A New Structure for Financial Insitutions, and Regulators?

Today we hear news many old line investment banks are reorganizing as commercial banks or bank holding companies. No long ago (like a year) commercial banks were considered too old school for modern capital markets. Now being regulated as a bank means ready access to the historically little-used Federal Reserve's cash drawer. Given the sense among investors that investment banks lack liquidity or ready access to capital, just having the option to tap the Fed's money may be viewed as a plus.

This just highlights our fractured regulatory system. In 1999 decades old restrictions on blending banking, insurance and investing functions were repealed. Yet the regulatory system remained a mix of mortgage lending compliance, capital ratios for depositories, lighter oversight of some holding companies and then the SEC for Wall Street. It seems the market might actually appreciate one set of rules which serve to reduce overall financial institution risk taking and also make information more transparent across firms. Commonly applied asset ratios means the former investment bank will need to have more cash and liquid assets and will not longer be able to place huge bets by borrowing or swapping liabilities.

During the S&L crisis of the 1980s (which rolled into the 1990s) there were some changes in the structure and functions of the bank regulators --to review this includes: the OTS (part of Treasury focused on thrifts or S&Ls), OCC ('national' banks), FDIC (state chartered but also broader functions related to deposit insurance), the Fed or 'FRB' (holding companies and commercial banks), HUD (a grab bag of institions doing mortgage lending including many former subprime institutions) and NCUA (credit unions).

In the last year the Federal Reserve has been clarified as the super-regulator. In general the regulatory agencies seem to be getting along (except maybe the SEC ). But as policymakers mull their chocies this week it is time to re-examine a more modern system of regulation with one agency outside of the executive branch to work with Treasury as needed.

In the process the community/public/consumer affairs function hopefully can be strenthened. Likewise the commitment to fair lending and community reinvestment can be affirmed. The UK's Financial Services Authority used to be a model to look towards, but the breakdown related to Northern Rock last year might suggest even the FSA model did not go far enough (the FSA lacked the Fed's market mechanism--that stayed with central bank).

In the 1990s financial instututions would shop around altering their charter or aquisitions to find a regulatory agency they felt best met their needs. In hindsight a standardize higher regulatory bar would have been a better approach. One could imagine the FDIC as the insurance agency, as well as expert in taking over failing banks. The FDIC could assess safety and soundness risk and be ready to jump in when firm-level instability looked immenient. The Fed could then take the OCC, OTS and NCUA under its wing, taking on safety and soundness as well as consumer affairs and fair lending.

Most likely there will be resistence to changes and agencies won't willingly give up power. With mega-bank instutitions like Bank of America, Citi, JPMorgan/Chase, and now Goldman and Morgan Stanley under the Fed's purview, the odds are more in favor of the Fed being the achitect of the regulatory structure going forward. Regardless, let's hope the new structure includes a robust consumer perspective in addition to making investors feel more secure about putting money into institutions.