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1.Prompt:

What are some of the limitations to the Basel and Basel 2 Accords? How does the Basel 3 Accord attempt to address these limitations?

Requirement: 75-150 words

2.Prompt:

Suppose that after a few mergers and acquisitions, only one bank holds 70% of all deposits in the United States. Would you say that this bank would be considered too big to fail? What does this tell you about the ongoing process of financial consolidation and the government safety net?

Requirement: 75-150 words

References:

The Economics of Money, Banking, and Financial Markets text

Part 3.10: Economic Analysis of Financial Regulations

Part 3.11: Banking Industry: Structure and Competition

The Economics of Money, Banking, and
Financial Markets
Business School Edition, Fifth Edition
Chapter 11
Banking Industry: Structure
and Competition
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Preview
• This chapter examines the historical trends in the banking
industry that help explain the unique structure of the U.S.
system.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Learning Objectives (1 of 2)
• Recognize the key features of the banking system and the
historical context of the implementation of these features.
• Explain how financial innovation led to the growth of the
shadow banking system.
• Identify the key structural changes in the commercial
banking industry.
• Summarize the factors that led to consolidation in the
commercial banking industry.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Learning Objectives (2 of 2)
• Assess the reasons for separating banking from other
financial services through legislation.
• Summarize the distinctions between thrift institutions and
commercial banks.
• Identify the reasons for U.S. banks to operate in foreign
countries and for foreign banks to operate in the United
States.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Historical Development of the Banking
System
• Bank of North America chartered in 1782
• Controversy over the chartering of banks
• National Bank Act of 1863 creates a new banking system
of federally chartered banks
– Office of the Comptroller of the Currency
– Dual banking system
• Federal Reserve System is created in 1913.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Figure 1 Time Line of the Early History of
Commercial Banking in the United States
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Primary Supervisory Responsibility of Bank
Regulatory Agencies
• Federal Reserve and state banking authorities: state banks
that are members of the Federal Reserve System.
• Fed also regulates bank holding companies.
• FDIC: insured state banks that are not Fed members.
• State banking authorities: state banks without FDIC
insurance.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Financial Innovation and the Growth of the
“Shadow Banking System”
• Financial innovation is driven by the desire to earn profits
• A change in the financial environment will stimulate a
search by financial institutions for innovations that are
likely to be profitable
– Financial engineering
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Responses to Changes in Demand
Conditions: Interest-Rate Volatility
• Adjustable-rate mortgages
– Flexible interest rates keep profits high when rates rise
– Lower initial interest rates make them attractive to
home buyers
• Financial derivatives
– Ability to hedge interest rate risk
– Payoffs are linked to previously issued (i.e., derived
from) securities.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Responses to Changes in Supply Conditions:
Information Technology
• Bank credit and debit cards
– Improved computer technology lowers transaction
costs
• Electronic banking
– ATM, home banking, ABM, and virtual banking
• Junk bonds
• Commercial paper market
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Securitization and the Shadow Banking
System
• Securitization
– To transform otherwise illiquid financial assets into
marketable capital market securities.
– Securitization played an especially prominent role in
the development of the subprime mortgage market in
the mid 2000s.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Bruce Bent and the Money Market Mutual
Fund Panic of 2008
• Bruce Bent, one of the originators of money market mutual
funds, almost brought down the industry during the global
financial crisis in the fall of 2008.
• Not surprisingly, given the extension of a government
safety net to the money market mutual fund industry, there
are calls to regulate this industry more heavily.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Avoidance of Existing Regulations
• Loophole Mining:
– Reserve requirements act as a tax on deposits
– Restrictions on interest paid on deposits led to
disintermediation
– Money market mutual funds
– Sweep accounts
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Financial Innovation and the Decline of
Traditional Banking (1 of 3)
• As a source of funds for borrowers, market share has
fallen.
• Commercial banks’ share of total financial intermediary
assets has fallen
• No decline in overall profitability
• Increase in income from off-balance-sheet activities
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Figure 2 Bank Share of Total Nonfinancial
Borrowing, 1960–2017
Source: Federal Reserve Bank of St. Louis, FRED data base: http://research.stlouisfed.org/fred2/;
https://www2.fdic.gov/hsob/index.asp.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Financial Innovation and the Decline of
Traditional Banking (2 of 3)
• Decline in cost advantages in acquiring funds (liabilities)
– Rising inflation led to rise in interest rates and
disintermediation
– Low-cost source of funds, checkable deposits, declined
in importance
• Decline in income advantages on uses of funds (assets)
– Information technology has decreased need for banks
to finance short-term credit needs or to issue loans
– Information technology has lowered transaction costs
for other financial institutions, increasing competition
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Financial Innovation and the Decline of
Traditional Banking (3 of 3)
• Banks’ Responses
– Expand into new and riskier areas of lending
â–ª Commercial real estate loans
â–ª Corporate takeovers and leveraged buyouts
– Pursue off-balance-sheet activities
â–ª Non interest income
â–ª Concerns about risk
â–ª Decline of Traditional Banking in Other
Industrialized Countries
• Decline of Traditional Banking in Other Industrialized
Countries
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Structure of the U.S. Commercial Banking
Industry
• Restrictions on branching
– McFadden Act and state branching regulations
• Response to branching restrictions
– Bank holding companies
– Automated teller machines
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Table 1 Size Distribution of Insured
Commercial Banks, March 31, 2017
Table 1 Size Distribution of FDIC Insured Banks, March 31, 2017
Assets
Number of
Banks
Share of
Banks (%)
Less than $100 million
1,501
25.6
0.5
$100 million–$1 billion
3,605
61.6
6.9
$1 billion–$10 billion
632
10.8
10.4
$10 billion–$250 billion
109
1.9
31.6
More than $250 billion
9
0.2
50.6
5,856
100.00
100.00
Total
Share of Assets
Held (%)
Source: FDIC Quarterly Banking Profile, https://www.fdic.gov/bank/analytical/qbp/index.html
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Table 2 Ten Largest U.S. Banks, 2017
Bank
Assets ($ billions)
Share of All Commercial Bank
Assets (%)
1. J.P. Morgan Chase & Co.
2,420
14.4
2. Bank of America Corp.
2,150
12.8
3. Citigroup Inc.
1,770
10.5
4. Wells Fargo & Co.
1,750
10.4
5. U.S. Bankcorp
416
2.5
6. Bank of New York Mellon Corp.
377
2.2
7. PNC Financial Services Group
362
2.2
8. Capital One Financial Corp.
314
1.9
9. HSBC North America Holdings
292
1.7
10. TD Bank U.S. Holding Co.
253
1.5
10,103
60.1
Total
Source: From Bankrate.com––Compare mortgage, refinance, insurance, CD rates: http://www.bankrate
.com/banking/americas-top-10-biggest-banks/#slide=1.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Bank Consolidation and Nationwide
Banking
• The number of banks has declined dramatically over the
last 30 years.
– Bank failures and consolidation
– Deregulation: Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994
– Economies of scale and scope from information
technology
• Results may be not only a smaller number of banks but a
shift in assets to much larger banks.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Figure 3 Number of Insured Commercial Banks in
the United States, 1934–2016 (Third Quarter)
Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2/.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
What Will the Structure of the U.S. Banking
Industry Look Like in the Future?
• Although the United States retains a unique banking
structure in possessing a large number of banks, its
structure is converging with systems in Europe and Japan.
• How far the convergence between banking systems will
extend is the subject of ongoing academic debate
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Are Bank Consolidation and Nationwide
Banking Good Things? (1 of 2)
• Benefits
– Increased competition, driving inefficient banks out of
business
– Also, increased efficiency from economies of scale and
scope
– Lower probability of bank failure from more diversified
portfolios
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Are Bank Consolidation and Nationwide
Banking Good Things? (2 of 2)
• Costs
– Elimination of community banks may lead to less
lending to small business
– Banks expanding into new areas may take increased
risks and fail
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Separation of the Banking and Other
Financial Service Industries (1 of 2)
• Erosion of Glass-Steagall
– Prohibited commercial banks from underwriting
corporate securities or engaging in brokerage activities
– Section 20 loophole was allowed by the Federal
Reserve enabling affiliates of approved commercial
banks to underwrite securities as long as the revenue
did not exceed a specified amount
– U.S. Supreme Court validated the Fed’s action
in 1988
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Separation of the Banking and Other
Financial Service Industries (2 of 2)
• Gramm-Leach-Bliley Financial Services Modernization
Act of 1999
– Abolishes Glass-Steagall
– States regulate insurance activities
– SEC keeps oversight of securities activities
– Office of the Comptroller of the Currency
regulates bank subsidiaries engaged in
securities underwriting
– Federal Reserve oversees bank holding companies
– Stimulated consolidation of the banking industry
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Separation of Banking and Other Financial
Services Industries Throughout the World
– No separation between banking and securities
industries in Germany, Holland and Switzerland
– Universal banking in Great Britain
â–ª May engage in security underwriting
â–ª Separate legal subsidiaries are common
â–ª Bank equity holdings of commercial firms are less
common
â–ª Few combinations of banking and insurance firms
– Japanese style system
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
The Global Financial Crisis and the Demise
of Large, Free-Standing Investment Banks
• Although the move toward bringing financial service
activities into larger, more complex banking organizations
was inevitable after the demise of Glass-Steagall, no one
expected it to occur as rapidly as it did in 2008. Over a sixmonth period from March to September 2008, all five of the
largest, free-standing investment banks ceased to exist in
their old form.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Thrift Industry: Regulation and Structure
(1 of 3)
• Savings and loan associations
– Chartered by the federal government or by states
– Most are members of Federal Home Loan Bank
System (FHLBS)
– Deposit insurance provided by Savings Association
Insurance Fund (SAIF), part of FDIC
– Regulated by the Office of Thrift Supervision
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Thrift Industry: Regulation and Structure
(2 of 3)
• Mutual savings banks
– Approximately half are chartered by states
– Regulated by state in which they are located
– Deposit insurance provided by FDIC or state insurance
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Thrift Industry: Regulation and Structure
(3 of 3)
• Credit unions
– Tax-exempt
– Chartered by federal government or by states
– Regulated by the National Credit Union Administration
(NCUA)
– Deposit insurance provided by National Credit Union
Share Insurance Fund (NCUSIF)
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International Banking
• Rapid growth
– Growth in international trade and multinational
corporations
– Global investment banking is very profitable
– Ability to tap into the Eurodollar market
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Eurodollar Market
• Dollar-denominated deposits held in banks outside of the
United States
• Ironic birth in Communist period
• Most widely used currency in international trade
• Offshore deposits not subject to regulations
• Important source of funds for U.S. banks
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Structure of U.S. Banking Overseas
• Shell operation
• Edge Act corporation
• International banking facilities (IBFs)
– Not subject to regulation and taxes
– May not make loans to domestic residents
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Foreign Banks in the United States (1 of 2)
• Agency office of the foreign bank
– Can lend and transfer fund in the United States
– Cannot accept deposits from domestic residents
– Not subject to regulations
• Subsidiary U.S. bank
– Subject to U.S. regulations
– Owned by a foreign bank
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Foreign Banks in the United States (2 of 2)
• Branch of a foreign bank
– May open branches only in state designated as home
state or in state that allow entry of out-of-state banks
– Limited service may be allowed in any other state
• Subject to the International Banking Act of 1978
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
Table 3 Ten Largest Banks in the World,
2017
Bank
Assets (U.S. $ trillions)
1. Industrial and Commercial Bank of China, China
3.62
2. China Construction Bank Corp., China
2.94
3. Agricultural Bank of China, China
2.82
4. Bank of China, China
2.63
5. HSBC Holdings, United Kingdom
2.57
6. JP Morgan Chase & Co., US
2.42
7. BNP Paribas, France
2.40
8. Mitsubishi UFJ Financial Group, Japan
2.32
9. Bank of America, US
2.15
10. Credit Agricole Group, France
1.91
Source: From Bankrate.com––Compare mortgage, refinance, insurance, CD rates, http://www.bankrate
.com/finance/banking/largest-banks-in-the-world-1.aspx.
Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved.
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