regulators, community groups in New York, Tennessee, and New Mexico recently complained about what they found to be the institution's habit of selectively steering minorities more frequently than whites to its finance company. These groups also charged that at the same time the bank is aggressively closing down its bank branches in certain neighborhoods, NationsCredit is launching new outlets in many of these same locations. Federal regulators eventually held that they did not have the authority to review the practices of NationBank's non-bank affiliates. Meanwhile, the bank say it is reviewing the charges and will correct whatever problems its finds. Nevertheless, the NationsBank story appears to illustrate the glaring disparity in the level of regulatory scrutiny these different affiliates of the same parent company receive. The lending activities of banks are routinely evaluated by federal regulators for CRA purposes, while the activities of non-bank affiliates are not, even though they maybe offering what are essentially the same products to the public. This distinction is increasingly become an artifical one, as the various affiliates of large financial giants function, at least from the consumers perspective, virtually as a seemless web. The time has come for CRA reviews to be extended along product lines. For example, if a bank makes mortgage loans, the mortgage lending activities of a mortgage company affiliate of the same parent should also be evaluated for CRA purposes. In fact, CRA regulations have always allowed a BHC to elect to have the activities of its mortgage company considered as part of the Federal Reserve Board's review of the lending records of bank affiliates. Unfortunately, the rule works only one-way. BHCs elect to have the activities of their mortgage companies considered for CRA purposes if they believe it would improve an an otherwise inadequate record by one of its banks. You can bet that they do not exercize this option if they believe the affiliates record would result in a lowering of the bank's CRA grade. This rationale no longer makes sense, assuming it ever did. Financial modernization means that most of the former distinctions between banks and non-bank financial institutions are rapidly disappearing. Modifications of CRA to reflect the interrelationships between these sister institutions are needed to maintain the law's effectiveness.. 3. Expanding Community Reinvestment Responsibilities To Non-Bank Financial Institutions. CRA was originally premised upon the view that although they are privately capitalized, banks and thrifts are subject to underlying charter obligations that form the quid pro quo for the extensive public backing they receive (i.e., taxpayer guarantee for deposit insurance, access to the Federal Reserve System's lender of last resort facility, etc.). And indeed, CRA stimulated depository institutions to fulfill certain public responsibilities and brought about significant improvements in credit access for many underserved households and businesses. We believe the case can be made for extending similar, although not necessarily identical requirements as CRA to nonbank financial institutions. Nonbank financial institutions have gained access to many of the same federal protections as banks but operate with no comparable reinvestment responsibility. For example, the mortgage banking industry is largely a creature of FHA. Mutual funds, whose accounts are not backed by FDIC, are protected by the Securities Investor Protection Corporation, a non-profit entity established by Congress, which in a pinch, has a $1 billion line of credit from the Treasury Department. Even the insurance industry's exemption from antitrust regulation can be viewed as a federal benefit. By permitting non-bank financial institutions to benefit from government supports current regulatory framework, the federal government is underwriting the expansion of a financial system that profits, both directly and indirectly, by taxpayer supports, but avoids corresponding public responsibilities to support compelling community needs. Legislation aimed at easing the distinctions between banking, securities, and insurance presents an important opportunity for lawmakers to consider what the appropriate public responsibilities should be for non-bank financial institutions. Mixing Banking and Commerce. We were asked to present our views on permitting commercial firms, such as a General Motors or a Microsoft, to own banks. H.R. 268 permits any commercial company to acquire a bank if no more than 25 percent of its business is devoted to commercial activities. We do not favor removing the current prohibitions against banks owning and being owned by commercial firms. H.R. 268 permits only a limited form of cross-ownership, which might seem reasonable on its face. However, this is not one door that we believe should be opened, even a little way. Permitting commercial companies to own banks will inevitably lead to a much greater concerntration of financial power in the hands of a few, all purpose corporate giants. Breaking down the walls that separate banking and commerce is likely to reduce competition and misallocate credit, thereby further steering lending away from underserved communities and businesses. No tangible evidence has been offered to suggest that the average Americans will benefit at all from such a radical change to our system. Just two years ago, Treasury Secretary Rubin testified before the House Committee on Banking and Financial Services, and I thought laid out very strong arguments against going down this road. At the time, he state that such combinations might: 1) pose additional risks to the safety and soundness of the financial system, thereby exposing the taxpayer to additional risk; 2) compromise the arm's length relationship between bankers and borrowers, creating unfair advantages for some borrowers over their competitors; 3) result in undesirable concentration of economic resources; 4) be difficult to supervise, thus necessitating increases in the size of the regulatory examination forces. We believe these arguments are no less compelling today. Finally, in closing let me say that the large scale consolidation of banking and the changes in the financial industry have occurred with scant public awareness, and even less public input. Therefore, we encourage you as lawmakers to take stock of these developments and to place a high priority on devising mechanisms for safeguarding the interests of consumers and communities as financial restructuring goes forward. This concludes my formal testimony. I will be glad to answer any question you have. NACDLF NATIONAL ASSOCIATION OF COMMUNITY DEVELOPMENT LOAN FUNDS THE PARALLEL BANKING SYSTEM & by Mark A. Pinsky and Valerie L. Threlfall National Association of Community Development Loan Funds Release Date: November 18, 1996 ADVANCE COPY FOR NACDLF's 12th ANNUAL TRAINING CONFERENCE Chicago, Illinois October 23-26 This paper is a product of NACDLF Public Purpose Financial Institutions Project. An earlier product, The authors are Executive Director and Program Associate, respectively, of NACDLF. NACDLF is a national financial intermediary representing 46 nonprofit community development financial institutions that provide capital and technical assistance in many of the nation's most distressed communities. For more information about NACDLF programs and policies, call 215.923.4754 or e-mail NACDLF@aol.com. Phone 215.923.4754 • 924 Cherry Street, 2nd Floor Philadelphia, PA 19107-2411 Fax 215.923.4755 • America Online NACDLF@aol.com CompuServe 71231,2211 THE PARALLEL BANKING SYSTEM & COMMUNITY REINVESTMENT by Mark A. Pinsky and Valerie L. Threlfall National Association of Community Development Loan Funds On October 4, 1996, a federal agency intervened to arrest an impending solvency crisis at a small but significant financial institution holding almost $425 million of 77,000 Americans' retirement savings. With lingering memories of the savings and loans crisis of the 1980s, which left thousands of anxious Americans without access to their savings, the federal government decided to act before the crisis hit. The agency was not one of the four bank regulatory agencies but the Pension Benefit Guarantee Corporation (PBGC), and the financial institution was not a bank or a thrift but a pension fund serving the men's suit industry'. This federal intervention was just a hint of one of the most important twentieth-century shifts in the financial services industry, the shift of dominance from the banking industry to the parallel banking industry. Contrary to the common wisdom, the rise of the parallel banking industry would not have occurred without significant federal and state assistance, such as the "lender of last resort" protection the PBGC is now providing. This paper explores the structural shift in the banking industry, the role government has played in abetting this shift, and the implications the transition creates for low-income and a growing number of moderate-income communities around the country. It raises important questions about the public and civic responsibilities of a multi-trillion dollar industry that derives substantial, critical benefits from taxpayers yet operates without a commensurate obligation to return benefits back to the American people. Introduction The U.S. financial industry has changed in dramatic and significant ways over the past thirty years as nonbank financial intermediaries have taken over many of the functions depository institutions traditionally considered their province. Notably, more than two-thirds of Americans' long-term savings and investments now reside in non-bank intermediaries, compared to less than one-third in the mid-1970s. Moreover, these nonbank intermediaries, known as parallel banks, now serve as the primary source of credit for many American households and businesses. The parallel banking industry consists primarily of mutual funds, pension funds, insurance companies, and corporate finance companies. Over the past three decades, the rapid growth in assets and influence of non-bank institutions has changed the role banks play in addressing the financial services needs of local individuals and institutions and altered the relationship between the financial services industry, broadly defined, and its users (investors, lenders, borrowers). On a macro level, the U.S. financial system is no longer characterized by locally based intermediary institutions but rather by sophisticated institutional savings arrangements, fee-generating bank activities, and global financial instruments. The resulting dislocation of capital and place as local savings flow out of local communities into regional, national, and international markets-has effectively widened the credit and capital gaps that plague many communities struggling to gain or retain their social, economic, and political vitality. Moreover, the old system that linked wealth to place, that kept savings in communities, is now in danger of disappearing. Low-income residents in particular lack access to modern financial services as they do not have the capital and expertise necessary to take advantage of institutional savings arrangements and technology-driven banking. If the traditional system is |