I. Introduction.

One of the most complex public policy issues facing consumer organizations in many industrial countries and increasingly in developing countries is what position to take in regard to legislative and administrative initiatives to roll back the scope of government regulation of financial institutions. These policy initiatives generally focus on depository (banking) institutions, but they often encompass other types of financial institutions, such as finance companies, securities firms, and even insurance companies.

Financial deregulation initiatives generally seek to eliminate price controls, portfolio requirements, product restrictions, and barriers to entry that operate within domestic financial service markets. In a growing number of countries, the initiatives also seek to eliminate restrictions designed to insulate domestic financial service markets from international financial markets and prevent their penetration by multinational financial firms.

Such deregulation initiatives have been variously labeled "financial deregulation", "financial liberalization", or "financial restructuring." This paper will generally use the term "financial deregulation."

The policy argument most commonly advanced to support financial deregulation is that it will provide direct benefits to consumers in the form of product innovation, increased competition, and lower prices. Without question, consumers want vigorous competition in financial service markets in order to hold down the cost of financial services, improve yields offered on savings instruments, and stimulate useful innovation.  Yet considerable evidence suggests that financial deregulation can set in motion forces that will prevent it from achieving the goal of broad-based consumer benefit.

First, and somewhat paradoxically, financial deregulation unaccompanied by stronger prudential supervision and regulation to curb excessive risk-taking by financial institutions can lead to a rising incidence of bank failure and a host of direct and indirect injuries to consumers. When banking institutions collapse in the wake of financial deregulation, consumer deposits are at risk. Where governments operate broad deposit protection schemes, consumer deposits may be safe, but consumers may be required to pay for the cost of bank bailouts or failure resolutions through higher taxes. Alternatively, where large banking institutions exercise significant market power over their retail customers, they may be in a position to extract higher profits from consumers in order to cover large losses in their commercial banking operations.

Second, financial deregulation unaccompanied by rigorous competition (antitrust) policy and new mechanisms to more effectively serve consumer information needs is not likely to enhance price competition in retail financial service markets on any sustainable basis. A strong antitrust policy against concentration is needed to ensure that retail financial service markets remain competitive on the supply side. On the demand side, new and more effective consumer information mechanisms are needed to enable consumers to participate effectively in increasingly complex financial service markets. Without both components in place, financial deregulation is not likely to stimulate real price competition.

Third, financial deregulation unaccompanied by access safeguards can diminished access to banking services for lower income persons, low and moderate income neighborhoods, and small businesses. Financial deregulation and technological change produce certain structural and operational changes in the banking industry -- i.e., stronger competitive pressure, industry consolidation, standardization of loan products, centralization of loan approval authority, and pressure to maximize fees and service charges. The evidence suggests that these changes tend to reduce both the willingness and the capacity of banking institutions to serve economically disadvantaged or isolated communities, small-sized businesses, and various non-standardized credit needs.

An assessment of financial deregulation from a consumer or public interest perspective must recognize that it affects a broad range of consumer and local community interests. And these interests and impacts must be viewed from a number of very different perspectives or disciplines: prudential control, competition policy, consumer information needs, considerations of social equity, and local economic and community development policy. The complexity of this assessment process is further compounded by a number of subtle interactions and potential trade-offs between key policy goals. For example, increased competition may exacerbate prudential control problems, or proliferation of financial service products may overwhelm consumers with information needs.

Needless to say, the complex web of subtle impacts and interactions makes it difficult to draw balanced conclusions about financial deregulation. Moreover, given this complexity, it is relatively easy for ideologues or powerful vested interests within the financial service industry to present superficially reasonable assessments of financial deregulation that, in fact, overlook or gloss over its impact on important consumer and local community interests.

For consumer and community organizations, however, there may be only limited value in a static debate over the pros and cons of financial deregulation. More to the point is the issue of what type of safeguards should be developed to contain the negative impact of financial deregulation. At least in the industrial countries, financial deregulation in some form has already arrived. Within these countries, price decontrol and elimination of product restrictions within the banking sector are commonplace, although key structural issues remain unresolved -- such as whether to permit banks to affiliate with commercial or industrial firms. Moreover, deregulation of domestic financial service sectors is beginning to unfold in many developing countries, including those which still continue to restrict entry by multinational financial service firms.

Financial deregulation has not only arrived, but in all likelihood, is also here to stay -- at least within the industrial countries. Technological change, the ascendancy of market-based economies, and the globalization of financial markets have guaranteed or at least weigh heavily in favor of this outcome. So the most urgent task is to establish adequate safeguard mechanisms.

The critical safeguard issues posed by financial deregulation can be categorized as follows: (1) prudential control of financial institutions, (2) competition policy, (3) consumer information needs, (4) consumer protection (unfair terms and practices), (5) access to basic financial services for disadvantaged consumers and small business, and (6) in the context of developing countries, the availability of credit for priority economic sectors. It is essential that consumer and local community organizations become actively involved in shaping the necessary safeguard mechanisms. These safeguards touch upon too many vital consumer and local community interests to allow their fashioning to be left exclusively, or even primarily, to the financial service industry itself or even its regulators, who are invariably subject to strong pressure from the financial service industry and generally have a narrow technical perspective.

II. The Forces Driving Financial Deregulation.

In most industrial countries, financial service markets have traditionally been highly regulated by means of price controls and product restrictions and also segmented into different types of institutions, such as commercial banks, housing finance specialists, cooperative credit institutions, finance companies, life insurers, and property/casualty insurers. Much of this market segmentation evolved over the course of the last 150 years as new types of financial institutions were established with government support to satisfy specific financial service needs not being met by existing financial institutions. Prime examples would include the cooperative credit institutions in Germany, Japan and Canada, the building societies in the U.K., and the savings and loans in the U.S.. 

The dominant rationale for financial regulation has been the need to maintain stability within the banking sector, exercise monetary control, and assure the solvency or "safety and soundness" of individual financial institutions. However, other goals, including the desire to allocate credit to certain sectors, enhance consumer protection, and, at least in the U.S., restrict financial concentration have also played a role.  In many developing countries, the desire to employ financial institutions, especially banking institutions, as vehicles to promote national economic development has exerted a strong influence over the shape of financial regulation.

Over the course of the last 20 years or so, a series of developments have combined to build mounting economic and political pressure for financial deregulation -- first in the industrial countries and then more recently in many developing nations.

First, new technology centering on computers and telecommunications has led to the introduction of many new financial service products, especially by less regulated financial institutions. These new products have frequently undercut the market position of traditional financial service providers.  For example, in the U.S. the extensive intrusion of securities products and securities firms into traditional corporate lending, home mortgage lending, and deposit markets has meant that banking institutions have lost many of their best customers and are faced with lower profit margins on some of their traditional products.

Second, the spiraling inflation and economic instability experienced by many industrial and developing countries during the 1970s and 1980s resulted in severe dislocations in many domestic financial markets, which placed many financial institutions under great stress.  At least in some countries, the rigidities associated with strict price and product controls for financial institutions came to be seen as a source of instability and even fragility within the financial sector. For example, in the U.S. long-standing regulations prohibiting savings and loans from making variable rate mortgages were a key factor contributing to the tremendous losses and erosion of capital experienced by the savings and loan industry in the environment of escalating interest rates that prevailed during the late 1970s and early 1980s. 

Third, aggressive pursuit of economic deregulation policies by the Thatcher, Reagan, and Bush administrations in the U.K. and the U.S. has provided powerful political impetus to financial deregulation. For example, over the last 11 years the U.S. Treasury Department has consistently advocated sweeping deregulation of the U.S. financial sector, including dramatic structural changes that would allow combinations between banks and industrial firms, as well as nationwide branch banking.[ ⁽¹⁾]

Aggressive advocacy of financial deregulation by the U.K. and the U.S. has not been confined to their own domestic financial markets. The two countries have employed trade negotiations and, in the case of the U.S., strong influence over the IMF and the World Bank to encourage or pressure other countries to deregulate their domestic financial sectors and open these markets to foreign entry. Needless to say, the appeal of such a strategy to the political leadership in the U.S. and the U.K. reflects the close fit between the theory of financial deregulation and the interests of powerful U.S. and U.K. financial service firms that seek entry into and operating flexibility within foreign financial service markets.

For example, while the U.K. has dragged its feet on many aspects of European integration, it has been a powerful influence in steering the European Commission to adopt a policy that not only supports cross-border trade and right of entry for financial service firms within a single European market, but also encourages financial deregulation within each EC member country. The U.S. has employed bilateral trade negotiations with Japan and Korea to exert pressure on both countries to open their domestic financial service sectors to foreign entry and accelerate the pace of domestic financial deregulation. The aggressive U.S. policy favoring financial deregulation in other countries and removal of barriers to entry by multinational financial service firms is also manifest in the draft GATT treaty on trade in financial services produced by the Uruguay Round negotiations in late 1991.[ ⁽²⁾]

The U.S. has achieved perhaps its greatest success in its campaign for financial deregulation in other countries by means of the powerful leverage that it wields over the policies of the World Bank and the IMF. These multilateral institutions have actively encouraged many developing countries to deregulate their financial service sectors and in some cases have conditioned access to structural adjustment loans on adoption of financial deregulation policies.

III. Need for Prudential Control of Financial Institutions.

The rationale for financial deregulation is generally framed in terms of the superiority of free markets over government intervention.  However, sweeping application of free market principles to the financial service sector is unrealistic because it overlooks the irreducible responsibility of governments to maintain stability within financial markets and protect consumer funds entrusted to financial institutions. 

Moreover, recent experience with financial deregulation suggests that when the level of competition within the financial service sector increases, there is a tendency toward greater risk-taking by financial institutions, which in turn warrants more rigorous prudential control.  Hence, there is a basic paradox: financial deregulation that is successful in increasing competition is likely to create a need for stronger prudential regulation.

1. Competition and Risk-taking in Banking.

The recent experience of U.S. commercial banks provides strong evidence of the connection between competition and risk-taking in banking.  During the 1970s and early 1980s, large commercial banks in the U.S. lost many of their more profitable loan and deposit customers to competition from the securities industry.  Large corporations began to raise funds by issuing commercial paper (usually underwritten by securities firms) instead of borrowing from commercial banks, while many consumers with large deposit balances shifted their funds from deposit accounts at banks to money market mutual funds (managed by securities firms).  At the same time, the finance company affiliates of U.S. auto manufacturers began to provide the banks with stiff competition in the market for auto loans.  Finally, the integration of home mortgage loans into the capital market -- via the securitization pipeline -- brought a vast new supply of funds into the mortgage market and began to exert downward pressure on mortgage interest rates.

Faced with the prospect of shrinking market shares and declining profitability, many large U.S. commercial banks began to invest their funds in higher-yield loans that also carried greater credit risks -- in particular, loans to developing nations (in the late 1970s and early 1980s) and commercial real estate loans and loans to finance highly-leveraged corporate take-overs in the mid-to-late 1980s.  Although overshadowed by the spectacular collapse of the U.S. savings and loan industry, the adverse consequences of this assumption of increased credit risk by commercial banks have also been dramatic.  For example, over the last 15 years, the loss rate on the loan portfolios of large commercial banks has increased more than tenfold, rising inexorably from an average annual rate of approximately 0.14% in the 1975-80 period to a rate of 2.22% for the 3rd quarter of 1991.[ ⁽³⁾]  Prior to the late 1980s, the federal deposit insurance program had brought stability and a low bank failure rate to the U.S. banking system.  Between 1933, when the program was first established, and 1980, there were on average only 12 commercial bank failures per year.  By way of contrast, over the 1987-1990 period, the U.S. has experienced an average of 198 commercial bank failures per year.

The cost of resolving recent commercial bank failures in the U.S. has exhausted the reserve of the deposit insurance fund maintained by the Federal Deposit Insurance Corporation (FDIC) to insure deposits of commercial banks.  In November 1991, the U.S. Congress authorized the FDIC to borrow up to $30 billion from the U.S. Treasury to meet the cost of handling future commercial bank failures.[ ⁽⁴⁾]  Since it is not clear whether the banking industry will have sufficient earnings in future years to provide the FDIC with insurance premium revenues that are adequate to recapitalize the deposit insurance and at the same time enable the FDIC to repay its "borrowing" from the Treasury, this $30 billion loan authorization is already viewed by many observers as an implicit government bailout. 

A rising incidence of bank insolvencies can be seen in many other developed countries, although the trend is usually not as dramatic as in the U.S.  Even in countries thought to have more stable banking systems, there is evidence of growing stress among depository institutions.  For example, in late 1991 the cooperative banks in Germany had to inject DM 900 million in new capital into Deutsche Genossenschaftsbank, the $130 billion banking institution that serves as a wholesale and clearing house bank for Germany's cooperative banking sector.[ ⁽⁵⁾] In Switzerland, Spar und Leihkasse Thun, a medium-sized regional bank, abruptly collapsed in early 1992.[ ⁽⁶⁾]  As more countries pursue strategies of financial deregulation, the level of competition within their domestic financial service markets should rise and this in turn is likely to induce greater risk-taking by their depository institutions.

2. Competition and Risk-taking in Insurance. 

A similar relationship between increasing competition and a rising incidence of insolvency is manifest in the U.S. life insurance and property/casualty insurance industries.  A number of factors are working to increase competitive pressures within the U.S. insurance industry -- in particular, new technology, the desire of some insurance companies to improve efficiency by eliminating the use of insurance agents and relying instead on direct marketing, the entry of foreign insurance companies with expansionist ambitions, and growing efforts by banks to sell insurance products.

Additionally, U.S. insurance companies operate in an economic and social environment that poses major new risks for insurers.  Prime examples of such risks include the following: the rising incidence of fraud in the auto insurance market; new environmental liabilities faced by property insurers; financial market risks inherent in holding portfolios of many new life insurance products, such as long-term annuity contracts; and the increasing volatility of commercial real estate assets, which represent a major investment for many life insurance companies. 

The combined effect of increasing competition and a riskier operating environment have resulted in a growing number of failures in the U.S. life insurance and property/casualty insurance industry. For example, an average of 35 property/casualty companies failed per year during the 1988-90 period, compared to an annual average of only 10 failures during the 1969-1983 period.  Similarly, an estimated average of 35 life insurance companies failed per year during the 1989-1991 period, compared to an annual average of only 6 failures during the 1981-83 period.[ ⁽⁷⁾]

IV. Depositor Protection: Necessary but Potentially Costly. 

1. Depositor Protection Programs. 

National governments in more than 30 countries operate or sanction some type of program to protect depositors at banking institutions in the event of bank failure.[ ⁽⁸⁾] Wide variation exists in the administrative structure and coverage of these various national programs.  The majority were established in the 1980s, as banking insolvencies became more frequent in a growing number of countries. 

Even in countries where there is no depositor protection scheme and no legal obligation for government to rescue depositors of failed banks, national governments often feel compelled to step in and protect depositors when banks are failing, especially large or strategically important banks.  For example, in 1984 the Bank of England rescued the small, but internationally strategic, Johnson Matthey Bankers, even though it was under no legal obligation to do so.[ ⁽⁹⁾]  In 1990, the Australian federal government came to the rescue of the depositors of the troubled Victoria State Bank by requiring the Commonwealth Bank, a large bank owned by the federal government, to acquire Victoria State Bank. This indirect federal government bailout was arranged even though Australia did not have a government deposit insurance scheme.

In these situations, national governments and bank regulators are motivated by a number of considerations -- the need to maintain stability in domestic banking markets, the adverse political repercussions of allowing a large number of depositors to incur financial hardship, and a desire to protect the international competitiveness of their larger banks. 

The U.S. has a statutory deposit insurance scheme that provides each depositor with deposit insurance up to $100,000 at each bank in which the depositor maintains deposit funds -- although to a limited extent a depositor may obtain insurance coverage above $100,000 at an individual bank by means of multiple deposit accounts.  At larger commercial banks, typically one-third to one-half of deposit balances are above this $100,000 ceiling and thus are not formally insured, while the uninsured deposit ratio is much lower at smaller banks.  Notwithstanding the statutory ceiling for deposit insurance coverage, U.S. banking regulators have routinely handled the majority of bank insolvencies -- including all large bank failures and virtually all savings and loan failures -- by providing financial assistance to a healthy banking institution to acquire the failing institution and thereby assume all of its deposit liabilities, both insured and uninsured. The consequence of this failure resolution policy has been to afford on a de facto basis 100% deposit insurance protection to all depositors, at least with respect to larger commercial banks and savings and loans -- in contrast to the statutory protection of only $100,000 per depositor per institution.

A similar failure resolution dynamic was at work in Canada during the 1980s.  The Canadian government protected all of the depositors of two regional commercial banks that failed in the mid-1980s, even though the government deposit insurance program only covered deposits up to $60,000 Canadian.

For a number of years, economists have warned that expansive government deposit insurance schemes and failure resolution policies are likely to encourage risk-taking by banking institutions and that such risk-taking must be restrained by rigorous prudential supervision and regulation.[ ⁽¹⁰⁾] In a nutshell, comprehensive government deposit protection, by eliminating most of the incentive for depositors to worry about the financial condition of their bank, enables banking institutions with a taste for high-yield, high-risk assets to fund such assets with low-cost (riskless) deposits. When this strategy works, it reaps high profit for banking institutions; when it fails, most of the losses are borne by the deposit insurance fund or taxpayers.

2.  U.S. Savings and Loan Debacle.

The devastating collapse of the U.S. savings and loan industry proves powerful testimony to the danger of mixing broad-based deposit protection policies with weak prudential controls.  At the start of the 1980s, the U.S. had approximately 4,000 savings and loans with combined assets of approximately $600 billion -- roughly 25% of the total assets of all U.S. depository institutions.  Even though plagued by earnings problems and insolvencies, the savings and loan industry continued to grow during the early and mid-1980s, with its total assets peaking at $1,350 billion in 1988. Over the course of the last 10 years, roughly 1,500 savings and loans with combined assets of $500 billion have failed.  Reflecting the escalation of savings and loan failures over the last four years, the total assets of the savings and loan industry have declined from $1,350 billion in 1988 to only $890 billion toward the end of 1991.

The federal government has handled virtually all savings and loan failures in a manner that protects all of their deposit funds, primarily through government assisted mergers and acquisitions.  Failed savings and loans have held so many real estate loans in default and worthless real estate equity investments that the cost to the federal government of resolving insolvent savings and loans has on average been equal to about 30% of each failed institution's total assets.  Thus, the total cost of dealing with failed savings and loans has been roughly $150 billion measured on a present value basis -- 30% of the $500 billion in total assets of all failed savings and loans. 

The federal deposit insurance fund established for savings and loans was for all practical purposes bankrupt by 1987 or 1988 and most of the cost of the savings and loan bailout has been borne directly by U.S. taxpayers.  Since 1989, federal expenditures for savings and loan resolutions have been approximately $105 billion, and in February 1992 the Bush Administration asked Congress for an additional appropriation of $55 billion to complete the savings and loan bailout.[ ⁽¹¹⁾] When the projected interest cost of the U.S. Treasury borrowing that is necessary to finance the federal expenditure on failed savings and loans is taken into consideration, the ultimate taxpayer cost for the savings and loan bailout is likely to be in the neighborhood of $500 billion. 

The broad-based nature of the U.S. depositor protection scheme was a central factor in the savings and loan debacle.  During the late 1970s, sharp escalation of interest rates had caused large operating losses at savings and loans and eroded much of their capital base.  During the 1980s, several state governments -- most dramatically Texas and California -- and, to a lesser extent, the federal government granted broad new real estate investment powers to savings and loans.  At the same time, prudential supervision of savings and loans was reduced in the name of "deregulation."  In such circumstances, depositors should have viewed savings and loans as high-risk institutions -- they were thinly capitalized, their assets were becoming increasingly risky, and their regulators were growing increasingly lax.  Instead of exercising caution, depositors poured funds into savings and loans because government deposit insurance and failure resolution policies protected virtually all of their deposits from risk of loss.  As long as public confidence was maintained, near-insolvent or even insolvent savings and loans were able to continue their operations and even grow.  Indeed, aggregate deposits of all savings and loans increased from $500 billion at year-end 1980 to $930 billion by the end of 1987 -- a perverse market boom in an economically troubled industry.[ ⁽¹²⁾]

V. Irreducible Role of Government in Protecting Deposits.

The rationale for financial deregulation is generally framed in terms of the superiority of free markets over government intervention. However, sweeping application of free market principles to the financial service sector is unrealistic because it overlooks the irreducible responsibility of government to maintain stability within financial markets and to protect consumer funds entrusted to financial institutions.

1. Efforts to Roll Back Depositor Protection Schemes.

In the U.S., belated recognition that under certain circumstances broad-based government deposit insurance can lead to (1) increased risk-taking by insured depository institutions, (2) a higher failure rate among such institutions, and (3) greater failure resolution costs has led to a rising chorus of calls for a major rollback in the scope of the federal government's deposit protection program.  The basic premise underlying such thinking is that if depositors were exposed to the possibility of substantial loss in the event of bank failure, depositors would be far more alert concerning the financial condition of their bank and would generally avoid placing funds in high-risk banks.  In large measure, the campaign to roll back federal deposit insurance coverage reflects the belief that depositors can be more effective in disciplining excessive risk-taking by banking institutions than bank regulators.

Concern about the large governmental costs that can result from broad-based deposit protection schemes is not unique to the U.S. During the 1980s, Canada's government-sponsored deposit insurance organization, the Canadian Deposit Insurance Corporation (CDIC), was required to resolve 21 deposit institution failures with an estimated total cost of $4.7 billion Canadian.  Most of the institutions that failed were trust and loan companies and mortgage companies -- depository institutions chartered to serve housing finance needs.  By 1983, losses resulting from these failures had caused the CDIC to become insolvent.[ ⁽¹³⁾] 

In 1985 a review committee established by the Canadian federal government to examine the issue of deposit insurance reform recommended that the primary objective of the CDIC should be to insure small, unsophisticated depositors and that it should not bear any responsibility for protecting deposit balances above the official ceiling or the funds of other bank creditors.  The review committee came out strongly in favor of exposing uninsured depositors to risk of loss as a means of instilling effective market discipline at depository institutions.[ ⁽¹⁴⁾]

2. Too-large-to-fail Syndrome.

A major obstacle to implementing policies that would expose depositors to some level of bank failure risk is the extreme reluctance of banking regulators to stand by passively while a major bank defaults on its deposit liabilities.  This "too-large-to-fail" syndrome stems from a number of mutually reinforcing factors: fear that a large bank default could disrupt the payments system and cause serious liquidity problems at other banks; concern that a default by a major bank would impair the international competitiveness of the country's other large banks; and recognition that if a large number of depositors were victimized by a default, they might well have sufficient political influence to gain legislative redress.

The powerful hold of the "too-large-to-fail" syndrome in the U.K. was put succinctly in 1987 by Professors Mervyn Lewis of the University of Nottingham and Kevin Davis of the University of Melbourne:

There would be a public outrage if the Bank of England allowed one of the major banks or depository institutions to fail (whether there would be in the case of a minor institution is less clear).  Most customers and staff of the major clearing banks, we contend, are unaware even of the existence of a deposit insurance fund, let alone its limited coverage.  The perception of the general public is that banks are made "safe" by the Bank of England, and any attempt to shake that faith would lead to greater financial instability.[ ⁽¹⁵⁾]

Moreover, even where large banks are allowed to fail in the sense that their stockholders are wiped out, banking regulators are likely to employ failure resolution procedures that protect all of their deposit liabilities -- in essence, a "too-large-to-default" syndrome. 

The conjunction of statutory ceilings on the scope of deposit insurance coverage and the "too-large-to-default" or "too-large-to-fail" syndrome means that some depositors at small banks that fail are likely to suffer losses, while all depositors at large banks that fail will always be protected.  Such disparity in treatment between large banks and smaller banks is clearly in evidence in U.S. failure resolution policies.  In the U.S., all depositors at large failing banks are routinely protected, while in many instances small banks that fail are liquidated and their depositors paid only up to the amount of the statutory deposit insurance ceiling. 

The "too-large-to-default" syndrome has a number of important consequences which tend to be magnified by financial deregulation. The more competition in banking markets increases and the incidence of bank failure rises, the more smaller banks are competitively disadvantaged by the double regulatory standard inherent in the "too-large-to-default" syndrome.[ ⁽¹⁶⁾] Also, the more the scope of formal deposit insurance coverage is rolled back in the name of reducing government intervention in financial markets, the greater the disparity in treatment between large banks and smaller banks.

Further, in cases where the smaller banks that fail have served minority communities, the double standard implicit in the "too-large-to-default" syndrome is likely to engender strong sentiments of social discrimination.  For example, when Freedom National Bank, a small black-owned bank based in Harlem and Brooklyn in New York City, failed in 1990, the U.S. Federal Deposit Insurance Corporation (FDIC) liquidated the bank and left its uninsured depositors unprotected. Many of the unprotected deposits (balances over $100,000) belonged to social service and church organizations that served the low income black community. In a public hearing on the Freedom National Bank case, U.S. Congressman Charles Schumer of Brooklyn contrasted the FDIC's handling of Freedom National Bank with its treatment of National Bank of Washington, a much larger bank based in Washington, DC that had recently failed and had all of its depositors protected by the FDIC.

The National Bank of Washington's uninsured deposits which were made whole include those of foreign depositors and sophisticated speculators. The Freedom National's deposits, which will not be made whole, include those of churches, charities small and large, and organizations which provide social services, affordable housing and economic sustenance to the communities they and Freedom National serve.[ ⁽¹⁷⁾]

Grace Harewood, Executive Director of the Fort Greene Senior Citizens Council in Brooklyn, expressed local community sentiment in the following blunt terms:

The FDIC's unfortunate and destructive action is a classical action of institutional racism. It is apparent that the FDIC operates using a dual standard: one for the so-called rich and powerful and one for the so-called poor.[ ⁽¹⁸⁾]

The manner in which the recent failure of BCCI has been handled by the Bank of England suggests the working of a similar double standard. BCCI is being liquidated and a number of its depositors in the U.K. -- many of whom come originally from Third World countries -- may recover only 60% of their deposit balances.

In November 1991, the U.S. Congress enacted major banking reform legislation designed to strengthen the prudential supervision and regulation of banking institutions. Although the legislation eschewed any major rollback in the scope of statutory deposit insurance coverage, it does direct the bank regulators to limit their use of failure resolution procedures that provide de facto 100% deposit insurance protection.[ ⁽¹⁹⁾] However, these new failure resolution guidelines do not become effective until 1995 and the extent to which they will, in fact, circumscribe the "too-large-to-fail" or "too-large-to-default" syndrome remains unclear.

3. Core Bank Proposal.

In the 1991 deliberations by the U.S. Congress on banking reform legislation, the only seriously considered alternative to the current regime of broad-based, government-sponsored deposit insurance was a proposal to confine access to government deposit insurance to banking institutions subject to rigorous curbs on their risk-taking activities -- so-called "core banks" or "narrow banks." Under the proposal, core banks would be free to invest their deposit funds in government securities, consumer loans, home mortgage loans, and small business loans, but other types of lending, such as commercial real estate financing or corporate take-over financing, would be severely restricted. Also, core banks would not be permitted to pay interest on their deposit accounts at a rate greater than the prevailing interest rate on U.S. Treasury securities of comparable maturity.[ ⁽²⁰⁾]

The core bank proposal represented an effort to employ the government deposit insurance system to support the payments system and retail banking activities, and at the same time eliminate its exposure to higher-risk banking activities, such as commercial real estate lending, financing of corporate takeovers, international lending, and various off-balance sheet banking liabilities. On the negative side, the proposal would have reduced to some extent the capacity of banking institutions to serve the business and real estate sectors and the international competitiveness of large U.S. commercial banks. Also, if large banks were permitted to engage in high-risk activities without limitation in unregulated affiliates -- as the core bank proposal would have allowed -- it is unclear whether a core bank strategy would actually lower the overall risk exposure of the U.S banking system and the deposit insurance funds. In any event, the core bank proposal was opposed by the Bush Administration and most larger banks and was defeated on the floor of the House of Representatives.

4.  Depositor Insecurity and Bank Instability.

The inherent difficulty with reliance on depositor discipline is that it requires depositors to make sophisticated judgments about the financial condition of banks -- a subject about which as a practical matter it is difficult for them to obtain adequate information.  The awkwardness of being placed in this position inevitably leads to insecurity among depositors.  As shown by the historical experience of a number of industrial countries prior to the establishment of lender-of-last-resort facilities and deposit protection programs, banking environments characterized by depositor insecurity can quickly lead to bank runs -- i.e., the panicked withdrawal of deposits based on rumors that a bank may be unsound.

It has been suggested that the best answer to the dilemma of depositor protection and bank risk-taking lies in some type of partial deposit insurance scheme in which the risk of bank failure is shared between depositors and the deposit insurance fund. Yet it is difficult to see how such a compromise solution will solve the underlying problem.  Most depositors with funds at risk are likely to want to withdraw their funds as fast as possible, irrespective of whether their exposure to loss is 100%, 50%, or only 10%.  Moreover, since depositors are likely to take action only after a bank has been damaged by nonperforming loans, their response of rapid deposit withdrawal may well increase the likelihood that troubled banks will fail.  

5. Inability of Financial Markets to Judge the Quality of Bank Loans.

Beneath the surface appeal of relying on "depositor discipline" as a means for exerting prudential control over depository institutions and reducing the exposure of deposit insurance funds lie a number of inherent difficulties.  Research in the U.S. suggests that financial markets are not very effective in gauging the level of risk embedded in bank assets, especially loan portfolios.[ ⁽²¹⁾] Prices of bank stocks and ratings of bank debt securities have not proved to be good leading indicators of loan quality problems at banking institutions. 

This inability of financial markets to foresee loan problems or to gauge their true extent once they have become public knowledge should not be viewed as surprising.  The inherent risk and underlying value of bank loans is largely determined by a bank's credit underwriting policies and practices and the economic condition of individual borrowers.  Much of this information is not public information. This holds true even in the U.S., which has the world's most comprehensive financial reporting laws for depository institutions. 

Given the fact that financial market professionals have not been very successful in assessing bank risk on an ex ante basis -- i.e., before loan losses begin to mount -- it seems unrealistic to assign such a task to depositors at large (even high-balance depositors). Depositors in general have far less expertise and less time to devote to the matter than financial market professionals.

The task of judging the true financial condition of banks is further complicated by the huge increases in banks' off-balance sheet liabilities, such as those arising from credit guarantees or hedging interest rate risk and foreign exchange positions. Needless to say, it is very difficult for market analysts or depositors to assess the level of risk associated with a given bank's particular volume and mix of off-balance sheet liabilities. 

6. Role of Banking Institutions as Financial Intermediaries.

The lack of transparency of bank assets and the resulting potential for runs by depositors are characteristics that in large measure are intrinsic to the special role of banking institutions within the broader financial marketplace. Banking institutions engage in a unique form of financial intermediation. They transform savings and checking account balances held by the public (liquid deposits) into credit advanced to borrowers, both consumer and business, who do not have direct access to capital markets (illiquid loans).

Professor Charles Goodhart of the London School of Economics, who served as a Chief Adviser of the Bank of England from 1980-85, has described this unique intermediation role of banking institutions as follows:

The key difference between a collective investment fund and a bank is that the former invests entirely, or primarily, in marketable assets, while the latter invests quite largely in nonmarketable or, at least, non-marketed assets.... In this sense, the particular role of banks is to specialize in choosing borrowers and monitoring their behavior. Public information on the economic condition and prospect of such borrowers is so limited and expensive that the alternative of issuing marketable securities is either nonexistent or unattractive.[ ⁽²²⁾]

The capacity of banking institutions to transform liquid deposits into illiquid loans greatly increases the overall supply of credit available for productive uses. The liquidity-creating and productivity-enhancing role of banking institutions is one of the major reasons why banks are so vital to the economy. A recent study of deposit insurance by the U.S. Federal Deposit Insurance Corporation summarizes this role in the following terms:

Banks issue deposits that satisfy depositors' liquidity needs. By pooling liquidity risk across individuals, the bank will need to hold fewer liquid assets than the depositors would hold if they lacked access to the bank. To the extent that the bank can meet the liquidity needs with fewer liquid (and less productive) assets, there are more funds available to support productive illiquid investment.[ ⁽²³⁾]

It is this unique type of financial intermediation performed by banking institutions that underlies the lack of transparency of their assets. As Professor Mervyn Lewis of the University of Nottingham and Professor Kevin Davis of the University of Melbourne have observed:

But part of the rationale for bank intermediation lies in the existence of imperfect information. Banks have a special role as "inside lenders" based on specialized information about borrowers, so that it is difficult, if not impossible, for outsiders to assess accurately the riskiness of a bank's portfolio.[ ⁽²⁴⁾]

However, the very characteristics that make banking institutions such unique and potentially productive financial intermediaries -- portfolios of illiquid loans and extensive nonpublic information -- carry the potential for great instability. Because it is extremely difficult for depositors or even sophisticated market analysts to judge the quality of a bank's assets, there is inevitably a substantial degree of public uncertainty about the true financial condition of banking institutions. This underlying public uncertainty makes banks prone to deposit runs in the event of bad news or even rumors about their condition. Moreover, such deposit runs can quickly spread to other banks, a danger commonly referred to as contagion or systemic risk.

Professors Lewis and Davies have described the consequences of public uncertainty about banks as follows:

One observed characteristic of the banking system, in the absence of a perceived guarantee of deposit safety, is the vulnerability of individual banks to "runs" and the contagious nature of the "run" mentality.... Indeed, in an environment of imperfect information, a bank run is seen to be a logical outcome of a free banking sector, given the usual form of the deposit contract.[ ⁽²⁵⁾]

The inescapable conclusion is that if banks are to perform their special financial intermediation function effectively, government must provide some form of depositor protection. If such protection is not forthcoming, banking institutions will ultimately have to confine most of their assets to marketable securities in order to enhance their transparency and maintain the confidence of their depositors. However, such a shift in the composition of bank assets would adversely effect the availability of credit for many borrowers, especially small and medium-sized businesses, housing developers, and many consumers. As Arthur J. Murton, as staff economist at the U.S. Federal Deposit Insurance Corporation has observed:

One of the simple results is that, in the face of the threat of bank runs, depositors will require banks to hold more liquid assets than if bank runs were not a threat.... Ex ante, in a world without deposit insurance, the threat of bank runs reduces productive investment.[ ⁽²⁶⁾]

In short, this analysis indicates that banking institutions are heavily dependent on government support in performing their special financial intermediation function. Without government support in the form of implicit or explicit deposit protection and lender of last resort facilities, the capacity of banking institutions as financial intermediaries would be substantially diminished and their role within the broader financial marketplace would be greatly reduced. Accordingly, even in deregulated and fully privatized financial systems, banking institutions must still be viewed as creatures of government support.

7. Primacy of Prudential Control of Banking Institutions.

The central lesson that should be drawn from the recent banking difficulties in many countries is the primacy of prudential control. Prudential control is paramount because banking institutions are to an important degree insulated from market discipline -- due to their intrinsic nature, but also as a consequence of public policy. The factors behind this insulation include (1) the difficulties encountered by financial markets in evaluating the true quality of bank assets (lack of transparency), (2) the inherent fragility of banking institutions, (3) the economic necessity of maintaining stability within the banking system, and (4) the need to safeguard deposit funds for equitable and political reasons. When financial deregulation is undertaken, strong prudential control becomes even more important because deregulation increases both the opportunities and the incentives for risk-taking by banking institutions.

VI. Key Elements of Prudential Control.

For a system of prudential control to be robust enough to cope with the risks posed by financial deregulation the following components are essential.

1. Prohibition against High-Risk Activities.

Banking institutions should be prohibited from investing deposit funds in high-risk activities, such as real estate equity, real estate development loans where developers provide little equity, or even large volumes of junk bonds or equity securities. Recent U.S. banking experience has demonstrated dramatically the danger of allowing banking institutions to make such investments. Large losses on high-risk real estate loans and investments were the predominant cause of the massive wave of savings and loan failures during the last 7 years as well as most of the failures of larger commercial banks during the last 3 years.

In the early 1980s, savings and loans, especially savings and loans chartered under state law (as opposed to federal law), were authorized to make equity investments in real estate -- a high-risk investment activity which in the U.S. had traditionally been prohibited for both savings and loans and commercial banks. Analysis of the financial statements filed by all federally-insured savings and loans at year-end 1987 indicates that savings and loans with a substantial level of investment in real estate equity (greater than 3% of total assets) had a dramatically higher insolvency rate than those with no such investment. Among the 2,893 savings and loans based outside Texas, the insolvency rate was 8.6% for those with no investment in real estate equity, compared to an insolvency rate of 36.1% for savings and loans with a substantial level of real estate equity investment. Among the 279 savings and loans in Texas, the insolvency rate was 23.9% for savings and loans with no real estate equity investment and 66.1% for those with substantial real estate equity investment.[ ⁽²⁷⁾]

Real estate equity investments by savings and loans accounted for losses that were far greater than the amount of such investments themselves. Many loans made to support real estate equity positions proved to be improvident and imposed large losses. Equally important, the ability to combine lending and equity investment served as a powerful magnet drawing real estate developers to gain control of savings and loans with the aim of using deposit funds to support their real estate activities.

2. Curbs on Loans to Support Commercial Affiliates and Insider Loans.

Lending by banks to support their commercial affiliates or to their own insiders has been an important cause of problem loans and bank failures. According to a 1989 report by the World Bank, loans to firms within the same conglomerate as the lending bank have been an important source of loan losses. In fact, in Spain, Chile, Columbia, and Thailand, most bad loans were loans that had been made to affiliated or related firms.[ ⁽²⁸⁾] In the U.S., a 1988 study by the Comptroller of the Currency, the federal agency that supervises national banks, found that insider abuse, including loans to insiders, was a significant factor in 35% of national bank failures.[ ⁽²⁹⁾]

The danger inherent in lending to affiliates or insiders is that it subjects bank loan officers to pressures and influences that undermine their ability to exercise independent and balanced judgment in reaching credit decisions. For this reason, lending to affiliates and insiders should be prohibited, or it should be restricted and carefully monitored by bank regulators.

3. Capital Adequacy Requirements.

Equity capital at banking institutions provides a cushion to absorb losses and gives bank regulators more time to seek corrective action before insolvency occurs. Moreover, poorly capitalized banking institutions have a tendency to gamble on high-risk strategies because they have little equity to lose.

The international capital standards established for commercial banks in 1988 by the Basle Committee on Banking Regulations and Supervisory Practices provide a useful framework for addressing the capital adequacy issue.[ ⁽³⁰⁾] International capital standards are needed to prevent competition between large banks at the international level from driving capital ratios down to unacceptably low levels.

There are, however, serious technical problems with the Basle capital standards, especially their failure to distinguish between high-risk loans and low or moderate-risk loans and their indirect impact on the allocation of credit. Community and consumer organizations in the U.S. have sharply criticized a key risk-weighting provision of the Basle standards that requires banking institutions to maintain more capital for multi-family and non-standardized housing loans than for standardized or securitized home mortgage loans. In the U.S., this provision has discouraged some banking institutions from serving the housing finance needs of low and moderate income neighborhoods.

While technical adjustments are clearly needed, the overall level of capital required under the rules should be maintained or even strengthened. Countries that have not adopted the Basle standards (or higher standards) should be encouraged to do so.

4. Supervisory Examinations.

Bank regulators must have accurate and timely information on the financial condition of banking institutions if they are to identify and properly supervise problem banks and promptly dispose of failing banks by merger or liquidation. All too often, the financial statements prepared by banking institutions and submitted to their regulators do not accurately reflect the true financial condition of the banks. In some cases, blatant fraud is involved, but more often than not, bank management has merely taken advantage of the broad discretion inherent in financial accounting rules to avoid recognizing and reporting risk and loan losses.

In order to obtain accurate information on the condition of banking institutions, regulators must subject these institutions to in-depth, on-site examinations on a periodic basis. Such supervisory examinations are especially critical in evaluating the quality of a bank's loan portfolio and the adequacy of its loan loss provisions. Such examinations need to be frequent because banking institutions are inherently fragile and their financial condition can deteriorate rapidly.

Recognizing the vital importance of supervisory examinations, the banking reform legislation recently enacted by the U.S. Congress requires the federal bank regulators to examine each large and medium-sized banking institution at least once every 12 months and each small bank (assets less than $100 million) at least once every 18 months.[ ⁽³¹⁾]

In a number of countries, there has been a tradition of relying on audits by independent public accountants in lieu of supervisory examinations conducted by the bank regulators. While audits by public accountants undoubtedly have a useful role to play in the monitoring process, they should not be seen as a substitute for on-site examinations by bank regulators who bear ultimate responsibility for the condition of the banking system.

5. Accounting Rules and Loan Loss Provisions.

One of the most serious weaknesses in prudential control has been the failure to devise special accounting rules for banking institutions that will give a realistic picture of their financial condition. To some extent this weakness is a consequence of the underlying nature of banks loans. As described above, many bank loans are originated on the basis of nonpublic information and not readily traded in financial markets. When loans of this nature become problem loans, it is very difficult to judge their true market value. Hence, assessing the value of a bank's problem loans and the adequacy of its specific loan loss provisions is an inherently complex and judgmental process.

Another accounting weakness has been the failure to require banking institutions to set aside general loan loss reserves that adequately reflect the level of risk embedded in loans when they are first made. Under existing practices, such general loan loss reserves tend to be much smaller than any realistic projection of likely future loan losses, especially when the banking institution is engaged in high-risk lending. This reflects a failure to link general loan loss provisions to the level of risk associated with different types of loans. In many respects, this accounting shortcoming parallels the failure of the risk-based capital rules to adequately consider the different levels of risk associated with different categories of loans.

In the U.S., the adoption of lax accounting rules for savings and loans was one of the principal techniques by which savings and loans and their regulators masked the growing number of savings and loan insolvencies during the 1980s. More recently, all depository institutions in the U.S. have been required to follow generally accepted accounting principles (GAAP). However, the U.S. General Accounting Office, the auditing arm of the U.S. Congress, has sharply criticized GAAP rules as applied to banking institutions on the ground that they give bank management and its independent public accountants far too much latitude to delay the recognition of loan losses.[ ⁽³²⁾]

Special accounting rules are needed for banking institutions that (1) provide clear guidance for estimating the level of risk associated with different categories of loans when they are originated and require a bank to establish general loan loss reserves that adequately cover this risk, (2) provide clear guidance for determining when bank loans should be classified as "problem loans" on which some loss is probable, and (3) provide clear guidance for estimating the likely level of losses on problem loans and require a bank to establish special loan loss provisions that reflect this estimated loss. In view of the large exposure of deposit insurance funds, government, and ultimately taxpayers when banks fail, the special accounting rules for banking institutions should lean in favor of recognizing risk and loss. Application of these rules to individual banking institutions should be a key part of the on-sight supervisory examinations conducted by the bank regulators.

6. Prompt Supervisory Action.

Bank regulators should be not just empowered, but also mandated to take prompt supervisory action against problem or failing banking institutions. The concept of prompt supervisory action can be summarized as follows. In the case of a problem bank, the regulator should forcefully curb risky activities and require a capital infusion to the maximum extent feasible. In the case of an insolvent or near-insolvent bank, rather than allowing the institution to continue to operate under its current management, the regulator should promptly arrange a take-over by a healthy banking institution, place the failing bank under government control, or liquidate the failing bank.

The failure of bank regulators in the U.S. to use their discretionary powers to force problem banks to take corrective measures and to promptly dispose of failing banks has been well documented.[ ⁽³³⁾] Recognizing this weakness, the banking reform legislation enacted by the U.S. Congress in 1991 established a set of prompt supervisory action requirements that are triggered by a progressive decline in a bank's capital ratio.[ ⁽³⁴⁾]

A central lesson of the savings and loan debacle in the U.S. is that the longer bank regulators delay disposition of insolvent banking institutions, the greater the ultimate cost to the deposit insurance fund. The most grievous public injury comes not from bank failures per se, but from bank failures which impose high resolution costs on deposit insurance funds.

If financial deregulation succeeds in increasing competition, then some bank failures would seem to be inevitable. Hence, a mandate for bank regulators to promptly dispose of failing banking institutions is especially important in deregulated financial markets.

7. Public Disclosure of Comprehensive Financial Statements.

Banking institutions, especially large commercial banks, should be required to publicly disclose comprehensive financial statements, including both balance sheet and income statement information. At present, in the vast majority of countries, the financial statements disclosed to the public by banking institutions are woefully inadequate. These financial statements generally fail to include key income statement information, especially interest income data, nonaccrual loan data, and loan charge-off data for different categories of loans and interest expense and fee income data for different categories of deposits.

In many industrial countries, the bank regulators do, in fact, require banking institutions to submit detailed financial information, but this information is not made available to the public. This practice stems from a tradition of regulation-in-secrecy among bank regulators that is inappropriate in an era of financial deregulation. While it is true that bank regulators remain ultimately responsible for monitoring and supervising banking institutions, it is, nonetheless, a mistake to withhold comprehensive financial statement information from the public. Most importantly, lack of public access to this information makes it all but impossible for anyone, including national legislatures, to monitor the performance of the bank regulators on an ongoing basis -- a consequence that is undoubtedly not lost on many bank regulators. Additionally, investors in bank equity and debt securities have a right to this information, and the public markets for bank equity securities would function more efficiently if such information were disclosed.

In the U.S., banking institutions are required by both federal banking law and federal securities law to make public detailed financial statements. In fact, virtually all of the financial statement information submitted on a regular basis by banking institutions to the bank regulators is made available to the public.[ ⁽³⁵⁾]

8. Public Disclosure of Supervisory Actions by Bank Regulators.

Bank regulators should be required to make public their supervisory actions, such as orders or agreements directing banks to cease risky practices or raise additional capital. Bank regulators have traditionally viewed such supervisory actions as strictly confidential. However, the resulting lack of transparency in the bank supervision process has made it exceedingly difficult for the legislative bodies that empower bank regulators and the public at large to monitor and evaluate the performance of the regulators. The lack of transparency in bank supervision means that the bank regulators are not publicly accountable for their actions on an ongoing basis. Further, lack of public disclosure of supervisory actions makes it difficult to determine whether supervisory inaction has been an important factor in bank failures and deposit insurance fund losses.

Additionally, the wall of secrecy surrounding supervisory actions tends to insulate the regulators from direct public pressure to take forceful supervisory action. Such pressure is needed to counterbalance the inevitable chorus of pleas from banking institutions for leniency and forbearance.

In the U.S., lack of transparency in the bank supervision process has come to be viewed as a key factor contributing to the reluctance of bank regulators to take prompt supervisory action. With this in mind, the U.S. Congress in 1989 directed the federal banking regulators to make public their enforcement orders.[ ⁽³⁶⁾] More recently, U.S. banking regulators have begun to make public many of their supervisory agreements with problem banking institutions. Further, in 1991 the Congress directed each federal banking regulator to prepare a report reviewing its supervisory actions in each case where a bank failure results in a material loss to the deposit insurance fund. Congress also mandated that these reports be made available to the public.[ ⁽³⁷⁾]

VII. Need for Vigorous Antitrust Policy.

Financial deregulation must be accompanied by a vigorous competition (antitrust) policy if the underlying goal of enhancing price competition is not to be undermined by a rising level of concentration and the formation of anticompetitive structures within financial service markets. The experience to date suggests that financial deregulation can set in motion forces leading to waves of bank mergers that sharply increase concentration within the banking sector. The Netherlands and Denmark provide stark examples of this pattern, but the trend is manifest in many different countries, including Australia and the Unites States.

1. Lack of Economies of Scale in Banking.

Without question, mergers between large banks that serve the same or overlapping markets -- known as horizontal mergers -- reduce the level of competition. But they are often justified on the ground that they will improve bank efficiency. Yet a broad body of economic research conducted in the U.S. over the last 30 years suggests that there are no inherent efficiencies resulting from bigness in banking. This research indicates that once a bank achieves a size of $100 million to $500 million in total assets -- the size of a robust community bank -- there are no significant economies of scale resulting from additional growth in size. The U.S. Federal Reserve Board recently summarized this research as follows:

In general, these studies have not found evidence of a significant cost advantage on the part of larger banks. They find that economies of scale, if they exist, are very small, and most studies do not show such scale economies to exist beyond a small to medium sized bank. Thus, this line of research has not provided strong evidence suggesting that large mergers in general can be counted on to achieve substantial cost savings.[ ⁽³⁸⁾]

The lack of economies of scale in banking has important implications for competition policy vis-a-vis the banking sector. Most pointedly, it means that large banks that propose to merge in the name of greater efficiency should be able to achieve the same improvement in efficiency without merging. Indeed, a comprehensive study of 134 bank mergers recently prepared by the Federal Reserve Board found that no more than one merged bank out of ten managed to increase its profitability relative to banks that did not merge.[ ⁽³⁹⁾]

Thus, the empirical evidence suggests that (1) bank mergers are not necessary to achieve greater efficiency and (2) bank mergers are not likely, in fact, to result in efficiency gains. In light of this evidence, proposed mergers between two large banks that would have significant anticompetitive effects should not be approved on the ground that the anticompetitive effects are likely to be outweighed by gains in efficiency. The anticompetitive effects are clearly predictable, while the efficiency gains projected by bank merger applicants are speculative and run counter to the great weight of the evidence. This analysis suggests the need for special antitrust standards for the banking sector that are in general more restrictive than those applied to the manufacturing sector, where significant economies of scale may be present.

A key factor fueling many recent bank mergers is the process of financial deregulation itself. As financial markets are deregulated, banking institutions often face increased competitive pressure and are more prone to make mistakes and become problem banks. Quite often, problem banks will seek to escape from their difficulties by selling out to a healthy bank. For example, large loan losses were the primary reason why Security Pacific (U.S.) was willing to be acquired by BankAmerica and why Midland Bank (U.K.) is currently the object of acquisition bids from Hongkong & Shanghai Banking Corporation and Lloyds Bank.

When a large bank encounters difficulties, antitrust standards should not be put aside out of fear that the only way to avoid a messy bank failure is to permit another large bank to acquire the problem bank. Anticompetitive effects can be minimized by dividing the branch network of the large problem bank into separate components and selling each component to a different bank. To a modest degree, this was the policy followed by U.S. banking and antitrust regulators in the recent BankAmerica acquisition of Security Pacific. Before the regulators would approve the acquisition, BankAmerica had to agree to divest 220 branch offices out of a pre-merger total of 2,512 branch offices for BankAmerica and Security Pacific combined.[ ⁽⁴⁰⁾]

2. Depositor Protection and Competition Policy.

The "too-large-to-fail" syndrome is another important factor that encourages concentration in banking markets. In countries that lack government-sponsored deposit insurance schemes or where such schemes provide only limited coverage, the "too-large-to-fail" syndrome provides an important competitive advantage to large banking institutions. In such countries, consumers are wise to place their deposit funds in one of the larger banks on the assumption that the deposit base of a very large bank will invariably be "protected" if problems should arise. On the other hand, when deposit funds are placed in a smaller bank, the risk of deposit loss in the event of bank failure cannot be safely ignored. This disparity gives large banks an advantage in attracting deposit funds that has nothing to do with economic efficiency or better service. In essence, it represents a spurious "economy of scale" that stems from supervisory policies that discriminate against smaller banking institutions.

Viewed from this perspective, broad-based deposit protection should be seen not just as a consumer protection measure, but also as a key component of competition policy. If deregulated banking markets are to provide a level playing field in which small depository institutions -- community banks, credit unions, credit cooperatives -- compete on equal terms with giant banks sheltered by the "too-large-to-fail" syndrome, then a broad-based deposit protection scheme must be established for depository institutions of all sizes.

In the U.S., the existence since the 1930s of a broad-based federal deposit insurance program has been a major factor in the continued vitality of small banks. At present, the U.S. has approximately 9,000 small, community banks with assets of $100 million or less. Since these banks are clearly not protected by the "too-large-to-fail" syndrome, their depositors would bear far greater failure risk than depositors of large banks in the absence of the federal deposit insurance program.

In Hong Kong, which does not have a deposit protection scheme, the leading consumer organization has recognized the vital link between deposit protection and competition policy. According to Professor Edward K. Y. Chen, Chairman of the Hong Kong Consumer Council:

Discrimination in dealing with bank failures will result in unfair competition in the banking sector when there is a crisis of confidence in the banking system. If there is no DPS [deposit protection system], people will tend to transfer their deposits from small banks to large banks, believing that these will not be allowed to fail.[ ⁽⁴¹⁾]

3. Concentration, Deregulation, and High Costs for Consumers and Small Business.

Both economic theory and empirical research indicate that high levels of concentration in banking markets result in higher loan costs and lower deposit yields for bank customers. After reviewing 34 major studies of the relationship between concentration and prices in U.S. banking markets, Professor Leonard Weiss of the University of Wisconsin observed:

The general conclusion seems obvious to me. Selling prices rise with concentration, and buying prices fall with concentration. The banking industry, which has produced about as many concentration-price studies as all the other industries put together, yields massive support for the prediction of conventional oligopoly theory.[ ⁽⁴²⁾]

Moreover, there are special reasons why concentration in deregulated banking markets can prove disadvantageous to consumers and small businesses. Retail banking and wholesale banking are in many respects different lines of business which operate in very different markets. Wholesale banking markets -- i.e., services for large corporations, large-scale real estate projects, institutional investors, governments, and inter-bank markets -- are national or global in scope, highly competitive, often entail high risks, and can result in large losses for banking institutions. On one hand, many wholesale banking markets provide only narrow profit margins in the best of times; when things go wrong, they can inflict heavy losses. On the other hand, retail banking markets -- which center on services for consumers and small businesses -- tend to be local in nature, generate only limited price competition, and entail comparatively low and relatively predictable levels of risk. As a result, retail banking markets usually provide high profit margins to banking institutions.

Banking institutions in almost all countries do not make public profitability data for their different lines of business, and thus it is difficult to measure with precision the difference in profit levels between wholesale and retail banking activities. Nonetheless, there is mounting evidence which indicates that financial deregulation tends to lower profit margins on wholesale banking activities, while leaving profit margins on retail banking activities relatively unchanged or even rising. In fact, where large banks have suffered major losses on their wholesale banking operations, the evidence suggests that they tend to increase profit margins on their retail activities in order to offset their wholesale losses.

Professor Ross Milbourne and Matthew Cumberworth of the University of New South Wales recently examined the net interest margins for the wholesale and retail banking operations of Australian banks as financial deregulation unfolded during the 1980s. The net interest margin represents the spread between loan rates and deposit rates. They found that:

Despite the fall in wholesale margins, retail margins continued to rise over the decade by an average of 0.2% per year. Thus, retail customers found the differential 2% more in 1990 than in 1980.... Corporations have gained the most from deregulation, facing constant or smaller interest margins at greater risk factors. Retail customers have correspondingly lost from deregulation.[ ⁽⁴³⁾]

The annual reports of a number of large U.S. banking organizations that straddle both consumer and wholesale banking markets indicate that high profits from consumer banking operations have been used to cushion losses resulting from high-risk wholesale banking activities, including Third World lending and the financing of commercial real estate development and corporate take-overs. For example, Citicorp reported that in 1990 its consumer banking operations provided net income of $979 million, while its wholesale banking operations resulted in a loss of $423 million. Similarly, Chase Manhattan reported for 1990 a net income of about $400 million on its retail banking operations (consumer and small business), but a loss of $734 million on its wholesale banking activities.

The U.S. Federal Reserve Board has reported that during 1990 large bank credit card issuers in the U.S. achieved an average pretax rate of return on their credit card portfolios (ROA) of 3.69%.[ ⁽⁴⁴⁾] This stands in sharp contrast to the average pretax rate of return on total banking assets of 0.56% achieved by larger U.S. banks in the same time period.[ ⁽⁴⁵⁾]

4. Diversification and Cross-Subsidization.

In the U.S., it has been suggested that consolidation of many of the nation's 12,000 commercial banks into a relatively small number of giant banks with nationwide retail branch networks would, by virtue of asset diversification, reduce the level of risk at individual banks and the incidence of bank failure. Yet a policy of encouraging large banks engaged in major wholesale banking operations to acquire extensive retail branch networks would maximize the capacity of such banks to extract high profits from consumers and small businesses in order to cover losses in wholesale banking markets.

Viewed in this light, such "diversification" is to a considerable degree really cross-subsidization at the expense of consumers and small businesses. Such cross-subsidization may, in fact, reduce the incidence of bank failure, but it accomplishes this goal by an extremely regressive means. In deregulated financial markets, the consumers and small businesses who bear the brunt of cross-subsidization tend to be those who have the least bargaining power and are often among the less affluent or economically disadvantaged. A far more direct and equitable approach to curbing the incidence of bank failure is to strengthen prudential control of wholesale banking activities.

To summarize, whenever financial deregulation is undertaken, competition policy vis-a-vis the banking sector needs to be invigorated and assigned a high priority. Competition policy for a deregulated banking sector should adopt and implement the following concepts. First, mergers between large banks that would have anticompetitive effects should be rejected. Second, regulatory policy should foster a structurally diverse banking sector that includes a mix of large banks and smaller, community-based depository institutions to prevent domination of retail banking markets by giant commercial banks. Third, explicit deposit protection should be available to depository institutions of all sizes and should be recognized as vital to establishing a level playing field for large and small institutions.

VIII. Access to Basic Financial Services for Disadvantaged Consumers, Small Businesses, and Communities.

Access to basic financial services (credit, savings, payment, and insurance) has long been recognized as essential to effective participation by individuals and small enterprises in a modern market-based economy. For this reason, governments in many different countries over the years have pursued a variety of strategies designed to ensure that disadvantaged segments of society have access to basic financial services. Traditional examples of this policy would include (1) the provision of savings account and payment services by government postal systems, (2) government support for a host of public-purpose credit and deposit institutions, and (3) government-sponsored insurance pools that provide coverage to high-risk individuals.

1. Erosion of Access for Disadvantaged Sectors.

Financial deregulation (especially banking deregulation) threatens to undermine some of the traditional access mechanisms and, more generally, exacerbate the problem of access to basic financial services by disadvantaged sectors.

A number of subtle forces underlie this trend toward reduced access. First, the worldwide trends toward privatization of banking institutions and elimination of formal credit allocation schemes undercut the ability of governments to directly control the price and availability of banking services for disadvantaged sectors. Second, banking institutions operating in deregulated financial markets tend to be less inclined to serve low and moderate income depositors, since they present fewer profit opportunities, and more inclined to raise fees and service charges on deposit and payment services for such customers. Third, when banking institutions are under pressure to extract additional profit (or cut operating costs) from their retail banking operations, the brunt of the ensuing fee increases or service cuts tends to fall on individuals and businesses with the least bargaining power -- who are often the ones who can least afford to pay more or are most affected by service cuts. Hence, new and robust access mechanisms are clearly needed to ensure that financial deregulation, including privatization, does not undermine access to basic financial service by disadvantaged sectors.

2. Access Mechanisms in Deregulated Banking Markets: The U.S. Experience.

One important access mechanism that has great relevance to deregulated banking markets is the U.S. Community Reinvestment Act (1977). This law subjects banking institutions to an affirmative obligation to serve the credit needs of the disadvantaged sectors within their communities, especially low and moderate income and minority neighborhoods.

A second, closely-related access mechanism in the U.S. is the Home Mortgage Disclosure Act (1975), which requires banking institutions to publicly disclose information on the geographic distribution of their home mortgage loans. Such public disclosure of loan data indicating the performance of banks in serving the housing credit needs of disadvantaged neighborhoods has proved to be indispensable in implementing the affirmative obligation standard of the Community Reinvestment Act.[ ⁽⁴⁶⁾]

A third mechanism recently enacted by the U.S. Congress requires banking institutions to publicly disclose information on the scope of their small business lending.[ ⁽⁴⁷⁾] This disclosure requirement reflects public concern that smaller firms, especially start-ups, young firms and minority-owned firms, may not have adequate access to credit.

Consumer and community organizations in the U.S. have sought federal legislation that would require banking institutions to offer low cost or no fee savings and checking accounts -- commonly referred to as basic banking services. Although no federal legislation has been enacted in this area, access to basic banking services has been raised as an issue by local community organizations lodging protests under the Community Reinvestment Act, and many agreements negotiated between banks and such organizations contain bank commitments to provide basic banking services.[ ⁽⁴⁸⁾] Moreover, during the 1980s, a number of states, including Massachusetts, Illinois, Rhode Island, Connecticut, and Minnesota, enacted laws requiring banking institutions to provide various types of basic banking services.[ ⁽⁴⁹⁾]

3. Access Mechanisms in Developing Countries.

Another important access mechanism arising in a very different context is provided by the regulatory requirements or procedures employed by a number of developing countries to encourage banking institutions to open branch offices in underdeveloped rural sectors. For example, in Thailand and Malaysia, the central bank requires commercial banks seeking approval to open branch offices in high-growth urban areas to make commitments to open branch offices in less developed rural areas.

For many developing countries, banking deregulation entails the elimination or winding down of formal credit allocation schemes (loan portfolio requirements and interest rate controls) that have traditionally been employed to steer credit to priority sectors, such as small business, housing, and rural areas. In these countries, it will be important to replace the discarded credit allocation rules with new, more flexible access mechanisms. With appropriate modification, some of the access mechanisms employed in industrial countries -- such as the Community Reinvestment Act and the related home mortgage loan and small business loan disclosure provisions -- have relevance for developing countries that deregulate their banking systems. Conversely, access mechanisms established in developing countries may provide useful models for industrial countries, such as the U.S., that seek to revitalize inner-city neighborhoods and promote minority-owned small business.

Many surprising parallels exist between industrial and developing countries when it comes to strategies to mobilize banking institutions to serve access goals in deregulated financial markets. Whether the objective is to promote low-cost housing and minority-owned enterprise in the inner-city neighborhoods of North America or small business start-ups and rural economic development in Indonesia and Thailand, the commitment desired of banking institutions is often the same -- the provision of technical expertise, cooperation with NGOs, participation in government loan guarantee programs, and willingness to absorb some of the above-average administrative costs that are generally associated with community development lending.

4. Access Requirements: Quid-Pro-Quo for Government Support.

In the U.S., the affirmative obligation standard of the Community Reinvestment Act has been interpreted to mean that banking institutions have an obligation to (1) offer the type of credit services required by the disadvantaged sectors of their local communities, (2) engage in affirmative marketing of these services, and (3) absorb some administrative costs or price some services at cost. This affirmative obligation standard is viewed as an appropriate quid-pro-quo for the extensive government support provided to banking institutions in the form of explicit or implicit protection of deposits, the central bank's lender of last resort facility, and exclusive or privileged access to the payments system. It is important to recognize that even when banking systems are deregulated and privatized, such government support remains vital to the proper functioning of banking institutions. Thus, the worldwide trend toward financial deregulation and privatization should not be seen as undercutting the validity of subjecting banking institutions to some duty to respond to the banking needs of disadvantaged sectors or sectors in need of economic and community development.

IX. Consumer Information Needs.

1. New Hazzards for Consumers.

Financial deregulation creates many new product options for consumers, but also introduces new consumer hazards. Financial institutions often respond to the new opportunities and increased competitive pressure stemming from deregulation by adopting aggressive marketing techniques. Advertizing and promotional material is often designed to obscure the cost of financial service products, especially credit. Hidden fees and the bundling of financial services into complex packages are common tactics. Financial institutions in general adopt more liberal credit standards and many credit institutions become willing to lend to consumers with high debt burdens. As a consequence, the default rate on consumer loans (including home mortgage loans) tends to rise with financial deregulation. For example, the Bank of England reports that the mortgage default rate in the U.K. has risen from an average of about 0.4% during the 1970s to a rate in excess of 2.5% in 1991.[ ⁽⁵⁰⁾]

Financial deregulation should be accompanied by strong consumer protection measures designed to provide consumers with adequate information on financial service products and to curb unfair contract terms and practices. However, it is doubtful that the conventional approach to consumer information needs -- product cost and term disclosures provided to the consumer by the financial service provider at the point of sale -- is adequate to the task of informing consumers in deregulated financial service markets. As financial service products become more differentiated and complex, conventional disclosure requirements are increasingly likely to omit key information or, alternatively, overload the consumer with information at the point of sale. Financial service firms are in a position to readily blunt the utility of specific disclosure requirements by redesigning or bundling financial service products. Regulatory and legislative bodies are notoriously slow in modifying disclosure requirements to catch up with innovations in financial service products.

2. Consumer Information Deficit.

Retail financial service markets have been characterized by consumer information gaps -- a chronic problem that is exacerbated by financial deregulation. The information deficit on the consumer side of the market stems from both consumer inertia and consumer ignorance -- the failure to engage in comparison shopping and the failure to examine or understand product terms and characteristics. As economic theory suggests, the failure of consumers to make informed decisions (imperfect information) translates into market power for financial service firms that are skilled in exploiting this weakness and is a primary reason why retail financial service markets have higher profit margins than wholesale financial service markets.

Even in countries with detailed consumer disclosure requirements and a large number of institutions competing in retail financial service markets, there is pervasive evidence of a consumer information deficit. For example, in the U.S. there are more than 4,000 credit card issuers, and a number of these offer credit cards at comparatively low interest rates. Yet, card holders have failed to switch to lower-rate cards, and the rate of return on bank credit cards is far in excess of the general rate of return on bank assets.[ ⁽⁵¹⁾] Moreover, one reason why retail deposits are valued so highly by banking institutions is that many consumers are extremely sluggish in responding to price signals in deposit account markets.

Perhaps the most dramatic example of the consumer information deficit in the financial service area is provided by life insurance products. According to a 1985 report issued by the U.S. Federal Trade Commission, 80% of consumers with life insurance policies have not shopped for life insurance, while another 18% of these consumers have not shopped effectively. In other words, only 2% of consumers with life insurance policies have engaged in effective comparison shopping.[ ⁽⁵²⁾] In a similar vein, a survey undertaken by the U.K. Office of Fair Trading in 1985 found that only 10% of consumers who had purchased life insurance policies had personally engaged in comparison shopping.[ ⁽⁵³⁾]

3. Need for Collective Information Systems.

What is needed in an era of financial deregulation is a new, collective approach to consumer information that emphasizes the systematic collection and analysis of comparative price and term information on financial service products and the dissemination of such information to individual consumers. To this end, collective information systems should be established to provide financial service consumers with (1) comparative price and term information (shoppers guides) for various financial service products; (2) computerized shopping programs that will scan the market for a specified type of financial service product and select the best buy for a given consumer, taking into consideration the consumer's financial characteristics; and (3) brochures and other publications providing analysis and advice about various financial service products offered in the market.[ ⁽⁵⁴⁾]

A collective information system for financial service products would dramatically reduce the search costs faced by individual consumers and would be in an excellent position to employ new computer and telecommunications technology directly to serve consumer information needs. Such a system could respond promptly to the introduction of new financial service products and could provide consumers with sophisticated evaluations of various products -- the kind of evaluation that is often needed to adequately assess inherently complex financial service products.[ ⁽⁵⁵⁾]

To be operationally efficient, a collective information system would need to be supported by a legislative or administrative framework that would give it ready access to current price and term information on various banking, credit, and insurance products offered by financial service firms. For example, such firms could be required to report this price and term information directly to the collective information system.

A collective information system should ultimately be able to generate enough revenues from membership dues and other fees to achieve self-sufficiency or close to it. However, during its start-up and early years of operation, it is likely to need a modest level of government support. Such support is especially important if the collective information system is to provide adequate information services to low and moderate income persons -- the persons who often have the most pressing information needs and the least capacity to pay fees.[ ⁽⁵⁶⁾]

A collective information system should be constituted as a consumer membership organization, democratically controlled by its consumer members -- i.e., a financial consumers association. Such consumer control through a democratic structure should impart to the system both a strong incentive to serve consumer information needs and a high degree of political independence.

One way to establish a collective information system would be for the national government to (1) charter a financial consumers association, (2) prescribe democratic rules of governance for the association, (3) provide the association with direct access to price and term information for various financial service products, (4) provide the association with a modest level of support, and (5) subject the association to a special obligation to serve the financial service information needs of low and moderate income persons.

X. Need for Consumer Participation to Create Adequate of Safeguards.

The available evidence suggests that financial deregulation will not provide sustainable net benefits to consumers on the whole without a comprehensive set of safeguards with respect to prudential control, competition policy, access concerns, consumer information, and consumer protection. Absent adequate safeguards in these areas, financial deregulation is likely to have the following adverse consequences: (1) an undesirable level of concentration within retail financial service markets; (2) periodic cycles of excessive risk-taking by banking institutions in wholesale banking markets followed by large loan losses, with most of the cost of absorbing these losses born by consumers and small business; (3) high profits in retail financial service markets stemming from the failure of consumers to shop effectively, with most of these profits captured by firms with dominant market positions and firms with aggressive, non-price marketing strategies; and (4) reduced access to banking services for consumers in low and moderate income neighborhoods and rural areas and small business in general. In a nutshell, financial deregulation without an adequate framework of safeguards provides aggressive banking institutions with a license to pursue high-risk strategies in high-prestige wholesale banking markets and then, when problems arise, dump the costs on their consumer and small business customers or even taxpayers.

The nature of the required safeguards is such that it is unlikely that they can be established and effectively implemented without active participation by consumer and local community organizations. Several factors work to elevate the importance of NGO participation in the safeguard process.

1. Advocacy by NGOs and the Adoption of Safeguards.

Most of the necessary safeguards are strongly opposed by powerful forces within the banking industry and garner little support from bank regulators or Treasury ministries or departments. Banks generally oppose strong antitrust standards, access requirements, many consumer protection measures, and even some important components of prudential reform, such as greater financial disclosure, prohibitions on high-risk activities, and more disciplined accounting rules. Bank regulators generally oppose prudential reforms that would enhance the transparency of the supervisory process or mandate prompt and forceful supervisory action. Bank regulators tend to be biased against strong antitrust standards because they are far more interested in maintaining the stability of banking institutions than in promoting vigorous competition within the banking system. Banking regulators also are generally unsympathetic to access safeguards. In many industrial countries, the Treasury ministries or departments, which usually are charged with drafting banking legislation, do not support most of the necessary safeguards. For example, the sweeping financial deregulation proposal advanced by the U.S. Treasury Department in 1991 ignored the need for access, consumer information, consumer protection, and antitrust safeguards, and the prudential safeguards that it proposed were extremely weak.[ ⁽⁵⁷⁾] Faced with opposition from such powerful quarters, adequate safeguards are not likely to be established unless they are championed by NGOs and have broad public support.

2. Participation by NGOs in the Implementation of Safeguards.

Active participation by consumer and local community organizations is important in the implementation of safeguards on financial deregulation -- a process that is quite distinct from the initial establishment of such safeguards. Most of the necessary safeguards do not provide black letter law instructions to the regulators, but instead give them wide latitude in the implementation process. Thus, once established, the safeguards are not self-executing, but rather depend on the exercise of discretion by regulators who at best are not well informed about many of the concerns underlying the safeguards and may not be sympathetic to the underlying purposes of the safeguards. Consequently, there is great need for continuous monitoring of the bank regulators and advocacy for rigorous implementation of the safeguards -- especially to offset pressures for tepid implementation emanating from the banking industry. Since the safeguards touch upon a broad range of consumer and local community interests, it is natural to look to consumer and local community organizations to perform a monitoring and advocacy role.

Several key safeguard mechanisms require extensive participation by consumer or local community organizations in order to function properly. The collective information system -- the key to effective participation by consumers in deregulated financial markets -- is in its very essence a consumer participation process and should be lodged within a consumer organization. Access mechanisms such as the Community Reinvestment Act require a high level of public participation in order to define the particular banking needs of disadvantaged neighborhoods or isolated communities. Equally important, to be fully effective in promoting community development financing in disadvantaged areas, such access mechanisms need to encourage working relationships between banking institutions and local community organizations. Even with respect to implementation of prudential safeguards, there is a degree of dependence on the independent monitoring and advocacy skills that are the hallmark of consumer organizations. For example, reforms to enhance the public accountability of bank regulators by improving the transparency of the supervisory process are likely to lie fallow unless the resulting flow of documents is monitored by consumer or other public interest organizations.

3. Key Role for a Financial Consumers Association.

As discussed previously, the best approach to establishing a collective information system would be for the national or a state government to charter an independent financial consumers association. Such an organization could also be assigned an important monitoring and advocacy role with respect to the other safeguards on financial deregulation -- prudential control, competition policy, access issues, and consumer protection measures. For example, the legislation chartering the financial consumers association could direct the association to (1) operate a collective information system; (2) monitor and report periodically on the prudential control performance of the bank and insurance regulators, the level of competition within retail financial service markets, and the availability of basic financial services to disadvantaged sectors; and (3) serve as an advocate for policies that advance prudential control, competition policy, access to basic financial services, and consumer protection in the financial service sector.

Financial deregulation, by reducing regulation-from-above, creates a vacuum with respect to controls to ensure that the banking system is responsive to a broad range of consumer and local community interests. This void needs to be filled by enhancing NGO participation in the shaping and implementation of safeguard mechanisms. In a sense, the reduction in rigid regulation-from-above needs to be counterbalanced with an increase in flexible regulation-from-below.

A financial consumers association with a broad mandate to address the safeguard issues posed by financial deregulation would provide a much needed institutional structure for organized participation by consumers in the process of establishing and implementing such safeguards. Creating such an organization with the necessary monitoring, advocacy, and information dissemination capacity, lodged within the consumer sector, would seem to be a prerequisite for adequate safeguards on financial deregulation.

1. See, e.g., U.S. Department of the Treasury, Modernizing The Financial System, Washington, DC, February, 1991.

2. GATT Secretariat, Draft Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations (Dunkel draft), December 20, 1991, Trade In Services (Annex II), at 51-55.

3. Federal Deposit Insurance Corporation, Quarterly Banking Profile, Washington, DC, Third Quarter 1991 and earlier FDIC data series.

4. U.S. Congress, Public Law 102-242, December 19, 1991, Section 101.

5. Reuters News Service, Frankfurt, November 15, 1991.

6. "For Swiss Banks, Solid World Shifts," New York Times, February 20, 1992, at D-1.

7. U.S. Congressional Research Service, Insurance Failures: An Overview of Recent Trends and Implications, Washington, DC, November 14, 1991, at 2, 5.

8. U.S. Congress, Congressional Budget Office, Reforming Federal Deposit Insurance, Washington, DC, September 1990, Appendix B.

9. Michael Moran, The Politics Of Banking, Macmillan Press, London, 1986, Epilogue: The Johnson Matthey Affair.

10. Mark Flannery, "Deposit Insurance Creates a Need for Banking Regulation," Business Review, Federal Reserve Bank of Philadelphia, January/February 1982.

11. "Bailout Agency Criticized On Its Auditing Procedures," New York Times, February 26, 1992, at D-1.

12. Ralph Nader and Jonathan Brown, Report To U.S. Taxpayers On The Savings & Loan Crisis, BankWatch, Washington, DC, February 1989, at 5.

13. U.S. Congress, Congressional Budget Office, Reforming Federal Deposit Insurance, supra note 7, at Appendix B.

14. Working Committee on the Canada Deposit Insurance Corporation, Final Report of the Working Committee on the Canada Deposit Insurance Corporation, Ottawa, April 24, 1985.

15. Mervyn Lewis and Kevin Davis, Domestic and International Banking, Cambridge, Massachusetts, 1987, at 147.

16. See, e.g., Testimony of Jonathan Brown, Hearings on Bank Mergers, Committee on Banking, Finance and Urban Affairs, U.S. House Of Representatives, Washington, DC, September 26, 1991.

17. Hearings on Closing of Freedom National Bank, Subcommittee on Financial Institutions Supervision, Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, Washington, DC, December 18, 1990, at 2.

18. Ibid, at 7.

19. U.S. Congress, Public Law 102-242, December 1991, Sections 141, 142, and 143.

20. See, Testimony of Lowell Bryan, Hearings on Core Banks Proposal, Committee on Banking, Finance, and Urban Affairs, U.S. House of Representatives, Washington, DC, June 18, 1991, at 137-181.

21. Richard Randall, "Can the Market Evaluate Asset Quality Exposure in Banks?," New England Economic Review, Federal Reserve Bank of Boston, July/August 1989.

22. Charles Goodhart, The Evolution of Central Banks, MIT Press, London, U.K., 1988, at 97.

23. Federal Deposit Insurance Corporation, Deposit Insurance For the Nineties: Meeting the Challenge, Washington, DC, 1989, at 19, 20.

24. Mervyn K. Lewis and Kevin T. Davis, Domestic and International Banking, supra note 14, at 135.

25. Ibid., at 135.

26. Arthur J. Murton, "Bank Intermediation, Bank Runs, and Deposit Insurance," FDIC Banking Review, Spring/Summer 1989, Washington, DC, at 4.

27. Jonathan Brown, The Separation of Banking and Commerce, Essential Information, Washington, DC, forthcoming 1992.

28. The World Bank, World Development Report: 1989, Washington, DC, 1989, at 76.

29. Office of the Comptroller of the Currency, Bank Failure: An Evaluation of the Factors Contributing to the Failure of National Banks, Washington, DC, June 1988.

30. Group of Ten, Committee on Banking Regulations and Supervisory Practices, International Convergence of Capital Measurement and Capital Standards, Basle, Switzerland, July 1988.

31. U.S. Congress, Public Law 102-242, December 19, 1991, Section 111.

32. U.S. General Accounting Office, Failed Banks: Accounting and Auditing Reforms Urgently Needed, Washington, DC, April 1991, at 32, 33.

33. See, e.g., U.S. General Accounting Office, Bank Supervision: OCC's Supervision of the Bank of New England Was Not Timely or Forceful, Washington, DC, September 1991.

34. U.S. Congress, Public Law 102-242, December 19, 1991, Section 131.

35. See, e.g., the Report of Condition and Income (Call Report) filed on a quarterly basis by each federally-insured banking institution in the U.S. for a good example of such public disclosure.

36. U.S. Congress, Public Law 101-73, August 9, 1989, Section 913.

37. U.S. Congress, Public Law 102-242, December 19, 1991, Section 131.

38. Testimony of John LaWare, Member, Board of Governors of the Federal Reserve System, Hearings on Bank Mergers, Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, Washington, DC September 24, 1991, at C-6.

39. "Does Merging Pay? Fed Studies Say No," American Banker, February 12, 1992.

40. Board of Governors of the Federal Reserve System, BankAmerica Corporation, Order Approving the Merger of Bank Holding Companies, Washington, DC, March 23, 1992, at 9, 10.

41. Edward K. Y. Chen, "The Need to Protect Bank Depositors," Sunday Morning Post, Hong Kong, May 17, 1992, at 11.

42. Leonard W. Weiss, "A Review of Concentration-Price Studies in Banking," in Leonard Weiss, editor, Concentration and Price, MIT Press, Cambridge, Massachusetts, 1989, at 259.

42. Leonard W. Weiss, "A Review of Concentration-Price Studies in Banking," in Leonard Weiss, editor, Concentration and Price, MIT Press, Cambridge, Massachusetts, 1989, at 259.

43. Ross Milbourne and Matthew Cumberworth, Australian Banking Performance in an Era of De-Regulation: An Untold Story, Working Paper No. 1990/3, Center For Applied Economic Research, The University of New South Wales, Kensington, Australia, August, 1990, at 23.

44. Board of Governors of the Federal Reserve System, Profitability of Credit Card Operations of Depository Institutions, Washington, DC, September 1991, at 6.

45. Author's calculation from Federal Deposit Insurance Corporation, Statistics on Banking, 1989 and 1990, Washington, DC.

46. See, Jonathan Brown, Community Benefit Requirements For Banking Institutions: The U.S. Experience, Centre for International Research on Communication and Information Technologies (CIRCIT), Melbourne, Australia, 1992, for an analysis of the Community Reinvestment Act and the important role played by public disclosure of information on home mortgage loans and small business loans made by banking institutions. Also see, Jonathan Brown, "A Consumer Perspective On Financial Deregulation," Ruby Hutchison Memorial Address for World Consumer Rights Day, Federal Bureau of Consumer Affairs, Canberra, Australia, 1992, for an overview of the Community Reinvestment Act.

47. U.S. Congress, Public Law 102-242, December 19, 1991, Sections 122 and 477.

48. Glenn Canner and Ellen Maland, "Basic Banking," 73 Federal Reserve Bulletin 255, Washington, DC, April 1987, at 269.

49. See, Jonathan Brown, Community Benefit Requirements For Banking Institutions: The U.S. Experience, supra note 45, for a brief description of some of these state laws.

50. F. Breedon and M. Joyce, "House Prices, Arrears and Possessions," Bank of England Quarterly Bulletin, May 1992, at 174. The default rate represents the percentage of outstanding mortgage loans that are over 6 months in arrears.

51. See Lawrence Ausubel, "The Failure of Competition in the Credit Card Market," American Economic Review, March, 1991 at 63, 64. Professor Ausubel's research shows that during the 1983-1988 period larger commercial banks in the U.S. achieved pretax rates of return on equity (ROE) on their credit card business that were 3 to 5 times greater than the ordinary pretax ROE for the U.S. banking industry.

52. Michael Lynch and Robert Mackay, Life Insurance Products and Consumer Information, Federal Trade Commission, Washington, DC, 1985, at 291.

53. Office of Fair Trading, The Selling of Insurance Policies: A Report on a Research Survey, London, U.K., 1986, at 17.

54. See, Hearings on Financial Consumers Associations, Committee on Banking, Housing, and Urban Affairs, United States Senate, Washington, DC, December 14, 1988, for extensive testimony on the need for a collective information system and the concept of chartering a financial consumers association to perform this function.

55. See, Jonathan Brown, "A Consumer Perspective On Financial Deregulation," Ruby Hutchison Memorial Address for World Consumer Rights Day, Federal Bureau of Consumer Affairs, Canberra, Australia, 1992, for additional discussion of the benefits of establishing a collective information system in the financial service area.

56. See, e.g., Hearings on Financial Consumers Associations, supra note 53, at 76, for a discussion of how government support enabled a California consumer organization to disseminate financial service information to low and moderate income consumers.

57. U.S. Department of the Treasury, Modernizing The Financial System, supra note 1.