Regulating the Banking Industry ECO 473 – Money & Banking – Dr. D. Foster
Rationales for Government Regulation Maintaining depository institution liquidity. Assuring bank solvency by limiting failures. Promoting an efficient financial system. Protecting consumers.
Federal Regulation: 1933–1970 The Banking Act of 1933 (Glass-Steagall Act): Created the Federal Deposit Insurance Corporation (FDIC). Placed interest rate ceilings on checking deposits of commercial banks. Separated commercial and investment banking. Branching restrictions.
Partial Deregulation: 1971–1989 Disintermediation in the 1970s. 1980 - Depository Institutions Deregulation and Monetary Control Act (DIDMCA): Six-year phaseout of interest rate ceilings. Permitted NOW accounts. Increased FDIC coverage to $100,000.
Partial Deregulation: 1971–1989 The Garn–St. Germain Act of 1982: Authorized money market deposit accounts. Increase the DIDMCA limit on consumer loans and commercial paper. Authorized savings institutions to make commercial real estate loans. Gave these institutions the power to purchase “unsecured loans,” including low-rated, “junk” bonds. Gave the FDIC power to permit troubled financial institutions to merge with healthier partners.
Partial Deregulation: 1971–1989 1989 - Financial Institutions Reform, Recovery & Enforcement Act (FIRREA): Authorized taxpayer funds to cover cost of liquidating failed thrifts. --Insurance wasn’t enough! Abolished current thrift regulatory structure. --Created Office of Thrift Supervision. --Created the Resolution Trust Corp. to liquidate thrifts. Moved thrift insurance (FSLIC) into FDIC. Required insurance fund = 1.25% of insured deposits.
Deposit Insurance Complications The moral-hazard problem of deposit insurance: S&L crisis. Too-big-to-fail policy: Continental Illinois. The FDIC Improvement Act Of 1991 -- Allowed for earlier intervention by the FDIC. -- Let FDIC set/change premiums to boost fund. -- Mandated risk-based premium structure.
The Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act) Act removes Glass-Steagall restrictions and permits: Securities firms and insurance companies to own commercial banks. Banks to underwrite insurance and securities, including shares of stock.
Capital Requirements Capital requirements: Minimum equity capital standards. Risk-based capital requirements: Risk factors that distinguish different depository institutions. [Degree of capitalization.] Risk-adjusted assets: A weighted average of bank assets to account for risk differences across types of assets. [Type of capitalization.]
Regulatory Issues Off-balance-sheet banking: Asset valuation: Loan commitment; credit default swaps. Asset valuation: Historical cost vs. market value Derivatives: Replacement cost exposure. Credit/market/operating risks. New wave of regulation: SOX; Dodd-Frank
Regulating the Banking Industry ECO 473 – Money & Banking – Dr. D. Foster