Commercial Banking
Structure, Regulation
and Performance
Chapter 15
© 2003 South-Western/Thomson Learning
Learning 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 2
Banking Regulatory Structure

Glass-Steagall Act of 1933

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Slide 3
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
Banking 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 4
Banking 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 5
Regulatory 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 6
Regulatory 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

Slide 7
States regulate:
 State-chartered, non-FDIC-insured
banks that are not Fed members
Structure 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 8
Structure 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 9
Bank 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 10
Exhibit 15–5
Allowable
Activities for
Bank Holding
Companies
(Federal
Reserve
Regulation Y,
Revised
January 1,
2001)
Slide 11
Bank 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:
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

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Data processing
Leasing
Investment counseling
Servicing out-of-state loans
 Almost all large banks are owned by
holding companies
Slide 12
Financial Holding Companies

Financial Holding Companies
 Engage in broader array of financialrelated activities than bank holding
companies
Slide 13
 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
Bank 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 14
Ongoing Changes in Structure
of Banking Industry
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Slide 15
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
Evolution 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 17
Bank 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 18
Managing 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 19
Managing 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 20
Bank Performance
Banks are facing increasing competition
from other FIs and nonfinancial
corporations in a global environment.

Nonbanks
 Other intermediaries and nonfinancial
companies that have taken increasing
share of intermediation
Slide 21