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.As it relates to permissible affiliations, the current regulatory system for commercialbanks (and some other insured depository institutions) is based on the principle thataffiliates should not pose significant risks to a commercial bank.Two common types ofregulation are available under the current regulatory structure to implement this principle:regulations imposed at the individual bank level and regulations imposed at the holdingcompany level.At the individual bank level, Sections 23A and 23B of the Federal Reserve Act providethe primary protections for limiting the risk a commercial bank can face from itsaffiliates.[126] Section 23A limits the amount of capital a commercial bank can expose to anaffiliate, and Section 23B requires that such transactions be done on market terms.The 134 Martin T.Bannister (Editor)23A/23B firewalls recognize the potential conflicts of interest present in affiliate relationshipsby limiting exposure and requiring transactions be conducted on a market basis.Otheraspects of current banking law applicable at the individual bank level are also designed toprovide protection from affiliate relationships and limit the transfer of the safety net.These registrations include restrictions on loans to insiders (i.e., Regulation O), anti-tying restrictions, the ability to examine affiliate relationships, and the ability to prohibitactivities potentially harming an insured bank.In addition to monitoring some of the same individual bank provisions described above,regulators impose other provisions at the holding company level to protect thecommercial bank, including activity restrictions (e.g., approving financially relatedactivities, new financial activities, and complementary activities) and consolidated capitalrequirements.Part of the motivation for this added level of protection is to provide abackstop in case the 23A/23B firewalls and other individual bank protection provisions proveineffective.The current system of having individual bank level supervision that operatesalongside holding company supervision results in a considerable amount of duplication inthe oversight process, and unclear lines of jurisdiction in some instances.To implement the key goals of the optimal framework, PFRA s regulation regardingaffiliates should be based primarily at the individual FIDI level.Extending PFRA s directoversight authority to the holding company should be limited as long as PFRA has anappropriate set of tools to protect a FIDI from affiliate relationships.At a minimum, PFRAshould be provided the same set of tools that exist today at the individual bank level toprotect a FIDI from potential risks associated with affiliate relationships.In addition,consideration should be given to strengthening further PFRA s authority in terms oflimiting transactions with affiliates or requiring financial support from affiliates.Forexample, 23A firewalls could be strengthened to prohibit all loans to affiliates and moredefinitive authority could be established to ensure that a parent has an obligation to providesupport to a FIDI (e.g., requiring the parent to maintain capital levels of a FIDI).To theextent necessary, PFRA should be able to monitor and examine the holding company andthe FIDI s affiliates in order to ensure the effective implementation of these protections.With these added protections in place, from the perspective of protecting a FIDI, activityrestrictions on affiliate relationships are much less important.Therefore, in the optimalstructure, a FIDI should be able to affiliate with a broad range of firms, including otherfederally chartered financial firms and commercial firms.Such affiliations should have totake place in a holding company structure, with all federally chartered financialcompanies forming a segregated part of the holding company.Allowing a FIDI to affiliate with commercial firms raises the long-standing debate in theUnited States about allowing for a broader mix of banking and commerce.[127] Proponents ofallowing FIDIs to affiliate with commercial firms generally point to several reasons: thepotential for increased competition and innovation, safety and soundness benefits ofdiversification, adequate protection of a FIDI through separation and firewalls, andantitrust protections against improper exercise of economic power.Opponents raiseseveral other concerns: increased safety and soundness risks (related to theineffectiveness of firewalls), undue concentration of economic power, conflicts of interest incredit allocation, misallocation of resources in the economy, and inappropriate extensionof the federal safety net. The Optimal Regulatory Structure 135In evaluating the issue of commercial affiliations with FIDIs, it is important to note thatthe GLB Act has already permitted broader affiliations between insured depositoryinstitutions and other financial firms though a financial services holding companyframework.Concerns regarding the transfer of the safety net should not differ forfinancial or commercial firms.One key difference is that, in general, financial affiliates aresubject to some degree of financial regulation while commercial firms are not.That mightprovide some comfort in terms of risks an affiliate may pose to a FIDI, but the history ofcommercial firms affiliating with insured depository institutions has not supported theview of greater risks present in such structures.[128] The enhanced individual bank oversightauthority provided to PFRA is designed to address the range of concerns existing across alltypes of affiliations with FIDIs.Holding company regulation was designed to protect the assets of the insured depositoryinstitution and to prevent the affiliate structure from threatening the assets of the insuredinstitution.However, some market participants view holding company supervision asintended to protect non-bank entities within a holding company structure.In the optimalstructure, PFRA will focus on the original intent of holding company supervision,protecting the assets of the insured depository institution; and a new market stabilityregulator will focus on broader systemic risk issues.Treasury believes that acombination of increased oversight of affiliate relationships by the prudential regulatorand a market stability regulator with the appropriate expertise and authority to harnessmarket forces provides the most effective and efficient method of supervision.Access to Lender of Last Resort Funding and Other FundingAs described above, FIDIs should continue to have access to discount windowfunding for normal funding needs.Other access to discount window funding could alsobe available for market stability purposes.Issues related to another important fundingsource for FIDIs, the Federal Home Loan Bank ( FHLB ) System, are described later in thischapter.Federal Role in Prudential Insurance RegulationStates have conducted the regulation of insurance in the United States for over 135years with limited direct federal involvement.While a state-based regulatory system forinsurance may have been appropriate over some portion of U.S.history, developments inthe insurance marketplace have increasingly put strains on this system.The insurance sector clearly constitutes a large part of the U.S
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