978-0077861667 Chapter 13 Lecture Note Part 4

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Chapter 13 – Regulation of Commercial Banks 6th Edition

1. Foreign Versus Domestic Regulation of Commercial Banks

a. Product Diversification Activities

The passage of the FSMA allowed U.S. banks to engage in activities similar to most other

developed country banks. Japan, which had a system more like the U.S., also

deregulated.

b. Global or International Expansion Activities

U.S. banks’ foreign activity

U.S. banks have been establishing foreign operations since the Investment Control Act

of 1964 limited U.S. banks’ ability to lend to U.S. firms seeking funding for foreign

investment. Under Regulation K of the Federal Reserve, foreign subsidiaries of U.S.

banks are normally allowed to engage in whatever banking activities are allowed in the

host country.

Financial services have traditionally been industries highly protected from international

competition (except for the U.S.). NAFTA and the WTO have reduced barriers to

international banking, and offshore banking is growing rapidly.

Foreign banks’ U.S. activity

The International Banking Act (IBA) of 1978 is the key piece of modern legislation that

affects foreign bank activity in the U.S. Prior to 1978 foreign banks’ U.S. operations

were not allowed to offer federally insured deposits, effectively excluding them from

retail banking activities. Foreign banks had advantages in wholesale banking however

since they were excluded from reserve requirements, the McFadden Act and the

Glass-Steagall Act. The IBA provided for ‘national treatment,’ i.e., all large banks

(global assets > $1 billion) regardless of their country of origin have to meet the same

requirements, although existing operations in violation of the laws were grandfathered.

In 1991 the Foreign Bank Supervision Enhancement Act (FBSEA) was passed, largely

as a response to the BCCI scandal. The five main provisions are:

1. A foreign banking organization has to obtain Federal Reserve approval to establish

any entity in the United States. The Fed may not grant approval unless the applicant

bank is adequately regulated at home and is willing to provide information to the Fed.

2. The Federal Reserve has the authority to close a foreign bank for various reasons,

including violation of U.S. laws or unsafe banking practices.

3. The Fed has the power to examine each office annually.

4. Retail deposits can be offered only if the bank has FDIC insurance.

5. State licensed entities cannot engage in activities not allowed federal entities.

Teaching Tip: Bank Board Oversight

An Op-Ed piece by Hugo Dixon in the Wall Street Journal suggests that many of the

problems experienced in the subprime crisis would have been avoided if banks’ board of

directors had performed their oversight rule more effectively.1 Dixon even recommends

1“Give Bank Boards a Spine: Directors Who Can Weight Risk Would Also Maintain a

Better Grip on CEOs,” by Hugo Dixon, The Wall Street Journal Online, May 27, 2008,

Page C12.

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Chapter 13 – Regulation of Commercial Banks 6th Edition

that boards employ a sort of ‘Star Chamber’ to hold bank CEOs accountable for the risks

their institutions is facing. Having CEOs explain things like CDO Squared investments

may have forced the bank executives to more fully understand the risks they faced.

William Isaac, former FDIC Chairman from 1981-1985, suggests that the 2007-2008

financial crisis atmosphere was a bit overdone and that lower housing prices would

eventually be a boon to many consumers.2 According to Isaac the biggest event from the

crisis was the Fed bailout of the private non-bank, Bear Stearns. This represented a major

policy change and one that could set an undesirable precedent. The bottom line is that if

institutions take on sufficient risk, they may go bankrupt. Trying to prevent those

bankruptcies creates a huge moral hazard problem in an industry that is not sufficiently

regulated to warrant even implicit government backing.

Market Value Accounting

Some, Isaac among them,3 are blaming market value accounting procedures for making

the subprime crisis worse. Under market value accounting financial firms must write

down assets to estimate of value which are likely to be at ‘fire-sale’ prices during a crisis.

This reduced the value of their collateral and probably helped exacerbate problems in the

repo and other short term markets. Remember however that market value accounting is

designed to bring problems to light more quickly, rather than allowing them to remain

hidden and grow. In my opinion the arguments against market value accounting are

overdone.

1.1.1.1 VI. Web Links

http://www.federalreserve.gov/ Website of the Board of Governors of the Federal

Reserve

http://www.americanbanker.com The publication of the banker’s trade association.

http://www.wsj.com/ Website of the Wall Street Journal Interactive

edition. The web version of the well known

financial newspaper can be personalized to meet

your own needs. Instructors can also receive via

e-mail current events cases keyed to financial

market news complete with discussion questions.

http://www.fdic.gov/ The Federal Deposit Insurance Corporation’s

website. New regulations and current and historical

banking statistics are available on this site.

2“The Fed and the Mortgage ‘Crisis’,” by William Isaac, Opinion, The Wall Street

Journal Online, May 22, 2008, Page A15.

3 Ibid

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Chapter 13 – Regulation of Commercial Banks 6th Edition

http://www.ftc.gov/ Federal Trade Commission

http://www.bis.org/ Bank of International Settlements, the central

bank’s central bank and a promulgator of the Basle

Accord and a source of OTC derivatives usage data.

http://www.senate.gov/~banking/conf/grmleach.htm

This site has the text of the FSMA.

http://www.ffiec.gov/ Federal Financial Institutions Examination Council

will shortly provide peer group average data for

banks. The website also includes forms needed to

fill out call reports and contains the Uniform Bank

Performance Report.

http://www.occ.treas.gov/ Office of the Comptroller of the Currency

http://thomas.loc.gov/cgi-bin/query/z?c111:H.R.4173:Library of Congress website with

link to the text of the 2010 Dodd

Frank Wall Street Consumer

Protection Act

1.1.1.1.1.1 VII. Student Learning Activities

1. Research the collapse of the Bank of Commerce Credit International (BCCI). Why

did this event worry U.S. bank regulators and lead to the passage of the Foreign Bank

Supervisory Enhancement Act? In general is the growth of offshore banking a

concern for U.S. regulators? Explain.

2. What are the major provisions of the Truth in Lending Act? The Fair Credit Billing

Act? Why are these laws important to you as a consumer of bank services?

3. Choose a large well known bank holding company and ascertain how many

enterprises are in the holding company. What activities are not traditional banking

activities? Should we as taxpayers be concerned that the regulators are allowing

banks that take insured deposits to be a part of a holding company that can engage in

high risk activities? Explain and defend your answer.

4. Go to a local bank and ask them about their rating under the Community

Reinvestment Act (they will be glad to talk to you about this, indeed they are required

to make this information publicly available.) How is the bank doing? Do you agree

with the purposes of the CRA? Are there better ways to achieve the goals of the

CRA? Explain.

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Chapter 13 – Regulation of Commercial Banks 6th Edition

5. How is banking likely to continue to change as a result of the financial crisis? Are the

new laws and regulations likely to be sufficient to prevent another crisis? Explain

and defend your answer.

6. To the instructor: Try to have a bank’s compliance officer or an examiner come and

talk to your class about what they do. There are good career opportunities in these

fields and you will find that many professionals are happy to come and speak to your

class.

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