Chapter 2 Impact of Government Policy and Regulation

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Chapter 2 Impact of Government Policy and
Regulation
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Impact of Government Policy and Regulation

• Key Topics
• Reasons for Regulation
• Major Regulators and Laws
• Riegle-Neal and Gramm-Leach-Bliley Acts
• Key Unresolved Regulatory Issues
• Central Banking System
• Federal Reserve System and Leading Central Banks
  of Europe and Asia
• Impact of Central Bank Policy Tools

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Why are banks regulated?

• Most regulated industry
• protect the public's savings
• control the money supply
• ensure adequate supply of loans and to ensure
  fairness
• maintain confidence in the system
• avoid monopoly powers
• provide support for government activities
• support special sectors of the economy

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Dual Regulatory System

• State closer control over banks operating in
  their states
• Federal ensure banks are treated fairly across
  state lines

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Chief Regulators

• Controller of the Currency
• Federal Reserve System
• Federal Deposit Insurance Corporation
• Department of Justice
• Securities and Exchange Commission
• State banking commissions

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Why do banks fail?

• Banks small capital base
• Financial repression by the government
• Bank runs
• Fraud

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Capital adequacy
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Bank growth and failure
Assets Liabilities Loan 102_at_9 Deposits
90_at_7 Loan loss reserve -2 100 Equity
12 -Loan loss prov. - 2
Totals 100 100
Net income 9.18 - 6.30 2.88 ROA
2.88/100 2.88 E/A 10/100
10 Well-capitalized
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Bank growth and failure
Assets Liabilities Loan 102_at_9 Deposits 11
0_at_7 Loan 10_at_9 Loan 10_at_9 Loan loss
reserve -2 120 Equity 12 -Loan
loss prov. - 2 Totals 120 120
Net income 10.98 - 7.70 3.28 ROA
3.28/120 2.73 E/A 10/120
8.33 Adequately capitalized
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Bank growth and failure
Assets Liabilities Loan 102_at_9 Deposits
110_at_7 Loan 10_at_9 Loan
0 Equity 12 Loan loss reserve
0 -Loan loss prov. - 2 112
-Excess loan loss - 8 Totals 112 1
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Net income 10.08 - 7.70 2.38 ROA
2.38/112 2.13 E/A 12/112
1.79 Critically undercapitalized
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Early significant banking regulation

• National Bank Act of 1864
• National banking system
• Created OCC to charter and regulate
• Circulate currency
• Federal Reserve Act of 1913
• Central payment system
• Monetary policy
• Lender of last resort

Based on Koch and MacDonald 2006
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Bank reforms of the 1930s

• Large scale failures prior to and during the
  Great Depression in the period 1921-1933 caused
  Congress to pass new legislation regulating banks

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Glass-Steagall Act of 1933

• Separated banking from investment banking and
  insurance
• Established the FDIC
• Fed may regulate time deposit rates and prohibit
  interest on demand deposits
• Increased the minimum capital requirements on
  national banks

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Banking reforms of the 1930s

• Restrictions
• Pricing - rates on deposits
• Geography entry and interstate banking
• Services scope and nature of business
  investment banking
• Capital minimum capital requirements and other
  balance sheet restrictions

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Social Graces and Morales-Social Responsibility
Laws

• Truth-in-lending Act
• Equal Credit Opportunity Act
• Community Reinvestment Act

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Late 1970s

• Banking stable since the 1930s regulation
• Banks compete with toasters, silverware, and
  entertaining customers
• Inflation in late 1970s due to oil prices

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Late 1970s

• Regulation Q placed limits on deposit costs
• Geographic restrictions on interstate banking and
  branch banking
• Product restrictions on securities powers
• Junk bond markets open to medium-sized firms
• Credit cards replace checking

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

• Uniform reserve requirements for all depository
  institutions.
• Federal Reserve services available to all
  depository institutions.
• Regulation Q to be phased out
• Deposit insurance limit raised to 100,000 per
  account
• Negotiable order of withdrawal (NOW) accounts
  approved (6 interest rate max)
• SLs to make consumer loans

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Garn-St Germain Depository Institutions Act of
1982

• Money market deposit accounts (MMDAs) to compete
  with money market mutual funds (MMMFs).
• FDIC/FSLIC assistance for troubled or failing
  institutions
• Asset powers of thrifts expanded in consumer and
  commercial lending

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Riegle-Neal Interstate Banking and Branching Act
of 1994

• Interstate banking allowed through acquisitions,
  mergers, or branching across state lines.

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Gramm-Leach-Bliley Act (Financial Services
Modernization Act of 1999

• Ended prohibitions on investment banking and
  insurance underwriting.
• Banks, brokerage firms, and insurance companies
  can merge.
• Financial holding companies allowed to engage in
  a wide variety of financial services (i.e.,
  financial supermarkets).

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21st Century Regulations

• USA Patriot and Bank Secrecy Acts
• Sarbanes-Oxley Accounting Standards Act SOX

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21st Century Regulations

• Fair and Accurate Credit Transactions (FACT)
• Check 21
• Bankruptcy Prevention and Consumer Protection Act
  of 2005
• Federal Deposit Insurance Reform Act of 2005

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New Regulatory Strategies

• Refocused to risk and capital, away from services
  and geography.
• Public disclosure

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Unresolved Regulatory Issues

• Moral hazard problem of deposit insurance
• Deregulation increases chances of bank failure
• Conglomerates raiding bank funds for other
  businesses
• Quality of regulators in complex world

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Unresolved Regulatory Issues

• Overlapping of regulation in firms with multiple
  types of financial services
• Mixing banking with traditional businesses
• International regulation issues

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Central Banking System

• Monetary policy
• Open market operations
• Reserve requirements
• Interest rates (discount rate)
• Currency values

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Questions?