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

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 155
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:

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
doesnt 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

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

Slide 20

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

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