1. Copyright © 2010 Pearson Education. All rights reserved. Chapter 11 Economic Analysis of Financial Regulation

2. Copyright © 2010 Pearson Education. All rights reserved. 11-2 Bank Panic and need for Deposit Insurance 金融市場 free-rider 問題 → bank private loans 存款人因 free rider 問題而不願監督銀行 Bank panics – 來自於經濟蕭條，會導致某些銀行淨值為負，因為排序支 付問題 (sequential service constraint) ，進而發生擠 兌與傳染效果 –19 世紀末至 20 世紀初， 差不多每 20 年一次金融風暴。 。

3. Copyright © 2010 Pearson Education. All rights reserved. 11-3 Asymmetric Information and Bank Regulation: Government Safety Net Bank panics and the need for deposit insurance: –FDIC( 聯邦存款保險公司 ): short circuits( 短期融通 ) bank failures and contagion effect. –Payoff method.( 支付法 ) –Purchase and assumption method ( 承購法 ) (typically more costly for the FDIC). –FDIC 創建之前平均每年有 2000 家銀行倒閉，之後倒閉 家數減少 15% 。 Other form of government safety net: –Lending from the central bank to troubled institutions (like 2008 subprime crisis)(lender of last resort( 最後貸款者 ).

4. Copyright © 2010 Pearson Education. All rights reserved. 11-4 Government Safety Net Moral Hazard –increased incentive to taking risks –Depositors do not impose discipline of marketplace (by withdrawing funds). –Financial institutions have an incentive to take on greater risk. –Bet: “Heads I win, Tails the taxpayer loses” Adverse Selection –Risk-lovers find banking attractive. –Depositors have little reason to monitor financial institutions.

5. Copyright © 2010 Pearson Education. All rights reserved. 11-5 Government Safety Net:Too Big to Fail Government provides guarantees of repayment to large uninsured creditors of the largest financial institutions even when they are not entitled( 不具資格 ) to this guarantee Uses the purchase and assumption method Increases moral hazard incentives for big banks

6. Copyright © 2010 Pearson Education. All rights reserved. 11-6 Government Safety Net: Financial Consolidation Larger and more complex financial organizations challenge regulation –Increased “too big to fail” problem –Extends safety net to new activities(underwriting, insurance, or real estate), increasing incentives for risk taking in these areas (as has occurred during the subprime financial crisis in 2007- 2008).

7. Copyright © 2010 Pearson Education. All rights reserved. 11-7 Restrictions on Asset Holdings Attempts to restrict financial institutions from too much risk taking –Bank regulations Promote diversification Prohibit holdings of common stock So onerous and impaired ( 繁複並有損效率 ) –Capital requirements Minimum leverage ratio (for banks)( 最低資本比率 ) Basel Accord: risk-based capital requirements (Basel I And Basel II) Regulatory arbitrage –Prompt corrective action( 迅速糾正措施 )(pg. 262- 263)

8. Copyright © 2010 Pearson Education. All rights reserved. 11-8 Financial Supervision: Chartering and Examination Chartering( 執照特許 ) (screening of proposals to open new financial institutions) to prevent adverse selection Examinations( 金融檢查 ) (scheduled and unscheduled) to monitor capital requirements and restrictions on asset holding to prevent moral hazard –Capital adequacy –Asset quality –Management –Earnings –Liquidity –Sensitivity to market risk Filing periodic ‘call reports’

9. Copyright © 2010 Pearson Education. All rights reserved. 11-9 Assessment of Risk Management Greater emphasis on evaluating soundness of management processes for controlling risk( 控管風險 的管理程序是否完好 ) Trading Activities Manual of 1994 for risk management rating based on –Quality of oversight provided –Adequacy of policies and limits for all risky activities –Quality of the risk measurement and monitoring systems –Adequacy of internal controls Interest-rate risk limits –Internal policies and procedures –Internal management and monitoring –Implementation of stress testing and Value-at risk (VAR)

10. Copyright © 2010 Pearson Education. All rights reserved. 11-10 Disclosure( 揭露 ) Requirements Requirements to adhere to standard accounting principles and to disclose wide range of information The Basel 2 accord and the SEC( 證管會 ) put a particular emphasis on disclosure requirements The Sarbanes-Oxley Act of 2002 established the Public Company Accounting Oversight Board Mark-to-market (fair-value) accounting

11. Copyright © 2010 Pearson Education. All rights reserved. 11-11 Consumer Protection Consumer Protection Act of 1969 (Truth-in- lending Act). Fair Credit Billing Act of 1974.( 公平的信用費 率法案 ) Equal Credit Opportunity Act of 1974, extended in 1976.( 反歧視 ) Community Reinvestment Act.( 放款所有區域 ) The subprime mortgage crisis illustrated the need for greater consumer protection.

12. Copyright © 2010 Pearson Education. All rights reserved. 11-12 Restrictions on Competition Justified as increased competition can also increase moral hazard incentives to take on more risk. –Branching restrictions (eliminated in 1994) –Glass-Steagall Act (repeated in 1999) Disadvantages –Higher consumer charges –Decreased efficiency

13. Copyright © 2010 Pearson Education. All rights reserved. 11-13 Table 1 Major Financial Legislation in the United States

14. Copyright © 2010 Pearson Education. All rights reserved. 11-14 Table 1 Major Financial Legislation in the United States (cont.)

15. Copyright © 2010 Pearson Education. All rights reserved. 11-15 FIGURE 1 Bank Failures in the United States, 1934–2008 Source: www.fdic.gov/bank/historical/bank/index.html.

16. Copyright © 2010 Pearson Education. All rights reserved. 11-16 The 1980s S&L and Banking Crisis Financial innovation( 金融創新 ) and new financial instruments increased risk taking Increased deposit insurance led to increased moral hazard Deregulation( 自由化 ) –Depository Institutions Deregulation and Monetary Control Act of 1980 –Depository Institutions Act of 1982

17. Copyright © 2010 Pearson Education. All rights reserved. 11-17 The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 Financial Institutions Reform, Regulatory and Enforcement Act of 1989 Federal Deposit Insurance Corporation and Improvement Act of 1991 –Cost of the bailout( 紓困 ) approximately $150 billion, or 3% of GDP.

18. Copyright © 2010 Pearson Education. All rights reserved. 11-18 Banking Crises Throughout the World “Déjà vu( 似曾相似 ) all over again” –Deposit insurance is not to blame for some of these banking crises –The common feature of these crises is the existence of a government safety net, where the government stands ready to bail out troubled financial institutions.

19. Copyright © 2010 Pearson Education. All rights reserved. 11-19 Table 2 The Cost of Rescuing Banks in Several Countries

20. Copyright © 2010 Pearson Education. All rights reserved. 11-20 Whither( 何去何從 ) Financial Regulation After the Subprime Financial Crisis? Regulation should focus on limiting the agency problems( 代理人問題 ) created by the “originate-to-distribute( 發行到分配 )” business model Increased regulation of mortgage brokers( 房 仲介商增加限制 ) –Tighten licensing requirements –Require to disclose information

21. Copyright © 2010 Pearson Education. All rights reserved. 11-21 Whither Financial Regulation After the Subprime Financial Crisis? (cont’d) Fewer subprime mortgage products. Regulation of compensation Higher capital requirements

22. Copyright © 2010 Pearson Education. All rights reserved. 11-22 Whither Financial Regulation After the Subprime Financial Crisis? (cont’d) Additional regulation of privately owned government sponsored enterprises –Fully privatize( 完全私有化 ) them –Completely nationalize( 完全公有 ) them –Leave them as privately owned government sponsored( 私人擁有政府贊助 ) enterprises and Strengthen regulation Reduce their size

23. Copyright © 2010 Pearson Education. All rights reserved. 11-23 Whither Financial Regulation After the Subprime Financial Crisis? (cont’d) Heightened regulation to limit financial institutions’ risk taking Increased regulation of credit-rating agencies( 信用評等機構 ) –Restrict conflicts of interest( 利益衝突限制 ) Additional regulation of derivatives( 衍生性商 品的規範 ) The danger of overregulation. ( 過度規範的危 險 )

24. Copyright © 2010 Pearson Education. All rights reserved. 11-24 FIGURE 2 Banking Crises Throughout the World Since 1970 Source: Gerard Caprio and Daniela Klingebiel, “Episodes of Systemic and Borderline Financial Crises” mimeo., World Bank, October 1999.