“Financial Markets and Accountability: A Better Way Forward”
-- Remarks by FDIC Vice Chairman Thomas M. Hoenig,
Presented to the
Conference on Systemic Risk and Organization of the Financial System,
Chapman University,
Orange, California
May 12, 2017
Introduction
Notwithstanding the experience of 2008, the U.S. financial system remains heavily subsidized,
increasingly concentrated, and, despite a host of new efforts to safeguard the system, it
continues to be vulnerable to inevitable financial shocks. I have long argued that we need an
organizational model that would turn the industry back toward capitalism. Such a model should
enhance the role of markets, allow for failure, and reduce reliance on intrusive regulations. Most
importantly, it should improve bank and economic performance.
To that end, I recently introduced “A Market-Based Proposal for Regulatory Relief and
Accountability.” Among its goals are addressing too-big-to-fail, enhancing financial stability, and
returning the safety net to its original purpose of depositor and payment system protection. My
proposal would require the largest banks to hold more capital, and it would partition nonbank
activities away from the safety net. Importantly, it also would create a more level playing field
between insured and noninsured financial firms, thus enhancing competition.
My remarks today are intended to provide some additional perspective on that proposal by
discussing the forces driving change within the industry and speculating on what they might
mean for the future of banking and long-term economic growth. I will conclude by outlining how
my proposal is the preferable alternative for addressing too-big-to-fail, strengthening the
financial system, and providing regulatory relief—all without compromising the public’s interest.
Forces of Change
For decades, until at least the late 1990s, the American banking industry was composed of firms
with a range of specialties and sizes, but all with a similar business model that relied heavily on
intermediation—that is, taking deposits and making loans. The industry also was highly
competitive with assets nearly evenly distributed among the various types of banks: money
center, regional, and community.1
In more recent years, the largest banks have become disproportionately larger, and their
activities within the safety net have become far more extensive than those of most other
financial firms. In thinking about the industry’s evolution toward this new order, four forces of
change have, in my estimation, been most influential: technology and financial engineering,
legislation, ownership structure, and of course the financial crisis of 2008.
Technology and Financial Engineering
As in all industries, technology has fundamentally altered the way banks operate. Tremendous
developments in computing power, data collection capabilities, and communication methods
have changed the supply chain for lending and how banks manage both sides of their balance
sheets. Since operational efficiencies increase with scale, these advances have also
-- Remarks by FDIC Vice Chairman Thomas M. Hoenig,
Presented to the
Conference on Systemic Risk and Organization of the Financial System,
Chapman University,
Orange, California
May 12, 2017
Introduction
Notwithstanding the experience of 2008, the U.S. financial system remains heavily subsidized,
increasingly concentrated, and, despite a host of new efforts to safeguard the system, it
continues to be vulnerable to inevitable financial shocks. I have long argued that we need an
organizational model that would turn the industry back toward capitalism. Such a model should
enhance the role of markets, allow for failure, and reduce reliance on intrusive regulations. Most
importantly, it should improve bank and economic performance.
To that end, I recently introduced “A Market-Based Proposal for Regulatory Relief and
Accountability.” Among its goals are addressing too-big-to-fail, enhancing financial stability, and
returning the safety net to its original purpose of depositor and payment system protection. My
proposal would require the largest banks to hold more capital, and it would partition nonbank
activities away from the safety net. Importantly, it also would create a more level playing field
between insured and noninsured financial firms, thus enhancing competition.
My remarks today are intended to provide some additional perspective on that proposal by
discussing the forces driving change within the industry and speculating on what they might
mean for the future of banking and long-term economic growth. I will conclude by outlining how
my proposal is the preferable alternative for addressing too-big-to-fail, strengthening the
financial system, and providing regulatory relief—all without compromising the public’s interest.
Forces of Change
For decades, until at least the late 1990s, the American banking industry was composed of firms
with a range of specialties and sizes, but all with a similar business model that relied heavily on
intermediation—that is, taking deposits and making loans. The industry also was highly
competitive with assets nearly evenly distributed among the various types of banks: money
center, regional, and community.1
In more recent years, the largest banks have become disproportionately larger, and their
activities within the safety net have become far more extensive than those of most other
financial firms. In thinking about the industry’s evolution toward this new order, four forces of
change have, in my estimation, been most influential: technology and financial engineering,
legislation, ownership structure, and of course the financial crisis of 2008.
Technology and Financial Engineering
As in all industries, technology has fundamentally altered the way banks operate. Tremendous
developments in computing power, data collection capabilities, and communication methods
have changed the supply chain for lending and how banks manage both sides of their balance
sheets. Since operational efficiencies increase with scale, these advances have also
encouraged industry consolidation, as the largest institutions gain the advantage in capturing
deposits, payments, and lending markets.
Technology also has enabled the largest banks to engage in financial engineering, which
facilitates product development and extends their business profile while also substantially
increasing product complexity and risk. Short-term wholesale funding instruments, such as
repos, rather than retail deposits now provides significant financing for loans. This change has
facilitated growth in products such as leveraged loans and securitized assets. It also has driven
growth of derivatives and other short-term trading activities, all of which have contributed to a
dramatic increase in on- and off-balance-sheet leverage among the largest, most systemically
important banking firms.
Legislation of the 1990s
Another force of change that helped shape the banking industry was legislation that relaxed
geographic, product, and affiliation restrictions on insured commercial banks, opening up
markets and opportunities. Two significant laws enacted in the 1990s, when coupled with
technological advances, accelerated institutional growth and changed the banking landscape by
allowing for more product expansion and geographic reach during the past few decades.
First, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 removed most of
the interstate banking restrictions that had been in place to address industry concentration and
supervisory concerns. The enactment of Riegle-Neal led to an acceleration in consolidation
within the industry as banks merged across state lines to take advantage of economies of scale
and to access new markets.
Next, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 broadened the
markets for commercial banking by formally removing barriers that prevented bank holding
companies and their insured banks from owning other financial service providers, such as
investment banks and insurance companies. Allowing the activities of these non-commercial
banking businesses to be subsidized with direct and indirect access to the federal safety net
dramatically changed the competitive and cultural dynamics of commercial and investment
banking and potentially set the stage for, as some call it, the “financialization” of our economy.2
Ownership Structure and Corporate Culture
Following Gramm-Leach-Bliley, commercial and investment banks began a series of significant
mergers that affected the combined industries in a profound way.
Investment banks originally were formed as partnerships, where owners were liable for all of the
firm’s debts. When the New York Stock Exchange relaxed its rules to permit joint stock
corporate ownership in 1970, over time it became an attractive opportunity for the investment
banking industry to grow and expand its business model. Investment banks that converted to
public companies altered the incentives of owners and management, increasing appetite for risk
and leveraging balance sheets. The further effect of combining insured commercial banks and
investment banks under Gramm-Leach-Bliley magnified these outcomes. In the end, there was
a profound change in industry culture that further changed the competitive dynamics among
firms. As universal banks formed and matured, and with increasing support from the expanding
safety net, the largest banks were increasingly drawn away from relationship banking and
deposits, payments, and lending markets.
Technology also has enabled the largest banks to engage in financial engineering, which
facilitates product development and extends their business profile while also substantially
increasing product complexity and risk. Short-term wholesale funding instruments, such as
repos, rather than retail deposits now provides significant financing for loans. This change has
facilitated growth in products such as leveraged loans and securitized assets. It also has driven
growth of derivatives and other short-term trading activities, all of which have contributed to a
dramatic increase in on- and off-balance-sheet leverage among the largest, most systemically
important banking firms.
Legislation of the 1990s
Another force of change that helped shape the banking industry was legislation that relaxed
geographic, product, and affiliation restrictions on insured commercial banks, opening up
markets and opportunities. Two significant laws enacted in the 1990s, when coupled with
technological advances, accelerated institutional growth and changed the banking landscape by
allowing for more product expansion and geographic reach during the past few decades.
First, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 removed most of
the interstate banking restrictions that had been in place to address industry concentration and
supervisory concerns. The enactment of Riegle-Neal led to an acceleration in consolidation
within the industry as banks merged across state lines to take advantage of economies of scale
and to access new markets.
Next, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 broadened the
markets for commercial banking by formally removing barriers that prevented bank holding
companies and their insured banks from owning other financial service providers, such as
investment banks and insurance companies. Allowing the activities of these non-commercial
banking businesses to be subsidized with direct and indirect access to the federal safety net
dramatically changed the competitive and cultural dynamics of commercial and investment
banking and potentially set the stage for, as some call it, the “financialization” of our economy.2
Ownership Structure and Corporate Culture
Following Gramm-Leach-Bliley, commercial and investment banks began a series of significant
mergers that affected the combined industries in a profound way.
Investment banks originally were formed as partnerships, where owners were liable for all of the
firm’s debts. When the New York Stock Exchange relaxed its rules to permit joint stock
corporate ownership in 1970, over time it became an attractive opportunity for the investment
banking industry to grow and expand its business model. Investment banks that converted to
public companies altered the incentives of owners and management, increasing appetite for risk
and leveraging balance sheets. The further effect of combining insured commercial banks and
investment banks under Gramm-Leach-Bliley magnified these outcomes. In the end, there was
a profound change in industry culture that further changed the competitive dynamics among
firms. As universal banks formed and matured, and with increasing support from the expanding
safety net, the largest banks were increasingly drawn away from relationship banking and