Maclachlan, Money & Banking Spring Banking Regulation Chap. 11

Maclachlan, Money & Banking Spring Review: Asymmetric Information Before transaction … ADVERSE SELECTION After transaction …. MORAL HAZARD

Maclachlan, Money & Banking Spring Types of Banking Regulation 1.Restrictions on bank’s assets. 2.Government safety net (FDIC). 3.Capital requirements. 4.Bank supervision. 5.Assessment of risk management. 6. Disclosure requirements. 7. Consumer protection. 8. Restrictions on competition.

Maclachlan, Money & Banking Spring Government Safety Net Emergency legislation March Bank failures : 2000/year : 15/year When bank fails, two things can happen … PAY OFF or PURCHASE & ASSUMPTION “Too Big to Fail” (relate to consolidation)

Maclachlan, Money & Banking Spring FDIC Improvement Act (1991) Limited brokered deposits. Renounced too-big-to-fail. Supervision of foreign banks in U.S. Risk based premiums

Maclachlan, Money & Banking Spring Restrictions on Assets No securities related activities except … Treasurys, municipals, government agency securities Foreign exchange Derivatives Commercial paper underwriting

Maclachlan, Money & Banking Spring Capital Requirements Leverage ratio = capital/assets > 5% Basel Accord: capital = 8% of risk adjusted assets (assets are weighted by risk factor) Regulatory arbitrage

Maclachlan, Money & Banking Spring Bank Supervision Three layers of supervision for nationally chartered bank: 1863 Comptroller of Currency 1913 Federal Reserve 1933 FDIC

Maclachlan, Money & Banking Spring CAMELS Capital adequacy Asset quality Management Earnings Liquidity Sensitivity to market risk

Maclachlan, Money & Banking Spring Assessment of Risk Management Looking at quality of assets is not enough. Diversification and hedging reduce risk. Examiners look at oversight, policies, risk measurement and monitoring, internal controls.

Maclachlan, Money & Banking Spring Disclosure Requirements Allows large depositors and investors to accurately assess risk.

Maclachlan, Money & Banking Spring Consumer Protection Consumer Protection Act of 1969 “Truth in Lending”: Disclosure of APR and total finance charges. Equal Credit Opportunity Act 1974 Community Reinvestment Act 1977 (prevents redlining)

Maclachlan, Money & Banking Spring Restrictions on Competition McFadden Act Glass Steagall

Maclachlan, Money & Banking Spring Financial Institutions Reform, Recovery, and Enforcement Act (1989) FSLIC closed down. Resolution Trust Corporation to close down S&L’s and pay off depositors. Total cost to taxpayer: $150 billion.

Maclachlan, Money & Banking Spring Innovation & Regulation How is bank regulation related to the following innovations? Commercial paper Adjustable rate mortgages Securitization MMMF’s Sweep accounts