We think you have liked this presentation. If you wish to download it, please recommend it to your friends in any social system. Share buttons are a little bit lower. Thank you!
Presentation is loading. Please wait.
Published byAnnalise Slaten
Modified over 2 years ago
REGULATION OF FINANCIAL INSTITUTIONSCHAPTER 15 REGULATION OF FINANCIAL INSTITUTIONS Copyright© 2012 John Wiley & Sons, Inc.
Financial institutions are heavily regulated because society heavily depends on them.Financial intermediation necessarily involves “asymmetric information”. Failures of financial institutions involve high social and economic costs. The power to allocate credit is a significant and valuable social and economic power. Copyright© 2012 John Wiley & Sons, Inc.
Asymmetric InformationMost consumers and businesses cannot expertly gauge a financial institution’s safety or soundness. Regulation is a mechanism for trust without personal verification. Regulators impose uniform standards of safety and soundness. Reliance on regulatory standards replaces individual trust in institutions. Benefits of financial intermediation are institutionalized into society. Copyright© 2012 John Wiley & Sons, Inc.
Major Banking Laws, 1913-1977 (Exhibit 15.1)Copyright© 2012 John Wiley & Sons, Inc.
Major Banking Laws, 1980-1991 (Exhibit 15.1)Copyright© 2012 John Wiley & Sons, Inc.
Major Banking Laws, 1994-2003 (Exhibit 15.1)Copyright© 2012 John Wiley & Sons, Inc.
Major Banking Laws, 2005-2010 (Exhibit 15.1)Copyright© 2012 John Wiley & Sons, Inc.
Failures of financial institutionsInvolve high social and economic costs. “Fallout” is worse than that of other business failures. Abrupt shrinkage of credit disrupts commerce; economic uncertainty inhibits saving, investing, and social progress; total costs to society typically exceed value of the institution. Regulation is a mechanism for preventing failures, or confining their effects. Regulators monitor safety and soundness proactively; deposit insurance protects against panic; central banks maintain liquidity in system as “lenders of last resort.” Copyright© 2012 John Wiley & Sons, Inc.
Allocating Credit and RegulationThe power to allocate credit is a significant and valuable social and economic power. So significant that government naturally seeks to share it. So valuable that financial institutions accept regulation as a condition of it. Copyright© 2012 John Wiley & Sons, Inc.
Preventing bank failuresMuch bank regulation is aimed at preventing bank failures. Generally, banks fail for either of 2 reasons: ILLIQUIDITY Inability to disburse cash as promised. INSOLVENCY Insufficiency of assets to cover liabilities. Copyright© 2012 John Wiley & Sons, Inc.
Copyright© 2012 John Wiley & Sons, Inc.
ILLIQUDITY An institution may be profitable, but still become illiquid. Too many depositors may withdraw at once. Loan demand may exceed planned funding ability. Too many long-term assets may be funded with short-term liabilities. Failures caused by illiquidity are preventable. Regulators proactively monitor funding practices. Regulators can arrange for emergency funding (e.g., discount window). Copyright© 2012 John Wiley & Sons, Inc.
INSOLVENCY If investments lose value or if loans default, a bank’s capital can erode. Because banks are highly leveraged, insolvency can happen when asset values fall by a relatively small amount. Regulators emphasize adequate capitalization— Minimum capital standards in terms of risk-weighted assets. Severe sanctions for undercapitalization. Copyright© 2012 John Wiley & Sons, Inc.
Lessons of Past Bank FailuresBy guaranteeing depositors’ funds, the FDIC has effectively prevented runs on institutions it insures. Regional or industry-wide depressions are a major cause of bank failures. Fraud, embezzlement, malfeasance, and poor management are the most notable causes of bank failures. Poor diversification is often a cause of bank failures. Copyright© 2012 John Wiley & Sons, Inc.
The FDIC Deposit Insurance Fund (DIF) consolidates formerBIF — Bank Insurance Fund SAIF — Savings Association Insurance Fund FDIC insurance is mandatory for commercial banks, savings banks & savings associations. Federal insurance is extended to credit unions through NCUSIF. Coverage is now indexed for inflation. Copyright© 2012 John Wiley & Sons, Inc.
Two ways the FDIC handles bank failuresPayoff & Liquidation Purchase & Assumption Copyright© 2012 John Wiley & Sons, Inc.
Pay off insured depositors Take over institution & sell off assets Payoff & Liquidation Pay off insured depositors Take over institution & sell off assets Pay other claimants against institution in order of their priority Copyright© 2012 John Wiley & Sons, Inc.
4) Subordinated creditors 5) ShareholdersOrder of claims 1) Expenses of receiver 2) Depositors FDIC as successor to insured depositors already paid Partial settlement with uninsured depositors depending on proceeds of liquidation 3) General creditors 4) Subordinated creditors 5) Shareholders Copyright© 2012 John Wiley & Sons, Inc.
Copyright© 2012 John Wiley & Sons, Inc.
Purchase & Assumption Take over and operate institution as going concern Find new ownership for institution and/or selected assets— “Clean Bank”—buyer can “put” troubled assets back to FDIC “Whole Bank”—buyer assumes entire balance sheet Guarantee deposits but don’t pay off depositors; hand them over to new management Copyright© 2012 John Wiley & Sons, Inc.
Copyright© 2012 John Wiley & Sons, Inc.
Deposit Insurance IssuesMoral Hazard “Too Big to Fail” “Policing” Premiums Copyright© 2012 John Wiley & Sons, Inc.
Moral Hazard Reduces incentive of depositors to be carefulIncreases temptation of depository institutions to “gamble” on higher risks Coverage is limited or “capped” for this reason. Uninsured depositors may take losses. Copyright© 2012 John Wiley & Sons, Inc.
This creates a “two-tiered” banking industry. “Too Big to Fail” To protect the economy, the government implicitly promises full bailout of the largest institutions. This creates a “two-tiered” banking industry. This adds to the temptation of the largest institutions to “gamble”. Of course the government does not explicitly say which banks it would save. Copyright© 2012 John Wiley & Sons, Inc.
“Policing” Insurance Agencies as “Police”: Depositors aren’t worried. They have no incentive to withdraw funds from an institution even if it is taking many risks. Deposit insurance funds must thus have a “police” mentality—try to protect the public who no longer protect themselves. This is a major reason institutions must be regularly examined. Stockholders and Creditors as “Police”: No insurance for them. If a bank is very risky, buyers of its securities will demand a very high return. Thus the capital market imposes a risk premium for risky banks. Bank examinations are costly and infrequent, but investors will monitor bank risk-taking and bid prices of the bank’s securities up or down as appropriate. Copyright© 2012 John Wiley & Sons, Inc.
For many years all banks paid the same premium rate.Premiums For many years all banks paid the same premium rate. Now premiums increase or decrease depending on— capitalization; examiner ratings. Copyright© 2012 John Wiley & Sons, Inc.
Safety and Soundness RegulationCapital Adequacy Regulation: Basel I (Basel Accord) Basel II Basel III Two forms of capital: Tier 1 Capital (Core Capital) Tier 2 Capital (Supplemental Capital) Risk weighted assets is a measure of assets that weights high-risk assets more heavily than low-risk assets. Copyright© 2012 John Wiley & Sons, Inc.
Minimum Capital RequirementsRequire the following: The ratio of Tier 1 capital to total assets must be at least 3% (leverage ratio). The ratio of Tier 1 capital to risk-weighted assets must be at least 4%. The ratio of total capital to risk-weighted assets must be at least 8%. Copyright© 2012 John Wiley & Sons, Inc.
Risk Weights for Assets, Exhibit 15.6Copyright© 2012 John Wiley & Sons, Inc.
Risk Weights for Assets, Exhibit 15.6, cont.Copyright© 2012 John Wiley & Sons, Inc.
Risk Weights for Off-Balance-Sheet ActivitiesCopyright© 2012 John Wiley & Sons, Inc.
For nonmember state banks it is the FDIC and the state banking agency.Bank Examinations All U.S. depository institutions are regularly examined by at least one regulator. For national banks, it is the OCC—the Office of the Comptroller of the Currency. For state banks who are members of the Federal Reserve System, it is the Federal Reserve and the state banking agency. For nonmember state banks it is the FDIC and the state banking agency. Copyright© 2012 John Wiley & Sons, Inc.
Safety & Soundness ExaminationsPromote and maintain safe and sound bank operating practices Procedure includes: bank financial information collected quarterly (call reports) on-site bank examinations discussion of findings with management “CAMELS” rating Copyright© 2012 John Wiley & Sons, Inc.
1 (Best) to 5 (Worst) in each of 6 areas: Capital adequacy CAMELS Ratings 1 (Best) to 5 (Worst) in each of 6 areas: Capital adequacy Asset quality Management competency Earnings Liquidity Sensitivity to Market Risk Copyright© 2012 John Wiley & Sons, Inc.
CAMELS Rating System, Exhibit 15.8Copyright© 2012 John Wiley & Sons, Inc.
CAMELS Rating System, Exhibit 15.8, cont.Copyright© 2012 John Wiley & Sons, Inc.
Community Reinvestment Act compliance Consumer compliance Other Examinations Community Reinvestment Act compliance Consumer compliance Trust Department examinations as applicable Copyright© 2012 John Wiley & Sons, Inc.
Structure & Competition RegulationsBranching Deposit rate ceilings Commercial banking vs. Investment banking Financial Services Modernization Act Copyright© 2012 John Wiley & Sons, Inc.
Branching LimitationsFor years branching was tightly controlled and subject to conflicting state regulations as well as ambiguous federal regulations. Interstate branching required approval of all states involved. Bank holding companies evolved as a regulatory avoidance technique. Today, after the Interstate Banking and Branching Efficiency Act of 1994— All banks can freely branch across state lines as long as it is through acquisition of another bank or branch. If allowed by state law, a bank can create a new branch (“de novo” branching) across state lines. Copyright© 2012 John Wiley & Sons, Inc.
Ceilings are gone now, but “innovation around” them left us with—Deposit Rate Ceilings Until 1980 “Reg Q” rate ceilings kept institutions from competing directly. Ceilings are gone now, but “innovation around” them left us with— MMDAs MMMFs NOW Accounts Copyright© 2012 John Wiley & Sons, Inc.
Commercial Banking vs. Investment BankingGlass-Steagall restrictions were gradually relaxed in the 1980s and 1990s. Financial Services Modernization Act of 1999 repealed most restrictions, allowing U.S. commercial banks affiliated subsidiaries for— investment banking; insurance; other financial activities. Copyright© 2012 John Wiley & Sons, Inc.
Financial Services Modernization Act of 1999Banks can have securities and insurance subsidiaries. A new organizational form, financial holding companies (FHCs), can have many different kinds of financial institutions as subsidiaries. Insurance companies and securities firms can acquire commercial banks and form FHCs with Federal Reserve approval. Institutions must obey new privacy rules about sharing customer information. Federal Reserve is “umbrella” supervisor over FHCs while bank and nonbank subsidiaries fall under other regulators (“functional regulation”). Copyright© 2012 John Wiley & Sons, Inc.
Consumer Protection RegulationsLoan rate ceilings Truth in Lending (1969) Equal Credit Opportunity Act (1974; 1976) Fair Credit Billing Act (1974) Community Reinvestment Act (1977) Fair Credit Reporting Act of 1970/Fair &Accurate Credit Transactions Act of 2003 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 Copyright© 2012 John Wiley & Sons, Inc.
State banking agencies FDIC Federal Reserve Bank Regulators State banking agencies FDIC Federal Reserve Office of the Comptroller of the Currency Office of Thrift Supervision Copyright© 2012 John Wiley & Sons, Inc.
Division of Responsibilities among Bank RegulatorsCopyright© 2012 John Wiley & Sons, Inc.
Copyright© 2006 John Wiley & Sons, Inc.1 Power Point Slides for: Financial Institutions, Markets, and Money, 9 th Edition Authors: Kidwell, Blackwell,
REGULATION OF FINANCIAL INSTITUTIONS
Chapter 4. Depository Institutions Banks Asset/Liability problem Commercial Banks Savings and Loans Credit Unions Asset/Liability problem Commercial Banks.
Copyright© 2003 John Wiley and Sons, Inc. Power Point Slides for: Financial Institutions, Markets, and Money, 8 th Edition Authors: Kidwell, Blackwell,
Maclachlan, Money & Banking Spring Banking Regulation Chap. 11.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14 Regulating the Financial System.
Chapter 14. Regulating the Financial System
Economic Analysis of Financial Regulation
© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter 14 Regulating the Financial System.
Chapter 10 Economic Analysis of Financial Regulation.
The Federal Reserve System Chapter 14 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 11 Economic Analysis of Financial Regulation.
Regulation of the Banking and Financial Services Industry Chapter 17 © 2003 South-Western/Thomson Learning.
Commercial Bank Operations
1 Lecture 20 Economic Analysis of Banking Regulation.
CHAPTER 10 CREDIT You’re in Charge
Chapter 11: The Economics of Financial Regulation.
Chapter Nine Government’s Role in Banking. Copyright © Houghton Mifflin Company. All rights reserved.9 | 2 Banking is one of the most heavily regulated.
Banking, Investing and Insurance BUSINESS AND BANKING AND PROFITABILITY.
Financial Innovation Innovation is result of search for profits
Asymmetric Information and Bank Regulation
Time for a BREAK! You have 45 Minutes.
McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Chapter Fourteen Regulation of Depository Institutions.
Copyright © 2003 Pearson Education, Inc. Slide 1 Computer Systems Organization & Architecture Chapters 8-12 John D. Carpinelli.
McGraw-Hill /Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Chapter Thirteen Regulation of Commercial Banks.
CHAPTER TWO The Impact of Government Policy and Regulation on Banking
COMMERCIAL BANK OPERATIONS & REGULATION
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-1 Financial Innovation and Banking Industry Structure Responses to Changes in Risk 1.Adjustable-rate mortgages 2.Financial Derivatives Responses to.
Chapter 11. Economic Analysis of Bank Regulation Asymmetric Information Banking Crisis of 1980s Asymmetric Information Banking Crisis of 1980s.
An Overview of the Financial System chapter 2 1. Function of Financial Markets Lenders-Savers (+) Households Firms Government Foreigners Financial Markets.
Copyright © 2012, Elsevier Inc. All rights Reserved. 1 Chapter 7 Modeling Structure with Blocks.
Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall.1 CHAPTER 3 Depository Institutions.
An Overview of the Financial System chapter 2. Function of Financial Markets Lenders-Savers (+) Households Firms Government Foreigners Financial Markets.
Chapter 10. The Banking Industry: Structure and Competition A Brief History Structure Thrifts International Banking The Decline of Traditional Banking.
U.S. Financial Regulations
Essential Cell Biology
McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved Chapter Two The Impact of Government Policy and Regulation on Banking and the Financial-Services.
Economic Analysis of Banking Regulation
Chapter 3 – Depository Institutions
Chapter 3 Banks and Other Depository Institutions © 2000 John Wiley & Sons, Inc.
Copyright © 2011, Elsevier Inc. All rights reserved. Chapter 6 Author: Julia Richards and R. Scott Hawley.
Ch 9: General Principles of Bank Management
Ch. 2, Business Basics.
Peterson’s Practice AP Exam
Chapter 32 Money Creation. I. Learning Objectives—In this chapter students will learn: A. The basics of a bank’s balance sheet and why the U.S. banking.
1 Chapter 18 Bank Regulation Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All.
Copyright © 2012 Pearson Prentice Hall. All rights reserved. CHAPTER 23 Risk Management in Financial Institutions.
The Commercial Banking Industry. I. Commercial Banking History A. State Banking, –Chartering by Legislation, 1714 –Free Banking, 1837 B. Dual.
© 2017 SlidePlayer.com Inc. All rights reserved.