Chapter 18
Regulation of the Accounting Process
The Sarbanes-Oxley (SOX) Act was enacted in 2002 to ensure a transparent process for financial reporting.
Interstate Banking Act
a. Removed interstate banking restrictions b. Enabled banks to achieve economies of scale
U.S. is a dual banking system
it includes both federal and state regulatory system.
Regulation of Bank Ownership
1. Ownership by a bank holding co. 2. Independently owned
Regulation of Off-Balance Sheet Transactions
Bank exposure to off-balance sheet activities has become a major concern of regulators. Banks could be riskier than their balance sheets indicate because of these transactions. Regulation of Credit Default Swaps Regulators increased their oversight of this market and asked commercial banks to provide more information about their credit default swap positions.
Liquidity
Banks ability to pay obligations Banks often borrow by accessing 1.) the discount window (the Fed) 2.) federal funds market If existing depositors sense that the bank is experiencing a liquidity problem, they may withdraw their funds, compounding the problem.
Reducing Dividends
Banks can increase their capital by reducing their dividends.
Retaining Earnings
Banks commonly boost their capital levels by retaining earnings or by issuing stock to the public.
The Glass- Steagall Act prevented any firm that accepted deposits from underwriting stocks and bonds of corporations.
Banks could underwrite general obligation bonds of states and municipalities or purchase or sell securities for their trust accounts. In addition, they could hold investment-grade corporate bonds within their asset portfolio. In this case, the Bank was acting as a creditor and not as a shareholder.
Regulators apply the CAMEL Ratings in their audits:
Capital Adequacy Asset Quality Management Earnings Liquidity
The Financial Services Modernization Act
Congress passed the Financial ServicesModernization Act (also called the Gramm-Leach-Bliley Act), which essentially repealed the Glass-Steagall Act. The 1999 Act allows affiliations between banks, securities firms and insurance companies. It also allows bank holding companies to engage in any financial activity through their ownership of subsidiaries.
Advance Warning System
Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.
Earnings
Criteria ratio: Return on Assets, ROA = (Earnings after Taxes)/Assets Compare earnings with industry standards
Transparency & Accountability for Exotic Instruments
Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated -- including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders
Ends Too Big to Fail Bailouts
Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed's authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.
The separation of securities activities from banking activities was intended to prevent potential conflicts of interest.
For example, the belief was that if a bank was allowed to underwrite securities, it might advise its corporate customers to purchase these securities and could threaten to cut off future loans if the customers did not oblige.
Asset Quality
Indicates the bank's exposure to credit risk (i.e. loan quality) Regulators use 5 C's to assess loan quality• 1.) capacity - The borrower's ability to pay.• 2.) collateral - The quality of the assets that back the loan.• 3.) condition - The circumstances that led to the need for funds.• 4.) capital - The difference between the value of the borrower's assets and its liabilities.• 5.) character - The borrower's willingness to repay loans as measured by its payment history on•the loan and credit report.
Regulatory Structure: (Regulatory Overlap)
National banks are regulated by the Comptroller of the Currency, the FED and the Federal Deposit Insurance Corporation (FDIC). The FDIC insures deposits . The Dodd-Frank Wall Street Reform and Consumer Protection Act (July 21, 2010) permanently raised the current FDIC standard maximum deposit insurance amount (SMDIA) to $250,000. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.
Executive Compensation and Corporate Governance
Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and golden parachutes
Protects Investors
Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.
Management
Ratings based on management's 1.) administrative skills 2.) ability to comply with existing regulations 3.) ability to cope with a changing environment b. Internal control system
How Banks Satisfy Regulatory Requirements
Retained Earnings Reducing Dividends Selling Assets
Enforces Regulations on the Books
Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefits special interests at the expense of American families and businesses.
Securities Services
The Banking Act of 1933 (better known as the Glass-Steagall Act) separated banking and securities activities. The Act was prompted by problems during 1929 when some banks sold some of their poor quality securities to their trust accounts established for individuals. Some banks also engaged in insider trading , buying or selling corporate securities based on confidential information provided by firms that had requested loans.
Dodd Frank Act
Was passed as a response to the late 2000s great recession, which is the most sweeping change to financial regulation in the US since the great depression
The Glass-Steagall Act (48 Stat. 162)
Was passed by Congress in 1933 and prohibits commercial banks from engaging in the investment business. It separated Commercial Banks from Investment Banks. It was enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression.
Selling Assets
When bank regulators of various countries develop their set of guidelines for capital requirements, they are commonly guided by the recommendations in the Basel accords.
Consumer Protections with Authority and Independence: Created The Consumer Financial Protection Bureau
a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.
Garn-St. Germain Act
a. Allowed more use of money market accounts b. Lowered geographic boundaries to conduct banking
Regulation of Operations
a. Bank Assets closely monitored 1.) highly leveraged transactions(HLTs) 2.) bank's exposure to foreign debt 3.) loan diversification
A charter from either a state (to be a state bank) or the federal government (to be a national bank) is required to open a commercial bank in the U.S.
a. Comptroller of the Currency issues charters for federal banks. b. Department of Financial Institutions or other agency (within each state) issues charters for state banks within their respective states. c. All national banks are required to be members of the Federal Reserve System (the FED). State banks can choose whether to be a member of the FED. Both members and non-members of the FED can borrow from the FED, and both are subject to the FED's reserve requirements.
Deregulation Act of 1980 (Depository Institutions Deregulation and Monetary Control Act (DIDMCA)
a. Eliminated interest-rate ceilings (formerly known as Regulation Q) b. All banks could offer NOW (negotiable order of withdrawal) accounts c. More flexibility in lending d. Fed would now charge for its services
Capital Adequacy
based on the capital ratio (=capital divided by assets) When banks hold more capital, they can more easily absorb potential losses The higher the ratio, the higher the capital adequacy rating
The stated aim of the legislation is:
•To promote the financial stability of the United States by improving accountability and transparency in the financial system, •to end "too big to fail", to protect the American taxpayer by ending bailouts, •to protect consumers from abusive financial services practices, prevent another Financial Crisis and for other purposes.