Why Are Financial Institutions
Special?
Chapter 6
Financial Institutions Management, 3/e
By Anthony Saunders
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Services of FIs

Key services:
•
•
•
•
•
Reduce monitoring costs (Diamond, 1984)
Increase liquidity
Reduce price risk
Reduce transaction costs
Maturity intermediation
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Specialness
• Transmission of monetary policy
• Credit allocation (Areas of special need such as
home mortgages)
• Intergenerational transfers or time
intermediation
• Payment services (FedWire and CHIPS)
• Denomination intermediation
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Specialness and Regulation

FIs receive special regulatory attention.
• Reasons:
» Special services provided by FIs in general.
» Institution-specific functions such as money supply
transmission (banks), credit allocation (thrifts, farm
banks), payment services (banks,thrifts), etc.
• Negative externalities arise if these services are
not provided.
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Regulation of FIs

Important features of regulatory policy:
• Protect ultimate sources and users of savings.
» Including prevention of unfair practices such as
redlining and other discriminatory actions.
• Ensure soundness of the system as a whole.

Regulation is not costless
• Net regulatory burden.
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Regulation

Safety and soundness regulation:
• Regulations to increase diversification
• Minimum capital requirements
• Guaranty funds:
» FDIC: Bank Insurance Fund (BIF), Savings
Association Insurance Fund (SAIF)
» Securities Investors Protection Fund (SIPC)
• Monitoring and surveillance
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Regulation

Monetary policy regulation
• Federal Reserve directly controls outside
money.
• Bulk of the money supply is inside money
(deposits).
• Reserve requirements facilitate transmission of
monetary policy.
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Regulation

Credit allocation regulation
• Supports socially important sectors such as
housing and farming.
» Requirements for minimum amounts of assets in a
particular sector or maximum interest rates or fees.
» Qualified Thrift Lender Test (QTL).
» Regulation Q.
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Regulation

Consumer protection regulation
• Community Reinvestment Act (CRA).
• Home Mortgage Disclosure Act (HMDA).
Effect on net regulatory burden.
 Potential extensions to other FIs such as
insurance companies.
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Regulation

Investor protection regulation
• Protections against abuses such as insider
trading, lack of disclosure, malfeasance, breach
of fiduciary responsibility.

Key legislation
• Securities Acts of 1933, 1934.
• Investment Company Act of 1940.
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Regulation

Entry regulation
• Level of entry impediments affects profitability
and value of charter.
• Regulations define scope of permitted
activities.
• Effects size of net regulatory burden.
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Trends

Trends in the United States
• Decline in share of depository institutions.
• Increases in pension funds and investment
companies.
• May be attributable to net regulatory burden
imposed on depository FIs.
• Recent regulatory changes partially alleviate
net regulatory burden on FIs.
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