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Information about banking

Published on April 14, 2008

Author: Lucianna


Slide1:  The Banking Industry Origins of Today’s Banking Industry:  Origins of Today’s Banking Industry The National Banking Act of 1863 created the banking system of federal and state banks. Federally chartered banks were originally allowed to issue bank notes as currency. State banks came up with the demand deposit as a substitute for bank notes. The Federal Reserve System was created in 1914 in response to waves of bank failures. Regulation and Supervision of U.S. Depository Institutions*:  Regulation and Supervision of U.S. Depository Institutions* Why the Banking Industry Is Regulated:  Why the Banking Industry Is Regulated The government has focused on information problems and liquidity risk. Bank run: many depositors withdraw their deposits and the bank’s funds are exhausted. Contagion: spreading of bad news about one bank to include other banks. Bankers’ private information limits depositors’ ability to sort out weak banks. Bank Runs and Bank Failures:  Bank Runs and Bank Failures Government Intervention in the Banking Industry:  Government Intervention in the Banking Industry Federal Reserve was created to serve as a lender of last resort and issue currency. In the 1930s, the federal government started to guarantee certain types of bank deposits. Since 1863 limits on banks’ ability to open branches have been imposed. Federal Deposit Insurance Corporation:  Federal Deposit Insurance Corporation Numerous bank failures led to the creation of the Federal Deposit Insurance Corporation. When a bank fails, the FDIC either pays off depositors or assumes control of the bank. The Bank Insurance Fund has the implicit guarantee of the U.S. Treasury and the Fed. Moral hazard problems caused by bank insurance increased the need for monitoring. Restrictions on Bank Industry Competition:  Restrictions on Bank Industry Competition Banks were restricted on geographic branching and permissible activities. Banks avoided branching restrictions with nonbank offices, nonbank banks, and ATMs. Branching restrictions have now eased. The Glass-Steagall Act prohibited banks from investment bank activities. Glass-Steagall restrictions have weakened. Branching:  Branching McFadden Act and state branching regulations prohibited branching across state lines and forced all national banks to conform to the branching regulations of the state in which they were located Bank holding companies and automated teller machines are responses to these regulations The Glass-Steagall Wall:  The Glass-Steagall Wall Slide11:  Breaking Down the Glass-Steagall Wall The Banking Industry in Japan:  The Banking Industry in Japan Until recently, firms turned to banks for financing because of regulations. Many large firms are affiliated with industrial groups called keiretsu. Due to deregulation, Japanese banks have lost many of their large-firm customers. The Banking Industry in Germany:  The Banking Industry in Germany Germany is one of only a few countries that allow universal banking. Close alliance between banking and industry may have helped growth. German banking may have higher costs due to limited competition. Economic Analysis of Banking Regulation:  Economic Analysis of Banking Regulation Asymmetric Information and Bank Regulation:  Asymmetric Information and Bank Regulation Government safety net: Deposit insurance and the FDIC Short circuits bank failures and contagion effect Payoff method Purchase and assumption method Moral Hazard Depositors do not impose discipline of marketplace Banks have an incentive to take on greater risk Adverse Selection Risk-lovers find banking attractive Depositors have little reason to monitor bank Too Big to Fail:  Too Big to Fail Government provides guarantees of repayment to large uninsured creditors of the largest banks even when they are not entitled to this guarantee Uses the purchase and assumption method Increases moral hazard incentives for big banks Financial Consolidation:  Financial Consolidation Larger and more complex banking organizations challenge regulation Increased “too big to fail” problem Extends safety net to new activities, increasing incentives for risk taking in these areas Restrictions on Asset Holding and Bank Capital Requirements:  Restrictions on Asset Holding and Bank Capital Requirements Attempts to restrict banks from too much risk taking Promote diversification Prohibit holdings of common stock Set capital requirements Minimum leverage ratio Basel Accord: risk-based capital requirements Regulatory arbitrage Bank (Prudential) Supervision: Chartering and Examination:  Bank (Prudential) Supervision: Chartering and Examination Chartering (screening of proposals to open new banks) to prevent adverse selection Examinations (scheduled and unscheduled) to monitor capital requirements and restrictions on asset holding to prevent moral hazard Capital adequacy Asset quality Management Earnings Liquidity Sensitivity to market risk Filing periodic ‘call reports’ Assessment of Risk Management:  Assessment of Risk Management Greater emphasis on evaluating soundness of management processes for controlling risk Trading Activities Manual of 1994 for risk management rating based on Quality of oversight provided Adequacy of policies and limits Quality of the risk measurement and monitoring systems Adequacy of internal controls Interest-rate risk limits Internal policies and procedures Internal management and monitoring Implementation of stress testing and Value-at risk (VAR) Consumer Protection:  Consumer Protection Truth-in-lending mandated under the Consumer Protection Act of 1969 Fair Credit Billing Act of 1974 Equal Credit Opportunity Act of 1974, extended in 1976 Community Reinvestment Act Restrictions on Competition:  Restrictions on Competition Justified by moral hazard incentives to take on more risk as competition decreases profitability Branching restrictions (eliminated in 1994) Glass-Steagall Act (repeated in 1999) Disadvantages Higher consumer charges Decreased efficiency 1980s S&L and Banking Crisis:  1980s S&L and Banking Crisis Financial innovation and new financial instruments increasing risk taking Increased deposit insurance led to increased moral hazard Deregulation Depository Institutions Deregulation and Monetary Control Act of 1980 Depository Institutions Act of 1982 1980s S&L and Banking Crisis (cont’d):  1980s S&L and Banking Crisis (cont’d) Managers did not have expertise in managing risk Rapid growth in new lending, real estate in particular Activities expanded in scope; regulators at FSLIC did not have expertise or resources High interest rates and recession increased incentives for moral hazard 1980s S&L and Banking Crisis: Later Stages:  1980s S&L and Banking Crisis: Later Stages Regulatory forbearance by FSLIC Insufficient funds to close insolvent S&Ls Established to encourage growth Did not want to admit agency was in trouble Zombie S&Ls taking on high risk projects and attracting business from healthy S&Ls Competitive Equality in Banking Act of 1987 Inadequate funding Continued forbearance Principal-Agent Problem for Regulators and Politicians:  Principal-Agent Problem for Regulators and Politicians Agents for voters-taxpayers Regulators Wish to escape blame (bureaucratic gambling) Want to protect careers Passage of legislation to deregulate Shortage of funds and staff Politicians Lobbied by S&L interests Necessity of campaign contributions for expensive political races Deja Vu:  Deja Vu It is the existence of a government safety net that increases moral hazard incentives for excessive risk taking on the part of banks

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