Bank Regulation Slides

7/25/2019 Bank Regulation Slides

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Regulating the Banking

System Banks provide important economic functions

Access to the payments system

Reduction of asymmetric information problems

Liquidity transformation

BUT, the structure of banks assets andliabilities that provides liquiditytransformation makes banks prone to runs

!urthermore, interconnectedness and commone"posure of banks can cause a bank run tospread into a full#blo$n %nancial crisis


2/18


System &overnment safety net reduces likelihood

of bank runs 'eposit insurance

Lender of last resort

BUT, government safety net createsmoral ha(ard for banks

)ncentives for e"cessive risk#taking *banksreap gains, government+ta"payers bearlosses

Too#big#to#fail


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System -hat is the ob.ective of %nancial regulation/

0itigate the asymmetric information problems and e"cessive risk#taking in the %nancial system

)ncentives for e"cessive risk#taking result from limited liability, and

are ampli%ed by the government safety net

!orms of regulation1

Restrictions on asset holdings

2apital requirements

3rompt corrective action

Supervision1 2hartering, e"amination, risk assessment

'isclosure requirements

2onsumer protection

Restrictions on competition


4/18

Restrictions on Asset

4oldings 2annot hold common stock

Bonds must be investment#grade

Bonds from a single issuer cannot e"ceed567 of capital

Loans to another bank cannot e"ceed567 of capital


5/18

2apital Requirements

Leverage ratio 2apital+total assets must be 867 to be considered 9$ell#capitali(ed:

Banks $ith lo$er leverage ratios are sub.ect to increased regulatoryrestrictions

-hy set capital requirements/ Basel Accords1 Risk#$eighted capital requirements

)nternational agreement on capital requirements

2apital should e"ceed to ;7 of risk#$eighted assets

Reserves and 7

0uni bonds and residential mortgages1 6>7

2onsumer and corporate loans1 ?>>7


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2apital Requirements

Basel ))) Updated risk $eights

Absolute *not risk#$eighted minimum leverage ratio -hy/

Restrictions on dividends and bonuses $hen bank gets tooclose to the minimum leverage ratio

-hy/

2ountercyclical capital bu@er1 higher minimum leverageratio in good times, lo$er in bad times

-hy/

Systemic capital surcharge1 higher minimum leverage ratiofor systemically important %nancial institutions *S)!)s

-hy/


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!inancial Supervision

2hartering -ith 2omptroller of the 2urrency *national banks

-ith state banking authority *state banks

Revie$ initial capital, management quality, likely earnings,

etc to determine $hether bank $ill be sound

="amination Regular onsite inspections by regulators

Capital adequacy, Asset quality, Management, Earnings,Liquidity, Sensitivity to market risk *CAMELS

Assessment of Risk 0anagement Assess internal oversight and policies for risk management

Stress tests

alue at risk


8/18

Regulatory 2apture

Refers to potential for regulators becomeco#opted by the entities or industriesthey are supposed to regulate

-ork to advance the commercial+politicalinterests of the industry, rather than thepublic interest

'icult to avoid, because former bank

e"ecutives are often the only ones $ithe"pertise to be e@ective regulators


9/18

Regulatory 2apture

)n ?>, Judge George Painter *;Cretired as ? of t$o acting .udges at the 2!T2*2ommodity !utures Trading 2ommissionD As partof his retirement, he asked that his pending casesnot be turned over to the only other 2!T2 .udge,the honorable Bruce LevineD

3ainter said, in a $ritten statement, E


10/18

Regulatory 2apture

-endy &ramm *$as chair of the 2!T2 under&eorge Bush

Shortly after 3resident Bill 2linton took oce in?KKC, and &ramm $as set to lose herchairmanship, she pushed through a rule

deregulating the trading of energy contractsD=nron had been lobbying for e"emption fromregulation for monthsD

Si" days later she resignedD !ive $eeks latershe $as on the board at =nron and served onits Audit Committee

After the =nron Scandal *e"ecutives agreed toa ?M; million settlement, of $hich ?66million $as paid by insurance

She currently sits on several boards *of large,$ell#kno$n %rms and is a distinguished seniorscholar at the 0ercatus 2enter N a think tankat &eorge 0ason UniversityD

She has discussed running for presidentD


11/18

'odd#!rank Act *5>?>

'odd#!rank -all Street Reform and2onsumer 3rotection Act

Single biggest overhaul of %nancial system

since ?KC>s

;>>#page monster

3roposed by Barney !rank *' and 2hris 'odd*' using a series of proposals crafted by the


12/18


The stated aim of the legislation19To promote the %nancial stability of theUnited States by improving accountability

and transparency in the %nancial system,to end Etoo big to failE, to protect theAmerican ta"payer by ending bailouts, toprotect consumers from abusive %nancial

services practices, and for otherpurposesD:

The 'odd#!rank Act has ?M di@erentprovisional headingsD


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0a.or components of the original proposals1

?D The consolidation of regulatory agencies, elimination of the national thriftcharter, and ne$ oversight council to evaluate systemic riskO

5D 2omprehensive regulation of %nancial markets, including increasedtransparency of derivatives *bringing them onto e"changesO

CD 2onsumer protection reforms including a ne$ consumer protection agencyand uniform standards for Eplain vanillaE products as $ell as strengthenedinvestor protectionO

QD Tools for %nancial crises, including a Eresolution regimeE complementingthe e"isting !ederal 'eposit )nsurance 2orporation *!')2 authority toallo$ for orderly $inding do$n of bankrupt %rms, and including a proposal

that the !ederal Reserve *the E!edE receive authori(ation from theTreasury for e"tensions of credit in Eunusual or e"igent circumstancesEO

6D arious measures aimed at increasing international standards andcooperation including proposals related to improved accounting andtightened regulation of credit rating agenciesD


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olcker Rule =ssentially a reestablishment and

clari%cation of the original

separation bet$een commercial andinvestment banks *&lass#Steagal

=@ectively bans proprietary#trading*prop#tradingby commercial banks usingdeposited fundsD

-hy is this a good idea/

-hy is this a bad idea/


15/18

'odd#!rank Act1

Successes/These are !idel contested and debatedD -hy might each ofthese help/ -hy might it hurt or be ine@ective/

?D)mproved systemic risk managementD '! creates a ne$committee, the !inancial Stability


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'odd#!rank Act1

Successes/5Dolcker Rule and 9skin#in#the#game: provisions Nrequiring issuers to maintain partial o$nership of%nancial instrumentsD

CDReducing TBT! through tighter !')2 restrictions and

restrictions on federal loans to nonbank institutionsD

QD2reating the 2onsumer !inancial 3rotection Bureau toprotect consumers from 9unscrupulous businesspractices:

6DThe -histleblo$er provision N reporting securityviolations entitles the $histleblo$er to a %nancialre$ardD

MDThe construction of clearinghouses *of sorts and publice"changes for derivatives N to increase transparencyD


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'odd#!rank Act1 !ailures/

These are also !idel contested and debatedD

?D!ails to address the overlapping and confusing mess ofregulator responsibilitiesD

5DThe implicit insurance of !')2 and S)!)#status continuesto encourage moral ha(ard and does not end TBT!D

CD&S=s are still a question markD &overning these quasi#government, quasi#private entities is still a mysteryD

QD'! says very little about 000!s *remember Lehman

and Reserve 3rimary !und6DLegislative and regulatory uncertainty continue to

curtail progressD


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!inal Thoughts

-ill '! ultimately be 9successful:/ -hatis 9success: in this conte"t/

Should banking regulation focus onlimiting behavior, or modifyingincentives/ -hy/

=conomic roles of banks1

-hat makes banks prone to runs/ )s this %nancial structure for banks, and all of

the problems it creates, really necessary/ -hich of the economic roles of banks requires this

structure/

'o $e still need banks to preform this role/

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