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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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