WASHINGTON - The Federal Reserve Board has renewed its assault against broader powers for industrial loan companies, arguing in its strongest language to date that they pose a danger to taxpayers and could cost banks hefty premiums.
In a nine-page letter to Sen. Tim Johnson, D-S.D., Fed Chairman Alan Greenspan outlined a litany of safety-and-soundness problems posed by such companies and said that the lack of sufficient regulatory authority over their parents contributed to a failure four years ago.
The letter appeared to be a point-by-point repudiation of arguments made recently by Federal Deposit Insurance Corp. Chairman Don Powell, who had said his agency has adequate authority to oversee industrial loan companies and that they posed no extra risk to the system.
Mr. Greenspan disagreed.
"It is also worth emphasizing again that these large, insured ILCs with unregulated parents could be placed at significant risk by the operations or difficulties of their parent," he wrote in his June 25 letter. "Any subsequent losses to the FDIC ultimately have the potential of taxpayer liability and increased deposit insurance premiums for insured bank subsidiaries of regulated bank holding companies."
An FDIC spokesman on Monday would not discuss the letter.
Opponents of industrial loan companies are expected to seize on the letter for use in debates over two bills in Congress.
House members have recently finished a deal to add to the regulatory relief bill a provision that would allow industrial loan companies to expand their interstate branching abilities, but only if they are owned by firms that are primarily financial in nature. Meanwhile, some senators have held up a bill to let financial institutions pay interest on business checking accounts over the issue of whether industrial loan companies, along with banks and thrifts, should be allowed to do so.
Though the Fed has long opposed both provisions, the letter was stronger and longer than its previous statements. Mr. Powell has adamantly maintained that industrial loan companies are subject to the same oversight as other financial institutions, but the Fed said that no one currently has sufficient supervisory authority over their parents.
The letter cited the Fed's broader authority over bank holding companies, including its ability to examine the firms regardless of whether they engage in transactions with a subsidiary bank; to institute consolidated capital requirements; and to take enforcement actions. It also warned that the rapid expansion of industrial loan companies over the past few years would weaken the barriers between banking and commerce.
Of particular note was the Fed's assertion that an industrial loan company failed in 1999 because of its connection to a commercial parent company. Though the letter did not name the company, the description matched the $118-million asset Pacific Thrift and Loan of Woodland Hills in Calif., whose failure cost the FDIC $50 million.
"Among the contributing factors in the failure of an FDIC-insured industrial loan company in 1999 were the unregulated borrowing and weakened capital position of the corporate owner of the ILC and the inability of any federal supervisor to examine the parent holding company to determine its financial strength," the letter said. "In that case, the corporate parent - which was exempt from the [Bank Holding Company] Act and consequently, not subject to the board's examination or capital requirements - borrowed a significant amount of funds without capital support and downstreamed those funds to the ILC.
"The parent company expected this debt to be repaid through income received from the operation of the ILC," Mr. Greenspan wrote. "In an effort to generate sufficient income to repay the debt incurred by the parent company, the ILC quickly expanded its activities and took on significant additional risk. This ultimately led to the failure of the ILC."
Some industry observers and representatives said the Fed's argument was exaggerated.
Bert Ely, an independent consultant in Alexandria, Va., and an outspoken critic of both the Fed and the FDIC, said the central bank's argument concerning the failed industrial loan company was misleading.
"There is an inference in the Fed's argument that only the regulator of the holding company could curtail these transactions - and that is simply not true, because federal banking supervisors have the statutory authority to bar transactions that harm the health of the bank," he said.
Diane Casey-Landry, the president of America's Community Bankers, said the Fed "is overstating the case of the risks posed by industrial loan companies to the banking system or to the insurance fund."
Sen. Johnson said the Fed letter should send a powerful message to the FDIC and to industrial loan companies.
"Chairman Greenspan cautions us that expanded powers for ILCs would increase risk to the banking system," he said in a statement in response to questions from American Banker. "While I respect Chairman Powell's leadership at the FDIC, I am puzzled by his opposition to consolidated Fed supervision of entities that are clearly analogous to bank holding companies."
The letter is liable to be a hot topic this week. Mr. Greenspan is scheduled to testify in front of the House and Senate banking committees today and Wednesday, and the FDIC will hold a symposium on the mixing of banking and commerce. Former FDIC Chairman L. William Seidman is the scheduled keynote speaker at the symposium.
Additionally, in a response to questions from American Banker, Senate Banking Committee Chairman Richard Shelby said that he expects to examine the issue during a hearing he intends to hold in the fall on regulatory relief proposals.
