Noreika Weighs In on Separation of Banking and Commerce

Financial Services Law

In his last remarks as Acting Comptroller of the Office of the Comptroller of the Currency (OCC), Keith A. Noreika took on the “taboo” topic of removing the separation between banking and commerce.

What happened

Recalling “gasps” from industry members when the issue has been broached in the past, Noreika said few topics have been more misunderstood and avoided than the separation of banking and commerce. For his comments at The Clearing House Annual Conference in New York, outgoing Acting Comptroller Noreika proposed an “alternative to the popular narrative.”

“What interest does separating banking and commerce protect?” he asked attendees. “Who benefits? Who suffers?” The traditional argument in favor of separation is based on the need to protect banks from the corruptive power of commercial ownership and protect the market from banks consolidating and wielding too much power, Noreika explained.

This position can be traced back to the origins of banking in the United States, patterned after the Bank of England, when strict limits were placed upon the power of banks.

“Such restrictions may have made sense in the early years of our nation because so few banks and businesses existed, and each bank had the potential to have an outside effect on its community or region,” Noreika said. “As corporations became more plentiful and state and federal statutes affirmed corporate charters to conduct lawful businesses, banks continued to be treated as ‘entities of public interest’ and have limits placed on their powers and activities.”

The Great Depression and two world wars further shaped attitudes with regard to the separation of banking and commerce, with many pointing fingers at the mingling of the two industries as a major factor in the savings and loan crises of the 1980s and ’90s as well as the financial crisis of 2008.

But Noreika cited to studies with contrary results, including one conducted by the Federal Reserve Bank of Cleveland that concluded that unitary thrift holding companies—those owned by commercial companies and free to engage in certain commercial activities—“tended to outperform the others and had more diversified revenue streams, loan and asset portfolios, and funding sources compared with other thrifts.”

Advocates for maintaining a separation also express concern about size as a source of inherent risk, arguing that if companies could combine banking and commerce they could grow even larger, at the expense of smaller community banks. Noreika disputed that size represents a danger, instead taking the position that concentration poses the risk.

“In smaller communities, fewer restrictions against mixing banking and commerce could allow for greater use of local capital, and support growth and business activity locally,” he said. “It could help smaller community banks grow and take advantage of benefits previously only available to grandfathered companies and banks that are big and sophisticated enough to convince the Federal Reserve to grant them an exception.”

Such “meaningful competition” could also benefit consumers, Noreika added. “If a commercial company can deliver banking services better than existing banks, we hurt consumers by making it hard for them to do so,” he noted. He referenced multiple studies that considered the effects of mixing banking and commerce and found both sectors benefited from the commingling.

“The takeaway from these studies is that mixing banking and commerce can generate efficiencies that deliver more value to customers and can improve bank and commercial company performance with little additional risk,” Noreika said. “Still, regulators should watch markets closely to avoid too much concentration and not enough competition. As prudential supervisors, regulators also need to match any increased complexity in the institutions they oversee with added sophistication and capabilities.”

Noreika bemoaned the fact that the recent financial crisis “has been used as an excuse” to silence the discussion on the separation of banking and commerce, “even though the evidence and data show that combining banking and commerce had little to do with the cause of the crisis and the Great Recession that followed.”

In conclusion, he urged attendees to “restart” the dialogue. “We need fresh research that looks at banking and commerce in a post-Dodd-Frank world,” he said. “In having that conversation we might find opportunities to do things a little differently, and we might start a powerful and beneficial economic engine.”

To read the Acting Comptroller’s prepared remarks, click here.

Why it matters

Separation of banking and commerce has been an active discussion topic in the United States for decades. By encouraging a restarting of the dialogue on this important topic, former Acting Comptroller Noreika, at the very least, reminded the financial industry that as the economy changes and new innovation comes to the fore, the industry is well-suited to at least examine the influence of its legislative history to determine if large or small amendments are needed to move the industry forward, and to closely consider the risks associated with that. Given his background, new Comptroller Joseph Otting should exhibit many of the same views.