copyright 2014 by diane scott docking1 the commercial banking industry – history & structure

Copyright 2014 by Diane Scott Docking 1

The Commercial Banking Industry – History & Structure

What is a BANK?

Is this a Bank?

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2Copyright 2014 by Diane Scott Docking

Copyright 2014 by Diane Scott Docking3

What is a Bank?

Corporations

(net borrowers)

Households

(net savers)

Cash

Equity & Debt

Intermediary that brings borrowers and savers of funds together.

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


U.S. Bank Failures


Source: http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=30

0

100

200

300

400

500

600

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

Bank Failures1934 - Aug. 22, 2014


Bank Entry is Regulated

Must get a charter to open a bank

Must show “need” for a bank


Why do we Regulate Commercial Banks?

1. Promote _______________________ Protect depositors

Bank failure can cause panic and contagion effect

Vital to community

2. Protect the ______________________ Intended to increase and maintain operational efficiency Cannot be closed for more than 3 days in a row

3. ______________________of the Industry Looks at concentration of power and money

Fear of “big-banking”


Why do we Regulate Commercial Banks?

4. Protect __________________ 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

5. Facilitate __________________ Bank deposits are part of the money supply

Fed uses banking system to affect the money supply


Regulatory Agencies

Federal Reserve System Comptroller of the Currency FDIC Dept. of Justice SEC OTS State Banking Boards or Commissions

Dodd-Frank billdisbanded OTS &merged it with OCC


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.

http://www.occ.treas.gov/

http://www.occ.treas.gov/

http://www.ots.treas.gov/

http://www.fdic.gov/

100% vs Fractional Reserve Banking

100% Reserve Banking - where the amount of reserves is exactly equal to the amount of liabilities


Assets Liabilities

Cash in Reserves

$100 million Deposits $100 million

Loans $5 million Bank Capital (from interest on loans)

$5 million

100% vs Fractional Reserve Banking

Fractional Reserve Banking - where cash reserves are smaller than the related liability


Assets Liabilities

Cash in Reserves

$10 million Deposits $100 million

Loans $95 million Bank Capital (from interest on loans)

$5 million


CAMELS Rating

What does the acronym CAMELS refer to in bank examinations?


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


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)


CAMELS ratings L_____________

Extent of reliance on outside sources for funds (discount window, federal funds)

S_____________ to interest rate changes and market

conditions


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.

Historical Development of the Banking Industry



Banking Act of 1933 (Glass-Steagall Act) and Banking Act1935

Created the ____________ Established FDIC insurance (safety net). Initially insured $2,500/account

_________________ commercial banking from the securities industry 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

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Copyright 2014 by Diane Scott Docking

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


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


Bank Holding Companies

An organization that owns controlling interest (25%) in one or more commercial banks OBHC (One BHC) MBHC (Multi BHC)


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

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

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


Community Reinvestment Act of 1977

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


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


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

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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


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

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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 Docking31

Organizational structure of financial services company

Bank Holding

Company

ThriftHolding

Company

SecuritiesSubsidiaries

InsuranceSubsidiaries

Real Estate

Subsidiary

NonbankSubsidiaries

Subsidiariesand ServiceCompanies

Financial ServicesHolding Company

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)



The Subprime Mortgage Crisis of 2008

Now going back the other way – More restrictive regulations

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 34Copyright 2014 by Diane Scott Docking

http://www.treas.gov/press/releases/hp871.htm

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

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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

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



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

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



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

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




Financial Innovations:

Bank Credit Cards Debit Cards ATMs Electronic Banking

internet, telephone

Virtual banks E-money

Other Consumer Protection Acts and Regulations


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



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.


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.


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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.

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


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.


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 docking1 the commercial banking industry – history & structure

Documents

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