18
Chapter
The Regulation Of
The Financial Institutions’ Sector
Money and Capital Markets
Financial Institutions and Instruments in a Global Marketplace
Eighth Edition
Peter S. Rose
McGraw Hill / Irwin
Slides by Yee-Tien (Ted) Fu
18 - 2
 Learning Objectives 
 To explore why financial institutions are one
of the most regulated industries in the modern
world.
 To discover the many types of regulation, and
to understand how the financial institutions
have been affected.
 To examine the recent global trend toward
deregulation.
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Reasons Behind Regulations
 Concern for the safety of the public’s funds.
 To promote public confidence in the system.
 To ensure equal opportunities and fairness in
the public’s access to financial services.
 To prevent excessive money creation, and
hence excessive inflation.
 To aid “disadvantaged” economic sectors.
 To ensure that important financial services are
provided reliably and at a reasonable cost.
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Do Regulations Benefit or Harm
Financial Institutions?
 Regulations can benefit financial institutions.

Regulations subsidize the growth of financial
institutions and protect them from competition.

Regulations tend to increase public confidence.

Regulations spawn innovative escapes (regulatory
dialectics) through loopholes in the regulations.
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Do Regulations Benefit or Harm
Financial Institutions?
 Regulations can harm financial institutions.

Regulatory dialectics are not the most productive
form of innovation.

The time and energy spent on regulatory
compliance activities are costly.
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Regulation of Commercial Banks
 Due to their importance in the financial
system, commercial banks are typically the
most regulated of all financial institutions.
 Responsibility for regulating U.S. banks today
is divided among three federal banking
agencies – the Federal Reserve System, the
Comptroller of the Currency, and the Federal
Deposit Insurance Corporation – and the state
banking commissions of the 50 states.
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The Federal Reserve System
 Supervises and regularly examines all member
banks operating in the U.S.
 Imposes reserve requirements on deposits held
by all depository institutions and grants
temporary loans of reserves.
 Must approve all applications of member
banks to merge, establish branches, or exercise
trust powers.
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The Federal Reserve System
 Supervises international banking corporations
organized by U.S. banks and foreign banks
operating in the U.S.
 Regulates and examines all bank and financial
holding companies in the U.S.
 Conducts monetary policy to control the
growth of money and credit in the financial
system.
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The Comptroller of the Currency
 Issues charters for new national banks.
 Regulates and regularly examines all national
banks.
 Must approve all national banks’ applications
for new branch offices, trust powers, mergers,
and consolidations.
 Declares insolvent national banks closed.
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Federal Deposit Insurance Corporation
 Insures deposits of savings institutions (thrifts)
and banks conforming to its regulations up to
$100,000, and acts as receiver for all national
banks declared insolvent and for state banks if
requested by a state banking commission.
 Must approve applications by insured banks to
set up branches, merge or exercise trust powers .
 Requires all insured banks to submit reports on
their financial condition.
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State Banking Commissions
 Issue charters for new state banks.
 Supervise and regularly examine all statechartered banks.
 Approve applications by state banks to form a
holding company, acquire subsidiaries, or
establish branches.
 Declare insolvent state-chartered banks closed
and appoint a receiver to liquidate or otherwise
dispose of the assets of failed state banks.
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Regulations Controlling
The Geographic Expansion of Banks
 The new geographic markets that banks can
enter have been tightly controlled.
National Bank Act (1863-4)
 Banking Act (1933)
 Bank Holding Company Act(1956,amended 1970)
 Bank Merger Act (1960, amended 1966)
 Financial Institutions Reform, Recovery, and
Enforcement Act (1989)
 Riegle-Neal Interstate Banking and Branching
Efficiency Act (1994)

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Regulation of the Services Banks Can Offer
 Regulations controlling the services banks can
offer have also been tight out of concern for
bank safety and a desire to protect certain
nonbank financial institutions from tough bank
competition.
Glass-Steagall Act (Banking Act) (1933)
 Financial Services Modernization (Gramm-LeachBliley) Act (1999)

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The Rise of Disclosure Laws in Banking
 One rapidly expanding area of U.S. banking
regulation today concerns disclosure rules.
Truth in Lending Act (1968)
 Home Mortgage Disclosure Act (1975)
 Community Reinvestment Act (1977)
 Truth in Savings Act (1991)
 FDIC Improvement Act (1991)
 Financial Services Modernization (Gramm-LeachBliley) Act (1999)

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18 - 15
The Growing Importance of
Capital Regulation in Banking
 Another major trend reshaping the regulation
of banks and other financial institutions today
centers upon their capital.
Basle Agreement (1988)
 FDIC Improvement Act (1991)

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The Unfinished Agenda for Banking Regulation
 Slowly, banking is experiencing an era of
deregulation, as legal constraints are lifted on a
variety of banking activities.
 Supervision of financial institutions in the
future will rest primarily upon:
government examinations (of market data and the
firms’ risk management systems)
 capital requirements, and
 market discipline.

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18 - 17
The Regulation of Nonbank Thrift Institutions
 Credit Unions
Chartering: National Credit Union Administration
(NCUA) / state
 New branches: No approval required
 Mergers & acquisitions: NCUA / state
 Deposit insurance: NCUA Share Insurance Fund /
state
 Supervision: NCUA / state
 Depository Institutions Deregulation and Monetary
Control Act (1980)

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The Regulation of Nonbank Thrift Institutions
 Savings and Loan Associations
Chartering: Office of Thrift Supervision (OTS) /
state
 New branches: OTS / FDIC / state
 Mergers & acquisitions: OTS / FDIC / state
 Deposit insurance: FDIC / state
 Supervision: OTS / state
 Financial Institutions Reform, Recovery and
Enforcement Act (1989)
 FDIC Improvement Act (1991)

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The Regulation of Nonbank Thrift Institutions
 Savings Banks
Chartering: Office of Thrift Supervision (OTS) /
state
 New branches: OTS / state
 Mergers & acquisitions: OTS / FDIC / state
 Deposit insurance: FDIC / state
 Supervision: FDIC / state

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18 - 20
The Regulation of Nonbank Thrift Institutions
 Money Market Funds
Chartering: Securities and Exchange Commission
(SEC)
 New branches: No approval required
 Mergers & acquisitions: No approval required
 Deposit insurance: no government insurance
 Supervision: SEC (selected activities)

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
18 - 21
The Regulation of Insurance Companies
 While not quite as heavily regulated as
commercial banks, insurance intermediaries
face tough regulatory rules that are imposed
primarily by state insurance commissions.
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18 - 22
The Regulation of Pension Funds
 Because pension funds have risen rapidly to
hold the bulk of the retirement savings of
workers, they are heavily regulated by the
courts and government agencies today.
Employee Retirement Income Security Act (1974)
 Pension Benefit Guaranty Corporation, or “Penny
Benny” (a federal agency)

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The Regulation of Finance Companies
 The bulk of regulation of finance companies is
at the state level and focuses principally upon
the making of consumer loans.
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18 - 24
The Regulation of Investment Companies
 Investment companies or mutual funds are
regulated predominantly by the federal
government in the U.S.
Securities and Exchange Commission
 Investment Company and Investment Advisers
Acts (1940)

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Trends in
The Regulation of Financial Institutions
 Regulation seeks to promote the safety and
stability of financial institutions in order to
preserve the confidence of the public and
avoid institutional failures.
 However, regulation can become a costly
burden that significantly increases the
operating costs of financial institutions and
limits the cleansing effects of failure and
competition.
McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
18 - 26
Trends in
The Regulation of Financial Institutions
 Increasingly,
market discipline is playing a bigger role,
 regulators are cooperating more (because the
distinctions between the financial institutions are
blurring),
 the focus of regulation is moving away from
control over the services offered and geographic
expansion to controlling risk taking, and
 there is increasing attention to public disclosure.

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18 - 27
Money and Capital Markets in Cyberspace
 The government commissions and agencies
that regulate financial institutions have become
increasingly visible on the world wide web:
http://www.federalreserve.gov
 http://www.occ.treas.gov/
 http://www.fdic.gov/
 http://europa.eu.int/index_en.htm
 http://www.wdfi.org/
 http://www.banking.state.ny.us/
 http://www.insurance.state.pa.us/
 http://www.sec.gov/

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
18 - 28
Chapter Review
 The Reasons Behind the Regulation of
Financial Institutions
 Do Regulations Benefit or Harm Financial
Institutions?
 The Regulation of Commercial Banks
The Federal Reserve System
 The Comptroller of the Currency
 Federal Deposit Insurance Corporation
 State Banking Commissions

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
18 - 29
Chapter Review
 The Regulation of Commercial Banks … continued
Regulations Controlling the Geographic Expansion
of Banks
 Regulation of the Services Banks Can Offer
 The Rise of Disclosure Laws in Banking
 The Growing Importance of Capital Regulation in
Banking
 The Unfinished Agenda for Banking Regulation

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
18 - 30
Chapter Review
 The Regulation of Nonbank Thrift Institutions
Credit Unions
 Savings and Loan Associations
 Savings Banks
 Money Market Funds

 The Regulation of Insurance Companies
 The Regulation of Pension Funds
 The Regulation of Finance Companies
McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
18 - 31
Chapter Review
 The Regulation of Investment Companies
 An Overview of Trends in the Regulation of
Financial Institutions
McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.