Friday Talk: Financial crisis Course in spring on financial crisis
Chapter 11 &12 Regulation & Industry Structure
Links: Marginal Revolution▪ http://www.marginalrevolution.com/
Safety and soundness regulation Entry, branching, network, and mergers▪ Chapter 12
Deposit insurance Deposit interest ceilings Portfolio restrictions, including reserve
requirements Capital requirements Regulatory monitoring and supervision
1-2
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 11-3
Source: www.fdic.gov/bank/historical/bank/index.html.
11-5
A story of Changing financial conditions
▪ See marginal revolution link
Deregulation
Reregulation
Declining profitability of traditional business High interest rate environment ▪ Cost of funds increase, but long term loans on books
Regulatory relief Depository Institutions Deregulation and
Monetary Control Act▪ Rate ceilings abolished (both lending and deposit)▪ Increased deposit insurance▪ Entry to new businesses allowed
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-6
11-7
Managers did not have expertise in managing risk
Rapid growth in new lending, real estate in particular
Activities expanded in scope; regulators at FSLIC did not have expertise or resources
High interest rates and recession increased incentives for moral hazard
11-8
Regulatory forbearance by FSLIC Insufficient funds to close insolvent S&Ls Established to encourage growth Did not want to admit agency was in trouble
Zombie S&Ls taking on high risk projects
Attract business from healthy S&Ls
Losses amount to $150 billion
11-9
Regulatory apparatus restructured Federal Home Loan Bank Board relegated
to the OTS FSLIC given to the FDIC RTC established to manage and resolve
insolvent thrifts Re-restricted asset choices
FDIC went broke Federal Deposit Insurance Corporation Improvement
Act of 1991 Recapitalize the Bank Insurance Fund
▪ Increase ability to borrow from the Treasury▪ Higher deposit insurance premiums
Reform the deposit insurance and regulatory system to minimize taxpayer losses Prompt corrective action provisions
▪ Classification scheme 1-5 , category 3 must have corrective action plan▪ Category 5 - weakest banks must be closed by FDIC▪ equity< 2% of assets receivership within 90 days
Risk-based insurance premiums▪ Later led to CDS market
Preserve independence of regulator by eliminating discretion Discretion creates opportunities for
corruption or capture Eliminate ‘zombies’ with prolonged capital
inadequacy Zombies likely to create additional harms
(by taking on more risky deals) Either bank or regulator must add capital
10-11
Top Related