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Speeches and Testimony |
Mr. Chairman and members of the Subcommittee, I appreciate
this opportunity to present the views of the Federal Deposit
Insurance Corporation on financial modernization and related
issues. I commend you, Mr. Chairman, and Congressman Kanjorski
for placing a high priority on the need to modernize and
strengthen the nation's banking and financial systems.
On behalf of the FDIC, I also want to express again our
gratitude to you, to members of this Subcommittee, and to other
members of the Congress for passing legislation providing
immediate financial stability to the Savings Association
Insurance Fund (the SAIF). The health and stability of the
financial industry are in the interest of everyone --
participants, regulators, banks and thrifts. Sound deposit
insurance funds contribute to that health and stability.
The Deposit Insurance Funds Act of 1996 (the Funds Act)
capitalized the SAIF and solved its immediate financial problems.
The Funds Act also recognized the need for a merger of the
deposit insurance funds. The FDIC strongly supports a merger of
the Bank Insurance Fund (the BIF) and the SAIF as soon as
practicable. The SAIF insures far fewer, and more geographically
concentrated, institutions than does the BIF, and, therefore,
faces potentially greater long-term risks.
A merger of the BIF and the SAIF is a necessary component of
a solution to long-term structural problems facing the thrift
industry, and consequently the industry's deposit insurance fund.
A combined BIF and SAIF would have a larger membership and a
broader distribution of geographic and product risks; a combined
fund would be stronger than the SAIF alone. Under the Funds Act,
Congress has made the merger of the BIF and the SAIF contingent
upon there being no more savings associations.
I am pleased to have this opportunity to testify on
financial modernization against the backdrop of two fully
capitalized deposit insurance funds and record bank earnings.
Although final numbers are still being tabulated, we expect to
announce next week that annual earnings for commercial banks
surpassed $50 billion for the first time in 1996. Average equity
ratios are at their highest levels in more than 50 years, and
nonperforming assets are well under one percent of total assets,
the lowest level in the 15 years that banks have reported
nonperforming assets.
Private-sector thrifts have earned more than $6 billion each
year since 1991, when the industry returned to profitability.
Thrift earnings in 1996 may have exceeded the record $7.6 billion
of 1995 if thrifts had not paid a special assessment to
capitalize the SAIF. Equity ratios remain near 40-year highs,
and nonperforming assets are down to approximately one percent of
total assets, the lowest level in the seven years that thrifts
have reported nonperforming assets.
Only six insured institutions, with aggregate assets of $220
million, failed in 1996. Also, the number and aggregate assets
of institutions on the FDIC's "problem" institution list have
declined sharply over the past five years. At the end of 1991,
there were 1,426 institutions with total assets of $819 billion
on the problem list. This was the highest level of problem-list
assets in the history of the FDIC. Since 1991, the problem list
has declined steadily. As of September 30, 1996, only 125
institutions, with assets of $15 billion, were on the list -- a
fraction of the highest level.
In recent years, banks and thrifts have benefited from
continued economic expansion and low inflation. These favorable
conditions have produced strong loan demand and have contributed
to wider net interest margins. The resultant growth in revenues
has enabled banks and thrifts to reduce their inventories of bad
assets while boosting profits.
Although banks have been making record profits recently,
evidence suggests that increasing numbers have turned to somewhat
riskier investments as they have lost business to competitors.
Loan-loss rates in today's favorable environment remain
significantly higher than in pre-1980 nonrecessionary periods.
Bank performance has varied greatly during the past ten years.
Figures 1 and 2 illustrate annual returns on assets and net
charge-offs as a percentage of average loans since 1960. The
volatility of earnings in the 1980s is readily apparent, as is
the relationship between recessionary periods and net charge-offs. In the
past ten years, the banking industry achieved both
its highest annual return on assets (1.20 percent in 1993) and
its lowest return on assets (0.10 percent in 1987) since 1934.
As we consider financial modernization, current favorable
economic conditions provide both an opportunity and a challenge.
We have the opportunity to merge the deposit insurance funds at a
time when both funds are capitalized fully. The challenge for us
is to recognize that good times may not last forever. We must
evaluate any financial modernization proposal by determining
whether it will operate effectively during times of stress for
financial institutions.
As the deposit insurer, the FDIC brings a unique perspective
to the financial modernization question. Events of the past
decade have demonstrated how costly bank failures can be for the
insurance fund, for communities across America, and for our
economy. The BIF and the banking industry spent approximately
$36.4 billion to resolve failing banks from 1980 through 1994.
The General Accounting Office has estimated that, from 1986
through 1995, the thrift crisis cost an estimated $160 billion to
resolve (including tax benefits); approximately $132 billion of
this amount was paid by the taxpayers. Thus, it is imperative
that we learn from the past and proceed deliberately as we
contemplate a substantial expansion of powers available to
banking organizations.
Let me turn now to a discussion of the issues before us
today. First, my testimony will discuss briefly the need for
financial modernization. Second, I will outline lessons the FDIC
has learned from studying the banking and thrift crises of the
1980s and early 1990s. I conclude with a discussion of guiding
principles for financial modernization, including an analysis of
whether permitting nonbanking activities to be conducted through
subsidiaries of banks would constitute an unwarranted expansion
of the federal safety net.
Modernization of the financial system is necessary to
achieve an efficient and competitive financial services industry
able to meet current and future challenges. The financial
markets have changed dramatically since the 1930s when many of
our nation's laws governing financial services were enacted.
To a greater extent than ever before, businesses have been
bypassing traditional financial intermediaries to access capital
markets directly. Large corporations now frequently meet their
funding needs by issuing commercial paper, debt securities and
equity, rather than by borrowing from banks. The shrinking role
of banks in lending to business is illustrated by the declining
proportion that bank loans represent of nonfinancial corporate
debt. This share declined from approximately 28 percent in 1975
to 21 percent at year-end 1995.
In addition to their shrinking role as providers of
traditional financial intermediation services, banks and thrifts
also are experiencing increasing competition from nonbanking
firms that now offer financial products that once were the
exclusive domain of banks and thrifts. Banks also have grown
much less rapidly than other financial intermediaries during the
past ten years. For example, from 1986 through 1995, banking
assets grew at an average annual rate of 5.7 percent, compared to
growth rates of 19.0 percent and 8.5 percent for mutual funds and
pension funds, respectively.
This relative decline in market share and relatively slower
growth do not paint the complete picture. Traditional market
share measures, which are based on asset holdings, generally do
not reflect the growing importance of bank income from
off-balance-sheet products and services. The rise in the
noninterest income share of bank earnings indicates less reliance
on traditional lending activities. From 1985 to 1995, banks'
noninterest income increased 165 percent, to $82 billion,
compared to growth in interest income of only 22 percent, to $302
billion. This also indicates that banks are innovating and
adapting to a changing marketplace.
Nevertheless, banks have experienced a relative decline in
market share and relatively slower growth. Financial
modernization should strengthen banking organizations by allowing
diversification of income sources and better service to
customers, which would promote an efficient, competitive, and
safe evolution of the U.S. financial markets.
When I became FDIC Chairman, I initiated a project that I
called the "Lessons of the Eighties" (the History Project) to
answer the question, "Did we, as bank regulators, learn the
correct lessons from the banking and thrift crises of the 1980s
and early 1990s?" At the time the History Project began, the
banking and thrift industries were recovering from the worst
period of failures since the 1930s. It is essential that we
thoroughly analyze and understand the factors that led to those
crises in order to be prepared for the problems that could occur
in the future.
The lessons we have learned thus far could be instructive to
this Subcommittee in its deliberations on financial
modernization. My testimony will focus on two broad lessons in
particular: (1) geographic and product constraints on insured
institutions can result in inadequate diversification of income
sources; and (2) rapid expansion of insured institutions into
unfamiliar activities, without adequate supervision, can have
undesirable consequences. In the context of this hearing, what
these lessons demonstrated to us is that we cannot attribute all
the losses from the failures of financial institutions in the
1980s and early 1990s to economic events or to poor management of
depository institutions. A significant share of the
responsibility must be assigned to overly restrictive laws,
changes in the law that provided little time for adjustment,
poorly planned deregulation and deficiencies in the supervisory
Geographic and Product Constraints
Geographic and product restrictions have constrained the
activities of U.S. depository institutions for much of their
history. Although these restrictions insulated them from
competition, at least for a time, they also hindered banks from
expanding their sources of income and from developing portfolios
that reflected product and geographic diversity.
The impact of product restrictions most notably is seen in
the experience of savings and loan associations. For years,
thrifts were limited to providing only savings deposits and home
mortgages to their customers. This created an inherently
unstable situation -- of borrowing short-term deposits to fund
long-term mortgages -- that became apparent in the late 1970s and
early 1980s when short-term interest rates rose above long-term
rates. This was the beginning of the savings and loan crisis
that in time led to the demise of the Federal Savings and Loan
Insurance Corporation. Although banks provided a broader range
of products, commercial lending was their primary focus, and this
market also came under pressure during this period. As the
commercial loan market declined, and the commercial paper and
junk bond markets grew, banks were forced to find new sources of
income since they were restricted in their ability to adapt to
their customers' needs.
The impact of geographic restrictions is evident in the
relatively high failure rates in states where branching was
prohibited or severely restricted, such as Texas, Kansas and
Illinois. This impact also is evident in the vulnerability of
banks to regional economic problems. Because most U.S. banks
serve relatively narrow geographic markets, regional and sectoral
recessions frequently have had a severe impact on them. There
were four major regional or sectoral economic downturns during
the 1980s and early 1990s, and each resulted in increased bank
The first economic downturn accompanied the decline in farm
prices in the early 1980s. Agricultural prices increased
steadily during the boom years of the 1970s. This ended,
however, in the late 1970s as interest rates soared,
significantly increasing farm operating costs. At the same time,
export demand decreased sharply due to worldwide competition.
These events contributed to a collapse in real farm income in
1980. Then, as inflation declined, land values collapsed.
Ultimately, this downturn took its toll on many agricultural
banks. In 1985, these banks accounted for 48 percent of bank
The second downturn occurred in Texas and other major
energy-producing states in the Southwest following the collapse
of oil prices in 1981 and again in 1985. Texas banks, for
example, had rapidly increased their commercial and industrial
loans in the 1970s as strong worldwide demand for oil and OPEC-restrictions
on supply brought on a sharp rise in oil prices.
Following the oil-generated cycle were wide swings in real estate
activity that contributed significantly to the downturn in the
economies of Texas and other states in the Southwest and the
sharp rise in bank failures in this region. The experience in
Texas and certain other states was aggravated by the large number
of new banks chartered during the 1980s, and by the fact that
newer banks failed more frequently than existing institutions.
Boom and bust conditions in real estate activity also
contributed to the third downturn, in the Northeast. In this
regional recession, mutual institutions that had converted to the
stock form of ownership failed with greater frequency than
mutuals that had not converted because of the difficulty of
employing excess capital successfully. Of the mutuals that
converted in the mid- and late-1980s, 21 percent failed during
the period 1990 through 1994. This compared with eight percent
of all mutuals that existed as of the end of 1989 and had not
converted. The final downturn was a recession in California --
a state without geographic branching restrictions -- following
defense cutbacks in the early 1990s. In this downturn we found
higher failure rates among smaller and newer banks that were tied
more closely to their local economies. The large California
banks that operated statewide were less affected.
The lesson we draw from these events is that attempts to
ensure the safety and soundness of insured institutions by
limiting market competition ultimately fail. In the long run,
geographic constraints and product restrictions do not insulate
depository institutions from competitors, who will eventually
find ways to enter markets.
Congress eliminated many geographic constraints by enacting
the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994. Over the years, Congressional action, agency
initiatives and court decisions slowly have removed some product
constraints. Nevertheless, barriers remain, such as the Glass-Steagall Act,
which limit the opportunities for financial
institutions to diversify and to respond quickly and efficiently
to changes in the marketplace. To maintain the safety and
soundness of the financial system, institutions must be allowed
to diversify.
Use of Expanded Powers and Supervision
In response to the deepening crisis in the thrift industry,
the early 1980s were dominated by actions to deregulate the
product and service powers of insured depository institutions.
The resultant rapid expansion of insured institutions into
unfamiliar activities without adequate supervision resulted in
significant losses for the industry. For example, many banks and
thrifts adopted a highly aggressive posture with respect to
commercial real estate lending. Large increases in the early
1980s in real estate investment produced a boom in commercial
construction and in bank and thrift commercial real estate
lending. Further stimulus was provided by legislation that
greatly enhanced the after-tax returns on real estate investment
and by the expansion of nonresidential lending powers of savings
and loan associations implemented through banking legislation.
Other factors led to increased risks in the 1980s as well.
During this time, chartering standards were lowered, the
inappropriate use of brokered deposits increased, and capital
standards were reduced for thrift institutions.
Relaxed chartering policies led to approximately 3,300 new
banks being chartered from 1980 through 1990. Of these new
institutions, 15 percent subsequently failed; this compared with
a 7.7 percent failure rate for banks in existence as of year-end
1979. The influx of new charters created markets that were
overbanked, which led to more competition for good loans. This,
in turn, created incentives for banks to loosen underwriting
standards and take on more risk. The increase in charters also
diluted the available management talent necessary to operate a
sound institution.
Insolvent thrifts were allowed to use brokered deposits to
stay in operation and, indeed, to grow their assets or engage in
new activities that could not have been funded through
traditional sources. At the same time, regulatory accounting
standards for thrifts were adopted allowing many to operate with
little or no capital. These institutions, with little or no
capital on the line, and access to fully-insured brokered
deposits, in many cases took extraordinary risks that resulted in
large losses to the old Federal Savings and Loan Insurance
Corporation fund, which was not managed by the FDIC, and,
ultimately, to taxpayers.
While powers were being expanded, insufficient attention was
being paid to safeguards against risky behavior. In the late
1970s and early 1980s, regulators increased their reliance on
off-site monitoring and prioritized examinations to focus
primarily on problem banks. This was attributable in part to
efforts to limit the size of the federal government. As a
result, intervals between examination cycles for healthy banks
increased on average from annually to as long as three years, and
even longer for some institutions, and the number of examiners
was reduced. From 1979 to 1984, examination staffs declined by
nearly 20 percent at the FDIC and the Office of the Comptroller
of the Currency, while the Federal Reserve's examiner staff
increased slightly. Additionally, state examiner ranks declined
12 percent during this period. These actions ultimately weakened
the ability of bank supervisors to detect and to respond to
problems as failure rates began to soar.
The lesson we learned from these events is that deregulation
must be accompanied by adequate safeguards and strong supervision
and monitoring by the regulators. Unfortunately, in the 1980s
this did not occur. In addition, during that period, legislation
was passed in a crisis situation without a full understanding of
the consequences of the changes being undertaken.
Diversification of income sources by depository institutions
remains a desirable goal and will contribute to stronger, more
competitive financial markets. With these lessons in mind -- and
in the absence of crisis conditions -- we have the opportunity to
design an appropriate analytical framework that addresses
competitive as well as supervisory issues.
Any financial modernization proposal must balance numerous
public policy goals. Financial reform must ensure the safety and
soundness of insured depository institutions and the integrity of
the deposit insurance funds. It also must allow insured
depository institutions to generate sufficient returns to attract
new capital essential for normal growth and expansion into new
areas. To achieve these goals, banking organizations must be
able to compete on an equitable basis with other businesses and
to evolve with the marketplace, consistent with safety and
soundness. Equally important, concerns about the potential for
credit judgments to be made on preferential terms to affiliated
companies or other conflicts of interest between banking and
nonbanking affiliates and the effects of undue concentration in
the economy must be addressed. Moreover, any financial
modernization proposal must be examined for its effect on small
communities, isolated markets, and customers of insured
depository institutions.
In this context, it is useful to have a framework for
analysis against which to judge the merits of the proposal.
Several key questions must be answered. First, what activities
should be permitted, including should commercial firms be allowed
to own insured financial institutions? Second, where should the
activity be housed within the corporate structure? Third, what
safeguards are necessary to protect the insured entity and the
deposit insurance funds? Finally, how should the activity be
First, with limited exceptions, a banking organization
should be permitted to engage in activities that are financial in
nature. The exceptions would consist of those activities that:
(1) pose significant safety and soundness concerns; or (2) harm
consumers or small businesses.
Easing the broad range of restrictions on activities of
banking organizations beyond those that are financial in nature
should proceed very cautiously. While affiliations between
banking and commercial firms could benefit the financial system
and the economy by permitting a wider deployment of capital, two
types of concerns argue for a deliberate approach.
First, while banking organizations have expertise in
managing financial risks, most have little experience managing
some of the activities that would be permissible under various
legislative proposals under discussion. Some savings
associations have affiliated with commercial firms under the
unitary savings and loan holding company structure, but this
experience has been limited. Moreover, the insured institutions
involved in these relationships have not been broad-based banking
intermediaries or active lenders to commercial firms, but have
specialized primarily in real estate lending. As such, the
potential effects of the combination of a major commercial firm
and a major commercial bank remain subject to conjecture. The
history of the 1980s discussed above, with respect to expanding
the powers of thrifts into areas in which they had no prior
experience provides a clear example of the risks of going too
far. A dramatic change of affiliations between banks and
commercial firms could not easily be undone.
The second area of concern involves the possibility that
combinations of commercial firms and banks may result in undue
concentrations of economic wealth and political power. Concern
about such concentrations has been a major theme in banking
legislation since the early years of our nation's history, and is
partly responsible for a distinctive feature of the U.S. banking
system as compared to those of other nations -- the large number
of separately owned banking organizations. As I will discuss
later, in times of economic stress affiliations sometime lead to
conflicts of interest. These potential conflicts of interest are
of particular concern with respect to the affiliation of a large
bank with a large commercial firm.
There are limited precedents under the Edge Act, applicable
to U.S. banking activities abroad, for noncontrolling investments
by subsidiaries and affiliates of U.S. banks in commercial
companies outside the United States. These may be a reasonable
starting point for evaluating whether a basket of noncontrolling
investment opportunities involving banks and commercial firms
would permit a more cautious foray into banking and commerce
Second, a banking organization should have flexibility to
choose the corporate or organizational structure that best suits
its needs, provided safeguards protect the insurance funds and
prevent expansion of the federal safety net. There are two
organizational structures with which we have experience in the
United States that can be used to combine traditional commercial
banking with new activities. These are: (1) conducting each
activity in separate organizations owned and controlled by a
common "parent" organization (the "bank holding company" model);
and (2) conducting each activity in a separate organization owned
and controlled by a commercial bank (the "bank subsidiary"
model). A third model -- the conduct of both activities within
the same entity (the "universal banking" model) -- has been used
in some other developed countries, although not with unmitigated
success in recent years. We believe that universal banking is
not a model that would best fit the dynamic financial marketplace
in the United States or provide sufficient protection for the
deposit insurance funds against the effects of potential
conflicts of interest between banking and nonbanking functions in
an insured entity or prevent the unwarranted expansion of the
federal safety net.
The Bank Holding Company Model. Since the adoption of the
Bank Holding Company Act of 1956, one of the primary methods of
expanding permissible activities beyond those associated with
traditional commercial banking has been through formation of
affiliated entities under the bank holding company umbrella.
Within this framework, banking organizations have been permitted
to engage in an increasing array of financial and related
The advantages of the bank holding company model include:
Maintaining a meaningful corporate separation between
insured and uninsured affiliates to ensure that the
insured bank is not held responsible for the losses
from uninsured activities.
The disadvantages of the bank holding company model
In distressed situations, the parent will have the
incentive to transfer or divert value away from the
insured bank, leaving greater losses for the FDIC if
the bank ultimately fails.
The holding company model requires bank owners to
establish and maintain an additional corporation. This
may add costs, inefficiencies, complexity and, in some
cases, an additional regulator. This may be
particularly burdensome for small banks.
Bank Subsidiary Model. The bank subsidiary model is
exemplified by FDIC bona fide subsidiaries. The FDIC has
permitted bona fide subsidiaries of insured nonmember banks to
engage in securities activities since December 1984 (12 CFR
337.4). A bona fide subsidiary of an insured nonmember bank must
meet certain capital standards. The operations of the subsidiary
must be physically separate and distinct from the operations of
the bank. As well, it must maintain separate accounting and
other corporate records and observe corporate formalities, such
as separate meetings of board of directors. It must share no
common officers or employees with the bank and must compensate
its own employees. A majority of the board of directors of the
subsidiary must be composed of persons who are neither directors
nor officers of the bank. It must conduct business in a way that
informs customers that the subsidiary is separate from the bank,
and that its products are not bank deposits and are not insured
by the FDIC nor guaranteed by the bank. Additionally,
restrictions are placed on loans, extensions of credit, and other
transactions between an insured bank and its securities
subsidiary. From a practical perspective, there has been much
less experience with the bona fide subsidiary form of
organization than with the bank holding company form.
Analytically, there are several factors that make the bank
subsidiary approach different from the bank holding company
model. The advantages of the bank subsidiary approach include:
The insured institution, rather than the parent,
controls the allocation of excess capital of the
organization. This may mean that in making corporate
investment decisions, greater weight is given to the
needs of the insured institution.
However, on the negative side:
Bank Subsidiary Structure and Safety and Soundness. While
the experience of the FDIC with bona fide securities subsidiaries
of insured nonmember banks has been limited, these subsidiaries
generally have not posed safety and soundness concerns. Only one
FDIC-supervised institution owns a subsidiary actively engaged in
the full range of securities activities permitted by the FDIC,
but over 400 insured nonmember banks have subsidiaries engaged in
more limited securities-related activities. These activities
include management of the bank's securities portfolio, investment
advisory services, and acting as a broker-dealer. With one
exception, none of these activities has given cause for a
significant safety and soundness concern.
There has been one failure of an insured institution
supervised by the FDIC that conducted securities activities
through a subsidiary. While not the sole cause of the failure,
the business relationship with the securities subsidiary added to
the cost of the failure. The bank made a substantial unsecured
loan that was used to benefit the securities subsidiary.
Expansion of the Federal Safety Net. Some have argued that
the existence of the federal safety net -- consisting of deposit
insurance, and access to the Federal Reserve's discount window
and payments system -- provides banks with funding advantages
that could be passed on to bank subsidiaries, thereby resulting
in an undesirable expansion of the federal safety net to
activities for which it was not intended. The presumed existence
of such advantages and the ability of banks to pass them to their
subsidiaries have led some to express a preference for the bank
holding company structure over the bank subsidiary structure.
I will discuss this subsidy issue in some detail later in
the testimony. However, the evidence shows that, if banks
receive a net subsidy from the federal safety net, it is small,
and that both the bank holding company structure and the bank
subsidiary structure would inhibit the passing of any net subsidy
that does exist out of the insured bank. Thus, the potential
expansion of the federal safety net is not a reason to prefer one
organizational structure over the other.
Existing Bank Activities. The activities that banks
currently conduct should be left undisturbed. To require that
these activities be moved to a subsidiary of either the bank or
the holding company, in the absence of compelling public policy
reasons, could cause unnecessary disruption and contribute to
market inefficiencies. Moreover, if banks historically have
conducted the activities in the insured institution with minimal
negative consequences, there is no compelling reason to require
that such activities be conducted in a subsidiary or an
affiliate. A combination of flexibility and sound regulation has
contributed to the successful development of the U.S. financial
system, and these key elements should be present in any proposal
for reform.
The third principle of financial modernization is that
safeguards should prohibit inappropriate transactions between
insured institutions and their subsidiaries and affiliates. If
these safeguards are inadequate or the resources are unavailable
to enforce them, the deposit insurance funds, the financial
system, and the public could suffer. Transactions between an
insured institution and a related firm pose several risks.
First, an insured institution may be used to benefit a related
firm inappropriately. As examples, this could occur through
unwarranted fees paid to an affiliate or subsidiary, or through
excessive direct equity injections to a subsidiary, or perhaps
upstreaming of excessive dividends to a parent that are used to
inject equity to an affiliate. Second, when an insured
institution is in danger of failure, the owners and creditors of
related entities may try to extract value from the insured entity
to minimize their own losses, thereby increasing losses to the
deposit insurance funds. As I will discuss later, the past
decade has provided examples of a number of instances where
transactions were proposed or consummated that served to
advantage a holding company or an affiliate at the expense of a
failing insured bank.
Third, the business relationship between the insured entity
and its subsidiary or affiliate may create a misperception that
the products of the subsidiary or affiliate are federally
insured. Finally, there is the danger that the business and
operating relationship will cause the courts to "pierce the
corporate veil" -- that is, to hold the insured entity
responsible for the debts of a subsidiary or affiliate in the
event the subsidiary or affiliate fails.
Sections 23A and 23B of the Federal Reserve Act place
certain restrictions on transactions between banks and their
affiliates. These restrictions are intended to safeguard the
resources of federally insured banks against misuse for the
benefit of an affiliate of the bank. Section 23A was designed to
prevent a bank from risking too large an amount in affiliated
enterprises and to ensure that if a bank extends credit to an
affiliate, the collateral behind the extension of credit is
sufficient to ensure recovery by the bank. Section 23A,
therefore, regulates certain "covered transactions" with
affiliates of an insured bank and does so primarily in two ways.
First, Section 23A places limits on the dollar amount of
loans a bank may make to, or investments it may make in, any
individual affiliates, as well as in investments to or in all
affiliates. Second, it requires that the loans or extensions of
credit meet certain standards as to collateral. In addition,
banks generally may not purchase low-quality assets from
Section 23B essentially expands Section 23A. Section 23B
requires that certain transactions between a bank and its
affiliate must be carried out at arm's length, under terms and
conditions comparable to the terms of similar transactions
between unaffiliated entities. The transactions subject to this
comparability requirement include: certain sales of securities
or other assets by a bank to its affiliate; payments or provision
of services by a bank to its affiliates under a contract; and
certain transactions between a bank and a third party where an
affiliate acts as a broker or agent.
Any financial modernization proposal should maintain the
principles of Sections 23A and 23B and apply similarly
appropriate safeguards to dealings between an insured bank and
any subsidiaries of the bank engaged in activities not otherwise
permissible to the bank. Exceptions under these safeguards
should be allowed rarely. Consideration also should be given to
requiring timely reporting of intercompany transactions, as the
Securities and Exchange Commission currently requires.
In addition, we believe that further safeguards are
necessary. Only banks that are "well capitalized" should be
permitted to have subsidiaries that engage in activities that are
not permissible to the bank itself. The bank's equity investment
in the subsidiary should be deducted from the bank's regulatory
capital and assets. Furthermore, the subsidiary should not be
consolidated with the bank for regulatory capital purposes.
These safeguards will ensure that support provided by a healthy
bank to a subsidiary is provided through transfers of excess
capital -- beyond that required for a well-capitalized bank.
Effective Regulation
The fourth principle for financial modernization is that
regulation should be commensurate with risk -- no more and no
less. Just as the banking and financial services industries are
evolving and changing, so are the requirements of an effective
and efficient regulatory system. Individually, the regulatory
agencies must have the tools to oversee their respective portions
of the financial services industry. Collectively, the agencies
should not impose undue burdens on the regulated, but they should
act in sufficient concert to ensure the overall integrity and
stability of the financial system. These individual and
collective concerns argue for an approach that combines
functional regulation with some measure of carefully designed,
comprehensive oversight.
Currently, banking and financial services institutions are
regulated largely as entities or on the basis of function. I
have long believed that a greater degree of functional regulation
would result in both less intrusive and more effective
regulation. Properly implemented, functional regulation could
avoid the redundancy that may result from subjecting multi-tiered
financial institutions to the overlapping jurisdictions of
several agencies. Functional regulation also ensures that an
appropriate and consistent degree of expertise is brought to bear
on an activity, regardless of the charter or structure of the
entity conducting it, and that there are adequate protections in
place for consumers and investors.
Improperly implemented, however, functional regulation can
be additive, thus increasing the regulatory burden on financial
institutions. Moreover, functional regulation may pose the
danger of an artificial restructuring of financial operations and
services based primarily on function rather than along strategic
or market-based lines. Such artificial restructuring of
financial operations would undermine the flexibility in corporate
structure that should be among the goals of financial
In view of the increasing complexity of the financial
marketplace, functional regulation alone may not be sufficient to
ensure effective and efficient oversight of banks and other
providers of financial services. Financial organizations
increasingly are moving toward a more comprehensive view of the
risks posed by their various activities. Some activities,
practices, and intercompany dealings that affect the distribution
of risk across the organization may go unnoticed if there is
singular reliance on a functional approach. This suggests a need
for some coordination and attention to interstitial concerns,
such as maintaining accurate information regarding all operations
in the organization, and monitoring compliance with the rules on
intercompany dealings.
In addition, some oversight of the consolidated financial
organization may be necessary to address concerns regarding the
stability and liquidity of the financial system. Certain
regulators have responsibilities that transcend supervision of a
particular function or type of institution. For example, the
Federal Reserve Board has responsibility for the integrity and
liquidity of the payments system and as lender of last resort,
particularly in times of financial stress. In carrying out its
responsibilities, the Federal Reserve may require a degree of
authority that goes beyond supervision of state-chartered banks
that are members of the Federal Reserve System. For all
regulators there will be a need to coordinate supervisory efforts
and ensure the ready availability of adequate information with
which to gauge risks to the financial system. Systemic risk, as
a joint responsibility of financial industry regulators, imposes
needs beyond those involved for any single regulator in
conducting its day-to-day activities. The FDIC also needs to be
able to protect the deposit insurance funds.
In light of these considerations, I believe that, as part of
the effort to modernize our financial system, it is important to
define what the appropriate role is for oversight or supervision
that spans the entities within a financial organization. As an
example, for financial organizations containing large
institutions that have access to the payments system, this role
could well be filled by the Federal Reserve, the ultimate
provider of liquidity for this system. However, this role need
not involve full-scope Federal Reserve examinations of nonbanking
For other organizations, with relatively limited access to
the payments system, the oversight could be provided by another
regulatory agency and may focus on coordinating supervisory
efforts, monitoring transactions among affiliates, and otherwise
addressing any gaps that appear in the supervisory network.
In neither case would it appear to be necessary, for safety
and soundness purposes, to include investment-by-investment or
activity-by-activity regulation as part of the oversight of the
consolidated organization, provided that risks to the financial
system and to the insurance funds are understood and
appropriately limited. To the extent that bank-like supervision
is imposed unnecessarily on nonbanking entities, this would serve
as a barrier to entry and thereby defeat one goal of financial
In summary, effective and efficient regulation should be an
important component of any financial modernization effort. I
believe that functional regulation should play an important role
in the regulatory scheme and that a concept of "umbrella"
supervision can be developed that is consistent with functional
regulation and an orderly evolution of the financial system.
Your letter of invitation asked for my "views on the
government benefits that banks receive from FDIC insurance, the
availability of the discount window, and access to the payments
system." As I mentioned earlier, some have argued that the
existence of this federal safety net provides banks with funding
advantages that could be passed to bank subsidiaries, thereby
resulting in an undesirable expansion of the safety net to
activities for which it was not intended. The presumed existence
of such advantages and the ability of banks to pass them to their
subsidiaries have led some to express a preference for the bank
holding company structure over the bank subsidiary structure.
Because of the importance of this topic, I have asked FDIC staff
to analyze these issues in some detail and they have made
substantial progress in this effort. Although the analysis is
ongoing, they have reached certain conclusions that I will share
with you today.
Let me first highlight several points regarding the subsidy
issue. These points also will serve to outline the flow of our
It has long been widely accepted, and the FDIC agrees,
that banks receive a gross subsidy from the federal
safety net.
However, banks also incur costs, both direct and
indirect, that at least partially offset this gross
The relevant question for purposes of this discussion,
therefore, is not whether banks receive a gross
subsidy, but whether banks receive a net subsidy, or
more accurately, a net marginal subsidy, after taking
account of offsetting costs and restrictions. That is
to say, the gross subsidy from raising additional
subsidized funds must exceed the additional regulatory
and other costs that result from raising those funds
before banks can pass a subsidy to the affiliated
organizations, including bank subsidiaries.
It is very difficult to measure directly whether banks
receive a net subsidy. However, on balance, the
evidence indicates that if a net subsidy exists, it is
very small.
Moreover, if a small net subsidy exists, firewalls,
such as those that require a bank's equity investment
in a subsidiary to be deducted from the bank's
regulatory capital, and the requirements of Sections
23A and 23B of the Federal Reserve Act, serve to
inhibit a bank from passing a net subsidy to a
subsidiary or to an affiliate of the holding company.
These firewalls are not impenetrable under all
circumstances, but neither are they in a bank holding
company structure. The available evidence indicates
that both structures will work equally well in
inhibiting a bank from passing a net subsidy to a
Allowing a bank to put new activities in a bank
subsidiary diversifies a bank's income stream. The
bank benefits from the earnings of the subsidiary and
with appropriate firewalls, the downside risk can be
limited to excess regulatory capital -- above well-capitalized
levels -- invested in the subsidiary.
Thus, the bank subsidiary structure lowers the risk to
the insurance funds and may actually lower any subsidy
that arises from deposit insurance.
Given these facts, we have concluded that allowing
banks to conduct financial activities in a bank
subsidiary does not represent an undue expansion of the
federal safety net. Banking organizations should be
able to apply their sound business judgments to choose
how best to organize their activities.
Now, having outlined the essentials of my analysis, let me
proceed to discuss the subsidy issue in some detail.
Sources of the Gross Subsidy
It is widely recognized that banks receive a gross subsidy
from the federal safety net. In terms of funding costs, this
means that, for any given level of capital, banks can borrow
funds at a lower interest rate than they could absent the safety
net. There are three sources of the gross subsidy that
commercial banks and thrift institutions enjoy: deposit
insurance, the discount window, and access to the payments
system. Let me briefly explain how a gross funding advantage
arises from each source.
Deposit Insurance. Deposit insurance lowers the cost of
insured deposits for banks. If banks were to pay a "market
premium" for this insurance, the lower cost of funds would not in
and of itself constitute a subsidy. For example, municipalities
often purchase municipal bond insurance to enhance municipal
bonds. The savings, in terms of lower yields on the bonds,
exceed the cost of purchasing the insurance (otherwise
municipalities would not buy it). Nonetheless, the
municipalities are not receiving a subsidy. By purchasing
insurance from a AAA-rated company, they merely are capturing
some of the risk premium they would have had to pay to get
investors to purchase their riskier securities.
However, deposit insurance differs from market-provided
insurance in two important ways. First, the premium is not set
by the market. As I will discuss later, it is very difficult to
measure what a market rate for deposit insurance should be.
Second, there are two parts to deposit insurance: the insurance
funds (the BIF and the SAIF), which the industry has paid for,
and a call on the full faith and credit of the United States
Government. Measuring the value of this call is quite difficult.
Since the call is only "in the money" if one of the insurance
funds goes bankrupt, its value varies over time with the health
of the banking industry and the insurance funds. Since this call
is similar to a standby letter of credit provided by the
government, the fee for the call would be paid to the U.S.
Treasury. There has never been an explicit charge for this call.
The experience during the recent banking crisis was that the
FDIC used deposit insurance funds to resolve bank failures until
1991 when it borrowed working capital from the U.S. Treasury.
Those funds were repaid in 1993 with interest, resulting in no
net cost to the U.S. taxpayer for deposit insurance for banks
insured by the FDIC. Nevertheless, the availability of credit
from the U.S. Government for deposit insurance purposes results
in insured institutions being able to borrow in the marketplace
at lower costs than uninsured financial institutions.
The Discount Window. The Federal Reserve's discount window
provides credit to solvent but illiquid banks. Although discount
window loans must be fully collateralized, its existence in times
when other sources of credit may not be available under any
terms, means this backup source of credit provides a subsidy to
depository institutions. Moreover, it is not necessary for a
depository institution to borrow from the window for some benefit
to accrue to the institution. Hence, banks may have the ability
to fund riskier and less liquid asset portfolios at a lower cost
and on a much larger scale than otherwise would be possible. As
with deposit insurance, it is extremely difficult to quantify the
subsidy provided by access to the discount window, because the
value varies with the health of individual institutions and the
banking industry.
Payments System Access. The Federal Reserve District Banks
operate Fedwire. Through Fedwire, banks and thrifts with reserve
or clearing accounts at a Federal Reserve Bank may transfer
balances to other institutions that have similar accounts. For
many institutions, payments made on a given day may exceed that
day's opening balance. When a bank's account goes into a
negative position, a daylight overdraft occurs. Because Fedwire
transfers are "guaranteed" by the Federal Reserve at the time
they are initiated, the Federal Reserve assumes the intra-day
credit risk that a participating bank will not have enough funds
at the end of the day to discharge its obligations.
Regulatory, Legislative, and Market Developments Have Lessened
the Gross Subsidy
While the federal safety net continues to provide banks with
a gross subsidy, a number of statutory and regulatory changes
during the past decade have lessened the subsidy. Indeed, many
changes were designed specifically to reduce the safety net-related
advantages that had been accruing to insured depository
Capital Regulation. Bank capital serves as a cushion to
absorb unanticipated losses and shrinkages in asset values that
could otherwise cause a bank to fail. Capital levels can be
likened to a deductible for federal deposit insurance. As such,
the higher the level of capital, the lower the "market" rate for
deposit insurance.
Because of concern about declining bank capital levels, the
major industrialized nations adopted uniform standards for
capital adequacy in 1988. The Basle Accord established total
capital to risk-weighted assets as the international capital
measure and set eight percent as the minimum acceptable level of
risk-based capital. The stated purposes of the Basle Accord were
twofold: (1) to promote the stability of global financial markets
and consistency in supervisory standards; and (2) to link capital
requirements to the riskiness of a bank's activities, including
off-balance-sheet risk exposure. Adoption of minimum capital
standards and capital requirements tied to the risk profiles of
banks has resulted in banks holding more capital -- indeed, U.S.
banks as a whole currently have the highest capital levels since
1941 -- and has moved industry capital levels closer to the
levels that might be imposed by the market in the absence of the
federal safety net. As such, capital standards have reduced
significantly the subsidy from the safety net.
The Least-Cost Test. In 1991, the Congress passed the
Federal Deposit Insurance Corporation Improvement Act (FDICIA),
which, among other things, instituted the "least-cost test."
With rare exceptions, the FDIC may meet its insurance obligations
by means other than a payout only if the other transaction is
"least costly" to the deposit insurance funds of all methods.
Prior to this requirement, the FDIC could choose any alternative
that was cheaper than the estimated cost of liquidation. Most
institutions with over $100 million in assets were resolved
through a purchase-and-assumption transaction in which all
liabilities except subordinated debt were assumed by an acquirer.
The least-cost test caused the FDIC to change the way it
structured resolutions, so that uninsured depositors or other
general creditors often suffer losses in a resolution.
In the five years leading to the enactment of FDICIA (1987
to 1991), uninsured depositors and other general creditors
suffered losses in only 17 percent of the 927 bank failures. In
the five years since FDICIA, during which 187 banks failed,
uninsured depositors and other general creditors suffered losses
in 63 percent of the cases. The market discipline brought about
by the greater risk borne by uninsured depositors and other
general creditors after the imposition of the least-cost test
serves to reduce the subsidy from the safety net.
Risk-Based Deposit Insurance. FDICIA also instructed the
FDIC to develop and implement a system of risk-based deposit
insurance premiums. Since the market rate for insurance is
related directly to the amount of risk an institution takes,
flat-rate insurance provided the greatest subsidy to the riskiest
institutions. The rationale underlying risk-based premiums is
to make the price of insurance a function of an institution's
portfolio risk, thus reducing the subsidy to risk-taking and
spreading the cost of insurance more fairly across depository
institutions. Though the magnitude of the reduction is not
quantifiable, the adoption of risk-based insurance premiums has
reduced the size of any subsidy that had been accruing to
depository institutions because of mispriced deposit insurance.
The FDIC currently is undertaking a comprehensive review of the
risk-based premium system in order to identify additional
information, alternative risk-measurement methods, and other
measures that may enhance our capability to charge appropriately
for risks posed to the insurance funds. To the extent that this
effort is successful, the value of any subsidy conferred through
federal deposit insurance will be reduced further.
Changes to Discount Window Policy. In order to enhance
market and regulatory discipline in the banking sector and to
protect the deposit insurance funds, FDICIA restricted the
ability of the Federal Reserve to lend to undercapitalized
institutions through the discount window. In particular, FDICIA
placed restraints on Federal Reserve lending to institutions that
fall below minimum capital standards by setting time periods
beyond which the Federal Reserve may not lend to undercapitalized
institutions without incurring a potential limited liability to
the FDIC. The liability is incurred if an undercapitalized
institution borrows for more than 60 days in any 120-day period.
Because undercapitalized institutions would have the most
difficulty obtaining credit at attractive rates elsewhere, and
thus benefit most from access to the discount window, the
imposition of restrictions on their access to the discount window
reduces the gross subsidy that flows from such access.
Changes to Payments System Policies. Changes also have
taken place over recent years reducing the subsidy from the
payments system. First, in 1988, the Federal Reserve instituted
a system of net debit caps (credit limits) on an institution's
daily Fedwire overdrafts. Then, in April 1994, the Federal
Reserve started charging fees for daylight overdrafts incurred in
accounts at Federal Reserve District Banks. Since April 1995,
the fee has been set at an annual rate of 15 basis points of
chargeable daily daylight overdrafts. A chargeable overdraft is
an institution's average per-minute daylight overdraft for a
given day, less a deductible amount equal to 10 percent of its
risk-based capital. From April 1995 through December 1995,
overdraft charges averaged $27 million at an annual rate. During
that same period, about 120 institutions incurred fees regularly,
with the largest banks (those with assets of more than $10
billion) accounting for, on average, 92 percent of total
charges. Following the implementation of daylight overdraft
fees and debt limits, the Federal Reserve observed a dramatic
decline in total daylight overdrafts -- averaging 40 percent in
the six months following the initial imposition of fees in April
1994. This reduction in daylight overdrafts has reduced the
Federal Reserve's intra-day credit risk and liability as
guarantor of all Fedwire transactions and thus has reduced the
subsidy that previously accrued from the government-operated
payments system.
In addition, changes in technology are rapidly transforming
the payments system; real-time settlement, as well as alternative
means for settling payments, are likely to erode further the
subsidy that banks receive from the payments system.
In summary, while banks still receive a gross subsidy from
the safety net, this subsidy is significantly smaller than it was
a decade ago.
Evidence of a Gross Subsidy Is Limited
Three facts are cited often as evidence that banks receive a
gross subsidy from the federal safety net. First, bank holding
company debt generally has a lower credit rating than comparable
debt of its lead bank. Second, bank capital levels fell after
the creation of the Federal Reserve in 1913 and again after the
creation of the FDIC in 1933. Third, banks hold less capital
than other financial institutions. Each of these arguments is
discussed below. It is important to remember, however, that this
evidence is really something of a red herring. Whether a
particular fact reflects a gross subsidy to the banking industry
does not advance the analysis because everyone accepts that a
gross subsidy exists. What is important is whether after taking
account of offsetting costs, banks have a net subsidy that they
can pass on to operating subsidiaries or holding company
affiliates. These facts relative to the gross subsidy shed no
light on the net subsidy question.
Credit Ratings of Banks and Bank Holding Companies. The
debt of a bank holding company generally has a lower credit
rating than comparable debt of the bank holding company's lead
bank. This rating differential -- which translates into lower
funding costs at the bank level than at the bank holding company
level -- is considered evidence that the safety net provides a
funding subsidy to the bank that is not transferred to its parent
holding company. Because it allegedly shows that the holding
company structure is more effective in limiting the advantages of
the safety net than a bank subsidiary, this observation is
considered a particularly important piece of evidence by those
who favor the bank holding company structure over the bank
subsidiary structure for financial modernization.
However, there is an alternative explanation of the credit-rating
differential between bank and bank holding company debt.
Bank holding companies get the vast majority of their income from
their bank subsidiaries. The primary asset of a bank holding
company is usually the stock of its lead bank. In 1995,
approximately 93 percent of the dividends received by the 50
largest bank holding companies came from banks, the remaining
seven percent came from nonbank subsidiaries. Thus, debt holders
of a bank holding company rely heavily on bank dividends to
service their debt. In a bank failure, bank holding company debt
holders will usually only get paid if there is residual value in
the receivership to pay to the holding company -- the bank's
equity holder. The debt-service discrepancy is exacerbated with
respect to bank holding companies, because regulators can
restrict dividends from the bank to the holding company while at
the same time the bank holding company is expected by regulators
to be a source of strength to the bank. Much as senior debt
usually has a higher credit rating than junior debt, the inferior
position of bank holding company debt with respect to both debt
service and claims in a bank failure could well explain the
difference in credit ratings between a bank and its bank holding
FDIC staff has analyzed extensively the causes of the
ratings differential between bank and bank holding company debt.
In particular, the staff has examined three areas: the credit
ratings of nonbank holding companies and their subsidiaries, the
existing literature, and the debt-rating criteria used by Moody's
and Standard & Poor's. We found substantial evidence that the
ratings differential is due to the inferior position of holding
company debt as compared with bank debt with respect to both debt
service and bankruptcy. We found no evidence that the safety net
plays a significant role in the ratings differential.
Nonbank holding companies - If the ratings differential
between banks and bank holding companies were due to the safety
net, one would not expect this differential to exist for nonbank
holding companies. On the other hand, if the differential were
due to a different priority structure of bank and bank holding
company debt, then it should exist for nonbanks as well.
However, as a general rule, nonbanking companies do not have
holding company structures in which the parent is dependant on a
lead subsidiary for most of its income. For example, while Ford
Motor Company may have numerous subsidiaries, the first tier
parent has productive capacity -- it makes cars. Thus, a direct
comparison of bank and nonbank holding companies is not possible.
However, the general absence of a holding company structure
outside the banking industry would tend to indicate that this
structure is not viewed as advantageous by the market. As such,
it may be evidence that forcing banks to operate through a
holding company structure adds costs and therefore results in
some disadvantage for banks relative to their nonbank
Literature - FDIC staff did not find any literature that
directly addresses the ratings differential between bank and bank
holding company debt. However, FDIC staff did find two articles
that indirectly address the issue. These articles investigate
the required rate of return on bank holding company debt when the
proceeds are downstreamed to the bank through equity investments,
a practice known as double leverage, and when they are
downstreamed to the bank as debt. Both articles concluded that
the greater the level of double leverage, the greater the
required rate of return. In a bank failure, funds downstreamed
to a bank as debt have a higher priority than funds downstreamed
as equity. Thus, these articles support the hypothesis that the
credit priority of bank holding company debt holders affects the
cost of bank holding company debt.
Bank-Rating Criteria of Standard & Poor's and Moody's - FDIC
staff spoke to analysts at Standard & Poor's and Moody's.
Analysts at both rating agencies cited the priority structure in
debt servicing (the fact that regulators can restrict dividends
to the holding company) and in bankruptcy as the primary reason
why bank debt typically has a higher credit rating than bank
holding company debt. Put simply, the fact that the bank debt
comes before bank holding company debt means that it has a lower
default risk and hence a higher credit rating. Both also said
that they monitor the amount of double leverage in an individual
bank holding company and, that all other things being equal, the
greater the amount of double leverage, the greater the default
risk and the ratings differential.
Standard & Poor's noted that another reason for the ratings
differential is that it views the cross-guarantee provisions of
FIRREA and the Federal Reserve's "source of strength doctrine" to
mean that a holding company would be expected to downstream most
or all of its financial resources to protect a bank that was in
risk of failing, thus raising the possibility of default at the
holding company level. Moody's noted that access to the payments
system does have a positive effect on banks, but that the effect
is "negligible" in accounting for the ratings differential
between banks and bank holding companies. (See Attachment 1,
bank holding company rating criteria of Standard & Poor's and
Moody's.) Thus, based on information by the two major rating
agencies, there is little reason to believe that the safety net
plays a substantive role in the ratings differential between
banks and bank holding companies.
Bank Capital Has Decreased Over Time - A second piece of
evidence regarding the existence of a gross subsidy from the
safety net is that capital levels at banks fell after the
creation of the Federal Reserve System in 1913, and again after
creation of the FDIC in 1933. These data were presented in a
1991 Treasury study on financial modernization, and updated in a
1995 paper by Berger, Herring, and Szego. As can be seen from
Attachment 2, reproduced from Berger et al., bank capital
decreased fairly steadily from at least 1840 through 1940. While
the pace of the decrease (the slope of the curve) increased
slightly after creation of the Federal Reserve and again after
the creation of the FDIC, capital also had decreased as sharply
before. Moreover, as shown in Attachment 3, drawn from a 1992
paper by Kaufman, the capital of virtually every industry, has
decreased since the beginning of the twentieth century. The most
likely explanation of this overall decrease in capital levels is
a general increase in the efficiency of the U.S. financial
system. Commenting on the decrease in capital in the banking
industry the 1991 Treasury study states:
Capital ratios were declining long before creation of either the
Federal Reserve System or the FDIC. Indeed, much of the decline both before and
after the creation of the safety net no doubt reflects the growing efficiency
of the U.S. financial system. Nevertheless, the federal safety net is most
likely a key factor in explaining why bank capital ratios can remain near their
current levels without weakening public confidence in the banking system. It is
difficult to believe that many banks and thrifts operating over recent decades
could have expanded their assets so much, with so little additional investment
by their owners, were it not for the depositors' perception that, despite
the relatively small capital buffer, their risks were minimal. (p. II-4)
This appears to be a fair interpretation of the evidence.
Banks' ability to expand in the 1980s and early 1990s with very
thin capital margins and the ability of thrifts to expand in the
1980s while insolvent is almost definitely a result of the
federal safety net. However, given the downward spiral in bank
capital that ran for 100 years from 1840 to 1940 and the overall
decrease in capital levels in all industries over this period, it
is difficult to conclude that the decrease in bank capital after
the creation of the Federal Reserve and the FDIC was due to the
federal safety net. Moreover, the significant increase in bank
and thrift capital since the late 1980s reduces the gross subsidy
from the safety net, as discussed above.
Banks Hold Less Capital Than Other Financial Services
Companies. A third argument offered to support the contention
that banks receive a gross subsidy from the safety net is the
observation that banks hold less capital than other financial
intermediaries. Attachment 4, drawn from the earlier-mentioned
1992 paper by George Kaufman, shows that in 1989 large commercial
banks and bank holding companies did indeed have lower capital
ratios than other financial institutions.
These data, however, need to be interpreted cautiously.
Capital levels are tied to the volatility of earnings. Thus, the
large difference in capital levels between banking organizations
and some nonbank financial firms is most likely due to the much
higher risk in their businesses, not the safety net.
Nonetheless, the fact that capital levels in industries like life
insurance, that are not very risky, are higher than those at
banks can reasonably be interpreted as evidence of a gross
subsidy, but as we have said, the real issue is the net subsidy.
Measurement of the Gross Subsidy
The earlier discussion showed how banks receive a gross
subsidy from the federal safety net, but that the subsidy has
been significantly reduced in recent years through statutory and
regulatory changes. Measuring the magnitude of the remaining
subsidy, however, is quite difficult and few estimates exist.
If one believes the argument discussed earlier that the
difference in bond ratings between banks and their bank holding
companies is due to the safety net, although evidence is to the
contrary, then the difference in bond yields that results from
the ratings difference offers a measure of the subsidy from the
safety net. According to the data collected by the Federal
Reserve, in 1990 this difference was 10 to 15 basis points, but
since 1994 this difference has been in the four to seven basis
point range. In interpreting these data, it is important to
remember two things. First, the ratings differential only
captures the difference between the bank and its holding company.
If the holding company's debt rating is enhanced by the safety
net, there is an additional portion of the gross subsidy not
captured by the ratings differential. Second, as discussed
earlier, there are other very good reasons aside from the safety
net for the ratings differential between the bank and its holding
company. Indeed, it is not clear that the safety net plays a
significant role in the four to seven basis point discrepancy
between the cost of bank and bank holding company debt. In any
event, under no circumstances can this entire discrepancy be
attributed to the safety net. This is an extremely important
point. It means that when comparing the funding cost of banks
and bank holding companies the difference is less than four to
seven basis points, even before taking account of offsetting
Another method of measuring the gross subsidy from the
safety net -- or at least the deposit insurance portion of the
safety net -- is to attempt to estimate the market rate for
deposit insurance. Unfortunately, it is very difficult to
measure what that rate should be. The bulk of the studies that
attempt to estimate a market rate for deposit insurance have used
an option pricing model applied to data from the 1980s. The
application of this model to deposit insurance is based on the
observation that if a bank is found to be insolvent, depositors
can, in effect, "sell" their share of a bank's liabilities to the
FDIC in exchange for cash. The appropriate price for insurance,
according to this approach, is the value of this option to sell.
If insurance premiums are set lower than the option price, then
the bank can be said to receive a subsidy.
Unfortunately, there are numerous methodological problems
with applying option pricing theory to value deposit insurance.
Most notably, option theory deals with finite time contracts that
expire in a year or some other finite period of time, while the
deposit insurance guarantee is theoretically open-ended. The
value of insurance as calculated by these models also depends
critically on the timing of bank examinations, where more
frequent examinations lower the risks to the insurance funds and,
therefore, the value of insurance, and on the actual recovery on
the assets of the failed bank. Hence, the estimated fair value
of deposit insurance, as computed by these models, varies
depending on the model's assumptions. With these caveats in
mind, most option based models estimated the average fair value
of deposit insurance premiums to be under 10 basis points. It
should be noted, however, that the premium rates estimated in
most of the studies employing option pricing models, on average,
would have been grossly insufficient to cover FDIC losses during
the 1980s. Thus, the "market" premium as estimated by option
pricing models is probably understated.
The fair value of deposit insurance, however, is not a
measure of the subsidy from deposit insurance because banks pay
premiums for the insurance. This holds even today, with both
funds fully capitalized and most banks paying no explicit
premiums, since banks can be considered to have "prepaid" their
deposit insurance premiums. Beginning in 1991, banks and thrifts
paid higher premiums to recapitalize the insurance funds, with
the premium assessment ranging as high as 31 basis points for
some institutions in the period 1993 through 1995. In addition,
in the third quarter of 1996, SAIF members paid a special
assessment of almost 65 basis points to capitalize the SAIF.
Moreover, whenever the FDIC Board of Directors determines
that circumstances exist that raise a significant risk of
substantial future losses to the insurance funds, the Board can
raise the reserve ratio and premium rates to reach the higher
ratio well in advance of a severe crisis -- thereby increasing
the likelihood that the call on the U.S. Government will not have
to be exercised in the future.
Offsets to the Gross Subsidy
The various evidence of the magnitude of the gross subsidy
that does exist points to a gross funding subsidy of around 10
basis points. In addition, banks face other costs such as
reserve requirements, interest payments on bonds issued by the
Financing Corporation (FICO) and regulatory burden expenses that,
at a minimum, partially offset the subsidy. These are discussed
in turn below.
Reserve Requirements. Banks must hold required reserves
against transaction accounts, nonpersonal time deposits, and
Eurocurrency liabilities. These noninterest-bearing reserves
must be held as vault cash or as a deposit at a Federal Reserve
District Bank. Reserve requirements are intended largely as a
tool of monetary policy. By contrast, the foregone income on
required reserves can be viewed as a tax or fee paid by the
banking industry. For the year 1996, FDIC staff has computed a
conservative estimate of the pretax cost to banks for holding
required reserves to be approximately $840 million. If one
spreads this amount over the approximately $3.8 trillion in
average deposits held by FDIC-insured institutions over this time
period, the pretax cost of required reserves is approximately 2.2
basis points.
FICO Assessment. In 1987, Congress created the FICO to sell
bonds to raise funds to help resolve the thrift crisis. The
interest payment on FICO bonds is $793 million annually, and the
last of the FICO bonds matures in 2019. Beginning in 1997, the
annual interest is being paid by all FDIC-insured institutions,
not just SAIF-member savings associations. Commercial banks were
asked to share the burden of these payments since they also share
in the benefits of deposit insurance, and thus their payment of
this fee is a direct result of banks' access to the safety net.
For the first quarter of 1997, the FICO assessments were 6.4
basis points (annualized) for SAIF members and 1.3 basis points
for BIF members. Beginning in 2000, or 1999 if the funds have
been merged, all institutions will pay a pro rata share for FICO,
which presently is estimated to be 2.4 basis points.
Regulatory Burden. Perhaps the greatest offset to the gross
subsidy that banks receive from the safety net is regulatory
costs. Unfortunately, good estimates of the cost of regulatory
burden do not exist. A 1992 Federal Financial Institutions
Examination Council (FFIEC) study reviewed the literature on
regulatory burden. The studies reviewed by the FFIEC differed
in methodology and scope. Nonetheless, the FFIEC found that
"[d]espite differences in methodology and coverage, findings are
reasonably consistent: regulatory cost may be 6 - 14 percent of
non-interest expenses, not including any measurement of the
opportunity cost of required reserves." Some of the studies
reviewed by the FFIEC included the cost of deposit insurance (at
the time 8.3 basis points), and some aspects of regulatory
burden, such as "truth in lending," are not unique to banks.
However, even the low end of the FFIEC range -- six percent --
still yields substantial regulatory costs. In particular, if we
take six percent of the approximately $150 billion of noninterest
expenses incurred by commercial banks during 1995, it yields a
cost of regulatory burden of $9 billion dollars. Expressed in
terms of average deposits at commercial banks during 1995 of
almost $3 trillion, this amounts to 30 basis points.
Thus, the total offset, including reserve requirements, FICO
interest payments, and regulatory burden, is estimated to be more
than 33 basis points for banks and more than 38 basis points for
thrifts. After the FICO payment is equalized, this offset will
be approximately 34 basis points for banks and thrifts.
The Net Subsidy
Measuring whether banks actually receive a net subsidy is
difficult because it depends on reliable estimates of the gross
subsidy and offsetting costs, which as we have stated, are
difficult to determine. Nonetheless, with most estimates of the
gross subsidy around 10 basis points, the costs would appear to
outweigh the subsidy significantly -- by more than threefold.
Clearly, with a difference of this magnitude, those who believe a
net subsidy exists must bear the burden of proof.
Given the difficulty of obtaining reliable estimates of a
net subsidy, it is helpful to look at other indicators to assist
us in determining whether banks receive a net funding subsidy
from the safety net that affects the business judgments they
make. In this regard, it is useful to look at how a banking
organization would best organize itself to exploit a net subsidy
if one were to exist. Federal Reserve Board Chairman Alan
Greenspan addressed this issue in recent testimony before the
House Subcommittee on Financial Institutions. Chairman Greenspan
stated that "one would expect that a rational banking
organization would, as much as possible, shift its nonbank
activity from the bank holding company structure to the bank
subsidiary structure. Such a shift from affiliates to bank
subsidiaries would increase the subsidy and the competitive
advantage of the entire banking organization relative to its
nonbank competitors."
Yet, banks conduct a wide range of activities through
holding company affiliates that could be conducted directly
through a bank or in bank subsidiaries without any firewalls. As
of September 30, 1996, the 50 largest bank holding companies had
155 mortgage banking affiliates, 98 commercial finance affiliates
and 263 consumer finance affiliates. At the same time, the bank
subsidiaries of these holding companies had 104 mortgage banking
subsidiaries, 24 commercial finance subsidiaries, and 89 consumer
finance subsidiaries. (See Attachment 5.) In addition, the
banks conduct mortgage, commercial, and consumer finance
activities directly, and could conduct these activities
nationwide directly through the bank.
Following Chairman Greenspan's logic that a rational banking
organization would choose its organizational structure so as to
maximize its competitive advantage from the subsidy, there appear
to be only three possibilities -- (1) the subsidy is the same
whether an activity is conducted in a holding company affiliate
or the bank proper, (2) there is no net subsidy, or (3) the net
subsidy is so small that it is outweighed by other
considerations. Because Sections 23A and 23B make it highly
unlikely that if a net subsidy exists, it is the same whether the
activity is conducted in a holding company affiliate or the bank,
the fact that banking organizations choose all three forms of
organization -- holding company affiliate, bank subsidiary, and
bank proper -- suggests that there is not a net funding subsidy,
or that if a net subsidy exists, it is so small so as to be
outweighed by other considerations.
While the evidence shows that if a net subsidy exists at all
it is small, reasonable firewalls designed to protect the insured
bank serve to inhibit the passing of any subsidy from a bank to
its subsidiary. In particular, as discussed previously, we
believe that in order for a bank subsidiary to engage in an
activity not permissible to the insured bank, the bank should be
"well-capitalized," the bank's equity investment in the
subsidiary should be deducted from regulatory capital (and
assets), the subsidiary should not be consolidated with the bank
for regulatory capital purposes, and that "covered transactions"
between the bank and its subsidiary should be subject to the
restriction of Sections 23A and 23B of a Federal Reserve Act.
These firewalls are not impenetrable. If a bank has excess
regulatory capital -- capital above the well-capitalized level --
it may sometimes have an incentive to pass on a portion of the
net subsidy to a bank subsidiary or a bank holding company
affiliate. In particular, if a bank had excess regulatory
capital that it did not want to leverage because it felt that the
market demanded that it hold additional capital, it could lower
its overall cost of funding by borrowing additional "subsidized"
funds at the bank, investing these funds as "equity" in the
subsidiary, and using the new funds to pay off market-rate
liabilities in the subsidiary. The banks regulatory capital
level would fall because the new equity investment in the
subsidiary would be deducted from regulatory capital, but where
the bank has excess regulatory capital this would not be a
problem. The bank's consolidated capital level would remain
unchanged because the increase in liabilities in the bank would
be exactly offset by the decrease in liabilities at the
subsidiary. Finally, the subsidiary's and bank's overall cost of
funds would fall because subsidized funds would have replaced
unsubsidized funds.
Of course, if it were the consolidated holding company
capital that the banking organization wanted to keep high -- and
it is, after all, the holding company that is the publicly traded
entity -- then the bank similarly could transfer part of a
subsidy to a holding company affiliate. The bank could borrow
additional subsidized funds at the bank and upstream additional
dividends to the holding company. The holding company could then
downstream these funds to an affiliate that could use the funds
to pay off market-rate liabilities. The consolidated capital
ratio of the holding company would remain the same, because the
additional funds borrowed at the bank are offset by the
liabilities paid off at the affiliate. The cost of funds of the
affiliate and the overall cost of funds of the holding company
would decline because subsidized funds borrowed at the bank would
have replaced market-rate liabilities borrowed at the affiliate.
Unlike the bank subsidiary model, however, such a transfer could
take place even if the bank were not well-capitalized, since
there is no requirement that a bank be well-capitalized to pay
dividends to its parent holding company.
There are three important points to remember about these
examples. First, under the bank subsidiary structure, Section
23A would restrict the total investment (equity and debt) in a
single subsidiary to 10 percent of the bank's equity capital.
Thus, aside from the fact that only excess capital could be
invested as equity in a subsidiary, there would be another limit
to the bank's investment in its subsidiary.
Second, the mere existence of excess regulatory capital is
not sufficient for there to be an incentive for a bank to pass a
portion of a net funding subsidy to either a subsidiary or an
affiliate. If the bank is willing to leverage its excess
regulatory capital -- perhaps because the excess regulatory
capital is a result of record profits rather than a business
strategy to hold additional capital, then it is more profitable
for the bank to leverage the additional capital either through
reducing capital levels or by growth, than to take advantage of
the excess capital to pass a portion of the subsidy to a
subsidiary or affiliate. The reason for this -- if the bank is
willing to increase its leverage by decreasing capital levels --
is that the bank can lower its overall cost of funds by borrowing
additional subsidized funds and paying out an additional
dividend. In this case, the subsidized funds replace equity
capital. Because of the greater risk borne by equity holders
than debt holders and the tax advantages of debt, the bank's cost
of equity is going to be higher than the cost of unsubsidized
borrowing at a bank subsidiary or holding company affiliate. As
such, paying an additional dividend is a superior strategy to
using the excess capital to transfer a portion of the subsidy to
a subsidiary or an affiliate. Although the explanation is more
complicated, the same result holds true if the bank chooses to
leverage its excess capital through growth.
Capital levels at banks, especially large banks, currently
are near historic levels. What is not clear is why the banks are
holding this capital. Certainly, it is possible that some of
this capital is being held because the market is demanding it.
However, it also is possible that some of this capital is a
product of the record profits that banks have experienced in
recent years that simply have not been leveraged yet. Banking
organizations, as well as other firms, are generally reticent to
increase dividends unless they are confident higher earnings will
be maintained since they do not want to have to lower dividends
when earnings fall. There is evidence that banks are increasing
payouts to their parents above current earnings to fuel stock
buy-backs. Of the 50 largest bank holding companies, more than
30 have announced stock buy-back programs since the beginning of
1996. (See Attachment 6.) It also is possible that banks are
building up excess regulatory capital to fuel future expansion
especially with interstate branching looming on the horizon.
Given the fact that large banks historically have held as little
capital as the regulators would allow, it is too early to tell if
their current capital levels reflect new business realities or
merely are a temporary phenomenon that is a result of record
earnings. Therefore, it is difficult to say if large banks have
even a theoretical incentive to use any of their excess capital
to subsidize a subsidiary or holding company affiliate.
Third, unless all of the liabilities of a bank subsidiary or
holding company affiliate were replaced with equity investments
funded by subsidized bank borrowings, only a portion of the
subsidy would be passed to the subsidiary or affiliate. Since we
are talking about a net subsidy that may not exist at all, or at
most is very small, a portion of the net subsidy would be a de
minimus amount.
The real question then is does the theoretical possibility
of passing on a subsidy make any real world difference? Chairman
Greenspan addressed this issue with respect to bank holding
company affiliates in his testimony before the Subcommittee on
Financial Institutions and Consumer Credit last month. He
recognized that banks could theoretically pass a subsidy to
affiliates through dividends paid to a holding company, but
argued that as an empirical matter such a transfer has not taken
Given the firewalls I have outlined above, the underlying
incentives to pass a subsidy to a bank subsidiary are quite
similar to the incentives to pass a subsidy to a holding company
affiliate. If we do not observe a subsidy being passed to
holding company affiliates, we would, in most cases, not expect
it to be passed to a bank subsidiary.
The available evidence appears to bear this out. As I
discussed earlier, the FDIC has allowed bona fide securities
subsidiaries of state nonmember banks for just over a decade.
These subsidiaries are subject to restrictions to protect the
insured bank similar to the firewalls I have outlined above. If
there were a substantial net subsidy that could be transferred to
a bona fide subsidiary, one would expect that at least some large
bank holding companies would conduct their securities activities
through bona fide subsidiaries rather than Section 20
subsidiaries of the holding company. This is especially true
since 1991, when the U.S. Court of Appeals for the Second Circuit
ruled that the Federal Reserve Board does not have jurisdiction
under the Bank Holding Company Act over bank subsidiaries of a
bank in a bank holding company (Citicorp v. Board of Governors of
Federal Reserve System, 936 F.2d 66). The fact that all large
bank holding companies continue to conduct their underwriting
activities through bank holding company subsidiaries seems to
indicate that, if there is a net subsidy, the bona fide
subsidiary structure is as effective in preventing it from being
transferred out of the bank as the bank holding company
Of course, in times of stress firewalls tend to weaken, and
transgressions have occurred both within and outside the reach of
the regulators. But our experience with the financial stress of
the 1980s and early 1990s indicates that in times of financial
stress, pressure can be exerted on a bank from its holding
company as well as from subsidiaries. Organizational structure
is unlikely to affect this potential problem. The past decade
provided a number of instances where "death-bed transactions"
were proposed or consummated that served to advantage the holding
company or an affiliate at the expense of the insured bank. The
transactions often involved sums in the tens of millions of
dollars. Not all of these transactions required regulatory
approval. The regulators often, but not always, denied those
that did. In some instances, regulators concluded that denial
might unnecessarily aggravate the plight of banking organizations
that might otherwise survive.
Unpaid tax refunds arose as an issue in more than one case.
Bank holding companies generally received tax payments from and
downstreamed tax refunds to their banking subsidiaries, acting as
agent between the bank and the Internal Revenue Service. The
FDIC has observed that in some cases unpaid tax refunds tended to
accumulate on the books of failing bank subsidiaries, leaving the
cash with the holding company. This practice took place without
regulatory approval.
Consolidation of nonbank activities at the parent level is
another way to transfer value away from insured bank
subsidiaries. When service company affiliates carry out data
processing or other activities for banks, the issue of
intercompany pricing also is raised.
Linked deals involving the sale of purchased mortgage
servicing rights have in some cases been used either to subsidize
the sale of a holding company asset or to allow the bank
subsidiary to book an accounting gain. The effect of a linked
deal either may be to transfer value to the parent or delay the
closing of a subsidiary without the benefit of needed fresh
Finally, there have been instances of "poison pills" created
by interaffiliate transactions. In one case, key bank staff were
transferred to the holding company payroll, apparently to reduce
the attractiveness of bringing in an outside acquirer.
Interaffiliate data processing contracts also have been
structured so as to limit the availability of information to the
FDIC or an acquirer after the bank was closed, thereby making
regulatory intervention more costly.
Contraction of the Safety Net
In examining the question of financial modernization and the
possible expansion of the federal safety net, it is important to
recognize that modernization may help contract the safety net.
In particular, as I have previously discussed, with appropriate
safeguards, having the earnings from new activities in bank
subsidiaries provides greater protection to the insurance funds
than the holding company structure.
Since the fair market price for deposit insurance is tied to
expected insurance losses, by reducing the expected losses of the
insurance funds, allowing banks to put new activities in a bank
subsidiary also lowers the fair market price for deposit
insurance. In addition, it lowers the value of the banking
industry's access to the full faith and credit of the United
States Government. As such, if banks do receive a net subsidy,
allowing banks to put new activities in bank subsidiaries would
lower any subsidy they receive.
Given the difficulty in measuring the subsidy to begin with,
estimating how much this reduction in subsidy would be is
virtually impossible. However, it is important to note that
since any net subsidy that does exist is clearly small, the
reduction in subsidy would not be material enough to warrant
favoring the bank subsidiary structure to the exclusion of the
bank holding company structure.
Current restrictions on the financial activities of banking
organizations are outdated. Their elimination would strengthen
banking organizations by helping them to diversify their income
sources, and would promote the efficient, competitive evolution
of financial markets in the United States. However, we should
proceed cautiously in easing the broad range of restrictions on
activities of banking organizations beyond those that are
financial in nature. Expansion of bank and thrift powers must be
accompanied by appropriate safeguards for the insurance funds.
Any financial modernization proposal should permit financial
organizations to engage in any type of financial activity, unless
the activity poses significant safety and soundness concerns or
is potentially harmful to consumers or small businesses.
Moreover, financial institutions should have flexibility to
choose the corporate or organizational structure that best suits
its needs, provided adequate safeguards exist to protect the
insurance funds and the taxpayer.
The two organizational structures with which we have
experience in the United States -- the holding company model and
the bank subsidiary model -- can provide adequate safety and
soundness and can inhibit the undue expansion of the federal
safety net, provided adequate safeguards are in place to protect
insured institutions and the deposit insurance funds.
This conclusion is based on the fact that if banks receive a
net subsidy at all, it is small. Moreover, reasonable firewalls
will inhibit the passage of any net subsidy that may exist to a
bank subsidiary, and the bank subsidiary structure is likely to
be as effective as the bank holding company structure in
preventing a subsidy from being passed out of the bank. In both
cases, any leakage of a net subsidy out of the insured bank would
be de minimus. In addition, the bank subsidiary structure of
financial modernization would be more effective than the bank
holding company structure in reducing any subsidy that does exist
because the placement of new activities in bank subsidiaries
provides greater protection for the insurance funds, lowers the
fair-market price for deposit insurance and lowers the value of
the industry's access to the full faith and credit of the United
States Government. For these reasons, allowing banks to conduct
new financial activities in a bank subsidiary would not lead to
an undue expansion of the federal safety net. Banking
organizations should be able to choose the organizational
structure -- bank subsidiary or bank holding company -- they feel
is best for pursuing their individual business strategies.
Any financial modernization proposal should be consistent
with the safeguards of Sections 23A and 23B of the Federal
Reserve Act and apply them to dealings between an insured bank
and any subsidiary of the bank. In addition, we believe that any
financial modernization proposal should require that the capital
adequacy of an insured institution be determined after deducting
the institution's investment in subsidiaries. The experience of
the FDIC has been that in times of financial stress, banking
organizations may attempt to engage in transactions that transfer
resources from the insured entity to the owners and creditors of
the parent company, nonbanking affiliates, or to subsidiaries of
the bank.
The FDIC believes that a greater degree of regulation along
functional lines may be preferable to the current practice of
regulating individual banking entities based on charter or
corporate structure. We must ensure, however, that functional
regulation is seamless and does not result in duplicate
regulation or in the artificial restructuring of banking
operations and services. We also must ensure that key
transactions between insured banks and their affiliates and
subsidiaries can be reviewed by regulators as part of the regular
examination process for insured banks.
Furthermore, to address concerns regarding the stability and
liquidity of the financial system, it may be necessary, as part
of the effort to modernize, to initiate some oversight of
consolidated financial organizations. With increasingly complex
financial products and organizational structures, some
activities, practices, and intercompany dealings may go unnoticed
if there is too heavy a reliance solely on a functional approach.
At the same time, there will be a growing need to coordinate
supervisory efforts to ensure the ready availability of adequate
information with which to gauge risks. However, such supervision
need not involve full-scope examinations of nonbanking
subsidiaries nor activity-by-activity or investment-by-investment
regulation of nonbanking activities.
The FDIC stands ready to assist the Subcommittee in
evaluating how best to reform our financial system.
Last Updated 06/25/1999


text:
After a cease-and-desist order from Ronnie James Dio, the Hawthorne, California quintet that originally broke ground last year as Dios was forced to adopt a new moniker and settled on Dios (Malos). Name change or not, the band's second self-titled album (Dios released Dios on Startime International last year) is another radiant assortment of songs.
With production by Phil Ek (Modest Mouse, the Shins), the sound is stellar. "I'm self-absorbed and I'm lazy," says vocalist Kevin Morales alongside the invigorating rhythm of opener "Feels Good Being Somebody." The album contains chilly acoustic ballads such as "Say Anything," and the guile in the band's harmonic precision paves the way for a tender flow in "I Want it All." "Epk" gives off a sense of warmth, and "Tokyo Sunrise" shows off the eclectic nature of the dual key arrangement, including some shimmering Eastern grooves from a swanky B-3 Hammond organ. "My Broken Bones" shines on while retaining a sugary primer of Americana twang, and a spacey prog-jazz vibe ensues with "I Feel Fine."
Dios (Malos)'s buoyant yet sophisticated glow incites a plethora of feelings, but the album stands out above most of the band's dreamy indie-rock counterparts because, undoubtedly, the members of the band are enjoying themselves. And that makes listening to the album a joyous occasion.
Cyne - Evolution Fight | Nickel Creek Why Should The Fire Die? |

subset: commoncrawl