=Shell operation
=Edge Act corporation
=International banking facilities (IBFs)
--Not subject to regulation and taxes
--May not make loans to domestic residents
Foreign Banks in the U.S.
=Agency office of the foreign bank
--Can lend and transfer fund in the U.S.
--Cannot accept deposits from domestic residents
--Not subject to regulations
=Subsidiary U.S. bank
--Subject to U.S. regulations
--Owned by a foreign bank
=Branch of a foreign bank
--May open branches only in state designated as home state or in state that allow entry of out-of-state banks
--Limited-service may be allowed in any other state
=Subject to the International Banking Act of 1978
=Basel Accord (1988)
--Example of international coordination of bank regulation
--Sets minimum capital requirements for banks
Ch11 (8th edition) ECONOMIC ANALYSIS of BANKING REGULATION
--(Note: In 9th edition, this chapter RETAINS THE SAME numberMish9ed_c11_StGuide.)
-text material, pages 279-305
-Questions at end of chapter: Page 306
This chapter stresses the economic way of thinking by conducting an economic analysis using the adverse selection and moral hazard concepts to explain why a regulatory system takes the form it does and how it led to a banking crisis in the 1980s.
It ends with a discussion of where financial regulation might be heading in the future.
Students can benefit--better understand adverse selection and moral hazard --by comparing how problems of trust and behavior are dealt with in private financial markets to the methods financial regulators (public agencies of the government) use to cope with both adverse selection and moral hazard.
================
*Asymmetric Information and Bank Regulation: Government Safety Net
-Bank panics and the need for deposit insurance:
--FDIC (deposit insurance fund): short circuits bank failures and contagion effect.
-- Payoff method (letting an insolvent bank fail and then FDIC pays any depositor up to the maximum amount by law for losses at the bank but FDIC does not pay off any of the uninsured liabilities)
-- Purchase and assumption method (typically more costly for the FDIC)(FDIC gets another bank to take over a bankrupt bank and also the FDIC takes over all the bad assets of the failed bank and also pays off any uncovered deposit liabilities)
-Other form of government safety net:
--Lending from the central bank to troubled institutions (lender of last resort)
* Government Safety NetEffects of Government insurance in dealing with Asymmetric Information problems (theory of free market failures and how government may even worsen them in the future though preventing bankruptcies in the present)
-Moral Hazard
--Depositors do not impose discipline of marketplace.
--Financial institutions have an incentive to take on greater risk.
-Adverse Selection
--Risk-lovers find banking attractive.
--Depositors have little reason to monitor financial institutions.
|
|
|
* Government Safety Net: Too Big to Fail
-Government provides guarantees of repayment to large uninsured creditors of the largest financial institutions even when they are not entitled to this guarantee
-Uses the purchase and assumption method
-Increases moral hazard incentives for big banks, now and in future (implicit guarantee is perceived by investors and depositors and lenders to big banks)
*Government Safety Net: May even promote more Financial Consolidation
-Larger and more complex financial organizations challenge regulation
--Increased too big to fail problem
--Extends safety net to new activities, increasing incentives for risk taking in these areas (as has occurred during the subprime financial crisis in 2007-2008).
* Restrictions on Asset Holdings
-Attempts to restrict financial institutions from too much risk taking
--Bank regulations
----Promote diversification
----Prohibit holdings of common stock
--Capital requirements
----Minimum leverage ratio (for banks) {=capital/assets)
----Basel Accord: risk-based capital requirements
----Regulatory arbitrage (banks manipulate their holdings of assets in each risk-category and avoid the intent of the Basel risk-based capital requirement)
*Financial Supervision: Chartering and Examination
-Chartering (screening of proposals to open new financial institutions) to prevent adverse selection
-Examinations (scheduled and unscheduled) to monitor capital requirements and restrictions on asset holding to prevent moral hazard {These are the so-called Camels ratings applied by banking inspectors: C.A.M.E.L.S. }
-- C apital adequacy
-- A sset quality
-- M anagement
-- E arnings
-- L iquidity
-- S ensitivity to market risk
-Filing periodic call reports
* Assessment of Risk Management: REGULATORS New Oversight Foci:
-Greater emphasis on evaluating soundness of management processes for controlling risk
-Trading Activities Manual of 1994 for risk management rating based on
--(1) Quality of oversight provided
--(2) Adequacy of policies and limits for all risky activities
--(3) Quality of the risk measurement and monitoring systems
--(4) 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)
* Disclosure Requirements
-Requirements to adhere to standard accounting principles and to disclose wide range of information
-The Basel 2 agreement (began 1999, in effect 2008) for internationally active banks (risk-weighted capital adequacy)
-In the USA, the SEC put a particular emphasis on disclosure requirements
----also, in USA, the Sarbanes-Oxley Act of 2002 established the Public Company Accounting Oversight Board to ensure more truthfulness about risks and transparency in reporting
- Mark-to-market (fair-value) accounting (Assets may only be valued at their current market price)
*Consumer Protections: Laws (stronger protective regulations) that prevent consumers from being so easily fooled or intentionally confused by financial jargon and presentation of financial information:
-Consumer Protection Act of 1969 (Truth-in-lending Act).
|
|
|
-Fair Credit Billing Act of 1974.
-Equal Credit Opportunity Act of 1974, extended in 1976.
-Community Reinvestment Act.
-The subprime mortgage crisis (2002-2008) illustrated the need for greater consumer protection.
* Restrictions on Competition: Increasing (or increasing then Decreasing?):
-Removing restrictions were justified as increasing competition; BUT it can also increase moral hazard incentives to take on more risk.
--Branching restrictions (eliminated in 1994)
--Glass-Steagall Act (repealed in 1999)
-Disadvantages of restrictions on competition
--Higher consumer charges
--Decreased efficiency
-{Disadvantages of removing restricted competition: May allow bigger banks to get even bigger, and ultimately be counter-productive, leading to even higher prices paid by consumers due to Oligopolistic control of entire financial services sectors.}
===================
* Bank Failures in USA
-Failures of Banks: Constant recurrence in entire history of US markets
Major bank collapses
1920s: even in the 1920s -- hundreds of bank failures every year;
- Periods of time with Very High Number of failures:
1931-40 Great Depression following Stock Market Bubble 1920s;
1984-1993 Deregulation of S&Ls following inflation 1979-83;
2008-2011 (today) Deregulation 1999 & Housing Bubble 2002-2007
*Recent Costly Banking Failure: The 1980s S&L Banking Crisis
-Financial innovation and new financial instruments increased risk taking
-Increased deposit insurance led to increased moral hazard
-Deregulation
--Depository Institutions Deregulation and Monetary Control Act of 1980; allowed more free market activity to occur.
--Depository Institutions Act of 1982; more freedom for S&L actions
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989: New laws in Response to major crisis of S&L banks of the 1980s:
-Financial Institutions Reform, Regulatory and Enforcement Act of 1989
-Federal Deposit Insurance Corporation and Improvement Act of 1991
--Cost of the bailout approximately $150 billion, or 3% of GDP
--{Compare Table of Costs/GDP for various countries banking crises where costs range from >50% and less for 1980-2005;
--{US Crisis of 2008 uncertain figures but Gross Costs >20% GDP while Net Costs will take years to calculate, but certainly less)}
===============================
