Bank Regulation

Bank Regulation

• G&K Chp. 2

• Need for Regulation

• Trends in Regulation

Need for Regulation

• Safety and Financial Soundness

• Provide Monetary Stability

• Maintain Financial Market Efficiency

• Protect Consumers

• Maintain Payments System

What Regulation Cannot Do

• Prevent Bank Failures

• Eliminate Risk– In Economy– In Bank Operations

• Guarantee Good Mgmt Decisions

Primary Regulators

• Federal Reserve (Fed)– http://www.ny.frb.org/banking/regulations.html

• Federal Deposit Insurance Corp. (FDIC)

• Office of the Comptroller of the Currency (OCC)

• Office of Thrift Supervision (S&L’s)

Safety and Soundness

• Supervision and Examination– Appraise Asset Quality, Mgmt & Mkt Risk– Asset Quality is mainly Loan Quality

• Problem Loans, Payments and Reserves/Chg-Offs

– Mgmt based on Policies and Procedures– Mkt Risk is Bank sensitivity to Int Rate Change

• Also can include off-balance sheet activities and trading portfolio.

Safety and Soundness

• Negative Results of Examination– Informal Advisory

• Suggested Actions for Improvement

– Memorandum of Understanding• IDs specific violations and prescribes actions

– Cease and Desist Order• Legal Document that IDs illegal or unfair practice

and requires discontinuance under penalty of law

Deposit Insurance

• Maintain confidence with Insurance of $100,000 per deposit account

• FDIC historically ran two funds– Bank Insurance Fund (BIF) for Banks– Savings Assoc Insur Fund (SAIF) for S&Ls– Paid fees of around 20 cents per $100 deposit

• There is now only one fund and after 1998, about 98% of banks pay no fees

Failures and Insurance Payout

• Failure is relatively rare with 50 in 1982 and only 2 in 1998

• Industry Failure was experienced by S&Ls in late 80’s and early 90’s with over 500 failures in 1990.

• Instead, usually Too Big Too Fail (TBTF)– Gov’t Organized Take-over– DeFacto 100% Insurance on all accounts

Federal Reserve Involvement

• Does not insure, but actions support system

• Discount Window Loans

• Support Financial Markets

• Support during failure of non-FDIC insured institutions

• Support in Repurchase Agreement and Farm Credit markets

Chartering and Regulation

• OCC (“national” bank) or appropriate state authority (“state” bank)

• National banks regulated by OCC, Fed and FDIC and are required to carry FDIC Ins.

• State banks elect Fed and FDIC supervision• OCC examines, approves mergers and branching• Fed sets reserves, approves mergers and

branching, examines state banks

Bank Regulation of 1930s

• The Banking Act of 1933 (Glass-Steagall Act)– Banks can’t do investment banking– Established the FDIC– Fed caps TD rates and prohibits int on DDs– Inc’d capital requirements on national banks

• The Banking Act of 1935– Expand Fed powers on capital reqs and rates– OCC powers to charter national banks

Bank Regulation of 1930s

• The 1933 and 1935 banking acts restricted : –Pricing

–Geography

–Products

–Capital

Bank reforms since 1980• Depository Institutions Deregulation and

Monetary Control Act (DIDMCA) of 1980– Uniform reserve requirements for all depository

institutions.– Federal Reserve services available to all depository

institutions.– Regulation Q to be phased out by the Depository

Institutions Deregulation Committee (DIDC).– Deposit insurance limit raised from $40,000 to $100,000

per account.– Negotiable order of withdrawal (NOW) accounts

approved (interest-bearing checking accounts with fixed limit of 6% interest rate).

– Savings and loans allowed to make more consumer loans and given trust powers.

Bank reforms since 1980

• Garn-St Germain Depository Institutions Act of 1982– Money market deposit accounts (MMDAs) to compete

with money market mutual funds (MMMFs).

– FDIC/FSLIC assistance for troubled or failing institutions

– Net worth certificates (or bank capital held by the government) was used by regulators to keep failing thrifts from being closed.

– Asset powers of thrifts expanded in consumer and commercial lending to enable them to compete with banks.

Bank reforms since 1980

• Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989– Regulatory restructuring FHLBB and FSLIC

closed; OTS established under the U.S. Treasury. FDIC insures all deposits thru different depts.

– Thrifts’ asset powers reduced by focusing more on home lending

– “Cease-and-desist” powers of regulators.– Enabled cross-bank guarantees in multi-bank

holding companies.

Bank reforms since 1990• Federal Deposit Insurance Corporation

Improvement Act (FDICIA) of 1991– Prompt corrective action (PCA) by regulators– 6% capital limit– Restrictions of the ability of the FDIC to

protect uninsured depositors in a large bank failure (i.e., lessened the “too big to fail” or TBTF problem).

– Risk-based deposit insurance scheme implemented.

– Raised deposit insurance fees to build up federal insurance reserves.

Bank reforms since 1990

• Omnibus Budget Reconciliation Act of 1993– Provided that insured depositors a priority over

noninsured depositors/creditors claims. – Increases “market discipline” and protects smaller

depositors.

• Riegle-Neal Interstate Banking and Branching Act of 1994– Interstate banking allowed in 1995 through multi-

bank holding companies.– Interstate branching allowed in 1997.

Bank reforms since 1990

• Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act)– Ended 1933 Glass-Steagall prohibitions on

separation of banks from investment banking– Ended 1956 Bank Holding Company Act’s

prohibitions on insurance underwriting.– Banks, brokerage firms, and insurance

companies can merge.– Financial holding companies allowed to engage

in a wide variety of financial services (i.e., financial supermarkets).

– Banking and commerce remain separate.

Regulation for a New Millennium

• USA Patriot Act of 2001– “Know your customer”– Monitor accounts for money laundering w/

reporting requiremts (SARs).– Monitor accounts from shell companies

• Unresolved Issues– Capital Adequacy – Basel II– Failure and Deposit Insurance Reform– Financing and Advisement of Hedge Funds