Regulation of Banks

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Regulations of Banks

Submitted To: Dr Muhammad Usman

Submitted By: Uzma Siddique


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The banking industry is highly regulated in the United States, as it is in most countries.

Regulators are responsible for chartering banks and examining their operations.. As a

result of the dual banking system, bank regulation is enforced by many regulators with

overlapping authority for these institutions.

Primary Regulators

Federal Reserve (Fed)

Federal Deposit Insurance Corp. (FDIC)

Office of the Comptroller of the Currency (OCC)

Office of Thrift Supervision (S&Ls)

National Banking Act (1863,1864)

Passed During the Civil War to Help Fund the War

Created A New Division of the Treasury, the Comptroller of the Currency

Created National Banks with a Federal Charter

Federal Reserve Act of 1913

Passed After a Series of Financial Panics at the Beginning of the Century

Created the Federal Reserve System

Gave the Fed the Authority to Act as the Lender of Last Resort

Created to Provide a Number of Services to Member Banks

Today the Fed Controls the Money Supply

Glass-Steagall Act 1933

Passed During the Great Depression

Separated Investment and Commercial Banking


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Created the FDIC

Fed Given the Power to Set Margin Requirements

Prohibited Interest to be Paid on Checking Accounts

What is Regulated?

Initial creation of depository institutions

Initial licensing and chartering

Location and number of physical branches, offices

Initial board of directors and officers

Minimum cash and capital requirements to open

On-going operations

Mergers and acquisitions

Opening or closing of offices, branches

Many operations procedures

Why Regulate Banks?

The government has focused on information problems and liquidity risk associated with

unanticipated withdrawals of deposits.

Banks have private information depositors may lose confidence in even financially

healthy banks. When enough savers lose confidence in a banks portfolio of assets a

bank run can occur.

Banks are opaque, creating inefficiencies in monitoring.

Bank failure (weakness) can have micro-systemic externalities

on borrowers

on other banks, arising through

informational contagion


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financial contagion

common shocks

Bank failure (weakness) can have macro-systemic externalities

On the functioning of the macro-economy as a whole

Bank-loan supply decisions may amplify economic fluctuations

Banks may over-invest in upturns. This creates vulnerabilities that

when crystallised lead to tightening of credit supply in downturns,

Borio and Lowe, 2002), Dell Arricia et al (2005).

Reasons for the Regulation of Banks

Help for Special Segments of the Economy Principal Regulatory Agencies Under

the Dual Banking System

Federal Reserve System

Comptroller of the Currency

Federal Deposit Insurance Corporation

Department of Justice

Securities and Exchange Commission State Banking Boards or Commissions

Protection of the Safety of the Publics Savings

Control of the Supply of Money and Credit

Ensure Equal Opportunity and Fairness in Access to Credit

Promote Public Confidence in the Financial System

Avoid Concentration of Power

Support of Government Activities


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GOVERNMENT INTERVENTION IN THE BANKING INDUSTRY

The government has intervened in the banking system to ensure that banks serve

savers and borrowers and to promote the efficiency of the financial system. Three

regulatory interventions after the National Banking Act shaped the modern U.S. banking

industry. In 1913, Congress created the Federal ReserveSystem (the Fed) to promote

stability in the banking industryby serving as a lender of last resort during banking

crises. The Fed was given a monopoly in issuing currency, now known as Federal

Reserve Notes. All national banks were required to join the system and obey its

regulations. State banks were allowed to choose whether they wanted to belong to the

Federal Reserve System; most chose not to, owing to the costs of complying with the

Feds regulations.

The second major intervention came during the Great Depression in the form offederal

deposit insurance, a federal government guarantee of certain types of bank deposits.

Thousands of bank failures had destroyed the savings of many depositors and eroded

their confidence in the banking system. In 1934, Congress responded by creating the

Federal Deposit Insurance Corporation (FDIC) to guarantee deposits at commercial

banks. [At the same time, Congress created the Federal Savings and Loan Insurance

Corporation (FSLIC) to insure deposits at savings institutions.] The act required banks

that were members of the Federal Reserve System to purchase deposit insurance.

Nonmember banks were given a choice. Virtually all banks were eventually covered by

deposit insurance. The purchase of deposit insurance subjected banks to additional

regulation by the FDIC.

Another significant government intervention in the banking industry is restrictions on

bank competition, to stabilize the banks profitability. The first such measures imposed

branching restrictions, geographic limitations on banks ability to open more than one

office or branch. (Such restrictions are no longer a feature of U.S. banking regulation.)

The National Banking Act of 1863 gave states the authority to restrict branch banking

within their borders. Indeed, some states prohibited branch banking. By giving banks a

monopoly sought to ensure a low cost of funds to banks and to stabilize the banking

system. A second branching restriction, the McFadden Act of 1927, prohibite national

banks from operating branches outside their home states. The act further required


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national banks to abide by state branching restrictions, thus placing them on an equal

footing with state-chartered banks. These regulation led to a larger number of banking

firms in the United States than would have existed otherwise. Anticompetitive

restrictions also prevented banks from competing with investment banks, brokers, and

dealers in the securities industry.

Ex post and ex ante intervention

Ex post government intervention LOLR (monetary policy) partly deals with micro-

and macro-systemic externalities.

Do we need ex ante requirements in addition?

Yes, if banks free-ride on ex post support

Micro: banks may free-ride on ex post LOLR support and reduce private holdings of

liquidity, making it harder for CB to assess the situation ex post and increasing

frequency of ex post intervention, Repullo (2003).

Macro: banks may free-ride on ex post monetary easing by over-investing ex ante,

making it harder for CB to reduce economic fluctuations (Rochet, 2004, Borio and Lowe,

2002)

Government intervention in the banking industry has the potential to change the

competitive landscape. There has been significant government intervention in the

banking industry recently, including equity investments, liquidity facilities and

guarantees. These actions have changed and have the potential to change the

competitive landscape significantly.


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The Pattern of Regulation In Pakistan

State Bank of Pakistan (SBP) which is the Central Bank of the country has been

entrusted with the responsibility for an ongoing effective supervision of the banking

sector. The relevant provisions of law which vest powers in State Bank of Pakistan

(SBP) to carry out inspection of banks are contained in the Banking Companies

Ordinance, 1962. Besides, State Bank of Pakistan Act, 1956 and the Banks

Nationalization Act, 1974, The Financial Institutions (Recovery of finances) Ordinance,

2001, Companies Ordinance, 1984 and Statutory Regulatory Orders (SROs) are the

relevant legislations, which cover the activities concerning the banking sector.

The financial sector in Pakistan comprises of Commercial Banks, Development FinanceInstitutions (DFIs), Microfinance Banks (MFBs), Non-banking Finance Companies

(NBFCs) (leasing companies, Investment Banks, Discount Houses, Housing Finance

Companies, Venture Capital Companies, Mutual Funds), Modarabas, Stock Exchange

and Insurance Companies. Under the prevalent legislative structure the supervisory

responsibilities in case of Banks, Development Finance Institutions (DFIs), and

Microfinance Banks (MFBs) falls within legal ambit of State Bank of Pakistan while the

rest of the financial institutions are monitored by other authorities such as Securities and

Exchange Commission and Controller of Insurance

Under the WTO commitments the operational status of branch network of foreign banks

operating in Pakistan as on 31-12-1997 has been protected and frozen. However,

existing foreign banks having less than 3 branches can have branches to the extent of

maximum number of 3 only. New foreign banks desirous of entering banking business

in Pakistan will now be required to incorporate as domestic bank under the local laws.

The branches of foreign banks operating in Pakistan can also be converted into a local

commercial bank by incorporating under the local laws and subject to a minimum paid

up capital of Rs.1 billion provided foreign share holding is restricted to a maximum of

49%.


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The State Bank has framed Prudential Regulations for banks and Rules of Business for

DFIs that present a prudent operating framework within which banks and DFIs are

expected to conduct their business in a safe and sound manner taking into account the

risks associated with their activities. These regulations incorporate the spirit and

essence of BIS regulations and are constantly watched for possible improvement so

that their enforcement yields the best results to promote the objectives of supervision.


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References:

Hubbard, R. Glenn Money the Financial System & Economy 6e Pearson Hall

Documents

Regulation of Banks