Banking Regulation - Banking - Lecture Slides, Slides of Banking and Finance

Download Banking Regulation - Banking - Lecture Slides and more Slides Banking and Finance in PDF only on Docsity! ECONOMIC ANALYSIS OF FINANCIAL REGULATION Asymmetric Information And Banking Regulation  The asymmetric information problem leads to two reasons why the banking system might not function well: Bank Failure – in which bank is unable to meet its obligations to pay its depositors and other creditors and this meant that depositors would have to wait to get their deposit funds until the bank was liquidated. Depositors’ lack of information about the quality of bank assets can lead to bank panics. Docsity.com Moral Hazard/Adverse Selection and the Government Safety Net.  Moral Hazard  With the existence of insurance , this will increase incentives for taking risks that might result in an insurance payoff.  Adverse Selection  People who are most likely to produce the adverse outcome insured against are those who most want to take advantage of the insurance. Docsity.com Too Big to Fail  The failure of a very large bank makes it more likely that a major financial disruption will occur e.g. Continental Illinois.  Too big to fail – the government provides a guarantees of repayment of large uninsured creditors of the largest banks. The FDIC would do this by using the purchase and assumption method, giving the insolvent bank a large infusion of capital and then finding a willing merger partner to take over the bank and its deposits. Docsity.com Financial Consolidation and the Government Safety Net  Financial consolidations poses two challenges to banking regulation because of the existence of the government safety net:  The increased in size of banks as a result of financial consolidation increases the too-big-to fail problem, because there will now be more large institutions whose failure would expose the financial system to systemic risk.  Financial consolidation of banks with other financial services firms means that the government safety net may be extended to new activities such as securities underwriting, insurance, or real estate activities, thereby increasing incentives for greater risk taking in these activities that can also weaken the fabric of the financial system. Docsity.com Assessment of Risk Management 1993 Federal Reserve System’s 1993 guidelines 1994 Trading Activities Manual (provided bank examiners with to evaluate risk management systems) 1995 Announcement of assessing risk management processes at the banks by the Federal Reserve and the Comptroller of the Currency ↓ CAMELS system enables bank examiners to give a separate risk management rating from 1 to 5 by four elements. (1) the quality of oversight provided by the board of directors and senior management (2) the adequacy of policies and limits for all activities that present significant risks (3) the quality of the risk measurement and monitoring systems (4) the adequacy of internal controls to prevent fraud or unauthorized activities on the part of employees Docsity.com Major Financial Legislation in the United States  Federal Reserve Act (1913) -created the Federal Reserve System  McFadden Act of 1927 -Effectively prohibited banks from branching across state lines -Put national and state banks on equal footing regarding branching  Banking Acts of 1933 (Glass-Steagall) and 1935 -Created the FDIC -Separated commercial banking from the securities industry -Prohibited interest on checkable deposits and restricted such deposits to commercial banks -Put interest-rate ceilings on other deposits  Securities Act of 1933 and Securities Exchange Act of 1934 -Required that investors receive financial info. on securities offered for public sale -Prohibited misrepresentations and fraud in the sale of securities -Created the Securities and Exchange Commission (SEC) Docsity.com Major Financial Legislation in the United States (cont’d)  Investment Company Act of 1940 and Investment Advisers Act of 1940 -Regulated investment companies, including mutual funds -Regulated investment advisers  Bank Holding company Act and Douglas Amendment (1956) -Clarified the status of bank holding companies (BHCs) -Gave the Federal Reserve regulatory responsibility for BHCs  Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 -Gave thrift institutions wider latitude in activities -Approved NOW and sweep accounts nationwide -Phased out interest-rate ceilings on deposits -Imposed uniform reserve requirements on depository institutions -Eliminated usury ceilings on loans -Increased deposit insurance to $100,000 per account Docsity.com