Domestic and Intl. Banking Chp 11

1. In light of the recent financial crisis of 2007-2009, do you think that the firewall created by the Glass-Steagall Act of 1933 between commercial banking and the securities industry proved to be a good thing or not?

Answers will vary. In general, one could say that the Glass Steagall Act was a good choice in term of separating a risky industry (the securities industry) from traditional commercial banking. In this sense, the Act of 1933 proved to be a good thing, since the banking industry did not experience many crises during its life (it was repealed in 1999). One could also argue that this Act put U.S. banks at a disadvantage against its foreign competitors in terms of lost opportunities to make profits.

1. Why has the number of bank holding companies dramatically increased?

Because becoming a bank holding company allows a bank to: (a) circumvent branching restrictions since it can own a controlling interest in several banks even if branching is not permitted and (b) engage in other activities related to banking that can be highly profitable.

1. Unlike commercial banks, savings and loans, and mutual savings banks, credit unions did not have restrictions on setting up branches in other states. Why, then, are credit unions typically smaller than the other depository institutions?

Credit unions are small because they only have members who share a common employer or are associated with a particular organization.

1. How could the approval of international banking facilities (IBFs) by the Fed in 1981 have reduced employment in the banking industry in Europe?

IBFs encourage American and foreign banks to do more banking business in the United States, thus shifting employment from Europe to the United States.

1. What incentives have regulatory agencies created to encourage international banking? Why have they done this?

International banking has been encouraged by giving special tax treatment and relaxed branching regulations to Edge Act corporations and to international banking facilities (IBFs); this was done to make American banks more competitive with foreign banks. The hope is that it will create more banking jobs in the United States.

Why is there only one U.S. bank among the ten largest banks in the world?

JP Morgan Chase is the only one. Due to the America's vast number of banks it is hard to have a super large one. Other countries have much smaller industries and thus consolidation in these countries is easier which leads to larger banks

1. How does the emergence of interest-rate risk help explain financial innovation?

Large fluctuations in interest rates during the 1970s and 1980s led to a need for financial products that could help reduce risk related to unexpected interest rate fluctuations. Two examples of this type of innovation are adjustable-rate mortgages and financial derivatives, both developed during the 1970s.

1. If reserve requirements were eliminated in the future, as some economists advocate, what effects would this have on the size of money market mutual funds?

Money market mutual funds are not subject to reserve requirements and so they avoid the tax effect of reserve requirements and have a cost advantage over banks in acquiring funds. Eliminating reserve requirements would reduce the cost advantage of money market mutual funds and would significantly reduce their size.

1. If the bank at which you keep your checking account is owned by foreigners, should you worry that your deposits are less safe than if the bank were owned by Americans?

No, because the foreign-owned bank is subject to the same regulations as the American-owned bank.

1. Why did new technology make it harder to enforce limitations on bank branching?

Several banks frequently share new technologies such as electronic banking facilities, so these facilities are not classified as branches. Thus, they can be used by banks to escape limitations on offering services in other states and, in effect, to escape limitations from restrictions on branching.

1. Why is loophole mining so prevalent in the banking industry in the United States?

Since the banking sector is so heavily regulated, there is a strong incentive for banks to find ways to skirt regulations that restrict their ability to earn profits. Through loophole mining, banks can create new financial products that allow them to operate within existing regulations, but make (or increase) profits that were stifled due to regulation.

1. What has been the likely effect of the Gramm-Leach-Bliley Act on financial consolidation?

The Gramm-Leach-Bliley Act opened the door to consolidation, not only in terms of the number of banking institutions but also across financial service activities. Banking institutions have thus become larger and increasingly complex organizations, engaging in the full gamut of financial services activities.

1. Why have banks been losing income advantages on their assets in recent years?

The growth of the commercial paper market and the development of the junk bond market meant that corporations were now able to issue securities rather than borrow from banks, thus eroding the competitive advantage of banks on the lending side. Securitization has enabled other financial institutions to originate loans, again taking away some of the banks' loan business.

1. Why have banks been losing cost advantages in acquiring funds in recent years?

The rise in inflation and the resulting higher interest rates on alternatives to checkable deposits meant that banks had a big shrinkage in this low-cost way of raising funds. The innovation of money market mutual funds also meant that the banks lost checking account business. The abolishment of Regulation Q and the appearance of NOW accounts did help decrease disintermediation, but raised the cost of funds for American banks, which now had to pay higher interest rates on checkable and other deposits. Foreign banks were also able to tap a large pool of domestic savings, thereby lowering their cost of funds relative to American banks.

1. What factors explain the rapid growth of international banking?

There are three main factors that have contributed to rapid growth in international banking: The growth in international trade and expansion of multinational corporations; the increased profitability of global investment banking; and the expansion of dollar-denominated deposits abroad (Eurodollars).

1. Why does the United States operate under a dual banking system?

Throughout most of the history of banking in the United States, there has been a fear of centralized banking power. As a result, all banks had been chartered locally by each state. Due to lax regulation by some states, banks regularly failed due to lack of sufficient capital or fraud. To stabilize the banking system, the federal government introduced the National Banking Act of 1863, which created a system of federally chartered banks that were subject to greater regulation and scrutiny. Since federally chartered banks were less prone to failure, they increased in number over the years. However, the skepticism of centralized power in the banking system still allowed state banks to operate effectively. And although there have been attempts over the years to force all banks to be federally chartered, due to more uniformity in the chartering process, the distinctions between state and federally chartered banks have diminished, and so the two standards are still in operation today.

"If inflation had not risen in the 1960s and 1970s, the banking industry might be healthier today." Is this statement true, false, or uncertain? Explain your answer.

True. Higher inflation helped raise interest rates, which caused the disintermediation process to occur and helped create money market mutual funds. As a result, banks lost cost advantages on the liabilities side of their balance sheets, leading to a less healthy banking industry. However, improved information technology would still have eroded the banks' income advantages on the assets side of their balance sheet, so the decline in the banking industry would still have occurred.

1. Do you think that before the National Bank Act of 1863 the prevailing conditions in the banking industry fostered or hindered trade across states in the United States?

Two important conditions hindered trade across states before 1863: there was no national currency, and banknotes issued by state banks could become worthless any day. Given these two conditions, individuals interested in conducting their business across states had to use mostly gold as a mean of payment, with all the inconveniences attached to that particular type of money.

1. "The invention of the computer is the major factor behind the decline of the banking industry." Is this statement true, false, or uncertain? Explain your answer.

Uncertain. The invention of the computer did help lower transaction costs and the costs of collecting information, both of which have made other financial institutions more competitive with banks and have allowed corporations to bypass banks and borrow directly from securities markets. Therefore, computers were an important factor in the decline of the banking system. However, another source of the decline in the banking industry was the loss of cost advantages for the banks in acquiring funds, and this loss was due to factors unrelated to the invention of the computer, such as the rise in inflation and its interaction with regulations, which produced disintermediation.

1. How do sweep accounts and money market mutual funds allow banks to avoid reserve requirements?

With a sweep account, any account funds left at the end of the business day are technically transferred to another account, which is invested in overnight securities. Since they are no longer classified as checkable deposits, the funds are not subject to reserve requirements. Money market mutual funds are set up such that deposits are used to invest in short-term money market securities. And although money market mutual fund accounts have check writing functions like checkable deposits, they are also not subject to reserve requirements.

1. Which regulatory agency has the primary responsibility for supervising the following categories of commercial banks? a. National banks b. Bank holding companies c. Non-Federal Reserve member state banks d. Federal Reserve member state banks e. Federally chartered savings and loan associations f. Federally chartered credit unions

a. Office of the Comptroller of the Currency b. The Federal Reserve c. State banking authorities and the FDIC d. The Federal Reserve e. Office of Thrift Supervision f. National Credit Union Administration.

Why is there only two U.S. bank among the ten largest banks in the world?

Because of tighter regulation in the United States compared to the rest of the world, there are many more banks, which has kept even the largest banks in the United States relatively small compared to those in other countries. In addition, the United States has been slower to consolidate in the banking sector than most other countries. However, as the banking sector continues toward consolidation, it is likely that the size of the largest U.S. banks will grow.because

1. Why is there a higher percentage of banks with less than $25 million of assets among commercial banks than among savings and loans and mutual savings banks?

Because restrictions on branching are stricter for commercial banks than for savings and loans. Thus, small commercial banks have greater protection from competition and are more likely to survive than small savings and loans.

1. How did competitive forces lead to the repeal of the Glass-Steagall Act's separation of the banking and securities industries?

Brokerage firms began to engage in the traditional banking business of issuing deposit instruments, while foreign bank activities in the United States further eroded the competitive position of U.S. banks. This led to the Federal Reserve's allowing bank holding companies to enter the underwriting business through a loophole in Glass-Steagall in order to keep them competitive. Finally, legislation in 1999 was passed to repeal Glass-Steagall.

1. "The commercial banking industry in Canada is less competitive than the commercial banking industry in the United States because in Canada only a few large banks dominate the industry, while in the United States there are around 5,700 commercial banks." Is this statement true, false, or uncertain? Explain your answer.

False. Although there are many more banks in the United States than in Canada, this does not mean that the American banking system is more competitive. The reason for the large number of U.S. banks has been anticompetitive regulations such as restrictions on banking.

1. Given the role of the loan originator in the securitization process of a mortgage loan described in the text, do you think the loan originator will be worried about the ability of a household to meet its monthly mortgage payments?

Given that the loan originator or mortgage broker is mostly worried about getting the household to accept the terms of the mortgage loan, so that the servicer can sell it to the bundler, then it is easy to see that he or she is not very worried about the financial constraints of this family. The loan originator is mostly worried about getting its fee, since he or she will not suffer any consequences if the household cannot repay its loan. This was one of the major problems at the origin of the global financial crisis of 2007-2009.