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Bank Regulation (US) zMajor Duties: Chartering and Examination zChartering -- Granting the bank permission to begin business. -- National Banks -- State.

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Presentation on theme: "Bank Regulation (US) zMajor Duties: Chartering and Examination zChartering -- Granting the bank permission to begin business. -- National Banks -- State."— Presentation transcript:

1 Bank Regulation (US) zMajor Duties: Chartering and Examination zChartering -- Granting the bank permission to begin business. -- National Banks -- State Banks zExamination – Supervision of bank activity, including periodic auditing of bank records.

2 Regulators: Commercial Banks zComptroller of the Currency -- charterer and primary examiner of national banks zState Banking Authorities -- charterer and primary examiner of state banks zFederal Reserve -- secondary examiner of member banks

3 Federal Deposit Insurance Corporation (FDIC) zSecondary examiner to some banks zInsures bank deposits, guaranteed up to $250,000 per depositor (more for some types of accounts, such as consumer saving for retirement)

4 Deposit Insurance: Pros and Cons zPros -- protects customers -- greatly reduces bank runs zCons -- gives banks implicit incentive to engage in bad business practices

5 Moral Hazard and Adverse Selection zMoral Hazard -- Those who have insurance may use it as a safety net, a justification to take on greater risk. zAdverse Selection -- Insurance tends to attract people most likely to take advantage of it.

6 FDIC -- Resolving Situations With Problem Banks zOptions: handling problem banks zClose bank, pay off depositors (e.g. Freedom National Bank of RI) zMerge bank with a healthy bank (e.g. Syracuse Savings Bank) zDecisions unique to individual cases (e.g. Bank of New England) - the too big to fail policy

7 Regulators -- Savings Banks and Savings and Loans zDeposit Insurance: FDIC zPrimary Examiners: Federal Reserve, FDIC, and Comptroller of the Currency zMost Savings and Loans: members of Federal Home Loan Bank System (FHLBS) zRegulatory system -- overhauled several times since late 1980s

8 Credit Unions zMost are members of the National Credit Union Administration (NCUA). zDeposit Insurance: National Credit Union Share Insurance Fund (NCUSIF). zNo major overhauls to regulatory system.

9 US Banking in the Postwar Period zA chronicle of US banking from the end of World War II until now. zSignificant ups and downs in US Banking, along with key regulatory changes.

10 US Banking in the 1950s and 1960s – Fat City zRegulation Q – mandated ceilings on bank deposits (no more than 3% max), kept cost of funds down for banks zLow inflation, low interest rate environment (e.g. 6% fixed rate mortgages) zThe Rule of Banking

11 The 1970s -- Banking in a Weakened State zDisintermediation -- due to rising market interest rates with Regulation Q, along with the emergence of Money Market Mutual Funds. zInterest Rate Risk -- inability to pass on rising interest rates to existing loans

12 Another Problem: The Fed Losing Member Banks zTraditional Advantage to Membership -- Use of the Discount Window. zTraditional Disadvantage to Membership -- Fed gives higher reserve requirements.

13 The Early 1980s -- Regulatory Forbearance zRegulatory Forbearance -- Passing legislation to improve banks competitive position, to see if they could fix the problem themselves.

14 The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) zCreated NOW and ATS Accounts. zPhased out Regulation Q, completed on 3/31/86. zAllowed Savings Banks and Savings and Loans to make restricted amounts of commercial loans (% of total assets).

15 More Provisions: DIDMCA zLiberalized capital requirements of Savings Banks and S&Ls. zIncreased deposit insurance from $40,000 to $100,000. zOpened the Discount Window to all banks. zImposed uniform reserve requirements for all banks.

16 More Legislation: The Garn-St. Germain Act (1982) zGranted Money Market Deposit Accounts (MMDAs) and Super NOW Accounts. zIncreased percentage of allowable assets of Savings Banks and Savings and Loans held as commercial mortgages.

17 Mid and Late 1980s -- The Problem Worsens zDefaults on very risky loans (shopping malls in the desert). zPurchases of junk bonds. zFraud in the banking system (Charles Keating)

18 Regulatory Forbearance: A Failure zIncreased moral hazard -- The Haymaker strategy. zIncreased adverse selection -- The size of the mess doesnt matter, illegal profiteering. zZombie Savings and Loans

19 Late 1980s and Early 1990s -- Handling the Crisis zThe Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of regulators stepping in and resolving Savings and Loan crisis (other banks as well)

20 Major Provisions: FIRREA zAbolished the regulatory structure at that time -- the Federal Home Loan Bank Board (FHLBB) and the Federal Savings and Loan Insurance Corporation (FSLIC) zFDIC -- insurer of Savings Banks and Savings and Loans

21 More Provisions: FIRREA zCreated Resolution Trust Corporation (RTC) -- manage the bailout zSavings and Loans -- can no longer purchase junk bonds zIncreased capital requirements of Savings Banks and Savings and Loans from 3% to 8% (with risk adjustment for loans).

22 Still More Provisions: FIRREA zSignificantly decreased percentage of assets of Savings Banks and Savings and Loans held as Commercial Loans. zRefocused Savings and Loans to consumer mortgages.

23 Legislation to Change the FDICs Role: FDICIA zFederal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 zGave more authority to FDIC in some areas, took authority away in other areas.

24 Major Provisions -- FDICIA zIncreased FDICs ability to fund the Savings and Loan bailout. zGave FDIC authority to intervene earlier for banks facing difficulties. zGave FDIC larger role in serving as bank examiner. zGreater limitations on imposing too big to fail policy.

25 More Provisions -- FDICIA zGave Federal Reserve supervisory responsibility for foreign banks operating in the US. zRisk-based deposit insurance: addressing moral hazard.

26 : Healthy But Shrinking zSavings and Loan bailout -- completed effectively. zDisintermediation legislation -- it worked! zBeneficial interest rate risk -- due to decreases in interest rates. zA series of beneficial financial innovations.

27 Financial Innovations -- Banking zThe Individual Retirement Account (IRA) -- tax advantages for long-term saving (Classic IRA vs Roth IRA) zShorter-term mortgages (15 year, even 10 year). zAdjustable Rate Mortgages (ARMs) -- sharing of interest rate risk zMortgage Securitization (Mortgage Backed Securities) – enabled banks to sell money- losing mortgage, decreases interest rate risk.

28 More Financial Innovations in Banking zSweep Accounts -- balances in a checking account above a forecasted necessary minimum are automatically swept into RP, Eurodollars, MMMF, or MMDA (lowers required reserves). zAutomatic Teller Machines (ATMs) zDebit cards and credit cards – makes checking accounts more attractive, increases bank offerings.

29 Hedging Interest Rate Risk: Futures and Options zLarge Banks in particular -- use with CDs, stabilizing cost of funds. zFinancial Futures Market -- Market to sell specified amounts of bonds at a specified bond price (and interest rate), at a specified future date.

30 zOptions Market -- Market to buy (call option) or sell (put option) a security at a given price over a fixed time interval (up to a maximum amount zOther Financial Derivatives

31 Compression of the Banking Industry zThe McFadden Act (1927) -- Prohibited interstate bank branching in the US zProtecting the small bank versus limiting competition.

32 Circumventing the McFadden Act zEmergence of Bank Holding Companies, corporations that house banks. zShared electronic banking facilities. zBanks striking deals with the FDIC.

33 The Final Action: The Riegle-Neal Act zThe Riegle-Neal Act (1994) -- Repealed the McFadden Act, permitted interstate branching in the US. zA flurry of bank mergers, for reasons different from the 1970s and 1980s.

34 2006- Subprime Mortgages and the Credit Crunch zSubprime Mortgages -- mortgages given to people with substandard credit qualifications. zHigher default risk than standard mortgages. zExist as securitized mortgages (MBS) – originate and distribute banking. zMBS done in tranches – splitting up bundles according to default risk.

35 Deceptiveness With Mortgage Backed Securities zCollateralized Debt Obligations (CDO) – MBS reconstituted (split into tranches) and then resold). zStructured Investment Vehicles (SIV) – off- the-balance sheet nonbanks created by banks to hold CDO, exempt from Basel I capital requirements. zConduits – similar to SIV but backed and owned by banks. Also buyers of CDO. zSIV, Conduits, financed through Asset- Backed Commercial Paper issued by banks

36 Subprime Mortgages, MBS, and the Credit Crunch zDefault risk not valued properly by holders of securitized mortgages (rating agencies paid by issuers of MBS). zMany MBS based upon subprime mortgages on ARMs – interest rate rises after adjustment period, increased defaults. zFalling house prices, bank and MBS holders cant recoup full value of defaulted loan. zFalling home prices exacerbated by many foreclosures at once. zMajor defaults on MBS, affects portfolios of holders beyond banks and the US.

37 The Federal Reserve: Banking and the Credit Crunch zExtended Discount Window loaning to banks, including establishing a Term Auction Facility (anonymous borrowing). zPurchased Asset-Backed Commercial Paper zMajor infusion of liquidity into banking system via open market operations. zKept Fannie Mae and Freddie Mac afloat zHelped to administer the Troubled Asset Relief Program (TARP): bailout funds for large banks facing financial difficulties.

38 The FDIC: Banking and the Credit Crunch zExtended deposit insurance protection to $250,000 (from $100,000). zWith the Federal Reserve, helped to arrange some mergers between banks (e.g. Wachovia and Wells Fargo).

39 The Federal Government: Banking and the Credit Crunch zPassed the Dodd-Frank Act (2010) – increased regulation for banks. ycreated Bureau of Consumer Financial Protection yincreased regulation on predatory lending ymodification of regulatory structure in banking ysome supervision of Federal Reserve by Federal Government yA number of provisions, but not considered tough enough by many

40 Underlying Issues: The Credit Crisis and Regulation zHow and how much should the Federal Reserve, and FDIC, and Federal Government help holders of MBS, banks, and borrowers with subprime mortgages? zAssistance to avoid crisis versus increasing moral hazard/adverse selection zHow to address which problem – liquidity versus loan defaults zThe Federal Reserve as stabilizer versus the Federal Reserve as enabler zHow to restore the confidence of banks

41 Issues in International Banking zTraditional Issue -- US banks (operating in the US or abroad) at a comparative disadvantage relative to foreign banks (operating in the US or abroad). zApplicable regulation comes from country of origin. zUS banking, more heavily regulated.

42 Related Legislation zInternational Banking Act of Foreign banks operating in the US have to follow US banking regulations. zProvision of FDICIA -- Gave Federal Reserve supervisory responsibility over foreign banks operating in the US. zRepeal of McFadden Act?

43 International Banking and the Credit Crunch zRecognized as global financial problem zA series of coordinated infusions of liquidity (by open market operations) among a number of central banks worldwide

44 Increased Global Coordination of Banking Regulations? zUS – traditionally reluctant in this area. zBasel Agreements – attempts to establish uniform global banking regulations across nations. yCapital requirements (equity-asset ratios) yAccounting of off-the-balance-sheet items yOther regulatory requirements on banks regarding loans and liquidity


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