By William Isaac, Published by American Banker

Creation of a super agency to regulate banks is a beguilingly simple idea. Senator Christopher Dodd (D-Conn.), Chairman of the Senate Banking Committee, recently sent up a trial balloon, giving the idea new life.

Proponents argue that “regulatory arbitrage” (i.e., shopping for the most lenient regulator) was a significant contributor to the current financial crisis – a thesis not supported by the facts.

The current crisis emanated from unregulated non-bank financial institutions. Moreover, Federal bank regulators do not allow institutions to switch charters if they have material open issues with their existing regulator.

The United Kingdom consolidated regulation of all financial services firms into the Financial Services Authority a decade ago. This did nothing to spare British financial institutions in the current financial crisis.

The most efficient and powerful financial regulatory authority our country has ever seen was the former Federal Home Loan Bank Board (Bank Board). The Bank Board had the combined authorities of the Office of the Comptroller of the Currency, the Federal Reserve, and the Federal Deposit Insurance Corporation under its wing. Yet the Bank Board oversaw the collapse of the S&L industry and the Federal Savings and Loan Insurance Corporation (FSLIC), which cost taxpayers $150 billion.

We do not need more concentration of regulatory power and more centralized decision making, we need more checks and balances and stronger watchdogs. One of the most important reforms we could make is creating an independent Systemic Risk Council to monitor the financial, regulatory, and accounting systems and report publicly on developing risks.

The Council would be headed by a Presidentially-appointed Chairman, subject to Senate confirmation, and would have an advisory board consisting of the Secretary of the Treasury and the chairmen of the FDIC, SEC, Fed, and possibly others. It would have its own staff and would have access to all information about the financial system in the government’s hands. The Council would not be a regulator but would oversee the activities of the regulators, including oversight of the Financial Accounting Standards Board.

We also need to strengthen the FDIC. The FDIC’s board should be reduced from five members to three by eliminating the seats held by the Comptroller of the Currency and the director of the Office of Thrift Supervision.

Congress recognized the importance of the FDIC’s watchdog role in 1991 when it granted the FDIC increased enforcement and examination powers over all banks and thrifts. Unfortunately, in folding the defunct FSLIC into the FDIC, Congress increased the FDIC’s board of directors from three to five, two of the members being the Comptroller of the Currency and the head of the OTS.

This five–person board structure can have a devastating effect on the FDIC when one or more vacancies exist. For example, the FDIC board had two vacancies in 1993, leaving the FDIC in the hands of Acting Chairman Skip Hove, Comptroller of the Currency Gene Ludwig, and the acting head of the OTS Jonathan Fiechter. The Comptroller offered a motion requiring the FDIC staff to obtain approval from the primary regulator before examining a national or Fed-member bank or a thrift.

The motion carried, and the FDIC’s authority to serve as a watchdog on the system was gutted. The FDIC, with a few brief exceptions, never had a full complement of directors from 1993 until 2004, making it impossible to override the 1993 vote. Two other changes at the FDIC need to be considered. The first is the pro-cyclical manner in which FDIC premiums are charged. Banks are not required to pay premiums in good times when the FDIC fund is deemed adequate, and they are assessed heavily in troubled times when they can least afford the charge.

Another change we need to consider is the limitation put into place in 1991 on the FDIC’s use of its emergency authorities. The FDIC today cannot use its emergency authorities unless requested to do so by the Secretary of the Treasury, in consultation with the President, and unless the action is also approved by the Fed board.
This restriction weakens the FDIC’s ability to respond to crises and politicizes the process. In reality the FDIC, Fed, and Treasury always work things out. But if the FDIC cannot act without approval from both the Fed and the Treasury, the FDIC’s negotiating hand is severely weakened, which was quite evident during the recent crisis.

We need real reforms to strengthen the oversight of our financial system and provide more checks and balances. A highly centralized regulatory system that takes us over the cliff with great efficiency is not the answer.