The 43rd Annual Conference on Bank Structure & Competition

On May 16–18, 2007, the Federal Reserve Bank of Chicago held its 43rd annual Conference on Bank Structure and Competition at the Westin Hotel in Chicago. Since its inception, the conference has encouraged an ongoing dialogue and debate on current public policy issues affecting the financial services industry. Each year, the conference brings together several hundred financial institution executives, regulators, and academics to examine current policy issues.

The 2007 conference addressed a number of issues including Basel II capital regulation, payday lending activity, the changing real estate markets, risk management, financial stability, banking industry structure and government-sponsored enterprises. However, a number of sessions were dedicated to the conference theme: The Mixing of Banking and Commerce.

The separation of banking and commerce was codified in the United States with the passage of the Glass–Steagall Act of 1933 and the 1956 Bank Holding Company Act. The Gramm–Leach–Bliley Act of 1999 allowed the mixing of commercial banking and other financial activities but maintained the separation of banking and commercial activities. Thus, some consider this separation the final frontier in terms of the deregulation of commercial banks. Indeed, some believe the passage of the Gramm–Leach–Bliley Act was an initial step in this deregulation because the general benefits associated with allowing banks to be affiliated with commercial firms are similar to those arising from allowing banks to be affiliated with nonbank financial firms. Combining assets into a more diversified portfolio should allow investors to obtain the same returns at lower risk relative to an individual asset. Given recent technological advances, there may also be savings in the financial services production process. There could be additional savings for consumers in terms of "one-stop-shopping" and information gains for banks as they obtain the information needed to intermediate and manage risk.

There are, however, potential risks from allowing the mixing of banking and commerce. First, the aforementioned savings could lead to adverse antitrust implications as large firms come to dominate across industries. There are also concerns about distortion of the credit allocation process as banks may assist their commercial affiliates by providing them with loans at below-market rates or by altering the bank's lending policy toward third parties. This could include, for example, denying credit to creditworthy competitors. Not only could capital allocation become distorted, but the fear is that this support of the commercial affiliate could also adversely affect the capital status of the bank. This raises still another concern about the mixing of commerce and banking: the expansion of the deposit insurance safety net (and its associated market distortions) outside of the banking sector. As a result, it is argued, disruptions outside of banking may become more common and problems could more easily transfer between sectors.

The debate over the appropriate mix of banking and commerce has gained prominence recently because of the proliferation of industrial loan corporations (ILCs). As is common with many "near-banks," ILCs came into existence in the U.S. early in the 20th century in an attempt to provide loans to a particular underserved segment of the economy. At first, ILCs were not considered banks because they were not allowed to accept deposits. Through time, ILCs obtained the ability to offer insured deposits and have remained exempt from bank holding company regulation. Many would argue that they provide many of the same services as a bank but, unlike banks, are able to affiliate with commercial firms. In recent years, ILCs have grown rapidly through affiliations with firms such as General Motors, Target, and Merrill Lynch. This growth may continue, with the recent ILC charter applications from Home Depot and Wal-Mart. Significant uproar from community bankers in response to the Wal-Mart application prompted the Federal Deposit Insurance Corporation (FDIC) to announce a moratorium on applications for deposit insurance for ILCs, which has recently been extended for an additional 12 months. Certain congressional leaders requested the extension to allow Congress to directly address the appropriate role of ILC and the appropriate mix of banking and commerce.

There are an array of public policy issues associated with the current ILC debate and, more generally, the mixing of banking and commerce. What is the history of the mixing of banking and commerce in the U.S. and in other countries? Are the associated costs and benefits of this mixing of banking and commerce quantifiable? Is broadening this mixing advisable? If so, how should it occur? Is this process developing less effectively than it should because it has resulted from the exploitation of a regulatory loophole rather than Congress directly deciding whether the combination is appropriate? What are the potential implications for banking industry structure and market power? Is there a role for "wholesale ILCs," with limited product powers instead of the current mix of products? What is the appropriate supervisory structure for ILCs? These and related questions were addressed at the 2007 Conference on Bank Structure and Competition. Some of the more influential industry experts gathered at the conference to debate the current situation. Highlights of the conference will include:

• Opening keynote address by Federal Reserve Board Chairman Ben Bernanke.
• A special luncheon presentation by FDIC Chairman Sheila Bair.
• A special luncheon presentation by Securities and Exchange Commission Chairman Christopher Cox.
• A panel discussion of the conference theme. What are the benefits? Costs? Regulatory and supervisory issues associated with the mixing of banking and commerce?
• A special presentation by The Honorable James A. Leach, Former Chairman of the House Committee on Banking and Financial Services, U.S. Congress.