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Level 23

Regulation of Banks

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Safety and soundness regulation
assets must be diversified
Dodd-Frank Act of July 2010 (Wall Street Reform and Consumer Protection Act)
Promote better supervision of financial firms by creating a new Financial Services Oversight Council: to limit systemic risk
Consumer Financial Protection Agency (Dodd-Frank)
Created to protect consumers from unfair, deceptive and abusive practices, and improve transparency in dealing with consumers
Consumer Protection Regulation
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
The facets of regulatory structure
regulation of product and geographic expansion
Commercial banking vs. investment banking
commercial banking involves deposit taking and lending
Glass-Steagall Act of 1933
imposed a rigid separation between commercial and investment banks
the Bank Holding Company Act (BHCA) of 1956
restricted insurance companies from owning or being affiliated with commercial banks
Restrictions on intrastate banking
most banks used to be unit banks—i.e., banks with single offices
The Federal Deposit Insurance Corporation (FDIC)
The FDIC was created in 1933 during the Depression to restore public confidence in the banking system. The initial insurance limit was $2,500; this amount was periodically increased to $100,000, where it remained until…
Liquidity regulation
banks must hold minimum levels of reserves against net transaction accounts
Tier I capital
capital is composed of the book value of common equity plus an amount of perpetual preferred stock plus minority equity interests held by the bank in subsidiaries minus goodwill
Tier II capital
includes secondary capital resources such as loan loss reserves and convertible and subordinated debt
Risk-adjusted assets
include both on- and off-balance-sheet assets whose values are adjusted for approximate credit risk
Total risk-based capital ratio
is equal to the sum of Tier I and Tier II capital divided by risk-adjusted assets
Tier I (core) capital ratio
is equal to Tier I capital divided by risk-adjusted assets
Pillar 1:
Update regulatory capital requirements for credit, market and operational risk
Pillar 2:
Emphasized separate regulatory evaluation process in addition to capital requirements and stressed the importance of a bank's internal control procedures
Pillar 3:
Promote disclosure of the institution's capital structure, risk exposure, and capital adequacy
Federal Deposit Insurance Corporation (FDIC)
:There is a battle to maintain high levels of integrity and competence in the financial sector.
:The process of rule making and legislation creating the supervisory system , the rules from the law.
Regulation (objectives)
:Promote understanding of the financial system.
Main Features of a Regulatory System
Why do we regulate?
:Asymmetric info: this occurs when one party in a negotiation or relationship is not in the same position of other parties, being ignorant , or unable to observe information which is essential in the decision making process.
The drawback of extensive regulation
:Moral Hazard , High compliance costs.
Regulation of UK Financial Services
: For over a decade the Financial Services Authority (FSA)
a subsidiary of the Bank of England
:Responsible for the prudential regulation and supervision of financial institution they regulate around 1700 institutions.
FCA and the Prudential Regulatory Authority
: The PRA works alongside the FCA creating a "twin peaks" regulatory structure in the UK.