1. Chapter 14 - Bank Regulations
Money and Banking – Michael Brandl ©2017 Cengage Learning

2. 14-1a Banks are Special
Banks exists primarily to solve the asymmetric information problem
Banks face the adverse selection problem: low quality borrowers want to borrow money
Money and Banking – Michael Brandl ©2017 Cengage Learning

3. 14-1b Bank Regulation In the U.S.
Private and proprietary information: banks have a lot of it
Application must be sent to the government for permission
Obtain a bank charter: A legal document that stipulates how a bank will be organized and regulated.
Issued by either state banking agency or by the Office of the Comptroller of currency, a brank of the Treasury
Money and Banking – Michael Brandl ©2017 Cengage Learning

4. 14-1b Bank Regulations In the U.S. (continue)
Dual banking system
A banking system where bank charters are granted by the national government as well as state or provincial governments
The asymmetric information problem also exists for bank depositors.
Depositors and other outsiders do not know how well a bank is run
Money and Banking – Michael Brandl ©2017 Cengage Learning

5. 14-1b Bank Regulations In the U.S.: Bank Products
Commercial bank involvement in the underwriting of stocks and bonds caused many bank failures.
Glass-Stegall Act of 1933 separated commercial banking, investment banking and the insurance industry.
Banks were forbidden from underwriting all stocks and bonds and banned from selling insurance.
April 1987 – Fed allows bank holding companies called Section 20 affiliates
Money and Banking – Michael Brandl ©2017 Cengage Learning

6. 14-1b Bank Regulations In the U.S.: Bank Products – (cont’d)
Banks could underwrite a wide variety of commercial paper, mortgage- backed securities, and municipal bonds.
1987 – Feds allow commercial banks takeover of existing investment banks
Financial Services Modernization Act, sometimes called the Gramm-Leach- Bliley Act – allowed bank holding companies to morph into “financial services holding companies”
Holding companies could be made up of commercial banks and investment banks.
The bill allowed commercial banks to underwrite securities
Money and Banking – Michael Brandl ©2017 Cengage Learning

7. 14-1b Bank Regulations In the U.S.: Geography
The McFadden Act of 1927: Forced federally chartered banks to obey state laws when it came to branching. Make it impossible for banks to cross state lines.
Geographical diversification – allows banks to make loans in other states
Banks asset diversification can be limited.
Restrictive geographical limitations – needed to be avoided by creating bank holding companies.
Money and Banking – Michael Brandl ©2017 Cengage Learning

8. Banks: the selection problem
Better flow of information
Better information collection
Government-required disclosure
Bank screening of potential borrowers
Money and Banking – Michael Brandl ©2017 Cengage Learning

9. Government-sponsored deposit insurance
1933- the FDIC has offered deposit insurance to banks.
It regularly examines banks for safety and soundness.
FDIC level was increased from $100K to $250K, Emergency Economic Stabilization act of 2008
FDIC insurance applies only to deposits in U.S. banks in the U.S.
Deposits in foreign branches of U.S. banks are not covered by FDIC insurance.
Money and Banking – Michael Brandl ©2017 Cengage Learning

10. 14-2a Balance Sheet Regulations
US banks have been limited in the amount of loans they can make to any one person or entity.
15% of the banks combined capital and reserves on an unsecured loan.
Secured loan “readily marketable collateral” limit is 25%
Limits ensure banks have a well-diversified loan portfolio also seen as a way to limit corruption in lending.
Money and Banking – Michael Brandl ©2017 Cengage Learning

11. 14-2b Liabilities: Regulation Q
Regulation Q – prohibited banks from paying interest on demand deposits.
Also imposed interest rate ceilings on various bank deposits.
Q was designed to limit the amount of competition between banks.
Banks “got around” regulation Q by creating new financial products, not technically demand deposits
Money and Banking – Michael Brandl ©2017 Cengage Learning

12. 14-2c Bank Capital
Banks must have enough bank capital to write down nonperforming assets.
Insolvent: Banks that do not have enough bank capital.
Accounting equation in banking:
Assets = Liabilities + Banking capital
Money and Banking – Michael Brandl ©2017 Cengage Learning

13. 14-2c Bank Capital: Bank Management Incentives and Bank Capital
Executives’ compensation is most often tied to stock prices.
The higher the stock price, the more executives get paid.
Dividends are tied to stock prices. As dividends increase, so do stock prices.
Basel Accords
Basel I
Basel II
Basel III
Money and Banking – Michael Brandl ©2017 Cengage Learning

14. 14-3 Bank Regulation: How It’s Done
Bank examiners – call reports and conduct on-site examinations.
Unannounced on-site examinations of a bank.
Take possession of the bank’s cash and marketable securities.
If a bank is in violation of any rules or regulations, examiners can issue a cease and desist order.
Money and Banking – Michael Brandl ©2017 Cengage Learning

15. 14-3a CAMELS Ratings
Capital, Assets, Management, Earnings, Liquidity, and Sensitivity
Scale 1-5, 1 being best/highest
Looking for:
Capital adequacy
Asset quality
Management
Earnings
Liquidity
Sensitivity to market conditions

16. 14-3b Dealing with a Failed Institution
Payoff and liquidate: Policy used by regulators to deal with failed or failing institutions.
Purchase and Assume: FDIC finds a healthy bank to purchase the failed institution and assume all of the failed bank’s liabilities.
FDIC cost of Purchase and Assume can be substantial, they are less, than the pay off and liquidation policies.
TBTF
Money and Banking – Michael Brandl ©2017 Cengage Learning

17. 14-4 Consumer Protection and Failures
14-4a Truth in Lending Act of 1968
14-4b The community Reinvestment Act of 1977
Redlining
14-4c Fair Credit Reporting Act of 1970
14-4d Dodd-Frank Wall Street Reform and consumer Protection Act of 2010

18. 14-4d Dodd Frank Wall Street Reform and Consumer Protection Act of 2010
Increases amount of consumer protection in financial markets
Bureau of Consumer Financial Protection (BCFP)
Limits unfair or abusive lending practices, enforces federal consumer protection laws, outlaws discrimination and other unfair treatment in consumer finance
Money and Banking – Michael Brandl ©2017 Cengage Learning

19. 14-4e Why Has the US Bank Regulatory System Failed?
Disagreement about in why our regulatory system failed to prevent the global financial crisis
Regulator shopping
Intellectual Capture
Money and Banking – Michael Brandl ©2017 Cengage Learning