T1-1 Why Study Financial Markets

Report
The Commercial Banking Industry
– History & Structure
Copyright 2014 by Diane Scott Docking
1
1-2
What is a BANK?
Is this a Bank?
Copyright 2014 by Diane Scott Docking
2
What is a Bank?
Equity & Debt
Households
Corporations
(net savers)
(net borrowers)
Cash
Intermediary that brings borrowers and savers of funds together.
Copyright 2014 by Diane Scott Docking
3
Small vs. Large Banks





Community Banks
< $1 billion in assets
Typical’ Size is $300
Million
Organizational Chart is
Not Complicated
Significantly Affected by
Health of Local Economy
Generally Know their
Customers Well –
Relationship Lending
Money Center Banks




Generally Multi-Billion Dollar
Company
Organizational Chart is Much
More Complex
Serve Many Different Markets
with Many Different Services
so are Better Diversified
Geographically and by
Product
Able to Raise Large Amounts
of Capital at Relatively Low
Costs
Copyright 2014 by Diane Scott Docking
4
U.S. Bank Failures
Bank Failures
1934 - Aug. 22, 2014
600
500
400
300
200
100
1934
1936
1938
1940
1942
1944
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
0
Source: http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=30
Copyright 2014 by Diane Scott Docking
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Bank Entry is Regulated

Must get a charter to open a bank

Must show “need” for a bank
Copyright 2014 by Diane Scott Docking
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Why do we Regulate Commercial Banks?
Promote _______________________
1.

Protect depositors

Bank failure can cause panic and contagion effect

Vital to community
Protect the ______________________
2.


Intended to increase and maintain operational efficiency
Cannot be closed for more than 3 days in a row
______________________of the Industry
3.

Looks at concentration of power and money

Fear of “big-banking”
Copyright 2014 by Diane Scott Docking
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Why do we Regulate Commercial Banks?
Protect __________________
4.

Truth in Lending Act of 1968

Prevent abuse in extension and collection of consumer debts

Provide full disclosure of credit costs and fees

Protect against discrimination
Facilitate __________________
5.

Bank deposits are part of the money supply

Fed uses banking system to affect the money supply
Copyright 2014 by Diane Scott Docking
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Regulatory Agencies

Federal Reserve System

Comptroller of the Currency

FDIC
Dodd-Frank bill
disbanded OTS &
merged it with OCC

Dept. of Justice

SEC

OTS

State Banking Boards or Commissions
Copyright 2014 by Diane Scott Docking
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Dual Banking System

______ chartered bank



Can not use “national” in title
Not required to join FRS or FDIC (but most do)
Individual state banking departments charter state banks
and savings institutes.

____________________chartered bank

Must have “National” or “N.A.”in name

Must be members of FRS and FDIC

The Office of the Comptroller of the Currency (OCC)
charters national banks and thrifts
The Office of Thrift Supervision (OTS) which use to charter
federal savings banks and savings associations was disbanded
by Dodd-Frank
The Federal Deposit Insurance Corporation (FDIC) insures the
deposits of banks and savings associations up to ________per
account and ____________per IRA account.


Copyright 2014 by Diane Scott Docking
10
100% vs Fractional Reserve Banking

100% Reserve Banking - where the amount of reserves is
exactly equal to the amount of liabilities
Assets
Cash in
Reserves
Loans
Liabilities
$100 million Deposits
$5 million Bank Capital
(from interest on
loans)
Copyright 2014 by Diane Scott Docking
$100 million
$5 million
11
100% vs Fractional Reserve Banking

Fractional Reserve Banking - where cash reserves are
smaller than the related liability
Assets
Cash in
Reserves
Loans
Liabilities
$10 million Deposits
$95 million Bank Capital
(from interest on
loans)
Copyright 2014 by Diane Scott Docking
$100 million
$5 million
12
CAMELS Rating

What does the acronym CAMELS
refer to in bank examinations?
Copyright 2014 by Diane Scott Docking
13
CAMELS ratings

C_______________



More capital allows banks to absorb losses
Regulators determine the “adequacy” of
capital
A_______________


Credit risk
Portfolio’s composition and exposure to
potential events
Copyright 2014 by Diane Scott Docking
14
CAMELS ratings

M_________________



Rates management according to administrative
skills, ability to comply with existing regulations, and
ability to cope with a changing environment.
Very subjective
E__________________


Banks fail when their earnings are consistently
negative
Commonly used ratio: Return on Assets (ROA)
Copyright 2014 by Diane Scott Docking
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CAMELS ratings

L_____________


Extent of reliance on outside sources for
funds (discount window, federal funds)
S_____________

to interest rate changes and market
conditions
Copyright 2014 by Diane Scott Docking
16
Supervision and Examination
… Regulators periodically examine individual banks and provide
supervisory directives


The OCC and FDIC assess the overall
quality of a bank's condition according
to the CAMELS system
Regulators assign ratings from 1 (best)
to 5 (worst) for each category and an
overall rating for all features combined.
Copyright 2014 by Diane Scott Docking
17
Historical Development of the Banking Industry
Copyright 2014 by Diane Scott Docking
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Banking Act of 1933 (Glass-Steagall
Act) and Banking Act1935

Created the ____________



_________________ commercial banking from
the securities industry


Established FDIC insurance (safety net).
Initially insured $2,500/account
Disallowed banks to provide investment banking
services, underwrite corporate stocks and bond.
Prohibited interest on ______________________and
restricted such deposits to commercial banks (Reg
Q)

Put interest-rate ceilings on other deposits (Reg Q)

Disallowed banks to sell __________________

No interstate banking
Copyright 2014 by Diane Scott Docking
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Erosion of Glass-Steagall
Bankers complained about restrictions of
Glass-Steagall, so erosion began:










Banks set up BHCs to circumvent restrictions

BHC Act of 1956
Community Reinvestment Act of 1977
DIDMCA of 1980
DIA of 1982
FIRREA of 1989
FDICIA of 1991
Riegle Neal Act of 1994
Gramm-Leach-Bliley Act of 1999
FDIRA of 2005
Copyright 2014 by Diane Scott Docking
20
Bank Holding Companies

Established to circumvent restrictive regulation:


operate banks in more than one state
engage in activities not permitted commercial banks








investment banking activities,
investment advice,
brokerage services,
credit cards,
leasing, etc.)
issue commercial paper and use nondeposit sources
of funds
increase accessibility to capital
decrease risk through diversification
Copyright 2014 by Diane Scott Docking
21
Bank Holding Companies

An organization that owns
controlling interest (25%) in one or
more commercial banks


OBHC (One BHC)
MBHC (Multi BHC)
Copyright 2014 by Diane Scott Docking
22
Bank Holding Company Act of 1956 & Douglass
Amendment of 1970

The Bank Holding Company Acts were a
reaction to the growth of Bank holding
companies in the U.S.




Gave the Federal Reserve control over the formation of
multibank and single bank holding companies and their
acquisition of banking and non-banking concerns
Forbade BHCs from acquiring banks in other states unless the
acquisition is specifically authorized by state law
Stipulating that any non-banking activities of a BHC must be
“closely related to banking”
Under the Section 20 loophole in the act investment banking
income limited to 25% of total income
Copyright 2014 by Diane Scott Docking
23
Community Reinvestment Act of 1977

Community Reinvestment Act (CRA) of 1977:
regulators encourage (and often require) lending to
socially important sectors of the economy (e.g.,
housing, farming)

Objectives
 Prevent redlining & steering




discriminatory practices
Encourage lending to disadvantaged groups (subprime)
Encourage banks to lend to startups and engage in
loans to micro businesses
Use of innovative or flexible lending practices to assist
low or moderate income individuals
Copyright 2014 by Diane Scott Docking
24
Depository Institution Deregulation and
Monetary Control Act (DIDMCA) 1980

First of Deregulation Acts

Phased Out Interest Rate Ceilings (Reg Q)


Allowed Interest to be Paid on Checking
Accounts (NOW Accounts)
Term Transaction Account Created – All
Institutions with These Accounts Subject to
Reserve Requirements
Copyright 2014 by Diane Scott Docking
25
Depository Institutions Act of 1982
(aka: Garn-St. Germain Act 1982)

Continued the Deregulation of DIDMCA

Created Money Market Deposit Account

FDIC Could Arrange Mergers Across State
Lines if Needed

Loan Limits were Liberalized

Banks in Need of Capital Could Get It From the
FDIC
Copyright 2014 by Diane Scott Docking
26
Financial Institutions Reform, Recovery
and Enforcement Act (FIRREA) 1989

Created in Response to Large Number of Bank and S&L
Failures

Combined FDIC and FSLIC into the FDIC and
Dismantled S&L Regulatory Body

Created the RTC to Take on the Assets of Failed S&Ls

$50 Billion Authorized to Handle Failed Institutions (Later Increased)

Created OTS

Allowed Bank Holding Companies to Purchase Savings
Banks
Copyright 2014 by Diane Scott Docking
27
FDIC Improvement Act (FDICIA) 1991

A small move towards Re-regulating the
Industry

Requires Regulators to Take Prompt Corrective
Action (PCA) When a Bank has Problems

Prompt Corrective Action Based on the Capital
Position of the Bank

Requires Regulators to Develop New Standards
for the Banks They Regulate
Copyright 2014 by Diane Scott Docking
28
Riegle-Neal Interstate Banking and Branching
Efficiency Act (Riegle-Neal Act) 1994
Allows full interstate branching
Promotes further consolidation




Bank Holding Company Can Acquire Banks
Nationwide
Consolidation of Interstate BHCs into Branches
Copyright 2014 by Diane Scott Docking
29
Financial Services Modernization Act of
1999 (Gramm-Leach-Bliley Act)
What GLBA did:

Repeals the restrictions on banks affiliating
with securities firms (i.e., repeals last
vestiges of the Glass Steagall Act of 1933):

Allows banks to branch across state lines and
acquire insurance and securities firms by forming
a _________________________________ that
is authorized to engage in:



underwriting and selling insurance and securities,
conducting both commercial and merchant banking,
investing in and developing real estate and other
"complimentary activities.“

There are limits on the kinds of non-financial activities these new
entities may engage in.
Copyright 2014 by Diane Scott Docking
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Organizational structure of financial services
company
Financial Services
Holding Company
Bank
Holding
Company
Thrift
Holding
Company
Nonbank
Subsidiaries
Subsidiaries
and Service
Companies
Securities
Subsidiaries
Copyright 2014 by Diane Scott Docking
Insurance
Subsidiaries
Real
Estate
Subsidiary
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Federal Deposit Insurance Reform Act
(FDIRA) 2005




First Significant Increase FDIC Coverage in 25
years
Raises FDIC Insurance Limits from $100,000 to
$250,000 for Retirement Accounts
Federal Regulators are Empowered to
Periodically Adjust Deposit Insurance Limits for
Inflation
Merges Bank Insurance Fund (BIF) and Savings
Association Insurance Funds (SIF) into Single
Deposit Insurance Fund (DIF)
Copyright 2014 by Diane Scott Docking
32
The Subprime Mortgage Crisis of
2008
Now going
back the
other way –
More
restrictive
regulations
Copyright 2014 by Diane Scott Docking
33
Emergency Economic Stabilization Act
(EESA) 2008



Passed in Response to Home Mortgage and
Financial System Problems
Temporarily Increases FDIC Deposit Insurance
Coverage from $100,000 to $250,000 for All
Deposits until Year-end 2009 (now permanent)
Allows the US Treasury to Add Capital to Banks
to Enhance Lending

www.treas.gov/press/releases/hp871.htm
Copyright 2014 by Diane Scott Docking
34
Dodd-Frank Wall Street Reform &
Consumer Protection Act of 2010






Passed in Response to 2008 Crisis
Establishes a new regulatory infrastructure to act as an
“early warning system” for threats to the financial
stability of the nation.
Sets up an independent Bureau of Consumer Financial
Protection within the Federal Reserve whose mission is
to look out for consumers’ interests
Mortgage loan reform
Eliminates OTS
FDIC Insurance $250,000
Copyright 2014 by Diane Scott Docking
35
Dodd-Frank Wall Street Reform &
Consumer Protection Act of 2010

More Specifics of Act


Promote better supervision of financial firms by
creating a new Financial Services Oversight
Council chaired by the Treasury and including the
heads of the primary federal regulators to limit
systemic risk
Increasing regulation of securitization processes
by requiring more transparency, stronger
regulations of credit ratings agencies, and
increasing the percentage of loan sales that must
be retained by originators
Copyright 2014 by Diane Scott Docking
36
Dodd-Frank Wall Street Reform &
Consumer Protection Act of 2010

More Specifics of Act
 Increase regulation of OTC derivatives and gives the
Federal Reserve additional authority over the nation’s
payment mechanisms
 Establish new methods to resolve problems in nonbanks
that may present systemic risks and improve the Fed’s
accountability in its emergency lending facilities
 Increase international regulatory standards and
cooperation, primarily by increasing capital requirements
at U.S. and non-U.S. banks
Copyright 2014 by Diane Scott Docking
37
Dodd-Frank Wall Street Reform &
Consumer Protection Act of 2010

More Specifics of Act

Establish the Consumer Financial Protection Agency
(CFPA)



Created to protect consumers from unfair, deceptive and abusive
practices, and improve transparency in dealing with consumers
Protects investors against unfair treatment such as
insider trading, lack of disclosure, malfeasance, and
breach of fiduciary responsibility
A 2010 bill on credit card practices effectively limits card
issuer’s ability to increase interest rates in the first year a
card is obtained, limits fees and penalties for missed
payments, and abolishes universal default penalties
Copyright 2014 by Diane Scott Docking
38
Financial Innovations:




Bank Credit Cards
Debit Cards
ATMs
Electronic Banking




internet,
telephone
Virtual banks
E-money
Copyright 2014 by Diane Scott Docking
39
Other Consumer Protection
Acts and Regulations
Copyright 2014 by Diane Scott Docking
40
Social Responsibility Acts

1968 – Full Information on Terms of Loans Must
be Given

1974 – Cannot Be Denied a Loan Based on Age,
Sex, Race, National Origin or Religion

1977 – Cannot Discriminate Based on the
Neighborhood in Which Borrower Resides

1987 and 1991 – Banks Must Disclose Full Terms
on Deposit and Savings Accounts
Copyright 2014 by Diane Scott Docking
41
Consumer Credit Protection Act of 1968
(Truth in Lending Act)







Requires banks to fully disclose info in a credit contract
(TIL form)
Consumers have right to rescind within 3 days (if house is
collateral, excluding 1st mtg.)
Prohibited extortion credit practices
Limited garnishment of wages
Created National Commission on Consumer Finance to
oversee enforcement of law
Banks must disclose APR and all finance charges (e.g.,
credit report fees, closing costs, points, etc.)
Reg. Z requires disclosure of effective rates of interest,
total interest paid, the total of all payments, as well as full
disclosure as to why a customer was denied credit.
Copyright 2014 by Diane Scott
Docking
42
Equal Credit Opportunity Act of 1974




A credit discrimination act (Reg B)
Forbids discrimination against credit applicants on
the basis of age, sex, marital status, race, color,
religion, national origin.
Credit applicants must be notified, in writing, of
approval or denial within 30 days
Lender may not request information on the
borrower’s race, color, religion, national origin, or
sex, except in the case of residential mortgage
loans.
Copyright 2014 by Diane Scott
Docking
43
Truth in Savings Act of 1991

Requires financial institutions to disclose the "Annual Percentage
Yield," or "APY," on savings accounts. The APY tells you how much
money you would earn if you kept $100 in the account for one year.

Requires that the institution credit your entire deposit instead of
crediting a portion of your deposit or using a "low balance per month"
method. This increases your earnings.

Requires that institutions have available a list of their fees for bounced
checks, stop payment orders, certified checks, wire transfers or similar
items. Ask for the list.

Prohibits institutions from advertising "free" checking if there are
hidden charges or requirements, for example, having to maintain a
minimum balance to qualify.
Copyright 2014 by Diane Scott Docking
44
Fair and Accurate Credit
Transactions (FACT) Act 2003

Passed in Response to Increased Problem of
Identity Theft

Federal Trade Commission Must Make it Easier
for Consumers Victimized to File Theft Report

Individuals and Families are Entitled to One
Free Credit Report Each Year

www.annualcreditreport.com/cra.index.jsp
Copyright 2014 by Diane Scott
Docking
45
Credit Card Accountability, Responsibility,
and Disclosure Act of 2009 (CARD Act)

Mail or deliver periodic statements 21 days before payment due
date and the expiration of any grace period.

Written notice to cardholder of increase in APR or any significant
changes, no later than 45 days prior to the change taking effect.

Cardholder has right to cancel after receiving notice

Payments in excess of the minimum payment must be applied first
to the balance with the highest interest rate.

Payment due dates must be the same day every month (or the next
business day, if date falls on a holiday or a weekend).

If payment due date is a day on which the creditor does not receive or
accept payments by mail (including weekends and holidays), the
creditor may not treat a payment received on the next business day as
late for any purpose.
Copyright 2014 by Diane Scott Docking
46
Credit Card Accountability, Responsibility,
and Disclosure Act of 2009 (CARD Act)

Changes to Periodic Statement format requirements make them
more understandable by grouping fees and interest charges
together.

Interest Charges & Fees

Must be grouped separately, with a monthly total for each.

Interest charges must be itemized according to type of transaction.

Separate year-to-date totals for fees and interest charges are also required.

Effective APR

Do not need to disclose an “effective annual percentage rate” due to lack of consumer understanding of
this term.

Must disclose interest and fee totals for the month and year-to-date to inform consumers of the total cost
of credit.

Minimum Payment Disclosure

Effect of making only the minimum required payment to repay the balances must be disclosed as required
by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Payment Due Date

Must be on the front side of the periodic statement.

Must disclose in close proximity to the due date

amt of late payment fee

penalty APR that could be triggered by a late payment
Copyright 2014 by Diane Scott Docking
47

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