mr. greenspan presents the views of the federal reserve board on some broad issues associated with financial modernization testimony of the chairman of the board of the us federal reserve system, mr. alan greenspan, before the subcommittee on financial institutions and consumer credit of the committee on banking and financial services of the us house of representatives on 13 / 2 / 97. madam chairwoman, members of the subcommittee on financial institutions and consumer credit, it is a pleasure to appear here today to present the views of the federal reserve board on some broad issues associated with financial modernization. the unremitting pressures of technology and the market are drastically changing the financial landscape and eroding traditional positions of competitors, inducing new competitive strategies and participants, forcing new regulatory responses, and building pressures on the congress to shape developments in the public interest. madam chairwoman, i know that you have been an active sponsor and supporter of legislation to modernize the financial system. the board also has been a strong proponent both of expanded financial activities for banking organizations and enhanced opportunities for nonbank financial institutions to enter banking. we continue to support financial modernization because we believe it would provide improved financial services for our citizens. moreover, both our experience and analysis suggest that the additional risks of new financial products are modest and manageable. indeed, technology already has resulted in a blurring of product and service - defining lines so dramatic as to make many financial products virtually indistinguishable from each other and the old rules inapplicable. in the process, we have already seen the public benefits, benefits that removal of old barriers could only enhance. but, as we proceed down the path of reform, reforms both desired for their benefits to the public and required by global markets and new technologies, the board urges that any modifications be tested against certain standards. in particular, the board believes that the changes we adopt should be consistent with ( 1 ) continuing the safety and soundness of the banking system ; ( 2 ) limiting systemic risks ; ( 3 ) contributing to macroeconomic stability ; and ( 4 ) limiting the spread of both the moral hazard and the subsidy implicit in the safety net. thus, if my comments today sound cautious, i want the subcommittee to understand that my observations do not reflect opposition to further freeing of constraints on financial competition. to the contrary. we strongly urge an extensive increase in the activities permitted to banking organizations and other financial institutions, provided these activities are financed at nonsubsidized market rates and do not pose unacceptable

, to fund its parent ’ s nonbank affiliates. however, the evidence appears to be that such transfers generally do not occur. existing holding company powers are limited and do not offer a broad spectrum of profitable opportunities. accordingly, it is not surprising that data for the top 50 bank holding companies indicate that transfers from bank subsidiaries to their parents which, like dividends, embody the subsidy, appear to have approximately equaled holding company net transfers to their own shareholders and long - term creditors. this indicates that few subsidized dollars in the aggregate found their way into the equity accounts of holding company nonbank affiliates from the upstreaming of bank funds. we must, i think, be continually on guard that the subsidy provided by the safety net does not leak outside the institutions for which it was intended and provide a broad subsidy to other kinds of activities. put another way, we must remain especially vigilant in maintaining a proper balance between a safety net that fosters economic and financial stabilization and one that benefits the competitive position of private businesses for no particular public purpose. as i noted, safety net subsidies have costs in terms of distorted incentives and misallocated resources. that is why the congress must be cautious in how the sovereign credit is used. it has been suggested that the bank holding company structure imposes inefficiencies on banking organizations, and that these organizations should thus be given the option of conducting expanded financial activities in a direct subsidiary of the bank. the bank subsidiary may be a marginally more efficient way of delivering such services, but we believe it cannot avoid being a funnel for transferring the sovereign credit subsidy directly from the bank to finance the new powers, thereby imparting a subsidized competitive advantage to the subsidiary of the bank. one can devise rules - - such as 23a and 23b - - to assure that loans from the bank to its own subsidiaries are limited and at market rates. one can even devise rules to limit the aggregate equity investment made by banks in their subsidiaries. but one cannot eliminate the fact that the equity invested in subsidiaries is funded by the sum of insured deposits and other bank borrowings that directly benefit from the subsidy of the safety net. thus, inevitably, a bank subsidiary must have lower costs of capital than an independent entity and even a subsidiary of the bank ’ s parent. indeed, one would expect that a rational banking organization would, as much as possible, shift its nonbank activity from the bank holding company structure