finish chapter 10 capital adequacy (solvency) and returns to equity fdic this weekend resolves 9...
TRANSCRIPT
Finish Chapter 10 Capital adequacy (solvency) and returns
to equityFDIC this weekend
Resolves 9 banks http://www.fdic.gov/index.html (bair)
Chapter 11 Regulation
High Bank Capital Low Bank Capital
Assets Liabilities Assets Liabilities
Reserves $10M Deposits $90M Reserves $10M Deposits $96M
Loans $90M Bank Capital $10M Loans $90M Bank Capital $4M
High Bank Capital Low Bank Capital
Assets Liabilities Assets Liabilities
Reserves $10M Deposits $90M Reserves $10M Deposits $96M
Loans $85M Bank Capital $5M Loans $85M Bank Capital -$1M
Return on Assets: net profit after taxes per dollar of assets
ROA = net profit after taxes
assetsReturn on Equity: net profit after taxes per dollar of equity capital
ROE = net profit after taxes
equity capital
Relationship between ROA and ROE is expressed by the
Equity Multiplier: the amount of assets per dollar of equity capital
EM =Assets
Equity Capital
net profit after taxes
equity capitalnet profit after taxes
assets assets
equity capital
ROE = ROA EM
Basic microeconomic principles on efficiency If market is competitive regulation can only
harm society
Conditions for competitive market Homogeneous good Free entry and exit Participants have full information Many buyers and sellers
Exceptions: where regulations can help Market failures▪ Market power (monopoly)▪ Pollution & environmental harms▪ Lack of property rights (e.g. fishing)▪ Asymmetric information (e.g. credit)
Caution▪ Government failure is possible when trying to
solve a market failure. However there are have been successes▪ e.g. clean air act estimate 22 trillion in benefits
These boats arethe same length Regulation intended
to cut fishing effort Instead regulation
limits boat length Result: ▪ Short & tall boats▪ Fishing effort up▪ Resources wasted…
10-6
A huge part of the company’s credit-default swap business was devised.. to allow banks to make their balance sheets look safer than they really were.
Under a misguided set of international rules that took hold toward the end of the 1990s, banks were allowed use their own internal risk measurements to set their capital requirements.
How did banks get their risk measures low? … they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G….which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets.
http://dealbook.blogs.nytimes.com/2009/03/02/propping-up-a-house-of-cards/
10-7
Safety and soundness regulation Entry, branching, network, and mergers Deposit insurance Deposit interest ceilings Portfolio restrictions, including reserve
requirements Capital requirements Regulatory monitoring and supervision
1-8
Canada: 60 banks, US: 8000 banks 1927 US Laws allows state to restrict
interstate and intrastate competition Too many inefficient banks Bank holding companies are a way
around the law▪ Independent company purchases many banks
in many states. States relax laws (1972-1991)
What’s the impact?
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Impacts of increased competition Operating costs decline (about 8%)▪ Includes wage decline ▪ Down 12% for men & 3% for women▪ Difference across gender: Evidence of
discrimination in noncompetitive setting
Loan losses decline
Interest rates decline for borrowers
What about economic growth? In States deregulating▪ economic growth increases by .51% to
1.19%▪ Convinced? What is the counterfactual?▪ States that don’t deregulate saw a decline
in growth rate (.6%) What is the mechanism?▪ The quality of lending improved not just the
quantity.
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Restrictions on interest paid on deposits
5.5% maximum (1934-1980)▪ Difficult to generate deposits when interest
rate are high e.g. late 1970’s▪ Regulation interacts with new economic
conditions, harming banks Response▪ Money market mutual funds▪ Push for deregulation
10-13
Decline in cost advantages in acquiring funds (liabilities) Rising inflation led to rise in interest rates and
disintermediation Low-cost source of funds, checkable deposits,
declined in importance
Decline in income advantages on uses of funds (assets) Information technology has decreased need for
banks to finance short-term credit needs or to issue loans
Information technology has lowered transaction costs for other financial institutions, increasing competition
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 11-14