Fall 2014 BMFS Chapter 2

1. Fall 2014 BMFS Chapter 2 Government Policy and Regulation of the Financial Services Industry

2. See Reasons for Regulation on top of pg. 26 • Banks are Regulated Because: • Loss of the funds would be catastrophic for individuals and families. • Banks’ power to create money impacts the general economy. • Loans are seen as necessary to support consumption and investment. • Discrimination in lending can impact whole economic groups. • The public is more confident in the system if it is regulated • Banks provide credit (etc.) to Federal, State, and Local Governments. • Avoiding Concentrations of financial power is desired…SEE Question at end of Ch. 1 ppt.

3. The Regulators • See Table 2-1 pg. 26 • Pay special attention to: • Federal Reserve System • Federal Deposit Insurance Corporation • Securities and Exchange Commission • Commodities Futures Trading Commission

4. Major Banking Laws • Know the Names and General Purpose of Each • National Currency and Bank Act—Chartered “National” Banks. • Federal Reserve Act—Created a “Lender of Last Resort.” • Banking Act (Glass-Steagall)—Separated Commercial Banks from Investment Banks and Insurance Companies to minimize the risk for depositors. • Establishing FDIC under Glass-Stegall—Created Insurance for Depositors by guaranteeing them up to a limit. • FDIC Improvement Act—Allowed the FDIC to borrow from the Treasury to stay solvent (created a bottomless pit after the crash of Savings and Loans)

5. Major Banking Laws (cont.) • Reigle-Neal Interstate Banking Law—Repealed the MacFadden Act of 1927 and the Douglas Amendment of 1970 to again allow full service banks to operate across state lines. Major elements include: • Big banks can buy up banks anywhere in the US. • Bank Holding Companies can consolidate their operations. Banks must make loans in all communities where they take deposits. (Why do you think that is important?) • No single bank can control more than 10% of all US holding or 30% of any single state. (Is this enough competition? See the Question at the end of Chapter 1)

6. Banking Laws cont. • Financial Services Modernization Act (Graham-Leach-Bliley Act)—Overturned parts of Glass-Steagall Act and the Bank Holding Company Act. It again allowed Big Banks to affiliate with Investment and Insurance Companies under common ownership. (Why was that originally prohibited?) It was intended to allow Financial Companies to diversify their products and reduce their own business risk. • Patriot Act and Bank Secrecy Act Amendments—required banks to report suspicious acts of their customers. Including: • Identifying Customers as Individuals, • Reporting money transfers greater than $10,000, • Filing reports of possible money laundering.

7. Banking Laws cont. • Sarbanes-Oxley Accounting Standards Act—Created the Public Company Accounting Standards Board to enforce higher standards in the Accounting Profession and ensure more accurate financial information on publically held companies. Corporate officers and accountants can personally be held criminally liable. Insider loans must meet the same risk assessment as the general public. Federal Banking Agencies can now bar public accounting firms from performing audits. • Fair and Accurate Credit Transactions (FACT) Act—Identity Theft Victims can file a theft report and the Credit Bureaus must help resolve the problem. Each individual can get one free report a year from each bureau in order to detect fraud.

8. Banking Laws cont. • Check 21 Act—allows replacing a paper check with a check “substitute” containing an image of the check.

9. Banking Laws cont. • Bankruptcy Abuse Prevention and Consumer Protection Act—forces higher income earners into more costly forms of bankruptcy requiring some repayment. It is designed to reduce interest to all and to encourage less risk-taking by borrowers. • Federal Deposit Insurance Reform Act—sets up inflation adjustments for insured deposit maximums. Currently the limit is $250,000 per depositor per bank. • Emergency Stabilization Act—allowed the US Treasury to buy up $700,000,000,000 in bad debt.

10. Banking Laws cont. • Credit Card Accountability, Responsibility, and Disclosure Act (CARD)—ensures full disclosure by lenders: • Limits interest rates, • Restricts terms—such as a 45 day notice of changes, • Fee Clarification and Limitations, • Terms and Conditions are Published on the Internet. • Dodd-Frank Wall Street Reform and Consumer Protection Act (FINREG)—designed to rescue the global financial system from near collapse. (Do you think one bill could do that effectively? If it could what are the chances it is too big?) FINREG allows federal regulatory agencies to downsize and even take apart financial-service providers.

11. Banking Laws cont. • International Capital Agreements BASEL I, II, and III between US, Europe, and Asia—imposes the same capital rules on all major banks around the globe. (See Ch. 13) • See the timeline on pages 42-43.

12. Laws Regulating Non-Bank Financial Services Firms • Credit Unions are supervised by the National Credit Union Administration. • Savings and Loans Act. (SNLs) and Savings Banks are supervised by the Comptroller of the Currency since Dodd-Frank Regulatory Reform Act. • Money Market Funds operate under the Securities and Exchange Commission. • Life and Property/Casualty Insurance Companies are supervised by State Insurance Commissions. The Federal government is asserting authority through the Security and Exchange Commission. Frank-Dodd Regulatory Reform Act Created the Federal Insurance Office (FIO) to reduce systemic risk.

13. Laws Regulating Non-Bank Financial Services Firms • Security Brokers and Dealers and Investment Banks—While both State and Federal Regulations apply, the Securities and Exchange Commission (SEC) is the dominant control through their reporting requirements. • Hedge Funds, Private Equity Funds, and Venture Capital—lightly regulated but under broad oversight by the SEC on information provided to the public. Dodd-Frank includes a greater separation between Commercial banks and these riskier investors.

14. The Central Banking System—The Federal Reserve (The Fed) • Its primary job is monetary policy—making sure the supply and cost of money and credit supports the nation’s economic goals: • Economic Growth, • Low Unemployment, • Low inflation. • Organization: 12 District Reserve Banks • Supervised by a Board of Governors—the center of authority and decision-making. Seven people appointed by the President and Confirmed by the Senate. • Sets Discount Rates. • Sets Reserve Requirements. • Helps determine open market policy.

15. The Fed cont. • Federal Open Market Committee (FOMC)—The 7 members of the Board of Governors and 5 of the 12 Federal Reserve Bank Presidents. Sets policy for the open market operations (OMO)—buying and selling securities in the open market to influence the economy and financial system. • 12 Federal Reserve Banks—one for each district—supervises and serves member banks in the district: • Issuing wire transfers of funds between members, • Safe-keeping securities owned by members, • Issuing new securities from the US Treasury and other federal agencies,

16. The Fed cont. • Making loans to qualified depository institutions through the “Discount Window”, • Dispensing supplies of currency and coin, • Clearing and collecting checks and other cash items, • Providing information to keep financial-firm managers and the public informed about developments affecting the welfare of their institutions. • Member Banks—all national and some state chartered banks • Must purchase stock up to 6 % of capital and surplus, • Are examined by auditors.

17. Tools of Monetary Policy • The Fed implements its policy by influencing the: • Legal Reserves—assets the Fed requires the banks to hold on hand—helps determine the money supply. • Discount Rates—the interest rate banks pay the Fed to borrow money—helps control the interest rate and therefore the amount of money borrowed. • Open Market Operations—buying and selling US Treasury Bills, Bonds, and Notes as well as other federal agency securities in the open markets.

18. T-Bills, Bonds, and Notes • notes and bonds are marketable securities the U.S. government sells in order to pay off maturing debt and to raise the cash needed to run the federal government. When you buy one of these securities, you are lending your money to the government of the United States. T-bills are short-term obligations issued with a term of one year or less, and because they are sold at a discount from face value, they do not pay interest before maturity. The interest is the difference between the purchase price and the price paid either at maturity (face value) or the price of the bill if sold prior to maturity. Treasury notes and bonds, on the other hand, are securities that have a stated interest rate that is paid semi-annually until maturity. What makes notes and bonds different are the terms to maturity. Notes are issued in two-, three-, five- and 10-year terms. Conversely, bonds are long-term investments with terms of more than 10 years.  • http://www.investopedia.com/ask/answers/154.asp

19. How the OMO Works • Sales decrease deposits and loans in the financial system by drying up the funds—interest rates go up, • Purchases increase the funds available and tend to increase the deposits and loans in the financial system—interest rates go down, • The target is the Federal Funds Rate—the rate for overnight loans of reserves between banks.

20. The Discount Window • The Fed loans the reserves of one bank to another on a short term basis. Making these loans expands the supply of reserves temporarily which increases the supply of credit (loanable funds). Repayment of these funds reduces the supply of reserves thus reducing the supply of credit. • The interest rate the Fed charges on these loans is the “discount rate.” Low rates increase borrowing—increasing credit supplies while high rates decrease borrowing—decreasing the credit supply.

21. Reserve Requirements • The Fed can raise the amount required to be held in reserve which reduces the supply available for credit. Interest rates tend to go up, also. • It can lower the amount required to be held in reserve which increases the supply of available credit. Interest rates will tend to decline.

22. Term Auction Facility (TAF) and Term Securities Lending Facility (TSLF) • New tools that lend money for a month.