copyright © 2004 by thomson southwestern all rights reserved. 3-1 financial regulation, technology...

Copyright © 2004 by Thomson Southwestern All rights reserved.

3-1

Financial Regulation, Technology &

Financial InnovationChapter 3


3-2

Regulatory Environment

Emphasis changing over time• The 1930s• The 1960s to 1980

1980 The rules of the game changed• High and highly variable interest rates• Severe disintermediation

◦ Interest-bearing checking accounts◦ Money market mutual funds◦ More open entry into banking


3-3

Regulatory Environment (continued)

The 1980s• Increasing flexibility to cope with disintermediation• Attempts to stabilize depository institution failures

The 1990s• Continuing deregulation

◦ Reduction in geographical branching restrictions◦ Reduction in limits on financial service offerings

• Stabilization of regulatory structure

Early 2000s Issues of Ethics & Fraud


3-4

Regulation of Depository Institutions

Regulators of commercial banks• Comptroller of the Currency (OCC)• Federal Reserve System (“The Fed”)• Federal Deposit Insurance Corporation (FDIC)• State Banking Departments

Regulators of thrifts• Office of Thrift Supervision (OTS)• Savings Association Insurance Fund (SAIF)

Regulator of credit unions – National Credit Union Administration (NCUA)


3-5

What is Regulated?

Initial creation of depository institutions• Initial licensing and chartering• Location and number of physical branches,

offices• Initial board of directors and officers• Minimum cash and capital requirements to open

On-going operations• Mergers and acquisitions• Opening or closing of offices, branches• Many operations procedures• What financial services/products may be offered

For depository institutions


3-6

What is Regulated?

Assets• Diversification of assets• Quality of assets• Liquidity of assets• Level of cash reserves

Liabilities & equity• Types of liabilities created• Distribution of financing of assets• Quality of liability and equity accounts• Minimum capital requirements



3-7

What is regulated? (continued)

Community involvementDegree of market share in each market areaNon-discriminatory operating policiesDegree of risk created through the use of

derivatives and other financial instruments



3-8

Regulatory Process

Examinations• Federal Financial Institutions Examination

Council (FFIEC)• Securities & Exchange Commission• State Regulatory Departments

Reports• Multiple agencies• Multiple areas• Sometimes cause conflicts

CAMELS Rating



3-9

CAMELS Rating

Capital adequacyAsset QualityManagement QualityEarnings – amount & stabilityLiquiditySensitivity to market risk



3-10

One versus Multiple Regulators

Multiple regulators• Provide more ability to detect problems• Provide cross-checks• Are inefficient and costly to maintain

One regulator• More efficient and lower cost• Too much power concentrated in one place

Perhaps functional reorganization is better



3-11

Finance Company Regulation

Regulated at the state not federal levelLicensing restrictions

• State licenses• Local business permits, zoning, etc.

Consumer Protection Legislation Applies• Consumer Credit Protection Act of 1968

(Truth-in-Lending)• Equal Credit Opportunity Act of 1974


3-12

Insurance Company Regulation

Regulated at state not federal levelLicensing & solvency requirementsMutual insurance funds by stateRate regulationProduct regulationInsurance industry modernization plan from

National Association of Insurance Commissioners)


3-13

Insurance Regulatory Modernization Action Plan

Consumer protectionMarket regulationSpeed-to-market for insurance productsProducer licensingInsurance company licensingSolvency regulationChange in insurance company control


3-14

Pension Fund Regulation

Federal Regulation through the Employee Retirement Income Security Act (1974) or ERISA

ERISA• Attempts to ensure assets equal liabilities• Most employees are fully vested

after 15 years of service• Gives fund managers fiduciary responsibility

Pension Benefit Guaranty Corporation provides insurance at a federal level


3-15Regulation of Investment

Companies & Mutual Funds

Federal Securities Laws• Securities Act of 1933• Securities Exchange Act of 1934• Investment Company Act of 1940• Investment Advisers Act of 1940

New federal legislation will deal with• After-hour trading allowed for some investors• Mandating stronger oversight of mutual fund

boards• Stronger disclosure requirements


3-16

Securities Firms Regulation

Federal securities laws• Securities Investor Protection Act of 1970• Securities Acts Amendments of 1975• Insider Trading & Securities Fraud

Enforcement Act of 1988• Sarbanes-Oxley Act of 2002

New legislation on • Providing valid investment advice to public• Adhering to equal disclosure principles


3-17

The Dialectic Process

Initial set of arguments/rules – THESISConflicting set of arguments or responses –

ANTITHESISA new set of arguments/rules emerging from

the interaction between 1 & 2 above – SYNTHESIS

The SYNTHESIS becomes the new THESIS for the next on-going round of the process


3-18

The Regulatory Dialectic

Regulators/legislators create rules – THESISCompanies seek loopholes to earn profits –

ANTITHESISRegulators modify rules – NEW THESISCompanies seek to earn profits around rules

– ANTITHESISEventually SYNTHESIS occurs and obsolete

rules are eliminated


3-19

Why Regulations Become Obsolete

Financial innovation

Technology and economic conditions

Globalization of financial markets


3-20

Major Banking Laws 1863 - 1935

1863-4 National Banking & Currency Acts1913 Federal Reserve Act1927 McFadden-Pepper Act1933 Glass-Steagall Act

Home Owners' Loan Act Securities Act of 1933

1934 Securities Exchange Act National Housing Act National Credit Union Act1935 Banking Act of 1935


3-21

Major Banking Laws 1935 - 1980

1956 Bank Holding Company Act and Amendments (1966, 1970)

1960 Bank Merger Act1966 Interest Rate Adjustment Act1968 Consumer Credit Protection Act (Truth-in-Lending)1970 Amendments to Bank Holding Company Act1970 Federal Credit Union Act Amended (NCUSIF)1974 Equal Credit Opportunity Act1977 Community Reinvestment Act1978 International Banking Act


3-22

Major New Laws 1980 - 2000

1980 DIDMICA1982 Garn – St. Germain Depository Institutions

Act1987 Competitive Equality Banking Act (CEBA)1989 Financial Institutions Reform, Recovery,

and Enforcement Act (FIRREA)1991 Federal deposit Insurance Corporation

Improvement Act (FDICIA)1994 Riegle-Neal Interstate Banking and

Branching Efficiency Act (IBBEA)1999 Financial Services Modernization (Graham-

Leach-Bliley (GLB)


3-23

Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA)

• Monetary Control Act of 1980• Depository Institutions Deregulation Act of 1980• Consumer Checking Account Equity Act of 1980• Expanded Powers for Thrifts• Preemption of State Interest Rate Ceilings• Truth-in-Lending Simplification• Amendments to the National Banking Laws• Financial Regulation Simplification Act of 1980• Moratorium on foreign takeovers of U.S. Financial

Institutions

DIDMCA - 1980


3-24

Garn-St. Germain Act of 1982

• The Deposit Insurance Flexibility Act• The New Worth Certificate Act• The Thrift Institution Restructuring Act• Changed loan limit, exempted some banks from reserve requirements

• Credit Union Amendments• Amendment to Bank Holding Company Act• Allowed governments to have NOW accounts• Alternative Mortgage Transaction Act of 1982


3-25

CEBA of 1987Competitive Equality Banking Act of 1987

• Financial Institutions Competitive Equality Act• Moratorium on Certain Nonbanking Activities• FSLIC Recapitalization Act• Thrift Industry Recovery Act• Financial Institutions Emergency Acquisitions Act• Expedited Funds Availability Act• Credit Union Amendments• Loan Loss Amortization• Reaffirmation of Federal Deposit Insurance to legal limit• Government Check Cashing Required


3-26

FIRREA of 1989Financial Institutions Reform, Recovery, and Enforcement Act of 1989

• Strengthened thrift standards & supervision• Made FDIC sole insurer for banks & thrifts• Restricted thrifts junk bond & R.E. investments• Created the Office of Thrift Supervision (OTS)• Abolished FSLIC & FHLBB, other reforms• Created the Resolution Trust Corporation, the

Resolution Funding Corp, & Oversight Board• Permitted BHOs to acquire healthy thrifts• Increased penalties for fraud by managers• Lowered tax benefits to acquirers of failed thrifts


3-27

FDICIA of 1991Federal Deposit Insurance Corporation Improvement Act

of 1991• Authorized FDIC to borrow up to $30 billion from the U.S.

Treasury to be repaid from bank insurance premiums• Authorized FDIC to borrow up to $45 billion from U.S. Treasury

to be repaid by sale of assets of failed banks• Ordered regulators to develop better capital adequacy measures,

and to move more promptly when an institution's capital position weakens; at 2%, institution must be closed

• Increases frequency of bank examination• Restricted FDIC from fully reimbursing uninsured and foreign

depositors when a bank fails• Restricted regulators in making long-term loans to banks in

difficulty• Required higher deposit insurance for riskier banks


3-28

Ownership Forms

Privately owned firmsStock owned firmsSubchapter S corporationsLimited liability companiesMutual firmsNot-for-profit organizationsFranchising and chain banks


3-29

Holding Companies

Bank Holding Companies (BHC) & Financial Holding Companies (FHC)

One bank versus multi-bankCreated to:

• Provide greater financial leverage• Circumvent regulations & restrictions• Take advantage of economies of scale• Provide multiple services to customer base


3-30

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994

• Allows interstate branching unless a state specifically passes a law prohibiting it

• De facto removes many restrictions about bank size• Encourages large banking conglomerates• Puts no restrictions on capital movements within the (now very expanded) bank

• Does not restrict the options of states to regulate banking within their environs


3-31

Riegle Community Development and Regulatory

Improvement Act of 1994Reduces frequency of examination for small, well-

managed banksReduces reporting requirementsRequires regulatory agencies to review and eliminate

outdated regulationsEstablishes Community Development Financial

Institutions Fund to • provide funding and technical support to "banks and

other community organizations" • promote local economic development in depressed

communities and neighborhoods


3-32

One-Bank Holding Companies

Circumvent product restrictions for banks

Glass-Steagall restrictions were eased in 1980s

Virtual Financial Institutions as Loopholes

Financial Services Modernization Act of 1999 or Graham-Leach-Bliley Act of 1999


3-33

Financial Services Modernization Act of 1999 or Graham-Leach-

Bliley Act of 1999Financial Holding CompaniesNational Bank Operating SubsidiariesFacilitating affiliation among banks, securities

firms, and insurance companiesFunctional regulationInsuranceUnitary savings and loan holding companiesPrivacyFederal Hold Loan Bank System modernizationMore complete disclosure to the public


3-34

Continuing Regulatory Concerns

Measuring risksControl of risks due to technologyDetecting and preventing fraud

• Operations• Corporate governance• Through partnerships/alliances• Money laundering

Controlling risk via market discipline

copyright © 2004 by thomson southwestern all rights reserved. 3-1 financial regulation, technology...

Documents

thomson southwestern

banking slide

financial regulation

s issues of ethics fraud

financial instruments

assets quality of liability

market risk

s increasing flexibility