Bank Management, 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2003 by South-Western, a division of Thomson Learning
BANK ORGANIZATION
AND REGULATION
Chapter 2
Government agencies that regulate commercial
banks have had to balance the banking system’s
competitiveness with general safety and
soundness concerns.
 Historically, regulation has limited who can:
 open or charter new banks and
 what products and services banks can offer.
 Imposing barriers to entry and restricting the
types of activities banks can engage in
clearly enhance safety and soundness, but
also hinder competition.
Historical regulation, which limits the number
of banks and types of activities, has three
drawbacks
1. It assumed that the markets for bank products, largely bank loans
and deposits, could be protected and that other firms could not
encroach upon these markets.
 Not surprisingly, investment banks, hybrid financial
companies, insurance firms, and others found ways to provide
the same products as banks across different geographic
markets.
2. It discriminated against U.S.-based firms versus foreign-based
firms.
 For example, prior regulations prohibited U.S. banks from
underwriting securities for firms in the U.S.
 In contrast, foreign banks are generally not restricted as to
their domestic corporate structure and thus have long been
able to circumvent U.S. restrictions on under-writing activities.
 Such restrictions place U.S. banks at a competitive
disadvantage.
3. Historical regulation has penalized bank customers who do not
have convenient access to the range of products they demand.
 In addition, such restrictions generally raise prices above
those obtained in a purely competitive marketplace.
The U.S. operates using a “dual banking system.”
 Individual states as well as the federal government
issue bank charters.



The Office of the Comptroller of the Currency (OCC)
charters national banks
Individual state banking departments charter state banks
and savings institutes.
The Office of Thrift Supervision (OTS) charters federal
savings banks and savings associations.
 The Federal Deposit Insurance Corporation (FDIC)
insures the deposits of banks and savings
associations up to $100,000 per account.
Bank regulation and supervision
…conducted by four federal agencies (OCC, OTS,
FDIC, and the Federal Reserve) as well as fifty
state agencies.
 Although this is a complicated system, it
allows for a separation of duties as well
as “competition” among the various
regulatory agencies to produce a safe
and efficient banking system.
Credit unions represent another type of
depository institution.
 Even though credit unions perform some of the same
functions as a bank, they are cooperative nonprofit financial
institutions that exist for the benefit of members.
 To join a credit union, one must share a “common bond”
with other members.
 The definition of common bond, however, has expanded to
incorporate a “community” and hence the differences
between credit unions and banks are disappearing as well.
 Credit unions often operate in subsidized office space with
subsidized labor and do not pay corporate or state income
taxes.
 This tax-exempt status puts them at a competitive
advantage over other banking institutions.
 Credit unions were first chartered at the state level in 1909.
 By 1934, the federal government began to charter credit
unions under the Farm Credit Association, and created the
National Credit Union Administration (NCUA) in 1970.
 A dual credit union regulatory system exists as well today as
both states and the NCUA charter credit unions today.
National versus a State bank charter
 Before issuing a new charter, the chartering
agencies ensure that the (de novo) bank will
have the necessary capital and management
expertise to ensure soundness and allow the
bank to meet the public’s financial needs.
 The agency that charters the institution is the
institution’s primary regulator with primary
responsibility to ensure safety and soundness
of the banking system.
 All banks obtain FDIC deposit insurance
coverage as part of the chartering process.
While national banks are regulated only by federal
regulatory agencies, state-chartered banks also have a
primary federal regulator.
 The Federal Reserve is the primary federal regulator of
an FDIC-insured state bank, which is a member of the
Federal Reserve System, while the primary regulator of
state non-Fed member banks is the FDIC.
Charter Class by their Primary Federal Regulator
(thousands of dollars): June 2001
#
Primary
Federal
Regulator
#
Charter Class
Institutions Offices
Deposits*
Commercial Banks
8,178
72,167
3,566,835,641
National Charter
2,176
34,691
1,890,611,980
State Charter
6,002
37,476
1,676,223,661
Federal Reserve Member
975
13,845
769,802,155
Federal Reserve Nonmember
5,027
23,631
906,421,506
Savings Institutions
1,561
13,888
755,422,190
Federal Charter Savings Associations
896
9,020
526,156,002
State Charter Savings Institutions
665
4,868
229,266,188
FDIC-Supervised Savings Banks
520
4,325
210,542,336
OTS-Supervised Savings Associations
145
543
18,723,852
U.S. Branches of Foreign Banks
18
18
4,069,399
Total
9,757
86,073
4,326,327,230
* Includes deposits in domestic offices (50 states and DC), Puerto Rico, and U.S. Territories
OCC
Fed
FDIC
OTS
FDIC
OTS
In contrast to federally regulated national banks,
state-chartered banks have generally had
broader powers.
 Many states allow securities underwriting and
brokerage; real estate equity participation,
development, and brokerage; and insurance
underwriting and brokerage.
 Still, regulations for banks are more restrictive than
those that apply to thrift institutions.
 While thrifts must maintain at least 65 percent of
their assets in housing-related investments and
cannot have more than 10 percent in loans to
businesses, they have historically been allowed
nationwide branching and full-service
underwriting and brokerage activities in
insurance, real estate, and corporate instruments.
For many years, commercial banks were
viewed as a special type of financial
organization.
 They were the only firms allowed to issue demand
deposits and thus dominated the payments system
 Prior to 1980, interest-bearing checking accounts
did not exist except at credit unions.
 Because of this status, authorities closely regulated
bank operations to control deposit growth and to
ensure the safety of customer deposits.
 Among other restrictions, government regulators
required:
 cash reserves against deposits,
 specified maximum interest rates banks could pay
on deposits,
 set minimum capital requirements, and
 placed limits on the size of loans to borrowers.
 In addition to regulatory constraints, federal banking
law further limited bank operations to activities closely
related to banking and, in conjunction with state laws,
prohibited interstate branching.
Historically, banks, savings associations,
and credit unions each served a different
purpose and a different market.
 Commercial banks mostly specialize in
short-term business credit, but also make
consumer loans and mortgages, and have a
broad range of financial powers.
 Banks accept deposits in a variety of
different accounts and invest these funds
into loans and other financial instruments.
 Their corporate charters and the powers
granted to them under state and federal law
determines the range of their activities.
Savings institutions, savings and loan
associations and savings banks, have historically
specialized in real estate lending; e.g., loans for
single-family homes and other residential
properties.
 Savings associations are generally referred to as
“thrifts” because they originally offered only savings or
time deposits
 They have acquired a wide range of financial powers
over the past two decades, and now offer checking
accounts, make business and consumer loans,
mortgages, and offer virtually any other product a bank
offers.
 Savings institutions must maintain 65% of their assets
in housing-related or other qualified assets to maintain
their savings institution status.
 This is called the “qualified thrift lender” (QTL) test.
The number of thrifts has declined
dramatically during the last two decades.
 The savings and loan crisis of the 1980s forced many
institutions to close or merge with others, at an
extraordinary cost to the federal government.
 Due to liberalization of the QTL, however, there was a
resurgence of interest in the thrift charter and many
insurance companies, securities firms, as well as
commercial firms acquired a unitary thrift holding
company in order to own a depository institution and
bypass prohibitions in the Glass Steagall Act and the
Bank Holding Company Act.
 This resurgence of interest stopped with the
passage of Gramm-Leach- Bliley, which eliminated
the issuance of new unitary thrift charters.
Credit unions are nonprofit institutions with an
original purpose to encourage savings and
provide loans within a community at low cost to
their members.
 A “common bond” defines their members, although this





common bond can be loosely defined.
The members pool their funds to form the institution’s
deposit base and the members own and control the
institution.
Credit unions accept deposits in a variety of forms.
 All credit unions offer savings accounts or time deposits,
while the larger institutions also offer checking and
money market accounts.
Credit unions have similarly expanded the scope of
products and activities they offer to include almost anything
a bank or savings association offers, including making
home loans, issuing credit cards, and even making some
commercial loans.
Credit unions are exempt from federal taxation and
sometimes receive subsidies, in the form of free space or
supplies, from their sponsoring organizations.
Although credit unions tend to be much smaller than banks
or savings associations, there are several very large credit
unions.
The largest federal and state chartered banks:
(thousands of dollars, 2001)
A. Largest Federally Charter Commercial Banks
Rank
1
2
3
4
5
6
7
8
9
10
Name
Bank of America NA
Citibank NA
First Union NB
Fleet NA Bk
US Bk NA
Bank One NA
Wells Fargo Bk NA
Wachovia Bk NA
Keybank NA
PNC Bk NA
State
NC
NY
NC
RI
OH
IL
CA
NC
OH
PA
Total Assets
551,691,000
452,343,000
232,785,000
187,949,000
166,949,055
161,022,572
140,675,000
71,555,121
71,526,246
62,609,780
Total Loans
314,167,000
284,809,000
123,754,000
126,301,000
115,108,238
83,639,674
95,264,000
46,996,841
56,410,074
40,452,019
Total Deposits
391,543,000
306,923,000
147,749,000
132,464,000
108,364,026
107,377,268
79,077,000
46,311,053
42,731,060
46,385,132
Total
Equity
52,624,000
37,623,000
16,133,000
19,012,000
18,449,335
10,990,222
16,186,000
13,670,966
4,878,880
4,887,661
Equity
to Assets
9.54%
8.32%
6.93%
10.12%
11.05%
6.83%
11.51%
19.11%
6.82%
7.81%
B. Largest State Chartered Commercial Banks
Rank
1
2
3
4
5
6
7
8
9
10
Name
State
Total Assets
JPMorgan Chase Bk
Suntrust Bk
HSBC Bank USA
Bank of New York
Merrill Lynch Bk USA
State Street B&TC
Branch Bkg&TC
Southtrust Bk
Bankers Trust Co
Regions Bank
NY
GA
NY
NY
UT
MA
NC
AL
NY
AL
537,826,000
102,377,306
84,230,380
78,018,745
66,092,639
65,409,590
54,700,008
48,849,559
42,678,000
42,001,585
Total
Loans
178,169,000
73,515,248
40,801,836
37,309,076
12,464,394
5,979,937
35,731,083
34,249,117
12,804,000
31,508,932
Total Deposits
280,473,000
67,995,077
58,220,243
55,810,439
59,954,429
38,855,475
32,103,069
32,965,152
21,423,000
31,536,453
Total
Equity
33,273,000
8,687,049
6,898,796
6,466,422
3,551,022
4,187,956
4,742,168
4,165,712
6,822,000
3,242,973
Equity
to Assets
6.19%
8.49%
8.19%
8.29%
5.37%
6.40%
8.67%
8.53%
15.98%
7.72%
Largest savings institutions and credit unions (thousands of dollars,
2001)
C. Largest Savings Institutions
Rank
1
2
3
4
5
6
7
8
9
Name
Washington Mutual Bank, FA
World Svgs Bk, FSB
California Federal Bank
Charter One Bank, SSB
Sovereign Bank
Citibank, FSB
Washington MSB
Dime Savings Bank of NY
Astoria FS&LA
State
S&L
S&L
S&L
S&L
S&L
S&L
SB
S&L
S&L
CA
CA
CA
OH
PA
CA
WA
NY
NY
Total
Assets
206,571,184
58,443,622
56,555,539
38,165,417
35,631,606
31,868,249
31,639,000
27,971,169
22,463,688
Total
Deposits
92,054,318
34,651,936
25,906,314
25,222,939
22,378,274
22,679,455
16,806,000
15,188,948
11,144,443
Total Loans
Total
Assets
26,217,598
12,446,130
11,188,619
6,301,035
3,385,160
3,313,673
3,243,137
2,987,051
2,852,330
2,583,594
Total
Loans
1,264,461
266,338
8,590,064
5,207,140
1,701,495
145,774
2,406,415
159,173
1,354,201
1,269,927
Total
Deposits
20,962,788
10,108,679
9,075,588
5,645,651
2,610,982
2,594,040
2,882,056
2,574,479
2,498,722
2,302,387
132,506,691
41,505,114
42,726,581
26,104,926
20,994,865
21,041,103
19,981,000
22,092,378
12,266,238
Total
Equity
12,562,515
4,701,922
4,124,022
2,343,285
3,642,986
2,707,701
2,044,000
2,384,304
1,506,548
Equity
to Assets
6.08%
8.05%
7.29%
6.14%
10.22%
8.50%
6.46%
8.52%
6.71%
D. Largest Credit Unions
Rank
1
2
3
4
5
6
7
8
9
10
Name
U. S. CENTRAL CREDIT UNION
WESTERN CORPORATE
NAVY
STATE EMPLOYEES'
BOEING EMPLOYEES
SOUTHWEST CORPORATE
PENTAGON
MID-STATES CORPORATE
UNITED AIRLINES EMPLOYEES'
AMERICAN AIRLINES
STATE
KS
CA
VA
NC
WA
TX
VA
IL
IL
TX
Total
Equity
1,428,725
820,696
1,365,675
488,698
276,596
313,924
338,609
259,016
341,144
229,820
Equity
to Assets
5.45%
6.59%
12.21%
7.76%
8.17%
9.47%
10.44%
8.67%
11.96%
8.90%
Number and total assets of various depository
institutions: 1970 – 2001.
1970
(Monetary Amounts Are in billions of Dollars)
1980
1989
1993
1997
2001
Annual
Growth Rate
1980-2001
Commercial Banks
Number
Total assets
(% of Total Assets)
13,550
14,163
12,410
10,957
9,144
8,080
$517.40 $1,484.60 $3,231.10 $3,705.90 $5,014.90 $6,569.24
66.0%
63.6%
65.3%
73.9%
78.5%
78.7%
-1.65%
8.54%
Thrift Institutions a
Number
Total assets
(% of Total Assets)
5,669
$249.50
31.8%
-4.13%
5.47%
4,594
3,011
2,327
1,779
1,533
$783.60 $1,516.50 $1,024.50 $1,026.20 $1,299.01
33.6%
30.7%
20.4%
16.1%
15.6%
Credit Unions*
Number
Total assets
(% of Total Assets)
23,819
$17.60
2.2%
21,930
$67.30
2.9%
15,205
$199.70
4.0%
12,720
$283.50
5.7%
11,238
$351.17
5.5%
10,145
$477.21
5.7%
-2.76%
11.43%
Commercial banks play an important role
in facilitating economic growth.
 On a macroeconomic level, they represent the
primary conduit of Federal Reserve monetary
policy.
 Bank deposits represent the most liquid form of
money such that the Federal Reserve System’s
efforts to control the nation’s money supply and
level of aggregate economic activity is
accomplished by changing the availability of
credit at banks.
 On a microeconomic level, commercial banks
represent the primary source of credit to most
small businesses and many individuals.
 A community’s vitality typically reflects the
strength of its major financial institutions and
the innovative character of its business leaders.
There has been a fundamental shift in the structure
of financial institutions over the past two decades.
Percent of Total, All Others
systematically declined relative to assets held by other financial
intermediaries.
20.0%
65.0%
18.0%
60.0%
16.0%
55.0%
14.0%
50.0%
12.0%
10.0%
45.0%
8.0%
40.0%
6.0%
35.0%
4.0%
30.0%
2.0%
25.0%
0.0%
1970
Dec-70
1975
Dec-75
1980
Dec-80
1985
Dec-85
1990
Dec-90
Dec-95
1995
Dec-00
2000
Dec-01
Monetary authority
5.1%
4.6%
3.5%
2.9%
2.4%
2.8%
2.4%
2.4%
Insurance Companies
16.8%
14.1%
13.9%
12.8%
14.6%
14.9%
11.6%
11.4%
Pension and Retirement Funds
7.0%
7.3%
8.2%
9.1%
8.6%
8.4%
7.2%
6.7%
Mutual Funds
0.6%
0.6%
1.7%
4.9%
7.6%
10.2%
11.8%
12.5%
Finance companies
4.5%
4.2%
4.9%
4.9%
4.7%
3.8%
4.0%
3.8%
Mortgage related
Other
1.3%
4.2%
2.2%
4.9%
3.6%
5.3%
6.3%
7.4%
10.8%
8.6%
11.8%
12.4%
12.2%
18.8%
12.8%
19.6%
Depository Institutions
60.5%
62.1%
58.9%
51.8%
42.8%
35.7%
31.9%
30.7%
Year
Percent of Total, Depository Institutions
 In particular, depository institutions’ share of U.S. financial assets has
Consolidations, new charters and bank
failures
 The number of failed banks increases sharply
from 1980 through 1988


This period coincides with economic problems
throughout various sectors of the U.S. economy
ranging from agriculture to energy to real
estate.
As regional economies faltered, problem loans
grew at banks and thrifts that were
overextended and subsequent losses forced
closings.
 New charters representing the start-up of a
new bank’s operations declined from 1984 to
1994, increased through 1998, and then
decreased through 2001.
The major force behind consolidation has been
mergers and acquisitions in which existing banks
combine operations in order to cut costs,
improve profitability, and increase their
competitive position.
 Bankers who either lose their jobs in a
merger or choose not to work for a large
banking organization often find investors to
put up the capital needed to start a new
bank.
 Both mergers and new charters slowed
dramatically in late 1998 as a result of a 25
percent fall in stock values at the largest
bank holding companies and in 2001 with
the continuing market decline.
Structural changes among FDIC-insured
commercial banks, 1980–2001
700
600
Number of Banks
Mergers
500
400
300
New Charters
200
100
Failures
0
1980
1983
1986
1989
1992
1995
1998
2001
The Central Bank
…Congress created the Federal Reserve System in
1913 to serve as the central bank of the United States
and to provide the nation with a safe, flexible and
more stable monetary and financial system


The Fed's role in banking and the economy has
expanded over the years, but its primary focus
has remained the same.
The Fed’s three fundamental functions are:
1.
2.
3.

conduct the nation’s monetary policy,
provide and maintain an effective and efficient
payments system, and
supervise and regulate banking operations.
All three roles have a similar purpose, that of
maintaining monetary and economic stability and
prosperity.
The Federal Reserve System (The Fed)
 A decentralized central bank, with
 12 districts reserve banks and branches across
the country,
 Coordinated by a Board of Governors in
Washington, D.C.
 The Board of Governors are appointed by the
president of the United States and confirmed by
the Senate for staggered 14-year terms.
 The seven-members of the Board Governors are
the main governing body of the Federal Reserve
System.
 The Board is charged with overseeing the 12
District Reserve Banks and with helping
implement national monetary policy.
Monetary Policy
 The Federal Reserve conducts
monetary policy through actions
designed to influence the supply of
money and credit in order to promote
price stability and long-term sustainable
economic growth.
 There are basically three distinct
monetary policy tools:
1.
2.
3.
open market operations,
changes in the discount rate, and
changes in the required reserve ratio.
Open market operations
… are conducted by the Federal Reserve Bank of
New York under the direction of the Federal Open
Market Committee (FOMC).
 The sale or purchase of U.S. government securities
in the “open market” or secondary market is the
Federal Reserve’s most flexible means of carrying
out its policy objectives.
 Through the purchase or sale of short-term
government securities, the Fed can adjust the level
of reserves in the banking system.


Fed open market purchases increase liquidity, hence
reserves in the banking system, by increasing a bank’s
deposit balances at the Fed.
Fed open market sales of securities decrease bank
reserves and liquidity by lowering deposit balances at
the Fed.
Changes in the discount rate
…directly affect the cost of borrowing
 Banks can borrow deposit balances, or required
reserves, directly from Federal Reserve Banks (in
its role as lender of last resort).

The discount rate is the interest rate that banks pay.
 When the Fed raises (decreases) the discount rate
it discourages (encourages) borrowing by making it
more (less) expensive.
 Many economists argue that the Fed changes the
discount rate primarily to signal future policy
toward monetary ease or tightness rather than to
change bank borrowing activity.

Changes in the discount rate are formally announced
and trumpeted among the financial press so that market
participants recognize that the Fed will likely be adding
liquidity or taking liquidity out of the banking system.
Changes in reserve requirements
…directly affect the amount of legal required reserves and
thus change the amount of money a bank can lend out.
 For example, a required reserve ratio of 10 percent
means that a bank with $100 in demand deposit liabilities
outstanding
 must hold $10 in legal required reserves in support of
the DDAs.
 The bank can thus lend only 90 percent of its DDAs.
 When the Fed increases (decreases) reserve
requirements, it formally increases (decreases) the
required reserve ratio that directly reduces (raises) the
amount of money a bank can lend.
 Thus, lower reserve requirements increase bank
liquidity and lending capacity while higher reserve
requirements decrease bank liquidity and lending
capacity.
Organizational form of the banking industry
 The organizational structure of banking has
changed significantly over the past two
decades but changed most dramatically in
the later half of the 1990’s due primarily to:



the impact of interstate branching,
the Federal Reserve System’s relaxation of
securities powers restrictions using a clause in
the Glass-Steagall Act and most recently
with the Gramm-Leach-Bliley Act of 1999.
 Banks can now branch across state lines
and acquire insurance and securities firms
by forming a Financial Holding Company
under the provisions of Gramm-LeachBliley.
Commercial banks are classified either as unit banks,
with all operations housed in a single office, or as
branch banks with multiple offices.
 Prior to the enactment of the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994, which
allow of nationwide interstate branch banking, state
law determined the extent to which commercial banks
could branch.
 Any organization that owns controlling interest in one
or more commercial banks is a bank holding
company (BHC).



Control is defined as ownership or indirect control via the
power to vote more than 25 percent of the voting shares in
a bank.
Prior to the enactment of interstate branching, the primary
motivation behind forming a bank holding company was
to circumvent restrictions regarding branching and the
products and services that banks can offer.
Today, the primary motive is to broaden the scope of
products the bank can offer.
Unit versus Branch banking
…The current structure of the commercial banking system
as well as the dramatic changes in the number of banks has
been heavily influenced by historical regulations which
prevent branching to one degree of another.
 One of the primary reasons the number of
banks has declined almost 50 percent since
the mid 1980’s is the relaxation of branching
restrictions provided by Riegle-Neal
Interstate Banking and Branching Efficiency
Act of 1994.
 Since the mid 1980’s, the number of banks
has fallen about 50 percent while the
number of branches has increased by 50
percent.
Changes in the number of banks and bank
branches, 1960 – 2001
80,000
70,000
Number of U.S. Banking Offices
60,000
All U.S. Banking Offices
(Main Offices plus Branches)
50,000
40,000
Branches
30,000
20,000
10,000
Main Offices
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2001*
Branches
10,556
15,872
21,839
30,205
38,738
43,293
50,406
56,512
64,079
63,989
Banks
13,126
13,544
13,511
14,384
14,434
14,417
12,347
9,942
8,315
8,178
The number of interstate branches
increased dramatically after interstate
branching became fully effective in 1997.
Unit banks each have their own board of directors, a
complete staff of officers, and separate documents and
technology for conducting business.
 Operating expenses are generally higher for the parent
company that owns multiple independent banks as
compared to branches of the “lead” bank.

the relaxation in branching restrictions and economic
efficiencies is a primary motivating factor for a bank to form
a bank holding company.
 Risk in the banking industry is considered higher with
restrictive branching because individual banks were
less diversified and more prone to problems

Not surprisingly, states with the highest bank failure rates
historically restricted branching.
 Branching generally reduces the number of
competitors, lowers expenses, allows greater asset
diversification, and expands each bank’s consumer
deposit base

Each of these factors decreases the chances of failure,
everything else being equal.
Organizational form
 Independent Banks
 The term independent bank normally refers to
a bank that is not controlled by a multibank
holding company or any other outside
interest.
 Bank Holding Companies
 A bank holding company is essentially a shell
organization that owns and manages
subsidiary firms.
Bank holding companies
 Bank holding companies are firms that control at least
one bank subsidiary.
 They typically also own several non-bank
subsidiaries--leasing or data processing firms.
 They generate earnings from fees, interest income,
and dividends from equity in subsidiaries.
 They pay interest on borrowings and have
administrative expenses.
 Control is defined as ownership or indirect control
via power to vote more than 25 percent of the voting
shares in a bank.
 Prior to nationwide interstate branching, the primary
motivation was to circumvent restrictions regarding
branching and the products and services that banks
can offer.
 Today, the primary motivation is to expand the
scope of products the bank can offer.
Like commercial banks, bank holding companies
are heavily regulated by states and the federal
government.
 The Bank Holding Company Act stipulates that
the Board of Governors of the Federal Reserve
System must approve all holding company
formations and acquisitions.


One-bank holding companies (OBHCs) control
only one bank and typically arise when the
owners of an existing bank exchange their
shares for stock in the holding company.
Multibank holding companies (MBHCs) control
at least two commercial banks.
The Gramm-Leach-Bliley Act of 1999 also gave
regulatory responsibility over Financial Holding
Companies to the Federal Reserve.
 The Glass-Steagall Act effectively separated commercial
banking from investment banking but left open the possibility
of banks engaging in investment banking activities through a
Section 20 affiliate so long as the bank was not “principally
engaged” in these activities.
 Commercial banks received permission (in 1987) from the
Federal Reserve to underwrite and deal in securities
through Section 20 subsidiaries.
 The Fed resolved the issue of “principally engaged”
initially by allowing banks to earn only 5 percent of the
revenue in their securities affiliates. This was raised to 10
percent in 1989 and to 25 percent in March of 1997.
 The Gramm-Leach-Bliley Act of 1999 repeals the restrictions
on banks affiliating with securities firms
 The law creates a new financial holding company,
authorized to engage in: underwriting and selling
insurance and securities, conducting both commercial and
merchant banking, investing in and developing real estate
and other "complimentary activities."
Financial holding companies (FHC) are distinct
entities from bank holding companies (BHC).
 A company can form a BHC or a FHC or both.
 The primary advantages to a banking organization to
forming a FHC is that they can engage in a wide range
of financial activities not permitted in the bank or with
in a BHC.

Some of these activities include:




insurance and securities underwriting and agency
activities,
merchant banking and
insurance company portfolio investment activities.
activities that are "complementary" to financial activities
also are authorized.
 The primary disadvantage to forming a FHC or
converting their BHC to a FHC is that the Federal
Reserve may not permit a company to form a financial
holding company if any of its insured depository
institution subsidiaries are not well capitalized and
well managed, or did not receive at least a satisfactory
rating in their most recent CRA exam.
Nonbank activities permitted bank holding
companies
 The Federal Reserve Board regulates allowable
nonbank activities that are “closely related to
banking” in which bank holding companies may
acquire subsidiaries.
 Restrictions came about for three reasons.
1.
2.
3.
It was feared that large financial conglomerates would
control the financial system because they would have
a competitive advantage.
There was concern that banks would require
customers to buy nonbank services in order to obtain
loans.
Some critics simply did not believe that bank holding
companies should engage in businesses that were not
allowed banks because these businesses were less
regulated and thus relatively risky.
Organizational structure of financial
services company
Financial Services
Holding Company
Bank
Holding
Company
Thrift
Holding
Company
Nonbank
Subsidiaries
Subsidiaries
and Service
Companies
Securities
Subsidiaries
Insurance
Subsidiaries
Real
Estate
Subsidiary
Organizational structure of the OBHC
One-Bank Holding Company
Board of Directors
Parent Company
Bank Subsidiary
The bottom four levels have
the same organizational form
as the independent bank.
Nonbank Subsidiaries
Each subsidiary has a
president and line officers.
Organizational structure of the MBHC.
MultiBank Holding Company
Board of Directors
Parent Company
Bank Subsidiaries
Nonbank Subsidiaries
Bank Subsidiaries
Citicorp's Multibank Holding Company Consolidated Balance Sheet for Parent Company
Only (millions $)
Citicorp's
multibank
holding
company
consolidated
balance sheet
for parent
company only
(millions $)
Citigroup (Parent Company Only)
Assets
2001
2000
Cash and balances due from depository institutions:
Balances with subsidiary depository institutions.
$
6,000 $ 78,000
Balances with unrelated depository institutions.
21,000
7,000
Securities:
Government agencies, corporations and political subdivisions
securities
48,000
0
Other debt and equity securities
1,439,000
0
Net Loans and leases
0
0
Investments in and receivables due from subsidiaries
120,622,000 87,404,000
Premises and fixed assets (including capitalized leases)
15,000
17,000
Goodwill
368,000
381,000
Other assets
368,000
491,000
Total Assets
122,887,000 88,378,000
Liabilities and Equities
Borrowings with a remaining maturity of < one year:
Commercial paper.
Other borrowings.
Other borrowings with a remaining maturity of >one year
Subordinated notes and debentures
Other liabilities
Balances due to subsidiaries and related institutions:
Subsidiary banks.
Nonbank subsidiaries
Related bank holding companies
Equity Capital:
Perpetual preferred stock (including related surplus)
Common stock (par value)
Surplus (exclude all surplus related to preferred stock)
Retained earnings .
Accumulated other comprehensive income
Other equity capital components
Total Equity
Total liabilities and Equities
481,000
5,804,000
25,168,000
4,250,000
113,000
496,000
3,000,000
10,947,000
4,250,000
616,000
100,000
5,714,000
10,000
28,000
2,835,000
0
1,525,000
1,745,000
55,000
54,000
23,196,000 15,635,000
69,803,000 58,012,000
-844,000
973,000
-12,488,000 -10,213,000
81,247,000 66,206,000
122,887,000 88,378,000
Citicorp's multibank holding company consolidated
income statement for parent company only (millions $)
Citigroup (Parent Company Only)
2001
Operating Income:
Income from bank subsidiaries :
Dividends
Interest
Management and service fees
Other
Total
Income from nonbank subsidiaries:
Dividends
Interest
Management and service fees
Other
Total
Income from subsidiary bank holding companies:
Dividends
Interest
Management and service fees
Other
Total
Securities gains/(losses) .
All other operating income.
Total operating income
Operating expense:
Salaries and employee benefits
Interest expense
Provision for loan and lease losses.
All other expenses.
Total operating expense
Income (loss) before taxes and undistributed income
Applicable income taxes
Extraordinary items, net of tax effect
Income (loss) before undistributed income of subsidiaries and associated companies
Equity in undistributed income (losses) of subsidiaries:
Bank
Nonbank
Subsidiary bank holding companies
Net Income (loss)
$0
0
0
0
0
2,586
5
0
1
2,592
6,426
1,220
0
0
7,646
0
53
10,291
225
1,876
0
35
2,136
8,155
-322
-7
8,470
0
2,440
3,216
14,126
Large and small banks
…When many of us think of banks, we think of the largest
banks in the country such as Bank of America, Citibank,
Chase Manhattan Bank, First Union National Bank,
Morgan Guaranty Trust Company, Fleet National Bank,
Wells Fargo Bank, and Bank One.
 Of the approximate 8,100 commercial banks
operating in the United States, however,
only about 80 are greater than $10 billion in
assets.



The vast majority of banks are small banks
(about 5,000), under $100 million in assets with
a legal lending limit of less than $1 million.
In fact, almost 96% of all banks have total
assets less than $1 billion.
Still, the largest banks (over $10 billion) hold
almost 70 percent of
Banking business models
…The
business models followed by the majority
of banks (small banks) is generally different
that that of largest banks.
 Historically, small banks have been called
independent or community banks while large
banks have been labeled large holding company
banks, multibank holding companies, or even
money center banks.
 Never the less, banks of the same size, however,
often pursue substantially different strategies
Business model structure of
commercial banking
 The organizational structure of commercial
banks can be characterized as banks falling
into one of the following categories based on
the range of products and services offered and
the different geographic markets served:





Global banks
Nationwide banks
Super Regional banks
Regional banks
Specialty banks


limited region
limited product line
Organizational structure of an
independent bank
Five fundamental objectives
of bank regulation
 Ensure the safety and soundness of banks and
financial institutions
 The Federal Reserve System uses regulation
to provide monetary stability
 To provide an efficient and competitive
financial system
 Protect consumers from abuses by creditgranting institutions
 To maintain the integrity of the nation’s
payments systems.
Three separate federal agencies along with
each state's banking department issue and
enforce regulations
 The Federal Reserve
 The Federal Deposit Insurance
Corporation (FDIC)
 Office of the Comptroller of the Currency
(OCC)
Most regulations can be classified in one of
three basic categories:
1. supervision, examination, deposit
insurance, chartering activity, and
product restrictions are associated with
safety and soundness
2. branching, mergers and acquisitions,
and pricing are related to an efficient and
competitive financial system
3. consumer protection.
Depository institutions and their regulators
Type of Commercial Bank
Type of Regulation
Safety and Soundness
Supervision and
Examination
National
Comptroller
State member
Insured state
nonmember
Federal Reserve FDIC and state
and state authority
authority
Noninsured state
nonmember
Bank holding
companies
State authority
Federal reserve
Deposit Insurance
FDIC
FDIC
FDIC
State insurance
or none
Not applicable
Chartering and Licensing
OCC
State authority
State authority
State authority
Federal Reserve
and state authority
Efficiency and Competitiveness
Federal Reserve FDIC and state
and state authority
authority
Federal Reserve FDIC and state
Mergers and Acquisitions Comptroller
and state authority
authority
Federal Reserve
Federal Reserve
Federal Reserve
Pricing New Products
and state
and state
and state authority
authority
authority
Federal Reserve,
Federal Reserve
Consumer Protection
Federal Reserve
FDIC, and state
and state authority
authority
Branching
Comptroller
Federal Reserve
and state authority
Federal Reserve
State authority
and state authority
Federal Reserve
and state
Not applicable
authority
Federal Reserve
and state
Not applicable
authority
State authority
Supervision and Examination
… Regulators periodically examine individual banks and
provide supervisory directives
 The OCC and FDIC assess the overall quality
of a bank's condition according to the
CAMELS system:






Capital adequacy
Asset quality
Management quality
Earnings quality
Liquidity
Sensitivity
 Regulators assign ratings from 1 (best) to 5
(worst) for each category and an overall rating
for all features combined.
Deposit insurance
…The Federal Deposit Insurance Corporation (FDIC) insures
the deposits of banks up to a maximum of $100,000 per
account holder while almost all credit unions are insured by
the National Credit Union Share Insurance Fund (NCUSIF),
which is controlled by the NCUA.
 The FDIC was created by the Banking Act of 1933, in response to
the large number of bank failures that followed the stock market
crash of 1929.
 Originally the FDIC insured deposits up to $5,000.
 Fundamentally, all newly chartered banks must obtain FDIC
insurance.
 The FDIC also acts as the primary federal regulator of statechartered banks that do not belong to the Federal Reserve System.
 State banks who are members of the Federal Reserve System
have that agency for their primary federal regulator.
 The FDIC also has backup examination and regulatory authority
over national and Fed-member banks.
 The FDIC is also the receiver of failed institutions.
 The FDIC declares banks and savings associations insolvent
and handles failed institutions by either liquidating them or
selling the institutions to redeem insured deposits.
Two insurance funds under the FDIC:
 The Bank Insurance Fund (BIF) for banks and
the Savings Association Fund (SAIF).

The BIF and SAIF funds are scheduled to be
merged but this has not occurred as of mid
2002.
 The OCC and state banking authorities
officially designate banks as insolvent, but the
Federal Reserve and FDIC assist in closings.
 The Federal Reserve also serves as the federal
government's lender of last resort.

When a bank loses funding sources, the Federal
Reserve may make a discount window loan to
support operations until a solution appears.
Federal Reserve bank regulations
REGULATION
A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
Q
R
Subject
Loans to Depository Institutions
Equal Credit Opportunity
Home Mortgage Disclosure
Reserve Requirements
REGULATION
S
T
U
V
Subject
Reimbursement for Providing Financial
Records
Margin Credit Extended by Brokers and
Dealers
Margin Credit Extended by Banks
Guarantee of Loans for National Defense
Work
Extensions of Consumer Credit (revoked)
Borrowers Who Obtain Margin Credit
Bank Holding Companies
Electronic Fund Transfers
W
Limitations on Interbank Liabilities
X
Margin Credit Extended by Parties
Other Than Banks, Brokers, and
Y
Dealers
Membership Requirements for State
Truth in Lending
Z
Chartered Banks
Stock in Federal Reserve Banks
AA
Consumer Complaint Procedures
Check Collection and Funds Transfer
BB
Community Reinvestment
International Banking Operations
CC
Availability of Funds and Collection of Checks
Interlocking Bank Relationships
DD
Truth in Savings
Consumer Leasing
EE
Netting Eligibility for Financial Institutions
Relationships with Foreign Banks
Loans to Executive Officers of Member Banks
Member Bank Protection Standards
Interest on Demand Deposits, Advertising
Interlocking Relationships Between Securities Dealers and Member Banks
Interstate Branches as a Percentage of Total Offices for FDIC-
The Riegle-Neal Interstate Banking
and Branching Efficiency Act, 1994,
mandates interstate branch banking,
superseding state banking pacts
Nonbank banks
…most large banking organizations have
established nonbank affiliates
 Edge Act corporations
 Edge Act corporations provide a full range of
banking services but, by law, deal only in
international transactions
 There are two types of Edge corporations:
banks and investment companies
 Loan production offices (LPOs)
 make commercial loans but do not accept
deposits
 Consumer banks outside their home state
 Consumer banks accept deposits but make
only consumer loans
Consumer Protection.
 State legislatures and the Federal Reserve have




implemented numerous laws and regulations to
protect the rights of individuals who try to borrow.
Regs. AA, B, BB, C, E, M, S, Z, and DD apply
specifically to consumer regulation.
Equal credit opportunity (Reg. B), for example, makes
it illegal for any lender to discriminate against a
borrower on the basis of race sex, marital status,
religion, age, or national origin.
Community reinvestment prohibits redlining in which
lenders as a matter of policy do not lend in certain
geographic markets.
Reg. Z requires disclosure of effective rates of
interest, total interest paid, the total of all payments,
as well as full disclosure as to why a customer was
denied credit.
Trends in federal legislation and regulation
 The fundamental focus of federal banking
legislation and regulation since 1970 has been
to define and ultimately expand the product
and geographic markets served by depository
institutions, and to increase competition.
 Subsequent problems with failed savings and
loans and commercial banks raised concerns
that only a few large organizations would
survive because all financial institutions would
eventually have the same powers and large
firms would drive small firms out of business.
Today, the banking and financial services
industry is evolving into a new and exciting
industry full of challenges and
opportunities.
 Smaller banks appear to have opportunities
in providing specialized products and
services.
 Larger banks have expanded their product
mix and have blurred the distinction
between a bank and a securities firm.
Key legislative and regulatory changes
have attempted to address three basic
issues
What is a bank?
2. Where can banks conduct business?
3. What products can banks offer and what
interest rates may be charged or paid?
1.
Key Legislation: 1980 - 2002
 Depository Institutions Deregulation and Monetary










Control Act of 1980
Garn-St. Germain Depository Institutions Act of 1982
The Tax Reform Act of 1986
Competitive Equality Banking Act of 1987
The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 (FIRREA)
The Federal Deposit Insurance Corporation Improvement
Act of 1991
Market value accounting and FASB 115
Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994
The 1998 Credit Union Membership Access Act
Financial Services Modernization Act (Gramm-LeachBliley Act of 1999)
USA Patriot Act of 2001
Financial Services Modernization Act
(Gramm-Leach-Bliley Act of 1999)
 The repeal of restrictions on banks affiliating
with securities firms clearly tops the list of
provisions of Gramm-Leach-Bliley.
 The Act, however, was more comprehensive
and addressed new powers and products of
banks and the financial services industry,
functional regulation of the industry, insurance
powers, the elimination of new charters for
unitary savings and loan holding companies
and even consumer privacy protection.
 In fact, it is the privacy section of the bill that
has some of the most far reaching beyond
banking.
Bank Management, 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2003 by South-Western, a division of Thomson Learning
BANK ORGANIZATION
AND REGULATION
Chapter 2