The Emerging Impact of the Financial Services Modernization Act

Government Finance Review, October 2000 | Go to article overview

The Emerging Impact of the Financial Services Modernization Act


On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Financial Services Modernization Act (GLBA), repealing after 66 years the Glass-Steagall Act that prohibited cross-sector affiliation between the banking and securities industries. It also repealed the 1956 Bank Holding Company Act, which prohibited unions between the banking and insurance industries. This article examines the provisions of GLBA and the various impacts they may have on state and local governments in the near future.

Overview

The repeal of the decades-old laws marked a significant achievement for the 106th Congress. Congress had tried for years without success to overhaul the Glass-Steagall Act and the Bank Holding Company Act. In the interim, industry practices and court decisions gradually eroded those laws. The GLBA aims to: 1) provide financial services companies with a more level playing field, 2) allow U.S. financial firms to become competitive globally, and 3) create one-stop shopping for financial services.

The legislation established a new entity called a Financial Holding Company (FHC). In order for a bank holding company (BHC) to qualify as a FHC, all of its depository institution subsidiaries must be well managed and well capitalized. Furthermore, they have to have a satisfactory Community Reinvestment Act (CRA) rating. The Federal Reserve Board published a list of "top-tier" bank holding companies as of July 14, 2000, in which the applications to become FHCs have taken effect (see Exhibit 1).

The GLBA also authorizes national banks to directly underwrite, purchase, and deal in municipal revenue bonds.

New Regulatory Regime

Congress arrived at a somewhat messy compromise that gives the Fed the role as an overarching, "umbrella" regulator, with "functional" regulation of specific financial activities by the Treasury Department's Office of the Comptroller of the Currency and myriad other agencies. While the GLBA ultimately confirms the Federal Reserve as the umbrella supervisor of both FHCs and BHCs, it limits the Fed authority with provisions on "functional regulation."

In practice, this means that the Fed will defer in most situations to functional regulators (e.g., the Fed will rely on functional regulators' reports on, and examinations of financial institutions). Different entities will continue to enforce regulations under the new law. Under the "functional regulation" provisions, the Fed and the Treasury Department's Office of the Comptroller of the Currency continue to have shared jurisdiction over banking; the Securities and Exchange Commission (SEC) regulates securities activities; and state governments oversee insurance.

The GLBA reaffirms the McCarranFerguson Act, which recognizes the legal authority of the state to regulate insurance activities. Overall, this means that the Fed will not be able to "go after" a non-bank affiliate (such as an SEC-regulated securities dealer) except in an emergency that might threaten the viability of the entire FHC or even trigger a broader financial crisis.

A financial institution seeking to become a multi-purpose financial institution can structure itself in two ways, as shown in Exhibit 2. It can become a FHC and set up affiliates. This provides the most flexibility and greatest possibility for one-stop shopping. Alternatively, it can create subsidiaries. While the federal government has issued an interim rule which states that banks and their subsidiaries are allowed to operate many financial services, insurance underwriting, merchant banking, and real estate development are not allowed. They also face a host of other restrictions as well.

Other Provisions

In addition to the revised regulatory regime, the GLBA amended existing law concerning the Community Reinvestment Act. It also changed privacy provisions targeted at customers of financial institutions.

Community Reinvestment Act (CRA). …

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