Federal Financial Services Regulatory Consolidation: An Overview

Federal Financial Services Regulatory
Consolidation: An Overview
Updated July 10, 2008
Walter W. Eubanks
Specialist in Economic Policy
Government and Finance Division

Federal Financial Services Regulatory Consolidation:
An Overview
Summary
Among the arguments offered for consolidating the federal regulatory structure of
the financial services industry is that the industry has changed in ways that blur the clear-
cut boundaries between the functional areas of banking, insurance, securities, and
commodities markets. It has also been argued that while the financial services firms are
primarily responsible for effectively managing their risks, the new nature of those risks
has created a need for the government to take a more comprehensive approach to
financial regulation. Moreover, a consolidated financial services regulator at the national
level is more suited to accommodate international regulatory negotiations on financial
services regulations such as capital, accounting, and privacy standards. The most recent
proposal to consolidate the federal regulatory structure is the Department of the Treasury
Blueprint for a Modernized Regulatory Structure (page 13), which would merge several
federal regulatory agencies’ functions into five distinct functional supervisory agencies.
The proposal consolidates regulatory functions, not agencies.
Even though a number of proposals to consolidate the federal regulatory
structure of the financial services industry have been put forth, the United States has
yet to make any significant move to do so. A key reason is that the functional,
competitive regulatory structure of the United States was, and continues to be,
viewed by most policymakers and knowledgeable observers as being sound over
time, despite a number of crises. For example, significant federal regulation of
banks first occurred during the Civil War when states’ management of their
currencies failed dramatically. In another example, financial regulators addressed the
savings and loan associations failures of the 1980s with risk-based capital
requirements for all insured-depository institutions for the first time. The Sarbanes-
Oxley Act established accounting standards for publicly traded companies in
response to the accounting frauds leading to the bankruptcy of several large publicly
traded firms. The structure has often been able to successfully address such problems
quickly before they disrupt the economy.
To improve their ability to regulate the modern financial services sectors, many
countries including the United Kingdom, Japan, and Germany have recently
consolidated their financial services regulatory agencies. Financial Services
Authority of the United Kingdom (FSA-UK), the Financial Services Agency of Japan
(FSA- Japan), and the Federal Financial Supervisory Authority (BaFin) in Germany
provide a point of comparison for the U.S. regulatory structure. These foreign
regulatory structures are said to offer more effective methods of regulating modern
financial services firms.
This report is a brief overview of the U.S. federal financial services regulatory
structure. It briefly provides an historical analysis of the current U.S. functional and
competitive regulatory structure. It discusses some of the recent proposals to
consolidate the U.S. regulatory agencies, and it assesses three consolidated financial
services regulatory structures abroad.
This report will be updated as developments warrant.

Contents
Introduction ..................................................1
The Major Financial Services Regulators...........................1
The Office of the Comptroller of the Currency (OCC).............2
The Federal Reserve System (Fed)............................2
The Federal Deposit Insurance Corporation (FDIC)...............2
The Office of Thrift Supervision (OTS)........................2
The National Credit Union Administration (NCUA)..............2
The Securities and Exchange Commission (SEC).................2
The Commodity Futures Trading Commission (CFTC)............3
Safety and Soundness Regulations................................3
Background ..................................................4
U.S. Functional and Competitive Regulatory Structure.................6
Regulatory Competition in Banking...........................7
Regulatory Competition in Insurance..........................7
Regulatory Competition in Securities..........................9
Regulatory Competition in Commodity Futures and Options.......11
The Problem of Regulating in the Current Environment...............12
Proposed Consolidation Solutions................................13
Consolidation in Other Countries................................16
Financial Services Authority of the United Kingdom.............17
The Financial Services Agency of Japan.......................19
The Federal Financial Supervisory Authority (BaFin).............20
U.S. Regulators Are Trying to Speak with One Voice................22
Some Implications............................................22
List of Figures
Figure 1. The Number of FDIC-Insured Bank Failures,
1934-2008 ...................................................4
Figure 2. FDIC-Insured Bank Deposits: Ratio of Failed Bank Deposit to
Total Bank Deposits, 1934-2008..................................5

Federal Financial Services Regulatory
Consolidation: An Overview
Introduction
Today, financial services, banking, insurance and securities trading are no longer
specific to an institution, but are delivered by almost every financial services
institution in most cases with little or no differentiation. Since the 1980s, financial
services companies increasingly commingle products and services. The passage of
P.L. 106-102, the Gramm-Leach-Bliley Act (GLBA), incorporated the commingling
of financial services within institutions into U.S. financial services law. In this new
GLBA framework, the responsibilities of regulating financial institutions are more
difficult to achieve because their business activities have become more interrelated.
Technological advances have helped to erase the traditional lines of demarcation
in financial services products upon which the regulatory structure was built. Bank
regulators, for example, continue to lower barriers to bank entry into commodity
futures and the options business, and insurance has become a popular bank product.
As bankers get more involved in the securities business, the business has been
changing rapidly. As financial instruments or products become more complicated,
the riskiness (probability of default) of the products is more difficult to determine for
regulatory purposes. Maintaining a regulatory structure and control based on past
market demarcations that are now slowly disappearing raises questions about the
effectiveness of the regulatory structure that has responsibility for the safety and
soundness of the financial institutions under its jurisdiction.
This report is a brief overview of the U.S. federal financial services regulatory
structure. The first section is a brief historical analysis of the functional and
competitive regulatory structure of the three major financial services — banking,
insurance, and securities, including commodities futures and options. The second
section deals with the difficulties in regulating institutions when they begin to
provide services outside their demarcated lines of business. The third section
discusses some of the recent proposals to consolidate regulatory agencies in the
United States. The fourth section briefly assesses the consolidated financial services
regulatory structures in the United Kingdom, Japan, and Germany, and the report
concludes with some implications.
The Major Financial Services Regulators
There are currently seven major federal regulators for the financial services
industry. The following is a summary of the supervisory duties of the Office of the
Comptroller of the Currency (OCC), the Federal Reserve System (the Fed), the
Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision

(OTS), the National Credit Union Administration (NCUA), the Securities and
Exchange Commission (SEC), and the Commodity Futures Trading Commission
(CFTC). All these agencies regulate for safety and soundness. The SEC and the
CFTC emphasize consumer protection more than the others.
^!The Office of the Comptroller of the Currency (OCC).
The OCC is the regulator for just under 2,000 nationally chartered
banks, and the U.S. branches and offices of foreign banks. The OCC
conducts on-site examinations of each national bank at least three
times within every two-year period.
^!The Federal Reserve System (Fed). The Fed supervises
about 950 state-chartered commercial banks that are members of the
system and more than 5,000 bank holding companies and financial
holding companies. Along with the OCC, it also supervises some
international activities of national banks. The Fed uses both on-site
examination and off-site surveillance and monitoring in its
supervision process. Each institution is examined on-site every 12
to 18 months. The Fed’s in-house examiners are to examine larger
institutions continuously. The Board of Governors of the Fed
coordinates the examination and compliance activities of the 12
regional banks.
^!The Federal Deposit Insurance Corporation (FDIC). The
FDIC regulates about 4,800 state-chartered commercial banks and
500 state-chartered savings associations that are not members of the
Fed. They also insure deposits of the remaining 4,000 depository
institutions without regulating them. The FDIC examines its
supervised institutions about once every 18 months.
^!The Office of Thrift Supervision (OTS). The OTS
supervises about 950 federally chartered savings associations,
savings banks, and their holding companies. Like the OCC, the OTS
is located within, but is independent of, the Treasury. The OTS is
to conduct on-site examinations of each institution at least three
times every two years.
^!The National Credit Union Administration (NCUA). The
NCUA currently regulates 9,369 federally chartered credit unions
and another 3,593 federally insured, state-chartered credit unions.
Most credit unions are small and considered to have limited risk
exposure. Consequently, credit unions and NCUA are not covered
further in this report.
^!The Securities and Exchange Commission (SEC). The
SEC regulates to protect investors against fraud and deceptive
practices in securities markets. It also has authority to examine
institutions it supervises for regulatory compliance. This covers
securities markets and exchanges, securities issuers, investment
advisers, investment companies, and industry professionals such as

broker-dealers. The SEC supervises more than 8,000 registered
broker-dealers with approximately 92,000 branch offices and 67,500
registered representatives.
^!The Commodity Futures Trading Commission (CFTC).
The CFTC protects market users and the public from fraud and
abusive practices in markets for commodity and financial futures and
options. The CFTC delegates regulatory examinations to its
designated self-regulatory organizations (DSROs), of which the
most prominent are the National Futures Association (NFA), the
Chicago Board of Trade, and the New York Mercantile Exchange.
NFA membership covers more than 4,000 firms and 50,000
individuals. The regulatory process generally starts at registration,
when the DSRO screens firms and individuals seeking to conduct
futures business. The DSROs monitor business practices and, when
appropriate, take formal disciplinary actions that could prohibit
firms from conducting any further business.
Safety and Soundness Regulations
Safety and soundness regulations for banks consist of basically five components:
federal deposit insurance to reduce the likelihood of bank runs and panics; deposit
interest ceilings to reduce the costs of bank deposits and weaken banks’ incentives
to invest in risky assets; regulatory monitoring to ensure that banks do not invest
in excessively risky assets, have sufficient capital given their risk, have no fraudulent
activities, and have competent management; capital requirements to provide
incentives for banks not to take excessive risk; and portfolio restrictions to prohibit
investment in risky assets.
Under regulatory monitoring, U.S. banking regulators adopted a uniform rating
system known as CAMEL to monitor banks’ safety and soundness. “C” stands for
capital adequacy; “A” stands for asset quality; “M” stands for management ability,
“E” stands for earnings, and “L” stands for liquidity. The bank’s capital is evaluated
on the basis of the bank’s size as well as the composition of its assets and liabilities,
on and off the balance sheet. The quality of the bank’s assets is determined by
assessing the bank’s credit risk of loans in its portfolio, which are classified as good,
substandard, doubtful, or loss. Management ability is determined by evaluating the
bank’s management as well as its board of directors. The examiners assess
competence, management acumen, integrity, and willingness to comply with banking
regulations. Earnings are evaluated in terms of trends relative to the bank’s peers.
In determining the bank’s liquidity, the examiners assess credit conditions, deposit
volatility, loan commitments, and other contingent claims against the bank’s capital,
current stock of liquid assets, and the bank’s perceived ability to raise funds on short
notice. From the list of regulators above, one can see that bank examiners have
overlapping jurisdictions. For example, national banks are also FDIC-Insured. Often
federal and state examiners accept each others’ examinations, and sometimes they

examine jointly. It is important to note that it is illegal to disclose a bank
examination (for example, CAMEL ratings) outside the bank.¹
Background
A number of proposals to consolidate the federal regulatory structure of the
financial services industry have been put forth. The United States, however, has yet
to make any significant move in this direction. One reason is that most policymakers
and knowledgeable observers believe that the functional, competitive regulatory
structure of the United States has proven sound over time.² For example, the number
of bank (a key financial services provider) failures would be among the indicators
of the health of a financial services structure. Figure 1 indicates that the number of
bank failures have declined, since it peaked during the S&L crisis in 1989 when 206
depository institutions failed.
Figure 1. The Number of FDIC-Insured Bank Failures,

1934-2008

deposits). At its peak in 1991, 124 institutions failed but only a little more than 2%
of the total banking deposits were held by these failed institutions. In contrast, at the
end of 2006 no depository institution failed for the first time two in consecutive
years since 1934. But the subprime turmoil that started in August of 2007 and the
credit crunch that followed contributed to the failure of three small banks in 2007 and
four in the first quarter of 2008.
Figure 2. FDIC-Insured Bank Deposits: Ratio of Failed Bank Deposit
to Total Bank Deposits, 1934-2008

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The regulatory structure of the United States is said to be functional because
regulators supervise by line of business such as banking, insurance, or securities
trading. The structure is said to be competitive because there are usually multiple
regulators responsible for a single function, for example, banking services.³
Regulatory responsibilities are widely dispersed among several regulators on the
federal as well as the state level of government.
The U.S. regulatory structure reflects historical evolution rather than deliberate
design. The structure has evolved by addressing regulatory deficiencies on whatever
level they are found. For example, federal regulation of banks occurred for the first
time after the Civil War when states’ management of their currencies failed
dramatically. For the first time in the 1980s, the financial regulators addressed the
savings and loan associations’(S&Ls) failures by abolishing the Federal Saving and
Loan Insurance Corporation (FSLIC), creating the OTS as the S&Ls’ new regulator
³ Bert Ely, “Functional Regulation Flunks: It Disregards Category Blurring,” American
Banker, February 27, 1997, p. 4.

and requiring all insured-depository institutions to increase their capital by
calculating their regulatory capital based on the riskiness of their assets. The purpose
was to increase the protection of taxpayers from future bailouts of these institutions.
More recently, the Sarbanes-Oxley Act created a new independent body, the Public
Company Accounting Oversight Board to oversee auditors and established
accounting standards for publicly traded companies in response to accounting fraud
leading to the bankruptcy of several large publicly traded firms. In most cases, the
U.S. regulatory structure has been able to handle most financial crises successfully
before they significantly disrupt economy activity. The issue is the regulatory
structure’s capacity to continue to handle most financial crises given the increased
interrelationships and functional commingling within the financial services industry.
The United Kingdom, Japan, and Germany recently consolidated and redesigned
their financial services regulatory agencies to meet recent developments in the
financial services markets. These recent developments included the blurring of
boundaries among functions, need for a comprehensive approach to risk
management, better allocation of regulatory resources, and the need to accommodate
international regulatory negotiations on trade in financial services.
The Financial Services Authority in the United Kingdom (FSA-UK), the
Financial Service Agency in Japan (FSA-Japan), and the Federal Financial
Supervisory Authority (BaFin) in Germany provide a point of comparison for the
U.S. structure. These foreign regulatory structures are said to offer more effective
methods of regulating modern financial services firms.
U.S. Functional and Competitive Regulatory Structure
U.S. regulation of financial services is dispersed among a number of regulators.
For example, the FDIC and the OCC have regulatory responsibilities for national
banks that are FDIC-insured. The OCC holds these banks’ charters, and therefore
determines the activities in which they may engage. The FDIC insures each of the
institutions’ deposit accounts for up to $100,000 on which it must make good if the
institutions fail. Proponents of the framework contend that competing regulatory
bodies regulate less but do it more efficiently. The redundancy of regulators is more
likely to detect and correct risky market behaviors before they develop into financial
cri s es.⁴
The structure allows regulations to be tailored to the specific deficiencies at the
appropriate level of the abusing firm(s). Also, the structure promotes innovations
and competition among financial services providers. Opponents argue that the
overlapping regulations are costly and allow astute financial services firms to exploit
weaknesses along the regulatory seams. The structure also allows financial services

⁴ See the Board of Governors of the Federal Reserve System comments on the Government
Accountability Report in U.S. Government Accountability Office, Financial Regulation:
Industry Changes Prompt Need to Reconsider U.S. Regulatory Structure, GAO Report
GAO-05-61, October 2004, p. 137, also see U.S. Task Group on Regulation of Financial
Services, Blueprint for Reform: The Report of the Task Group on Regulation of Financial
Services (Washington: GPO, 1984), pp. 29-33.

providers to shop for the regulator that best suits their business plan. This was
confirmed in a recent FDIC survey that shows that the top reasons given by the 34
banks that changed their charter to the FDIC were that “the FDIC was less expensive
and more banker friendly, and that other regulators were stricter, and that institutions
could more readily pursue market share increases.”⁵ On the other hand, the ability
to shop for regulators could lead to more institutions being regulated by the weakest
regulators, which would increase systemic risk.
Regulatory Competition in Banking. In the beginning of the nation, the
federal government exercised an indirect role in the regulation of banking through
the First and Second Banks of the United States. When President Andrew Jackson
refused to renew the Second Bank’s charter, states’ regulatory banking commissions⁶
filled the regulatory vacuum that was created. The Civil War and the disarray of the
national currencies led to the reintroduction of the federal government into regulating
banks by establishing the national bank charter system, which was governed by the
Comptroller of the Currency (OCC) established in 1863.⁷ Its creation immediately
began the dual banking system which exists today and placed the federal government
in competition with states for the number and size of banks under their respective
jurisdictions. Until recently, most bankers preferred state charters because states’
regulations were considered less burdensome.
More layers to the regulatory structure, and therefore competition between
regulators, were added with the creation of the Federal Reserve Board after the Panic
of 1907 and the creation of the Federal Deposit Insurance Corporation (FDIC) after
the banking failures of the Great Depression in the 1930s. Further layers of
regulatory competition were added when saving banks and credit unions were
provided with separate federal regulators which evolved into the Office of Thrift
Supervision (OTS) and the National Credit Union Administration (NCUA).⁸ The
Great Depression also led Congress to pass the Glass-Steagall Act of 1933 (Ch.89,
48 Stat.162) to further seal off banking from other financial services enterprises by
prohibiting banks from engaging in investment banking activities until it was
repealed by the Gramm-Leach-Bliley Act of 1999 (GLBA) (P.L. 106-102). It
repealed the Glass-Steagall Act and allows financial companies owning or operating
institutions to commingle financial services.
Regulatory Competition in Insurance. Like banking, the insurance
industry owes its competitive regulatory structure to correcting deficiencies. States
began regulating insurance in 1837, starting with Massachusetts and New York, to

⁵ BNA Banking Report, “Bank Supervision ‘Burdensome’ Regulations Complaint In FDIC
Ombudsman Surveys, Agency Says,” BNA’s Banking Report, March 28, 2005, p. 1. See
the original report at [http://www.fdic.gov/regulations/resources/ombudsman.html].
⁶ Jerry W. Markham, Banking Regulation: Its History and Future (Chapel Hill, NC: North
Carolina Banking Institute, 2000), pp. 226-227.
⁷ National Bank Act of 1863, ch. 106, 13 stat. 99.
⁸ Broome and Markham, Regulation of Bank Financial Service Activities (New York: West
Publishing, 2001), pp. 78-81, 87.

ensure that insurance companies maintained adequate reserves to meet claims.⁹ In
the early 1920s, states significantly increased legislative restrictions on insurance
companies, starting in New York and copied by other states. A New York
legislature’s investigation uncovered massive insurance companies’ abuses that left
them without adequate reserves to pay claims. That led to the New York state’s
legislature passing laws barring companies from underwriting insurance while
underwriting other securities.
Copying New York state’s regulations, states separated insurance companies
from the banking industry.¹⁰ These regulatory provisions also protected the insurance
industry from the excesses of the securities industry in the late 1920s that led to the
stock market crash. Consequently, when the stock market crashed in 1929, the
insurance companies were in relative good shape.¹¹ Having escaped the massive
failures of the other parts of the financial services sector, the insurance companies
were not included in New Deal regulatory legislation, even though in 1934 the
Securities and Exchange Commission (SEC) proposed a federal agency to regulate
insurance companies. The proposal was soundly rejected upon objections from the
industry and state regulators.¹²
Another possible expansion of federal regulation of insurance came in 1944 out
of a Supreme Court ruling which held that the insurance industry was subject to the
federal antitrust laws.¹³ The insurance industry feared that this ruling would preempt
their state regulation. As a result, the industry lobbied Congress heavily to pass the
McCarran-Ferguson Act, which granted insurance companies immunity from the
antitrust laws to the extent that they were regulated by state insurance laws.¹⁴ The
McCarran-Ferguson Act protected the insurance industry until the early 1950s when
insurance companies began selling variable annuities, which the SEC challenged.
The SEC argued that variable annuities were securities subject to its regulation
because the returns on these investments were based on investment of the annuitants’
premium payments in securities. The Supreme Court found for the SEC. Insurance

⁹ Broome and Markham, “Banking and Insurance: Before and After the Gramm-Leach-
Bliley Act,” Journal of Corporation Law, summer 2000, p. 727.
¹⁰ Ibid., p. 731.
¹¹ Temporary National Economic Committee (TNEC), Investigation of the Concentration
of Economic Power, Monograph No. 28A: Statement on Life Insurance, 76^th Congress, 2^nd
sess., 1941, pp. 2, 107.
¹² Broome and Markham, “Banking and Insurance: Before and After the Gramm-Leach-
Bliley Act,” p. 732.
¹³ United States v. South-Eastern Underwriters Association, 322 U.S. 533 (1944).
¹⁴ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States, the United Kingdom, and Japan,” Brooklyn Journal of International Law,

2003, p. 4.

companies selling variable annuity contracts are now regulated by states and the
SEC.¹⁵
The insurance industry was able to stave off other federal intrusions, despite
suffering significant losses from contracts sold in the 1980s.¹⁶ The industry,
however, could not avoid competition from the banking and securities industries.¹⁷
One reason was that variable annuities became a growing line of financial services
products sold by stockbrokers. In addition, federal bank regulators began allowing
banks to sell insurance products in the 1990s.¹⁸ This competition resulted in many
insurance companies demutualizing¹⁹ and expanding their own financial service
offerings, such as more securities-like products with banking services options.²⁰ In
sum, even though regulatory competition was maintained with the states, state
insurance regulators could not protect insurance companies from competition from
other financial services providers. There have been several legislative proposals in
recent years to impose federal regulation on some companies who offer securities-
like products with banking services options.²¹
Regulatory Competition in Securities. When the Securities and Exchange
Commission was created by Congress in 1934 — in the wake of the stock market
crash of 1929 — it was to establish a strong federal regulatory presence in the market²²
for corporate securities. The SEC’s main focus was full disclosure in the securities
markets. The Securities and Exchange Act of 1934 did not preempt state securities
regulations. Consequently, the SEC has competed with state securities regulators for

¹⁵ Broome & Markham, “Banking and Insurance: Before and After the Gramm-Leach-Bliley
Act,” p. 737.
¹⁶ Ibid., p. 739.
¹⁷ Cedric V. Fricke, The Variable Annuity: Its Impact on the Savings-Investment Market,
Bureau of Business Research, School of Business Administration, University of Michigan,

1959, 90 p.

¹⁸ For example, states were unable to restrict banks from selling insurance following banks’
victories in the courts. See U.S. National Bank of Oregon v. Independent Agents of Agents
of America, 508 U.S. 439 (1993), and Barnett Bank of Marion County N.A.B. Nelson, 517
U.S. 25 (1996).
¹⁹ Many insurance companies changed from being owned by their customers to publicly
owned companies. See Broome & Markham, Banking and Insurance: Before and After the
Gramm-Leach-Bliley Act, pp. 19, 745-746.
²⁰ See CRS Report RL32138, Revising Insurance Regulation: Policy Considerations, by
Baird Webel and Carolyn Cobb.
²¹ See U.S. Congress, Senate Committee on Commerce, Science, and Transportation,
Federal Involvement in the Regulation of the Insurance Industry, hearing, 108^th Cong., 1^st
sess., October 22, 2003, available at [http://www.commerce.senate.gov].
²² Joel Seligman, The Transformation of Wall Street: A History of the Securities and
Exchange Commission and Modern Corporate Finance (New York: Aspen Publishing,

1995), p. 45.

most of its existence.²³ With the exception of mortgage-backed securities in 1984,
it was not until the National Securities Markets Improvement Act of 1996 that some
of the states’ securities regulations were preempted or states were required to
conform their standards to those of the SEC.²⁴ Federal securities law and SEC
regulations apply to the markets where securities are traded and to all businesses that
sell stocks or bonds to public investors. Other regulated entities include mutual
funds, bidders in corporate mergers and acquisitions, certain investment advisers,
public accountants, and power utilities (the SEC has some control over the market
structure under the Public Utility Holding Company Act of 1935).²⁵
In this securities regulatory structure, regulatory competition remains in the form
of self-regulatory organizations (SROs). These are non-governmental organizations
that were given regulatory authority and shelter from the antitrust laws by the
Securities and Exchange Act of 1934.²⁶ SROs like the securities exchanges and the
National Association of Securities Dealers, Inc. (NASD) are required to regulate the
conduct of their members. The SEC’s role is to oversee the exchanges, as well as act
directly when the SROs’ oversight fails.²⁷
In addition to the SROs, the structure of securities regulation also includes
accountants that certify the financial statements of public companies and broker-
dealers as well as the Nationally Recognized Statistical Ratings Organizations
(NRSROs). The NRSROs include rating agencies such as Moody and Standard &
Poor’s. The SEC’s ability to enforce its rules over accountants and broker-dealers
has been strengthened by the Sarbanes-Oxley Act of 2002, which created a Public
Company Accounting Oversight Board to oversee the auditing principles of auditors.
Sarbanes-Oxley also requires the SEC to conduct a study of NRSROs and to report
to Congress on any deficiencies. Concerns about conflict of interest and certification
have resulted in the Senate Committee on Banking, Housing, and Urban Affairs
holding hearings on the regulation of NRSROs.²⁸

²³ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States, the United Kingdom, and Japan,” p. 4.
²⁴ Ibid., p. 34.
²⁵ See the Securities and Exchange Commission section by Mark Jickling in CRS Report
RL32309, Appropriations for FY2005: Commerce, Justice, State, the Judiciary, and Related
Agencies, coordinated by Ian F. Fergusson and Susan B. Epstein.
²⁶ Self-regulation by the National Association of Securities Dealers was added in 1938 by
the Maloney Act, 52 Stat. 1070 (Codified as amended at 15 U.S.C.§ 780-3 (2000)).
²⁷ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States, the United Kingdom, and Japan,” p. 5.
²⁸ Alec Klein, “Debt-Rating Firms Resist Prospect of More Supervision” The Washington
Post, February 9, 2005, p. E-2. For testimonies presented at the Senate hearing, see
[http://banki ng.senate.gov/index.cfm?Fuseaction=Hearings.Detail&HearingID=136].

Regulatory Competition in Commodity Futures and Options. Like
the other financial services, commodities futures were separated from the rest of the
industry as part of historical regulatory development in the United States. The
agricultural recession of 1921 following World War I, and speculative manipulation
of commodity prices prompted Congress to pass the Grain Futures Act of 1922 under
its commerce powers.²⁹ The Grain Futures Act required commodity futures trading
to be conducted on organized exchanges, such as the Chicago Board of Trade, which
would register with the government as contract markets. With commodity
speculation and market manipulation unchecked in the Great Depression, President
Roosevelt added regulation of the commodity markets to his request for regulation
of the securities market. Congress responded with the Commodity Exchange Act of
1936 (CEA), which continued many of the requirements of the Grain Futures Act, but
required futures commission merchants (the equivalent to broker-dealers in the
securities business) to register with the government.³⁰
For decades, even though options trading of regulated commodities, and
manipulation of commodity prices, were prohibited, the government was unable to
stop speculation and manipulation in commodity prices, particularly in options on
unregulated commodities which added to the rapid rise in commodity prices in the
early 1970s. The Commodity Futures Trading Commission Act of 1974 was enacted
in response to developments in the commodities markets which carried forward the
Commodity Exchange Act and created the CFTC.³¹
The CFTC was given exclusive jurisdiction over the trading of commodity
futures and commodity options on all commodities and it was given more
enforcement powers than its predecessor. Its regulatory reach included commodity
trading advisors, commodity pool operators, and associated persons of futures
commission merchants.³² Despite the increased federal regulation of the commodity
trade, the regulatory control of commodity trade remained less stringent than SEC’s
control of trade in securities. Competition between the SEC and the CFTC
developed when the financial services industry began developing new financial
instruments and trading strategies that converged on products regulated by both
regulators — stock index futures, and other equity-based derivatives. The difference
in the level of regulation in the securities and the commodity futures and options
markets became important to investors. Over-the-counter (OTC) instruments such
as swaps, caps, collars, and floors were increasingly popular alternatives to exchange-
traded commodity futures and options. Some of these instruments were abused by

²⁹ The Futures Trading Act of 1921, Ch.86, 42 Stat. 187 (1921) was found unconstitutional
by the Supreme Court as an impermissible use of the congressional taxing powers. See
Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States, the United Kingdom, and Japan,” p. 7.
³⁰ Ibid., pp.7-8.
³¹ Jerry W. Markham, “Manipulation of Commodity Futures Prices — The Unprosecuteable
Crime,” Yale Journal on Regulation, vol. 8, 1991, p. 281.
³² Jerry W. Markham, History of Commodity Futures Trading and Its Regulation (New
York: Praeger, 1987), pp. 66-72.

both SEC- and CFTC-regulated firms and traders. In 1978, Congress mandated that
the two agencies consult with each other and with banking regulators in curtailing
these abuses.³³
The over-the-counter market for derivatives was the source of regulatory
competition between the CFTC and the banking regulators — the Fed and the OCC.
The banking regulators argued for no regulation of OTC financial derivatives, even
though Congress had given the CFTC exclusive jurisdiction over all contracts and
mandated that all such contracts be traded on CFTC-regulated exchanges. However,
the CFTC did not move to assert its regulatory jurisdiction over these derivative
contracts. The lack of regulation provided a legal risk to swaps contracts. That is,
if a court had ruled that swaps were illegal, trillions of dollars in OTC derivative
contracts might have been rendered void and unenforceable.³⁴
The Commodity Futures Modernization Act of 2000 (CFMA; P.L. 106-554) was
enacted to clarify the situation. It specifies that the CEA does not apply to contracts
between “eligible contract participants” (which include financial institutions,
regulated financial professionals, units of government, nonfinancial businesses or
individual persons with assets more than $10 million, and others whom the CFTC
may approve) based on “excluded commodities.” Excluded commodities are defined
as financial products and indicators, and are thought to be less susceptible to
manipulation than physical commodities with finite supplies. Derivatives based on
agricultural commodities, however, may be traded only on CFTC-regulated
exchanges, because of concerns about price manipulation — “corners” and
“squeezes” — in those markets.³⁵
The Problem of Regulating in the Current Environment
Today, financial services, such as banking, insurance and securities trading are
no longer specific to an institution. Insurance, for instance, does not have to be
bought from an insurance company; instead it can be purchased from a bank with
little or no differentiation in the policy being delivered to the customer. Since the
1980s, financial services companies increasingly commingle financial services. The
passage of P.L. 106-102, the Gramm-Leach-Bliley Act of 1999, incorporated the
commingling of financial services within institutions into U.S. financial services law.
In this new GLBA framework, the responsibilities of regulating financial
institutions are more difficult to achieve because the regulators no longer have the
separation of the lines of businesses that they had in the past. Technological
advances have helped to erase the traditional lines of demarcation in financial
services products upon which the regulatory structure was built. Bank regulators, for
example, continue to lower barriers to bank entry into commodity futures and options
businesses, and insurance has become a popular bank product. As bankers get more

³³ Ibid., pp. 99-100.
³⁴ CRS Report RS20560, The Commodity Futures Modernization Act (P.L. 106-554), by
Mark Jickling.
³⁵ Ibid., p. 3.

involved in the securities business, the business has been changing rapidly.
Maintaining a regulatory structure and control based on past established market
behavior that is now slowly disappearing raises questions about the effectiveness of
the structure to manage the changing risks. Most regulatory changes have occurred
after the risks have risen sufficiently to show the deficiencies.
Proposed Consolidation Solutions
The most recent proposal to consolidate the federal regulatory structure of
financial services industry is the Department of the Treasury Blueprint for a
Modernized Regulatory Structure (the Blueprint). It was motivated by the Bush
Administration’s recognition that the existing functional regulatory framework no
longer provides efficient and effective safeguards against poor prudential behavior
of financial services firms.³⁶ The Administration believed that the existing
framework is based on a structure that has been largely knitted together more than 75
years to address specific economic disruptions and is not optimal because financial
institutions have become more opaque and more difficult to understand as the
institutions develop new products and complex risk-hedging strategies that are
difficult to evaluate.
For these reasons, on March 31, 2008, Treasury Secretary Henry Paulson offered
the Blueprint as a more optimal federal financial regulatory structure. This proposed
framework would consolidate similar functions more than it would consolidate
agencies by renaming existing regulatory agencies and make significant changes in
their responsibilities, and functions. There will be five major regulatory agencies
which is the same number as there are federal banking regulators: a market stability
regulator, which is essential the monetary and lender of last resort functions of the
Federal Reserve; a prudential regulator, which would enforce the safety and
soundness prudential regulations that are shared by all existing regulators; a business
conduct regulator, which is a consumer and business protection regulator whose
functions are now shared by all regulators and particularly the SEC/CFTC; a federal
insurance regulator, which is essentially the Federal Deposit Insurance Corporation
with additional insurance responsibilities preempted from states, and a corporate
financial regulator, which is essentially the SEC/CFTC and related self regulated
organizations, such as the securities exchanges.
The financial services industry’s reaction to the Blueprint has been mixed with
the criticisms outweighing the support of the proposal. Banking groups supported
the prospects of regulatory modernization, but were critical of the Blueprint’s plan
to eliminate the thrift and credit unition charters along with their supervisory
agencies — the Office of Thrift Supervision (OTS), and the National Credit Union
Administration (NCUA). On the other hand, the mortgage bankers supported the
Blueprint arguing that it would lead to resolving regulatory inconsistences in
mortgage lending supervision at the state level. For insurance, most smaller
insurance companies opposed the Blueprint’s optional federal charter, which would
give insurance companies the option of federal regulation rather than the existing

³⁶ The Department of the Treasury, The Department of the Treasury Blueprint for a
Modernized Financial Regulatory Structure, March, 2008. 218pp.

state regulation of insurance companies. By contrast, large insurance companies
operating in several states supported the optional federal charter proposal, while state
insurance commissions were quick to oppose the Blueprint’s insurance proposal.
The commissioners argue that they support needed modernization but that does not
mean federalization. On the securities and futures markets, the Blueprint proposes
to merge the SEC with the CFTC, which has been proposed before as shown below,
but has not happened.
Congress and regulators in the first term of the George W. Bush Administration
raised the long-standing issue of consolidating federal financial services regulators.³⁷
The former U.S. Treasury Undersecretary for Domestic Finance, Peter R. Fisher,
made an argument that the supervisory process of the financial services industry
should remain diverse, and aimed at the risk-bearing parts of financial firms.
However, he strongly advocated creating one regulator to write rules and regulations.
This single regulatory agency — a super-regulator — should be responsible for only
this activity.³⁸ Such an agency would absorb the regulation-making functions of all
the major federal financial regulators. The George W. Bush Administration’s
restructuring efforts for financial services regulators was later shifted to oversight of
particular institutions such as the government-sponsored housing enterprises Fannie
Mae and Freddie Mac.
An even earlier suggested reform of the federal financial regulatory agencies
was put forth in 2002 by Donald E. Powell, Chairman of the Federal Deposit
Insurance Corporation. Chairman Powell proposed to design a new regulatory
system that would reflect the modern financial services marketplace. Three federal
financial services regulators would carry out federal supervision. One would be
responsible for regulating the banking industry, another for the securities industry,
and a third for insurance companies that choose a federal charter.³⁹ Under this
proposal, regulators like the OCC would be restructured out of existence.
Along this line of thinking there have been other regulatory restructuring plans
for the financial services industry by sectors:
Banking. During the Clinton Administration, Secretary of the Treasury Lloyd
Bentsen proposed that certain functions of the Federal Reserve, the FDIC, the OCC,
and the OTS be combined into an independent agency called the Federal Banking
Commission. This commission would have been responsible for bank regulation and

³⁷ See Donald E. Powell, Federal Deposit Insurance Corporation Chairman, Why Regulatory
Restructuring? Why Now?, Delivered at the Exchequer Club, Washington DC, November
16, 2002. The FDIC also sponsored a symposium entitled, “The Future of Financial
Regulation: Structural Reform or the Status Quo?,” March 13, 2003. The American
Enterprise Institute conducted a similar conference on February 21, 2003 entitled, Is
Consolidated Financial Regulation Appropriate for the United States? [http://www.aei.org].
³⁸ Kim Betz, “Super Regulator Could Aid Consistency in Financial Services Rule Writing
Process,” BNA Banking Report, September 23, 2002, p. 1.
³⁹ Don Powell, Remarks before the Conference on Bank Structure and Competition, Federal
Reserve Bank of Chicago, Chicago, IL, May 2002, p. 2, [http://www.fdic.gov
/news/news /speeches/archives/w00w/sp1may02.html ].

supervision. The FDIC would have remained responsible for administering federal
deposit insurance, and the Federal Reserve would have retained its central banking
responsibilities for monetary policy, liquidity lending, and the payments system.
However, both the FDIC and the Fed would lose most of their bank supervisory rule-
making authority to the Banking Commission.⁴⁰
In 1994, former Federal Reserve Governor, John P. LaWare recommended
combining the OCC with the OTS. The combined agencies would form an
independent Federal Banking Commission. The Federal Reserve would supervise
all independent state banks and all depository institutions in any holding company
whose lead institution was state chartered. The commission would have supervised
all independent national banks and thrifts. The FDIC would not have independent
examination powers but would be authorized to join in the examination of problem
banking institutions. In 1996, the GAO recommended that primary supervisory
responsibilities of the OTS, OCC, and the FDIC be consolidated into a new,
independent Federal Banking Commission. The Commission and the Federal
Reserve would be responsible for supervision of banking organizations.⁴¹
Insurance. Since there is no federal insurance regulatory agency, the issue
becomes, should one be created. Bills have been introduced in Congress to create
some federal regulation of the insurance industry. These bills have been supported
by several insurance trade associations. In the 107^th Congress, the Insurance Industry⁴²
Modernization and Consumer Protection Act (H.R. 3766) proposed optional federal
charters for insurance companies that would have created a dual system, on the
federal and state levels of government. H.R. 3766 would have required the creation
of a federal regulatory agency for insurance. In the 108^th Congress, the Insurance
Consumer Protection Act (S. 1373) would have created a federal commission within
the Department of Commerce to regulate the interstate business of property-casualty
and life insurance and require federal regulation of all interstate insurers. Unlike the
bills in the 107^th Congress which made federal regulation optional for insurance^th
companies, the bill in the 108 Congress would have pre-empted most current state
regulation of insurance.⁴³
A draft bill which began circulating in August 2004 entitled the State
Modernization and Regulatory Transparency Act, is quite different from previous
proposals. It would establish uniform standards for almost every area of the
insurance business including market conduct, product and producer licensing, life

⁴⁰ U.S. Senate Committee on Banking, Housing, and Urban Affairs, Banking Industry
Regulatory Consolidation, hearings, 103^th Congress, 2^nd sess., March 1, 1994, pp. 44-66.
⁴¹ U.S. Government Accountability Office, Financial Regulation: Industry Changes Prompt
Need to Reconsider U.S. Regulatory Structure, GAO Report GAO-05-61, October 2004, p.

77.

⁴² See CRS Report RS21153,Optimal Federal Chartering for Insurers: Legislation and
Viewpoints, by S. Roy Woodall Jr.
⁴³ U.S. Government Accountability Office, Financial Regulation: Industry Changes Prompt
Need to Reconsider U.S. Regulatory Structure, GAO Report GAO-05-61, October 2004, p.

81.

insurance, property and casualty insurance, and reinsurance. It would preempt state
laws if these laws were not made to conform to its uniform standards⁴⁴
Securities. The regulatory competition between the SEC and the CFTC has
brought about several proposals to combine the two agencies. As mentioned
previously, the changes in the financial services industry have led to the development
of financial instruments that appear to fall into the jurisdiction of both the SEC and
the CFTC.⁴⁵ To solve the problem, in the 1990s, the Treasury proposed three
alternative solutions: combining the SEC and the CFTC, giving the SEC regulatory
authority over all financial futures, or transferring regulation of stock index futures
from the CFTC to the SEC. In a hearing concerning the Markets and Trading
Reorganization and Reform Act of 1995, (H.R. 718) that would have merged the
CFTC and the SEC, the GAO pointed out to those considering the merger the
difficulty of quantifying both the potential benefits and risks. The GAO also noted⁴⁶
that a merger might yield only small budgetary cost savings. As an alternative to
consolidation, the Commodity Futures Modernization Act of 2000 specified the
respective jurisdictions of the two agencies and mandate that the two agencies
negotiate their jurisdictional disputes as they may occur in the future. The Blueprint
also proposed combining the SEC and the CFTC.
Consolidation in Other Countries
Most of the arguments used in other countries to justify a consolidation of
financial services regulatory structure are applicable to the United States. These
arguments were successful in convincing several of the United States’ major trading
partners to consolidate their financial services regulators into a single regulatory
agency or authority. The key arguments were:⁴⁷
^!The financial services industry has changed in ways that blur the
clear-cut boundaries between the functional areas of banking,
insurance, securities, and commodities markets.
^!While the financial services firms are primarily responsible for
effectively managing their risks, the nature of the risks has created
a need for the government to take a more comprehensive approach
to regulating those firms’ risk management procedures.

⁴⁴ CRS Report RL32789, Insurance Regulation: Issues, Background, and Current
Legislation, by Baird Webel.
⁴⁵ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States, the United Kingdom, and Japan,” Brooklyn Journal of International Law,

2003, p. 17.

⁴⁶ U.S. Government Accountability Office, Financial Regulation: Industry Changes Prompt
Need to Reconsider U.S. Regulatory Structure, GAO Report GAO-05-61, October 2004, p.

78.

⁴⁷ Ibid., p. 68; and see the Bafin’s 2002 Annual Report, p. 9, at
[http://www.bafin.de/j ahresbericht/j b02_e_T eilA.pdf].

^!The functional regulatory structure is not conducive to
comprehensively understanding the appropriate risk-taking activities
of large, complex, international firms. Furthermore, the functional
regulatory structure does not have the ability to allocate resources
across agencies to carry out strategically focused priorities.
^!A consolidated financial services regulator at the national level is
more suited to accommodate international regulatory negotiations on
financial services regulations and supervision, such as capital,
accounting, and privacy standards.
Among the countries that have adopted a single national regulator are the United
Kingdom, Japan, and Germany. In all three countries, the new agencies are generally
recognized as the sole financial services supervisors. However, to a varying extent,
the traditionally dominant regulators such as the central bank, and/ or the ministry of
finance still have important roles to play in the new consolidated framework. In
addition, in contrast to the American competitive regulatory model, these countries’
financial services sectors have been closer to a monolithic regulatory structure than
the United States. In Europe, for example, through universal banking, banks have a
long tradition of providing banking services as well as trade in securities and
insurance, and the central banks and/or ministry of finance were the dominant
regulators.⁴⁸
Financial Services Authority of the United Kingdom. In 1997, the
Financial Services Authority of the United Kingdom (FSA-UK) consolidated
financial services regulation in the UK by combining nine regulatory bodies. FSA-
UK was given the responsibility to regulate virtually every aspect of financial
services. To compare with the United States, FSA-UK has the roles played by the
federal and state banking agencies, the SEC, the CFTC, insurance and securities⁴⁹
commissions, as well as the SROs. It was also given expanded independent
enforcement powers enabling it to bring action against violators and impose
sanctions. FSA-UK has a single ombudsman to handle complaints by consumers in
all financial services. This is in contrast to the numerous hotlines to the various
federal and state agencies in the United States. Another remarkable provision of the
FSA-UK is that it assigns one office to develop policies on capital requirements for
all financial sectors (similar to the Fisher proposal mentioned previously). By
comparison, in the United States, the assessment of risks and capital requirements are
developed separately for insurance, banks, broker-dealers, and futures commission
merchants.

⁴⁸ Anthony Saunders and Ingo Walter, Universal Banking in the United States (New York:
Oxford University Press, 1994), p. 276.
⁴⁹ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States the United Kingdom, and Japan,” Brooklyn Journal of International Law,

2003, p. 19.

The FSA-UK is organized as a private corporation with a chairman and a chief
executive officer and 16-person board of directors. Eleven members of the board are
independent. The FSA-UK is answerable to the Treasury and the British Parliament.
A practitioner panel and a consumer panel oversee FSA-UK for their respective
constituencies. There is also a requirement for consultation on rules and an appeals
process for enforcement. FSA-UK organization strategy is to focus on the most
damaging potential risks to the financial system. Consequently, it generally targets
larger financial firms. It is required to furnish cost-benefit analyses for its proposals
and report annually on its costs relative to the cost of regulations in other nations.⁵⁰
Most financial firms under the FSA-UK and the International Monetary Fund
(IMF) have reported that the FSA-UK has been successful in regulating the financial
services industry in the United Kingdom.⁵¹ However, a major financial crisis came
to light in 2001 that caused FSA-UK to reexamine its regulatory activities in the
insurance sector. Equitable Life is a mutual insurer that sold policies in the high
interest environment of the 1980s without setting aside the necessary reserves for
these policies. While Equitable Life assured pensioners that its assets would exceed
its liabilities for years, in 2001 the stated value of its customers’ policies was ^4.4
billion more than Equitable’s assets were worth. Consequently, the company slashed
its pension holders’ policy value by 16%.⁵² A major study of the crisis blamed the
“light touch, reactive regulatory environment” that preceded the FSA-UK. In
response to the crisis, FSA-UK has become more aggressive in regulating the
insurance sector, and has begun a program of enforcement actions, imposing fines
and banning wrongdoers from the industry.⁵³ In the 2002 the International Monetary
Fund found that “the insurance industry is under considerable stress, reflecting
depressed investment returns, declining profitability in base life insurance products,
and, more recently, increasing regulatory compliance cost as the FSA introduces
more stringent prudential supervision.”⁵⁴

⁵⁰ U.S. Government Accountability Office, Financial Regulation: Industry Changes Prompt Need
to Reconsider U.S. Regulatory Structure, GAO Report GAO-05-61, October 6, 2004, p. 66.
⁵¹ International Monetary Fund, United Kingdom: 2002 Article IV Consultation — Staff
Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and
Statement by the Executive Director for the United Kingdom, Country Report no. 03/48,
February 2003, pp. 31-32.
⁵² Andrew Verity, “Where Equitable Life Went Wrong,” BBC News, March 9, 2004, p. 1,
[http://news.bbc.co.uk/1/hi/business/3547441.stm].
⁵³ U.S. Government Accountability Office, Financial Regulation: Industry Changes Prompt
Need to Reconsider U.S. Regulatory Structure, GAO Report GAO-05-61, October 6, 2004,
p. 66. Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional
Regulation: Super Regulator: A Comparative Analysis of Securities and Derivatives
Regulation in the United States, the United Kingdom, and Japan,” p. 20, and James
Mackintosh, and James Archer, “Banned from City Trading for Shares Deception,”
Financial Times, July 28, 2001, p. 3.
⁵⁴ International Monetary Fund, United Kingdom: 2002 Article IV Consultation — Staff
Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and
Statement by the Executive Director for the United Kingdom, Country Report no. 03/48,
February 2003, p. 31.

The Financial Services Agency of Japan. In 2000, the Financial Services
Agency (FSA-Japan) was established by renaming the Financial Supervisory Agency
(created in 1998) and transferring the Securities Exchange Surveillance Commission
(SESC) of the ministry of finance along with other functions and staff from the
ministry of finance to FSA-Japan. The SESC was created in 1992 to police the
securities markets. Besides SESC, there are three bureaus: the planning and
coordination bureau, the inspection bureau, and the supervision bureau. The
planning and coordination bureau is responsible for the administration of relevant
laws including the deposit insurance law. The inspection bureau is responsible for
examining and supervising the accounting profession and auditing standard for
financial institutions as a whole. The supervision bureau is responsible for the
supervision of insurance companies, securities firms, and all financial institutions
under FSA’s jurisdiction. FSA-Japan is responsible to the minister for financial
services, a member of the Cabinet answerable to the Diet (Japan’s legislature) for
legislative matters. He has effective management control over FSA. All significant
reports on individual institutions are referred to him. However, FSA’s management
is the responsibility of the Commissioner and his staff. There is no board of
directors.⁵⁵
The legislation creating FSA-Japan allowed the establishment of previously⁵⁶
banned holding companies which increased the size and diversification of banks.
In addition, consumer protection was enhanced through the law concerning the sale
of financial products. After World War II General Douglas MacArthur required
Japan to adopt U.S. laws regulating finance, including securities, and the Glass-⁵⁷
Steagall Act. Although insurance is under FSA-Japan, the agency has not made a
strong effort to bring about the promised reform of the insurance industry. It was not
until several insurance companies failed that FSA-Japan increased regulatory control
over the industry by requiring mark-to-market accounting and increased solvency⁵⁸
margins.
FSA-Japan’s performance to date has been criticized heavily. The IMF raised
questions about the independence and enforcement powers of the agency.⁵⁹ The
ministry of finance, combined with the Bank of Japan, was essentially the monolithic
financial services regulator. They were the managers of the economy, business

⁵⁵ International Monetary Fund, Japan: Financial System Stability Assessment and
Supplementary Information, Country Report no. 03/287, Washington, September 2003, p.

76.

⁵⁶ For more detailed FSA-Japan information see
[ h t t p : / / www.f s a.go.j p/ en/ a bout / a bout 03.pdf ] .
⁵⁷ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States the United Kingdom, and Japan,” Brooklyn Journal of International Law, 28,

319, 2003, p. 20.

⁵⁸ Ibid., p. 19.
⁵⁹ International Monetary Fund, Japan: Financial System Stability Assessment and
Supplementary Information, Country Report no. 03/287, Washington, September 2003, pp.

47, 65, 77.

promoters, and it has been argued that they continue to exert significant influence
over FSA-Japan limiting FSA-Japan’s effectiveness. An example of this criticism
is that SESC, a sub-agency of FSA-Japan, lacks a strong enforcement mechanism.
It has only the power to investigate and not the authority to impose sanctions, but
must refer matters of sanction to the commission.⁶⁰
FSA-Japan’s poor regulatory performance was reflected in bank regulation. It
has shored up some troubled large banks while allowing them to keep their bad debt
instead of urging them to write off these bad debts.⁶¹ The government nationalized
Credit Bank of Japan and Nippon Credit Bank after they could be no longer kept
afloat and public funds were also injected into all but one major bank.⁶² Most
recently, FSA-Japan has pushed for market solutions and encouraged banks to merge,
and offering endorsed government guarantees.⁶³
On the positive side, the financial condition of the banking system continues to
improve. The ratio of nonperforming loans to total assets has declined from 8% in
2001 to 3% in 2004. In the same time period, the capital adequacy ratio has risen
from less than 8% to 11.6%. FSA-Japan has improved recognition and provisioning
or bad loans.⁶⁴ FSA-Japan increased public disclosures of financially troubled
financial services firms. It raised overall bank capital in Japan, even though some
bank capital remains below the Basel minimum international standard. In addition,
FSA-Japan allowed banks to sell life and other insurance. It also allows banks to
affiliate with brokers. FSA-Japan has also lowered barriers to entry by foreign
financial services firms.⁶⁵
The Federal Financial Supervisory Authority (BaFin). In 2002,
Germany consolidated its banking, securities, and insurance regulators into BaFin,
which was the federal banking regulator. The new structure kept the old divisions

⁶⁰ Jerry W. Markham, “A Comparative Analysis of Consolidated and Functional Regulation:
Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the
United States the United Kingdom, and Japan,” p. 23, and International Monetary Fund,
Japan: Financial System Stability Assessment and Supplementary Information, Country
Report no. 03/287, Washington, September 2003, p. 44; David Pilling, “Regulator Drafts
Plan for Japanese Bank Mergers,” Financial Times, July 11, 2002, p. 10.
⁶¹ International Monetary Fund, Japan: Financial System Stability Assessment and
Supplementary Information, Country Report no. 03/287, Washington, September 2003, p.

13.

⁶² Alexandra Nusbaum, “Investment Trust Hopes Lift Tokyo,” Financial Times, January 29,

2000, p. 24.

⁶³ Phred Dvorak, “Japan’s Central Bank Will Buy Stocks Held by Troubled Lenders,” Wall
Street Journal, September 19, 2002, p. A-1.
⁶⁴ International Monetary Fund, Japan: 2005 Article IV Consultation — Staff Report; Staff
Supplement; and Public Information Notice on the Executive Board Discussion, IMF
Country Report No. 05/273, August 2005, p. 9.
⁶⁵ Hakuo Yanagisawa, “Japan’s Financial Sector Reform: Reform: Progress and
Challenges,” address to the Financial Services Authority, September 3, 2001, [http://www.
fsa.go.j p/gaiyou/gaiyoue/presen/p200010903.html ].

of financial services — banking, securities, and insurance. While the banking and
insurance divisions are in Bonn, the securities division is in Frankfurt, home of
Germany’s stock market. As a federal agency, BaFin is under the oversight of the
ministry of finance. It has a board of directors composed of the ministers of finance,
economics, and justice, members of Parliament, officials of the Bundesbank, and
representatives of the banking, insurance, and securities sectors. Like the other
consolidated regulators, BaFin has an advisory council made up of industry, unions,
and consumer representatives.⁶⁶
A significant part of the impetus for creating BaFin was the European Union’s
Financial Services Action Plan for a unified Europe-wide single financial services
regulator.⁶⁷ BaFin facilitates interaction with Germany’s regulators and the other EU
regulators. At the same time, BaFin regulates institutions more equitably within
Germany and throughout Europe than its predecessor framework. Conglomerate
regulations are more comprehensive and the costs of regulations were expected to fall
under this arrangement. BaFin helped Germany to interface with creation of the
European Central Bank.⁶⁸ BaFin seems to have met most of its pre-establishment
goals.
Germany has a state system of banking institutions, but their supervision takes
place on the federal level similar to FDIC-insured state banks in the United States.
This system consists of private as well as state-owned banks. Banks are also owned
by cities as well as other governmental entities. Some insurance as well as securities
activities are supervised on the state level. Even though BaFin is required to
supervise financial services firms, the Bundesbank maintains its responsibilities to
continuously monitor the financial services sector.⁶⁹ To date, most analysts consider
BaFin to be successful in regulating financial services firms in its all-in-one
fram ework.⁷⁰

⁶⁶ For more detailed information about the Financial Supervisory Authority go to
[ h t t p://www.bafin.de/cgi -bin/baf in.pl?sprache=1&ve rz=01_$A$bout_us *01_$T $asks_an
d_Obj ectives&nofr=1&site=0&f ilter=&ntick=0].
⁶⁷ See CRS Report RL32354, European Union — United States: Financial Services Action
Plan’s Regulatory Reform Issues, by Walter W. Eubanks.
⁶⁸ Ibid.
⁶⁹ Government Accountability Office, Financial Regulation: Industry Changes Prompt Need
to Reconsider U.S. Regulatory Structure, GAO Report GAO-05-61, October 6, 2004, pp. 67-

68.

⁷⁰ International Monetary Fund, Germany — 2003 Article IV Consultation Concluding
Statement of the Mission, IMF, country Report no. 3/48, July 14, 2003, p. 5,
[ h t t p : / / www.i mf .or g/ ext e r n al / np/ ms / 2003/ 071403.ht m] .

U.S. Regulators Are Trying to Speak with One Voice
A consolidated financial services regulator at the national level in the United
States would better accommodate negotiations and implementation of international
regulatory agreements such as Basel II. In the Basel II negotiations, while all the
major banking regulators participated, they disagreed on specific aspects of the
negotiations (Basel II sets a more comprehensive framework for judging and
containing bank portfolio risks and capital adequacy than Basel I, the current system
being used in most industrial countries. Basel II should be more easily fine-tuned to
react to changes in risks that affect bank capital). Overall recently, all indications are
that the banking regulators are now in agreement on Basel II, even though they do not
always speak with one voice.⁷¹ On April 1, 2008, 11 large banks were to begin
submitting Basel II implementation plans to their primary regulator, despite the fact
the FDIC remained concern about the internal models the banks are expected to use
to determine the level of risk-based capital they are required to hold.⁷²
Some Implications
The United States’ functional and competitive regulatory structure has been
effective primarily because of its ability to address deficiencies in financial
institutions’ management of risk wherever they may appear. While doing this, the
structure promotes economic growth by encouraging innovation, competition, and
risk taking in the financial services markets. In addition, this structure is able to
maintain its flexibility, and resiliency. On the other hand, the federal regulatory
structure is replete with costly redundancies that proponents call checks and balances,
but opponents call needless duplication. All regulators in this structure write rules,
conduct off-site monitoring, and examine financial services firms for compliance
with their rules and regulations. Proponents also argue that the costs of these
duplicated activities are affordable due to the benefits the stable financial services
industry contributes to overall economic growth.
While Congress has heard the arguments promoting consolidation of U.S.
financial services regulators at the federal level, Congress has not enacted legislation
to bring this about. The industry and its regulators have argued against creating a
monolithic regulator, because it could lead to unchecked extension of regulation
beyond the established jurisdictional boundaries. A consolidated regulator would
alter the existing regulatory checks and balances. If such a consolidated regulator
extended its regulatory powers, it could stifle innovation in financial services and
prevent firms from shopping for regulators that provide the greatest advantage to

⁷¹ R. Christian Bruce, “Agencies Spar Over Capital Requirements as Discord Persists on
Basel II Agreement,” BNA Banking Report, May 16, 2005. p. 1,
[http://ippubs.bna.com/IP/BNA/bar.nsf/SearchAllV iew/09D20CE5C743FB1F852570010

00A97AE?Open&highlight=BASEL,II] .

⁷² See CRS Report RL34485, Basel II in the United States: Progress toward a Workable
Framework, by Walter W. Eubanks and See U.S. Congress Senate Committee on Banking,
Housing and Urban Affairs, The Interagency Proposal Regarding The Basel Capital Accord,^th^st
hearing, 110 Cong., 1 sess., September 26, 2006, Available at
[http://banki ng.senate.gov/ public/_files/ACF4A63.pdf].

their business plans. On the other hand, shopping for regulators could undermine
safety and soundness by allowing the least effective regulator to supervise an
increasing number of financial services institutions.
Evidence from the experience in the other industrialized nations that have
consolidated their financial services regulatory structures suggests that a single
regulatory structure could watch for systemic risk more effectively, but that evidence
is inconclusive. These nations have not had these new regulatory structures in place
for a long time, making it difficult to draw conclusions from their experience with
any certainty. Moreover, these nations continue to experience failures at rates not
significantly different from before their consolidation took place