in August 2004.16 GLBA had amended the Securities Exchange Act of 1934 

to permit an investment bank holding company that is not affiliated with 

certain types of banks and has a subsidiary broker-dealer with a substantial 

presence in the securities markets to elect to become an SIBHC and be 

subject to SEC supervision on a groupwide basis. SEC established a similar 

set of rules for holding companies with the largest broker-dealers to 

voluntarily consent to consolidated supervision by becoming a CSE. Under 

the CSE rules, broker-dealers may apply to SEC for a conditional 

exemption from the application of the standard net capital calculation and, 

instead, use an alternative method of computing net capital that permits 

utilization of mathematical modeling methods. As a condition for granting 

the exemption, broker-dealers’ ultimate holding companies must consent 

to capital requirements consistent with Basel standards and groupwide 

SEC supervision unless they are determined to already be subject to 

“comprehensive, consolidated supervision” by another principal regulator. 

For companies that choose to become SIBHCs or CSEs, SEC would have 

supervisory authority over OTC derivatives transactions undertaken in 

previously unregulated affiliates. 

Federal Reserve and U.S. 

Treasury Play Roles in 

Maintaining Financial 

Stability 

As the U.S. central bank, the Federal Reserve also has responsibility for 

ensuring financial stability. In practice, this has entailed providing liquidity 

to financial markets during periods of crisis. For example, in the immediate 

aftermath of the September 11, 2001, attacks, the Federal Reserve provided 

about $323 billion to banks to overcome problems that resulted from the 

inability of a major bank to clear trades in government securities. In 

addition, the Federal Reserve is also both a provider and regulator of 

clearing and payment services.17

The Department of the Treasury shares in the responsibility for maintaining 

financial stability and has other responsibilities related to financial 

institutions and markets as well. Treasury shares responsibility for 

managing systemic financial crises, coordinating financial market 

regulation, and representing the United States on international financial 

market issues. Treasury, in consultation with the President, may also 

16For the SEC rules regarding consolidated supervised entities, see 69 Fed. Reg. 34428 (June 

21, 2004). For the SEC rules regarding supervised investment bank holding companies, see 

69 Fed. Reg. 34472 (June 21, 2004).

17See GAO, Federal Reserve System: Mandated Report on Potential Conflicts of Interest, 

GAO-01-160 (Washington, D.C.: Nov. 13, 2000).
Chapter 1

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Page 39 GAO-05-61 Financial Regulation

approve special resolution options for insolvent financial institutions 

whose failure could threaten the stability of the financial system. Twothirds of the members of the Federal Reserve’s Board of Governors and of 

the FDIC Directors must approve any extraordinary coverage.

The United States 

Participates in 

International 

Organizations Dealing 

with Regulatory Issues

U.S. regulators meet with regulators from other nations in a number of 

different forums:

• Basel Committee on Banking Supervision (Basel Committee). Agency 

principals from OCC, FDIC, and the Federal Reserve18 participate as 

members in the Basel Committee, along with central bank and 

regulatory officials of other industrialized countries.19 The committee 

formulates broad supervisory standards and guidelines, including those 

for capital adequacy regulation, and recommends best practices in the 

expectation that individual authorities will take steps to implement 

them through detailed arrangements—statutory or otherwise—that are 

best suited for their own national systems. One of the objectives of the 

Basel Committee is to close gaps in international supervision coverage 

so that no internationally active banks escape supervision and 

supervision is adequate. The committee encourages convergence 

toward common approaches and common standards without attempting 

detailed harmonization of member country supervisory techniques. 

• International Organization of Securities Commissions (IOSCO). IOSCO 

is the principal international organization of securities commissions, 

and is composed of securities regulators from over 105 countries. SEC is 

a member of IOSCO, and CFTC participates as an associate member. 

IOSCO develops principles and standards for improving cross-border 

securities regulation, reviews major securities regulatory issues, and 

coordinates practical responses to these concerns. Areas addressed by 

IOSCO include: multinational disclosure, accounting, auditing, 

regulation of the secondary markets, regulation of intermediaries, 

18The Federal Reserve is represented by principals from the Federal Reserve Board of 

Governors and the Federal Reserve Bank of New York. OTS officials say that they 

participate in the Basel Committee as a temporary member pending acceptance of OTS’s 

request for permanent membership. 

19The committee’s members come from Belgium, Canada, France, Germany, Italy, Japan, 

Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the 

United States.
Chapter 1

Introduction

Page 40 GAO-05-61 Financial Regulation

enforcement and the exchange of information, investment management, 

credit rating agencies, securities analysts’ conflicts of interest, and 

securities activity on the Internet. 

• International Association of Insurance Supervisors (IAIS). Established 

in 1994, IAIS represents insurance supervisory authorities of some 180 

jurisdictions. It was formed to promote cooperation among insurance 

supervisors, set standards for insurance supervision and regulation, 

provide training for members, and coordinate work with regulators in 

the other financial sectors and international financial institutions. NAIC 

works with IAIS.

• Joint Forum. Established in early 1996 under the aegis of the Basel 

Committee, IAIS, and IOSCO, the Joint Forum publishes papers 

addressing supervisory issues that arise from the continuing emergence 

of financial conglomerates and the blurring of distinctions between the 

banking, securities, and insurance sectors.20 The Joint Forum comprises 

an equal number of senior insurance, bank, and securities supervisors 

representing 13 countries.21

• Financial Stability Forum (FSF). Convened in April 1999, FSF brings 

together national authorities responsible for financial stability in 

significant international financial centers, international financial 

institutions, sector-specific international groupings of regulators and 

supervisors, and committees of central bank experts. FSF seeks to 

coordinate the efforts of these various bodies in order to promote 

international financial stability, improve the functioning of markets, and 

reduce systemic risk. The Federal Reserve, SEC, and Treasury 

participate in FSF.

The International Monetary Fund (IMF) also plays a role in promoting 

effective regulation of financial services. IMF is an organization of 184 

countries, working to foster global monetary cooperation, secure financial 

stability, facilitate international trade, promote high employment and 

20The Joint Forum was initially referred to as “The Joint Forum on Financial 

Conglomerates.” During 1999, its name was shortened to “The Joint Forum” to recognize 

that its new mandate went beyond issues related to financial conglomerates to other issues 

of common interest to all three sectors.

21The countries are Australia, Belgium, Canada, France, Germany, Italy, Japan, the 

Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
Chapter 1

Introduction

Page 41 GAO-05-61 Financial Regulation

sustainable economic growth, and reduce poverty. As part of its 

surveillance activities, IMF and the World Bank have taken a central role in 

developing, implementing, and assessing internationally recognized 

standards and codes in areas that are crucial for the efficient functioning of 

a modern economy, including central bank independence, financial sector 

regulation, corporate governance and policy transparency, and 

accountability. In response to banking crises in the 1990s, they created the 

Financial Sector Assessment Program to assess the strengths and 

weaknesses of countries’ financial sectors. The staffs of these institutions 

also conduct research related to these activities. 

These international institutions and forums have generally agreed on a set 

of principles or prerequisites for achieving the objectives of financial 

regulation. These generally include 

• formulating clear objectives for regulators;

• ensuring regulatory independence, but with appropriate accountability;

• providing regulators with adequate resources, including staff and 

funding;

• giving regulators effective enforcement powers; and

• ensuring that regulation is cost efficient. 

Objectives, Scope, and 

Methodology

Our objectives were to describe changes over recent decades in (1) the 

financial services industry; (2) the U.S. regulatory structure and those of 

several other industrialized countries; and (3) U.S. financial market 

regulation, focusing on capital requirements, supervision, market 

discipline, and domestic and international coordination. Our objectives 

also included assessing (4) U.S. regulators’ efforts to communicate, 

coordinate, and cooperate with each other and with regulators abroad, and 

(5) the strengths and weaknesses of the present U.S. financial regulatory 

system. While housing finance is often considered part of the financial 

services industry, this report does not include government-sponsored
Chapter 1

Introduction

Page 42 GAO-05-61 Financial Regulation

enterprises with a major role in housing finance or their regulators.22 In 

addition, because credit unions have only about 9 percent of domestic 

deposits and ILCs have only 1 percent of domestic deposits, this report 

does not discuss them in detail.23 Finally, we have not included pension 

funds or their regulator in this report. In addition, we do not discuss the 

role of the Federal Trade Commission or the impact of tax policy on the 

financial services industry.

To address the objectives of this report, we conducted interviews with 

senior supervisory and regulatory officials at the federal level, including the 

Federal Reserve, FDIC, OCC, OTS, SEC, and CFTC. At the state level, we 

interviewed supervisory and regulatory officials in Florida, Illinois, 

Massachusetts, Michigan, Minnesota, and New York as well as trade 

associations representing state regulators, including supervisors of the 

Conference of State Bank Supervisors, North American Securities 

Association of Administrators, and National Association of Insurance 

Commissioners. Finally, we spoke to a variety of SROs, including the New 

York Stock Exchange (NYSE), NASD (formerly the National Association of 

Securities Dealers), Municipal Securities Rulemaking Board, National 

Futures Association, Chicago Mercantile Exchange, Chicago Board of 

Trade, and Chicago Board Options Exchange. These agencies provided us 

with documents and statistics, including research studies, examination 

manuals, annual and strategic reports, performance plans, and financial 

and budgetary data. In addition to our interviews with supervisory and 

regulatory officials, we also met with officials representing financial 

services firms and exchanges and their trade associations, and academic 

experts. Information about depository institutions identified in this report 

was obtained from publicly available sources.

This report also draws on extensive work we have done in the past on the 

financial services regulatory structure and includes information gathered 

from many sources. These sources include studies of the history of the 

financial services industry; records from congressional hearings related to 

regulatory restructuring; and professional literature concerned with the 

industry structure and regulation. We also reviewed relevant banking, 

securities, insurance, and futures legislation at the federal level. 

22We recently reviewed our work on regulation of government-sponsored enterprises in 

Government-Sponsored Enterprises: A Framework for Strengthening GSE Governance 

and Oversight, GAO-04-269T (Washington, D.C.: Feb. 10, 2004).

23See GAO-04-91. 
Chapter 1

Introduction

Page 43 GAO-05-61 Financial Regulation

To address issues of international harmonization and to compare the U.S. 

regulatory regime with more consolidated structures abroad, we 

conducted fieldwork in Belgium, Germany, and the United Kingdom. 

During our field visit, we interviewed officials from the European Union 

(EU), European Central Bank, Financial Services Authority in the United 

Kingdom (UK-FSA), The Bank of England, Her Majesty’s Treasury (HMTreasury), Federal Financial Supervisory Authority in Germany (BaFin), 

Deutsche Bundesbank (Bundesbank), and German Treasury. Many of the 

officials we interviewed provided us with documents and research studies 

on their regulatory processes and the reasons for implementing more 

consolidated structures. We also interviewed officials from financial 

services firms, including subsidiaries of U.S. firms as well as two firms 

headquartered in the countries we visited. In addition, we spoke with trade 

associations and other experts on the EU and regulatory consolidation 

within various countries. For those countries we did not visit (Australia, 

Japan, and the Netherlands), we reviewed documents and provided our 

findings for review by government officials from the relevant country or 

other recognized experts. We did not conduct a full legal review of the 

regulatory regimes for any of these countries.

To develop certain other information, we collected data from federal and 

state regulators and SROs on the resources they devoted to supervision 

from 1999 to 2003. We also collected information about ongoing regular 

communication these entities had with other regulatory bodies between 

January 2003 and March 2004. We did not use any nonpublic supervisory 

data in conducting our work for this report.

We provided a draft of this report to the Department of the Treasury, Board 

of Governors of the Federal Reserve System, CFTC, FDIC, NAIC, OCC, 

OTS, and SEC for review and comment. The written comments of the 

Board of Governors, FDIC, OCC, OTS, and SEC are printed in appendixes I 

through V and are discussed at the end of chapter 7. The staffs of these 

agencies also provided technical comments that have been incorporated, 

as appropriate. The Department of the Treasury, CFTC, and NAIC did not 

provide written comments, but their staffs provided technical comments 

that have been incorporated, as appropriate. We conducted our work 

between June 2003 and July 2004 in accordance with generally accepted 

government auditing standards in Washington, D.C.; Boston; Chicago; New 

York City; Brussels, Belgium; London; and Berlin, Bonn, and Frankfurt, 

Germany.
Page 44 GAO-05-61 Financial Regulation

Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes Chapte2r

The environment in which the financial services industry operates and the 

industry itself have undergone dramatic changes that include globalization, 

consolidation, conglomeration, and convergence. These forces have 

affected financial services firms, markets, and products. First, globalization 

that includes the financial services industry has become a characteristic of 

modern economic life. Second, consolidation (merging of firms in the same 

sector) and conglomeration (merging of firms in other sectors) have 

increasingly come to characterize the large players in the financial services 

industry. Third, the roles of financial institutions and the products and 

services they offer have converged so that institutions often offer 

customers similar services, although sectors still specialize to some extent. 

As a result of these changes, as well as the development of innovative 

financial products, the financial services industry has become more 

complex, and thus the kinds and extent of risks the industry faces have 

changed. 

Financial Services 

Have Played an 

Integral Part in 

Globalization

Globalization has had a major impact on a broad range of economic 

activities, including financial markets. Figure 2, which shows the ongoing 

growth of international corporate and sovereign debt, illustrates the 

linkages among financial markets around the globe. 
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 45 GAO-05-61 Financial Regulation

Figure 2: International Debt Securities, 1987-2004 

The financial services industry—firms, markets, and products—have been 

an integral part of the globalization trend. At present, firms have a greater 

capacity and increased regulatory freedom to cross borders, creating 

markets that either eliminate or substantially reduce the effect of national 

boundaries. U.S.-owned financial services firms have increased their 

international activities, and a significant number of foreign-owned financial 

services companies are operating within the United States. In banking, for 

example, Citibank has substantial and growing retail banking activities in 

Germany and ING Direct, a Dutch-owned company, has a large deposit 

base in the United States. In the securities sector, in 2003 U.S. investors 

held $2.5 trillion of foreign securities, and foreign holdings of U.S. 

securities other than U.S. Treasury securities rose to $3.4 trillion. In the 

insurance sector, a significant portion of U.S. insurers and the U.S. market 

are now foreign controlled. In 2001, 142 U.S. life insurers were foreignowned, up from 69 in 1995. And, according to the International Insurance 

Institute, from 1991 to 1999, sales by foreign-owned property-casualty 

insurers doing business in the United States grew by 62.8 percent.

Deregulation and technological change have facilitated globalization. 

Barriers that once limited international financial transactions have been 

substantially reduced or removed, and greater computing power and better 

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Dollars in billions

Source: Bank for International Settlements.
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 46 GAO-05-61 Financial Regulation

telecommunications networks have driven the technological revolution. 

These technological changes have had a major effect on wholesale 

securities and futures markets around the world. Many securities and 

futures products can be traded 24 hours a day from any place in the world. 

Electronic trading and other changes have made this transformation 

possible. Large U.S.-based institutional investors can now buy stock in 

publicly traded foreign companies by accessing foreign stock markets. 

Smaller retail investors can participate in the equity markets of foreign 

countries by buying mutual funds that specialize in developed or emerging 

foreign markets.

Large Institutions Have 

Become Larger 

through Consolidation 

and Conglomeration

Generally, over the last several decades, large financial institutions have 

consolidated by merging with or acquiring other companies in the same 

line of business. Consolidation has occurred in all of the industry segments 

discussed in this report—banking, securities, futures, and insurance. While 

the number of firms declined, the percentage of industry assets 

concentrated in the largest 10 commercial banks, thrifts, life insurers, and 

property-casualty insurers rose between 1996 and 2002, as shown in figure 

3. While the percentage of assets of the largest 10 securities firms has fallen 

somewhat, these firms still have more than 50 percent of the industry’s 

assets. The same technological and improvements and deregulation that 

have driven globalization have also contributed to consolidation and 

conglomeration. While large firms have gotten larger and often account for 

an increasing share of each industry, there are still a large number of firms 

in each industry segment. Some observers believe that the financial 

services sectors will come to be characterized by a few large players and 

lots of small, niche-market players, with few in between.
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 47 GAO-05-61 Financial Regulation

Figure 3: Share of Assets in Each Sector Controlled by 10 Largest Firms, 1996-2002

60

55

50

45

40

35

30

25

20

65

10

5

15

0

Source: TowerGroup.

Property/casualty insurance

Life insurance

Commercial banks

Securities firms

Savings institutions

Percent

1996 1997 1998 1999 2000 2001 2002
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 48 GAO-05-61 Financial Regulation

The change in the banking sector has been especially dramatic, as it has 

been driven by both technological change and significant deregulation. In 

the early 1980s, bank holding companies faced limitations on their ability to 

own banks located in different states. Some states did not allow banks to 

branch at all. With the advent of regional interstate compacts in the late 

1980s, some banks began to merge regionally. Additionally, the Riegle-Neal 

Interstate Banking and Branching Efficiency Act of 1994 removed 

restrictions on bank holding companies’ ability to acquire banks located in 

different states and permitted banks in different states to merge, subject to 

a process that permitted states to opt out of that authority.1

 While the U.S. 

banking industry is still characterized by a large number of small banks and 

researchers have questioned whether economies of scale and scope exist, 

the larger banking organizations have grown significantly through mergers 

after 1995. As figure 4 shows, 40 large banking organizations operating in 

1990 had consolidated into 6 banking organizations by August 2004. These 

six banking organizations had about 40 percent of total bank assets in the 

United States. 

1

Pub. L. No. 103-328, 108 Stat. 2238 (1994).
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 49 GAO-05-61 Financial Regulation

Figure 4: Merger Activity among Banking Organizations, January 1990-June 2004 

1990-1995 1996 1997 1998 1999 2002 2004 2000 2001

Citicorp

European American Bank

Universal Bank, N.A.

First Interstate Bancorp

Wells Fargo & Company

Norwest Holding Company

Wells Fargo & Company Wells Fargo

& Company

Source: GAO.

J.P. Morgan

Chase & Co.

American National

American National Bank and Trust Company of Chicago

Banc One

First Commerce

First Chicago

NBD Bancorp First Chicago NBD

First Chicago NBD

Bank One

Bank One

Chase Manhattan

J.P. Morgan & Co.

Chemical Banking

Manufacturers Hanover

J.P. Morgan Chase & Co.

Chemical Banking

Chase Manhattan

United States National Bank of Oregon

Mercantile Bancorporation

First Bank System

U.S. Bancorp U.S. Bancorp

Firstar U.S. Bancorp

Firstar

Citigroup

Citigroup

Maryland National Bank

BankAmerica

Boatmen's National Bank of St. Louis

Continental Bank

Security Pacific Bancorporation Northwest

C & S/Sovran

Barnett Banks

BankAmerica

NationsBank NationsBank

Bank of

America

NatWest Bank National Association

BancBoston Holdings

Bay Banks 

Fleet Financial Group

Bank of New England

Shawmut

Summit Bancorp

UJB Financial

BankBoston

FleetBoston Financial

FleetBoston Financial

Fleet Financial Group

Fleet Financial Group

Summit

BankAmerica

NationsBank

NCNB National Bank of Florida

Philadelphia National Bank

Central Fidelity National Bank

First Fidelity

Signet

Wachovia

First Union

First Union

Wachovia

Wachovia

First Union

Meridian Bank

Corestates Financial Corestates Financial

Corestates Financial
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 50 GAO-05-61 Financial Regulation

Many of the larger financial services firms are part of holding companies 

that operate in more than one of the traditional sectors. These firms are 

called conglomerates. A research study by IMF staff shows that based on a 

worldwide sample of the top 500 financial services firms in assets, the 

percentage of firms in the U.S. that are conglomerates—firms having 

substantial operations in more than one of the sectors (banking, securities, 

and insurance)—increased from 42 percent of the U.S. firms in the sample 

in 1995 to 61.5 percent in 2000; however, for the sample of U.S. firms, the 

percentage of assets controlled by conglomerates declined from 78.6 

percent in 1995 to 73 percent in 2000.2

 The largest banks in the United 

States have brokerage operations, and many sell insurance and mutual 

fund products. While much of the conglomeration in the United States took 

place prior to GLBA, that important piece of legislation removed 

restrictions on the extent to which conglomerates could engage in banking 

and nonbanking financial activities, thus, for example, making it possible 

for financial conglomerates to purchase insurance companies and other 

financial institutions to purchase banks. 

To facilitate and recognize the trend toward conglomeration, GLBA 

authorized new regulatory regimes. The act authorized bank holding 

companies to qualify as financial holding companies and provided for 

voluntary SEC supervision of investment bank holding companies. While 

rules for the latter were issued only in June 2004, financial holding 

companies grew from 477 in 2000 to 630 in March 2003. Metropolitan Life 

Insurance Company, one of the largest life insurance companies in the 

United States, and Charles Schwab & Co., a sizable securities firm, acquired 

or opened banks and became financial holding companies. In addition, 

several major insurance and commercial companies, including American 

International Group, General Electric, and American Express, have thrifts 

and Merrill-Lynch has chartered an ILC in addition to its commercial bank 

and thrift. As a result, a consumer can make deposits, obtain a mortgage or 

other loan, or purchase insurance products from the same company. 

Although some had expected that conglomeration would intensify after 

GLBA, as yet, this does not seem to have happened. The reasons vary: Many 

firms were already conglomerates before the passage of GLBA, the removal 

of some limitations on bank-affiliated broker-dealers allowed banks to 

grow internally, banks did not see any synergies with insurance 

2

Gianni De Nicoló, Philip Bartholomew, Jahanara Zaman, and Mary Zephirin, “Bank 

Consolidation, Internationalization, and Conglomeration: Trends and Implications for 

Financial Risk” (IMF Working Paper 03/158, Washington, D.C., July 2003).
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 51 GAO-05-61 Financial Regulation

underwriting, and a general slowdown occurred in merger and acquisition 

activity across the economy in the early 2000s. While merger and 

acquisition activity in banking has picked up, sizable mergers between 

firms in different sectors have not materialized so far. It may be that these 

mergers are not economically efficient, the regulatory structure set up 

under GLBA is not advantageous to these mergers, or it may simply be too 

soon to tell what the impact will be. In addition, some cross-sector mergers 

have been unwound. For example, Citigroup sold off the property-casualty 

unit of Travelers, which had been affiliated with Citibank since their 

merger in 1998.

Roles of Large 

Financial Services 

Firms Have Changed 

and Financial Products 

Have Converged, but 

Some Differences 

Remain

Increasingly, financial intermediaries are relying on fee-based services, 

including asset management, for their profitability. Firms in all of the 

sectors are also increasingly involved in activities to manage their and their 

institutional customers’ risks. In addition, product offerings by firms in 

different segments of the financial services industry have converged so that 

product offerings that might appear to be different are competing to meet 

similar customer needs, such as having access to liquid transaction 

accounts, saving for retirement, or insuring against the failure of a party to 

live up to the terms of a commercial contract.

Market Developments Have 

Forced Financial Services 

Firms to Adapt

Generally, financial services firms, especially banks, have had to adapt to 

the ease with which corporations can now directly access capital markets 

for financing, rather than depending on loans. For example, with the 

emergence of the commercial paper market, many large firms with strong 

credit ratings that had been dependent on bank loans were able to access 

capital markets more directly. As a result, those large banks that had been 

major lenders to these firms have had to find new sources of revenue. 

Banks are now relying more on fee-based income that is generated by 

structuring and arranging borrowing facilities, providing risk management 

tools and products, and servicing the loans they have sold off to other 

institutions as well as from fees on deposit and credit card activity, 

including account holder fees, late fees, and transactions fees. Many large 

banking institutions have moved into investment banking activities, 

including arranging OTC derivative transactions for their corporate 

customers. These institutions also earn fees on their investment banking 

activities as well as from their sales of insurance and mutual fund products.
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 52 GAO-05-61 Financial Regulation

These role changes have been facilitated by the development of new 

products, such as securitized assets, that depend on sophisticated 

mathematical models and the technology needed to support them. In its 

simplest form, asset securitization is the transformation of generally 

illiquid assets into securities that can be traded in capital markets. The 

process includes several steps: the firm that issued the loans creates a legal 

entity (a “pool”), segregates loans or leases into groups that are relatively 

homogeneous with respect to their cash-flow characteristics and risk 

profiles, including both credit and market risks, and sells the group to the 

pool. The pool then issues securities and sells them to an underwriter, who 

prices them and sells them to investors. Securitized assets generally consist 

of mortgage-backed securities and other asset backed securities where 

loans for products such as credit cards or commercial loans are securitized 

and sold. Mortgage-backed securities3

 grew from about $1,123 billion in 

1990 to about $3,796 billion in 2003, while other asset-backed securities 

grew by a factor of 12 over that same period of time. Because the risk 

embedded in securitized assets can be structured and priced so that 

financial institutions and others may be better able to manage credit and 

interest rate risk with these instruments.

Because banks and insurance companies could reduce their capital 

requirements by securitizing assets and removing those assets from their 

balance sheets, securitization was also driven by changes in capital 

requirements implemented in these industries in the early 1990s that 

required firms to hold more capital for certain assets.4

Along with securitized assets, derivatives have been used increasingly by 

financial institutions to manage assets and risks for themselves and others 

or to take a position on the direction of market movements in hopes of 

making a profit. Derivatives are contracts that derive their value from a 

reference rate, index, or the value of an underlying asset, including stocks, 

bonds, commodities, interest rates, foreign currency exchange rates, and 

indexes that reflect the collective value of underlying financial products. 

There are several types of derivatives, including the following:

3

Mortgage-backed securities numbers are from the Federal Reserve’s flow of funds data and 

include federal agency and government sponsored enterprise-backed mortgage pools and 

mortgages backing privately issued pool securities and collateralized mortgage obligations.

4

See chapter 4 for information about capital requirements.
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 53 GAO-05-61 Financial Regulation

• Futures and forwards—contracts that obligate the holder to buy or sell a 

specific amount or value of an underlying asset, reference rate, or index 

(underlying) at a specified price on a specified future date. Futures and 

forwards are used to hedge against changes or to speculate by 

attempting to make money off of predicting future changes in the 

underlying. Futures are often traded on exchanges and forwards are 

traded as OTC transactions and generally result in delivery of an 

underlying. (See ch. 1.)

• Options—contracts that grant their purchasers the right but not the 

obligation to buy or sell a specific amount of the underlying at a 

particular price within a specified period. Options can allow their 

holders to protect themselves against certain price changes in the 

underlying or benefit from speculating that price changes in the 

underlying will be greater than generally expected. 

• Swaps—agreements between counterparties to make periodic 

payments to each other for a specified period. Swaps are often used to 

hedge market risk or speculate on whether interest rates or currency 

values will change in a particular direction.

• Credit default swaps—a contract whereby the protection buyer agrees 

to make periodic payments to the protection seller for a specified period 

of time in exchange for a payment in the event of a credit event such as 

a default by a third party referenced in the swap. Credit default swaps 

allow market participants to keep loans or loan commitments on their 

books and essentially purchase insurance against borrower default.

Figure 5 shows the growth in the number of exchange-traded futures since 

1995.5

 In addition, Bank for International Settlements’ estimates of the 

notional amounts of OTC derivatives outstanding increased globally by 

about 146 percent between 1998 and 2003, going from about $80 trillion in 

1998 to about $197 trillion in 2003.

5

For earlier information on derivatives, see GAO, Financial Derivatives: Actions Needed to 

Protect the Financial System, GAO/GGD-94-133 (Washington, D.C.: May 18, 1994); and 

Financial Derivatives: Actions Taken or Proposed Since May 1994, GAO/GGD/AIMD-97-8

(Washington, D.C.: Nov. 1, 1996).
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 54 GAO-05-61 Financial Regulation

Figure 5: Number of Futures Contracts Traded, 1995-2003

The growth of derivatives activity attests to the usefulness of these 

instruments to the participants, but there are concerns about the 

management of derivatives risk. The complexity of some of these 

instruments can make it difficult for the users to understand and estimate 

the potential value or loss; moreover, the reliance on a counterparty to 

make an expected flow of payments during future years means that the 

recipient is exposed to the credit risk that the counterparty might default in 

the meantime. 

Product Offerings in 

Different Sectors Have Also 

Converged 

While convergence has taken place among firms using similar securitized 

products and derivatives to manage assets and risks, it has also taken place 

in product offerings by firms in different segments of the financial services 

industry. These firms are competing against each other to provide 

households, businesses, and governments with the same basic services. 

For example, table 1 illustrates how financial firms in the various sectors, 

regardless of whether they are affiliated with firms in other sectors, are 

0

500

1,000

1,500

2,000

1995 1996 1997 1998 1999 2000 2001 2002 2003

Number of futures contracts in millions

United States

International

Source: GAO analysis of Futures Industry Association data.
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 55 GAO-05-61 Financial Regulation

offering functionally similar products to satisfy the same retail customer 

needs.

Table 1: Selected Retail Products by Financial Institution and Functiona

Source: GAO

a

While most of these products could be offered by any financial institution through its affiliates, the 

products are classified here according to whether a stand-alone financial institution would offer the 

product. 

b

Subject to a grandfathering provision, GLBA prohibits national banks from engaging in title insurance 

activities, except that national banks and their subsidiaries may act as agents to sell title insurance in 

states where state banks are permitted to engage in that activity. 15 U.S.C. 6713 (2000 & Supp. 2004). 

Also, national banks may underwrite certain insurance products, such as credit insurance, where the 

activity is incidental to the business of banking, and may act as insurance agents directly only under 

certain circumstances, although they may engage fully as insurance agents through subsidiaries.

Similarly, firms in different sectors compete by offering products that have 

similar ability to meet some business needs. Issuance of commercial paper 

can provide financing similar to commercial loans, and catastrophe bonds 

and reinsurance provide similar protection, as do surety bonds and standby 

letters of credit. 

Although financial services firms and products have converged in 

numerous ways, firms in the various sectors, especially smaller firms, 

continue to specialize in some traditional functions. Commercial banks still 

make commercial loans to businesses, especially those smaller businesses 

Financial 

institution

Transaction 

accounts

Fixed return 

investments

Variable return 

investments Risk management Raising money

Banks Checking, savings Certificates of 

deposit, corporate 

bonds, municipal 

bonds, Treasuries

Variable annuities Insurance distributionb Loans (all types)

Broker-dealers Cash management 

account

Corporate bonds,

municipal bonds,

Treasuries

Stocks,

mutual funds,

variable annuities

Options Loans associated 

with margin 

accounts

Investment 

companies 

Money market mutual 

fund

Guaranteed 

investment

contracts

Mutual funds,

variable annuities

Insurers Fixed annuities, 

guaranteed 

investment contracts

Variable annuities, 

mutual funds

Property-casualty, life 

insurance

Futures firms Futures, options

Other financing 

companies 

Consumer loans
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 56 GAO-05-61 Financial Regulation

that may not be able to raise funds directly in capital markets; insurance 

firms still underwrite the risks involved in insuring a life or property or 

casualty; and investment banks still underwrite new securities and advise 

firms on mergers and acquisitions. 

As Financial Services 

Institutions Have 

Diversified, Introduced 

New Products, and 

Become More 

Complex, Risks Have 

Changed

Globalization, consolidation, conglomeration, and convergence of financial 

institutions have changed the risk profile of the institutions and the 

linkages among them. Today, a large modern financial firm may operate in a 

variety of product and geographic markets. Figure 6 illustrates how such a 

complex firm might be organized. 
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 57 GAO-05-61 Financial Regulation

Figure 6: Structure of a Hypothetical Financial Holding Company

Generally, diversification into new geographic and product markets would 

be expected to reduce risk, while securitized and derivative products have 

given firms new tools to manage risk. Because risks interact, however, the 

net result on the risk of an individual institution or the financial system 

cannot be definitively predicted. In addition, managing risks in an 

environment that crosses industry and geographic lines along with new 

products have increased the complexity of institutions and the industry. As 

a result of all of these factors, the risks facing the industry have changed in 

some ways. 

Life

insurance

company

(broker/

agent/

underwriter)

National

bank

Futures

commission

merchant

Broker/

dealer

Bank

holding

company

Special

financing

entity

National

thrift

State

thrift

Asset

management

company

Non-U.S.

investment

bank

Domestic

sales

offices

State

member

bank

State

nonmember

bank

National

bank

Financial

holding company

National

bank

Non-U.S.

commercial

bank

U.S.

securities

broker/

dealer/

underwriter

Commercial

paper

funding

corporation

Futures

commission

merchant

Non-U.S.

securities

broker/

dealer/

underwriter

Insurance

agencies

Source: GAO.
Chapter 2

The Financial Services Industry Has 

Undergone Dramatic Changes

Page 58 GAO-05-61 Financial Regulation

Credit Risks Have Changed 

as a Result of Industry 

Changes 

Generally, diversification of borrowers will reduce the credit risk of a 

financial services firm, and many of the changes in the industry have done 

just that. U.S. banks have consolidated and spread across the country so 

that they are no longer operating in a single small town, city, or state. If a 

town or even a region falls on hard times and borrowers increasingly 

default on loans, the bank, or other institution that made the loans, may be 

less affected than they once would have been, because borrowers in other 

markets may be enjoying positive economic circumstances and defaults in 

those markets may be dropping. The same is true for firms diversifying 

their types of products and for those diversifying to other parts of the 

world. In addition, by securitizing loans and selling them off or by using 

credit derivative products, individual firms or sectors may also reduce 

credit risk. For example, in its Global Financial Stability Report issued in 

April 2004, the IMF reported that, for many years, banks have been 

transferring risk, especially credit risk, to other financial institutions, such 

as mutual funds, pension funds, insurers, and hedge funds.6

Many of the same forces that may have reduced credit risk for some 

institutions, as well as other forces, may have increased risk as well. For 

example, while globalization allows for diversification, it also complicates 

the evaluation of credit risk. Because bankruptcy laws differ among 

countries, the assets of a failed household or corporate borrower in 

another country may be less available to U.S. creditors. In addition, little 

recourse exists when foreign governments default on their debt. Further, 

the extent to which diversification and new products reduce credit risk 

depends on how the firm to which the risk is passed understands, 

measures, and manages its new markets and products—as well as the 

combined risks of old and new exposures. If it does not manage them well, 

these normally credit reducing activities could actually increase credit or 

other kinds of risks. 

The degree to which diversification and new products reduce credit risk 

will also depend on the linkages between markets, products, and firms, and 

the relationship or correlation among the risks. For example, securitized 

products and credit derivatives can allow one institution to pass on risk to 

another. Regulators and others have expressed concern that this risk can 

become concentrated in a few firms or be passed to buyers that may be less 

6

IMF, Global Financial Stability Report: Market Developments and Issues, April 2004 

(Washington, D.C., April 2004).
Chapter 2

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Page 59 GAO-05-61 Financial Regulation

equipped to handle it. Some research has been conducted because 

regulators and others were concerned that the banking sector was passing 

credit risk to the insurance sector or ultimately to households and that 

these developments could have implications for overall financial stability.7

For example, IMF reported in April 2004 that on a global basis the transfer 

of credit risk from banks to life insurers might increase financial stability 

because life insurers generally hold longer-term liabilities. However, the 

report notes that in recent years, many insurers have changed their 

products in ways that have begun to shorten the duration of their liabilities, 

raising questions about their advantage in handling credit risk. And as 

insurers in some parts of the world take steps to manage their balance 

sheet risk, they would likely transfer that risk to others—including the 

household sector, which might be less able to manage the risk.

Because financial services firms are competing and cooperating with each 

other across traditional industry and geographic boundaries, there are 

increased linkages that may not be well understood. Thus, downturns 

somewhere in the world, such as those in Russia in 1998 or Mexico in 1995, 

can have a large impact on all of the major financial institutions. In 

addition, if the large financial institutions are linked to each other as 

counterparties in various transactions, a major credit failure at one could 

send systemic shockwaves through the United States and even the world’s 

economy. 

Many of the concerns raised here were evident in the near collapse of LongTerm Capital Management (LTCM)—one of the largest U.S. hedge funds—

in 1998 following the Russian downturn.8

 Most of LTCM’s balance sheet 

consisted of trading positions in government securities of major countries, 

but the fund was also active in securities markets, exchange-traded futures, 

and OTC derivatives. According to LTCM officials, LTCM was counterparty 

to over 20,000 transactions and conducted business with over 75 

counterparties. Further, the Bank for International Settlements reported 

that LTCM was “perhaps the world’s single most active user of interest rate

7

See IMF, Global Financial Stability Report, April 2004; FSA, Cross-Sector Risk Transfers 

(London, U.K., May 2002); and Committee on the Global Financial System of the Bank for 

International Settlements, Global Credit Risk Transfer (Basel, Switzerland, January 2003).

8

GAO, Long-Term Capital Management: Regulators Need to Focus Greater Attention on 

Systemic Risk, GAO/GGD-00-3 (Washington, D.C.: Oct. 29, 1999). 
Chapter 2

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Undergone Dramatic Changes

Page 60 GAO-05-61 Financial Regulation

swaps.”9 In addition many of the financial institutions that LTCM dealt with 

failed to enforce their own risk management standards. 

Comparing the largest U.S. financial firms today with some large failures 

resulting from credit risk that did not appear to have systemic implications 

in the past can help shed light on the potential for systemic disruptions 

today. Bank of New England, which failed, in part, because of bad real 

estate loans, had $19.1 billion in assets at the time of its failure. In 

comparison, the largest bank holding company today had bank subsidiaries 

with assets of $823 billion in March 2004. Similarly, in the insurance area, 

one of the largest U.S. insurers has assets of $678 billion, while the largest 

insurance failure on record is Mutual Benefit, which had assets of only 

$13.5 billion. While the unwinding of Drexel, Burnham, Lambert Group is 

sometimes pointed to as evidence that the failure of a major securities firm 

would not necessarily raise concerns about systemic risk sufficient to 

warrant intervention, some experts suggest that four trends in the 

international financial system since that collapse suggest that the outcome 

for a future failure of a major securities firm might be different:10 (1) 

Leading securities firms have become increasingly international, operating 

in markets around the world and through a complex structure of affiliates 

in countries with differing bankruptcy regimes; (2) securities firms are 

increasingly parts of conglomerates that include banks, and thus the 

systemic concerns related to bank failures might extend to securities firms; 

(3) securities firms themselves have grown in size so that while they may 

be less likely to fail, any failure is more likely to have systemic implications; 

and (4) the largest securities firms have become increasingly involved in 

global trading activities, particularly OTC derivatives. An SEC staff member 

told us that while they believe that a gradual unwinding of one of the 

largest securities firms today could still be handled without systemic 

implications, the sudden failure of one of these firms would likely have 

major implications for a broad swath of markets and investors. Because of 

the sheer size of today’s financial institutions, some question whether these 

firms are too big to be allowed to fail. This belief could skew the incentives 

facing managers and investors to manage risk effectively. 

9

Bank for International Settlements, 69th Annual Report, 1 April 1998-31 March 1999 

(Basel, Switzerland; June 7, 1999).

10Richard Herring and Til Schuermann, “Capital Regulation for Position Risk in Banks, 

Securities Firms, and Insurance Companies” (paper at the Conference on Risk-Based 

Capital: The Tensions between Regulatory and Market Standards, Program on International 

Financial Systems, Harvard Law School (Cambridge, Massachusetts; June 10, 2003). 
Chapter 2

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Page 61 GAO-05-61 Financial Regulation

Other Risks Have Also Been 

Affected by Changes in the 

Industry

Changes in the industry, especially the growth of large institutions that 

cross industry and national boundaries, have also affected the level and 

management of operational and reputation risk. An official at one of the 

large securities firms told us that opportunities for fraud or other violations 

of law or regulation in some part of the organization increase immediately 

after a merger of entities with different corporate cultures. And to the 

extent that a firm operates centrally and the public believes the parts are 

connected, the ability to isolate such problems in some part of an 

organization will be more difficult. The collapse of Barings, a British bank, 

demonstrates the potential vulnerability to operational risk of firms 

operating across a wide range of markets. In this case, management did not 

effectively supervise a trader in Singapore, and his actions brought down 

the bank.11 Further, a firm’s reputation can be damaged by disreputable 

practices, such as happened when a major institution violated derivatives 

sales practices and when it was discovered that ownership of a U.S. bank in 

Washington, D.C., was tied to BCCI, a corrupt bank headquartered in 

Luxembourg. Regulators have recognized the increased importance of 

operational risks, including reputation risk, in the new capital standards 

adopted by the Basel Committee in June 2004. (See ch. 4.)

11The failure of Barings did not involve the use of British government funds. In addition, 

officials at the Federal Reserve note that Barings was much smaller than many of today’s 

banking organizations.
Page 62 GAO-05-61 Financial Regulation

Chapter 3

While Some Countries Have Consolidated 

Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure Chapte3r

Since the mid-1990s, several major industrial countries, including Australia, 

Germany, Japan, the Netherlands, and the United Kingdom, have 

consolidated their regulatory structures, and some U.S. states have 

consolidated their structures as well. While proposals have been advanced 

that would change the U.S. regulatory structure, the United States, most 

notably with the passage of GLBA, has chosen not to adopt any substantial 

changes. Proposals to change the U.S. regulatory structure made 

throughout the 1990s and early 2000s included consolidating bank 

regulators, merging SEC and CFTC, changing the SRO structure for 

securities, and creating a federal regulator to oversee those companies 

opting for the proposed federal insurance charter. Proposals have also 

been made that would cut across sectors, including proposals for a single 

federal regulator in each area, an oversight board, and a fully consolidated 

federal regulator. 

Some Countries and 

States Have 

Consolidated Their 

Regulatory Structures

During the 1990s and early 2000s, some other countries consolidated their 

regulatory structure. According to a research report by World Bank staff,1

by 2002, 29 percent of the countries that supervise banking, securities, and 

insurance had consolidated their regulatory structure to include only a 

single regulator, and another 30 percent of the countries had consolidated 

regulators across two of the three sectors. The remaining countries had 

multiple regulators, with a minimum of one for each of the sectors. 

Countries within the EU2

 made changes that sometimes reflect steps to 

create an integrated financial market but not an EU-wide regulatory 

regime. Generally, these countries’ industries and regulatory structures 

historically had differed from those in the United States, largely because 

banking, securities, and insurance activities had not been legally separated 

as they were in the United States under the Glass-Steagall Act. The 

products and services that financial services firms in these countries 

offered had changed, however, reflecting the financial innovations that 

have also transformed the U.S. financial services industry. Some U.S. states 

have also consolidated their regulatory structure. In addition, many states 

have combined some aspects of their banking, insurance, and securities 

1

José de Luna Martínez and Thomas A. Rose, “International Survey of Integrated Financial 

Sector Supervision” (World Bank Policy Research Working Paper 3096, July 2003).

2

The EU is a treaty-based organization of European countries in which those countries cede 

some of their sovereignty so that decisions on specific matters of joint interest can be made 

democratically at the European level.
Chapter 3

While Some Countries Have Consolidated 

Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 63 GAO-05-61 Financial Regulation

regulators, and some have chosen to combine all of their financial 

regulation in a single government agency. 

The EU Has Taken Steps 

Designed to Create an 

Integrated Financial Market 

but Not an EU-Wide 

Regulatory Regime

EU member states that have consolidated their regulatory structures have 

done so in the larger context of efforts to create an integrated financial 

market in the EU. Building on long-term actions to create a single financial 

market in Europe, the EU has taken several actions that are influencing 

regulatory frameworks in European countries. First, in 1998 the European 

Central Bank was established, and this has diminished the roles of the 

central banks in countries that began using the euro in 2002.3

 Second, the 

European Commission proposed an extensive Financial Services Action 

Plan (Action Plan) in 1999 that it expects to fully implement by 2005. Under 

the Action Plan, the EU would not create any EU-wide financial services 

regulatory bodies, but would instead enact legislation that would be 

adopted by the individual countries and implemented by their regulators. 

Since under the EU charter, firms can do business in all EU countries if 

they are located in one of them (the so-called Single Passport), EU officials 

and others have said that convergence is necessary to prevent duplicative 

requirements and regulatory arbitrage. That is, companies should not have 

an incentive to choose their location based on the regulatory regime in a 

particular country and should not be able to pit one regulator against 

another to get favorable regulatory decisions. Finally, to streamline 

European lawmaking and stimulate regulatory and supervisory 

convergence, the EU has created a process under which committees of 

securities, banking, and insurance regulators from the individual member 

states now consult and coordinate their work at several stages in the 

process between adoption of more detailed rules. These supervisory 

committees are the Committee of European Securities Regulators (CESR), 

the Committee of European Banking Supervisors, and the Committee of 

European Insurance and Occupational Pensions Supervisors.

The United Kingdom, 

Germany, and Japan Have 

Adopted a Single Regulator 

Structure

Along with other countries, the United Kingdom, Germany, and Japan have 

each adopted versions of the single regulator model. However, the 

regulatory organizations in these countries differ significantly. The United 

Kingdom’s consolidation is the most notable in that, according to a 

3

Together with the state central banks, the European Central Bank conducts monetary 

policy for the EU, but has no regulatory or supervisory powers.
Chapter 3

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Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 64 GAO-05-61 Financial Regulation

research paper by IMF staff, it provided an enormous impetus for other 

countries to unify their supervisory agencies. 

United Kingdom Beginning in 1997, the United Kingdom consolidated its financial services 

regulatory structure, combining nine different regulatory bodies, including 

SROs, into the Financial Services Authority (UK-FSA). While UK-FSA is the 

sole supervisor for all financial services, other government agencies, 

especially the Bank of England and Her Majesty’s Treasury (HM-Treasury), 

still play some role in the regulation and supervision of financial services. 

Formal financial regulation and supervision are relatively new to the 

United Kingdom; before 1980, according to officials at the Bank of England, 

a “raised eyebrow” from the Head of the Bank of England was used to 

censure inappropriate behavior. Thus, most of the agencies and SROs that 

were replaced did not have long histories. 

Government officials and experts cited important changes in the financial 

services industry as some of the reasons for consolidating the regulatory 

bodies that oversee banking, securities, and insurance activities. These 

included the blurring of the distinctions between different kinds of 

financial services businesses, and the growth of large conglomerate 

financial services firms that allocate capital and manage risk on a 

groupwide basis. Other reasons for consolidating included some 

recognition of regulatory weaknesses in certain areas and enhancing the 

United Kingdom’s power in EU and other international deliberations.

U.K. officials have reported that the United Kingdom did not separate its 

regulators by objective—the twin peaks model, which usually includes a 

prudential or safety and soundness regulatory agency and a conduct-ofbusiness or market conduct regulatory agency—because the same senior 

management and groupwide systems and controls that determine a firm’s 

ability to manage financial risk effectively also determine a firm’s approach 

to market conduct. Similarly, while British experts acknowledge that 

groupwide supervision could be managed with regulators who specialize in 

the regulation of specific sectors, they say that the need for 

communication, coordination, cooperation, and consistency across the 

specialist regulatory bodies would make it exceedingly difficult to operate 

within a multiple regulator system. 

According to documents provided by UK-FSA officials, the agency’s 

enabling legislation stipulated four goals:

• maintaining confidence in the financial system;
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Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 65 GAO-05-61 Financial Regulation

• promoting public understanding of the financial system;

• securing the appropriate degree of protection for consumers; and

• reducing the potential for financial services firms to be used for a 

purpose connected with financial crime.

In pursuing these goals, UK-FSA is directed to take account of additional 

obligations, including achieving its goals in the most efficient and effective 

way; relying on senior management at financial services companies for 

most regulatory input; applying proportionality to regulatory decisions, 

including the costs and benefits of each act; not damaging the competitive 

position of the United Kingdom internationally; and avoiding any 

unnecessary distortions in or impediments to competition, including 

unnecessary regulatory barriers to entry or business expansion. 

UK-FSA is organized as a private corporation with a chairman and chief 

executive officer and a 16-person board of directors. Eleven members of 

the board are independent, while the other five are UK-FSA officials. UKFSA is ultimately answerable to HM-Treasury and the British Parliament. 

The statute provides for a Practitioner Panel and a Consumer Panel to 

oversee UK-FSA for their respective constituencies. In addition, there are 

requirements for consultation on rules and an appeals process for 

enforcement actions. 

UK-FSA documents and officials present UK-FSA as an organization 

strategically focused on achieving its statutory objectives. It has adopted a 

risk analysis model that it believes allows it to allocate resources so as to 

minimize the chance that UK-FSA will fail to meet its goals. As a result of 

this analysis, it focuses on the largest firms—the ones most likely to pose 

significant costs of failure—and on the needs of retail consumers. To 

assure that UK-FSA accomplishes its goals efficiently, it is required to 

submit cost-benefit analyses for its proposals. In addition, UK-FSA must 

report annually on its costs relative to the costs of regulation in other 

countries and must provide its next fiscal year’s budget for public comment 

three months prior to the end of the current fiscal year. 

UK-FSA officials say that they have also taken actions, within the 

institution, to break down the barriers—often called stovepipes or silos—

between those regulating the different industries. From the beginning, they 

forged a new common language across industry segments and traditional 

regulatory boundaries. Staff have to explain why a requirement imposed on 
Chapter 3

While Some Countries Have Consolidated 

Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 66 GAO-05-61 Financial Regulation

one segment should differ from that imposed on other sectors. The current 

organizational structure is designed around retail and wholesale divisions. 

The structure also includes crosscutting teams looking at various issues, 

including asset management, financial crime, and financial stability as well 

as the traditional areas of banking, securities, and insurance. 

Most of the representatives of firms we spoke to in the United Kingdom, 

including U.K. subsidiaries of U.S. companies, felt that UK-FSA was doing a 

good job, but some industry representatives have raised concerns. Much of 

UK-FSA’s success is attributed to the caliber of the people working there. 

For example, we heard that the ability to pull off the creation of UK-FSA 

depended greatly on the caliber of the early leadership and that using highquality bank supervisors to supervise in other areas has had benefits, even 

though these staff may not have expertise specific to a particular business. 

However, some industry participants were concerned about the future and 

about the lack of expertise in some areas such as insurance. In addition, the 

Practitioner Panel in its 2003 annual report expressed concerns about UKFSA’s cost-benefit analyses, saying that certain costs are often 

unrepresentative or not included at all, and that there is a disregard for the 

total cost of regulation and the industry’s ability to absorb the incremental 

cost of rule changes. They also suggested that analyses should include 

potential areas of consumer disadvantage, such as a reduction in choice 

and the possibility of unintended consequences. However, a UK-FSA 

official said that while the agency is working to improve its cost-benefit 

analysis, one industry trade association working on the issue had noted 

that UK-FSA is a world leader in the area. 

Since UK-FSA took over, a major crisis in the life insurance area has come 

to light. Equitable Life is a mutual insurer in the United Kingdom that 

inappropriately sold policies in the high interest rate environment in the 

1970s and 1980s that are now coming due and failed to reserve 

appropriately for them. A major study of this problem, the Penrose report, 

was issued in March 2004. The report concluded that the crisis was due to 

the “light touch, reactive regulatory environment” that preceded UK-FSA 

and that UK-FSA’s work since 1997 “has sought to anticipate many of the 

lessons that might be drawn by this inquiry and it should come as no 

surprise that it has largely succeeded.” The report also concluded that the 

lack of coordination between safety and soundness and market conduct 

regulation in the past was unacceptable. HM-Treasury is now undertaking 

an extensive review of UK-FSA’s authorizing legislation, in part, to 

determine the impact UK-FSA might be having on competition in the U.K. 

financial services sector.
Chapter 3

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Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 67 GAO-05-61 Financial Regulation

 While UK-FSA is the sole financial services supervisor, other government 

entities still play a role in regulating the financial services industry. A 

tripartite agreement lays out the roles of the Bank of England, HMTreasury, and UK-FSA. While UK-FSA is responsible for supervision of 

financial entities, the Bank of England retains primary responsibility for the 

overall stability of the financial system. It retains the lender of last resort 

responsibilities but must consult with HM-Treasury if taxpayers are at risk. 

High-level representatives from the three agencies meet monthly to discuss 

issues of mutual concern. According to officials at the Bank of England, it 

is difficult to tell how well the system is working because it has not yet had 

to weather a significant banking crisis. 

Germany In 2002, Germany combined its securities, banking, and insurance 

regulators into BaFin; however, the changes appear less dramatic than at 

UK-FSA. Although crosscutting groups have been added to handle 

conglomerate supervision, international issues, and other cross-sectoral 

topics that concern all of the supervisory divisions, the new structure still 

maintains the old divisions related to banking, securities, and insurance. In 

addition, the insurance and banking divisions are housed in Bonn, while the 

securities markets regulators are in Frankfurt. Finally, BaFin shares 

supervisory responsibilities in the banking area with the Bundesbank, 

Germany’s central bank.

Organizationally, BaFin is a federal agency overseen by the treasury that 

must follow civil service laws. BaFin has an administrative board 

composed of the ministers of Finance, Economics, and Justice, members of 

Parliament, officials of the Bundesbank, and representatives of the 

banking, insurance, and securities industries. The Advisory Council made 

up of industry, union, and consumer representatives also advises BaFin.

BaFin’s statutory mandate is to take supervisory or enforcement actions to 

counteract developments that may

• endanger the safety and soundness of the assets entrusted to 

institutions in the banking, insurance, and other financial services 

sectors; 

• impair the proper conduct of banking, insurance, and securities 

business or provision of financial services; or

• involve serious disadvantages to the German economy. 
Chapter 3

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Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 68 GAO-05-61 Financial Regulation

Much of the immediate impetus for the creation of BaFin came from 

developments in the EU. However, the new organization also recognizes 

the blurring of industry lines and the need for reducing the costs of 

supervision to the government. Specifically German government officials 

cited the following reasons for the creation of a consolidated regulator:

• Financial institutions that are taking on similar risks must be treated the 

same. 

• Conglomerates need effective oversight.

• The cost of regulation could be reduced through greater efficiency and 

by providing for industry funding of BaFin’s operations.

• The role of the Bundesbank, in light of the creation of the European 

Central Bank, would be clarified.

• International standing and clout could be increased. 

Like the United States, Germany has a state system of financial institutions 

and regulators as well as the federal system. The banking system consists 

of private banks and state banks, or Sparkassen, that are owned by a city or 

other government entity. The fragmentation of the banking industry has 

impacted the commercial banking industry in that private banks have 

difficulty expanding their retail banking operations. In addition, securities 

exchanges, as well as some insurance activities, are overseen at the state 

level.

Statutes and agreements lay out the complex relationship between BaFin 

and the Bundesbank. When we last reviewed the German bank regulatory 

system in 1995, we noted that while the Bundesbank played a role in the 

oversight of banks, this role was not then spelled out statutorily. With 

creation of the European Central Bank, the role of the Bundesbank in the 

supervision of credit institutions was also clarified. While BaFin conducts 

its own document analyses and, if required, its own investigations of 

troubled institutions and institutions of relevance to the system, BaFin is 

required to consult with the Bundesbank on new rules, and the 

Bundesbank is responsible for most of the ongoing monitoring of 

institutions. Officials at one of the German subsidiaries of a U.S. 

investment bank we spoke with said that most of their dealings are with the 

Bundesbank. 
Chapter 3

While Some Countries Have Consolidated 

Regulatory Structures, the United States Has 

Chosen to Maintain Its Structure

Page 69 GAO-05-61 Financial Regulation

Japan Japan consolidated and modified its financial services regulatory structure 

in response to persistent problems in that sector. Japan’s financial markets 

sector had certain similarities to that of the United States. Most notably, 

until 1996, Japan maintained legal separations between commercial 

banking, investment banking, and insurance. Japanese law, however, did 

allow cross ownership of financial services and commercial firms, 

permitting development of industrial groups or keiretsu that dominated the 

Japanese economy. These groups generally included a major or lead bank 

that was owned by other members of the group and that provided financial 

services to the members.

Problems in Japan’s financial sector are generally accorded some 

responsibility for the persistent stagnation of its economy through the 

1990s. The Financial Reform Act of 1992 allowed the Ministry of Finance to 

impose capital requirements for banks and banks to own securities 

affiliates and created the Securities Exchange and Surveillance 

Commission. According to one author, while these laws were designed to 

reduce the Ministry of Finance’s control over the financial sector, the 

ministry retained its role. In 1998, the Financial Supervisory Agency, 

renamed the Financial Services Agency (Japan-FSA) in 2000, was created, 

with functions and staff transferred from the Ministry of Finance. The 

Securities Exchange and Surveillance Commission was also moved into 

that organization. Japan-FSA has overseen the mergers of several large 

banks and reports progress in addressing the issue of nonperforming loans 

held by Japanese banks. In the review of Japan-FSA issued in 2003, 

however, IMF raised questions about the independence and enforcement 

powers of the agency.

The Netherlands and 

Australia Have Consolidated 

Their Regulatory Structure 

Using the Twin Peaks Model

Both the Netherlands and Australia consolidated their regulatory structure, 

but they did not adopt the single regulator structure. Instead, they adopted 

a structure that separates the regulators by objective,4

 such that one 

regulatory body is responsible for prudential regulation and another for 

conduct-of-business regulation—often referred to as the twin peaks model.

In 2001, when the Netherlands Ministry of Finance proposed a 

restructuring of the financial regulatory structure, the country had three

4

Officials in the Netherlands call this functional regulation as do officials in other countries 

that have adopted a similar structure.
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Chosen to Maintain Its Structure

Page 70 GAO-05-61 Financial Regulation

regulatory bodies—the Dutch Central Bank regulated banks, the Pensions 

and Insurance Supervisor regulated insurance, and the Securities Board 

regulated securities. Both the Central Bank and the Insurance Supervisor 

had some responsibility for financial stability. Since 1999, the Council of 

Financial Supervisors had helped to coordinate regulatory activities 

between the three agencies, but has received less attention as the country 

moves to the new structure. 

The Netherlands is now in the final stages of consolidating its regulatory 

system and separating it into prudential and market conduct activities. The 

Pensions and Insurance Supervisor is merging with the Dutch Central Bank 

so that all prudential supervision will be done within the central bank, and 

in 2003, the Securities Board became the Netherlands Authority for the 

Financial Markets (AFM), the body responsible for market conduct in all 

segments of financial services. 

As with the other countries, several factors contributed to the Netherlands’ 

decision to change its regulatory structure. The Netherlands is the home of 

several of the largest, most globally active conglomerates. Supervision of 

these conglomerates had been divided among the three regulatory bodies 

and was not always consistent. As with the other central banks of other 

countries that adopted the Euro, the Dutch Central Bank no longer has 

primary responsibility for monetary policy or for the nation’s currency. Like 

Germany, the Netherlands needed to clarify the role of its central bank 

after the formation of the European Central Bank. 

With regard to its regulatory and supervisory roles, the Dutch Central Bank 

operates as an autonomous administrative authority. After the merger with 

the Pensions and Insurance Supervisor, its main objective is to ensure that 

banks, insurance companies, pension funds, and other financial service 

providers are sound businesses that can meet their liabilities to others now 

and in the future. The supervision focuses on protecting as well as possible 

the interests of consumers of financial services, whether they are 

individuals or businesses. 

A three-person executive board, subject to oversight by a five-person 

supervisory board appointed by the Minister of Finance, manages AFM. 

According to its 2003 Annual Report, this authority’s objectives are to 

• promote access to financial markets; 
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• promote the efficient, fair, and orderly operation of financial markets; 

and 

• ensure confidence in financial markets.

AFM is not organized around traditional industry sectors, but around three 

clusters of activities: Supervision Preparation, Supervision 

Implementation, and Business Operations. 

In 1998, Australia’s regulatory reforms provided for the establishment of 

the Australian Prudential Regulation Authority (APRA) to regulate the 

safety and soundness of financial institutions and the Australian Securities 

and Investments Commission (ASIC) to regulate corporations, market 

conduct, and consumer protection in relation to financial products and 

services. These changes followed a major study of Australia’s regulatory 

regime—called the Financial System Inquiry or Wallis Report—that 

reported to the Australian Government in March 1997. This report 

identified the following reasons for recommending reform: 

• to achieve a more competitive and efficient financial system while 

maintaining financial market stability, prudence, integrity, and fairness;

• to design a regulatory framework that is adaptable to future financial 

innovations and other market developments; and 

• to ensure that the regulation of similar financial functions, products, or 

services is consistent between different types of institutions.

APRA, the safety and soundness regulator, provides prudential regulation 

for deposit-taking institutions, insurers, and pension funds. APRA 

consolidated prudential regulation responsibilities at the national level, 

taking on the responsibilities of nine regulatory agencies (the Reserve Bank 

of Australia, the Insurance Superannuation Commission and seven statebased regulators). It is an independent authority that is overseen by a threeperson executive group. Its structure includes a risk management and audit 

committee and has four major divisions—diversified institutions, 

specialized institutions, supervisory support and policy, research and 

statistics. 

ASIC is an independent commonwealth government body that has 

responsibility for regulating financial markets and corporations as well as 

consumer protection in relation to the provision of financial products and 
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services, including securities, derivatives, pensions, insurance, and deposit 

taking. As one ASIC official put it, ASIC looks after consumers as individual 

customers, ensuring they receive proper disclosure, are dealt with fairly by 

qualified people, and continue to receive useful information about their 

investments. ASIC replaced the Australian Securities Commission, which 

had replaced the National Companies and Securities Commission at the 

federal level and the Corporate Affairs offices of the states and territories 

in 1991. 

Along with APRA and ASIC, the Wallis report recommended that a Council 

of Financial Supervisors, initially composed of representatives of APRA, 

ASIC, and the central bank, be formed to deal with issues of coordination 

and cooperation. The council comprises high-level executives from each 

group and meets at least quarterly to discuss issues of mutual interest. As 

part of regulatory reforms flowing from a recent significant failure of an 

insurer, representatives of the treasury have also been included on the 

council.

Some U.S. States Have Also 

Consolidated Their 

Regulatory Structures 

Largely in Response to 

Industry Conglomeration 

and Product Convergence 

According to information provided by the Conference of State Bank 

Supervisors, in July 2004, 23 states supervise banking and either insurance 

or securities in one department. That information also shows that 14 states 

have consolidated financial regulatory structures, combining banking, 

securities, and insurance regulation into one department.5

 We interviewed 

officials in large states—Florida, Michigan, and Minnesota—that had 

consolidated their regulatory structures. Regulatory officials from each of 

these states told us they consolidated in response to industry changes that 

were blurring the traditional demarcations between banking, securities, 

and insurance activities. In all three states, officials said that although 

consolidation was not designed to conserve resources, they believed there 

had been cost savings due to consolidation. 

State officials from Florida, Michigan, and Minnesota told us that 

consolidation had improved information sharing across different financial 

services sectors, specifically in the areas of licensing and customer 

complaints. Michigan has consolidated licensing of all sales agents, 

including mortgage, insurance, and securities. Now that all financial 

5

Regarding exchange-traded futures, federal law generally pre-empts state authority. 

However, states may have jurisdiction to enforce anti-fraud laws related to activities 

involving futures contracts. 
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licensing is housed in one division, the state can more easily detect and 

discipline fraudulent behavior. For instance, individuals who have recently 

lost their license to sell securities due to fraudulent or other criminal acts 

cannot apply for a license to sell insurance or mortgages. Consolidation of 

customer complaints call centers has enabled Florida, Michigan, and 

Minnesota to downsize personnel and provide better services to consumers 

of financial products, according to officials from those states. 

United States Has 

Chosen to Maintain the 

Federal Regulatory 

Structure, although 

Proposals Have Been 

Made to Change It 

While GLBA removed restrictions against affiliations among financial 

services providers across sectors, it did not change the financial services 

regulatory structure. Over the years, many proposals had been made to 

change the U.S. regulatory structure. Many of the proposals, including one 

we made in 1996, have concerned reducing the number of federal bank 

regulators. Suggestions have also been made to combine SEC and CFTC, 

and to consolidate the securities SRO structure. In addition, proposals for 

an optional federal charter for insurance companies are currently being 

considered. Finally, some proposals for consolidating across sectors were 

made in the discussions leading up to the passage of GLBA, and that law 

did not end calls for regulatory restructuring across sectors.

GLBA Permitted Affiliations 

across Areas without 

Changing the Regulatory 

Structure

While GLBA removed many of the barriers that had restricted firms from 

engaging in banking, securities, and insurance activities, thus allowing 

many financial services firms to offer a wider array of services, it did not 

change the regulatory structure. By allowing banking organizations, 

securities firms, and insurance companies to affiliate with each other 

through a financial holding company structure, GLBA addressed several 

regulatory developments that had already permitted the affiliation of 

depository institutions with providers of nonbanking financial services. In 

1998, the Federal Reserve had permitted Citicorp, at the time the largest 

bank holding company in the United States, to become affiliated with 

Travelers Group, a diversified financial services firm engaged in insurance 

and securities activities.6

 Without the adoption of GLBA, the combined 

entity would have been subject to a requirement to divest or otherwise 

restructure many of its securities and insurance activities. In addition, OCC 

had promulgated regulations permitting national bank subsidiaries to 

6

See Federal Reserve Board, Order Approving Formation of a Bank Holding Company and 

Notice to Engage in Nonbanking Activities, 84 Fed. Res. Bull. 985 (1998).
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engage in activities that were not permissible for the banks themselves.7

Moreover, as discussed earlier, most thrift holding companies were not 

subject to activities restrictions. GLBA codified regulatory developments 

that had already allowed expanded services within a holding company or 

from a national bank subsidiary. 

After GLBA, banking, securities, and insurance activities continued for the 

most part to be regulated by the same primary federal regulator that had 

regulated them when only separate firms could participate in each activity. 

For instance, SEC primarily regulates securities activities regardless of 

where they occur within a financial holding company structure.8

 Similarly, 

states continue to be responsible for regulation of insurance underwriting 

and other insurance-related activities undertaken by insurance companies.9

However, because the blurring of distinctions that once separated the 

financial products and services of banks, securities firms, and insurances 

companies also could blur the regulatory responsibilities of their respective 

regulators, GLBA contains provisions designed to enhance regulatory 

consultation and coordination. For example, with respect to insurance 

activities by insurance companies that are part of a financial holding 

company, the act calls for consultation, coordination, and information 

sharing among federal financial regulators and state insurance regulators.10

In addition, although GLBA established the Federal Reserve as the 

umbrella regulator of financial holding companies, the act requires the 

Federal Reserve generally to coordinate with and defer to the “functional” 

regulators with respect to the institutions they regulate.11 Federal Reserve 

supervision of holding companies is to focus primarily on the consolidated 

7

Under OCC regulations effective December 31, 1996, national banks were permitted to 

engage in a broader range of activities through subsidiaries than the Comptroller permitted 

within the banks themselves. See 61 Fed. Reg. 60351-52 (Nov. 27, 1996).

8

National banks can be subject to SEC broker registration requirements if they execute 

orders for customers that involve securities not exempt from SEC jurisdiction or 

transactions not subject to an exception under the securities laws. See 15 U.S.C. § 78c(a)(4) 

(2000 & Supp. 2004).

9

Subject to the preemption standard set forth in GLBA and prohibitions against 

discriminatory state laws, GLBA authorizes limited state regulation of insurance sales by 

banks and savings associations. Pub. L. No. 106-102 § 104, 15 U.S.C. § 6701 (2000 & Supp. 

2004).

10Pub. L. No. 106-102 § 307, 15 U.S.C. § 6716 (2000 & Supp. 2004).

11Pub. L. No. 106-102 §§ 111, 112, 12 U.S.C. §§ 1844(c), (g).
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risk position of the entire holding company, the risks the holding company 

system may pose to the safety and soundness of any of its depository 

institution subsidiaries, and compliance with consumer protection laws it 

is charged with enforcing.12 GLBA also retained OTS responsibility for 

supervising thrift holding companies, although it did limit the ability of 

nonfinancial companies to obtain thrift charters after May 4, 1999. In 

addition to establishing the scheme for the regulation of consolidated 

financial organizations involving a bank or thrift, GLBA provided for a 

program allowing for consolidated supervision by the SEC of investment 

bank holding companies. 

One area for which GLBA discussed a potential new regulatory agency was 

insurance. As an incentive for states to modernize and achieve uniformity 

in insurance regulation, GLBA provided for a federal licensing agency, the 

National Association of Registered Agents and Brokers, that was to come 

into existence three years after the enactment of GLBA, if a majority of 

states failed to enact legislation for state uniformity or reciprocity.13

However, that agency has not come into existence because a majority of 

the states adopted the types of laws and regulations called for in the 

section.

Since 1990, Various 

Proposals Have Sought to 

Simplify the Bank 

Regulatory Structure and 

Reduce the Number of 

Regulators

According to FDIC, many regulatory restructuring proposals concerned the 

restructuring of the multiagency system for federal oversight of banking 

institutions in the United States have been made since the 1930s, when 

federal deposit insurance was introduced. Since 1990 several additional 

proposals have been made, including the following three made between 

1993 and 1994:

• 1994 Treasury proposal.14 This proposal would have realigned the 

federal banking agencies by core policy functions—that is, bank 

supervision and regulation function, central bank function, and deposit 

insurance function. Generally, this proposal would have combined OCC, 

OTS, and certain functions of the Federal Reserve and FDIC into a new 

12Pub. L. No. 106-102 § 111, 12 U.S.C. § 1844(c).

13Pub. L. No. 106-102 § 321.

14This proposal was outlined in the statement of the Honorable Lloyd Bentsen, Secretary of 

the Treasury, before the Committee on Banking, Housing, and Urban Affairs of the U.S. 

Senate (Mar. 1, 1994).
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independent agency, the Federal Banking Commission, that would have 

been responsible for bank supervision and regulation. FDIC would have 

continued to be responsible for administering federal deposit insurance, 

and the Federal Reserve would have retained central bank 

responsibilities for monetary policy, liquidity lending, and the payments 

system. Although FDIC and the Federal Reserve would have lost most 

bank supervisory rule-making powers, each would have been allowed 

access to all information of the new agency as well as limited secondary 

or backup enforcement authority. In addition, the Federal Reserve 

would be authorized to examine a cross section of large and small 

banking organizations jointly with the new agency. FDIC would have 

continued to oversee activities of state banks and thrifts that could pose 

risks to the insurance funds and to resolve failures of insured banks.

• H.R. 1227 (1993).15 This proposal would have consolidated OCC and OTS 

in an independent Federal Bank Agency and aligned responsibilities 

among the new and the other existing agencies. It also would have 

reduced the multiplicity of regulators to which a single banking 

organization could be subject, while avoiding the concentration of 

regulatory power of a single federal agency. The role of the Federal 

Financial Institution Examination Council would have been 

strengthened; it would have seen to the uniformity of examinations, 

regulation, and supervision among the three remaining supervisors. 

According to a Congressional Research Service (CRS) analysis, this 

proposal would have put the Federal Reserve in charge of more than 40 

percent of banking organization assets, with the rest divided between 

the new agency and a reorganized FDIC.16

• 1994 LaWare proposal.17 The LaWare proposal was outlined in 

congressional testimony, but never presented as a formal legislative 

proposal, according to Federal Reserve officials. It called for a division 

of responsibilities defined by charter class and a merging of OCC and 

OTS responsibilities. The two primary agencies under the proposal 

15H.R. 1227: The Bank Regulatory Consolidation and Reform Act of 1993 (Mar. 4, 1993).

16CRS, Bank Regulatory Agency Consolidation Proposals: A Structural Analysis 

(Washington, D.C.; Mar. 18, 1994).

17This proposal was outlined in the statement of Alan Greenspan, Chairman, Board of 

Governors of the Federal Reserve System, before the Committee on Banking, Housing, and 

Urban Affairs of the U.S. Senate (Mar. 2, 1994).
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would have been an independent Federal Banking Commission and the 

Federal Reserve, which would have supervised all independent state 

banks and all depository institutions in any holding company whose 

lead institution was a state-chartered bank. The new agency would have 

supervised all independent national banks and thrifts and all depository 

institutions in any banking organization whose lead institution was a 

national bank or thrift. FDIC would not have examined financially 

healthy institutions, but would have been authorized to join in 

examination of problem banking institutions. Based on estimates of 

assets of commercial banks and thrifts performed by CRS, the LaWare 

proposal would have put the new agency in charge of somewhat more 

commercial bank assets than the Federal Reserve.

In 1996, we also recommended ways to simplify bank oversight in the 

United States in accord with four principles for effective supervision: 

• consolidated and comprehensive oversight of entire banking 

organizations, with coordinated functional regulation and supervision of 

individual components;

• independence from undue political pressure, balanced by appropriate 

accountability and adequate congressional oversight;

• consistent rules, consistently applied for similar activities; and

• enhanced efficiency and as low a regulatory burden as possible 

consistent with maintaining safety and soundness.

We recommended consolidating the primary supervisory responsibilities of 

OTS, OCC, and FDIC into a new, independent federal banking agency or 

commission. This new agency, together with the Federal Reserve, would be 

assigned responsibility for consolidated, comprehensive supervision of 

those banking organizations under its purview, with appropriate functional 

supervision of individual components. We also recommended that in order 

to carry out its primary responsibilities effectively, the Federal Reserve 

should have direct access to supervisory information as well as influence 

over supervisory decision making and the banking industry. In addition, we 

recommended that Treasury have access to supervisory information, 

including information on the safety and soundness of banking institutions 

that could affect the stability of the financial system. Furthermore, we 

recommended that under any restructuring, FDIC should have an explicit 

backup supervisory authority to enable it to effectively discharge its 
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responsibility for protecting the deposit insurance funds. In coordination 

with other regulators, such authority should allow FDIC to go into any 

problem institution on its own without the prior approval of any other 

regulatory agency.

Partly in Response to 

Market Convergence, 

Proposals Have Been Made 

to Consolidate Securities 

and Futures Regulators

Over the years, proposals have been made to consolidate SEC and CFTC, 

partly in response to increasing convergence in new financial instruments 

and trading strategies of the securities and futures markets. For instance, 

according to a 1990 CRS study, futures contracts based on financial 

instruments such as stock indexes are used by securities firms and large 

institutional investors simultaneously and are sometimes interchangeable 

with certain securities products. However, these transactions are regulated 

separately by CFTC and SEC. Prior to the passage of the Commodity 

Futures Modernization Act (CFMA) in 2000, the two agencies had 

disagreed on the jurisdiction of certain derivatives. In addition, new trading 

strategies involving both securities and futures transactions that have 

significant potential impacts on price movements have called for the need 

for better monitoring. Treasury also proposed three options to address 

these industry changes: (1) merging SEC and CFTC, (2) giving SEC 

regulatory authority over all financial futures, or (3) transferring regulation 

of stock index futures from CFTC to SEC.

In 1995, Members of Congress introduced the Markets and Trading 

Reorganization and Reform Act, which was intended to improve the 

effectiveness and efficiency of financial services regulation by merging 

SEC and CFTC. In testimony before the House Committee on Banking and 

Financial Services, we presented the major benefits and risks of merging 

SEC and CFTC, as well as specific issues related to this bill, to be 

considered in merging the two agencies. The anticipated benefits of a 

merger would have included reduced regulatory uncertainty concerning 

the two agencies’ regulatory jurisdictions over particular financial 

products, a clarification that would likely have enhanced market efficiency 

and innovation. Another potential benefit we identified was greater ease in 

conducting international regulatory negotiations. We also identified some 

risks involved in such a merger, including (1) a potential for over-regulation 

that might have resulted in decreased market innovation and (2) a potential 

dominance of one market and regulatory perspective to the detriment of 

the other. In addition, we noted some operational risk that might arise 

during the transition to a single government agency, such as differences in 

institutional cultures and histories. Finally, we cautioned those considering 

the merger about the difficulty of quantifying both potential benefits and 
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risks, and noted further that a merger might yield only small budgetary cost 

savings.

Efforts Have Been Made to 

Change the SRO Structure 

for Securities

In 2002, NASD completed the sale of its subsidiary Nasdaq Stock Market 

Inc. (NASDAQ), in recognition of the inherent conflicts of interest that 

exist when SROs are both market operators and regulators. These conflicts 

had become evident in the mid-1990s when NASD was under scrutiny for 

price fixing. Concerns about conflicts of interest and regulatory 

inefficiencies also prompted proposals to simplify the SRO structure for 

securities. In January 2000, the Securities Industry Association (SIA) 

detailed the following three possibilities for changing the SRO structure.18

• Hybrid SRO model. Under this model, a single consolidated entity 

unaffiliated with any market would have assumed responsibility for 

broker-dealer self-regulation and cross-market issues, such as those 

related to sales practices, industry admissions, financial responsibility, 

and cross-market trading. Individual SROs would have remained 

responsible for market-specific rules, such as those related to listings, 

governance, and market-specific trading. The majority of SIA members 

believed that the hybrid SRO model would reduce member-related 

conflicts of interest and SRO inefficiencies. Eliminating duplicative SRO 

examinations, in their view, would have reduced inefficiencies in areas 

such as rule making, examinations, and staffing. SEC officials agreed 

that consolidating member regulation into one SRO could be an 

advantage of the hybrid SRO model. They noted that the industry was 

moving toward a hybrid model as NASDAQ separated from NASD and 

NASD contracted to provide regulatory services to more SROs.

• Single SRO model. Under this model, a single SRO would have been 

vested with responsibility for all regulatory functions currently 

performed by the SROs, including market-specific and broker-dealer 

regulation. According to SIA, the single SRO model could have 

eliminated the conflicts of interest and regulatory inefficiencies 

associated with multiple SROs, including those that would remain under 

18SIA, Reinventing Self-Regulation, White Paper of the Securities Industry Association’s 

Ad Hoc Committee on Regulatory Implications of De-Mutualization (Washington, D.C.; 

Jan. 5, 2000). We discussed this report and SEC’s views in our report Securities Markets: 

Competition and Multiple Regulators Heighten Concerns about Self-Regulation, 

GAO-02-362 (Washington, D.C.: May 3. 2002).
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the hybrid SRO model. However, SIA did not endorse this alternative, 

primarily because of the risk that self-regulation would have become too 

far removed from the functioning of the markets. In May 2002, we 

reported that, according to SEC officials, it might not be appropriate or 

feasible to give a single SRO responsibility for surveilling all of the 

markets, such as NASDAQ and NYSE, which have different rules that 

reflect differences in the way trades are executed.19

• SEC-only model. Under this model, SEC would have assumed all of the 

regulatory functions currently performed by SROs. SIA did not endorse 

the SEC-only model because doing so would have eliminated selfregulation of the securities industry, taking with it the expertise that 

market participants contribute. SIA also expected the SEC-only model 

would have been more expensive and bureaucratic, because 

implementing it would have required additional SEC staff and 

mechanisms to replace SRO regulatory staff and processes. In addition, 

according to SIA’s report and SEC, a previous SEC attempt at direct 

regulation was not successful, owing to its high cost and low quality 

(relative to self-regulation), and this convinced SEC and other market 

participants that it was not a feasible regulatory approach.20

We reported in 2002 that at that time, none of the models appeared to have 

the support from market participants that would be needed for 

implementation. However, since that time the governance structures of 

SROs have been under greater scrutiny. 

Proposals Have Been Made 

for an Optional Federal 

Insurance Charter 

While proposals to regulate insurance at the federal level have been made 

from time to time, since 2000 this idea has been gathering steam. Several 

trade associations have made proposals for some federal regulation of 

insurance, and bills have been introduced in Congress. According to a CRS 

study, two bills introduced in the 107th Congress—the National Insurance 

Chartering and Supervision Act and the Insurance Industry Modernization 

19GAO-02-362.

20In 1965, SEC became responsible for direct regulation of a small number of broker-dealers 

that traded only in the over-the-counter market. This program, called the Securities and 

Exchange Only program, was designed to provide participating firms with a regulatory 

alternative to NASD. In 1983, SEC concluded that the industry would be better served if the 

program were discontinued, because needed improvements would be costly and not an 

efficient use of agency resources.
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and Consumer Protection Act—included an optional federal charter for 

insurance companies that would be similar to a national bank charter. The 

proposals would have required the creation of a federal insurance 

regulator. These proposals suggested creating a new federal agency 

(similar to OCC and OTS) in Treasury. A bill introduced in July 2003, the 

Insurance Consumer Protection Act, would create a federal commission 

within the Department of Commerce to regulate the interstate business of 

property-casualty and life insurance and require federal regulation of all 

interstate insurers. It thus would pre-empt most current state regulation of 

insurance. Generally, these proposals differed in whether a federal charter 

would include insurance agencies, brokers, or agents and where a federal 

regulator would be housed. 

Supporters of an optional federal charter include members of trade 

associations that generally represent the interests of larger life and 

property-casualty insurers—the American Council of Life Insurers, the 

American Bankers Insurance Association, and the American Insurance 

Association. These and other supporters have argued that an optional 

federal charter had benefited the banking sector by encouraging 

competition, regulatory efficiency, and product expansion and would 

benefit insurers by (1) removing the disadvantage large insurers have in 

competing with other financial service providers because large insurers 

have to comply with multiple state insurance standards; (2) allowing for 

more innovation among insurers because they would no longer have to 

secure product approval from different state regulators; (3) better 

representing the industry in federal policy and international trade 

negotiations through a single federal regulator; and (4) allowing consumers 

to have more product choices and more uniform protections across states.

Opponents of an optional federal charter, including some smaller life 

insurers, property- casualty insurers specializing in local services such as 

auto and homeowners insurance, and consumer groups, have argued that 

creating a new federal regulator would (1) create competition over industry 

charters between the federal regulator and state regulators and hence 

cause deterioration in the state regulatory system and industry regulatory 

standards; (2) lead to the loss of regulatory innovation and the testing and 

emergence of better policies because the current state system allows for 

regulatory innovation; and (3) be more costly than supporting NAIC’s 

current efforts to achieve uniformity in the state system; and (4) be less 

responsive to consumer needs.
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Proposals Made Before and 

After GLBA Cut across 

Functional Areas 

Prior to the passage of GLBA, some proposals to restructure the U.S. 

regulatory system concerned regulators across the financial services 

sectors. For example, in the early 1990s the Chicago Mercantile Exchange 

proposed that all federal financial regulation, including that of OCC, OTS, 

FDIC, CFTC, SEC, and certain functions of the Federal Reserve, be 

consolidated into “a single cabinet level department within the executive 

branch” to, among other things, facilitate regulatory coordination and allow 

for equal regulation of similar products, services and markets. In 1997, a 

congressional proposal included a National Financial Services Oversight 

Committee with representatives from Treasury, each of the federal bank 

regulators, SEC, and CFTC that would, among other things, establish 

uniform examination and supervision standards for financial services 

providers and identify providers that require “special supervisory 

attention.” Following the passage in 1999 of GLBA, which did not change 

the regulatory structure, calls for regulatory restructuring across sectors 

continued, including a recommendation in 2002, by the Chairman of FDIC, 

for a single bank regulator, securities regulator, and insurance regulator at 

the federal level. 
Page 83 GAO-05-61 Financial Regulation

Chapter 4

Regulators Are Adapting Regulatory and 

Supervisory Approaches in Response to 

Industry Changes Chapte4r

Although the U.S. regulatory structure has not changed in response to the 

industry changes we have identified—globalization, consolidation, 

conglomeration, and convergence—some U.S. regulators have adapted 

their regulatory and supervisory approaches to these changes. Some of 

these adaptations, especially those related to large, internationally active 

firms, have been made as part of or in response to efforts to achieve some 

degree of harmonization across the major industrial nations and within the 

EU. Some U.S. regulatory agencies have also made or considered other 

changes in response to the industry changes that we have identified. 

New Basel II Structure 

and EU Requirements 

Will Likely Affect 

Oversight of U.S. 

Financial Institutions

As part of the evidence of continuing globalization and increased 

complexity of financial institutions, the Basel Committee adopted a new 

set of standards (Basel II) in June 2004 that member and nonmember 

countries may adopt.1

 These Basel II requirements are designed to address 

some of the shortcomings of the Basel I standards, and include supervision 

and market discipline requirements as well as standards for minimum 

capital levels. U.S. bank regulators are in the process of determining how to 

apply these standards for large, internationally active firms. Because the 

EU is requiring securities firms and other firms with significant insurance 

operations operating in the EU to adopt Basel standards as part of its 

Action Plan, international harmonization efforts are also having an impact 

on other U.S. regulators that oversee large, internationally active firms. 

While U.S. Regulators 

Applied Basel I Standards to 

All Banks, They Propose to 

Require Only Large, 

Internationally Active Banks 

to Adopt Basel II Standards

In 1988, the Basel Committee adopted the Basel Accord for international 

convergence of capital standards (now referred to as Basel I) to provide 

uniform risk-based capital requirements with the objectives of 

strengthening the soundness and stability of the international banking 

system and diminishing a source of competitive inequality among 

international banks. These risk-based capital requirements, which were 

available for implementation in the Basel Committee members’ countries 

between 1990 and 1992, focused on limiting credit risk by requiring certain 

firms to hold capital equal to at least 8 percent of the total value of their 

risk-weighted on-balance sheet assets and off-balance sheet items, after 

adjusting the value of the assets according to certain rules intended to 

1

The Basel II framework includes several levels of approaches for determining capital 

requirements for banks. While the standard approaches will be available for implementation 

in 2006, the most advanced approaches, which are the only ones being proposed for some 

U.S. banks, will not be available for implementation until 2007. 
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Page 84 GAO-05-61 Financial Regulation

reflect their relative risk.2 U.S. bank regulators applied these standards to 

banks and bank holding companies. Basel I was amended in 1996 to include 

capital requirements for market risks for those banks or bank holding 

companies with a certain amount of securities and derivatives trading 

activity or, if deemed necessary by the regulator for safety and soundness 

purposes. Although Basel I generally is credited with improving the 

regulatory capital levels of most banks and reducing competitive inequities 

among international banks, it did not fully address changes and risks 

arising from increasingly complex financial markets. For instance, Basel I 

did not account for the internal credit risk mitigation activities of large, 

internationally active banks. Also, the limited number of risk-weighted 

categories under Basel I meant that the standards had limited risk 

sensitivity. This has, among other outcomes, allowed banks to take on 

higher risk assets within each category without having to hold more capital 

for regulatory purposes. Moreover, Basel I did not explicitly account for 

operational risks, such as poor management or security and process 

failures. 

Basel II, which is available for implementation in banking organizations in 

2006 or 2007, is intended to address the shortcomings of Basel I. As 

illustrated in figure 7, Basel II has three pillars: (1) minimum capital 

requirements, (2) supervision of capital adequacy, and (3) market discipline 

in the form of increased disclosure.

2

Off-balance sheet items are financial contracts that can create credit losses for banks but 

are not reported on banks’ balance sheets under standard accounting practices. An example 

of such an off-balance sheet position is a letter of credit or an unused line of credit 

committing the bank to making a loan in the future that would be on the balance sheet and 

thus creates a credit risk. To adjust for credit risks created by financial positions not 

reported on the balance sheet, U.S. regulations provide conversion factors to express offbalance sheet items as equivalent on-balance sheet items, as well as rules for incorporating 

the credit risk of off-balance sheet derivatives. 
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Figure 7: The Three Pillars of Basel II

Under the first pillar of Basel II—the definition of capital—the treatment of 

market risk and the minimum capital requirement of 8 percent of riskweighted assets remain the same as that in Basel I. With regard to credit 

and operational risk, however, Basel II allows firms with sophisticated risk 

management systems—generally large or internationally active firms—to 

use their internal risk assessment models and techniques to determine the 

appropriate amount of regulatory capital, with certain restrictions. These 

advanced approaches will not be available for implementation until the end 

of 2007.

The second pillar of Basel II focuses on supervisory review of and action in 

response to banks’ capital adequacy. Supervisory review is expected to 

capture potential risks, including those that are external to banks, that are 

not fully captured under Pillar I and to assess banks’ compliance with 

minimum standards and disclosure requirements of the more advanced 

capital calculation options being used by some firms. Supervisors are to 

evaluate banks’ assessment, monitoring, and maintenance of their capital 

adequacy relative to their risk profile, including compliance with regulatory 

capital ratios. Supervisory review can involve on-site examinations or 

inspections, off-site review, discussions with bank management, review of 

work done by external auditors, and periodic reporting. Basel II calls for 

Minimum capital

requirements

Supervision of

capital adequacy

Market discipline

(disclosure)

• Requires capital for credit

 risk, market risk, and

 operational risk

• Large and/or

 internationally active

 firms with sophisticated

 risk management

 systems may use their

 own internal risk 

 assessment models to

 determine appropriate

 amount of capital

• Compliance with

 minimum standards

• Supervisory review of

 • assessment

 • monitoring

 • maintenance of

 capital adequacy

• Encourages early

 intervention to prevent

 capital from falling

 below minimum levels

• Requires banks to publicly 

 disclose information

 about their

 • capital adequacy

 • risk profile, including

 credit, market,

 operational, and

 interest rate risk

 and securitization

 • risk assessment

 process

Source: GAO.
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supervisors to intervene at an early stage to prevent capital from falling 

below minimum levels and to require remedial action if capital is not 

maintained or restored.

The third pillar of Basel II—market discipline—calls for banks to disclose 

information about their risk profile, risk assessment processes, and 

adequacy of their capital levels. The rationale is that a bank’s borrowing 

and capital costs will rise if market participants perceive a bank to be risky, 

and banks will thus have an incentive to refrain from excessive risk taking. 

Members of the Basel Committee note that market discipline will become 

more important once banks are using their internal models and techniques 

to make capital decisions. 

In recognition that large, internationally active banks pose different risks 

and use different risk management techniques than smaller, less 

internationally active banks, U.S. regulators are proposing to require that 

only a number of large, internationally active institutions comply with 

capital standards that are consistent with Basel II. Federal regulators 

expect that fewer than 10 large, internationally active banking 

organizations will be required to operate under rules consistent with Basel 

II by the end of 2007. Under current proposals, other U.S. banks that satisfy 

certain requirements will have the option of implementing the Basel II 

framework, and federal regulators expect roughly another 10 large banking 

organizations to adopt capital standards consistent with Basel II 

requirements.

EU Financial 

Conglomerates Directive Is 

Requiring Some Securities 

and Insurance Firms to 

Have Consolidated 

Supervision and Apply Basel 

Capital Standards

Certain directives in the EU Action Plan, especially the Financial 

Conglomerates Directive, will impact some internationally active firms in 

the United States, especially those that have not been subject to bank or 

financial holding company oversight by the Federal Reserve because they 

do not own commercial banks. In recognition of the risks posed by 

financial conglomerates and other financial firms that do not have 

consolidated supervision, the directive specifies minimum requirements 

for consolidated supervision of such firms conducting business in the EU. 

The directive defines a financial conglomerate as a firm with insurance 

operations that also engages in banking or securities activities. In addition, 

the directive requires that non-European conglomerates, banks, and 

securities firms have adequate consolidated supervision, which would
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generally include application of Basel standards.3 Under the directive, 

which goes into effect at the beginning of 2005, a non-European financial 

conglomerate or group that has a banking presence in the EU that is not 

considered to be supervised on a consolidated basis by an equivalent home 

country supervisor would be subject to additional requirements by EU 

regulators, which could include additional direct supervision.

U.S. regulators that provide or might provide consolidated oversight—the 

Federal Reserve, OTS, and SEC, among others—responded to EU requests 

for information about their activities as holding company supervisors. This 

information was used to develop EU guidance for EU country regulators in 

determining whether U.S. firms doing business in EU countries have 

consolidated supervision that is equivalent to that required to be in place in 

EU host countries. According to EU officials, specific regulators in EU 

countries will use this guidance to determine whether a specific U.S. 

company operating in Europe has adequate consolidated supervision. 

Officials at the Federal Reserve say that they do not expect to have to make 

any changes in the way they oversee bank or financial holding companies 

to be deemed an equivalent home country supervisor for affected 

companies under their supervision. However, because U.S. securities firms 

that are not owned by a bank or financial holding company are currently 

not supervised on a consolidated basis the way bank and financial holding 

companies are,to comply with the directive, these securities firms that 

conduct business in the EU will need to have a consolidated supervisor 

sometime in 2005.4 Some of these firms requested that SEC develop a 

program to provide them with consolidated supervision, and SEC 

responded with its CSE proposal. Firms opting to become CSEs will be 

subject to capital requirements that are consistent with Basel standards,5

which are described by the rules governing CSEs as an alternative to the 

3

EU member states have been required to adopt capital adequacy rules that are generally 

consistent with Basel standards for credit institutions (banks and securities firms). Thus, to 

satisfy the EU requirements, U.S. banks and securities firms operating in EU member states 

would be subject to similar requirements. The EU is currently considering amendments to 

relevant directives partly in response to the adoption of Basel II.

4

See SEC, Alternative Net Capital Requirements for Broker-Dealers That Are Part of 

Consolidated Entities, 69 FR 34428 (June 21, 2004); and Supervised Investment Bank 

Holding Companies 69 FR 34472 (June 21, 2004).

5

Because the EU Financial Conglomerate Directive is effective in January 2005 and the 

Basel II standards are not required until year-end 2006, there is some question as to whether 

CSEs will adopt Basel II standards at the time of their registration. 
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net capital requirements generally required for broker dealers.6 Because 

the requirements of Basel II were not established with U.S. securities firms 

in mind, SEC staff notes that it is participating in a joint working group 

established by IOSCO and the Basel Committee to address issues relating 

to the treatment of positions held in the trading book. One issue of interest 

to holding companies with broker-dealer subsidiaries is the development of 

a more risk-based approach to capital requirements for securities activities. 

For example, since the Basel II standards were developed with the 

expectation of long-term credit exposures that are common for banks, 

securities firms believe that credit risk in their trading books that have 

much shorter exposures is overstated using Basel II requirements. IOSCO 

and the Basel Committee have had several meetings to discuss this and 

other issues. 

With regard to required examination and disclosure requirements at the 

consolidated level, SEC says it expects to better monitor the financial 

condition, risk management, and activities of a broker-dealer’s affiliates 

that could impair the financial and operational stability of the broker-dealer 

or CSE. SEC will examine regulated affiliates of CSE’s that do not have a 

principal U.S. regulator, but will defer to the UK-FSA (or another EU 

regulator) to examine affiliates in EU countries. For the ultimate holding 

company, SEC will examine the holding company unless it determines that 

it is already subject to “comprehensive, consolidated supervision” by 

another principal regulator. Thus, bank or financial holding companies 

generally would be exempt from SEC examination. In the case of holding 

companies, SEC believes the disclosure requirements that are part of Basel 

II are not consistent with those required by SEC.7

 However, SEC staff said 

that they would apply Basel II disclosure standards while working to make 

them more consistent. SEC says that data being collected by the Basel 

Committee to measure the impact of Basel II will include data from the 

large securities firms that will register as CSEs, and this may allow the 

standards to better reflect the risks of these firms over time. 

In response to the Financial Conglomerates Directive, U.S. and other firms 

with insurance and banking operations in the EU will need to choose a 

consolidated regulator and comply with Basel II. OTS is responsible for the 

6

Some bank, financial, and thrift holding companies with significant broker-dealer affiliates 

may also register as CSEs. Their broker-dealers will have the option of complying with the 

capital standards consistent with Basel II rather than SEC’s net capital rule.

7

SEC staff notes that it raised this issue before completion of the final Basel II draft.
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consolidated supervision of Thrift Holding Companies, including a number 

of firms that are conglomerates under the EU directive. Some of the largest 

such firms may choose OTS as their consolidated supervisor for purposes 

of the directive. These firms qualify as thrift holding companies because 

they own a thrift under the exemption provided before May 1999 or have 

obtained a thrift charter since then. Officials at OTS say that 40 companies 

with insurance operations are now thrift holding companies, but not all of 

these are operating in EU countries or would be deemed conglomerates. 

These companies may not qualify as financial holding companies because 

they do not own a commercial bank and the scope of their activities, which 

may include commercial enterprises, make doing so impractical. 

Furthermore, they may not qualify for SEC oversight because they do not 

have a broker-dealer affiliate with a substantial presence in the securities 

markets. OTS expects its level of supervisory coordination with foreign 

regulators to increase as a result of the EU directive.

U.S. Regulators Have 

Made or Considered 

Some Other Changes to 

Their Regulatory and 

Supervisory 

Approaches in 

Response to Industry 

Changes 

Because of the increased size and complexity of some banks, U.S. bank 

regulators had adopted risk-focused examination procedures that tailor 

reviews to key characteristics of each bank, including its asset size, 

products offered, markets in which it competes, and its tolerance for risk. 

In recognition of the increased size of the largest banks and the possibility 

that shareholders and creditors believe that these banks are too big for 

regulators to allow them to fail, regulators have considered requiring banks 

to issue subordinated debt as a mechanism to enhance market discipline of 

banking institutions. However, regulators have not adopted this 

requirement, because evidence of its potential effectiveness is limited. 

Bank regulators also have adjusted their approaches in response to what 

appears to be heightened concern about reputational risk. SEC had made 

some changes related to the increased size and complexity of securities 

firms prior to adopting its consolidated supervision rules in response to the 

EU financial conglomerates directive. These changes affected the 

collection of information related to risk management from the parents and 

affiliates of broker-dealers. While CFTC and state insurance regulators will 

not adopt Basel II requirements, they have made other changes that 

acknowledge how the industry is changing. CFMA acknowledges the 

increasingly global nature of the futures industry and the increasing 

importance of new financial products. As a result of property-casualty 

failures in the 1980s and recognition of changes in the insurance industry, 

NAIC adopted a new Solvency Policy Agenda that included risk-based 

capital and the creation of a Financial Analysis Unit that analyzes the 

behavior of insurers that operate across state lines. 
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U.S. Bank Regulators 

Adopted Risk-Focused 

Supervision for Large, 

Complex Firms and Made or 

Considered Other Changes

In response to the development of large, complex banking organizations 

with diverse and changing risks and sophisticated risk management 

systems, U.S. bank regulators have generally placed greater emphasis on 

examining an institution’s internal control systems and on the way it 

manages and controls its risks, rather than on assessing a bank’s condition 

at a specific point in time. The federal bank regulators generally apply riskfocused examinations. We reported in 2000 that since the mid-1990s, the 

Federal Reserve and OCC have developed and refined their on-site 

examination policies and procedures for large, complex banks to focus on 

risk assessments along business lines, which often cross bank charters 

within the banking organization.8

 Under the risk-focused approach, Federal 

Reserve and OCC examiners are to continually monitor and assess an 

institution’s financial condition and risk management systems through the 

review of a variety of management reports and frequent meetings with key 

bank officials, documenting the areas they select for review, including their 

rationale for selecting those areas. Federal Reserve officials noted that 

detecting fraud remains a difficult task under the risk-focused approach, 

but that the approach was designed to detect the areas of a bank’s (or bank 

holding company’s) activities that posed the greatest risk to the safety and 

soundness of the institution. 

In 2002, FDIC adopted an agreement with OTS, OCC, and the Federal 

Reserve that allows FDIC to examine insured depository institutions that 

pose a greater than normal risk to the deposit insurance funds. According 

to FDIC’s annual report, under the agreement FDIC has assigned dedicated 

examiners to each of the eight largest insured banking institutions to 

monitor their financial condition and risk management processes and 

obtain timely information on the potential risks of these institutions. As 

FDIC is not the primary regulator of these institutions, it will rely on 

supervisory information provided by the primary regulators. In 2003, FDIC 

established a Risk Analysis Center to analyze information generated from 

the dedicated examiner program, among other tasks.

One change that has been discussed but not made in response to the 

growing size of banks is whether banks should be required to issue 

subordinated debt as a market discipline tool. The usual disclosure 

requirements for publicly traded companies may not be sufficient for large 

8

GAO, Risk-Focused Bank Examinations: Regulators of Large Banking Organizations 

Face Challenges, GAO/GGD-00-48 (Washington, D.C.: Jan. 24, 2000).
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banks because shareholders may believe that the banks are too big for 

regulators to allow them to fail. Because subordinated creditors are 

especially sensitive to risks that a bank may fail, mandatory issuance of 

subordinated debt has been proposed as a means of enhancing market 

discipline to inhibit risk-taking activities and limit losses to the insurance 

funds when excessive risk taking damages a bank. Requiring banks to issue 

subordinated debt has been discussed in relation to the market discipline 

pillar of Basel II, but no such requirement appears in the standards adopted 

in June 2004. Similar proposals have not been adopted in the United States. 

GLBA directed the Federal Reserve and Treasury to study the feasibility of 

requiring depository institutions that pose significant systemic risk and 

their holding companies to maintain some portion of their capital in the 

form of subordinated debt. The Federal Reserve and Treasury supported 

the use of subordinated debt as a way of enhancing market discipline but 

said that more evidence would be needed to make such a policy mandatory. 

According to the report, almost all of the largest banking organizations had 

voluntarily issued and had subordinated debt outstanding in excess of 1 

percent of their assets, providing some degree of direct market discipline 

and transparency. The Federal Reserve, OCC, and OTS agreed to continue 

to use various data and supervision to evaluate the use of subordinated 

debt. 

U.S. bank regulators are also charged with ensuring that banks comply with 

various consumer protection laws and laws concerning money laundering 

and corporate governance issues. In addition to safety and soundness 

examinations, banks are also subject to examinations that evaluate their 

performance in meeting the needs of their communities under the 

Community Reinvestment Act and their compliance with anti-money 

laundering rules under the Bank Secrecy Act and the USA PATRIOT Act. 

The regulatory agencies recently announced new examination procedures 

for banks’ customer identification programs, for instance; this program was 

required under section 326 of the USA PATRIOT Act.9

 Regulators also note 

that failure to comply with consumer protection and anti-money laundering 

laws and regulations can endanger a bank’s safety and soundness because 

they may affect the bank’s reputation. For example, OCC asserts that 

predatory lending practices in national banks could damage the reputations 

9

See joint press release issued by Federal Reserve, FDIC, NCUA, OCC, and OTS 

(Washington, D.C.; July 28, 2004), http://www.federalreserve.gov/boarddocs/press/ 

bcreg/2004/20040728/default.htm (downloaded Sept. 10, 2004). See also 31 U.S.C. 5318(l) 

(2000 & Supp. 2004).
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and thus the safety and soundness of those institutions. Furthermore, 

recent money laundering activities at some banks—which could affect the 

reputation of those banks—appear to have heightened regulatory efforts to 

prevent such activity. 

SEC Had Made Changes 

Related to Size and 

Complexity of Firms Prior 

to Becoming a Consolidated 

Regulator

With regard to adopting consolidated regulations for CSEs and SIBHCs, 

SEC officials said that what appear to be significant changes in their 

regulatory and supervisory approach are merely continuations of 

previously ongoing trends that recognized the increased size and 

complexity of many securities firms. Further, SEC officials recognize that 

because of the size of the parent firms, the sudden failure of a large 

securities firm that has broker-dealer affiliates could have a major impact 

on markets and investors. 

SEC says that in setting capital requirements, it has been concerned with 

the safety and soundness of broker-dealers for some time. Since 1975, the 

net capital rule has required that broker-dealers maintain a minimum level 

of net capital sufficient to satisfy all obligations to customers and other 

market participants and to provide a cushion of liquid assets to cover 

potential credit, market, and other risks. SEC amended its net capital rule 

in early 1997 to allow broker-dealers to use statistical models to calculate 

required capital charges for exchange-traded financial instruments to 

better reflect market risk. In 1999, SEC adopted an optional regulatory 

framework that includes alternative net capital requirements for OTC 

derivatives dealers. Under this framework, OTC derivatives dealers may be 

permitted to use statistical models to calculate capital charges for market 

risk and to take alternative charges for credit risk. SEC rules also require 

firms to integrate their statistical models into their daily risk management 

processes and establish a system of internal controls to monitor and 

manage the risks associated with their business activities, including 

market, credit, leverage, liquidity, legal, and operational risks. With regard 

to supervision of risk management of securities firms, SEC officials say 

that they have long sought more information on the parents and affiliates of 

broker-dealers. Since 1992, SEC has collected risk assessment information 

from securities firms that own large broker-dealers. And, beginning in 1999, 

SEC has held monthly discussions regarding these risk assessments. 

Much of SEC’s examination program is related to ensuring that SROs, 

broker-dealers, and investment advisers comply with federal securities 

laws and rules, including having adequate systems and procedures in place 

to ensure compliance. SEC’s examination procedures have evolved over 
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time. In the mid-1990s, SEC’s examination office began conducting fewer 

full scope examinations, which review all aspects of operations, and more 

frequent risk-focused examinations, which focus on specific areas or 

issues. We noted in a 2002 report10 that although SEC officials said they had 

been able to maintain their examination schedules and workload with their 

existing staff levels, some officials were concerned that the cycle for 

certain types of reviews could stretch beyond the planned time frames. In 

that report, we noted SEC officials also said that newly implemented rules 

would add time and complexity to the reviews. Overall, SEC officials said 

their examination office had lost a lot of experienced staff at the junior 

level and that new staff requires constant training. 

With the corporate governance and accounting scandals that came to light 

beginning in 2002 and with the 2003 revelation of market timing and late 

trading abuses in mutual funds, SEC has made additional changes in its 

compliance exams and developed rules to improve corporate governance. 

We have reported that SEC did not identify the abusive practices in mutual 

funds for several reasons, including the inherent difficulty of detecting 

fraud and the focus of examinations on operations of mutual funds rather 

than on trading in the funds themselves.11 In response to late trading and 

other abuses in the mutual fund industry, SEC says that it is reassessing its 

supervision of investment companies. 

We also reported that anticipating and identifying problems in a timely 

manner is a continuing problem for SEC:

One of the challenges SEC faces is being able to anticipate potential problems and identify 

the extent to which they exist. Historically, limited resources have forced the SEC to be 

largely reactive, focusing on the most critical events of the day. In this mode, the agency 

lacked the institutional structure and capability to systematically anticipate risks and align 

agencywide resources against those risks. In an environment like this, it is perhaps not 

surprising that SEC was not able to identify the widespread misconduct and trading abuses 

in the mutual fund industry. Increasing SEC’s effectiveness would require it to become more 

proactive by thinking strategically, identifying and prioritizing emerging issues, and 

marshaling resources from across the organization to answer its most pressing needs.12 SEC 

10GAO, SEC Operations: Increased Workload Creates Challenges, GAO-02-302 (Washington, 

D.C.: Mar. 5, 2002). 

11GAO, SEC Operations: Oversight of Mutual Fund Industry Presents Management 

Challenges, GAO-04-584T (Washington, D.C.: Apr. 20, 2004).

12GAO-04-584T, 14.
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is in the process of staffing a new risk assessment office that may lead to more proactive 

risk-based policies in the future. 

Futures and Insurance 

Regulators Have Not 

Adopted Basel Standards, 

but Have Made Changes in 

Their Regulatory and 

Supervisory Approaches 

Many of the changes being made in CFTC’s regulatory and supervisory 

approaches have come as a result of the passage of CFMA in 2000. The 

primary goal of that legislation was to address changes in market 

conditions such as the introduction of a wider variety of products, 

including contracts based on individual stocks. CFMA replaced “one-sizefits-all” regulation with broad, flexible core principles.13 Generally, the new 

rules recognize the speed with which these markets change by laying out 

core principles for participants and markets, rather than by specifying 

prescriptive rules.14 For example, a CFTC regulation requires that certain 

entities–derivatives transaction execution facilities and contract markets–

provide authorities and the public with trading information such as trading 

practices and contract conditions and prices, and that they enforce rules to 

minimize conflicts of interest in the decision making process, but it does 

not require specific measures for carrying out the principles.15

CFTC has also changed its net capital rules for FCMs to better reflect 

changes in the commodity business. To modernize capital requirements for 

FCMs, CFTC adopted rules in August 2004 that replace the net capital 

requirement based on segregated customer funds with minimum risk-based 

capital requirements. The new rules attempt to reflect an FCM’s complete 

exposure to commodity positions carried for both customers and 

noncustomers. According to CFTC’s 2003 annual report, the rules are 

expected to ensure that a firm’s capital requirement reflects the risks of the 

futures and options positions it carries. 

In addition to the self-regulatory programs administered by the exchanges 

and NFA, CFTC oversees the compliance activities of SROs through audits 

and financial surveillance to ensure that SRO member firms are properly 

capitalized, maintain appropriate risk management capabilities, and 

13See 7 U.S.C. § 7a(d) (2000 & Supp. 2004).

14See Trading Facilities, Intermediaries and Clearing Organizations; New Regulatory 

Framework; Final Rule, 66 Fed. Reg. 42256-42289 (Aug. 10, 2001); see also Proposed Rules 

for Execution of Transactions: Regulation 1.38 and Guidance on Core Principle 9 69 Fed. 

Reg. 39880-39886 (July 1, 2004).

1517 C.F.R. § 37.6 (2004).
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segregate customer funds. According to CFTC’s 2003 annual report, to meet 

CFMA objectives, in the early 2000s CFTC modified its oversight process 

for SROs, moving from compliance-based examinations to risk-focused 

programs that respond to regulatory core principles. These exams were to 

focus on an institution’s exposure to, and internal controls for, managing 

underlying risks.These programs were first implemented in 2003 in an SRO 

oversight examination of the Chicago Mercantile Exchange covering 

“financial capacity, customer protection, risk management, market move 

surveillance and stress testing, and operational capability.” According to its 

2003 annual report, CFTC is also developing a risk management tool that 

uses data received from firm financial filings and large trader reports to 

proactively monitor firm risk exposure and assess trader losses from risky 

positions that may cause firms to become undercapitalized.

According to an NAIC official, during the mid- to the late 1980s, a high 

number of failures among property-casualty insurers as well as a collective 

recognition on the part of the insurance regulatory community that the 

industry was becoming more complex, in part, because of technological 

advances, globalization, and capital market innovations, led NAIC to adopt 

its Solvency Policy Agenda. The agenda was composed of a number of 

initiatives, including risk-based capital and the Financial Analysis Unit. 

According to NAIC, by 1990 a number of states were experimenting with 

risk-based capital formulas, and NAIC approved risk-based capital 

standards for life insurance companies in 1992 and for property-casualty 

insurers in 1993. NAIC developed and recommended that states adopt the 

Risk-Based Capital for Insurers Model Act, which gave state insurance 

regulators the authority to act on the results generated by the risk-based 

capital formulas. For life insurers, companies are required to hold 

minimum percentages of various assets and liabilities as capital, with these 

percentages based on the historical variability of the value of those assets 

and liabilities. Risk factors are to be applied, usually as multipliers, to 

selected assets, liabilities, or other specific company financial data to 

establish the minimum capital needed to bear the risk arising from that 

item (similar to risk-weights in banking).In addition, the risk-based capital 

formula requires the performance of sensitivity tests to indicate how 

sensitive the formula is to changes in certain risk factors. 

NAIC’s Solvency Policy Agenda also led to the setting up of the Financial 

Analysis Unit. This unit’s mission is to assist insurance regulators in 

achieving their objective of identifying, at the earliest possible stage, 

insurance companies that may be financially troubled. In pursuit of this 
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mission, the Unit performs financial analysis of insurance companies under 

the direction of an NAIC working group. The working group was formed to 

identify nationally significant insurance companies—large firms or firms 

operating in a number of states—that are, or may become, financially 

troubled, and to determine whether appropriate regulatory action is being 

taken with regard to these firms. 
Page 97 GAO-05-61 Financial Regulation

Chapter 5

Regulators Communicate and Coordinate in 

Multiple Ways, but Concerns Remain Chapte5r

In a system with multiple financial services regulators, communication and 

coordination are essential to preventing duplication in agency oversight, 

while ensuring that all regulatory areas are effectively covered. U.S. federal 

financial services regulators communicate and coordinate with other 

federal, state, and foreign regulators within their sector, and state 

insurance regulators communicate and coordinate across states and with 

insurance regulators in other countries; however, in each sector concerns 

remain. To a lesser extent, financial services regulators communicate and 

coordinate across sectors with U.S., state, and foreign regulators, but 

coordinating regulatory activities and sharing information continue to be 

sources of concern. Agencies have had problems systematically sharing 

information across sectors, making it more difficult for regulators to 

identify potential crises, fraud, and abuse, and for consumers to identify 

the relevant regulators. In addition, regulators do not routinely assess risks 

that cross traditional regulatory and industry boundaries. 

U.S. Financial 

Regulators 

Communicate and 

Coordinate with Other 

Regulators in Their 

Sectors, but 

Sometimes Find It 

Difficult to Cooperate 

Within each of the four sectors, federal regulators have established 

interagency groups to facilitate coordination and also communicate 

informally on a variety of issues. Within sectors the federal regulators 

generally communicate with each other, with SROs, with relevant state 

regulators, and with their international counterparts. In insurance, NAIC is 

the primary vehicle for state regulators to communicate with each other 

and to coordinate with insurance regulators in other countries. 

Federal Banking Regulators 

Coordinate Their Activities, 

but Bank Failures and 

International Negotiations 

Have Been Problematic 

The Financial Institutions Regulatory and Interest Rate Control Act of 

19781

 established the Federal Financial Institutions Examination Council 

(FFIEC) in 1979 as a vehicle through which bank regulators could 

communicate formally. FFIEC is empowered to prescribe uniform 

standards and principles and to devise report forms for member agencies’ 

examinations of financial institutions. FFIEC makes recommendations to 

promote uniformity in the supervision of financial institutions, conducts 

schools for examiners, and has also established interagency task forces on 

1

Pub. Law No. 95-630, Title X. See http://www.ffiec.gov/about.htm.
Chapter 5

Regulators Communicate and Coordinate in 

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consumer compliance, examiner education, information sharing, 

supervision, reports, and surveillance systems. Finally, it serves as a forum 

for dialogue between federal and state bank supervisory agencies. 

A joint evaluation by the Offices of the Inspector General from three 

federal banking regulators found that FFIEC was accomplishing its 

legislative mission of prescribing uniform principles, standards, and report 

forms.2

 Some officials criticized it for not accomplishing its mission more 

effectively and taking too long to complete interagency projects, however. 

FFIEC is discussing improvements to its effectiveness by developing 

annual goals, objectives, and work priorities. In response to questions 

about whether FFIEC should have a broadened role in coordinating 

banking, insurance, and securities regulators as a result of GLBA, most 

officials interviewed were not in favor of broadening FFIEC to include 

regulatory representatives from the insurance and securities industries. 

Most officials also did not see the need for a separate coordinating entity 

under GLBA modeled after FFIEC. Officials indicated that coordination 

under GLBA was occurring as needed and on an ad hoc basis and through 

periodic cross-sector meetings hosted by the Federal Reserve. Banking 

industry and professional associations said that FFIEC could be more 

proactive in communicating with the banking industry, however.

The 1994 Riegle Community Development and Regulatory Improvement 

Act mandated improvements to the coordination of examinations and 

supervision of institutions that are subject to multiple bank regulators. A 

set of basic principles, issued by the regulators in 1993, said that the 

agencies place a high priority on working together to identify and reduce 

the regulatory burden and on coordinating supervisory activities with each 

other as well as with state supervisors, securities and insurance regulators, 

and foreign supervisors.3

 Their objective is to minimize disruption and 

avoid duplicative examination efforts and information requests by

• coordinating the planning, timing, and scope of examinations and 

inspections of federally insured depository institutions and their holding 

companies; 

2

Offices of the Inspector General at Treasury, FDIC, and Federal Reserve, Joint Evaluation 

of the Federal Financial Institutions Examination Council (Washington, D.C.; June 21, 

2002).

3

See OCC, “Policy Statement on Examination Coordination and Implementation 

Guidelines,” Examination Planning and Control Handbook (Washington, D.C., July 1997). 
Chapter 5

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Multiple Ways, but Concerns Remain 

Page 99 GAO-05-61 Financial Regulation

• conducting joint interagency examinations or inspections; 

• coordinating and conducting joint meetings between bank or bank 

holding company management and regulators; 

• coordinating information requests; and 

• coordinating enforcement actions.

The Federal Reserve, FDIC, and OCC have additional mechanisms to 

communicate and coordinate. Under the Shared National Credit Program, 

for example, they jointly review large syndicated loans that involve several 

banks to ensure that loans are reviewed consistently and to reduce 

regulatory burden on financial institutions. Program reports also include 

information on the level of credit risk in banks overall and by type of bank 

as well as credit exposures to certain industries. Similarly, representatives 

from the agencies meet regularly as the Interagency Country Exposure 

Review Committee to jointly determine the level of risk for credit 

exposures to various countries. 

U.S. bank regulators also communicate regularly with bank regulators in 

other countries, both bilaterally and through multicountry organizations 

that specialize in bank issues. U.S. bank regulators overseeing U.S. 

subsidiaries of foreign banks work with the host-country regulators in 

overseeing those institutions. U.S. bank regulators and UK-FSA explained 

how they coordinate examinations of U.K. institutions with U.S. operations 

such as HSBC and U.S. banks with U.K. subsidiaries such as MBNA. 

Similarly, some U.S. regulators coordinate with BaFin in overseeing 

Citigroup’s activities in Germany and Deutsche-Bank Securities’ activities 

in the United States. The Federal Reserve, FDIC, and OCC are members of 

the Basel Committee4

 and a Federal Reserve Official chaired that 

committee during much of the Basel II discussions. 

Throughout our meetings with banking agencies, officials told us they 

communicate regularly on both a formal and informal basis. They 

explained that officials in different agencies, both at the federal and 

regional level, know each other well and have each other’s personal cell 

phone numbers so they can easily contact each other in case of a crisis. At 

4

OTS officials say that they participate in the Basel Committee as a temporary member 

pending acceptance of OTS’s request for permanent membership. 
Chapter 5

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the regional level, officials and staff from the Federal Reserve, OCC, FDIC, 

OTS, and state bank regulatory agencies regularly meet formally and talk 

often. Communication across these agencies, according to several officials, 

is facilitated by staff often moving between agencies and by long-standing 

working relationships.

In some cases, however, interagency cooperation between bank regulators 

has been hindered when two or more agencies share responsibility for 

supervising a bank. The Superior Bank and the First National Bank of 

Keystone (West Virginia) episodes illustrate this problem. Superior Bank, 

FSB, a federally chartered savings bank located outside Chicago failed in 

2001. The failure was caused by Superior’s strategy of originating and 

securitizing large volumes of high-risk loans and the failure of its 

management to properly value and account for the interest that Superior 

retained in pooled home mortgages. Shortly after the bank’s closure, FDIC 

projected that the failure of Superior Bank would result in a substantial 

loss to the deposit insurance fund. We found that federal regulators had not 

identified and acted on the problems at Superior Bank early enough to 

prevent a material loss to the deposit insurance fund. Problems between 

OTS, Superior’s primary supervisor, and FDIC hindered a coordinated 

supervisory approach; OTS refused to let FDIC participate in at least one 

examination.5

 Similarly, disagreements between OCC and FDIC 

contributed to the 1999 failure of Keystone Bank, which was caused by the 

bank’s maintaining loans that it did not own on its balance sheet; these 

overstated assets were attributed to alleged fraud. FDIC subsequently 

announced that it had reached agreement with the other banking regulators 

to establish a better process for determining when FDIC will examine an 

insured institution where FDIC is not the primary federal regulator. 

Over the last couple of years, bank regulators have expressed differing 

views concerning the complex Basel Committee negotiations over Basel II 

(see ch. 4). However, it is unclear whether the differing views of the 

regulators improved the process, as the regulators claim, or unnecessarily 

complicated the process and possibly disadvantaged U.S. companies, as 

others have claimed. Bank regulators who sit on the Basel Committee told 

us that the outcome of the Basel II negotiations is better than it would have 

been with a single U.S. representative because of the contributions of 

regulators who represent the perspectives and expertise of their varied 

5

See GAO, Bank Regulation: Analysis of the Failure of Superior Bank, FSB, Hinsdale, 

Illinois, GAO-02-419T (Washington, D.C.: Feb. 7, 2002).
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agencies. Regulators note that they have communicated regularly, but still 

have the responsibility of representing their agencies’ differing objectives 

publicly. U.S. Basel Committee members said that this requirement to 

discuss differences in an open and transparent manner, rather than 

privately, is a strength of the system. The regulators also noted that some of 

the concerns raised by others about the timeliness of U.S. agencies’ 

involvement in the negotiations might stem primarily from the long public 

comment period mandated in U.S. law, rather than the involvement of 

multiple agencies. This public comment period, they noted, would be a 

requirement even if fewer agencies were involved.

However, the lack of a single contact or negotiating position has raised 

questions about these negotiations. Since each of the agencies on the Basel 

Committee is charged with representing the objectives of its agency or the 

firms it oversees, the negotiations may not represent the interests of those 

who are not at the table. For example, OTS—which oversees some firms 

that will likely have to comply with Basel II, due, in part, to the EU Action 

Plan—does not have a permanent seat on the Basel Committee. Since the 

large firms overseen by OTS differ in some important ways from those 

overseen by the other agencies, their positions may not be adequately 

represented in these negotiations. However, OTS officials say that they 

have a temporary seat on the Basel Committee, while that body considers 

their request for membership. OTS also noted that they are active members 

of two Basel capital implementation groups. In addition, the sometimesconflicting views being expressed by U.S. regulators made it difficult for 

other countries to understand our position. Finally, in November 2003 

members of the House Financial Services Committee warned in a letter to 

the bank regulatory agencies that the discord surrounding Basel II had 

weakened the negotiating position of the United States and resulted in an 

agreement that was less than favorable to U.S. financial institutions.6

 H.R. 

2042 would establish a committee of financial regulators chaired by the 

Secretary of the Treasury to ensure that there is a unified U.S. position in 

Basel Committee negotiations.

6

Letter from Representative Michael Oxley et al. to Chairman Alan Greenspan et al., Nov. 3, 

2003.
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Federal Securities 

Regulators Often 

Communicate and 

Coordinate Activities with 

State Regulators, Securities’ 

SROs, and Foreign 

Securities Regulators, but 

Problems Persist

Federal securities regulators communicate and coordinate with SROs and 

state securities regulators. State securities regulators, including those in 

New York and Massachusetts, told us that for the most part they coordinate 

enforcement activities with SEC. One difficulty they pointed to was that 

privacy issues prevent them from discussing a case before they are ready to 

bring charges. However, they note that state regulators, SEC, and some 

SROs have jointly pursued securities law violators. 

In addition to overseeing the securities SROs, SEC communicates regularly 

with them about various issues. For example, SEC and the SROs have 

taken steps to coordinate their examinations. In 2002, we reported that, 

according to SEC and SRO officials, representatives of SEC, all SROs, and 

the states attend annual summits to discuss examination coordination, 

review examination results from the prior year, and develop plans for 

coordinating examinations for the coming year. In addition, regional SEC 

staff and SRO compliance staff are to meet quarterly to discuss and plan 

examination coordination, and SRO examiners are to meet monthly to plan 

specific examinations of common members. At these latter meetings, 

examiners are expected, among other things, to collaborate on fieldwork 

dates, document requests, and broker-dealer entrance and closeout 

meetings. SROs also are to share their prior examination reports before 

beginning fieldwork. We noted, however, that SEC officials told us that 

some broker-dealers that have tried the coordinated examination program 

have concluded that it is more efficient for them to have two separate 

examinations.7

 Additionally, SEC met with NYSE to discuss registrations of 

private foreign issuers. 

Securities SROs also communicate regularly with each other. Ten of them, 

the major U.S. securities exchanges, are full members of the Intermarket 

Surveillance Group (ISG), a group they created in 1983 to share 

information across jurisdictions. The purpose of ISG is to share 

information and to coordinate and develop procedures designed to assist in 

identifying possible fraudulent and manipulative acts and practices across 

markets, particularly, between markets that trade the same or related 

securities and between markets that trade equity securities and options on 

an index in which such securities are included. 

7

GAO, Securities Markets: Competition and Multiple Regulators Heighten Concerns about 

Self-Regulation, GAO-02-362 (Washington, D.C.: May 3, 2002).
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Internationally, SEC communicates and coordinates with international 

securities regulators through IOSCO and has worked with the EU’s CESR 

to help harmonize activities between the EU and United States. SEC staff 

notes that it is participating in a joint working group established by IOSCO 

and the Basel Committee to address issues relating to the treatment of 

security positions held in the trading book, which includes securities held 

for dealing or proprietary trading. One issue is the development of a riskbased approach to capital requirements for securities activities, an issue of 

interest to holding companies with broker-dealer subsidiaries. And CESR 

officials told us that their communications with SEC have been fruitful in 

easing certain concerns, such as those associated with European 

companies’ U.S. operations having to adopt Sarbanes-Oxley requirements. 

In May 2004, SEC and CESR announced their intentions to increase their 

cooperation and collaboration aimed at two primary objectives, namely to

• identify emerging risks in the U.S. and EU securities markets to address 

potential regulatory problems at an early stage; and

• engage in early discussion of potential regulatory projects in the interest 

of facilitating converged, or at least compatible, ways of addressing 

common issues.

For the rest of 2004 and 2005, SEC and CESR proposed considering issues 

related to market structure, mutual fund regulation, accounting 

convergence, and credit rating agencies. 

Despite efforts of SEC and state securities regulators to communicate and 

coordinate their activities, some well-publicized disagreements developed 

following the corporate, accounting, and mutual fund scandals. After a 

settlement with one of the major U.S. securities firms concerning the use of 

research and during investigations of mutual fund irregularities, SEC and 

state regulators sometimes disagreed on what is an appropriate role for 

each, and on how effective each has been. For example, the Attorney 

General of New York, testifying before Congress concerning analyst 

conflicts of interest, said that while the issues had been widely reported in 

the press for years, SEC had issued no meaningful new regulations and had 

taken no serious enforcement actions prior to New York’s investigation. 

Some securities industry officials told us that state officials should leave 

securities issues to federal officials and noted that unilateral actions by 

states have led to differing state securities laws. In addition, an official at 

one of the SROs told us that communication often takes place in a crisis 

situation, but that there is little or no time for strategic thinking.
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Page 104 GAO-05-61 Financial Regulation

NAIC Is the Coordinating 

Body for State Insurance 

Commissioners, but States 

Often Pursue Their Own 

Course

NAIC is the long-standing structure for communication and coordination 

among state insurance commissioners. NAIC’s meetings of all state 

regulators occur four times a year and interstate working groups meet 

regularly in various locations or by teleconference or videoconference to 

consider almost every aspect of insurance. Through its development of 

model laws such as those concerning risk-based capital standards and its 

accreditation program, NAIC has been a mechanism for achieving some 

harmonization in state securities regulation. In addition, NAIC officials and 

individual state insurance commissioners have coordinated with insurance 

regulators from other countries through IAIS and other forums. IAIS has 

developed core principles of insurance supervision and is working on 

developing a regulatory framework. 

Because each state ultimately determines what actions it will take, NAIC 

cannot ensure uniform regulation. One tool NAIC has used to attempt to 

achieve a consistent state-based system of solvency regulation throughout 

the country is its accreditation program. However, we have reported that 

the accreditation program has weaknesses. In our review of the program in 

2001, we noted that while the accreditation program had improved over the 

10 years of its existence, and 47 state insurance departments had been 

accredited by NAIC, it still had weaknesses that raised questions about 

NAIC’s accreditation reviews.8

 For example, Mississippi and Tennessee 

received accreditation during and after a $200 million theft that involved 

four failed insurance companies in those states as well as two others. In 

addition, because New York will not adopt the risk-based capital model 

law, what is usually considered one of the strongest state regulatory bodies 

is not accredited. As a result of NAIC’s inability to force states to adopt 

certain rules and regulations, some critics think the voluntary aspect of 

NAIC reduces it effectiveness. Other critics argue that because NAIC 

operates as a quasi-governmental entity, it exercises too much power over 

individual state regulators. 

8

GAO, Insurance Regulation: The NAIC Accreditation Program Can Be Improved, GAO01-948 (Washington, D.C.: Aug. 31, 2001). 
Chapter 5

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CFTC Coordinates Activities 

with SROs and Futures 

Regulators in Other 

Countries 

According to CFTC, it coordinates with futures SROs and foreign financial 

services regulators. CFTC says it coordinates with exchanges in monitoring 

of daily trading activities, looking at the positions of large traders, and 

reviewing products listed by exchanges. CFTC’s coordination with futures 

regulators in other countries—for example, UK-FSA and BaFin—takes 

place partially through CFTC’s participation in the activities of IOSCO. 

CFTC participates in IOSCO working groups on secondary markets and 

market intermediaries, enforcement and information sharing, and 

investment management. CFTC also participates on IOSCO task forces 

covering issues such as implementation of IOSCO objectives and principles 

of securities regulation, and payment and settlement systems. While CFTC 

participates in working groups and task forces, it does not have the same 

status at IOSCO that SEC has; CFTC is an associate member of that 

organization, rather than a ordinary member. 

Financial Services 

Regulators Also 

Communicate across 

Financial Sectors, but 

Do Not Effectively 

Identify Some Risks, 

Fraud, and Abuse That 

Cross Sectors 

Federal financial regulators also communicate and coordinate their 

activities across “functional” areas. Federal Reserve officials note that, as 

directed by GLBA, they rely on information that is shared by functional 

regulators, including SEC, in the Federal Reserve’s supervision of bank and 

financial holding companies. Channels for communication and 

coordination have been set up by the regulators or at the direction of the 

President or Congress, often in response to a crisis. However, regulators do 

not always share information or monitor risks across sectors. 

Federal Reserve Reports 

That It Relies on Functional 

Regulators in Supervision of 

Bank and Financial Holding 

Companies

GLBA directed the Federal Reserve to rely on functional regulators in its 

supervision of nonbanking activities in bank and financial holding 

companies. For example, broker-dealer subsidiaries of bank or financial 

holding companies are subject to oversight by SEC, NASD, and, potentially, 

other SROs. In its 2001 strategic plan, the Federal Reserve reported that it 

is coordinating with other regulators to fulfill its role as the holding 

company supervisor. Federal Reserve officials told us that this 

coordination is a key component in their supervision of bank and financial 

holding companies, and that information has been readily provided by 

functional regulators as part of that process.
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Page 106 GAO-05-61 Financial Regulation

Regulators and SROs Have 

Created Mechanisms for 

Communicating across 

Sectors 

SEC and CFTC have jointly developed regulations implementing portions 

of CFMA that lifted the ban on certain types of securities-based futures, but 

the process was difficult. Before CFMA was enacted, SEC and CFTC 

competed over regulation of single-stock futures for nearly two decades. 

SEC claimed jurisdiction because single-stock futures behave like the 

underlying individual stocks and bonds; CFTC claimed jurisdiction because 

single-stock futures behave like futures. As a result of this stalemate, 

Congress banned the trading of single-stock futures. CFMA lifted the 

prohibition on trading single-stock futures and narrow-based stock index 

futures and allows these futures to be traded under a system of joint 

regulation by SEC and CFTC. However, according to CFTC and SEC 

officials, the market for single-stock futures has been slow to develop. In 

addition, a CFTC official told us that it had long had routine, if informal, 

contacts with SEC concerning financial integrity and on how certain firm 

assets and liabilities should be treated in calculating net capital. SEC staff 

told us that they agree with this statement. Similarly, CFTC coordinates its 

efforts with SEC on enforcement cases with jurisdiction in several different 

geographic areas. 

Since its creation in 1983, ISG has expanded to include futures and foreign 

exchanges as affiliate members. According to CFTC, the purpose of ISG 

today is to provide a framework for the sharing of information and the 

coordination of regulatory efforts among exchanges trading securities and 

related products to address potential intermarket manipulation and trading 

abuses. ISG plays a crucial role in information sharing among markets that 

trade securities, options on securities, security futures products, and 

futures and options on broad-based security indexes. ISG also provides a 

forum for discussing common regulatory concerns, thus enhancing 

members’ ability to fulfill efficiently their regulatory responsibilities. 

Internationally, regulators from multiple sectors have established forums to 

facilitate multinational communication across sectors. The Joint Forum 

and FSF are two such forums. The Basel Committee, IOSCO, and IAIS 

established the Joint Forum in 1996 to examine cross-sectoral supervisory 

issues related to financial conglomerates such as risk assessment and 

disclosure. The Federal Reserve, Treasury, and SEC serve on FSF, which 

was initiated in 1999 in response to the Asian financial crisis. FSF brings 

together, on a regular basis, representatives of governments, international 

financial institutions, and others to promote international financial stability 

through information exchange and international cooperation in financial 

supervision and surveillance.
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Congress and the President 

Have Directed Regulators to 

Communicate across 

Sectors, Especially after 

Crises

By executive order in March 1988, the President established the President’s 

Working Group on Financial Markets, which is composed of the heads of 

the Federal Reserve, SEC, and CFTC and chaired by Treasury, to address 

issues related to the 1987 stock market crash. As we reported in 2000,9

 the 

President’s Working Group was established in response to a crisis and, as 

the need had arisen, had continued to function as such. The President’s 

Working Group was formally reactivated in 1994 and since then has 

considered several issues, including the 1997 market decline, hedge funds 

and excessive leverage, year 2000 preparedness issues, the rapid growth of 

the OTC derivatives market, and threats to critical infrastructure.10 The 

group meets on a bimonthly basis at the staff level and has sent letters to 

Congress with common positions on issues such as energy derivatives 

legislation and mutual fund reform.

After the events of September 11, 2001, the President issued an executive 

order to create the Financial and Banking Information Infrastructure 

Committee (FBIIC), which is charged with coordinating federal and state 

financial regulatory efforts to improve the reliability and security of the 

U.S. financial system. Chaired by Treasury’s Assistant Secretary for 

Financial Institutions, FBIIC includes representatives from federal and 

state financial regulatory agencies, including CFTC, the Conference of 

State Bank Supervisors, FDIC, the Federal Housing Finance Board, the 

Federal Reserve, NAIC, NCUA, OCC, the Office of Cyberspace Security, the 

Office of Federal Housing Enterprise Oversight, the Office of Homeland 

Security, OTS, and SEC. 

In passing GLBA, Congress recognized the need for regulators engaged in 

supervising parts of holding companies to communicate and coordinate 

across “functional” areas. For example, the Federal Reserve and state 

insurance regulators must coordinate efforts to supervise companies that 

control both a bank and a company engaged in insurance activities; 

similarly, OTS and state insurance regulators have to coordinate activities 

as well. The Federal Reserve, FDIC, OCC, and OTS have signed regulatory 

cooperation agreements with almost all insurance jurisdictions; NAIC and 

the bank regulators say the remainder of the insurance jurisdictions have 

9

GAO, Financial Regulatory Coordination: The Role and Functioning of the President’s 

Working Group, GAO/GGD-00-46 (Washington, D.C.: Jan. 21, 2000).

10GAO, Critical Infrastructure Protection: Efforts of the Financial Services Sector to 

Address Cyber Threats, GAO-03-173 (Washington, D.C.: Jan. 30, 2003). 
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state laws that prohibit them from sharing information. GLBA also 

established the National Association of Registered Agents and Brokers, 

subject to NAIC’s oversight, and stipulated that the association coordinate 

with NASD in order to ease the administrative burden on those who are 

members of both organizations—that is, agents and brokers that deal both 

in insurance and securities.

Other congressionally directed communication includes directing the 

Federal Reserve, OCC, and SEC to form an interagency group to draft 

guidance on complex structured finance transactions following the 

corporate and accounting scandals of the late 1990s. At the invitation of 

these agencies, FDIC and OTS joined the interagency group. On May 19, 

2004, the agencies issued that guidance for comment. More recently, 

Congress has created the Financial Literacy and Education Commission to 

coordinate federal efforts and develop a national strategy to promote 

financial literacy.11 The commission, which is chaired by the Secretary of 

the Treasury, consists of 20 federal agencies, including all of the federal 

financial regulators. 

In light of the major changes being made in the EU as a result of the Action 

Plan as well as other factors, Treasury and EU officials agreed in early 2002 

to establish an informal dialogue on financial market issues. As part of that 

dialogue, U.S. and EU financial services policymakers, including officials 

from the Federal Reserve and SEC, meet regularly (1) to foster a mutual 

understanding of each other’s approach to the regulation of financial 

markets, (2) to identify any potential conflicts in approaches as early in the 

regulatory process as possible, and (3) to discuss regulatory issues of 

mutual interest. Some of the issues that have been considered in the 

dialogue are Sarbanes-Oxley, the Financial Conglomerates Directive, 

accounting standards, and allowing the placement of foreign electronic 

trading screens in the United States absent registration of either the 

exchange or its listed securities. As figure 8 shows, regulators and others 

are talking to their EU counterparts in a number of separate venues. 

11The commission was created in Title V of the Fair and Accurate Credit Transactions Act of 

2003, known as the Financial Literacy and Education Improvement Act. See Pub. L. No. 108-

159, Title V, 117 Stat. 2003 (codified at 20 U.S.C. §§ 9701–08). The act also mandated that 

GAO report on recommendations for improving financial literacy among consumers. On 

July 28, 2004, GAO hosted a forum entitled “Improving Financial Literacy: The Role of the 

Federal Government.” The results of this forum will appear in a forthcoming GAO report.
Chapter 5

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Page 109 GAO-05-61 Financial Regulation

Figure 8: United States—EU Regulatory Dialogue 

Cross-Sector 

Communication Has Not 

Facilitated Sharing of 

Important Information or 

Monitoring of Risks

In evaluating some of the means by which U.S. regulators communicate 

across sectors, we have found that these generally do not provide for the 

systematic sharing of information, making it more difficult for regulators to 

identify potential fraud and abuse, and for consumers to identify the 

relevant regulator. In addition, these means do not allow for a satisfactory 

assessment of risks that cross traditional regulatory and industry 

boundaries and therefore may inhibit the ability to detect and contain 

certain financial crises, as can be seen in the following.

Title United States European Union

Participants

Objectives

Financial markets

regulatory

dialogue

None

CESR-SEC

Dialogue

Mixed 

Technical Group

Insurance

dialogue

U.S. Treasury; Securities

and Exchange Commission;

Federal Reserve

Financial Accounting

Standards Board

Securities and Exchange

Commission

Securities and Exchange

Commission and federal

banking regulators

National Association of

Insurance Commissioners

Informal discussion of

current regulatory

problems

Information exchange on

regulatory and

supervisory practices

Financial Conglomerates

Directive equivalence

Cross-border information

sharing and early

discussion of regulatory

initiatives in the interest of

facilitating convergence

Convergence between

United States and

international accounting

standards

European Commission

(Internal Market Directorate)

European Commission

European Commission

desk officers, member state

experts

Committee of European

Securities Regulators

International Accounting

Standards Board

Source: GAO analysis of HM-Treasury information.
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Page 110 GAO-05-61 Financial Regulation

• With regard to the President’s Working Group, we reported in 2000 that 

although it has served as a mechanism to share information during 

unfolding crises, its activities generally have not included such matters 

as routine surveillance of risks that cross markets or of sharing 

information that is specific enough to help identify potential crises.12

• In reviewing the near collapse of LTCM—one of the largest U.S. hedge 

funds—in 1998, we reported that regulators continued to focus on 

individual firms and markets but failed to address interrelationships 

across industries. Thus, federal financial regulators did not identify the 

extent of weaknesses in bank, securities, and futures firm risk 

management practices until after LTCM’s near collapse and had not 

sufficiently considered the systemic threats that can arise from 

unregulated entities.13

• Our reviews of financial crises showed that almost never did a single 

federal financial services regulator have the necessary authority, 

jurisdiction, or resources to contain the crisis. Several officials told us 

that this dispersion had sometimes limited the federal government’s 

ability to identify incipient financial crises or to monitor a crisis once it 

had occurred.14

• In reviewing responses to the events of September 11, 2001, we reported 

that the multiorganization nature of U.S. financial services regulation 

has slowed the development of a strategy that would ensure continuity 

of business for financial markets in the event of a terrorist attack.15

• In a recent review of interagency communication regarding 

enforcement actions taken by the regulatory agencies against 

individuals and firms, we reported that while information sharing among 

financial regulators is a key defense against fraud and market abuses, 

the regulators do not have ready access to all relevant data related to 

12GAO/GGD-00-46.

13GAO, Long-Term Capital Management: Regulators Need to Focus Greater Attention on 

Systemic Risk, GAO/GGD-00-3 (Washington, D.C.: Oct. 29, 1999).

14GAO, Financial Crisis Management: Four Financial Crises in the 1980s, GAO/GGD-97-

96 (Washington D.C.: May 1, 1997).

15GAO, Potential Terrorist Attacks: Additional Actions Needed to Better Prepare Critical 

Financial Market Participants, GAO-03-251 (Washington, D.C.: Feb. 12, 2003).
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regulatory enforcement actions taken against individuals or firms. We 

also reported that many financial regulators do not share relevant 

consumer complaint data among themselves on certain hybrid products 

such as variable annuities (products that contain characteristics of both 

securities and insurance products) in a routine, systematic fashion, 

compounding the problem that consumers may have in identifying the 

relevant regulator.16 Determining the relevant regulator for variable 

annuities has been a source of regulatory disagreement for some time. 

After years of court battles, it was determined that variable annuities 

would be regulated as securities by the federal government but also fall 

under the authority of state insurance and securities regulators. At the 

federal level, SEC regulates the registration of variable annuity 

products. Under federal law, variable annuity products registered with 

SEC are generally exempt from registration with state securities 

regulators. As with other securities products, NASD regulates the sale of 

variable annuity products through broker-dealers. At the state level, the 

insurance companies that offer variable annuities generally fall under 

the jurisdiction of insurance regulators, though sales of such products 

can also fall under the jurisdiction of state securities regulators, or some 

combination of both regulators, depending on the state. Some state 

securities regulators told us they are making an effort to amend the 

Uniform Securities Act to place the oversight of variable annuities sales 

under the jurisdiction of state securities departments. 

While financial regulators generally supported better sharing of regulatory 

information, they cited some barriers to sharing. Those barriers generally 

centered on the need for individual agencies to meet their statutory 

objectives, including protecting confidential regulatory information from 

public disclosure. Officials at one banking agency, additionally, noted that 

they are sometimes reluctant to discuss some issues with SEC because of 

concern that the discussion would immediately trigger an investigation, 

while the banking officials are working to resolve the issue in a manner that 

does not compromise safety and soundness. However, officials at that 

agency also note that if the agency becomes aware of a securities law 

violation, they make an immediate referral to SEC. 

Officials at several of these regulatory agencies noted that their 

responsibilities are outlined in law. For example, with regard to airing 

16GAO, Better Information Sharing among Financial Services Regulators Could Improve 

Protections for Consumers, GAO-04-882R (Washington, D.C.: June 29, 2004).
Chapter 5

Regulators Communicate and Coordinate in 

Multiple Ways, but Concerns Remain 

Page 112 GAO-05-61 Financial Regulation

differences on Basel II, bank regulators noted that they are required to put 

documents out for public comment and respond to those comments. In 

other cases, agencies note that they were created as independent agencies 

rather than as components of executive agencies and departments to avoid 

interfering with these responsibilities. Officials at one agency, for instance, 

noted that while Treasury would have a role in coordinating the efforts of 

executive agencies prior to or during international negotiations, their 

agency would have to ensure that any such coordinating role did not 

interfere with their statutory responsibilities. We have also reported that 

banking and securities regulators have said that NAIC’s status as a 

nonregulatory entity was a barrier to information sharing, even when NAIC 

was acting on behalf of its member agencies. In some cases, current state 

statutes may also hinder information sharing.
Page 113 GAO-05-61 Financial Regulation

Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation Chapte6r

While structure is not the determining factor in the success of efforts to 

provide efficient and effective regulation, it can facilitate or hinder 

regulators’ efforts. Some U.S. regulators and financial market participants 

we spoke with cited the contribution of the current regulatory structure to 

the development of U.S. capital markets, and the U.S. economy overall—

for example, for encouraging competition and promoting stability. 

However, the regulatory system does not facilitate the monitoring of risks 

across firms and markets and does not provide for a proactive, strategic 

approach to systemwide issues. In addition, some outside the U.S. 

regulatory system, including foreign regulators, have criticized the U.S. 

regulatory system for hindering effective oversight of large, complex firms. 

We also found that dividing supervision of large, complex firms among U.S. 

regulators can result in inconsistent supervision. In addition, the U.S. 

regulatory system is not well structured for dealing with issues in a world 

where financial firms and markets operate globally. 

While the demarcations between the “functional” areas have blurred and 

large firms have diversified across sectors, differences among the sectors 

are still important. Thus, the system benefits from having regulators that 

specialize in the “functional” areas. However, “functional” specialization 

has drawbacks as well, including the inability to take advantage of 

economies of scale and scope, the danger of becoming a voice for certain 

interests, and the possibility that firms may seek supervision from the least 

intrusive regulators.

U.S. Financial Services 

Regulatory System Has 

Generally Been 

Successful but Lacks 

Overall Direction

The U.S regulatory system has allowed financial intermediaries and 

markets to contribute broadly to the U.S. economy. Corporations have a 

range of financing options to choose from—including bank lending and 

securities issuance—that have generally allowed the economy to grow and 

consumers have a range of options to choose from that allow them to make 

purchases and save for retirement. In addition, new products have been 

developed that allow financial institutions to manage risk. Some of the 

people we spoke with wondered why anyone would want to change a 

regulatory system that has generally supported these aspects of our 

economy. Officials at one trade association told us that because our system 

is so successful, some other countries are trying to replicate aspects of it. 

In addition, at least one academic researcher has commented that 

European countries tried to create SEC-type regulatory agencies where the 

focus, in part, is on protecting consumers. 
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 114 GAO-05-61 Financial Regulation

U.S. financial institutions are generally characterized as dynamic and 

innovative and some aspects of the regulatory system have these 

characteristics as well. In chapter 4 of this report, we showed how some 

regulatory approaches have evolved over time to better address changes in 

the industry. The U.S. financial system is dynamic and innovative because it 

is populated by a large number of firms and different industries that 

compete with each other in an environment where no one sector or firm 

has gained the market power that would stifle innovation. Similarly, the 

regulatory system is characterized by a large number of regulators that 

must often compete with each other to provide more innovative or vigilant 

regulation. Competition among the banking regulators, especially the 

Federal Reserve and OCC, is given credit for changes in regulation 

including the modernization that removed prohibitions against securities 

firms, banks, and insurance companies operating in a single holding 

company structure, and increased regulatory attention to the provision of 

loans in certain minority areas. Similarly actions by some state attorneys 

general and other securities officials helped prod the Justice Department 

and SEC to take more aggressive action and may have helped to highlight a 

need for increased resources at SEC. 

Having multiple regulators also allows for regulatory experimentation. An 

insurance regulator in Illinois can allow the market to set insurance rates, 

while insurance regulators in Massachusetts must approve rate increases. 

Similarly, for depository institutions, Utah offers certain advantages to ILCs 

that obtain charters in that state. The movement of CFTC to a principlesbased approach while SEC stays with a rules-based approach to regulation 

is another example of how regulators can be innovative in experimenting 

with different approaches to regulation. 

One of the international criteria for a successful regulatory system is to 

have adequate resources, and the success of the U.S. regulatory system is 

often attributed to the overall quality of U.S. regulators. Many of the 

industry officials we talked with felt that their regulators had the needed 

skills to provide effective supervision. Whether the U.S. regulatory 

structure facilitates the hiring of a sufficient number of quality staff across 

all of the regulatory agencies is an open question. Officials at UK-FSA said 

they felt they were better able to attract good staff in a consolidated 

regulatory structure because they had better visibility in the marketplace, 

could offer better career paths, and in some cases, were able to pay higher 

salaries than the agencies that existed before consolidation. However, that 

organization still has only about 2,300 staff members. Because several of 

the U.S. regulators are this large, have visibility in the marketplace, and are 
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 115 GAO-05-61 Financial Regulation

able to offer competitive salaries, they are well positioned to hire good 

staff. However, some of the federal regulators and state insurance 

regulatory agencies are relatively small and could face difficulties in 

attracting qualified staff due to the substantial demand by other 

government agencies and the private sector for the best personnel. 

The regulatory system is also credited with helping to foster financial 

stability and maintain continuity. The system has allowed for creative 

solutions to potentially destabilizing events. For example, between January 

and September 1998, LTCM lost almost 90 percent of its capital. In 

September 1998, the Federal Reserve determined that rapid deterioration 

of LTCM’s trading positions and the related positions of some other market 

participants might pose a significant threat to global financial markets that 

were already unsettled with Russia’s default on its debt. As a result, the 

Federal Reserve facilitated a privately funded recapitalization to prevent 

LTCM’s total collapse.1

 While some experts believe that the market would 

have handled this crisis, the Federal Reserve Bank of New York is credited 

by many with facilitating the resolution of a major liquidity crisis with 

potential systemic repercussions. Again, when the events of September 11, 

2001, led to unsettled government securities trades and other financial 

market disruptions, the Federal Reserve provided needed liquidity to 

financial markets. Federal bank regulators also provided guidance to banks 

on maintaining business relations with their customers that had been 

affected by the attacks and issued a joint statement advising banks that any 

temporary drops in bank capital would be evaluated in light of a bank’s 

overall financial condition. SEC took similar actions to facilitate the 

successful reopening of stock markets, including providing temporary 

relief from some regulatory requirements.2

Through its supervision of bank and financial holding companies, the 

Federal Reserve does have oversight responsibility for a substantial share 

of the financial services industry. The scope of its oversight, however, is 

limited to bank and financial holding companies. However, no government 

agency is charged with looking at the financial system as a whole, and the 

ability of regulators to meet their objectives on an ongoing basis. We have 

repeatedly noted that regulators do not share information or monitor risks 

1

See GAO/GGD-00-3; and GAO, Responses to Questions Concerning Long-Term Capital 

Management and Related Events, GAO/GGD-00-67R (Washington, D.C.: Feb. 23, 2000).

2

See GAO-03-251. 
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 116 GAO-05-61 Financial Regulation

across markets or “functional” areas preventing them from identifying 

potential systemic crises and limiting opportunities for fraud and abuse 

(see ch. 5). In addition, we noted limitations on effectively planning 

strategies that cut across regulatory agencies. 

In addition, there is no mechanism for the regulatory agencies to perform 

this task cooperatively. From an overall perspective the system is not 

proactive, but instead reacts in a piecemeal, ad hoc fashion—often when 

there is a crisis. No one has the authority, and there is no cooperative 

mechanism to conduct risk analyses, prioritize tasks, or allocate resources 

across agencies, although the Office of Management and Budget may 

perform some of these tasks for agencies that are funded by federal 

appropriations. Similarly, no one has the responsibility, and there is no 

cooperative mechanism, for putting together a long run strategic plan that 

develops a clearly defined set of objectives for the financial regulatory 

system and lays out a plan for achieving those goals over time. 

Each agency does develop its own strategic plan. The Federal Reserve, for 

instance, published its most recent plan in December 2001, providing three 

primary goals—including promoting “a safe, sound, competitive, and 

accessible banking system and stable financial markets.” The plan provided 

specific objectives and performance measures, and discussed the external 

factors that would affect the Federal Reserve. For instance, it noted the 

following:

Continued integration of U.S. financial market sectors, accompanied by the introduction of 

new financial products and means for their delivery, is further blurring lines between banks 

and nonbanks. Securities firms, insurance companies, financial companies, and even many 

prominent industrial companies—as well as commercial banks—are exploiting 

technological and financial innovations to seek to capture larger shares of the financial 

services market. Industry consolidation will affect the way the Federal Reserve operates to 

ensure safety and soundness and limit systemic risk. 

However, no entity is charged with developing a strategic plan like this that 

would address how industry changes affect the ability of the financial 

regulatory system, as a whole, to meet its many missions.
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 117 GAO-05-61 Financial Regulation

Structure of U.S. 

Financial Services 

Regulatory System May 

Not Facilitate 

Oversight of Large, 

Complex Firms

Legal experts and some regulators in EU and Joint Forum countries believe 

that large, complex, internationally active firms need to be supervised on a 

consolidated level. In response, the EU is requiring consolidated 

supervision for certain financial institutions on the assumption that these 

firms are so large and so complex that a failure at anyone of them could 

pose systemic threats within and across countries. In addition, many of the 

countries we studied said that one of the primary reasons they 

consolidated their regulatory structure was to better supervise 

conglomerates. Historically, in the U.S., holding company supervision—a 

form of consolidated supervision—has been required for companies 

owning commercial banks and thrifts. These bank and thrift holding 

companies were expected to be sources of financial and managerial 

strength to their subsidiary banks. They were supervised to ensure this, and 

to enforce laws intended to protect the insured bank even if the parent 

failed. The goal is to protect the banking system and, by extension, the 

deposit insurance fund. Another goal of this supervision has been to wall 

off the bank, so that other parts of the holding company do not benefit from 

any subsidy inherent in the provision of deposit insurance or other safety 

net provision. Holding company supervision in the United States has 

evolved to include broader concerns about the potential systemic risk 

posed by large financial services firms. 

GLBA continued the U.S. tradition of requiring holding company 

supervision when such a company owns a commercial bank or thrift, and 

provided for supervision of investment bank holding companies. However, 

the structure set up in GLBA has led to concerns about (1) the scope and 

effectiveness of the Federal Reserve’s authority to examine functionally 

regulated entities within a financial holding company, and (2) the 

possibility of competitive imbalances among holding company supervisors. 

Officials at the Federal Reserve say that because firms file consolidated 

financial statements and the Federal Reserve has the authority to conduct 

examinations of the holding companies, including verifying information in 

the consolidated financial statements, it generally has the information it 

needs to oversee bank and financial holding companies. The officials also 

said that when the Federal Reserve has needed information from other 

regulators, they have been able to obtain it. 

However, some large financial services firms offer insured deposits and 

provide a range of banking services without incurring bank holding 

company supervision from the Federal Reserve. By owning or obtaining 

thrift charters, for instance, some have opted to be thrift holding 
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 118 GAO-05-61 Financial Regulation

companies under OTS supervision. Given the complexity of some of these 

parent companies, OTS officials told us they have had to hire staff and 

develop expertise needed to understand these companies. We have neither 

evaluated OTS’s efforts nor compared the depth and coverage of OTS 

examinations of large, complex thrift holding companies with that of 

Federal Reserve examinations of similarly large, complex bank and 

financial holding companies. Other companies have obtained or control 

firms with ILC charters, and are not, by virtue of that affiliation, subject to 

federal holding company supervision unless the holding company elects to 

be a CSE subject to SEC consolidated oversight. 

The differential oversight of holding companies in the different sectors has 

the potential to create competitive imbalances. In discussions with some of 

these companies, we were told they offer similar services and see 

themselves as competing more with other large, internationally active firms 

in other sectors than with smaller entities in their own sector. They also 

raise funds in the same markets and often participate in the same 

transactions. Thus, they are taking on similar risk profiles. However, they 

may not be subject to the same supervision and regulation. Bank and 

financial holding companies are supervised by the Federal Reserve. Other 

companies may opt to organize themselves as thrift holding companies 

under OTS supervision, and with SEC’s recent CSE and SIBHC rules, some 

may opt for SEC oversight. While these differences stem from differences 

among the supervisory agencies and their regulatory goals, the differences 

potentially could have competitive implications as well. There is no 

mechanism to ensure that differences in these regulatory approaches do 

not create competitive differences among the different types of holding 

companies. Further, under the new CSE rules some firms could be subject 

to both SEC and OTS holding company oversight and, as OTS pointed out 

in its response to the CSE proposal, perhaps subject to conflicting 

regulatory requirements. Finally, there is no mechanism to ensure that any 

systemic risk that these large firms might pose would be treated in a 

consistent manner.

The regulatory system for consolidated supervision set up under GLBA 

rests on the “functional” regulatory system envisioned there—a system in 

which “functional” regulators oversee specific activities or products. Some 

industry experts believe that this system conflicts with reality in that it 

rests, in part, on preserving distinctions between financial firms based on 

their lines of business, even though the differences between financial 

products and services are blurring and management of affiliated firms is 

more efficient and effective when it is performed centrally, rather than on a 
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 119 GAO-05-61 Financial Regulation

firm-by-firm basis. Businesses say that to benefit from conglomeration, 

they integrate certain functions such as risk management and capital 

allocation. In addition, new corporate governance standards require that 

the board and senior management of a consolidated corporation be 

responsible for a variety of conduct-of-business issues throughout the 

organization. Moreover, using a brand name or symbol across these legal 

entities further links subsidiaries and affiliates in these large, complex 

firms. Some legal experts and regulators note that because conglomerates 

are managed centrally, regulators that specialize in understanding risks 

specific to their “functional” sector may not appreciate complex risks that 

span financial sectors and may not understand the risk aggregation 

methodologies employed by these firms. Moreover, they note that the 

existence of a range of supervisory authorities poses the risk that financial 

firms will engage in a form of regulatory arbitrage that involves the 

placement of particular financial services or products in that part of the 

financial conglomerate in which supervisory oversight is the least intrusive.

GLBA considers linkages among affiliated firms and contains several 

provisions under which regulators are to coordinate and cooperate with 

each other to achieve effective and efficient regulation. However, as we 

have seen, cooperation among regulators in different sectors is difficult 

within a system that values regulatory competition—a feature of our 

system that is often credited with making the regulatory system dynamic 

and innovative but that may be inefficient as well. As figure 9 shows, the 

agency overseeing a holding company might have to rely on a large number 

of other regulators for information about subsidiaries engaged in many 

different functions.
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 120 GAO-05-61 Financial Regulation

Figure 9: Regulators for a Hypothetical Financial Holding Company 

Consolidated regulators in the United States also rely on consolidated 

financial statements that may include descriptions of risk management 

techniques as well. However, these same firms have to create reports and 

risk analyses to meet the specific demands of individual “functional” 

regulators, particularly when the focus of the regulators differs from the 

firm’s focus on its consolidated position and risk management techniques. 

Life

insurance

company

(broker/

agent/

underwriter)

National

bank

Futures

commission

merchant

Broker/

dealer

Bank

holding

company

Special

financing

entity

National

thrift

State

thrift

Asset

management

company

Non-U.S.

investment

bank

Domestic

sales

offices

State

member

bank

State

nonmember

bank

National

bank

Financial

holding company

National

bank

Non-U.S.

commercial

bank

U.S.

securities

broker/

dealer/

underwriter

Commercial

paper

funding

corporation

Futures

commission

merchant

Non-U.S.

securities

broker/

dealer/

underwriter

Insurance

agencies

Federal Reserve

FDIC

CFTC

Non-U.S. regulator

OCC

OTS

SEC

SRO

State regulator

Unregulated

U.S. Federal regulators Other

Source: GAO.
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 121 GAO-05-61 Financial Regulation

These reports may have little connection to the overall risk position of the 

larger entity. 

Regulators say that in certain cases they are not concerned about the 

holding company because the entity they supervise is walled off from the 

larger entity. For example, several state insurance regulators noted that the 

entities they regulate are incorporated and do business only within their 

states, although the companies are subsidiaries of parent companies in 

other states. Similarly, FDIC notes that the safety net provided in the form 

of deposit insurance is only extended to banks as legal entities. However, it 

is difficult to imagine that problems in a significant subsidiary of a 

conglomerate would not impact the rest of the organization. Especially 

when the parts of an organization are being managed centrally and a 

company brand name is used across sectors, the reputation of any part of 

an organization is likely to impact the other parts. The problems of its junk 

bond operations led to the wider collapse of Drexel Burnham Lambert 

Group, for instance. Some observers have noted that when an organization 

is interconnected in these ways, it is less likely that a healthy organization 

would let any one of its significant parts fail. In addition, Federal Reserve 

regulations say that bank holding companies are to be a source of strength 

for their bank subsidiaries. Regulators also note that unlike other 

countries, the United States still has a large number of small and mediumsized firms in all of the financial sectors who engage in activities that are 

primarily within one sector; however, a research study issued in 2000 by 

IMF staff shows that based on a sample of the top 500 financial services 

firms in assets worldwide, 73 percent of the financial assets held by U.S. 

firms in the sample were held by firms that engaged in some significant 

degree in at least two financial services sectors.3

3

Gianni De Nicoló, Philip Bartholomew, Jahanara Zaman, and Mary Zephirin, “Bank 

Consolidation, Internationalization, and Conglomeration: Trends and Implications for 

Financial Risk” (IMF Working Paper 03/158, Washington, D.C., July 2003).
Chapter 6

The U.S. Regulatory System Has Strengths, 

but Its Structure May Hinder Effective 

Regulation 

Page 122 GAO-05-61 Financial Regulation

Structure of U.S. 

Financial Services 

Regulatory System May 

Not Facilitate 

Response to Increased 

Globalization 

For multinational financial services firms to have effective oversight, 

regulators from various countries must coordinate, if not harmonize, 

regulation/supervision of financial services across national borders and 

must communicate regularly. Many of the companies we spoke with told us 

that international harmonization of regulatory requirements would be good 

for their businesses. In addition, the degree to which financial services are 

integrated across countries makes it essential for regulators in different 

countries to communicate regularly. (See ch. 5.) However, as we have seen 

in the Basel II discussions and with the U.S.-EU dialogue, the current U.S. 

regulatory structure is not conducive to communicating a single U.S. 

position in these discussions. Negotiations related to harmonizing financial 

regulation across international borders differ from negotiations related to 

international trade, such as those involving the General Agreement on 

Tariffs and Trade or the allocation of radio-frequency spectrum.4

 In those 

negotiations, a structure is in place to develop a unified negotiating 

position. And while the outcome of negotiations may not depend on the 

number of regulators involved—the relative importance of U.S. financial 

institutions, especially in overseas capital markets, and many other factors 

are also important—speaking with a single voice would ensure that the U.S. 

position is effectively heard. 

One area where the mismatch between globalization and the U.S. 

regulatory structure is marked is in the area of insurance regulation. 

Companies in the insurance industry increasingly operate on a national and 

international basis and many companies are foreign-owned, but the 

industry is regulated by 55 independent jurisdictions. While insurance 

regulators in the United States responded through NAIC to a solvency crisis 

in that industry during the early 1990s, the NAIC process remains 

cumbersome in a multinational world. Some of the kinds of problems that 

can develop as a result of an international industry being overseen at the 

state level are evident in the case of Executive Life. In 1998, issues 

surrounding the sale of Executive Life, a life insurer that became insolvent 

in the early 1990s after investing heavily in junk bonds, came to light. The 

issue essentially pitted the insurance regulator of California against the 

national government of France. While this problem was handled within the 

current structure, the structure did not facilitate the solution. Not 

surprisingly, officials at the EU, UK-FSA, and BaFin told us that having a 

4

See GAO, Telecommunications: Better Coordination and Enhanced Accountability 

Needed to Improve Spectrum Management, GAO-02-906 (Washington, D.C.: Sept. 30, 2002).
Chapter 6

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but Its Structure May Hinder Effective 

Regulation 

Page 123 GAO-05-61 Financial Regulation

single point of contact on insurance issues within the United States would 

facilitate international decision making. EU officials noted that 

international negotiations with NAIC led to the creation of IAIS; however, 

the effectiveness of this organization may be limited by its inability to 

speak for the actual insurance regulators in the U.S. In addition, NAIC’s 

supervisory stance embodied in its model laws differs from the Solvency II 

model being created in the EU, especially with regard to the oversight of 

insurance groups. NAIC says that IAIS is developing a model for insurance 

supervision that conforms to the U.S. position. Finally, some foreign-based 

financial services firms that want to sell insurance products in the United 

States have characterized the fragmented U.S. regulatory system as an 

unfair trade barrier.

Regulators Provide 

Some Other Benefits 

by Specializing in 

Particular Industry 

Segments or 

Geographic Units, but 

Specialization Has 

Costs As Well

Since there are still significant differences in many areas of the banking, 

securities, insurance, and futures businesses, specialized expertise with 

knowledge of those businesses is still deemed important. In addition, state 

regulators often argue that they have better knowledge of the needs of 

consumers in their respective states. Officials at OTS felt that even though 

all of the banking regulators are in the banking sector, OTS is able to focus 

its skills on the needs of institutions whose primary asset is mortgages. 

According to officials in the futures industry and at CFTC, creating a 

specialized regulator for the futures industry has permitted that industry to 

be innovative in ways that would not have been possible under either an 

SEC or bank regulatory environment. Many of the people we talked with 

were concerned about what might happen to these specialized skills and 

knowledge if regulators were combined into fewer agencies. In addition, a 

few industry representatives in the United Kingdom mentioned the lack of 

industry specific skills and knowledge as a concern in the United Kingdom 

once the regulator was unified across sectors. 

Specialization in a particular industry segment ensures that the issues of 

that segment will get considered in larger forums, before Congress, or in 

international negotiations. This is particularly evident in the Basel II 

negotiations, where FDIC and OTS have expressed the concerns facing 

smaller banks—including the possibility that lower capital requirements 

for larger banks could place smaller banks at a competitive disadvantage. 

The Federal Reserve says that it is conducting a series of studies looking at 

the likely impact of Basel II. After two such studies, they have found no 

potential negative effects on smaller banks; however, one study did suggest 

that larger banks that do not adopt Basel II could face some competitive 
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but Its Structure May Hinder Effective 

Regulation 

Page 124 GAO-05-61 Financial Regulation

disadvantage. Similarly, OCC expressed the concerns of trust banks over 

the capital charges they will have for operational risk. 

Of course, specialization can be a double-edged sword that requires 

vigilance on the part of the regulator. First, a regulator’s specialization can 

lead to an inability to track risks that cross sectors. This inability can be the 

result of statutory limitations on the regulator, as well as the regulator’s 

policies and procedures that reflect its focus on particular risks. Second, if 

the regulator becomes too responsive to the needs of the industry, its 

independence can be in jeopardy. Again, the Basel II negotiations illustrate 

the trade-offs. It is unclear whether regulators who presented the views of 

particular segments of the industry were exhibiting their specialized 

knowledge or lobbying for the segment of the industry they oversee. One 

regulator told us they did not present certain issues earlier in the process 

because the regulator had not yet heard from the industry. The chance for 

regulators to lose their independence is stronger for agencies that oversee 

relatively few entities. An agency is at greater risk of being “captured” by 

the industry as consolidation in industry segments reduces the number of 

firms being overseen by that regulator. Alternatively, combining regulators 

could reduce the impact of any one segment in decisions, but runs the risk 

of swallowing up particular industry segments. 

Although having knowledge of a particular industry segment is important 

for regulators, other specialized skills and knowledge cut across regulatory 

agencies, and these skills and knowledge may not be efficiently allocated 

across some of the smaller agencies. All regulators write rules, conduct offsite monitoring, and examine firms to determine whether firms are 

managing their risks effectively and complying with rules and regulations. 

In Massachusetts, we found former Federal Reserve examiners on the staff 

of OCC and at the Massachusetts Department of Insurance. In addition, 

CFTC told us that part of their implementation of new risk-focused 

examination procedures includes some training by Federal Reserve 

examiners. However, having some relatively small agencies limits the 

ability of these agencies to take advantage of economies of scope and scale 

relative to these skills. This is especially true with regard to the specialized 

skills related to understanding the complex statistical models that firms are 

using to manage risks and the structured products they provide. These 

skills are needed in varying degrees by all financial regulatory agencies. 

Finding people with the requisite skills is complicated because they are 

scarce and in demand by the industry, where the pay is often considerably 

higher than at a regulatory agency. Regulators say that consolidating 

regulatory agencies would not alleviate this shortage because even if they 
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but Its Structure May Hinder Effective 

Regulation 

Page 125 GAO-05-61 Financial Regulation

added together all of the staff of all of the regulatory agencies involved in 

these complex tasks, there would still not be enough staff with the requisite 

skills. However, the current system does not provide a mechanism to 

ensure that the staff is allocated optimally.
Page 126 GAO-05-61 Financial Regulation

Chapter 7

Congress May Want to Consider Changes to 

the U.S. Regulatory Structure Chapte7r

As we have seen, over the last several decades the financial services 

industry has changed in many significant ways. These changes have blurred 

the clear-cut boundaries between the “functional” areas underlying our 

regulatory structure, so that large firms and products increasingly compete 

across or otherwise ignore these boundaries. Very large firms are 

increasingly competing in more than one of the four sectors of the industry 

and across national boundaries. In addition, these firms take on similar 

risks and manage these risks at the consolidated level. Policies and 

procedures related to market conduct and corporate governance also tend 

to be set centrally in these organizations. Moreover, hybrid products are 

blurring the lines between “functional” activities, and even firms that 

specialize in a specific functional area are competing to provide similar 

services to the same consumers and businesses. 

The financial services industry is critical to the health and vitality of the 

U.S. economy. While the industry itself bears primary responsibility to 

effectively manage its risks, the importance of the industry and the nature 

of those risks have created a need for government regulation as well. While 

the specifics of a regulatory structure, including the number of regulatory 

agencies and the roles assigned to each, may not be the critical determinant 

in whether a regulatory system is successful, the structure can facilitate or 

hinder the attainment of regulatory goals. The skills of the people working 

in the regulatory system, the clarity of its objectives, its independence, and 

its management systems are critical to the success of financial regulation. 

The U.S. regulatory structure facilitates regulators having detailed 

knowledge about banking, insurance, securities, and futures activities, and 

these regulators report that they do exchange information relevant to the 

supervision of institutions that operate in more than one of these areas. 

However, the regulatory structure hinders comprehensively understanding 

and, when appropriate, containing the risk-taking activities of large, 

complex, internationally active institutions; promoting the global 

competitiveness of the U.S. financial services industry; maintaining to the 

greatest extent possible competitive neutrality; and handling possible 

systemic repercussions. The U.S. regulatory structure also does not have 

an ability to develop a strategic focus that would guide the priorities and 

activities of each agency and does not have the ability to allocate resources 

across agencies. 

Because our regulatory structure relies on having clear-cut boundaries 

between the “functional” areas, industry changes that have caused those 

boundaries to blur have challenged the regulatory framework. While 
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diversification across activities and locations may have lowered the risks 

being faced by some large, complex, internationally active firms, 

understanding and overseeing them has also become a much more 

complex undertaking, requiring staff that can evaluate the risk portfolio of 

these institutions and their management systems and performance. 

Regulators must be able to ensure effective risk management without 

needlessly restraining risk taking, which would hinder economic growth. 

Similarly, because firms are taking on similar risks across “functional” 

areas, to understand the risks of a given institution or of the system as a 

whole, regulators need a more complete picture of the risk portfolio of the 

financial services industry both in the United States and abroad. For 

example, in our report on LTCM and its rescue, we said the following:

Because of the blurring in recent years of traditional lines that separate the businesses of 

banks and securities and futures firms, it is more important than ever for regulators to 

assess information that cuts across these lines. Regulators for each industry have generally 

continued to focus on individual firms and markets, the risks they face, and the soundness 

of their practices, but they have failed to address interrelationships across each industry. 

The risks posed by LTCM crossed traditional regulatory and industry boundaries, and the 

regulators would have needed to coordinate their activities to have had a chance of 

identifying these risks. Although regulators have recommended improvements to 

information reporting requirements, they have not recommended ways to better identify 

risks across markets and industries.1

The regulatory framework envisioned in GLBA recognizes some of the 

linkages within institutions and contains a framework for consolidated 

oversight of some types of firms. Activities at the Basel Committee and 

requirements that take affect in early 2005 for firms conducting business in 

EU countries have led regulators to adopt some new policies and rules in 

this area. However, different regulatory treatment of bank and financial 

holding companies, consolidated supervised entities, supervised 

investment bank holding companies, and thrift holding companies may not 

provide a basis for consistent oversight of their consolidated risk 

management strategies, guarantee competitive neutrality, or contribute to 

better oversight of systemic risk.

Recognizing that regulators could potentially overcome the impediments of 

a fragmented regulatory structure through better communication and 

coordination across agencies, Congress has created mechanisms for 

coordination and on a number of specific issues directed agencies to 

1

GAO/GGD-00-3, 3.
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coordinate their activities. In addition, we have repeatedly recommended 

that federal regulators improve communication and coordination. For 

example, in our report on LTCM, we recommended that federal financial 

regulators develop ways to better coordinate oversight activities that cut 

across traditional regulatory and industry boundaries. While we continue 

to support these recommendations, we recognize that the sheer number of 

regulatory bodies, their underlying competitive nature, and differences in 

their regulatory philosophies will continue to make the sharing of 

information difficult and true coordination and cooperation in the most 

important or most visible areas problematic as well. Therefore, Congress 

might want to consider some changes to the U.S. financial services 

regulatory structure that address weaknesses and potential vulnerabilities 

in our current system, while maintaining its strengths. 

However, structural changes themselves will not ensure the attainment of 

various regulatory goals. That will require a structure with the right people 

and skills, clear regulatory objectives, effective tools, and appropriate 

policies and procedures. A different organizational structure will not 

necessarily make the inherently difficult task of detecting fraud in a 

financial institution easier, and it also would not ensure more accurate and 

comprehensive detection. In addition, any major change in the regulatory 

structure poses the risk of unintended consequences and transition costs. 

Organizational changes may take place over several years, and regulators 

might lose sight of their objectives while management jockeys for control 

of the agenda of a new or reformulated regulatory body, staff worry about 

having jobs in the new system, or employees become accustomed to their 

new roles in the new organization. 

Matter for 

Congressional 

Consideration

While maintaining sector expertise and ensuring that financial institutions 

comply with the law, Congress may want to consider some consolidation or 

modification of the existing regulatory structure to (1) better address the 

risks posed by large, complex, internationally active firms and their 

consolidated risk management approaches; (2) promote competition 

domestically and internationally; and (3) contain systemic risk. If so, our 

work has identified several options that Congress may wish to consider: 

• consolidating the regulatory structure within the “functional” areas;

• moving to a regulatory structure based on a regulation by objective or 

twin peaks model; 
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• combining all financial regulators into a single entity; or

• creating or authorizing a single entity to oversee all large, complex, 

internationally active firms, while leaving the rest of the structure in 

place.

If Congress does wish to consider these or other options, it may want to 

ensure that legislative goals are clearly set out for any changed regulatory 

structure and that the agencies affected by any change are given clear 

direction on the priorities that should be set for achieving these goals. In 

addition, any change in the regulatory structure would entail changing laws 

that currently govern financial services oversight to conform to the new 

structure. 

The first option would be to consolidate the regulatory structure within 

“functional” areas—banking, securities, insurance, and futures—so that at 

the federal level there would be a primary point of contact for each. The 

two major changes to accomplish this at the federal level would be 

consolidation of the bank regulators and, if Congress wishes to provide a 

federal charter option for insurance, the creation of an insurance 

regulatory entity. The bank regulatory consolidation could be achieved 

within an existing banking agency or with the creation of a new agency. In 

1996, we recommended that the number of federal agencies with primary 

responsibilities for bank oversight be reduced. However, we noted that in 

the new structure, FDIC should have the necessary authority to protect the 

deposit insurance fund and that the Federal Reserve and Treasury should 

continue to be involved in bank oversight, with access to supervisory 

information, so that they could carry out their responsibilities for 

promoting financial stability. We have not studied the issue of an optional 

federal charter for insurers, but have through the years noted difficulties 

with efforts to normalize insurance regulation across states through the 

NAIC-based structure. Having a primary federal entity for each of the 

functional sectors would likely improve communications and coordination 

across sectors because it would reduce the number of entities that would 

need to be consulted on any issue. Similarly, it would provide a central 

point of communication for issues within a sector. Fewer bank regulators 

might reduce the cost of regulation and the opportunities for regulatory 

arbitrage, choosing charters so that transactions have the least amount of 

oversight. In addition, issues related to the independence of a regulator 

from the firms they oversee with a given kind of charter would be 

alleviated. However, consolidating the banking regulators and establishing 

a federal insurance regulator would raise concerns as well. While improved 
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communication and cooperation within sectors would help to achieve the 

other objectives outlined above, it would not directly address many of 

them. In addition, some constituencies, such as thrifts, might feel they were 

not getting proper attention for their concerns; and opportunities for 

regulatory experimentation and the other positive aspects of competition 

in banking could be reduced. Further, while this option represents a more 

evolutionary change than some of the others, it might still entail some costs 

associated with change, including unintended consequences that would 

undoubtedly erupt as various banking agencies and their staff jockeyed for 

position within the new banking regulator. Similarly, the establishment of a 

federal insurance regulator might have unintended consequences for state 

regulatory bodies and for insurance firms as well. 

Another option would be consolidating the regulatory structure using a 

regulation by objective, or twin peaks model. The twin peaks model would 

involve setting up one safety and soundness regulatory entity and one 

conduct-of-business regulatory entity. The former would oversee safety and 

soundness issues for insurers, banks, securities, and futures activities, 

while the latter would ensure compliance with the full range of conduct-ofbusiness issues, including consumer and investor protection, disclosure, 

money laundering, and some governance issues. This could be 

accomplished by changing the tasks assigned to existing agencies or by 

restructuring the agencies or creating new ones. On the positive side, this 

option would directly address many of the regulatory objectives related to 

larger, more complex institutions, such as allowing for consolidated 

supervision, competitive neutrality, understanding of the linkages within 

the safety and soundness and conduct-of-business spheres, and regulatory 

independence. In addition, conduct-of-business issues would not become 

subservient to safety and soundness issues, as some fear. On the negative 

side, in addition to the issues raised by any change in the structure, this 

structure would not allow regulators to oversee the linkages between 

safety and soundness and conduct-of-business. As reputational risk has 

become more important, the linkages between these activities have 

become more evident. In addition, if the controls and processes for 

conduct-of-business issues and safety and soundness issues are coming 

from the top of the organization, they are probably closely related. Finally, 

combining regulators into multifunctional units might not allow the 

regulatory system to maintain some of the advantages it now has, including 

specialized expertise and the benefits of regulatory competition and 

experimentation.
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The most radical option would combine all financial regulators into a single 

entity, similar to UK-FSA. The benefits of the single regulator are that one 

body is accountable for all regulatory endeavors. It can more easily 

evaluate the linkages within and across firms, including those between 

conduct-of-business and safety and soundness considerations, plan 

strategically across sectors, and facilitate the allocation of resources to 

their highest priority use. However, achieving these goals would depend on 

having the right people and skills, clear regulatory objectives, effective 

tools, and appropriate policies and procedures. While the UK-FSA model is 

intriguing, this option raises some concerns for the United States. First, 

because of the size of the U.S. economy and the number of financial 

institutions this entity would have to be very large and, thus, could be 

unwieldy and costly. UK-FSA has about 2,300 employees, while estimates of 

the number of regulators currently in the United States range from about 

30,000 to 40,000. In addition, officials at UK-FSA have commented about 

the difficulty of setting priorities when a large number of issues have to be 

dealt with. Prioritizing these issues for the United States would be 

particularly difficult. Further, an entity with this scope and size might have 

difficulty responding to smaller players and might therefore damage the 

diversity that has enriched the U.S. financial industry. Also, staff at such an 

entity might lose or not develop the specialized skills needed to understand 

both large and small companies and risks that are specific to the different 

“functional” sectors. And without careful oversight, such a large and allpowerful entity might not be accountable to consumers or the industry.

A more evolutionary change would be to have a single entity with 

responsibility for the oversight of all large, complex, or internationally 

active financial services firms that manage risk centrally, compete with 

each other within and across sectors, and, by their size and presence in a 

wide range of markets, pose systemic risks. Having a single regulatory 

entity for large, complex, or internationally active firms could be 

accomplished by giving this responsibility to an existing regulator or by 

creating a new entity. A new entity might consist of a small staff that would 

rely on the expertise of staff at existing regulatory agencies to accomplish 

supervisory tasks. 

Having a single regulatory entity for large, complex, or internationally 

active firms would have the advantage of addressing industry changes, 

while leaving much of the U.S. regulatory structure unchanged. A single 

regulatory entity for large, complex holding companies would have 

responsibilities that more closely align with the businesses’ approach to 

risk than the current regulatory structure. In addition, this entity could 
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promote competition between these firms by ensuring, to the greatest 

extent possible, that oversight is competitively neutral. A single regulatory 

entity for internationally active firms would also be better positioned to 

help coordinate the views of the United States in international forums, so 

that the U.S. firms are not competitively disadvantaged during negotiations. 

Finally, this entity would be better able to appraise the linkages across 

large, complex, internationally active firms and, thus, with the aid of the 

Federal Reserve and Treasury, could contribute to promoting financial 

stability. These potential improvements could be obtained without losing 

the advantages afforded by our current specialized regulators, who would 

continue to supervise the activities of regulated firms such as brokerdealers or banks. However, this option also has drawbacks. While the 

transition costs might be less than in some of the other options, the 

creation of a new entity or changing the role of an existing regulatory entity 

would still entail costs and likely some unintended consequences. It might 

also be difficult to maintain the appropriate balance between the interests 

of the large or internationally active firms and smaller, more-specialized 

entities. It also could involve creating one more regulatory agency in a 

system that already has many agencies. 

Agency Comments and 

Our Evaluation

We received written comments on a draft of this report from the Chairman 

of the Board of Governors of the Federal Reserve System, the Chairman of 

Federal Deposit Insurance Corporation, the Comptroller of the Currency, 

the Director of the Office of Thrift Supervision, and the Director of SEC’s 

Division of Market Regulation. These letters are reprinted in appendixes I-V 

of this report. 

In his comments, the Chairman of the Federal Reserve’s Board of 

Governors said that GLBA provided for a regulatory framework that struck 

a balance between the need for regulation and the need for adaptability. 

Congress at that time chose to retain and build upon the functional 

regulation approach, one that has worked well for the United States and, as 

the report notes, has helped promote the competition and innovation that 

is a “hallmark” of the U.S. financial system. He further wrote that, in GLBA, 

“Congress also reaffirmed its determination that functional regulation 

needed to be supplemented by consolidated supervision of holding 

companies only in the case of affiliations involving banks and other insured 

depository institutions” because of risks associated with the access that 

banks and other insured depository institutions have to the federal safety 

net. These risks include the subsidy implicit in the federal safety net being 

extended to nonbank affiliates and ownership of an insured bank reducing 
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market discipline. In addition, he cautioned that if Congress were to 

consider restructuring the federal financial regulatory agencies, it should 

carefully consider the benefits and costs, including the effect on the 

industry’s competition and innovation and that any agency “strategic plan” 

would be unable to anticipate the effects of this innovation. 

The Chairman of the Federal Deposit Insurance Corporation wrote that the 

draft report paid insufficient attention to the fact that deposit insurance is 

limited to insured depository institutions, and the danger that focusing on 

consolidated supervision would blur the distinction between the insured 

depository institution and any uninsured affiliates. He noted that this 

distinction would become more important if the marketplace drives greater 

mixing of commerce and finance than currently occurs. He also warned 

that, if federal financial regulators were to be consolidated, the value of 

differing perspectives within the regulatory system would be lost and 

independence of the deposit insurer could be diminished.

The Comptroller of the Currency also warned that any change in the federal 

financial regulatory structure “should be approached judiciously and 

cautiously.” Like the Chairman of the Federal Reserve’s Board of 

Governors, the Comptroller cautioned that changes in the federal 

regulatory structure could diminish the value of the dual banking system, 

with both state and federal charters for banks and thrifts. He noted that, 

while some foreign regulators may have preferred the “convenience” of 

having only one U.S. negotiator in the Basel II negotiations, this might have 

been less important than their desire to reach an agreement without the 

formal rule-making process that U.S. regulators must follow.

We agree with many of these comments, and believe the report accurately 

reflects the challenges that Congress would face if it were to choose to 

consider some consolidation or modification of the current federal 

financial regulatory structure. Achieving a balance between market forces 

and regulation is an inherently difficult task. We have made several changes 

to our report to ensure that it reflects this difficulty. In particular, we 

expanded our discussion of the statutory goals for the federal financial 

regulators. We also changed phrasing in the report to make clear that 

federal deposit insurance does not extend beyond FDIC-insured depository 

institutions. It is a valid concern that deposit insurance not be extended 

beyond the insured depository under any circumstances. We have also 

noted that the federal rule-making process could contribute to the 

statements made to us by foreign financial regulators about U.S. 

participation in the Basel II negotiations. In addition, we expanded our 
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discussion of agency strategic plans to make clear that their purpose is 

better preparing agencies to meet the challenges posed by the industry’s 

innovations. During our study, we were impressed by the strategic focus 

that appears to permeate UK-FSA and believe that, in this regard, it is a 

useful model for U.S. agencies to study. We agree with the Chairman of the 

Federal Reserve’s Board of Governors that a single regulator could 

“prohibit or restrain” innovation, and believe that the report does recognize 

this risk. In addition, while we recognize that Congress referred to the 

importance of deposit insurance and of not extending the safety net in its 

discussion of the Federal Reserve’s role as a consolidated supervisor, it did 

not limit its discussion of consolidated supervision to this purpose and did 

not ensure that all insured depositories owned by other entities would be 

subject to consolidated supervision. For example, GLBA gave SEC the 

authority to oversee SIBHCs—investment bank holding companies that do 

not own certain types of insured depositories (at the option of the 

investment bank.) In addition, because GLBA exempts some insured 

depositories, either directly or as a result of grandfathering some preexisting conditions, some of the most complex institutions in the United 

States that own insured depositories are not required to have consolidated 

supervision. Instead, these institutions are seeking consolidated 

supervision because of changes in EU law. 

In his comments, the Director of the Office of Thrift Supervision wrote that 

the report inadequately recognized OTS’s authority over thrift holding 

companies, including the top-tier parent company; that the report 

inaccurately portrayed OTS’s international activities; and presented an 

“unbalanced” view in referring to the failure of Superior Bank, FSB, 

without referring to other bank failures. 

We do not agree. Our report recognizes OTS’s authority, noting that, under 

the Home Owners’ Loan Act and other legislation, “companies that own or 

control a savings association are subject to supervision by OTS.” Further, 

the report includes a section in chapter 1 devoted to a discussion of OTS’s 

authority to oversee thrift holding companies; again in chapter 4, we 

discuss OTS’s authority as a consolidated supervisor. In the report, we 

acknowledge that because OTS oversees some of the largest, most 

complex U.S. financial services firms, it may serve as the consolidated 

supervisor for some of these firms under the Conglomerates Directive of 

the EU Action Plan. As noted, however, we have neither evaluated OTS’s 

thrift holding company examinations nor compared them with Federal 

Reserve examinations of bank or financial holding companies of similar 

size and complexity. Our report also discusses OTS’s role in international 
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forums—specifically its participation in the Basel II negotiations—and at 

OTS’s suggestion, we have modified the report to make clear that OTS has 

applied to be a permanent member of the Basel Committee. However, we 

note that they continue to be the only federal regulator of depository 

institutions, other than NCUA, that does not have a permanent seat on this 

important committee. 

Finally, while Superior Bank failed because of its own actions, the failure 

also provided lessons on the need for federal regulators to work together 

better. The then-Director of OTS acknowledged this need in testimony 

before the Senate Committee on Banking, Housing, and Urban Affairs.2

 In 

our assessments of that failure, both the FDIC Inspector General and we 

found that effective coordination was lacking.3

 We did revise this report to 

make explicit that the primary reason for Superior’s failure was actions by 

its owners and management. We also added a reference to the failure of the 

First National Bank of Keystone (West Virginia) that, according to a report 

by the Treasury Inspector General, also showed the need for better 

communication between FDIC and a primary federal regulator. (In the 

Keystone instance, OCC was the primary federal regulator.) Our report 

does discuss an agreement among federal bank regulators establishing a 

better process to determine when FDIC will join in the examination of an 

insured bank. In the comments, OTS also noted that, as a percentage of 

assets, the cost to the insurance fund of resolving Superior Bank was the 

lowest of the group of failures it cited (including Keystone). However, the 

Keystone and Superior failures did incur the largest costs to the insurance 

funds ($635 million and $436 million, respectively) of the failures that OTS 

cited. 

In SEC’s comments on the draft report, the Director of the Division of 

Market Regulation noted that “supervision and regulation can always be 

improved, but the costs of change must always be weighed against its 

benefits.” As noted above, we concur. 

2

Statement of Ellen Seidman, Director of the Office of Thrift Supervision, in U.S. Senate, 

Committee on Banking, Finance, and Urban Affairs, “The Failure of Superior Bank, FSB, 

Hinsdale, Illinois,” September 11, 2001, and October 16, 2001, S. Hrg. 107-698, p. 13.

3

Office of the Inspector General, FDIC, Issues Related to the Failure of Superior Bank, 

FSB, Hinsdale, Illinois, Audit Report 02-005 (Washington, D.C.; Feb. 6, 2002); and GAO, 

Bank Regulation: Analysis of the Failure of Superior Bank, FSB, Hinsdale, Illinois, 

GAO-02-419T (Washington, D.C.: Feb. 7, 2002).
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In addition to the written comments, we also received technical comments 

and corrections from the staffs at these agencies, or in the case of OTS as 

part of their written comments. We have incorporated these into the report, 

as appropriate.

We also provided the Department of the Treasury and CFTC with a draft of 

the report, so that they could provide written comments, if they wished. 

Neither agency chose to provide such comments. Because the report 

discusses proposals for an optional federal insurance charter, we also 

provided a draft to NAIC, representing the state insurance regulatory 

agencies, for them to provide comments; NAIC did not provide comments. 

We did receive technical comments and corrections from Treasury, CFTC, 

and NAIC staff that we have incorporated into the report, as appropriate.
Page 137 GAO-05-61 Financial Regulation

Appendix I

Comments from the Board of Governors of Apendxies

the Federal Reserve System ApendxiI
Appendix I

Comments from the Board of Governors of 

the Federal Reserve System

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Appendix I

Comments from the Board of Governors of 

the Federal Reserve System

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Appendix II

Comments from the Federal Deposit 

Insurance Corporation ApendxiI
Appendix II

Comments from the Federal Deposit 

Insurance Corporation

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Appendix II

Comments from the Federal Deposit 

Insurance Corporation

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Appendix III

Comments from the Office of the Comptroller 

of the Currency ApendxiI
Appendix III

Comments from the Office of the Comptroller 

of the Currency

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Appendix III

Comments from the Office of the Comptroller 

of the Currency

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Appendix IV

Comments from the Office of Thrift 

Supervision ApendxiIV
Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix IV

Comments from the Office of Thrift 

Supervision

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Appendix V

Comments from the Securities and Exchange 

Commission ApendxiV
Appendix V

Comments from the Securities and Exchange 

Commission

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Appendix VI

GAO Contacts and Staff Acknowledgments ApendxiVI

GAO Contacts Thomas J. McCool, (202) 512-8678

James M. McDermott, (202) 512-5373

Staff 

Acknowledgments 

In addition to the individuals named above, Nancy S. Barry, Emily 

Chalmers, Patrick Dynes, James Kim, Marc W. Molino, Suen-Yi Meng, Kaya 

Leigh Taylor, Paul Thompson, John Treanor, and Cecile Trop also made key 

contributions to this report.
Page 162 GAO-05-61 Financial Regulation

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