BANK REGULATION CHAPTER 18 All Rights Reserved Dr David P Echevarria

REGULATORY STRUCTURE OF THE BANKING SYSTEM Comptroller of the Currency Chartering and Auditing Oversight for Intrastate branching, mergers, acquisitions, and consolidations Federal Reserve System Setting reserve requirements Controls borrowing at the discount window Oversight for state-chartered member banks State Banking Commissions Limitations on inter- and intra-state banking as well as branching Non-Insured states have considerably less FED and US Government oversight All Rights Reserved Dr David P Echevarria

REGULATION OF BANK OWNERSHIP Bank Holding Companies (BHC) http://www.ffiec.gov/nicpubweb/nicweb/Top50Form.aspx 1970 Amendments to Bank Holding Company Act (1956) Permits BHC to enter non-banking activities Permits BHC to acquire banks in different states Financial Services Modernization Act (1999) Repeals Glass-Steagal Act (1933) Permits affiliations with Insurance and Brokerage firms Engage in any financial activity via subsidiaries of BHC Most important – cleared way for consolidation of industry All Rights Reserved Dr David P Echevarria

BALANCE SHEET REGULATIONS Regulation of Deposits; DIDMCA (1980) All depository institutions can offer NOW accounts; dealing with disintermediation De facto entry of banks into money market activities Regulation of Loans Attempting to limit portion of loan portfolio in high leverage transactions Limiting amount of loans to any individual client All Rights Reserved Dr David P Echevarria

BALANCE SHEET REGULATIONS Regulation of Capital Capital = Total Assets minus Total Liabilities The greater the capital of a bank, the greater the stability (5 - 8 % is typical) Recent development in the EC have begun to result in uniform capital requirements Basel Accords, 1988, 2004, 2010-11: Greater risk level require greater capital (equity), capital adequacy and stress testing (decreasing bank leverage) All Rights Reserved Dr David P Echevarria

INTEREST RATE REGULATIONS Deposit Rate Regulations The Problem of disintermediation; rate caps result in deposit flight After 1980, rates largely deregulated on most accounts (Regulation Q) Loan Rate Regulations Truth-in-Lending regulations Reporting of transactions in mortgage markets All Rights Reserved Dr David P Echevarria

GEOGRAPHIC REGULATIONS Intrastate Regulations Few limits on intra-state banking and branching Acquisitions by out-of-state BHC still a touchy issue, particularly in capital deficit areas Interstate Regulations McFadden Act; prevent concentration of banking power Competition spurs lower rates and more services to borrowers and depositors Some Mutual Funds now performing limited banking-type services via MM funds Large national brokerage houses offer a variety of bank-like services; ML CMA All Rights Reserved Dr David P Echevarria

REGULATION OF NONBANKING ACTIVITIES Bank Provision of Insurance Services Potential for unfair competition for credit insurance Many other ways to bundle services to clients All Rights Reserved Dr David P Echevarria

HOW REGULATORS MONITOR BANKS (CAMEL) Capital Adequacy The greater the capital ratio, the stronger the bank Ability to absorb losses is a function of capital Asset Quality and Average Maturity of the Loan Portfolio How much credit risk exposure 5-Cs of Credit Management Regulatory conformance Internal controls All Rights Reserved Dr David P Echevarria

HOW REGULATORS MONITOR BANKS (CAMEL) Earnings strength and Trends ROA measure Liquidity Vault resources Borrowings (from Fed or Fed Funds) to cover reserve short-falls All Rights Reserved Dr David P Echevarria

REGULATORY ISSUES IN BANKING THE "TOO BIG TO FAIL" ISSUE Argument for Government Rescue Argument against Government Rescue Bear-Stearns? Was the Fed right to come to the "rescue" of BSC? All Rights Reserved Dr David P Echevarria

HOMEWORK QUESTIONS What functions does the Comptroller of the Currency perform? What are primary objectives of Federal Reserve System? What oversight exists for state chartered banks? Why are Bank Holding Companies (BHC) an important? How did regulators deal with the disintermediation issue? What metrics do auditors and regulators use to ensure bank performance? What does it mean when banks engage in off-balance sheet activities? All Rights Reserved Dr David P Echevarria