Financial Regulators An Economic Analysis of Financial Regulation

1. Financial Regulators An Economic Analysis of Financial Regulation

2. History of the Fed Created in 1913 by an act of Congress. Two previous failed attempts at instituting an European-style government-controlled Central Bank: • Bank of the United States (1791-1811) • Second Bank of the United States (1816-1836) Unique in its organization and structure Resembles the American system of governance characterized by checks and balances. Recently replicated by the European Central Bank.

3. Formal Structure of the Fed The Fed is controlled by three organisms: • Board of Governors: Seven governors of the Fed appointed by the President with Senate approval for 14-year terms • Reserve Banks: there are 12 Federal Reserve Banks, each located in a large city in its district • The Federal Open Market Committee (FOMC): the principal policy-making body within the Federal Reserve System, composed of the seven members of the Board of Governors and five Reserve Bank presidents

4. Functions of the Federal Reserve System The Fed (central bank of the United States) has the following functions: • Formulates Monetary Policy, so that recessions are short and expansions non-inflationary. • Supervises and Regulates the Financial System, insuring the safety and soundness of the financial system. • Facilitates the Payments Mechanism, guaranteeing the safe and efficient transfer of funds. • Acts as Fiscal Agent for the U.S. Government -maintains the Treasury’s transactions account.

5. Fed Controls Monetary Policy Monetary Policy: The attempts by the Fed to stabilize the economy and to ensure sufficient money and credit for an expanding economy Tools of Monetary Policy: Control of the money supply is achieved by management of: • Required Reserve Ratio: the fraction of reserve assets that the Fed requires depository institutions to hold against outstanding checkable deposit liabilities • Discount Rate: the rate depository institutions are charged to borrow reserves from the Fed • Open Market Operations: the buying and selling of government securities conducted by the Fed in order to change the reserves of depository institutions

6. The Fed Regulates the Financial System Promotion of Safe and Sound Financial Institutions: by setting minimum capitalization levels, banning excessively risky financial operations and supervising proper record-keeping and auditing Consumer Advocate: protection of bank costumers’ interests when dealing with financial intermediaries so that these behave in a fair and non-discriminatory fashion. Lender of Last Resort: the Fed is responsible for lending to commercial banks during emergencies and thus providing banks with the necessary funds to avoid insolvency

7. The Fed Facilitates the Payment Mechanism Issuing currency: the Fed issues new bills and coins (minted by the Bureau of Engraving and Printing) to the member banks. It also withdraws from circulation the worn and damaged currency Transferring Funds: • The Fed manages the electronic system that centralizes the transferring of funds among financial institutions • The Fed is also responsible for the physical paper check processing –what is known as check clearing

8. The Fed is the Bank of the Federal Government As chief banker for the US Govt. the Fed is the agent of the US treasury: • Govt. purchases are paid from Fed accounts • Tax revenues are deposited in Fed accounts • Tax reimbursement checks are issued by the Fed • Govt. bonds and bills are issued, serviced and redeemed by the Fed Financial independence: the Fed does not receive a budget allocation because it can self-finance its operations. This increases its management independence from Congress

9. Allocation of Policy Tools inside the Fed Board of Governors: • Sets reserve requirements and approves discount rates • Supervises and regulates member banks and bank holding companies • Establishes and administers protective regulations in consumer finance • Oversees Federal Reserve Banks Reserve Banks: • Propose discount rates • Lend funds to depository institutions (discount policy) • Furnish currency to commercial banks • Collect and clear checks and transfer funds for depository institutions • Handle U.S. government debt and cash balances The Federal Open Market Committee (FOMC): • Directs open market operations, which are the primary instrument of monetary policy

10. History of the IMF Created in 1947 by an international agreement known as the Bretton Wood Accord of 1944. • This is the first international institution ever created to supervise international finance • It is owned and directed by the countries that choose to join it (182 members) • Its financing comes from member dues (US=17%) There are two clear periods of IMF operations: • Bretton Woods period (1947-1973) • Managed float period (1973-present)

11. Functions of the IMF The International Monetary Fund has the following functions: • Short-term lender, so that member countries can borrow those funds needed to pay for temporary balance of payments disequilibria. • Evaluator of credit risk, determining the access to credit from World Bank that developing countries may enjoy. • Medium-term lender, providing financial assistance to countries with specific financial problems under terms of conditionality. • Gatherer of statistical information, supplied by each member country.

12. Recent IMF Interventions

13. The Controversy with the IMF The IMF loans are made under “conditionality”: • Funds are not disbursed all at once but in “tranches” -installments. • Access to each tranche is conditional to having fulfilled certain previous requirements. • Financing conditions usually involve strict fiscal and monetary policies that are politically unpopular. • Lack of transparency and concerns about economic neo-colonialism have put the IMF in the spotlight.