1. 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 Industry

2. 2-2 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Key areas of bank regulation Adequacy of bank’s capital The quality of its loans and security investments Its liquidity position Fund raising options Services offered Ability to expand through branching and forming holding companies

3. 2-3 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Reasons for the Regulation of Banks Protection of the Safety of the Public’s Savings Control of the Supply of Money and Credit (power to create money) Ensure Equal Opportunity and Fairness in Access to Credit Promote Public Confidence in the Financial System Avoid Concentration of Power/Maintain competition Support of Government Activities Help for Special Segments of the Economy (Banks provide loans that support consumption and investments)

4. 2-4 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Principal Regulatory Agencies Federal Reserve System – Supervises and examines national banks chartered by the comptroller of the currency and state chartered member banks. Regulates activities of BHC (Monetary policy is one of the Fed’s principal responsibilities –control of money and credit growth to achieve broad economic goals related to economic growth, employment and inflation.)

5. 2-5 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Principal Regulatory Agencies Comptroller of the Currency – Charters and supervises the activities of national banks Federal Deposit Insurance Corporation – Insures deposits of bank customers up to a total of 100,000 per account owner in banks that are federally supervised and conform to FDIC’s regulations – Approves all applications of insured depositories to establish branches, merge or exercise trust powers

6. 2-6 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Principal Regulatory Agencies Department of Justice – Must approve application for mergers and holding company acquisitions for their effect on competition Securities and Exchange Commission – Must approve public offerings of debt and equity securities by banking and thrift companies and oversee the activities of the bank security affiliates State Banking Boards or Commissions – Issues charters for new depositary institutions – Supervise and examine all state chartered banks and thrifts

7. 2-7 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. FDIC Note: FDIC ran into serious problems in 1980s and 1990s because there were system wide failures. FDIC was brought to the brink of bankruptcy. Charging the same fees to all banks no matter risk was a mistake. FDIC deals with most failures by getting other banks to take over the deposits and clean assets – a process known as purchase and assumption. Some banks are closed and insured depositors are paid off. FDIC also loans money to troubled banks.

8. 2-8 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. National Banking Act (1863,1864) Passed During the Civil War to Help Fund the War Created A New Division of the Treasury, the Comptroller of the Currency Created National Banks with a Federal Charter

9. 2-9 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Reserve Act of 1913 Passed After a Series of Financial Panics at the Beginning of the Century Created the Federal Reserve System Gave the Fed the Authority to Act as the Lender of Last Resort Created to Provide a Number of Services to Member Banks Today the Fed Controls the Money Supply

10. 2-10 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Glass-Steagall Act 1933 Passed During the Great Depression Separated Investment and Commercial Banking Created the FDIC Prohibited Interest to be Paid on Checking Accounts

11. 2-11 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. FDIC Act 1935 Gave the FDIC the Power to Examine Banks and Take Necessary Action because it insured deposits. Examines the most number of banks. Examines state banks that are members of the FED and all national banks

12. 2-12 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

13. 2-13 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Depository Institution Deregulation and Monetary Control Act (DIDMCA) 1980 First of Deregulation Acts Phased Out Interest Rate Ceilings Allowed Interest to be Paid on Checking Accounts (NOW Accounts) Term Transaction Account Created – All Institutions with These Accounts Subject to Reserve Requirements

14. 2-14 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

15. 2-15 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Competitive Equality in Banking Act 1987 Allowed Creation of Special Bridge Banks for Failed Institutions Bridge Banks Are Special National Banks Operated by the FDIC Bridge Banks Created When Bank is Essential to the Community

16. 2-16 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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 $50 Billion Authorized to Handle Failed Institutions (Later Increased) Allowed Bank Holding Companies to Purchase Savings Banks

17. 2-17 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. FDIC Improvement Act 1991 Move Towards Re-regulating the Industry Requires Regulators to Take Prompt Corrective Action 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

18. 2-18 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Riegle-Neal Acts 1994 Bank Holding Company Can Acquire Banks Nationwide Consolidation of Interstate BHCs into Branches Smaller Well Managed Banks Only Examined Every 18 Months Community Development Fund Created to Promote Development of Depressed Local Communities Cancelled the Mcfadden act which prevented interstate banking

19. 2-19 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Gramm-Leach-Bliley Act 1999 Permits Banking-Insurance-Securities Affiliations Consumer Protections for Consumers Purchasing Insurance Through a Bank Must Disclose Policies Regarding the Sharing of Customers’ Private Information Customers are Allowed to ‘Opt Out’ of Private Information Sharing Fees for ATM Use Must be Clearly Disclosed Federal Crime to Use Fraud or Deception to Steal Someone’s Account or Personal Information

20. 2-20 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The USA Patriot Act 2001 Requires Banks and Financial Service Providers to Establish the Identity of their Customers Requires Banks and Financial Service Providers to Check the Customer’s ID Against Government-Supplied Lists of Possible Terrorists and Terrorist Organizations Report Suspicious Activity in Customer’s Account to the US Treasury

21. 2-21 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Sarbanes–Oxley Accounting Standards Act 2002 Creates Panel to Promote Accurate and Objective Audits of Public Companies Top Corporate Officers Must Vouch for the Accuracy of their Companies’ Financial Statements

22. 2-22 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

23. 2-23 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Check 21 2004 Reduces the Need for Banks to Transport Paper Checks Can Provide a Customer with ‘Substitute’ Check Which Contains Image of Front and Back of Original Check Allows for Electronic Transmission of ‘Substitute’ Checks for Clearing of Checks

24. 2-24 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Deposit Insurance Reform Act 2006 First Significant Increase FDIC Coverage in 25 years Raises FDIC Insurance Limits from $100,000 to $250,000 for Certain Retirement Deposits FDIC and NCUA are Empowered to Adjust Deposit Insurance Limits Every 5 years for Inflation Merges Bank Insurance Fund and Savings Association Insurance Funds

25. 2-25 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Regulating Nonbank Financial- Service (state & federal level) Credit Unions –National Credit Union Administration Savings Associations –Office of Thrift Supervision Money Market Funds –Securities and Exchange Commission Insurance Companies –State Insurance Commissions Finance Companies –State Governments Mutual Funds –Securities and Exchange Commission Securities Brokers and Dealers –Securities and Exchange Commission Financial Conglomerates –Functional Regulation

26. 2-26 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Organizational Structure of the Federal Reserve System Board of Governors Federal Open Market Committee 12 Federal Reserve Banks Member Banks

27. 2-27 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. European Central Bank Central Policy is to Maintain Price Stability Structure is Similar to the Federal Reserve Eleven Member Nations

28. 2-28 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. How Bank failures influenced legislation Provided regulators with new tools such as bridge banks Granted banks the ability to diversify through more service powers and geographic expansion Moved to risk based insurance premiums

29. 2-29 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services of the Federal Reserve bank Check clearing, wiring of funds, shipment of currency and coin, loans to qualified depository institutions Supplying information on economic and financial trends Monetary policy – most important function today

30. 2-30 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. What is monetary policy? Monetary policy consists of regulation and control over the growth of money and credit in an attempt to pursue broad economic goals such as full employment, avoidance of inflation, and sustainable economic growth. Its principal tools are open market operations, changes in the discount (lending) rate, and changes in reserve requirements behind deposits

31. 2-31 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Open market operations of the Fed Consists of buying and selling securities by the Fed to influence the shape and course of interest rates and the growth of money and credit. Fed sells securities to designated banks in order to raise interest rates and buys securities to lower interest rates. OMO affect bank deposits – their volume and growth. Also the volume of lending and the interest rates on loans. OMO therefore impacts the value of bank stock It is the preferred tool because it is flexible – can be used every day and any mistakes can be quickly reversed

32. 2-32 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. What is a primary dealer A primary dealer is a dealer in US treasury bills and other securities that meet the Fed’s requirement for trading directly with the Fed’s trading desk. It is through these deals with primary dealers that the Fed carries out monetary policy.

33. 2-33 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Impact of changes in the discount rate and reserve requirements Banks can use the discount window, a department of the fed, to obtain credit for short periods of time. The rate is called the discount rate. If a borrows then the reserves will rise by the amount borrowed. Recent changes – primary credit (based on fed funds rate) and secondary credit( based on prime rate) Reserve requirements are the amount of cash and deposits at the fed that banks must hold against recordable liabilities (checking accounts, business CDs, and borrowings of euro dollars from abroad. Higher reserves requirements reduces the amount of money available for lending