United States General Accounting Office

GAO Testimony

Before the House Committee on Banking

and Financial Services

For Release on Delivery

Expected at

10:00 a.m., EDT

Wednesday

May 7, 1997

FINANCIAL REGULATION

Bank Modernization

Legislation

Statement of James L. Bothwell

Chief Economist

Office of the Chief Economist

GAO/T-OCE/GGD-97-103

Summary 

Financial Regulation: Bank Modernization

Legislation

The laws governing the financial services industry and the regulatory

structure that oversees it were developed for an industry

compartmentalized into commercial banking, investment banking, and

insurance. In recent decades, however, these activities have converged to

where many financial products and services offered by banks, securities

firms, and insurance companies are more alike than different. Attempts by

financial regulators to adapt to the rapid changes taking place in the

financial marketplace have been incremental and ad hoc, resulting in

overlaps, anomalies and even some gaps. Thus, Congress could improve

the functioning of our regulatory system by modernizing our banking laws.

However, modernization should not ignore other goals, such as

maintaining the safety and soundness of the financial system and the

deposit insurance funds, preventing undue concentrations of economic

power, and protecting consumers from conflicts of interest. GAO suggests

that specific safeguards be included in any modernization legislation.

• Financial services holding companies should be regulated on a

consolidated, comprehensive basis, with appropriate firewall provisions to

protect both consumers and taxpayers against potential conflicts of

interest and to prevent the spread of the federal safety net provided to

banks and any associated subsidy to nonbanking activities.

• Capital standards for both insured banks and financial services holding

companies should exist that adequately reflect all major risks, including

market and operations risk as well as credit risk.

• Clear rulemaking and supervisory authority should be established that

results in a consistent set of rules that are consistently applied for similar

financial activities and minimizes regulatory burden.

Furthermore, while the case for modernizing our banking laws is clear,

GAO would urge that Congress proceed cautiously if it decides to relax the

current separation of banking and commerce. GAO found that the potential

benefits of mixing banking and commerce generally lacked empirical

support or could be realized without removing the current restrictions.

GAO’s work also indicated that eliminating the current separation could

pose a variety of risks to the safety and soundness of the financial system,

the deposit insurance funds, and to consumers and taxpayers.

Page 1 GAO/T-OCE/GGD-97-103
Statement 

Financial Regulation: Bank Modernization

Legislation

Mr. Chairman and Members of the Committee:

We are pleased to be here today to assist your continuing efforts to

modernize our financial services regulatory system. As you are well aware,

both the laws governing the financial services industry and the regulatory

structure that oversees it were developed for an industry that was

compartmentalized into commercial banking, investment banking, and

insurance. Since that structure was established more than 60 years ago,

however, these activities have converged to the point where many of the

financial products and services offered by banks, securities firms and

insurance companies are more alike than different. Some of the most

notable examples include: (1) competition by money market and mutual

funds that has been so successful that the value of such funds—many of

which permit check writing—now exceeds the value of insured bank

deposits; (2) the issuance of guaranteed investment contracts by insurance

companies that compete directly with both mutual funds and bank

certificates of deposit, (3) the securitization of over $2 trillion in

mortgages and other loans that a few years ago would have been held in

portfolio by insured depository institutions; (4) the increasing involvement

of commercial banks in the sale of insurance products, in mutual funds,

and in securities underwriting through “section 20” holding company

affiliates; and (5) the increasing involvement of securities firms and

insurance companies in making and syndicating commercial loans in

competition with banks.

As we testified before this committee two years ago, our various financial

regulators have been attempting to adapt to the dramatic and rapid

changes taking place in the financial marketplace on an incremental and

ad hoc basis.1

 As a result, as our work over the past few years has shown,

our existing financial regulatory system has significant overlaps,

anomalies and even some gaps. Thus, Congress, by updating and

modernizing our banking laws, could substantially improve the functioning

of our regulatory system, and we commend the committee’s efforts to do

so. However, the goal of financial modernization should not be achieved at

the expense of other important goals, such as maintaining the safety and

soundness of the financial system and the deposit insurance funds,

preventing undue concentrations of economic power, and protecting

consumers from potential conflicts of interest.

1

Financial Regulation: Modernization of the Financial Services Regulatory System

(GAO/T-GGD-95-121, Mar. 15, 1995). See also, Separation of Banking and Commerce

(GAO/OCE/GGD-97-61R, Mar. 17, 1997), Bank Oversight: Fundamental Principles for Modernizing the

U.S. Structure (GAO/T-GGD-96-117, May 2, 1996).

Page 2 GAO/T-OCE/GGD-97-103
Statement 

Financial Regulation: Bank Modernization

Legislation

Safeguards Are

Needed

Toward this end, our work suggests that the following specific safeguards

should be included in any modernization legislation:

• Financial services holding companies should be regulated on a

consolidated, comprehensive basis, with appropriate firewall provisions to

protect both consumers and taxpayers against potential conflicts of

interest and to prevent the spread of the federal safety net provided to

banks and any associated subsidy to nonbanking activities.2

 Our work on

past financial institution failures has shown the importance of having an

umbrella supervisory authority to assess how risks to insured institutions

may be affected by risks in the other components of a holding company

structure. While firewall provisions can be extremely important safeguards

in preventing potential conflicts of interest and protecting insured

deposits, firewalls may not hold up under stress or if managers are

determined to breach them. Moreover, consolidated supervision is

consistent with the way that most, if not all, large bank holding companies

are managed today — on a consolidated basis with the risks and returns of

various affiliates being used to offset or enhance one another.3

 It is also

compatible with a functional approach to financial regulation.4

 For

example, the SEC could be the regulator for a securities affiliate of a

financial services holding company, the OCC the regulator for a nationally

chartered bank affiliate, with either of these two agencies or the Federal

Reserve being responsible and accountable as the umbrella regulator for

the operations of the holding company in its entirety. This basic approach

— i.e. having consolidated supervision of banking organizations with

coordinated functional regulation of individual components — is also

consistent with the approach taken by five other major industrialized

2

Firewalls are systems of controls that are meant to keep bank resources from improperly being used

to support other activities, such as securities underwriting, and to protect against potential conflicts of

interest. The federal government provides a safety net to the banking system that includes federal

deposit insurance, access to the Federal Reserve discount window, and the final riskless settlement of

payment system transactions. This safety net, while helping to ensure the safety and soundness of the

banking system, also provides a subsidy to commercial banks and other depository institutions by

allowing them to obtain low-cost funds.

3

Currently, the Federal Reserve acts as the overall regulator for bank holding companies, which

includes setting consolidated capital requirements for the company as a whole, exercising supervisory

authority over the company, determining what types of activities can be affiliated with banks under the

holding company structure, and approving such holding company activities as mergers and

acquisitions.

4

For a detailed discussion of functional regulation, see appendix I.

Page 3 GAO/T-OCE/GGD-97-103
Statement 

Financial Regulation: Bank Modernization

Legislation

countries that we recently studied.5 In these five countries — Canada,

United Kingdom, Germany, France and Japan — if securities, insurance, or

other nontraditional banking activities were permissible in bank

subsidiaries, functional regulation was provided by the appropriate

authority. While bank regulators generally relied on those functional

regulators for information, they remained responsible and accountable for

ascertaining the safety and soundness of the consolidated banking

organization as a whole.

• Capital standards for both insured banks and financial services holding

companies should exist that adequately reflect all major risks, including

market and operations risk as well as credit risk. Because our work on

failed banks has shown that capital can be quickly eroded in times of

stress and can be a lagging indicator of an institution’s true financial

condition, regulators should be required to conduct periodic assessments

of risk management systems for all the major components of a financial

services holding company, as well as for the holding company itself. While

the FDIC Improvement Act of 1991 requires bank regulators to take prompt

corrective action against troubled institutions before their capital is

completely eroded, our recent review showed that the implementation of

these provisions may not be as effective in preventing deposit insurance

losses as Congress originally intended.6

• Clear rulemaking and supervisory authority should be established that

results in a consistent set of rules that are consistently applied for similar

financial activities and minimizes regulatory burden. This is particularly

important for critical matters, such as consolidated capital requirements,

firewalls, and permissible activities, and can be accomplished in a number

of ways. Having the Federal Reserve serve this function, which is the

approach taken in H.R. 10, is one obvious alternative, at least for large

financial services holding companies. Still another approach would be to

have a special interagency rulemaking board or committee. We found that

each of the five major foreign countries that we recently reviewed had

unique ways to ensure that their banking institutions that were conducting

the same lines of business were generally subject to a single set of rules,

standards, or guidelines. The important point is to have some mechanism

to achieve consistent, effective oversight and rules and to limit

unnecessary overlaps and regulatory burden on our financial institutions.

5

Bank Oversight Structure: U.S. and Foreign Experience May Offer Lessons for Modernizing U.S.

Structure (GAO/GGD-97-23, Nov. 20, 1996). See also, Bank Regulatory Structure: The Federal Republic

of Germany (GAO/GGD-94-134BR, May 9, 1994), Bank Regulatory Structure: The United Kingdom

(GAO/GGD-95-38, Dec. 29, 1994), Bank Regulatory Structure: France (GAO/GGD-95-152, Aug. 31, 1995),

Bank Regulatory Structure: Canada (GAO/GGD-95-223, Sept. 28, 1995), and Bank Regulatory Structure:

Japan (GAO/GGD-97-5, Dec. 27, 1996).

6

Bank and Thrift Regulation: Implementation of FDICIA’s Prompt Regulatory Action Provisions

(GAO/GGD-97-18, Nov. 21, 1996).

Page 4 GAO/T-OCE/GGD-97-103
Statement 

Financial Regulation: Bank Modernization

Legislation

Mr. Chairman, as you and other members of the committee are well aware,

the number of banks has declined substantially over the past five years

and there has been considerable consolidation among our largest banking

organizations in particular. Because these trends could be accelerated

even more by financial modernization, it is also important, through

effective enforcement of our antitrust and banking laws, to prevent any

monopolistic exercise of market power and to assure that entry into the

financial services marketplace is not restricted unnecessarily. For without

competitive markets, the benefits of financial modernization are unlikely

to be passed on to small businesses and consumers.

Banking and

Commerce

Mr. Chairman, while our work shows that the case for modernizing our

banking laws is clear, we would urge that Congress proceed cautiously if it

decides to relax the current separation of banking and commerce. Our

recent review of the existing economics literature, which is discussed in

detail in appendix II, found that the potential benefits of eliminating the

current separation generally lacked empirical support and that most such

benefits could be realized through other means.7

 Furthermore, the

available literature, as well as our own extensive work on the causes of

past financial institution failures, indicated that eliminating the current

separation could pose a variety of risks to the safety and soundness of the

financial system, to the deposit insurance funds, and to consumers and

taxpayers. While the exact magnitudes of such risks are uncertain and

would depend, in large part, on the effectiveness of the legislative and

regulatory safeguards that are put into place, our work shows that a

compelling economic argument for the unbridled mixing of banking and

commerce has simply not yet been made.

Mr. Chairman, this concludes my prepared statement. My colleagues and I

would be happy to respond to any questions that you and other members

of the committee may have.

7

Separation of Banking and Commerce (GAO/OCE/GGD-97-61R, Mar. 17, 1997).

Page 5 GAO/T-OCE/GGD-97-103
Appendix I 

An Explanation of Consolidated Holding

Company Regulation and Functional

Regulation

The closest model for a financial services holding company is the existing

bank holding company structure. This appendix explains how bank

holding companies are regulated, as well as the concepts of consolidated

regulation of the holding company and functional regulation.

Large Bank holding companies are complex. They consist of combinations

of banks, thrifts, subsidiary holding companies, securities firms, and other

nonbank firms (such as mortgage, finance, or data processing companies).

In total, these large firms typically have many separate subsidiaries, with

operations conducted throughout the U.S. and overseas.

The regulation of a bank holding company can be shown with a simplified

illustration of such a company, as in figure 1. The company in this

illustration consists of a national bank, a subsidiary bank holding

company, a thrift holding company, a securities firm registered with the

SEC, and another nonbank subsidiary. The diagram also shows how each

entity is regulated.

Consolidated

Regulation of the

Holding Company

Under current bank holding company regulation, the Federal Reserve

System is responsible for regulating the company as a whole. This means

that the Federal Reserve sets capital requirements on a consolidated basis

for the company as a whole, has authority to supervise all parts of the

company, determines what activities can be affiliated with banks, and

approves holding company mergers and acquisitions. Consolidated

supervision typically involves concentrating on capital structure, key risk

management systems, and the flow of funds within the company.

The holding company regulation provided by the Federal Reserve can be

referred to as “umbrella” type regulation because it is in addition to other

regulation of holding company subsidiaries or of the markets within which

the entities of the holding company operate. This other regulation is

provided by various federal and state regulators. The authority of the

Federal Reserve is limited in that in some circumstances a bank regulator

such as OCC can, for example, authorize activities for a national bank that

the Federal Reserve cannot authorize at the holding company level.

Functional Regulation The concept of functional regulation refers generally to a regulatory

process in which a given financial activity is regulated by the same

regulator regardless of who conducts the activity. In discussions about

Page 6 GAO/T-OCE/GGD-97-103
Appendix I 

An Explanation of Consolidated Holding

Company Regulation and Functional

Regulation

regulation of financial service holding companies, the concept can be used

in somewhat different ways.

Functional regulation is sometimes used to refer principally to the idea of

regulating a complex company in a way that eliminates the umbrella role,

the role now played by the Federal Reserve for bank holding companies.

Referring to figure 1, this approach to functional regulation means that the

Federal Reserve regulation of the parent and of nonbank subsidiaries

would disappear from the diagram. Regulation would then be focused

solely on the various regulated subsidiaries. For example, OCC would

continue to regulate the lead national bank and the national bank in the

subsidiary holding company, while the SEC (in part through the

involvement of securities regulation) would regulate the securities

affiliate. OCC would be responsible for setting the capital requirements for

the national banks and using its supervisory authority over those banks to

see that capital is not drained away by the actions of the holding company

parent or of any affiliates. OCC also would enforce the firewall limitations

applicable to the national banks, in which capacity it would have the

ability to obtain records from other parts of the holding company.

Functional regulation can also be used to emphasize the way in which

regulatory responsibilities are divided up among the various regulatory

bodies. This concept is particularly important because the U.S. regulatory

system combines both regulation of markets (securities exchanges,

futures exchanges, and over the counter trading) and regulation of firms

(banks, securities firms, thrifts, and insurance companies). With functional

regulation defined in this way, the SEC, as regulator of securities markets,

would set rules that apply to all firms active in those markets, whether

those firms are banks, registered broker dealers, or insurance companies.

The enforcement of the SEC rules can be done either by the regulator of the

market or the regulator of the firm.

As the activities of various types of financial institutions have converged,

the concept of regulating by function is likely to take on greater

significance, extending across traditional definitions of markets as well as

firms. For example, sales practice rules could be developed to apply to

many products sold by many different firms in many different markets.

Functional regulation viewed in this way is not inconsistent with

consolidated supervision of the activities of companies which participate

in many different markets.

Page 7 GAO/T-OCE/GGD-97-103
Appendix I 

An Explanation of Consolidated Holding

Company Regulation and Functional

Regulation

Figure 1: Regulation of a Hypothetical Bank Holding Company

Page 8 GAO/T-OCE/GGD-97-103
Appendix II 

Potential Benefits and Risks of Eliminating

the Current Separation of Banking and

Commerce

Eliminating the current separation of banking and commerce involves

both potential benefits and risks. Specifically, the major potential benefits

that have been mentioned in recent years in support of eliminating the

separation of banking related activities and commerce include

(1) increased economies of scale, (2) greater diversification of risks, and

(3) synergies that may result from affiliations between banks and

commercial firms.

• Increased Economies of Scale. Some observers claim that the U.S. banking

industry would benefit from the relaxation of banking and commerce

restrictions because it would allow banks to expand their scale of

operations and lower their unit costs of production. While some early

studies seemed to indicate the presence of significant scale economies in

banking,8

 the results of more recent work have been mixed.9 Moreover, to

the extent that scale economies exist and are significant in banking, banks

should be able to capture them through mergers with other banks. Banks

do not need to combine with commercial firms to be able to achieve scale

economies.

• Greater Diversification of Risks. Some observers also claim that banking

and commercial conglomerations would be beneficial because they would

allow for greater diversification of risks across more product lines and

thus reduce the variability of corporate earnings. Because the gains from

this type of diversification rise when firms’ earnings are less correlated,

and fall when firms’ earnings are more correlated, this argument rests on

the assumption that the earnings of commercial firms fluctuate

independently of the earnings of banks. We found the empirical evidence

on this point to be inconclusive. One study we reviewed found some

evidence that the returns on banking stocks and commercial firm stocks

were not highly correlated, and thus concluded that diversification

benefits were possible.10 However, a more comprehensive study that

examined a longer time period and controlled for more factors found that

the variation in the stock returns of bank holding companies and

8

A review of the literature is provided in G. Bentson, G. Hanweck, and D. Humphrey, “Scale Economies

in Banking: A Restructuring and Reassessment,” Journal of Money Credit and Banking, 14 (1982),

435-456.

9

See L. Mester , “Efficient Product of Financial Services: Scale and Scope Economies,” Federal Reserve

Bank of Philadelphia Business Review, January/February (1987), 15-25, and S. Shaffer, “A

Revenue-Restricted Cost Study of 100 Large Banks,” mimeo, Federal Reserve Bank of New York, 1988,.

10A. Saunders, and P. Yourougou , “Are Banks Special: The Separation of Banking from Commerce and

Interest Rate Risk,” Journal of Economics and Business, 42 (1990), 171-182.

Page 9 GAO/T-OCE/GGD-97-103
Appendix II 

Potential Benefits and Risks of Eliminating

the Current Separation of Banking and

Commerce

nonfinancial companies are reasonably highly correlated and concluded

that the benefits of diversification are overstated.11

Moreover, banks do not need to combine with commercial firms to reduce

the variability in their earnings through diversification. For example,

banks can diversify their assets through their loan portfolios and other

investments, and their ability to diversify geographically was recently

enhanced by the Interstate Banking and Branching Efficiency Act of 1994.

• Synergies. Some observers argue that conglomerations of commercial

firms and banks might result in other efficiencies, often referred to as

synergies. Two possible sources of synergies are economies of scope and

information efficiencies. Economies of scope exist if a combined firm can

produce a mix of products at a lower cost than if the products were

produced separately. The main source of the cost savings comes from

using the same inputs to produce multiple outputs. The virtually

unanimous finding in the literature is that economies of scope are

insignificant in banking.12 We were unable to find any studies on the

existence of potential economies of scope between banking and

commercial activities.

Another possible synergy might result from improved informational flows

within a combined entity. For example, by combining with commercial

firms, banks might obtain better information about the commercial firms’

activities, which the banks could then use to reduce the default rate on

their loans. In addition, the commercial firms could benefit by obtaining

bank loans at lower interest rates. However, the increased information

flows might also induce banks to approve more risky loans.13 We were

unable to find any studies that attempt to quantify these potential effects.

• Other Theoretical Arguments. Some observers have also argued that

restrictions on bank affiliations lead to inefficiencies, because such

restrictions impede the free flow of capital or managerial resources.14

Although impediments to resource flows can lead to inefficiencies in

11M.J. Isimbabi, “The Stock Market Perception of Industry Risk and the Separation of Banking and

Commerce,” Journal of Banking and Finance, 18 (1994), 325-349.

12Mester (1987) surveys a number of studies.

13A summary of the trade-off is provided in K. John, T.A. John, and A. Saunders, “Universal Banking

and Firm Risk-taking.” Journal of Banking and Finance, 18 (1994), 307-323.

14See A. Saunders, “Banking and Commerce: An Overview of the Public Policy Issues,” Journal of

Banking and Finance, 18 (1994), 231-254..

Page 10 GAO/T-OCE/GGD-97-103
Appendix II 

Potential Benefits and Risks of Eliminating

the Current Separation of Banking and

Commerce

certain cases, we found no clear evidence that such inefficiencies exist in

the banking industry at the present time.

Those who argue that there is a capital shortage in banking believe that

banks have a difficult time attracting capital, and that allowing banks and

commercial firms to affiliate is necessary to allow the banking industry to

attract capital from other industries. However, there are many sources of

capital, such as new stock issues, that are open to banks and we are not

aware of any empirical evidence that the U.S. banking industry is currently

suffering from a capital shortage. In fact, the banking industry currently is

very well capitalized by historic standards. The average capital asset ratio

in the industry in 1996 was 8.3 percent, compared to 6.7 percent in 1991.15

By regulatory standards, capital in the banking industry is also high. At the

end of 1995, 98.4 percent of banks were considered well capitalized,

compared to 93.8 percent at the end of 1992.16

Another argument, which holds that separating banking and commerce

causes inefficiencies by blocking resource flows, focuses on managerial

talent and cost consciousness. According to this argument, allowing banks

and commercial firms to merge would generate fears of a potential

takeover resulting from poor performance and thus would induce

managers to increase efficiency. It should be noted, however, that this type

of discipline can take place even if banks and commercial firms are not

allowed to merge. As long as better managed banks are allowed to

purchase weaker banks, this efficiency-enhancing mechanism, to the

extent that it works, would still be operable.

Our review of existing studies, as well as our own prior work assessing

past financial institution failures, indicated that eliminating the separation

of banking and commerce might subject the financial system, the deposit

insurance fund, and consumers and taxpayers to a variety of risks.17 The

primary risks include those associated with (1) a potential expansion of

the federal safety net provided banks to commercial operations, (2) the

potential for increased conflicts of interest within a banking and

commercial conglomerate, (3) the potential for contagion effects from

15The FDIC Quarterly Banking Profile: Commercial Banking Performance-Third Quarter 1996, p. 5.

16See Bank and Thrift Regulation: Implementation of FIDICIA’s Prompt Regulatory Action Provisions

(GAO/GGD-97-18, Nov. 21, 1996), p. 28.

17See, for example, Thrift Failures: Costly Failures Resulted From Regulatory Violations and Unsafe

Practices (GAO/AFMD-89-62, June 16, 1989), Bank Supervision: OCC’s Supervision of the Bank of New

England Was Not Timely or Forceful (GAO/GGD-91-128, Sept. 16, 1991), and Bank Insider Activities:

Insider Problems and Violations Indicate Broader Management Deficiencies (GAO/GGD-94-88, Mar. 30,

1994).

Page 11 GAO/T-OCE/GGD-97-103
Appendix II 

Potential Benefits and Risks of Eliminating

the Current Separation of Banking and

Commerce

commercial operations spreading to insured banks, and (4) a potential

increase in economic power exercised by large conglomerate enterprises.

• Potential Expansion of the Federal Safety Net. Allowing conglomerations

of banks and commercial firms would increase the risk that the safety net,

and any associated subsidy, might be transferred to commercial

operations and result in inappropriate risk-taking, misallocations of

resources, and uneven competitive playing fields in other industries. While

such risks could be mitigated by establishing firewalls between banks and

their commercial affiliates, our work has shown that such firewalls may

not work in times of stress, or where managers are determined to evade

them.18 Moreover, firewalls require regular monitoring and enforcement by

regulators and, if set too high, may prevent the realization of whatever

potential benefits were expected to derive from allowing such

conglomerations to occur.

• Potential for Increased Conflicts of Interest. Allowing conglomerations of

banks and commercial firms could also add to the potential for increased

conflicts of interest and raise the risk that banks might engage in

anticompetitive or unsound practices. For example, some have argued

that, to foster the prospects of their commercial affiliates, banks might

begin to restrict credit to their affiliates’ competitors, or tie the provision

of credit to the sale of products by their commercial affiliates.19 Perhaps

more likely, banks might begin to extend credit to their commercial

affiliates when they would not have done so otherwise, thus increasing the

risks to the deposit insurance fund and to taxpayers.20 Such behavior

could also undermine the valuable monitoring function that banks provide

in our economy. As long as banks are perceived as providing credible,

objective assessments of the creditworthiness of companies and their

activities, bank credit decisions can provide valuable information to the

market about the soundness of these companies and their activities. The

value and reliability of such signals could be diminished if banks were

viewed as having conflicts of interest that adversely affected the

objectivity of their credit decisions.

• Potential for Increased Contagion Effects. Allowing conglomerations

between banks and commercial firms could also increase risks to the

18Using Firewalls in a Post Glass-Steagall Banking Environment (GAO/T-GGD-88-25, Apr. 13, 1988).

19A. Saunders, “Banking and Commerce: An Overview of the Public Policy Issues,” Journal of Banking

and Finance, 18 (1994), 231-254.

20In our review of the 286 bank failures that occurred in 1990-1991, we found that insider problems and

associated conflicts of interest were cited as contributing factors in 175 of the failures. See Bank

Insider Activities: Insider Problems and Violations Indicate Broader Management Deficiencies

(GAO/GGD-94-88, Mar. 30, 1994).

Page 12 GAO/T-OCE/GGD-97-103
Appendix II 

Potential Benefits and Risks of Eliminating

the Current Separation of Banking and

Commerce

deposit insurance fund and taxpayers if affiliated commercial firms were

to extend any financial stress they experienced to their banking affiliates.

Even if firewalls were able to keep such problems from actually being

transmitted to bank affiliates, depositors who believed that commercial

affiliates were experiencing financial problems might decide to withdraw

their funds from the commercial firms’ bank affiliates for fear that the

banks’ soundness might also be in jeopardy. If enough depositors did this,

the fear could be self-fulfilling in that the viability of both the affiliated

banks and the commercial firms could become threatened.

• Possible Increased Concentration of Economic Power. There are also

concerns that ending the current restrictions between banking and

commerce could promote the formation of very large conglomerate

enterprises with substantial amounts of economic power. Such enterprises

could adversely affect the efficient operation of the economy and place

consumers at risk of increased prices if they began to exert market power

in either their banking or commercial operations. This risk would be

enhanced to the extent that these new conglomerates could effectively

access the subsidy inherent in the safety net and gain advantages over

their competitors.

(972630) Page 13 GAO/T-OCE/GGD-97-103
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