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Copyright 2014 by Diane Scott Docking1 The Commercial Banking Industry – History & Structure.

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1 Copyright 2014 by Diane Scott Docking1 The Commercial Banking Industry – History & Structure

2 What is a BANK? Is this a Bank? 1-2 2 Copyright 2014 by Diane Scott Docking

3 3 What is a Bank? Corporations (net borrowers) Households (net savers) Cash Equity & Debt Intermediary that brings borrowers and savers of funds together.

4 Small vs. Large Banks Community Banks < $1 billion in assets Typical’ Size is $300 Million Organizational Chart is Not Complicated Significantly Affected by Health of Local Economy Generally Know their Customers Well – Relationship Lending Money Center Banks Generally Multi-Billion Dollar Company Organizational Chart is Much More Complex Serve Many Different Markets with Many Different Services so are Better Diversified Geographically and by Product Able to Raise Large Amounts of Capital at Relatively Low Costs Copyright 2014 by Diane Scott Docking4

5 U.S. Bank Failures 5Copyright 2014 by Diane Scott Docking

6 6 Bank Entry is Regulated Must get a charter to open a bank Must show “need” for a bank

7 Copyright 2014 by Diane Scott Docking7 Why do we Regulate Commercial Banks? 1. Promote _______________________  Protect depositors  Bank failure can cause panic and contagion effect  Vital to community 2. Protect the ______________________  Intended to increase and maintain operational efficiency  Cannot be closed for more than 3 days in a row 3. ______________________of the Industry  Looks at concentration of power and money  Fear of “big-banking”

8 Copyright 2014 by Diane Scott Docking8 Why do we Regulate Commercial Banks? 4. Protect __________________  Truth in Lending Act of 1968  Prevent abuse in extension and collection of consumer debts  Provide full disclosure of credit costs and fees  Protect against discrimination 5. Facilitate __________________  Bank deposits are part of the money supply  Fed uses banking system to affect the money supply

9 Copyright 2014 by Diane Scott Docking9 Regulatory Agencies  Federal Reserve System  Comptroller of the Currency  FDIC  Dept. of Justice  SEC  OTS  State Banking Boards or Commissions Dodd-Frank bill disbanded OTS & merged it with OCC

10 Copyright 2014 by Diane Scott Docking10 Dual Banking System ______ chartered bank Can not use “national” in title Not required to join FRS or FDIC (but most do) Individual state banking departments charter state banks and savings institutes. ____________________chartered bank Must have “National” or “N.A.”in name Must be members of FRS and FDIC The Office of the Comptroller of the Currency (OCC) charters national banks and thriftsOffice of the Comptroller of the Currency (OCC) The Office of Thrift Supervision (OTS) which use to charter federal savings banks and savings associations was disbanded by Dodd-FrankOffice of Thrift Supervision (OTS) The Federal Deposit Insurance Corporation (FDIC) insures the deposits of banks and savings associations up to ________per account and ____________per IRA account.Federal Deposit Insurance Corporation (FDIC)

11 100% vs Fractional Reserve Banking 100% Reserve Banking - where the amount of reserves is exactly equal to the amount of liabilities Copyright 2014 by Diane Scott Docking11

12 100% vs Fractional Reserve Banking Fractional Reserve Banking - where cash reserves are smaller than the related liability Copyright 2014 by Diane Scott Docking12

13 Copyright 2014 by Diane Scott Docking13 CAMELS Rating What does the acronym CAMELS refer to in bank examinations?

14 Copyright 2014 by Diane Scott Docking14 CAMELS ratings C_______________  More capital allows banks to absorb losses  Regulators determine the “adequacy” of capital A_______________  Credit risk  Portfolio’s composition and exposure to potential events

15 Copyright 2014 by Diane Scott Docking15 CAMELS ratings M_________________  Rates management according to administrative skills, ability to comply with existing regulations, and ability to cope with a changing environment.  Very subjective E__________________  Banks fail when their earnings are consistently negative  Commonly used ratio: Return on Assets (ROA)

16 Copyright 2014 by Diane Scott Docking16 CAMELS ratings L_____________  Extent of reliance on outside sources for funds (discount window, federal funds) S_____________  to interest rate changes and market conditions

17 Copyright 2014 by Diane Scott Docking17 Supervision and Examination … Regulators periodically examine individual banks and provide supervisory directives The OCC and FDIC assess the overall quality of a bank's condition according to the CAMELS system Regulators assign ratings from 1 (best) to 5 (worst) for each category and an overall rating for all features combined.

18 Historical Development of the Banking Industry 18Copyright 2014 by Diane Scott Docking

19 19 Banking Act of 1933 (Glass-Steagall Act) and Banking Act1935 Created the ____________  Established FDIC insurance (safety net).  Initially insured $2,500/account _________________ commercial banking from the securities industry  Disallowed banks to provide investment banking services, underwrite corporate stocks and bond. Prohibited interest on ______________________and restricted such deposits to commercial banks (Reg Q)  Put interest-rate ceilings on other deposits (Reg Q) Disallowed banks to sell __________________ No interstate banking

20 Copyright 2014 by Diane Scott Docking 20 Erosion of Glass-Steagall Bankers complained about restrictions of Glass-Steagall, so erosion began:  Banks set up BHCs to circumvent restrictions BHC Act of 1956  Community Reinvestment Act of 1977  DIDMCA of 1980  DIA of 1982  FIRREA of 1989  FDICIA of 1991  Riegle Neal Act of 1994  Gramm-Leach-Bliley Act of 1999  FDIRA of 2005

21 Copyright 2014 by Diane Scott Docking21 Bank Holding Companies Established to circumvent restrictive regulation:  operate banks in more than one state  engage in activities not permitted commercial banks investment banking activities, investment advice, brokerage services, credit cards, leasing, etc.)  issue commercial paper and use nondeposit sources of funds  increase accessibility to capital  decrease risk through diversification

22 Copyright 2014 by Diane Scott Docking22 Bank Holding Companies An organization that owns controlling interest (25%) in one or more commercial banks  OBHC (One BHC)  MBHC (Multi BHC)

23 Copyright 2014 by Diane Scott Docking23 Bank Holding Company Act of 1956 & Douglass Amendment of 1970 The Bank Holding Company Acts were a reaction to the growth of Bank holding companies in the U.S.  Gave the Federal Reserve control over the formation of multibank and single bank holding companies and their acquisition of banking and non-banking concerns  Forbade BHCs from acquiring banks in other states unless the acquisition is specifically authorized by state law  Stipulating that any non-banking activities of a BHC must be “closely related to banking”  Under the Section 20 loophole in the act investment banking income limited to 25% of total income

24 Community Reinvestment Act (CRA) of 1977: regulators encourage (and often require) lending to socially important sectors of the economy (e.g., housing, farming)  Objectives Prevent redlining & steering  discriminatory practices Encourage lending to disadvantaged groups (subprime) Encourage banks to lend to startups and engage in loans to micro businesses Use of innovative or flexible lending practices to assist low or moderate income individuals Community Reinvestment Act (CRA) of 1977: regulators encourage (and often require) lending to socially important sectors of the economy (e.g., housing, farming)  Objectives Prevent redlining & steering  discriminatory practices Encourage lending to disadvantaged groups (subprime) Encourage banks to lend to startups and engage in loans to micro businesses Use of innovative or flexible lending practices to assist low or moderate income individuals 24Copyright 2014 by Diane Scott Docking Community Reinvestment Act of 1977

25 Depository Institution Deregulation and Monetary Control Act (DIDMCA) 1980 First of Deregulation Acts Phased Out Interest Rate Ceilings (Reg Q) Allowed Interest to be Paid on Checking Accounts (NOW Accounts) Term Transaction Account Created – All Institutions with These Accounts Subject to Reserve Requirements 25 Copyright 2014 by Diane Scott Docking

26 Depository Institutions Act of 1982 (aka: Garn-St. Germain Act 1982) Continued the Deregulation of DIDMCA Created Money Market Deposit Account FDIC Could Arrange Mergers Across State Lines if Needed Loan Limits were Liberalized Banks in Need of Capital Could Get It From the FDIC 26 Copyright 2014 by Diane Scott Docking

27 Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) 1989 Created in Response to Large Number of Bank and S&L Failures Combined FDIC and FSLIC into the FDIC and Dismantled S&L Regulatory Body Created the RTC to Take on the Assets of Failed S&Ls  $50 Billion Authorized to Handle Failed Institutions (Later Increased) Created OTS Allowed Bank Holding Companies to Purchase Savings Banks 27 Copyright 2014 by Diane Scott Docking

28 FDIC Improvement Act (FDICIA) 1991 A small move towards Re-regulating the Industry Requires Regulators to Take Prompt Corrective Action (PCA) When a Bank has Problems Prompt Corrective Action Based on the Capital Position of the Bank Requires Regulators to Develop New Standards for the Banks They Regulate 28 Copyright 2014 by Diane Scott Docking

29 Riegle-Neal Interstate Banking and Branching Efficiency Act (Riegle-Neal Act) 1994 Allows full interstate branching Promotes further consolidation  Bank Holding Company Can Acquire Banks Nationwide  Consolidation of Interstate BHCs into Branches 29 Copyright 2014 by Diane Scott Docking

30 30 Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act) What GLBA did: Repeals the restrictions on banks affiliating with securities firms (i.e., repeals last vestiges of the Glass Steagall Act of 1933): Allows banks to branch across state lines and acquire insurance and securities firms by forming a _________________________________ that is authorized to engage in: underwriting and selling insurance and securities, conducting both commercial and merchant banking, investing in and developing real estate and other "complimentary activities.“  There are limits on the kinds of non-financial activities these new entities may engage in.

31 Copyright 2014 by Diane Scott Docking 31 Organizational structure of financial services company Bank Holding Company Thrift Holding Company Securities Subsidiaries Insurance Subsidiaries Real Estate Subsidiary Nonbank Subsidiaries and Service Companies Financial Services Holding Company

32 Federal Deposit Insurance Reform Act (FDIRA) 2005 First Significant Increase FDIC Coverage in 25 years Raises FDIC Insurance Limits from $100,000 to $250,000 for Retirement Accounts Federal Regulators are Empowered to Periodically Adjust Deposit Insurance Limits for Inflation Merges Bank Insurance Fund (BIF) and Savings Association Insurance Funds (SIF) into Single Deposit Insurance Fund (DIF) 32 Copyright 2014 by Diane Scott Docking

33 33 The Subprime Mortgage Crisis of 2008 Now going back the other way – More restrictive regulations

34 Emergency Economic Stabilization Act (EESA) 2008 Passed in Response to Home Mortgage and Financial System Problems Temporarily Increases FDIC Deposit Insurance Coverage from $100,000 to $250,000 for All Deposits until Year-end 2009 (now permanent) Allows the US Treasury to Add Capital to Banks to Enhance Lending  www.treas.gov/press/releases/hp871.htm www.treas.gov/press/releases/hp871.htm 34 Copyright 2014 by Diane Scott Docking

35 Passed in Response to 2008 Crisis Establishes a new regulatory infrastructure to act as an “early warning system” for threats to the financial stability of the nation. Sets up an independent Bureau of Consumer Financial Protection within the Federal Reserve whose mission is to look out for consumers’ interests Mortgage loan reform Eliminates OTS FDIC Insurance $250,000 35 Copyright 2014 by Diane Scott Docking Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010

36 More Specifics of Act  Promote better supervision of financial firms by creating a new Financial Services Oversight Council chaired by the Treasury and including the heads of the primary federal regulators to limit systemic risk  Increasing regulation of securitization processes by requiring more transparency, stronger regulations of credit ratings agencies, and increasing the percentage of loan sales that must be retained by originators More Specifics of Act  Promote better supervision of financial firms by creating a new Financial Services Oversight Council chaired by the Treasury and including the heads of the primary federal regulators to limit systemic risk  Increasing regulation of securitization processes by requiring more transparency, stronger regulations of credit ratings agencies, and increasing the percentage of loan sales that must be retained by originators 36Copyright 2014 by Diane Scott Docking Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010

37 More Specifics of Act Increase regulation of OTC derivatives and gives the Federal Reserve additional authority over the nation’s payment mechanisms Establish new methods to resolve problems in nonbanks that may present systemic risks and improve the Fed’s accountability in its emergency lending facilities Increase international regulatory standards and cooperation, primarily by increasing capital requirements at U.S. and non-U.S. banks More Specifics of Act Increase regulation of OTC derivatives and gives the Federal Reserve additional authority over the nation’s payment mechanisms Establish new methods to resolve problems in nonbanks that may present systemic risks and improve the Fed’s accountability in its emergency lending facilities Increase international regulatory standards and cooperation, primarily by increasing capital requirements at U.S. and non-U.S. banks 37Copyright 2014 by Diane Scott Docking Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010

38 More Specifics of Act Establish the Consumer Financial Protection Agency (CFPA)  Created to protect consumers from unfair, deceptive and abusive practices, and improve transparency in dealing with consumers Protects investors against unfair treatment such as insider trading, lack of disclosure, malfeasance, and breach of fiduciary responsibility  A 2010 bill on credit card practices effectively limits card issuer’s ability to increase interest rates in the first year a card is obtained, limits fees and penalties for missed payments, and abolishes universal default penalties More Specifics of Act Establish the Consumer Financial Protection Agency (CFPA)  Created to protect consumers from unfair, deceptive and abusive practices, and improve transparency in dealing with consumers Protects investors against unfair treatment such as insider trading, lack of disclosure, malfeasance, and breach of fiduciary responsibility  A 2010 bill on credit card practices effectively limits card issuer’s ability to increase interest rates in the first year a card is obtained, limits fees and penalties for missed payments, and abolishes universal default penalties 38Copyright 2014 by Diane Scott Docking Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010

39 Copyright 2014 by Diane Scott Docking 39 Financial Innovations: Bank Credit Cards Debit Cards ATMs Electronic Banking  internet,  telephone Virtual banks E-money

40 Other Consumer Protection Acts and Regulations Copyright 2014 by Diane Scott Docking40

41 Social Responsibility Acts 1968 – Full Information on Terms of Loans Must be Given 1974 – Cannot Be Denied a Loan Based on Age, Sex, Race, National Origin or Religion 1977 – Cannot Discriminate Based on the Neighborhood in Which Borrower Resides 1987 and 1991 – Banks Must Disclose Full Terms on Deposit and Savings Accounts 41 Copyright 2014 by Diane Scott Docking

42 42 Consumer Credit Protection Act of 1968 (Truth in Lending Act) Requires banks to fully disclose info in a credit contract (TIL form) Consumers have right to rescind within 3 days (if house is collateral, excluding 1 st mtg.) Prohibited extortion credit practices Limited garnishment of wages Created National Commission on Consumer Finance to oversee enforcement of law Banks must disclose APR and all finance charges (e.g., credit report fees, closing costs, points, etc.) Reg. Z requires disclosure of effective rates of interest, total interest paid, the total of all payments, as well as full disclosure as to why a customer was denied credit.

43 Copyright 2014 by Diane Scott Docking 43 Equal Credit Opportunity Act of 1974 A credit discrimination act (Reg B) Forbids discrimination against credit applicants on the basis of age, sex, marital status, race, color, religion, national origin. Credit applicants must be notified, in writing, of approval or denial within 30 days Lender may not request information on the borrower’s race, color, religion, national origin, or sex, except in the case of residential mortgage loans.

44 Copyright 2014 by Diane Scott Docking 44 Truth in Savings Act of 1991 Requires financial institutions to disclose the "Annual Percentage Yield," or "APY," on savings accounts. The APY tells you how much money you would earn if you kept $100 in the account for one year. Requires that the institution credit your entire deposit instead of crediting a portion of your deposit or using a "low balance per month" method. This increases your earnings. Requires that institutions have available a list of their fees for bounced checks, stop payment orders, certified checks, wire transfers or similar items. Ask for the list. Prohibits institutions from advertising "free" checking if there are hidden charges or requirements, for example, having to maintain a minimum balance to qualify.

45 Fair and Accurate Credit Transactions (FACT) Act 2003 Passed in Response to Increased Problem of Identity Theft Federal Trade Commission Must Make it Easier for Consumers Victimized to File Theft Report Individuals and Families are Entitled to One Free Credit Report Each Year  www.annualcreditreport.com/cra.index.jsp www.annualcreditreport.com/cra.index.jsp 45 Copyright 2014 by Diane Scott Docking

46 Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (CARD Act) Mail or deliver periodic statements 21 days before payment due date and the expiration of any grace period. Written notice to cardholder of increase in APR or any significant changes, no later than 45 days prior to the change taking effect. Cardholder has right to cancel after receiving notice Payments in excess of the minimum payment must be applied first to the balance with the highest interest rate. Payment due dates must be the same day every month (or the next business day, if date falls on a holiday or a weekend).  If payment due date is a day on which the creditor does not receive or accept payments by mail (including weekends and holidays), the creditor may not treat a payment received on the next business day as late for any purpose. 46 Copyright 2014 by Diane Scott Docking

47 Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (CARD Act) Changes to Periodic Statement format requirements make them more understandable by grouping fees and interest charges together. Interest Charges & Fees  Must be grouped separately, with a monthly total for each.  Interest charges must be itemized according to type of transaction.  Separate year-to-date totals for fees and interest charges are also required. Effective APR  Do not need to disclose an “effective annual percentage rate” due to lack of consumer understanding of this term.  Must disclose interest and fee totals for the month and year-to-date to inform consumers of the total cost of credit. Minimum Payment Disclosure  Effect of making only the minimum required payment to repay the balances must be disclosed as required by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Payment Due Date  Must be on the front side of the periodic statement.  Must disclose in close proximity to the due date amt of late payment fee penalty APR that could be triggered by a late payment 47 Copyright 2014 by Diane Scott Docking


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