1. Chapter 15 The Regulation of Markets and Institutions

2. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-2 KEY WORDS AND CONCEPTS WHY REGULATION of Financial Markets? Secondary Market – Securities Two main laws SECURITIES EXCHANGE COMMISSION (SEC) DISCLOSURE – PROSPECTUS INSIDER TRADING

3. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-3 KEY WORDS AND CONCEPTS WHY REGULATION OF COMMERCIAL BANKS? US BANKING REGULATORY STRUCTURE Creation of the FED (Central Bank) Federal Deposit Insurance Corporation (FDIC) DEPOSIT INSURANCE CAPITAL REQUIREMENTS REGULATION OF NON-DEPOSITORY FINANCIAL INTERMEDIARIES

4. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-4 KEY WORDS AND CONCEPTS 2 IMPORTANT LAWS IN US BANKING HISTORY GLASS-STEAGALL ACT 1933 (Regulation) GRAMM-LEACH-BLILEY 1999 (De-regulation) FINANCIAL HOLDING COMPANIES (FHC) PORTFOLIO DIVERSIFICATION RISK OF UNIVERSAL BANKING

5. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-5 Introduction Financial system is one of the most regulated sectors in US economy 1. Promote 促进 (Cùjìn) competition 2. Protection for consumers 3. Assure stability of financial system 4. Help set monetary policy

6. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-6 Regulation of Financial Markets in the United States Desire to protect individual investor Best protection is information about securities Full disclosure 信息披露 (Xìnxī pīlù) helps investor’s to be active in financial markets

7. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-7 Regulation of Financial Markets in the US REGULATION OF SECONDARY MARKET – SECURITIES (Created as a result of the Great Depression) –Securities Act of 1933 Requires disclosure of information for newly issued securities –Securities Exchange Act of 1934 Created the government agency called the Securities and Exchange Commission (SEC) A traded security must file a prospectus 招股说明书 (Zhāogǔ shuōmíngshū) disclosing information about issuer.

8. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-8 Regulation of Financial Markets in the United States (Cont.) Regulation of Secondary Market –Securities Exchange Act of 1934 Insider Trading Laws 内幕交易 (Nèimù jiāoyì) –Prevent insiders of a company from trading on private information not given to the public (people)

9. SEC & Example of Insider Trading SEC Charges Analyst with Insider Trading 03/13/2014 03:33 PM EDTSEC Charges Analyst with Insider Trading The Securities and Exchange Commission (SEC) today charged a former analyst at an affiliate of hedge fund advisory firm S.A.C. Capital Advisors with insider trading based on nonpublic information that he obtained about a pair of technology companies. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-9

10. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-10 Regulation of Commercial Banks in the United States Protect individual depositor Keep a competitive banking system For bank safety and soundness. Keep your money safe.

11. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-11 Regulation of Commercial Banks in the United States (Cont.) U.S. Banking Regulatory Structure (Cont.) –Federal Reserve Act of 1913 Created the FED (Central Bank). All banks currently fall under regulation of the Fed (member or not) –Federal Deposit Insurance Corporation (FDIC) All member banks of Fed (national and some state banks) are required to carry FDIC insurance.

12. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-12 Regulation of Commercial Banks in the United States (Cont.) Deposit Insurance –FDIC established by Banking Act of 1933 to insure deposits at commercial and savings banks. –Many bank failures in the early 1930’s due to the Great Depression. –It is to protect small savers and reduce the “run on a bank” –CARTOON PAGE 294

13. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-13 Regulation of Commercial Banks in the United States (Cont.) Deposit Insurance (Cont.) –Currently insure deposits up to $250,000, but could be more “Too big to fail” Doctrine— FDIC may extend loans to very large banks in trouble to allow continued operations

14. News Flash! Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-14 Imminent negative surprise in store for Too Big To Fail banks? Dec 2 2014, 15:42 ET | By: Stephen Alpher, SA News EditorStephen Alpher

15. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-15 Regulation of Commercial Banks in the United States Protecting Individual Depositors and Financial System Stability –Purpose of bank regulation is on bank examinations and corrective action when necessary –The primary liabilities of a commercial bank are their demand deposits Banks must maintain sufficient liquidity to meet demand deposits

16. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-16 Regulation of Commercial Banks in the United States (Cont.) Risk-Based Capital (Equity) Requirements –Bank capital provides a cushion against failure –Risk-based capital requirements— as a bank’s assets become riskier regulators will force banks to increase their capital by increasing their shareholder investment (stock)

17. In the News! The Fed intends to impose a capital surcharge on banks tougher than the international standard, according to Fed Governor Daniel Tarullo's prepared remarks for the Senate Banking Committee. Those banks with heavier reliance on short-term funding like overnight loans - i.e. intends to imposeprepared remarks Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-17 U.S. banks to be hit with tougher capital rule Sep 9 2014, 12:24 ET | By: Stephen Alpher, SA News EditorStephen Alpher

18. NEWS – MORE CAPITAL NEEDED!! The Banks that will need to raise more capital: Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-18  What's not yet clear is who would need to raise capital to meet the new, tougher standard.  Largest Banks if America – Too Big to Fail  Citigroup, Bank of America, JPMorgan, Wells Fargo, State Street, Bank of New York Mellon.

19. DISCUSSION QUESTIONS 1.What are the reasons for bank regulation? Why regulation the financial system? 2.What government agency was created to regulate securities investment? 3.What is Insider Trading? Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-19

20. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-20 Regulation of Nondepository Financial Intermediaries Pension funds and life insurance companies –Heavily regulated because their liabilities are purchased by small investors and need to protect small investors

21. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-21 Regulation of Nondepository Financial Intermediaries (Cont.) –Life Insurance Companies Regulated at the state level Set risk-based capital requirements Perform audits 审计 Shěnjì Make restrictions on pricing of products

22. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-22 The Glass-Steagall Act 1933 Separated the banking industry from the rest of the financial services industry Banks are barred from owning corporate stock and other activities deemed too risky The Glass-Steagall Act 1933 –Prior to 1933, investment banking and commercial banking were conducted together under same roof –Following the Great Depression of the 1930s, investment banking activities were too risky for banks

23. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-23 The Glass-Steagall Act 1933 (cont) The Glass-Steagall –Main point of law: separate investment banks from commercial banks –This combination represented a substantial threat to financial system stability

24. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-24 The Glass-Steagall Act 1933 (Cont) The Repeal 废除 (Fèichú) of Glass- Steagall (Example of De-regulation) –Commercial banks put pressure on the Federal Reserve to reduce the barriers caused by Glass-Steagall –Introduction of Financial holding Companies (FHC’s) Permitted banks to conduct nonbanking activities through subsidiaries 子公司 (Zǐ gōngsī)

25. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-25 Cancelling of Glass-Steagall Gramm-Leach-Bliley Act 1999 The Gramm-Leach-Bliley Act (1999) De-regulation Allowed affiliates 子公司 (Zǐ gōngsī) of financial holding companies to engage in various banking activities and insurance underwriting Regulation by the Federal Reserve (FED)

26. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-26 The Glass-Steagall Act, A Collapsing Barrier (Cont.) The Risk of Universal Banking –Concern that the risk of securities activities may be a problem for the stability of banks –Just because investment banking is riskier than commercial banking, this does not mean that the combination of the two will be riskier –WHAT DO YOU THINK?

27. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-27 The Glass-Steagall Act, A Collapsing Barrier (Cont.) The Risk of Universal Banking –The portfolio idea of risk suggests that diversification may reduce risk when commercial banking combine with investment banking and life insurance activities –Perhaps it is time to let the banks decide for themselves whether universal banking reduces risk

28. CHAPTER 15 SUMMARY 1.The main reason for securities regulation is to protect the investor. This is done by full disclosure 信息披 露 (Xìnxī pīlù) of information 2.Protecting depositors and keeping the banks stable are the 2 main goals of bank regulation. Deposit insurance helps to prevent bank panics. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-28

29. CHAPTER 15 SUMMARY 3. The Glass-Steagall Act 1933 separated the commercial banking industry from the investment banking industry. 4. The Gramm-Leach-Bliley Act (1999) reversed the Glass-Steagall act allowing commercial banks full authority to engage in investment banking forming large holding companies. Copyright © 2004 Pearson Addison-Wesley. All rights reserved. 15-29