Regulating the Banking Industry ECO 473 Money Banking

Regulating the Banking Industry ECO 473 – Money & Banking – Dr. D. Foster

Rationales for Government Regulation Maintaining depository institution liquidity. Assuring bank solvency by limiting failures. Promoting an efficient financial system. Protecting consumers.

Federal Regulation: 1933– 1970 The Banking Act of 1933 (Glass-Steagall Act): ◦ Created the Federal Deposit Insurance Corporation (FDIC). ◦ Placed interest rate ceilings on checking deposits of commercial banks. ◦ Separated commercial and investment banking. ◦ Branching restrictions.

Partial Deregulation: 1971– 1989 Disintermediation in the 1970 s. 1980 - Depository Institutions Deregulation and Monetary Control Act (DIDMCA): ◦ Six-year phaseout of interest rate ceilings. ◦ Permitted NOW accounts. ◦ Increased FDIC coverage to $100, 000.

Partial Deregulation: 1971– 1989 The Garn–St. Germain Act of 1982: ◦ Authorized money market deposit accounts. ◦ Increase the DIDMCA limit on consumer loans and commercial paper. ◦ Authorized savings institutions to make commercial real estate loans. ◦ Gave these institutions the power to purchase “unsecured loans, ” including low-rated, “junk” bonds. ◦ Gave the FDIC power to permit troubled financial institutions to merge with healthier partners.

Partial Deregulation: 1971– 1989 - Financial Institutions Reform, Recovery & Enforcement Act (FIRREA): (FIRREA) ◦ Authorized taxpayer funds to cover cost of liquidating failed thrifts. --Insurance wasn’t enough! ◦ Abolished current thrift regulatory structure. --Created Office of Thrift Supervision. --Created the Resolution Trust Corp. to liquidate thrifts. ◦ Moved thrift insurance (FSLIC) into FDIC. ◦ Required insurance fund = 1. 25% of insured deposits.

Deposit Insurance Complications The moral-hazard problem of deposit insurance: insurance ◦ S&L crisis. Too-big-to-fail policy: policy ◦ Continental Illinois The FDIC Improvement Act Of 1991 -- Allowed for earlier intervention by the FDIC. -- Let FDIC set/change premiums to boost fund. -- Mandated risk-based premium structure.

The Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act) Act removes Glass-Steagall restrictions and permits: ◦ Securities firms and insurance companies to own commercial banks. ◦ Banks to underwrite insurance and securities, including shares of stock.

Regulatory Issues Off-balance-sheet banking: ◦ Loan commitment; credit default swaps. Asset valuation: ◦ Historical cost vs. market value Derivatives: ◦ Replacement cost exposure. ◦ Credit/market/operating risks. New wave of regulation: ◦ SOX; Dodd-Frank

Case: Bernard Madoff Involved on Wall Street since 1960. Prominent philanthropist. Client losses $65 bill. “Ponzi” scheme: ◦ ◦ Began in 1991. “Model” unreplicated. Targeted charities. Client suicides.

Regulating the Banking Industry ECO 473 – Money & Banking – Dr. D. Foster