ChapterTwoTheImpactofGovernmentPolicyandRegulationontheFinancial-ServicesIndustryKeyTopicsThePrincipalReasonsforBankingandFinancial-ServicesRegulationMajorFinancial-ServicesRegulatorsandLawsTheRiegle-NealandGramm-Leach-Bliley(GLB)ActsTheCheck21,FACT,Patriot,Sarbanes-Oxley,BankruptcyAbuse,FederalDepositInsuranceReform,andFinancial-ServicesRegulatoryReliefActsEmergencyEconomicStabilizationActandtheGlobalCreditCrisisKeyTopics(continued)FINREGispassedintolawtoavoidseveredisruptioninthefinancialsystemanddealwithsystemicrickSomeKeyRegulatoryIssuesLeftUnresolvedTheCentralBankingSystemOrganizationandStructureoftheFederalReserveSystemandLeadingCentralBanksofEuropeandAsiaFinancial-ServicesIndustryImpactofCentralBankPolicyToolsIntroductionThischapterisdevotedtoastudyofthecomplexregulatoryenvironmentthatgovernmentsaroundtheworldhavecreatedforfinancial-servicefirmsinaneffortto:Safeguardthepublic’ssavingsBringstabilitytothefinancialsystemPreventabuseoffinancial-servicecustomersFinancialinstitutionsmustcontendwithsomeoftheheaviestandmostcomprehensiverulesappliedtoanyindustryRegulationisanuglywordtomanypeopleBurdensomeCostlyDamagingtoinnovationandefficiencyBankingRegulationWhyarebankscloselyregulated?Banksareamongtheleadingrepositoriesofthepublic’ssavingsBanksarecloselywatchedbecauseoftheirpowertocreatemoneyintheformofreadilyspendabledepositsbymakingloansandinvestmentsBankshavealonghistoryofinvolvementwithfederal,state,andlocalgovernmentsIntheUnitedStates,banksareregulatedthroughadualbankingsystemBothfederalandstateauthoritieshavesignificantregulatorypowersTABLE2–1Banking’sPrincipalRegulatoryAgenciesandTheirResponsibilitiesRegulationTheoriesOneoftheearliesttheoriesaboutregulationcontendsthatfirmsinregulatedindustriesactuallyseekoutregulationItbringsbenefitsintheformofmonopolisticrentsbecauseregulationsoftenblockentryintotheregulatedindustryAmorerecenttheoryarguesthatregulationscanincreasecustomerconfidence,whichmaycreategreatercustomerloyaltytowardregulatedfirmsThereisanongoingstrugglebetweenregulatedfirmsandtheregulatorsRegulatorydialecticFinancial-servicemanagerswillsearchtofindwaysaroundnewrulesinordertoreducecostsandallowinnovationtooccurMajorBankingLaws–WhereandWhentheRulesOriginatedNationalCurrencyandBankActs(1863–64)ThefirstmajorfederalgovernmentlawsinU.S.bankingweretheNationalCurrencyandBankActs,passedduringtheCivilWarTheselawssetupasystemforcharteringnewnationalbanksthroughanewlycreatedbureauinsidetheU.S.TreasuryDepartment,theOfficeoftheComptrolleroftheCurrency(OCC)TheComptrollernotonlyassessestheneedforandchartersnewnationalbanksbutalsoregularlyexaminesthoseinstitutionsMajorBankingLaws–WhereandWhentheRulesOriginated(continued)TheFederalReserveAct(1913)Aseriesoffinancialpanicsinthelate19thandearly20thcenturiesledtothecreationoftheFederalReserveSystem(theFed)TheFed’sprincipalrolesaretoserveasalenderoflastresortandtohelpstabilizethefinancialmarketsandtheeconomyTheirmostimportantjobtodayistocontrolmoneyandcreditconditionstopromoteeconomicstabilityMajorBankingLaws–WhereandWhentheRulesOriginated(continued)TheBankingActof1933(Glass-Steagall)TheGlass-SteagallActdefinedtheboundariesofcommercialbankingbyprovidingconstraintsthatwereeffectiveformorethan60yearsThislegislationseparatedcommercialbankingfrominvestmentbankingandinsuranceTheFederalDepositInsuranceCorporation(FDIC)wascreatedtoguaranteethepublic’sdepositsuptoastipulatedmaximumamountinordertoenhancepublicconfidenceinthebankingsystemInitially$2,500andtodayitisupto$250,000MajorBankingLaws–WhereandWhentheRulesOriginated(continued)TheFDICImprovementAct(1991)

TheFDICwastheobjectofcriticismduringthe1980sand1990sThislegislationpermittedtheFDICtoborrowfromtheTreasurytoremainsolvent,calledforrisk-basedinsurancepremiums,anddefinedtheactionstobetakenwhendepositoryinstitutionsdidnotmeetcapitalrequirementsPriorto1993,theFDICimposedfixedinsurancepremiumsonalldepositseligibleforinsurancecoverage,regardlessoftheriskinessofanindividualdepositoryinstitution’sbalancesheetThisfixed-feesystemledtoamoralhazardproblemMajorBankingLaws–WhereandWhentheRulesOriginated(continued)SocialResponsibilityLawsConsumerCreditProtectionAct(knownasTruthinLending)Requiredthatlendersspelloutthecustomer’srightsandresponsibilitiesunderaloanagreementDodd-FrankRegulatoryReformbillEmphasizedprovidingconsumerswithmorecompleteandunderstandablelanguagetoconveyservicepricesandavoidmisleadinginformationEqualCreditOpportunityActIndividualsandfamiliescouldnotbedeniedaloanmerelybecauseoftheirage,sex,race,nationalorigin,orreligiousaffiliation,orbecausetheywererecipientsofpublicwelfareMajorBankingLaws–WhereandWhentheRulesOriginated(continued)SocialResponsibilityLawsCommunityReinvestmentActProhibitsU.S.banksfromdiscriminatingagainstcustomersresidingwithintheirtradeterritoriesmerelyonthebasisoftheneighborhoodinwhichtheylivedCompetitiveEqualityinBankingActandtheTruthinSavingsActRequirebankstomorefullydisclosetheirservicepoliciesandthetrueratesofreturnofferedonthepublic’ssavingsandthefeesassociatedwithcreditservicesTABLE2–2RegulatorsofU.S.InsuredBanksMajorBankingLaws–WhereandWhentheRulesOriginated(continued)TheRiegle-NealInterstateBankingLaw(1994)Repealedpreviousprovisionsthatpreventedfull-serviceinterstatebankingnationwideMajorprovisionsoftheRiegle-NealActincluded:AdequatelycapitalizedandmanagedholdingcompaniescanacquirebanksanywhereintheUnitedStatesInterstateholdingcompaniesmayconsolidatetheiraffiliatedbanksacquiredacrossstatelinesintofull-servicebranchofficesNosinglebankingcompanycancontrolmorethan10percentofnationwidedepositsormorethan30percentofdepositsinasinglestate(unlessastatewaivesthislatterrestriction)ForthefirsttimeinU.S.history,AmericanbankscouldacceptdepositsandfollowtheircustomersacrossstatelinesMajorBankingLaws–WhereandWhentheRulesOriginated(continued)TheFinancialServicesModernizationAct(TheGramm-Leach-BlileyAct(1999))OneofthemostimportantU.S.bankingstatutessignedintolawOverturnedlong-standingprovisionsoftheGlass-SteagallActandtheBankHoldingCompanyActPermittedbankingcompaniestoaffiliatewithinsuranceandsecuritiesfirmsundercommonownershipSecuritiesandinsurancecompaniescouldformfinancialholdingcompaniesthatcontroloneormorebanksBankswerepermittedtosellinsuranceandsecurityservices,providedtheyconformtostateandfederalrulesThislaw’spurposewastoallowqualifiedU.S.financial-servicecompaniestodiversifytheirserviceofferingsandreducetheiroverallbusinessriskexposureMajorBankingLaws–WhereandWhentheRulesOriginated(continued)TheUSAPatriotActMadeaseriesofamendmentstotheBankSecrecyActPassedoriginallyin1970tocombatmoneylaunderingRequiresthatfinancial-serviceprovidersestablishtheidentityofcustomersopeningnewaccountsorholdingaccountswhosetermsarechangedUsuallyaccomplishedbyaskingforadriver’slicenseorotheracceptablepictureIDandobtainingthesocialsecuritynumberofthecustomerServiceprovidersarerequiredtocheckthecustomer’sIDagainstagovernment-suppliedlistofterroristorganizationsandreportanysuspiciousactivityinacustomer’saccountThe21stCenturyUshersinanArrayofNewLawsandRegulations–FINREG,TheBaselAgreement,andOtherRulesAroundtheGlobeTheFACTActof2003TheCheckClearingforthe21stCenturyAct(Check21Act)TheBankruptcyAbusePreventionandConsumerProtectionActof2005TheFederalDepositInsuranceReformActof2005TheEmergencyEconomicStabilizationActof2008TheCreditCardAccountability,Responsibility,andDisclosureActof2009TheDodd-FrankWallStreetReformandConsumerProtectionActof2009(FINREG)BaselIandII,andBaselIIIThe21stCenturyUshersinanArrayofNewLawsandRegulations–FINREG,TheBaselAgreement,andOtherRulesAroundtheGlobe(continued)UnresolvedRegulatoryIssuesWhatshouldwedoabouttheregulatorysafetynetsetuptoprotectsmalldepositorsfromloss,usuallythroughgovernment-sponsoreddepositinsurance?Canwetrainregulatorstobeasgoodastheyneedtobeinamorecomplexfinancialmarketplace?Withthefinancial-servicesindustryconsolidatingandconvergingintofewer,butbigger,firms,canwegetbywithfewerregulators?Canwesimplifythecurrentregulatorystructureandbringgreaterefficiencytothetask?Asfinancialfirmsreachtheirarmsaroundtheglobe,whatnationornationsshouldregulatetheiractivities?TheRegulationofNonbankFinancial-ServiceFirmsCompetingwithBanksCreditUnionsNationalCreditUnionAdministration(NCUA)SavingsandLoansandSavingsBanks(“Thrifts”)State-charteredassociationsaresupervisedandexaminedbystateboardsorcommissionsFederallycharteredsavingsassociationsfallunderthejurisdictionoftheOfficeofThriftSupervisionTheDodd-FrankActmergedtheOfficeofThriftSupervisionwiththeOfficeoftheComptrolleroftheCurrencysothatthriftinstitutionsandnationalbankswouldhavethesameregulatoryagencyatthefederallevelMoneyMarketFundsSecuritiesandExchangeCommission(SEC)TheRegulationofNonbankFinancial-ServiceFirmsCompetingwithBanks(continued)LifeandProperty/CasualtyInsuranceCompaniesStateinsurancecommissionsRecentlythefederalgovernmenthasbecomesomewhatmoreinvolvedininsuranceWheninsurersformholdingcompaniestoacquirecommercialandinvestmentbanksorotherfederallyregulatedfinancialbusinesses,theymaycomeundertheFederalReserve’sreviewUndertheDodd-FrankAct,anewfederalinsuranceofficewassetuptohelpreducethesystemicriskcausedbyinnovative,butsometimeshighlyrisky,activitiesofthelargestinsurers(suchasAIG)andpreventdisruptiveinsurancefailuresTheRegulationofNonbankFinancial-ServiceFirmsCompetingwithBanks(continued)FinanceCompaniesRegulatedatthestategovernmentlevelformanydecadesThedepthofstateregulationvariesacrosstheUnitedStatesMoststatesfocusuponthetypesandcontentsofloanagreementstheyofferthepublic,theinterestratestheycharge(withsomestatessettingmaximumloanrates),andthemethodstheyusetorepossesspropertyortorecoverfundsfromdelinquentborrowersRelativelylightstateregulationhasledtoarecentexplosioninthenumberofsmall-loancompaniesThepassageoftheDodd-FrankActin2010causedmanytocloseasthemaximuminterestratesthattheseentitiescouldchargewasdrasticallyreducedTheRegulationofNonbankFinancial-ServiceFirmsCompetingwithBanks(continued)MutualFundsTheU.S.SecuritiesandExchangeCommission(SEC)requiresthesebusinessestoregisterwiththatagency,submitperiodicfinancialreports,andprovideinvestorswithaprospectusthatrevealsthefinancialcondition,recentperformance,andobjectivesofeachfund

SecurityBrokersandDealersandInvestmentBanksAcombinationoffederalandstatesupervisionappliestothesetradersinfinancialinstrumentswhobuyandsellsecurities,underwritenewsecurityissues,andgivefinancialadviceThechieffederalregulatoristheSECRequiresthesefirmstosubmitperiodicreports,limitsthevolumeofdebttheytakeon,andinvestigatesinsidertradingpracticesTheRegulationofNonbankFinancial-ServiceFirmsCompetingwithBanks(continued)HedgeFunds,PrivateEquityFunds,andVentureCapitalCompaniesSomeofthemostlightlyregulatedofallfinancialinstitutionsTheSECintheUnitedStateshasbroadoversightoftheinformationthesefirmsprovidetothepublicwhentheychoosetosellsecuritiesintheopenmarketthatareaccessibletosmallinvestorsRegulationinthissectorisvirtuallyinvisible,inpartbecauseitisrelativelynewandbecauseitnormallydoesnotseekoutmanyfundsfromsmallinvestorsTheDodd-FrankActof2010callsforgreaterseparationbetweencommercialbanksandtheseriskierprivateinvestorsTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutionsThecentralbankoftheUnitedStatesistheFederalReserveSystem(theFed)Acentralbank’sprimaryjobismonetarypolicyInvolvesmakingsurethesupplyandcostofmoneyandcreditfromthefinancialsystemcontributetothenation’seconomicgoalsBycontrollingthegrowthofmoneyandcredit,theFedandothercentralbanksaroundtheglobetrytoensurethattheeconomygrowsatanadequaterate,unemploymentiskeptlow,andinflationishelddownTheFedisfreetopursuethesegoalsbecauseitdoesnotdependonthegovernmentforitsfundingPassesalongmostofitsearningstotheU.S.TreasuryTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)TheEuropeanUnionalsohaveacentralbank–theEuropeanCentralBank(ECB)ItisrelativelyfreeandindependentofgovernmentalcontrolasitpursuesitsmaingoalofavoidinginflationIncontrast,theBankofJapan(BOJ),thePeople’sBankofChina(PBC),andcentralbanksinotherpartsofAsiaappeartobeunderclosecontroloftheirgovernmentsSeveralofthesecountrieshaveexperiencedhigherinflationrates,volatilecurrencyprices,andothersignificanteconomicproblemsinrecentyearsRecentresearchsuggeststhatmoreindependentcentralbankshavebeenabletocomeclosertotheirnation’sdesiredlevelofeconomicperformance(particularlybettercontrolofinflation)TheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)OrganizationalStructureoftheFederalReserveSystemBoardofGovernorsThisgoverningbodymustcontainnomorethansevenpersons,eachselectedbythepresidentoftheUnitedStatesandconfirmedbytheSenatefortermsnotexceeding14yearsTheboardchairmanandvicechairmanareappointedbythepresidentfromamongcurrentboardmembers,eachforfour-yearterms(thoughtheseappointmentsmayberenewed)Theboardregulatesandsupervisestheactivitiesofthe12districtReservebanksandtheirbranchofficesItsetsreserverequirements,approvesallchangesinthediscount(loan)ratespostedbythe12Reservebanks,andtakestheleadinthesystemindeterminingopenmarketpolicyTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)OrganizationalStructureoftheFederalReserveSystemFederalOpenMarketCommittee(FOMC)TheFederalReserveBoardmembersmakeupamajorityofthevotingmembersoftheFOMCTheothervotingmembersare5ofthe12FederalReservebankpresidents,whoeachserveoneyearinfillingtheremainingfiveofficialvotingseatsontheFOMCExceptforthepresidentoftheNewYorkFederalReserveBank,whoisapermanentvotingmemberPrimarytaskistosetpoliciesthatguidetheconductofopenmarketoperationsThebuyingandsellingofsecuritiesbytheFederalReservebanksTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)OrganizationalStructureoftheFederalReserveSystemThereare12districtscontainedintheFederalReserveSystem,withaFederalReserveBankcharteredineachdistrictKeyservicesthattheFederalReservebanksoffertodepositoryinstitutionsintheirdistricts:IssuingwiretransfersoffundsbetweendepositoryinstitutionsSafe-keepingsecuritiesownedbydepositoryinstitutionsandtheircustomersIssuingnewsecuritiesfromtheU.S.TreasuryandselectedotherfederalagenciesMakingloanstoqualifieddepositoryinstitutionsthroughthe“DiscountWindow”TheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)OrganizationalStructureoftheFederalReserveSystemKeyservicesthattheFederalReservebanksoffertodepositoryinstitutionsintheirdistricts:DispensingsuppliesofcurrencyandcoinClearingandcollectingchecksandothercashitemsProvidinginformationtokeepfinancial-firmmanagersandthepublicinformedaboutdevelopmentsaffectingthewelfareoftheirinstitutionsAllbankscharteredbytheComptrolleroftheCurrency(nationalbanks)andthosefewstatebankswillingtoconformtotheFed’ssupervisionandregulationaredesignatedmemberbanksMemberinstitutionsmustpurchasestock(upto6percentoftheirpaid-incapitalandsurplus)inthedistrictReservebankandsubmittocomprehensiveexaminationsTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)TheCentralBank’sPrincipalTask:MakingandImplementingMonetaryPolicyAcentralbank’sprincipalfunctionistoconductmoneyandcreditpolicytopromotesustainablegrowthintheeconomyandavoidsevereinflationTopursuetheseimportantobjectives,mostcentralbanksuseavarietyoftoolstoaffectthelegalreservesofthebankingsystem,theinterestrateschargedonloansmadeinthefinancialsystem,andrelativecurrencyvaluesintheglobalforeignexchangemarketsToinfluencethebehavioroflegalreserves,interestrates,andcurrencyvalues,centralbanksusuallyemployoneormoreofthreemaintools:openmarketoperations,thediscountrateonloanstoqualifiedfinancialinstitutions,andlegalreserverequirementsonvariousbankliabilitiesTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)TheOpenMarketPolicyToolofCentralBankingOpenmarketoperations(OMO)havebecometheprincipaltoolofcentralbankmonetarypolicyIntheUnitedStates,OMOinvolvesthebuyingandsellingofU.S.Treasurybills,bonds,andnotesandselectedfederalagencysecuritiesThesetransactionsareconductedbetweentheFed’stradingdeskandselectedprimarydealerswhomeettheFed’squalificationsOMOisconsideredtobethemostimportantpolicytoolformanycentralbanksbecauseitcanbeusedeverydayand,ifamistakeismadeorconditionschange,itseffectscanbequicklyreversedTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)TheOpenMarketPolicyToolofCentralBankingCentralbanksalesofsecuritiestendtodecreasethegrowthofdepositsandloanswithinthefinancialsystemInterestratestendtoriseIncontrast,centralbankpurchasesofsecuritiestendtoincreasethegrowthofdepositsandloansInterestratestendtofallTheFOMCtargetsthefederalfundsrateattachedtoovernightloansofreservesbetweendepositoryinstitutionsinordertoachievetheFed’smonetarypolicygoalsInthehopethatchangesinthefederalfundsratewillspreadtootherinterestratesintheeconomyEXHIBIT2–1LeadingPrimaryDealersAuthorizedtoTradeSecuritieswiththeFederalReserveinordertoAssistwithMonetaryPolicy(April2010)EXHIBIT2–2ExampleofaFederalOpenMarketCommittee(FOMC)Statement,SettingaTargetfortheFederalFundsRatetoBeAchievedthroughOpenMarketOperationsTheCentralBankingSystem:ItsImpactontheDecisionsandPoliciesofFinancialInstitutions(continued)OtherCentralBankPolicyToolsManycentralbanksareanimportantsourceofshort-termloansfordepositoryinstitutionsWhentheFedloansreserves,thesupplyoflegalreservesexpandstemporarily,whichmaycauseloansanddepositstoexpandWhenthesediscountwindowloansarerepaid,theborrowinginstitutionslosereservesandmaybeforcedtocurtailthegrowthoftheirdepositsandloansTheloanratechar