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• W3123313482 abstract "It also raises legitimate questions about the specific quantitative thresholds enshrined in section 23A: Why are ten and twenty percent of a bank’s capital and surplus the magic limits that cannot be sacrificed easily, even in a crisis? Assuming there is a strong basis for reiterating the importance of the main purposes of section 23A, it may be much more difficult to justify these specific numerical criteria. Eliminating these thresholds, by simply prohibiting all extensions of credit by banks to their nonbank affiliates, would remove this difficulty but would not resolve the problem of regulatory discretion. 383. See COP REPORT, supra note 13, at 24. 384. See CARNELL ET AL., supra note 8, at 427. OMAROVA.PTD3 6/13/2011 2:03 PM 1766 NORTH CAROLINA LAW REVIEW [Vol. 89 subsidy would make such affiliation potentially less attractive. From this perspective, the real promise of section 23A in the post-GLB Act world is its potential ability to serve as a key mechanism in reducing incentives for excessive conglomeration in the financial services sector. However, as this Article shows, the Board consistently failed to recognize and realize this hidden potential of the section 23A regime. The Board’s extensive use of its exemptive authority, especially during the years preceding the recent financial crisis, effectively undermined the statute’s ability to restrict the growth of shadow banking and discourage arbitrage-driven conglomeration. Ironically, in the post-GLB Act world, this permissive regulatory approach was combined with the grand notion of section 23A as the principal firewall keeping banks safe from risks generated by their nonbank affiliates. The story this Article has laid out strongly suggests that this notion helped to create a false sense of security with respect to broader systemic risk issues. In reality, section 23A has not been very effective in meeting its officially stated policy objectives primarily because of a fundamental design flaw. The statute relies exclusively on imposing quantitative and qualitative limitations on bank transactions with affiliates as the method of achieving its objectives. As the prior discussion shows, such limitations are relatively easily and frequently lifted by regulatory action. In addition, on its face, the statute conspicuously lacks systemic focus and operates purely on a microprudential, individual entity level, which undermines its ability to safeguard the U.S. depository system in today’s complex and interconnected financial marketplace. The key to understanding why section 23A was designed this way, and why it largely failed to deliver on its alleged promise, is the fact that it was never supposed to promise that much. At the time of its enactment in 1933, the statute’s approach was based on the key premise that none of banks’ nonbank affiliates would actually engage in securities dealing or other financial activities that Congress viewed at the time as unacceptably risky for federally insured commercial banks. Originally, section 23A was not designed to be the single most important statutory mechanism keeping banks, and federal deposit insurance funds, safe from risky capital markets activities. Neither was it meant to be the main statutory provision safeguarding the fundamental principle of separation of banking and commerce. In 1933, Congress assigned those functions primarily to the Glass-Steagall Act. Section 23A of the Federal Reserve Act was an 385. See supra notes 40–43 and accompanying text. 386. Banking (Glass-Steagall) Act of 1933, Pub. L. No. 73-66, 48 Stat. 162 (codified as amended in scattered sections of 12 U.S.C.), repealed in part by Financial Services OMAROVA.PTD3 6/13/2011 2:03 PM 2011] UNFULFILLED PROMISE 1767 ancillary provision, an additional protection applicable to a much narrower set of transactions between banks and their permissible affiliates, which at the time excluded investment banks, hedge funds, derivatives dealers, and most of the rest of the financial world. It was the interplay between these statutes that created a coherent legal regime. After the partial repeal of Glass-Steagall in 1999, section 23A was propelled to new prominence as its “successor” statute, in the sense of preserving the integrity of a federally insured depository system. The problem is that, if quantitative limits on bank affiliate transactions were not designed to fulfill such a complex and important policy objective back in 1933, they certainly could not be expected to meet that challenge in the twenty-first century. And that leaves us facing another dilemma. If we scale back our expectations of section 23A and stop relying on it as the centerpiece legislation protecting banks from externally generated risks and preventing the leakage of public subsidy outside the banking system, we need to look for other, more viable alternatives. We also have to admit that U.S. bank regulation does not currently provide a functioning mechanism for preserving the wall between federally insured commercial banks and “shadow banks” or, more broadly, between banking and commerce. Acknowledging this sobering reality is the necessary first step toward a potential solution. One such potential solution may be returning to the old Glass-Steagall principle of institutional separation among different classes of financial institutions, based on their business and risk profile. In the runup to the enactment of the Dodd-Frank Act, the idea of resurrecting the Glass-Steagall Act in its original form had gained significant popularity. Of course, a complete reconstitution of the old regulatory regime may not be the most desirable choice in the context of the twenty-first century financial marketplace. Nevertheless, that does not preclude us from thinking about devising an alternative regulatory system, in which certain financial institutions (including federally insured banks), whose safety and soundness are critical for ensuring a steady supply of credit to support productive functioning of the national economy, are expressly disallowed from affiliating with other classes of institutions engaged in potentially high-risk and complex financial dealings. After all, if it is so difficult to ensure effective policing of affiliate transactions, it makes perfect sense to prohibit publicly subsidized depository institutions from affiliating with Modernization (Gramm-Leach-Bliley) Act of 1999, Pub. L. No. 106-102, 113 Stat. 1338 (codified in scattered sections of 12 and 15 U.S.C.). 387. See supra notes 45–49 and accompanying text. 388. See, e.g., Allison Vekshin & James Sterngold, War on Wall Street as Congress Sees Returning to Glass-Steagall, BLOOMBERG (Dec. 27, 2009), http://www.bloomberg.com/ apps/news?pid=newsarchive&sid=aeQNTmo2vHpo. OMAROVA.PTD3 6/13/2011 2:03 PM 1768 NORTH CAROLINA LAW REVIEW [Vol. 89 any entities whose potentially risky activities endanger their safety and soundness. Choosing how and where to draw the line between acceptable and unacceptable risks would require serious deliberation and analysis, which goes far beyond the scope of this Article. Of course, this approach rests on a fundamental assumption that building statutory firewalls to protect depository institutions from the rest of the financial system remains a relevant and critically important policy goal in today’s financial markets. However, one can challenge that assumption and argue for a radically different approach to safeguarding the depository system. For instance, it may be more effective to manage the safety and soundness of depository institutions through legal and regulatory mechanisms aimed at ensuring stability of the entire financial system. Technology-driven innovation, complexity, and the global interconnectedness of today’s financial markets elevate systemic risk prevention to the very top of regulatory priorities. These factors also make it increasingly difficult to maintain the fiction that the safety and soundness of the banking system are neatly separable from the safety and soundness of the nonbanking financial sector. Taking this approach one step further, one could advocate adopting the universal banking model, which would allow commercial banks to engage in an unlimited variety of financial, and even commercial, activities. Legalizing universal banking, among other things, would render section 23A irrelevant and would have to rely instead on a conceptually different set of legal and regulatory safeguards against systemic risk. There may be a broad range of potential regulatory design options that fall between the revival of the Glass-Steagall principle of organizational separation, on the one hand, and the acceptance of universal banking, on the other. However, regardless of the merits of any particular proposal, the most important first step toward a solution is to face the complex reality of the existing section 23A regime and its unfulfilled promise." @default.
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• W3123313482 title "From Gramm-Leach-Bliley to Dodd-Frank: The Unfulfilled Promise of Section 23A of the Federal Reserve Act" @default.
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