Federal Reserve Board Chairman Alan Greenspan urged Congress yesterday to give the nation's commercial banks new freedoms but at the same time require them to put up more of their own money to ensure their safety.
These steps, coupled with tighter supervision by federal authorities, the nation's central bank chief said, would protect American taxpayers and increase the banks' competitiveness.
The Banking Committee is holding a series of hearings on deposit insurance reform, new bank powers and related issues in anticipation of receiving a report from the Treasury late this year.
Action on legislation to give the banks new powers while limiting taxpayer exposure to losses through deposit insurance guarantees is planned for next year.
Specifically, Greenspan told the Senate Banking Committee that the nation's commercial banks should increase the amount of capital they have on hand to offset losses and that bank regulators should have much clearer authority to shut down banks before they go broke.
In exchange, Greenspan said, banks should be given the right to provide a wide range of financial services now largely prohibited, such as underwriting corporate securities and setting up mutual funds.
Higher capital requirements, he argued, would mean that bank owners would have more of their own money on the line and would therefore be more careful in lending it.
That care, along with the larger amount of money to cover losses and closer supervision by federal regulators, would protect taxpayers and the financial system as a whole.
Also, in a major shift of Fed opinion, Greenspan said corporations owning banks should not necessarily build so-called fire walls to separate the bank taking federally insured deposits from other subsidiaries, such as those underwriting securities.
Such fire walls do not work in situations in which the owning corporation gets into trouble, Greenspan said.
He cited what happened when the brokerage and investment banking firm of Drexel Burnham Lambert failed early this year.
Greenspan also proposed amending the McFadden Act, which allows states to restrict ownership and branching of banks within their borders, to permit full interstate branching.
That proposal is certain to be opposed strongly by smaller independent banks who fear additional competition from larger institutions.
The Federal Reserve Board, he said, concluded that stiffer capital requirements and better bank supervision are the only ways in which taxpayers can be protected when federal deposit insurance funds are used to pay off insured depositors after an institution fails.
There is no way in which deposit insurance itself can be reformed to both protect the taxpayer and prevent damage to the financial system in the event of widespread bank "runs" in which depositors withdraw their funds from shaky institutions.
The existence of deposit insurance played a major role in the huge losses in savings and loan associations, which the federal government is now covering. It has played a similar role in hundreds of bank failures in recent years by encouraging banks to grow rapidly while taking unacceptably high risks, Greenspan argued.
"It is difficult to believe that many of the banks operating over recent decades would have been able to expand 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," Greenspan said.
"Our goal should be for banks to operate as much as possible as if there were no safety net" of deposit insurance and banks' access to loans from the Fed when they get caught short of cash. "In fact, runs of uninsured deposits from banks under stress have become commonplace."
Greenspan said the package of changes he was proposing, including higher capital requirements and prompt corrective action when banks get in trouble, "would increase the cost and reduce the availability of credit from insured institutions to riskier borrowers." That would mean more creditworthy borrowers would pay less for their loans and the economy would benefit, he said.