FRBSF Economic Letter
98-13; April 24, 1998
Bank Charters vs. Thrift Charters
Western Banking Quarterly is a review of banking developments
in the Twelfth Federal Reserve District, and includes FRBSF's Regional Banking Tables. It
is published in the Economic Letter on the fourth Friday of January,
April, July, and October.
One of the key issues in Congress's current debates about modernizing
the financial services industry is whether to eliminate the charter for
thrifts (savings and loans). The savings and loan associations originally
were created with a special mandate to channel funds to the housing industry.
But over the years, the charter has changed and so has mortgage financing,
raising the question of whether a "special" charter is needed.
For example, the thrift charter was greatly liberalized during the savings
and loan debacle in the 1980s in an attempt to rescue the industry; and
with the advances in the mortgage market and the prevalence of other financial
institutions that engage in mortgage financing, the role of thrifts in
house financing has faded.
With liberalized charters, thrifts today still emphasize mortgage lending,
but they also offer their customers an array of financial products similar
to those of commercial banks. Indeed, in some respects, thrift charters
are more liberal than bank charters. For example, while the Glass-Steagall
Act separates commercial banking from investment banking and the Bank
Holding Company Act separates banking from commerce, certain thrift holding
companies have relatively unfettered financial and commercial powers.
These and other differences in the charters give financial services providers
the opportunity to engage in structural and regulatory arbitrage, choosing
the charter that is most advantageous to their operation. In this
Economic Letter, I discuss the major differences between bank and
thrift charters and recent developments that may affect their future.
Comparing the two charters
Today, both banks and thrifts can offer virtually the same bundle of
financial services products, from transactions, savings, and time deposits
to consumer, real estate, and commercial loans. But they differ noticeably
in their commercial lending capacity. Unlike banks, thrifts face a statutory
lending limit for commercial loans of less than 20 percent of assets,
of which half may only be used for small business loans. In addition,
to be eligible to obtain advances from a Federal Home Loan Bank, a thrift
must meet the qualified thrift lender test. This test restricts a thrift's
commercial lending by requiring that 65 percent of its portfolio assets
be in mortgage and consumer-related assets. The commercial lending limit
does not appear to be much of a constraint for thrifts: as of 1997, the
aggregate commercial and industrial loans made by thrifts represented
only 1.5 percent of their assets, compared to 14.8 percent of commercial
bank assets that are in commercial loans.
Banks and thrifts also differ in terms of their authority to affiliate
with other nondepository entities through a holding company structure.
Banking firms are governed both by Glass-Steagall, which separates commercial
banking from investment banking, and by the Bank Holding Company Act.
Although recently, commercial banking organizations have made inroads
into investment banking via their so-called "Section 20 subsidiaries,"
these Fed authorized securities subsidiaries can only engage in a limited
amount of bank-ineligible securities activities (see Kwan 1997). Specifically,
revenues from bank-ineligible securities activities at the Section 20
subsidiaries are limited to 25 percent of total revenues. Regarding other
nonbank activities, the Bank Holding Company Act states that bank holding
companies' non-bank subsidiaries can engage only in activities that are
closely related to the business of banking. This prevents banking firms
from underwriting most insurance products, although insurance agency activities
have been authorized for direct operating subsidiaries of banks subject
to geographic restriction. Thrift holding companies that control more
than one thrift face restrictions similar to those for bank holding companies.
Unitary thrift holding companies, that is holding companies controlling
only one thrift subsidiary, have far broader affiliation rights. They
are free to engage directly or indirectly in any legitimate business activities,
provided the activity does not pose a safety and soundness risk to their
thrift subsidiary. There are currently 102 unitary thrift holding companies
that actively engage in nonbanking activities, including securities underwriting
and dealing, real estate development, insurance sales and underwriting,
automobile sales, fast food, and dairy farming. Their thrift subsidiaries
hold approximately $196 billion in assets, representing about 26 percent
of the industry total.
In addition to broader affiliation rights, the thrift charter also provides
greater flexibility to firms seeking to offer financial services nationwide.
Federally chartered thrifts have long been allowed to establish branches
nationwide. Before the enactment of the Riegel-Neal Interstate Banking
and Branching Efficiency Act, banks were prohibited from branching across
state lines. And banks still cannot branch into Texas and Montana, states
that opted out of the federal interstate branching law. But a federally
chartered thrift can operate branch offices nationwide without geographic
restrictions. Furthermore, federal pre-emption of state laws allows federal
thrifts to operate under one set of federal rules, rather than also complying
with different state statutes, which can greatly enhance their efficiencies
in providing financial services across the country.
Reflecting the greater flexibility in affiliation that comes with the
thrift charter, a number of nonbank financial institutions and commercial
firms recently either have obtained or have applied for a thrift charter.
They include Merrill Lynch, General Electric Company, Morgan Stanley-Dean
Witter-Discover, A.G. Edwards, Travelers Group, Transamerica, State Farm
Mutual Automobile Insurance Company, Allstate Corporation, and PaineWebber
Group Inc. For firms that already have a nationwide network of offices,
the thrift charter allows them to offer banking products through their
existing distribution channel, providing consumers access to a wider array
of financial products. This is particularly appealing to securities firms
and insurance companies that are prohibited from owning commercial banks.
It is not surprising that the Congress currently is debating the future
of the thrift charter. Clearly, while both banks and thrifts are selling
the same financial services products, they have very different powers
and are regulated somewhat differently. Furthermore, it is unclear whether
the thrift charter is still needed in today's environment to provide financing
for housing (see Laderman and Passmore, forthcoming). Finally, the thrift
charter gives financial services providers the opportunity to engage in
structural and regulatory arbitrage.
While the latest financial modernization proposal would not eliminate
the thrift charter outright, it calls for somewhat more parity between
the two charters. While grandfathering most existing arrangements, going
forward, the proposed Financial Services Competition Act would eliminate
the unitary thrift loophole by limiting new thrift holding companies to
activities that are permissible for bank holding companies, and it would
close the branching gap between banks and thrifts by allowing federal
thrifts to open new interstate branches only to the extent permissible
for national banks. The proposed legislation also would merge the thrift
and bank regulators, as well as the two deposit insurance funds.
The thrift charter was originally intended to promote home ownership
by channelling funds to the housing industry. Over time, it has evolved
into a very flexible vehicle for providing a broad array of financial
services products by firms that are not allowed to operate commercial
banks. While thrifts are allowed to engage in virtually the same activities
as banks, they can more freely affiliate with securities firms and insurance
companies than banks. Thus, the thrift charter allows financial conglomerates
to complete their financial services product line-from securities brokerage
to insurance to banking. As the debate about thrift charters continues,
these advantages will weigh at least as heavily in the discussion as whether
the thrift charter is still needed to promote residential financing.
Kwan, S. 1997. "Cracking the Glass-Steagall Barriers." FRBSF Economic Letter 97-08 (March 21).
Laderman, E., and W. Passmore. 1998. "Is Mortgage
Lending by Savings Associations Special?" Federal Reserve
Bank of San Francisco Economic Review, forthcoming.
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or of the Board of Governors of the Federal Reserve System. Editorial
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