Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

CHAPTER 8: BANK LEGISLATION AND REGULATION

Group 5Pheng Chandara

Seam KimhayKeo Sombo

Paññāsāstra University of Cambodia

Group 5 15-2

Contents

I. Learning Objectives

II. Introduction

III. Regulatory Goals and the Banking System Structure

IV. Banking Legislation

V. Consumer Protection Legislation

VI. Compliance Examinations

VII. Banking Regulations

VIII. Summary

IX. References

Group 5 15-3

I. Learning Objectives

• Explain the major goals of bank regulation

• Differentiate between unit, dual, and correspondent banking systems

• Discuss examples of federal banking legislation enacted from the late

twentieth century to the present

• Identify the major consumer protection regulations

• Cite procedures examiners use to ensure compliance with the

community reinvestment act

• Define the key terms listed in this chapter

Group 5 15-4

II. Introduction

• In the United States banking system, federal governmentagencies and state governments share regulation power.

• This chapter examines the dual bank regulatory structure and themajor principles, laws, and regulations that set the boundaries forthe banking business.

• The public policy goals of bank regulation are examined first,then the significant banking laws enacted in the late twentiethand early twenty-first centuries are introduced.

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III. Regulatory Goals and theBanking System Structure

• Bank regulation is theimplementation of bankinglaws through government-issued rules, guidance, anddirectives.

• Bank supervision involvesmonitoring and examiningthe condition of banks andtheir compliance with lawsand regulations.

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III. Regulatory Goals and theBanking System Structure

• The U.S. government’s major goal in regulatingbanks is the protection of banks, their depositors, andthe communities in which they operated from bankfailures.

• The regulatory structure includes:

– dual banking,

– unit banking,

– and correspondent banking.

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1. Dual Banking

• Dual banking refers to the systemunder which bank are chartered.

• A bank may choose to be charteredeither by the federal governmentthrough the Office of theComptroller of the Currency (OCC)or by the state in which it isdomiciled through the state bankingdepartment.

• A bank operates under a number ofregulatory authorities depending onits charter.

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2. Unit Banking

• Before to the 1980s the U.S. banking industry was characterized by

small single-office banks-a system known as Unit Banking.

• Unit banking refers to a single bank which renders services and

operates without any branches anywhere. This kind of banking

system is common in the USA.

• Unit banking operate one full banking services.

• Most states permitted branching only within a limited geographic

area surrounding a bank’s headquarter office or completely

prohibited branching within the state.

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3. Correspondent Banking

• A correspondent bank holds the account balance of other banks and provides or sell

services to these banks, know as respondent banks.

• Today correspondent banks typically provide respondent banks with a variety of

services including:

– Check collection

– Loan participation

– Dividend reinvestment program maintenance for respondent bank’s stockholders

– Investment advice and etc…• Respondent banks pay for correspondent services either directly through a fee, or

indirectly by maintaining a required minimum account balance with the correspondent

bank.

Group 5 15-10

IV. Banking Legislation

• Banking Legislation is the law and regulation that governs bank operations and business

activities.

• To achieve all these laws and regulations, U.S. government have focused on preventive

measures as below:

Control the terms and conditions under which banks obtain and use assets and liabilities

Insure bank depositors against loss

Set capital requirements

Establish liquidity, solvency, and profitability guidelines

Define a consumer code of rights

Prohibit unfair or discriminatory practices

Protect the nation and the economy from criminal and terrorist activity

Group 5 15-11

IV. Banking Legislation (Con’t)

• Federal legislation’s congress enacted laws to:

Promote more competition between banks and other financial institutions

Allow commercial and savings banks, savings associations, and credit unions tooffer new products

Deal with the S&L industry crisis of the 1980s

Protect the FDIC insurance fund

Allow banks to establish branches across the country

Enable banks, insurance companies, and securities firms to affiliate into singleFHCs

Enlist the banking industry to help the U.S. government deter criminal activity andprotect the nation and the economy

Group 5 15-12

1. Monetary Control Act

• Monetary Control Act is the law and regulation thatenacted in 1980 in order to control, mange, and issuerelated with money.

• Act: reduced the asset and liability powers for banks and

thrifts. reinforced many of the regulations that had been put in

place during the Great Depression. set uniform and universal reserve requirements for all

depositories and suspended usury ceilings.

Group 5 15-13

2. Garn-St Germain Act

• Garn-St Germain Act is established in 1982 and itsubstantially expended thrifts’ lending powers.

• Act:

Authorized banks and thrifts to offer money market depositaccounts (MMDAs) to allow them to better compete withexisting money market funds.

Provided support to the struggling S&L industry bypermitting banks to purchase failing thrifts across statelines and receive financial assistance with their purchases.

Group 5 15-14

3. Competitive EqualityBanking Act

• Competitive Equality Banking Act is passed in 1987 on the activitiesand growth of nonbank banks.

• Act:

Closed the consumer bank, or nonbank, loophole in the Bank HoldingCompany Act, which inadvertently allowed nonfinancial entities toown and operate banks.

The Expedited Funds Availability Act, a section of the CompetitiveEquality Banking Act, established maximum check-hold periods fordepository institutions and required the Fed to change check-collectionprocedures to speed the return of dishonored checks to a depositor’sbank.

Group 5 15-15

4. Financial Institutions Reform,Recovery, and Enforcement Act

• Financial Institutions Reform, Recovery, and Enforcement Act, passedin 1989, was designed primarily to address problems that had emergedduring the 1980s in the S&L industry and the deposit insurance system.

• Act:

Provided $50 billion in taxpayer funds to close failed S&Ls andestablished the Resolution Trust Corporation (RTC) under themanagement of the FDIC to administer the funds.

Tightened restrictions on S&L activities by reversing some of thelegislation of 1980 and 1982 that broadened thrift lending powers, andraised S&L capital requirements to increase the industry’s safety andsoundness.

Group 5 15-16

5. Federal Deposit InsuranceCorporation

• Federal Deposit Insurance Corporation was created in 1933by the Federal Deposit Insurance Act and this legislation wasenacted in response to the failure of more than 9,100 banksduring the early years of the Great Depression between 1930 and1933.

• Act:

Protect depositors

Prevent runs-mass customer withdrawals driven by fear of lossagainst banks

Insure deposits at saving associations

Group 5 15-17

6. Federal Deposit InsuranceCorporation Improvement Act

• Federal Deposit Insurance Corporation Improvement Actwas created in 1991 and greatly increased the powers andauthority of the FDIC. Major provisions recapitalized the BankInsurance Fund and allowed the FDIC to strengthen the fund byborrowing from the Treasury.

Group 5 15-18

7. Deposit Insurance Coverage

• During the 1980s many savings and loan associationsrelied on brokered certificates of deposit as a means ofacquiring large amounts of funds from outside theirmarkets.

• Many S&Ls used these funds for high-risk loans andinvestments.

• To end this practice, FDICIA eliminated insurancecoverage on brokered deposits for all banks and S&Lsexcept those with the highest capital ratings.

Group 5 15-19

8. Deposit Insurance Premiums

• Deposit Insurance Premium was based on a bank’s deposit balancesize.

• FDICIA changed the way the FDIC assesses banks for depositinsurance by linking premiums to risk.

• Under risk-based premium system, each bank and thrift insurance rateis dependent on the amount of capital it holds as a proxy for risk andthe FDIC’s assessment of its financial condition, known as asupervisory rating.

• Beginning in 1993, banks paid a risked-based premium between 23 to31 cents per $100 of insured deposits.

• The rate later was lowered to 0 to 27 cents.

Group 5 15-20

9. Federal Deposit InsuranceReform Act

• FDIRA changes include:

Increasing the deposit insurance limit from $100,000 to $250,000 per account holder for

many retirement accounts beginning April 2006 and establishing an inflation adjustment

that could result in higher insured limits as of 2011

Maintaining the limit at $100,000 for nonretirement accounts, but establishing an inflation

adjustment beginning April 1, 2010 like the one established for retirement accounts

Merging the BIF and SAIF into the Deposit Insurance Fund (DIF)

Eliminating the 1.25% designated reserve ratio and allowing the FDIC to set the DRR

between 1.15% and 1.5%

Giving banks rebates for premiums paid to BIF or SAIF in the 1990s and allowing these

funds to be used to offset future premiums

Group 5 15-21

10. FDIC Policies and Actions

• The FDIC can respond to a failed bank in one of five ways, including:

Paying out insurance to the bank’s depositors in an outright payoff

Allowing a sound bank to buy selected assets and assume the liabilitiesof a failed bank

Selling all of failed bank’s assets and insured liabilities to a soundbank

Taking over a failed bank and operating it in an attempt to restore it toprofitability

Declaring insurance protection for all of the failed bank’s deposits,regardless of amount, because the bank is “too big to fail”

Group 5 15-22

11. Interstate Banking andBranching Efficiency Act

• The Interstate Banking and Branching Efficiency Act is the law ofrelationship between banking and branching of a state to another banking andbranching of a state.

• The Interstate Banking and Branching Efficiency Act was established in 1994.

• In 1997, the Interstate Banking and Branching Efficiency Act authorizedcompanies that own controlling interest in one or more banks to buy banks inany state and allowed these bank holding companies to consolidate theirinterstate banks into branch networks.

• Individual banks also could establish interstate branches by merging withother banks across state lines.

Group 5 15-23

12. Gramm-Leach-Bliley Act

• Gramm-Leach-Lliley Act was passed in 1999.

• It authorized banks and other financial institutions toestablish financial holding companies that can own bothbanks and companies that provide insurance, securities,and specialized financial service.

Group 5 15-24

13. Bank Secrecy Act and USAPATRIOT Act

• In 1970, Bank Secrecy Act and USA PATRIOT Act(BSA) was created.

• It requires banks and other financial institutions toassist government agencies in efforts to curb federalcrime by imposing recordkeeping and reportingrequirements.

Group 5 15-25

V. Consumer Protection Legislation

• Consumer Protection was primarily a stat responsibility.Most states, for example, prohibited to set higher interestrates on consumer loans.

• Most financial transactions involving consumers arecovered by consumer protection laws. These includetransactions involving credit, charge, and debit cards.

• Lenders are required to provide consumer borrowers withspecific written information on the cost of credit,especially the two most important measures of the cost-the finance charge.

Group 5 15-26

V. Consumer Protection Legislation

• Fair Housing Act (1968)

Prohibits discrimination in the extension of housing credit on the basis of

race, color, religion, national origin, sex, handicap, or family status.

• Community Reinvestment Act (1977)

Encourages financial institutions to help meet the credit needs of their entire

communities, particularly low- and moderate-income neighborhoods.

• Federal Trade Commission Improvement Act (1980)

Authorizes the Feds to identify unfair or deceptive acts or practices by banks

and to issue regulation to prohibit them.

Group 5 15-27

VI. Compliance Examinations

• a review of consumer complaints about the bank’s operations and a review ofthe operational areas generating the complaints

• an onsite review of the bank’s lending program, credit applications, anddisclosure statements

• a review of a statistical sample of the bank’s installment loan files to ensurethe bank is calculating APRs correctly and properly disclosing credit costs

• a review of a sample of the mortgage files and accepted and rejected mortgageapplications to determine whether a pattern of discrimination or deviationfrom established lending policy exists

• a discuss with bank management about all matters of concern noted by theexaminer

• a written report of the examination sent to the bank with a request thatmanagement respond to the report and comment on how violations will becorrected

Group 5 15-28

VII. Banking Regulations

• There are five categories:monetary policybank safety and soundnessinternational banking and the activities of bank

holding companiesFed membership and Federal Reserve bank

proceduresconsumer protection

Group 5 15-29

1. Monetary Policy Regulations

• A Extensions of credit by Federal Reserve banks

• D Reserve requirements for depository institutions

• T Credit by brokers and dealers

• U Credit by banks and persons other than brokersor dealers for the purpose of purchasing orcarrying margin stocks

• X Borrowers of securities credit

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2. Bank Safety and Soundness

• F Limitations on interbank liabilities

• L Management of official interlocks

• O Loans to executive officers, directors, and principalshareholders of member banks

• Q Prohibition against payment of interest on demanddeposits

• R Exceptions for banks from the definition of broker inthe Securities Exchange Act

• W Transactions between member banks and their affiliates

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3. International Banking andBank Holding Companies

• K International banking operations

• Y Banking holding companies and changein bank control

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4. Federal Reserve Membershipand Reserve Bank Procedures

• EE Netting eligibility for financial institutions

• H Membership of state banking institutions in the FederalReserve System

• I Issue and Cancellation of Federal Reserve Bank capital stock

• J Collection of checks and other items by the Federal Reservebanks and funds transfers through Fedwire

• N Relations with foreign banks and bankers

• S Reimbursement to financial institution for providing financialrecords; recordkeeping requirements for certain financialrecords

Group 5 15-33

5. Consumer Protection

• AA Unfair or deception acts or practices

• B Equal credit opportunity

• BB Community reinvestment

• C Home mortgage disclosure

• CC Availability of funds and collection of checks

• DD Truth in savings

• E Electronic fund transfers

• FF Obtaining and using medical information in connection with credit

• G Disclosure and reporting of Community Reinvestment Act related agreements

• GG Prohibition on funding of unlawful Internet gambling (proposed)

• M Consumer Leasing

• P Privacy of consumer financial information

• V Fair credit reporting

• Z Truth in lending

Group 5 15-34

VIII. Summary

• The U.S. bank legislation and regulation was createdin order to give power to the federal and stategovernments control the terms and conditions underwhich banks obtain and use assets and liabilities;insure bank depositors against loss; set capitalrequirements; establish liquidity, solvency, andprofitability guidelines; prohibit unfair ordiscriminatory practices; and protect the nation andthe economy from crimial and terrorist activity.

Group 5 15-35

IX. References

• Jon A. Hooks, Ph.D., “Money & Banking”, 6th Edition.

• Source: www.swcollege.com/bef/burton/restricted/finsys3e/tb15.doc

• Source: http://www.law.cornell.edu/cfr/text/12/225.145

Thank for your attention!