Commercial Banking Structure, Regulation

and Performance

Commercial Banking Structure, Regulation

and Performance

Chapter 15

© 2003 South-Western/Thomson Learning

Slide 2

Learning ObjectivesLearning Objectives Who regulates whom in banking system and

why

What a bank holding company is and why

virtually all large banks are now organized as

holding companies

What is a financial holding company

Nature of and reasons for the recent wave of

bank mergers

Profitability of the banking system in recent

years

Slide 3

Banking Regulatory StructureBanking Regulatory Structure

Glass-Steagall Act of 1933 Banking legislation Enacted in response to Great Depression Established Regulation Q interest rate ceilings Separated commercial and investment banking Created the FDIC

Regulation Q Interest rate ceilings on deposits at

commercial banks Established during the Great Depression Phased out after 1980

Slide 4

Banking Regulatory StructureBanking Regulatory Structure

Federal Deposit Insurance Corporation (FDIC) Federal agency Insures the deposits of banks and

savings associations Comptroller of Currency

Federal agency Charters national banks

Slide 5

Banking Regulatory StructureBanking Regulatory Structure Chartered

Given permission to engage in business of commercial banking

Banks must obtain charter before opening Commercial banks in U.S. are chartered

National Bank Bank that has received charter from

Comptroller of Currency (federal government) Dual Banking System

System whereby a bank may have either a national or state charter

Slide 6

Regulatory ResponsibilitiesRegulatory Responsibilities

FDIC regulates: State-chartered, insured non-Fed

members Insured branches of foreign banks

Comptroller of Currency regulates: National banks that are not bank

holding companies Federally chartered branches of foreign

banks

Slide 7

Regulatory ResponsibilitiesRegulatory Responsibilities

Fed regulates: State-chartered, insured members of the

Fed All bank holding companies All financial holding companies Branches of foreign banking

organizations operating in U.S. and their parent bank

States regulate: State-chartered, non-FDIC-insured

banks that are not Fed members

Slide 8

Structure of Commercial Banking SystemStructure of Commercial Banking System Regulators

Interested in monitoring, influencing, controlling structure of market for banking services

Control entry into market Control mergers among existing firms Control branching in effort to maintain

many small firms

Slide 9

Structure of Commercial Banking SystemStructure of Commercial Banking System McFadden Act - 1927

Outlawed interstate branching Made national banks conform to the intrastate

branching laws of states in which they were located

Interstate Banking and Branching Efficiency Act (IBBEA) Signed into law in September 1994 by

Congress Allows unimpeded, nationwide branching

Slide 10

Bank Holding CompaniesBank Holding Companies

Bank Holding Company Corporation that owns several firms - at least

one is a bank Owns one - one-bank holding company Owns more than one – multi-bank holding company

Many banks organize into holding companies to: Circumvent restrictions on branching, thus seek out

sources and uses of funds in other geographical markets

Diversify into other product areas, thus providing public with a wider array of financial services, while reducing risk associated with limiting operations to traditional banking services

Slide 11

Exhibit 15–5Allowable Activities for Bank Holding Companies (Federal Reserve Regulation Y, Revised January 1, 2001)

Slide 12

Bank Holding CompaniesBank Holding Companies Organizing into holding company allows

banks to: Circumvent prohibitions on intrastate and

interstate branching (which now have been virtually eliminated)

Participate in activities that otherwise would be barred such as:

Data processing Leasing Investment counseling Servicing out-of-state loans

Almost all large banks are owned by holding companies

Slide 13

Financial Holding CompaniesFinancial Holding Companies Financial Holding Companies

Engage in broader array of financial-related activities than bank holding companies Securities underwriting & dealing Insurance agency and underwriting activities Merchant banking activities Other activities that Fed determines to be

financial or incidental to financial activities Any non-financial activity that Fed determines

is complementary to financial activity and doesn’t pose a substantial risk

Slide 14

Bank Holding Companies and Financial Holding CompaniesBank Holding Companies and Financial Holding Companies

Merchant Banking Direct equity investment (purchasing of

stock) by a bank in a start-up or growing company

Slide 15

Ongoing Changes in Structure of Banking IndustryOngoing Changes in Structure of Banking Industry

Increased competition in financial services industry

Considerable erosion in domain and effectiveness of many long-standing financial regulations

Significant increase in share of total bank assets controlled by largest banks

Pace and dollar volume of mergers increased significantly

Slide 16

Slide 17

Evolution of International BankingEvolution of International Banking Increase in international borrowing and

lending by domestic banks Many foreign banks made significant

inroads into U.S. markets by the 1980s. Agency of a Foreign Bank

U.S. Banking office of foreign bank Can borrow funds only in wholesale and

money markets Not allowed to accept retail deposits

Slide 18

Bank Management: Managing Risk and ProfitsBank Management: Managing Risk and Profits

Primary function of a bank loan officer is to evaluate or assess the default risk associated with lending to particular borrowers firms individuals domestic and foreign governments

Slide 19

Managing Risk and ProfitsManaging Risk and Profits

Asymmetric Information Potential borrower knows more about

the risks and returns of an investment project than bank loan officer

Adverse Selection Problem When least desirable borrowers pursue

a loan most diligently

Slide 20

Managing Risk and ProfitsManaging Risk and Profits

Moral Hazard Problem When borrower has incentive to use

proceeds of loan for more risky venture after loan is funded

Bank manager must manage interest rate risk

Adjustable-(Variable-) Rate Loan When interest rate on loan is adjusted up

or down as cost of funds rises or falls Banks can use financial futures, options

and swaps to manage interest rate risk

Slide 21

Bank PerformanceBank Performance

Nonbanks Other intermediaries and nonfinancial

companies that have taken increasing share of intermediation

Banks are facing increasing competition from other FIs and nonfinancial

corporations in a global environment.