The Effect of Garn and Proxmire on Powers and Products

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Before the first session of the 98th Congress recessed, a number of bills were introduced in the Senate that could have a major impact upon the financial services industry. This series provides a three-part analysis of that legislation.

The first part covers powers and products. The second addresses issues of plate -- namely those with geographical implications. The third section analyzes the provisions that affect the pricing of bank services.

While the primary focus is on the bill introduced by Sen. Jake Garn, R-Utah, chairman of the Senate Banking Committee, other bills introduced by Sen. William Proxmire, D-Wis., the ranking Democrat on the committee also are addressed, since they reflect a full spectrum of congressional responses to these issues. Proxmire and Garn Bills

This section focuses on the provisions of the Proxmire bill (S. 2134) and Title I of the Garn bill (S. 2181) that affect the powers and structure of the financial services industry.

Redefinition of "bank." Both bills redefine "bank" to delineate more clearly the characteristics of institutions that are subject to the Bank Holding Company Act and its restrictions on non-banking activities. The bills define "bank" as: (1) any insured bank or (2) any institution that both accepts deposits that the depositor may withdraw by check or similar means and makes commercial loans.

Sen. Proxmire's bill also includes institutions that are eligible for insruance. This redefinition of "bank" eliminates the current "nonbank bank" option. There are, however, new exemptions for consumer banks in the Garn bill and trust companies in the Garn bill and trust companies in the Proxmire bill. In addition, thrift institutions continue to be exempted from the definition under both bills, and Sen. Garn adds FDIC-insured state-chartered stock savings banks to that exemption. The Consumer Bank Exemption

The consumer bank exemption in the Garn bill legitimizes one of the two "nonbank bank" options utilized today by nonbank entities to acquire insured depository institutions. Those entities now avoid the act by not engaging in commercial lending -- a category of activities that the Federal Reserve Board vastly expanded in a recent amendment to Regulation Y.

Under the bill, a "consumer bank" is a bank that does not engage in commercial lending activities. Activities that are not considered commercial lending and so are permitted for consumer banks include consumer loans, loans for charitable purposes, loans secured by residential real property, money market activities, and liquidity or funding investments -- transactions the Fed has just said are commercial loans -- and a 5%-of-assets basket for loans to finance small businesses and consumer goods inventories.

Nonbank entities that own consumer banks are not subject to the act. As a result, there are no limitations on those entities' activities, and they are not subject to Fed approval procedures or supervision. Moreover, other provisions of the act, such as anti-tying provisions, which are of particular importance in the insurance context, do not apply to consumer banks -- even if they are owned by insurance companies.

Holding companies also are authorized to own consumer banks. Geographical restrictions on the ownership of consumer banks by bank holding companies and nonbank entities -- to be discussed in Part II -- affect the scope of the consumer bank authority. Grandfather Clauses

A more limited exemption in the Proxmire bill permits any company to own a trust company and still avoid the act as long as substantially all deposits are received solely in a fiduciary capacity.

Nonbank banks owned prior to July 1, 1983, (the Garn bill) or June 23, 1983, (the Proxmire bill) are grandfathered. Any company acquiring a "bank," as newly defined, after those dates is required to divest its bank or conform its activities. …