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Disciplining the financial marketplace

One upon a time, a bank was just a bank. It offered checking services, paid modest rates of interest (government controlled) on savings accounts, and provided credit to individuals and businesses within its community.

Inexorably, the statutory and regulatory fetters are being loosened, and banks and other depository institutions are taking on new roles and providing new services. The day of the ''financial supermarket'' is approaching. When it finally arrives, you and your bank may have a relationship that looks something like this:

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From the keyboard of your home computer, you instruct your bank to make payments from your interest-bearing checking account on your mortgage, utility bills, and credit card balances and transfer funds from your money market deposit account into a long-term market-rate certificate of deposit.

Still using your computer, you communicate with the bank's discount brokerage division and instruct it to sell some of your stock in National Widget Company. Then, still seated at the console, you place an order with the bank's insurance division to use part of the proceeds from the stock sale to buy a 20-year term insurance policy. Using what's left of the income from the sale, you ask the bank's travel service division to book reservations and purchase tickets for you and your spouse on a 15-day tour of the South Pacific.

One-stop shopping for financial services is far from fanciful. In fact, each of the transactions described above is available piecemeal from various sources today. It's only a matter of time before the initiative of imaginative state legislatures and marketplace pressures force Congress to respond to the public's demand for full and convenient services.

Already, deregulation of interest rates on deposits, a process that began in 1980, is well advanced. Institutions now may pay interest on your personal checking account and recently were permitted to offer you a new insured account that competes directly with the money market funds. On Oct. 1 interest rate ceilings and other restrictions on time deposits not already deregulated will be lifted, giving banks and savings-and-loan associations even greater freedom to offer you more investment opportunites.

These intitiatives directly benefit the nation's investors and other users of financial services, fueling competition among depository institutions, as well as enabling them to compete against unregulated segments of the financial services industry. For the consumer, this translates to greater choice and investment opportunity in personal money management.

But such drastic changes in our financial system result in a critically important set of considerations: Without government-imposed restrictions on competition, how do we control excessive risk-taking and destructive competitive behavior by financial institutions? How do we assure that deposits flow to the vast majority of prudently operated firms rather than to marginal operations that are willing to make the highest risk loans and pay the highest rate for deposits? How do we continue to protect depositors in a free-wheeling financial marketplace?

There are two options. We can adopt countless new laws and regulations to govern every aspect of bank and savings-and-loan operations and hire thousands of additional examiners to monitor and enforce compliance. Or, we can substitute increased marketplace discipline.

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At the Federal Deposit Insurance Corporation (FDIC) we are convinced that the interests of the public and the financial industry require promotion of marketplace discipline and modernization of our 50-year-old federal regulatory structure.

For the marketplace to operate effectively, two conditions must exist. First, the financial condition of individual institutions must be public knowledge. Second, institutional investors and individual depositors, especially those with substantial funds, must have the incentive to invest only in sound institutions.

To achieve the first objective, bank regulators have decided to make available to the public data on banks' problem loans and their exposure to loss due to changes in interest rates. We are also considering additional disclosures about insider lending practices and enforcement actions taken to correct banking problems. This should help turn the spotlight on the small minority of marginal, high-risk banks, deterring unsound banking activities and destructive competition. If problems arise nonetheless, troubled banks under public scrutiny will either correct the problems promptly or fail more quickly, causing less financial damage to affected parties.

To reach our second objective of encouraging investment only in prudently run institutions, we must change the deposit insurance system so that large depositors (those over the $100,000 insurance limit) face some risk of loss in a bank failure. Under current law, these creditors must be made whole if we arrange a merger for a failed institution, which is the way we prefer to handle failures. A change along these lines would encourage depositors to select a bank on some basis other than its size or the rate of interest it pays on deposits. Depositors would begin to inquire about such matters as capital adequacy, risks in the loan portfolio, insider dealings, and liquidity. As a corollary, we would change the current flat-rate system for assessing deposit insurance premiums to a risk-based system.

Our final recommendation is to reform the federal financial regulatory structure. Seven different departments and agencies have pieces of the regulatory pie, causing inexcusable duplication of personnel, facilities, and other resources. Coordination of seven regulators' activities is practically impossible, a situation we simply cannot afford in a deregulated, rapidly changing environment. And bank customers and taxpayers pay for it at least indirectly in waste and inefficiency.

The recent rash of bank failures in Tennessee illustrates the problem. In that case, some 40 affiliated banks, savings-and-loans, and an industrial bank spread over two states were regulated by seven different state and federal agencies, making accurate identification and assessment of the problems extraordinarily difficult.

An important first step would be to merge the insurance funds and operations of the FDIC and the Federal Savings and Loan Insurance Corporation. There is little justification for maintaining two agencies with identical objectives to insure accounts in banks and savings and loans that are growing more alike with time. The combined strength of the pooled funds would add to the safety of everyone's deposits.

The regulatory functions of the FDIC, the Federal Home Loan Bank Board, the Federal Reserve, and the Comptroller of the Currency should be consolidated into a single independent agency headed by a board. The states would continue to exercise these functions for state-chartered institutions. The FDIC would focus its examinations on troubled institutions and merely spot-check the others.

Other regulatory activities currently lodged in the banking agencies and the Federal Home Loan Bank Board should be redistributed along functional lines. For example, the Securities and Exchange Commission should be given exclusive jurisdiction over all securities matters relating to banks and thrifts, as it now has for bank holding companies and other corporations. The Justice Department should assume sole responsibility for antitrust enforcement. The Federal Trade Commission should enforce compliance with consumer laws such as truth-in-lending.

The FDIC soon will submit to Congress our deposit insurance reform proposals. A task group chaired by Vice-President George Bush is expected to announce recommendations this fall for regulatory restructuring. And the Treasury Department has submitted legislation addressing the important and controversial issue of permitting banks and savings-and-loans to offer additional financial services, such as insurance, real estate, and securities brokerage.

The FDIC believes strongly that Congress should consider all three of these initiatives as a package. If we have the wisdom and political courage to enact a comprehensive reform measure along these lines, the American public will be the clear winner. The changes will promote strength and stability in our financial system while fostering the development of a greater range of convenient financial services at more competitive prices.

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