Banking Regulation by 7uXYvB

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									Banking Regulation

Chapter 10 cont., Chapter 11




      Maclachlan, Money & Banking   1
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Review: Asymmetric Information
Before transaction …
        ADVERSE SELECTION

After transaction ….
       MORAL HAZARD



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         Types of Banking Regulation

1.   Government safety net (FDIC).
2.   Restrictions on bank’s assets.
3.   Capital requirements.
4.   Bank supervision.
5.   Assessment of risk management.
6.   Disclosure requirements.
7.   Consumer protection.
8.   Restrictions on competition.




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    1. Government Safety Net
Emergency legislation March 1933.
Bank failures 1930-33: 2000/year
              1934-1981: 15/year
When bank fails, two things can happen …
PAY OFF or PURCHASE & ASSUMPTION
“Too Big to Fail” (relate to consolidation)

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                       Spring 2005
    FDIC Improvement Act (1991)
•   Limited brokered deposits.
•   Renounced too-big-to-fail.
•   Supervision of foreign banks in U.S.
•   Risk based premiums




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      2. Restrictions on Assets
No securities related activities except …
Treasurys, municipals, government agency
  securities
Foreign exchange
Derivatives
Commercial paper underwriting

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      3. Capital Requirements
Leverage ratio = capital/assets > 5%
Basel Accord: capital = 8% of risk adjusted
  assets (assets are weighted by risk factor)
Regulatory arbitrage




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         4. Bank Supervision
Three layers of supervision for nationally
  chartered bank:
1863 Comptroller of Currency
1913 Federal Reserve
1933 FDIC



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CAMELS
               Capital adequacy
               Asset quality
               Management
               Earnings
               Liquidity
               Sensitivity to market risk



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       5. Assessment of Risk
           Management
Looking at quality of assets is not enough.
Diversification and hedging reduce risk.
Examiners look at oversight, policies, risk
 measurement and monitoring, internal
 controls.



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    6. Disclosure Requirements
Allows large depositors and investors to
 accurately assess risk.




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      7. Consumer Protection
Consumer Protection Act of 1969
“Truth in Lending”: Disclosure of APR and
  total finance charges.
Equal Credit Opportunity Act 1974
Community Reinvestment Act 1977 (prevents
  redlining)


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  8. Restrictions on Competition
McFadden Act 1927-1994
Glass Steagall 1933-1999




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       Case Study: S&L Crisis
Background:
Oil crisis in 1970’s
Inflation
High interest rates
Problems for depository
  institutions



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                         Spring 2005
    What was the problem …?
• Spread based banking: lending long,
  borrowing short.
• Regulation Q (price ceiling on interest on
  deposits).
• Disintermediation (savings going into direct
  finance process)


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                        Spring 2005
          S&L’s hit hard …
S&L’s were given incentives to finance home
 ownership.
Well diversified against CREDIT risk but not
 INTEREST RATE risk.
Why not?



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                       Spring 2005
             Capital shortage …
FSLIC (Federal Savings and Loan Insurance
  Corporation) should have shut down
  insolvent S&L’s and paid off depositors.

It didn’t.

Why not?
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                         Spring 2005
      Regulatory Forbearance
Looking the other way.
Loosening regulations.
Hoping S&L’s would turn themselves around.

Huge MORAL HAZARD problem.
Long bomb strategy.

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                      Spring 2005
             Zombie S&L’s
Dead (insolvent)
Living (still in operation)
Killing the healthy (offering high rates to lure
  depositors away)




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                         Spring 2005
          Corrupt practices …
•   Buy insolvent S&L for next to nothing.
•   Lure depositors with incentives.
•   Lend money to cronies.
•   Example: Castle Grande trailer park in
    Arkansas (see blog for more)



                 Maclachlan, Money & Banking   20
                         Spring 2005
Financial Institutions Reform, Recovery,
     and Enforcement Act (1989)
• FSLIC closed down.
• Resolution Trust Corporation to close down
  S&L’s and pay off depositors.
• Total cost to taxpayer: $150 billion.




               Maclachlan, Money & Banking   21
                       Spring 2005
      Innovation & Regulation
How is bank regulation related to the
  following innovations?
Commercial paper
Adjustable rate mortgages
Securitization
MMMF’s
Sweep accounts
                Maclachlan, Money & Banking   22
                        Spring 2005

								
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