1. Unit 2: Banking
Bank Regulation
3/22/2011

2. Financial Institutions
Type of Intermediary
Primary Liabilities
Primary Assets
Depository Institutions (banks)
Commercial Banks
Deposits
Business and consumer loans, mortgages, US Govt securities and municipal bonds
Savings and Loans Institutions
Mortgages
Mutual Savings Banks
Credit Unions
Consumer Loans

3. Financial Institutions
Type of Intermediary
Primary Liabilities
Primary Assets
Contractual Savings Institutions
Life Insurance Companies
Premium from Policies
Corporate bonds and mortgages
Fire and Casualty Insurance Companies
Municipal bonds, corporate bonds and stocks, US Govt securities
Pension Funds, Government Retirement Funds
Employee and Employer Contributions
Corporate bonds and stock
Investment Intermediaries
Finance Companies
Commercial paper, stock, bonds
Consumer and business loans
Mutual Funds
Shares
Stocks and bonds
Money Market Mutual Funds
Money market instruments

4. Financial Institutions Value of Assets (Billions of $)
Type of Intermediary
1970
1980
1990
2007
2010Q1
Depository Institutions (banks)
Commercial Banks
517
1481
3334
14438
Savings and Loans Institutions and Mutual Savings Banks
250
792
1365
1815.0
1262.3
Credit Unions 18 67
215
758.7
892.4

5. Financial Institutions Value of Assets (Billions of $)
Type of Intermediary
1970
1980
1990
2007
2010Q1
Contractual Savings Institutions
Life Insurance Companies
201
464
1367
4952.5
4919.0
Fire and Casualty Insurance Companies 50
182
533
1381.0
1386.1
Pension Funds (Private)
112
504
1629
6410.6
5726.7
State and local Government Retirement Funds 60
197
737
3198.8
2793.9
Investment Intermediaries
Finance Companies 64
205
610
1911.2
1665.8
Mutual Funds 47 70
654
7829.0
7311.9
Money Market Mutual Funds 76
498
3033.1
2930.7

6. Financial Institutions
Pre-1970
commercial banks
monopoly on checking accounts
more diversified
thrifts
could pay higher interest rates
mostly mortgages
investment banks
could invest in equity securities

7. Financial Institutions
thrift institutions (thrifts) –
savings and loan associations (S&Ls), mutual savings banks, and credit unions
credit unions –
cooperative lending institutions organized around a particular group
(e.g., union members, employees, etc.)

8. Financial Institutions
S&Ls and Savings Banks
assets: focused on mortgages
liabilities: focused on savings accounts
mutually owned (not shareholder owned)
eliminates debt/equity distinction
decreases moral hazard
regulated separately from other banks

9. Financial Institutions
Credit Unions
type of mutual
1 vote regardless of # of shares
volunteer management
usually small
qualify as non-profits
exempt from corporate income tax
regulated separately from other banks

10. Financial Institutions
The lines between thrifts and commercial banks have become blurred as regulations have changed opening up thrifts to more assets and liabilities, deposit insurance has been extended to thrifts, and S&Ls became stockholder owned rather than mutual owned post-WWII.

11. Financial Institutions
closed end investment company –
stock owned: issues fixed # of shares and has a secondary market
(e.g., stock on exchange)
open end investment company –
mutually owned: variable # of shares, not saleable on secondary market, direct link between share/asset value
(e.g., mutual fund, hedge fund)

12. Regulatory Agencies Regulatory Agency Subject of Regulation
Nature of Regulation
Office of the Comptroller of the Currency
Federally charted commercial banks
Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold
National Credit Union Administration (NCUA)
Federally chartered credit unions
Charters and examines the books of federally chartered credit unions and imposes restrictions on assets they can hold
State banking and Insurance Commissions
State chartered depository institutions
Charters and examines the books of state chartered banks and insurance companies; imposes restrictions on assets they can hold and imposes restrictions on branching

13. Regulatory Agencies Regulatory Agency Subject of Regulation
Nature of Regulation
Securities and Exchange Commission (SEC)
Organized Exchanges and Financial Markets
Requires disclosure of information; restricts insider trading
Commodities Futures Trading Commission (CFTC)
Futures Markets Exchanges
Regulates procedures for trading in futures markets
Federal Deposit Insurance Corporation (FDIC)
Commercial banks, mutual savings banks, savings and loans associations
Provides insurance for each depositor. Currently it is set to $ per depositor, until 12/31/2013, whereas it will revert back to the pre-crisis level of $ per depositor; examines the books of insured banks and imposes restrictions on assets they can hold
Office of Thrift Supervision
Savings and Loans Associations
Examines the books of savings and loans associations and imposes restrictions on assets they can hold
Federal Reserve System
All depository institutions
Examines the books of commercial banks that are members of the system; sets reserve requirements for all banks

14. Regulatory Agencies Office of Thrift Supervision (OTS)
analogous to Comptroller of the Currency
national charters and regulations for thrifts
created in 1989
renamed Federal Home Loan Bank Board
abolished in 2010
rolled into Comptroller of the Currency

15. Regulatory Agencies Federal Savings & Loan Insurance Corporation
(FSLIC)
analogous to FDIC
federal deposit insurer to S&Ls
created in 1934
abolished in 1989
insolvent due to S&L crisis
S&L deposit insurance went to FDIC

16. Regulatory Agencies Federal Home Loan Bank System (FHLBS)
analogous to Federal Reserve
lender of last resort to S&Ls
12 regions
dual chartering (national/state)
national S&Ls (OTS) must join FHLBS
state S&Ls may join FHLBS
80% of S&Ls joined FHLBS
created in 1932
Federal Home Loan Bank Act

17. Regulatory Agencies Pre-1989 division: S&Ls FHLB Board (charter)
FHLBS (LOLR)
FSLIC (insurance)
banks
Comptroller of Currency (charter)
Federal Reserve (LOLR)
FDIC (insurance)

18. Regulatory Agencies
Thrifts have been all but eliminated by the Financial Stability Act of Thrift charters still exist, but thrifts are now regulated by the Comptroller of the Currency, the Federal Reserve, and the FDIC.

19. Narrative History (branching)
Restrictions on branch banking have been present since Some states allowed intrastate branching, so banks switched from national to state charters in those states. The McFadden Act put national banks on equal footing allowing intrastate branching where state banks could. In 1994 both intrastate and interstate branching was allowed.

20. Financial Legislation (branching)
McFadden Act of 1927
prohibited interstate branch banking
put national and state banks on equal footing
if state banks branch, national can too
Riegle-Neal Interstate Branking and Branching Efficiency Act of 1994
allowed interstate branch banking
allowed intrastate branch banking

21. Narrative History (the Fed)
The Federal Reserve was created so the United States would have a central bank that could conduct monetary policy and act as a LOLR. Bank holding companies were unregulated, so the Bank Holding Company Act gave oversight to the Federal Reserve in 1956.

22. Financial Legislation (the Fed)
Federal Reserve Act of 1913
created the Federal Reserve
Bank Holding Company Act of 1956
clarified status of bank holding companies
Federal Reserve regulates bank holding companies

23. Narrative History (wall)
The Glass-Steagall Act was a response to the stock market crash of It imposed a wall between commercial banks and investment banks: commercial banks could not invest in equity securities (stocks). The Gramm-Leach-Bliley Act of repealed this restriction, but it was re-imposed by the Financial Stability Act of 2010.

24. Financial Legislation (wall)
Banking Act of 1933 (Glass-Steagall Act) and 1935
created the FDIC
separated banking and securities industries
prohibited interest on checkable deposits
checkable deposits for commercial banks only
regulation Q: interest-rate ceilings on deposits
Gramm-Leach-Bliley Financial Services Modernization Act of 1999
removed separation of banking and securities

25. Narrative History (regulation Q)
Regulation Q was imposed by the Glass-Steagall Act of In the 1970s banks were hurt by interest rate caps and disintermediation, so they called for deregulation. Mutual savings banks created Negotiable Orders of Withdraw (NOW accounts) in 1972, which behaved like checking accounts. Banks complained. The DIDMCA of 1980 repealed regulation Q.

26. Financial Legislation (regulation Q)
Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980
gave thrifts wider latitude in activities (deposits)
approved NOW and sweep accounts
phased out interest-rate ceilings on deposits
imposed uniform reserve requirements
eliminated usury ceilings on loans
increased deposit insurance to $100,000

27. Financial Legislation (misc)
Depository Institutions Act of 1982 (Garn-St. Germain Act)
emergency powers for FDIC and FSLIC
depository institutions can offer MMDAs
granted thrifts wider latitude in lending (assets)
Competitive Equality in Banking Act (CEBA) of 1987
provided $10.8 billion to the FSLIC
regulatory forbearance in depressed areas

28. Narrative History (S&Ls)
Savings & Loans were deregulated with other thrifts in the early 80’s. Deposit insurance created a moral hazard problem (fixed premiums irrespective of risk) leading to risky investments. S&Ls had higher interest rate risk and a lower equity cushion. When insolvent they would gamble even more to get even again (zombie S&Ls).

29. Narrative History (S&Ls)
In the late 1980’s many S&Ls failed. The Federal Savings and Loan Insurance Corporation (FSLIC) did not have enough money to pay out deposit insurance claims. When it went bankrupt the federal government passed FIRREA: bailed out S&Ls, re-imposed restrictions on S&L activities, and put S&Ls under the FDIC for future deposit insurance.

30. Financial Legislation (S&Ls)
Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989
funds to resolve S&L failures
eliminated FSLIC and FHLB Board
created Office of Thrift Supervision
created Resolution Trust Corporation
raised deposit insurance premiums
re-imposed restrictions on S&L activities

31. Narrative History (FDIC)
The FDIC created moral hazard in part because its premiums were unrelated to the riskiness of assets. This was partly fixed by imposing risk-based premiums. In addition banks were monitored closer to identify solvency problems earlier. Congress stopped the “too big to fail” policy, but it left a loophole in the Federal Reserve legislation that Bernake exploited.

32. Financial Legislation (FDIC)
Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991
recapitalized the FDIC
limited “too big to fail” policy
established risk-based premiums for FDIC
increased examinations, capital & reporting reqs.
Federal Reserve supervision of foreign banks

33. Financial Legislation (FDIC)
Federal Deposit Insurance Corporation Reform Act of 2005
merged Bank Insurance Fund & Savings Ass. Fund
increased deposit insurance on IRAs to $250k
revised risk-based premiums for FDIC

34. Narrative History (stocks)
The SEC was created in 1934 to regulate stock trades. The stock crash of 1929 precipitated this legislation. Accounting shenanigans by the Enron Corporation in 2001 led to the Sarbanes-Oxley Act of 2002, which imposed accounting regulations on publicly traded companies.

35. Financial Legislation (stocks)
Securities Act of 1933 / Securities Exchange Act of 1934
required financial reports for investors
prohibited securities misrepresentations and fraud
created Securities and Exchange Commission (SEC)
Sarbanes-Oxley Act of 2002
Public Company Accounting Oversight Board (PCAOB)
prohibits certain conflicts of interest
requires CEO/CFO certification of financial statements

36. Financial Legislation (brokers)
Investment Company Act of 1940
regulated investment companies
Investment Advisers Act of 1940
regulated investment advisers

37. Narrative History (2010)
In response to the Great Recession (the sub-prime crisis) Congress enacted a comprehensive financial reform bill in July of It undoes a lot of past deregulation and imposes many new regulations. The unintended consequences of this legislation are not yet clear.

38. Financial Legislation (2010)
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
consolidates regulatory agencies
eliminates thrift charter
creates Financial Stability Oversight Council
creates Bureau of Consumer Financial Protection
Volcker rule
regulates derivatives
regulates hedge funds

39. Financial Legislation (2010)
Volcker Rule
prohibits banks from proprietary trading
trading own money instead of client money
prohibits banks from investing in hedge funds
limits liabilities banks can hold

40. Financial Stability Oversight Council
Secretary of the Treasury (chair)
Chair of the Federal Reserve
Comptroller of the Currency
Director of the Bureau of Consumer Financial Protection
Chair of the SEC
Chair of the FDIC
Chair of the CFTC
Director of the Federal Housing Finance Agency
Chair of the National Credit Union Administration Board
independent member (with insurance expertise)