Money and Capital Markets

1818C h a p t e r

Eighth Edition

Financial Institutions and Instruments in a Global Marketplace

Peter S. Rose

McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

The Regulation Of The Financial Institutions’ SectorThe Regulation Of The Financial Institutions’ Sector

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Learning Objectives

To explore why financial institutions are one of the most regulated industries in the modern world.

To discover the many types of regulation, and to understand how the financial institutions have been affected.

To examine the recent global trend toward deregulation.

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The Reasons Behind Regulations

Concern for the safety of the public’s funds. To promote public confidence in the system. To ensure equal opportunities and fairness in

the public’s access to financial services. To prevent excessive money creation, and

hence excessive inflation. To aid “disadvantaged” economic sectors. To ensure that important financial services are

provided reliably and at a reasonable cost.

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Do Regulations Benefit or HarmFinancial Institutions?

Regulations subsidize the growth of financial institutions and protect them from competition.

Regulations tend to increase public confidence. Regulations spawn innovative escapes (regulatory

dialectics) through loopholes in the regulations.

Regulations can benefit financial institutions.

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Do Regulations Benefit or HarmFinancial Institutions?

Regulatory dialectics are not the most productive form of innovation.

The time and energy spent on regulatory compliance activities are costly.

Regulations can harm financial institutions.

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The Regulation of Commercial Banks

Due to their importance in the financial system, commercial banks are typically the most regulated of all financial institutions.

Responsibility for regulating U.S. banks today is divided among three federal banking agencies – the Federal Reserve System, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation – and the state banking commissions of the 50 states.

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The Federal Reserve System

Supervises and regularly examines all member banks operating in the U.S.

Imposes reserve requirements on deposits held by all depository institutions and grants temporary loans of reserves.

Must approve all applications of member banks to merge, establish branches, or exercise trust powers.

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The Federal Reserve System

Supervises international banking corporations organized by U.S. banks and foreign banks operating in the U.S.

Regulates and examines all bank and financial holding companies in the U.S.

Conducts monetary policy to control the growth of money and credit in the financial system.

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The Comptroller of the Currency

Issues charters for new national banks. Regulates and regularly examines all national

banks. Must approve all national banks’ applications

for new branch offices, trust powers, mergers, and consolidations.

Declares insolvent national banks closed.

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Federal Deposit Insurance Corporation

Insures deposits of savings institutions (thrifts) and banks conforming to its regulations up to $100,000, and acts as receiver for all national banks declared insolvent and for state banks if requested by a state banking commission.

Must approve applications by insured banks to set up branches, merge or exercise trust powers

Requires all insured banks to submit reports on their financial condition.

.

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State Banking Commissions

Issue charters for new state banks. Supervise and regularly examine all state-

chartered banks. Approve applications by state banks to form a

holding company, acquire subsidiaries, or establish branches.

Declare insolvent state-chartered banks closed and appoint a receiver to liquidate or otherwise dispose of the assets of failed state banks.

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Regulations ControllingThe Geographic Expansion of Banks

The new geographic markets that banks can enter have been tightly controlled. National Bank Act (1863-4) Banking Act (1933) Bank Holding Company Act (1956, amended 1970) Bank Merger Act (1960, amended 1966) Financial Institutions Reform, Recovery, and

Enforcement Act (1989) Riegle-Neal Interstate Banking and Branching

Efficiency Act (1994)

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Regulation of the Services Banks Can Offer

Regulations controlling the services banks can offer have also been tight out of concern for bank safety and a desire to protect certain nonbank financial institutions from tough bank competition. Glass-Steagall Act (Banking Act) (1933) Financial Services Modernization (Gramm-Leach-

Bliley) Act (1999)

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The Rise of Disclosure Laws in Banking

One rapidly expanding area of U.S. banking regulation today concerns disclosure rules. Truth in Lending Act (1968) Home Mortgage Disclosure Act (1975) Community Reinvestment Act (1977) Truth in Savings Act (1991) FDIC Improvement Act (1991) Financial Services Modernization (Gramm-Leach-

Bliley) Act (1999)

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The Growing Importance ofCapital Regulation in Banking

Another major trend reshaping the regulation of banks and other financial institutions today centers upon their capital. Basle Agreement (1988) FDIC Improvement Act (1991)

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The Unfinished Agenda for Banking Regulation

Slowly, banking is experiencing an era of deregulation, as legal constraints are lifted on a variety of banking activities.

Supervision of financial institutions in the future will rest primarily upon: government examinations (of market data and the

firms’ risk management systems) capital requirements, and market discipline.

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The Regulation of Nonbank Thrift Institutions

Credit Unions Chartering: National Credit Union Administration

(NCUA) / state New branches: No approval required Mergers & acquisitions: NCUA / state Deposit insurance: NCUA Share Insurance Fund /

state Supervision: NCUA / state Depository Institutions Deregulation and Monetary

Control Act (1980)

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The Regulation of Nonbank Thrift Institutions

Savings and Loan Associations Chartering: Office of Thrift Supervision (OTS) /

state New branches: OTS / FDIC / state Mergers & acquisitions: OTS / FDIC / state Deposit insurance: FDIC / state Supervision: OTS / state Financial Institutions Reform, Recovery and

Enforcement Act (1989) FDIC Improvement Act (1991)

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The Regulation of Nonbank Thrift Institutions

Savings Banks Chartering: Office of Thrift Supervision (OTS) /

state New branches: OTS / state Mergers & acquisitions: OTS / FDIC / state Deposit insurance: FDIC / state Supervision: FDIC / state

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The Regulation of Nonbank Thrift Institutions

Money Market Funds Chartering: Securities and Exchange Commission

(SEC) New branches: No approval required Mergers & acquisitions: No approval required Deposit insurance: no government insurance Supervision: SEC (selected activities)

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The Regulation of Insurance Companies

While not quite as heavily regulated as commercial banks, insurance intermediaries face tough regulatory rules that are imposed primarily by state insurance commissions.

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The Regulation of Pension Funds

Because pension funds have risen rapidly to hold the bulk of the retirement savings of workers, they are heavily regulated by the courts and government agencies today. Employee Retirement Income Security Act (1974) Pension Benefit Guaranty Corporation, or “Penny

Benny” (a federal agency)

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The Regulation of Finance Companies

The bulk of regulation of finance companies is at the state level and focuses principally upon the making of consumer loans.

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The Regulation of Investment Companies

Investment companies or mutual funds are regulated predominantly by the federal government in the U.S. Securities and Exchange Commission Investment Company and Investment Advisers

Acts (1940)

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Trends inThe Regulation of Financial Institutions

Regulation seeks to promote the safety and stability of financial institutions in order to preserve the confidence of the public and avoid institutional failures.

However, regulation can become a costly burden that significantly increases the operating costs of financial institutions and limits the cleansing effects of failure and competition.

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Trends inThe Regulation of Financial Institutions

Increasingly, market discipline is playing a bigger role, regulators are cooperating more (because the

distinctions between the financial institutions are blurring),

the focus of regulation is moving away from control over the services offered and geographic expansion to controlling risk taking, and

there is increasing attention to public disclosure.

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Money and Capital Markets in Cyberspace

The government commissions and agencies that regulate financial institutions have become increasingly visible on the world wide web: http://www.federalreserve.gov http://www.occ.treas.gov/ http://www.fdic.gov/ http://europa.eu.int/index_en.htm http://www.wdfi.org/ http://www.banking.state.ny.us/ http://www.insurance.state.pa.us/ http://www.sec.gov/

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Chapter Review

The Reasons Behind the Regulation of Financial Institutions

Do Regulations Benefit or Harm Financial Institutions?

The Regulation of Commercial Banks The Federal Reserve System The Comptroller of the Currency Federal Deposit Insurance Corporation State Banking Commissions

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Chapter Review

The Regulation of Commercial Banks … continued

Regulations Controlling the Geographic Expansion of Banks

Regulation of the Services Banks Can Offer The Rise of Disclosure Laws in Banking The Growing Importance of Capital Regulation in

Banking The Unfinished Agenda for Banking Regulation

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Chapter Review

The Regulation of Nonbank Thrift Institutions Credit Unions Savings and Loan Associations Savings Banks Money Market Funds

The Regulation of Insurance Companies The Regulation of Pension Funds The Regulation of Finance Companies

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Chapter Review

The Regulation of Investment Companies An Overview of Trends in the Regulation of

Financial Institutions