Banking Regulation

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Banking Regulation

• Chap. 11

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Review Asymmetric Information

• Before transaction
• ADVERSE SELECTION
• After transaction .
• MORAL HAZARD

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Types of Banking Regulation

• Government safety net (FDIC).
• Restrictions on banks assets.
• Capital requirements.
• Bank supervision.
• 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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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 gt 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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Financial Institutions Reform, Recovery, and
Enforcement Act (1989)

• FSLIC closed down.
• Resolution Trust Corporation to close down SLs
  and pay off depositors.
• Total cost to taxpayer 150 billion.

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Innovation Regulation

• How is bank regulation related to the following
  innovations?
• Commercial paper
• Adjustable rate mortgages
• Securitization
• MMMFs
• Sweep accounts