President's Letter

You are cordially invited to attend the Federal Reserve Bank of Chicago's 43rd Annual Conference on Bank Structure and Competition. The Conference has a rich tradition as a leading forum for dialogue on public policy issues affecting the financial services industry. This year's conference focuses on what many consider to be the final frontier in terms of bank deregulation: 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 (GLB) Act of 1999 allowed the mixing of commercial banking and other financial activities but maintained the separation of banking and commercial activities. Some believe the passage of the GLB Act was an initial step in relaxing the separation of banking and commerce, since the general benefits associated with allowing banks to be affiliated with commercial firms may be similar to those arising from allowing banks to be affiliated with nonbank financial firms. For example, combining assets into a more diversified portfolio should allow investors to obtain the same portfolio returns at lower risk, or a higher return at the same level of risk, relative to the return on an individual asset. Given recent technological advances, there may also be efficiencies in the joint financial–commercial firm production process. There could also be savings for consumers in terms of "one–stop–shopping" and efficiency gains for banks as they obtain the information needed to intermediate and manage risk.

There are those who argue, however, that the potential risks from allowing the mixing of banking and commerce are significant enough to warrant keeping them separate. First, the aforementioned savings from scale and scope economies could lead to adverse changes in market power as large firms come to dominate across industries. There are also concerns about distortions to the credit allocation process as banks may assist their commercial affiliates by providing them loans at below–market rates. Alternatively, they may alter their lending policy toward unaffiliated third parties, resulting in loans being denied to creditworthy competitors. Not only could capital allocation become distorted, but the fear is that this support of the commercial affiliate could adversely affect the financial health 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, these distortions could cause disruptions outside of banking to 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 twentieth century in an attempt to channel loans to a particular segment of the economy that was thought to be underserved by traditional financial services firms. 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. Thus, 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 ILC applications for deposit insurance. Certain congressional leaders have indicated that they would prefer that Congress respond and directly address the appropriate role of ILCs 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. To discuss these issues, we have gathered some of the most qualified and respected members of the financial community. The conference program delivers a broad range of perspectives from large and small bank and securities firm executives, regulatory authorities, industry analysts, and academics. The discussion will begin on Thursday morning with a keynote address by Federal Reserve Board Chairman Ben S. Bernanke. The Chairman has been kind enough to support the conference in each of his first two years as Chairman, and in the past as a renowned research economist. We are also fortunate to have The Honorable James A. Leach, Former Chairman of the House Committee on Banking and Financial Services, U.S. House of Representatives, open the proceedings on Friday morning with a keynote address. Congressman Leach may be best known for having his name associated with the 1999 Financial Services Modernization Act, better known as the Gramm–Leach–Bliley Act, which had much to say about the mixing of banking and other financial activities and potential inferences for the mixing of banking and commerce.

The discussion will continue on Thursday and Friday with panel discussions of current regulatory and business policy issues, including an evaluation of how the mixing of banking and commerce may affect certain aspects of the industry including safety and soundness and market structure; the current state of Basel II capital regulation; payday lending activity; the economics of the evolving real estate markets; and bank risk management. The panelists are an impressive group of experts with a wide range of opinions and unique perspectives, and these discussions promise to be both lively and informative. Finally, the conference features two special luncheon presentations from leading financial regulatory authorities. On Thursday, Sheila C. Bair, Chairman of the Federal Deposit Insurance Corporation, will address issues associated with the conference theme and the current situation surrounding the moratorium on new ILC applications for deposit insurance. On Friday, Christopher Cox, Chairman of the U.S. Securities Exchange Commission, will bring a new perspective to the conference as it is the first time we have been fortunate to have the chairman of the SEC address the conference.

This will be my last Bank Structure Conference as President of the Federal Reserve Bank of Chicago, because I will retire from the Bank in August. I take great pride in the 43-year history of the conference and wanted my final one to be one of the best of what has been a very impressive run of policy conferences. As you look over the agenda and list of participants, I think you will agree that we have accomplished that goal. I hope you will be able to join us in Chicago in May.

Michael H. Moskow
President and Chief Executive Officer