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CHAPTER 18

CHAPTER 18. Bank Regulation. CHAPTER 18 OVERVIEW. This chapter will: A. Describe the key regulations imposed on commercial banks B. Explain how regulators monitor banks. Key Regulations. 1. U.S. is a dual banking system: it includes both federal and state regulators

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CHAPTER 18

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  1. CHAPTER 18 Bank Regulation

  2. CHAPTER 18 OVERVIEW This chapter will: A. Describe the key regulations imposed on commercial banks B. Explain how regulators monitor banks

  3. Key Regulations 1. U.S. is a dual banking system: it includes both federal and state regulators 2. A state or national charter is required to open a commercial bank in the U.S. 3. National banks are regulated by Comptroller of Currency, the Fed, and federal deposit insurance corporation (FDIC). 4. State banks are regulated by state agency, the Fed( if they are Fed members), and the FDIC.

  4. Key Regulations 4. Deregulation Act of 1980 a. Eliminated interest-rate ceilings (formerly known as Regulation Q) b. All banks could offer NOW accounts c. More flexibility in lending d. Fed would now charge for its services

  5. Regulation of Operations Regulation of Assets 1.) highly leveraged transactions (HLTs) 2.) bank’s exposure to foreign debt 3.) loan diversification 4.) not allowed to use borrowed or deposited funds to purchase common stock; can invest in bonds with investment-grade quality.

  6. Regulation of Operations Regulation of Capital (equity) are required to maintain minimum amount of capital a. Basel Accord: promoted uniform capital requirements between 12 countries banks were required to have a minimum Tier 1 capital ratio of 4 %. (shareholder’s equity, retained earnings, preferred stock) b. Basel II Accord

  7. How Regulators Monitor Banks Regulators apply the CAMELS Ratings in their audits: 1. Capital Adequacy 2. Asset Quality 3. Management 4. Earnings 5. Liquidity 6. Sensitivity

  8. CAMELS 1. Capital Adequacy a. based on the capital ratio (=capital divided by assets) b. When banks hold more capital, they can more easily absorb potential losses c. The higher the ratio, the higher the capital adequacy rating

  9. CAMELS 2. Asset Quality Indicates the bank’s exposure to credit risk (i.e. loan quality)

  10. CAMELS 3. Management a. Ratings based on management’s 1.) administrative skills 2.) ability to comply with existing regulations 3.) ability to cope with a changing environment b. Internal control system

  11. CAMELS 4. Earnings a. Criteria ratio: Return on Assets (ROA) ROA = Earnings after Taxes assets b. Compare earnings with industry standards

  12. CAMELS 5. Liquidity Ability to pay obligations

  13. CAMELS 6. Sensitivity the degree to which a bank might be exposed to adverse financial market conditions.

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