BANKING REGULATION: Its Purposes, Implementation, and Effects docx

BANKING REGULATION Its Purposes, Implementation, and Effects Fifth Edition Kenneth Spong Division of Supervision and Risk Management Federal Reserve Bank of Kansas City 2000 Title page.qxd 12/21/00 4:40 PM Page 1 First Edition, 1983 Second Edition, 1985 Third Edition, 1990 Fourth Edition, 1994 Fifth Edition, 2000 Copies of this book may be obtained from: Public Affairs Department Federal Reserve Bank of Kansas City Kansas City, Missouri 64198-0001 This book can be obtained in electronic form from the Federal Reserve Bank of Kansas City’s website, located at http://www.kc.frb.org, under Publica- tions or Supervision and Risk Management. This service contains a wide array of information and data from the bank’s Economic Research, Commu- nity Affairs, Supervision and Risk Management, Financial Services, Public Affairs, and Consumer Affairs departments, and the Center for the Study of Rural America. Title page.qxd 12/21/00 4:40 PM Page 2 FOREWORD Throughout U.S. history, banking regulation has been an important factor in establishing the role of banks within the finan- cial system. This will continue to be true with the pathbreaking banking legislation that was passed in 1999 and with the many rev- olutionary changes that are taking place in our financial system today. Most notably, the 1999 legislation is opening the door for banking, securities, and insurance activities to be merged together. At the same time, technological innovation, new financial theories and ideas, changes in the competitive environment, and expanding international relationships are all leading to a remarkable transfor- mation in how the financial system operates. Among the more sig- nificant and ongoing changes are interstate banking, banking over the Internet, a broad array of new financial services, and a rapid increase in our capacity to process and utilize financial information. As a regional institution and an integral part of the nation’s cen- tral bank, the Federal Reserve Bank of Kansas City places much emphasis on its role in monitoring developments within banking and promoting a stable and competitive financial system. The fifth edition of Banking Regulation: Its Purposes, Implementation, and Effects not only reflects these objectives, but reaffirms our inten- tions to bring about a greater understanding of the U.S. banking system and its supervisory framework. The four previous editions of this book have been widely used by bankers, the general public, colleges and universities, and bank- ing supervisors. I trust this fifth edition will continue to be a use- ful source of information on our supervisory process and the challenges we all face in maintaining a sound and innovative finan- cial system. THOMAS M. HOENIG President November 2000 iii Foreword.qxd 12/21/00 4:41 PM Page iii ACKNOWLEDGEMENTS I greatly appreciate the support of the personnel in the Division of Supervision and Risk Management and the Public Affairs Department who provided comments or assisted in writing or producing this book. This includes Marge Wagner, Alinda Mur- phy, Jill Conniff, and Jenifer McCormick, who helped draft Chap- ter 7; Jim Hunter, David Klose, Linda Schroeder, and Susan Zubradt, who provided many helpful comments; and Beth Welsh, who assisted in the production of this book. KENNETH SPONG Senior Economist v Acknowledgement.qxd 12/21/00 4:43 PM Page v CONTENTS Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .iii Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .v INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 CHAPTER 1WHY REGULATE BANKS . . . . . . . . . . . . . . . . .5 Protection of depositors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Monetary and financial stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 Efficient and competitive financial system . . . . . . . . . . . . . . . . . . . . . . . .9 Consumer protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 What bank regulation is not intended to accomplish . . . . . . . . . . . . . . .11 CHAPTER 2HISTORY OF BANKING REGULATION . . . . . . . . . . . . . . . . .15 Early American banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16 Development of dual banking and the national bank system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 Development of the Federal Reserve System . . . . . . . . . . . . . . . . . . . . .20 Great Depression and 1930s reform . . . . . . . . . . . . . . . . . . . . . . . . . . .22 A rapidly evolving banking system . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 CHAPTER 3BANKS, BANK HOLDING COMPANIES, AND FINANCIAL HOLDING COMPANIES . . . . .35 Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35 Bank holding companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41 Financial holding companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 CHAPTER 4REGULATORY AGENCIES . . . . . . . . . . . . . . . . .51 Comptroller of the Currency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 Federal Reserve System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 Federal Deposit Insurance Corporation . . . . . . . . . . . . . . . . . . . . . . . . .55 Federal Financial Institutions Examination Council . . . . . . . . . . . . . . . .57 State banking agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 Other regulatory agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59 vii Table of contents.qxd 12/21/00 4:41 PM Page vii CHAPTER 5REGULATION FOR DEPOSITOR PROTECTION AND MONETARY STABILITY . . . . . . . . . . . . . .63 Banking factors and regulations affecting depositor safety . . . . . . . . . . .65 Supervisory compliance procedures . . . . . . . . . . . . . . . . . . . . . . . . . . .116 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .143 CHAPTER 6REGULATION CONSISTENT WITH AN EFFICIENT AND COMPETITIVE FINANCIAL SYSTEM . . . . . . . . . . . . . . . . . . .145 Chartering regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .146 Bank ownership regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .151 Geographic scope of operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 Changes in the competitive marketplace . . . . . . . . . . . . . . . . . . . . . . .196 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .199 CHAPTER 7REGULATION FOR CONSUMER PROTECTION . . . . . . . . . . . . . .201 Regulatory considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .202 Disclosure laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .204 Civil rights laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .224 Other consumer credit laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237 Interrelationship of consumer laws . . . . . . . . . . . . . . . . . . . . . . . . . . . .250 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .252 CHAPTER 8FUTURE TRENDS IN BANKING REGULATION . . . . . . . . . . . . . . . .253 Factors influencing future regulation . . . . . . . . . . . . . . . . . . . . . . . . . .254 Implications for regulatory change . . . . . . . . . . . . . . . . . . . . . . . . . . . .258 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .267 INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .269 viii Table of contents.qxd 12/21/00 4:41 PM Page viii INTRODUCTION Banking and the regulation of banks have both been key ele- ments in the development of the United States and its financial system. Banks have attained a unique and central role in U.S. financial markets through their deposit-taking, lending, and other activities. Banks hold the vast majority of deposits that are trans- ferable by check. These demand deposit powers have allowed bankers to become the principal agents or middlemen in many financial transactions and in the nation’s payments system. As a result, most payments in this country involve a bank at some point, and this payments system plays a vital role in enabling goods and services to be exchanged throughout our economy. In terms of deposit activities, banks are also important because indi- viduals have traditionally placed a substantial amount of their funds in bank time and savings deposits. On the lending side, banking organizations have significant flexibility in the types of borrowers they can accommodate. Banks are major lenders to the business sector and to individuals, and thus determine how a large portion of credit is to be allocated across the nation. Moreover, through a combination of lending and deposit activities, the banking system can affect the aggregate supply of money and credit, making banks a crucial link in the monetary mechanism and in the overall condition of the economy. Other activities of banks are also of major consequence within the financial system and the overall economy. In particular, bank- ing organizations, through the use of bank holding companies, are expanding into many new markets and financial services. In addi- Chap1.qxd 12/21/00 4:53 PM Page 1 tion, banking legislation passed in 1999 allows banking organiza- tions to set up financial holding companies and thereby participate more fully in insurance, securities, and merchant banking activi- ties. Consequently, banking organizations can now provide a wide range of services, including insurance and securities brokerage and underwriting, mutual funds, leasing, data processing of financial information, and operation of thrift associations, consumer finance companies, mortgage companies, and industrial banks. Given the overall importance of banks to the economy and the level of trust customers place in banks, few people would be sur- prised to find that governmental regulation and oversight extend to many aspects of banking. In fact, since banks first appeared in the United States, banking has been treated as an industry having strong public policy implications. The general public, bankers, and regulators have all played roles in developing the present system of banking laws and supervision. As a consequence, the regulatory sys- tem has been responsive to many different needs and now serves an important function in establishing many of the guidelines and stan- dards under which banking services are provided to the public. There are many reasons to study banking regulation and super- vision, but two general objectives stand out. One is practical: we all conduct transactions through the financial system and deal with banks on a frequent basis. Some knowledge of bank regulations is helpful in carrying out these transactions, understanding how the banking system works, and judging the extent of regulatory pro- tection being provided. Moreover, an understanding of banking regulation has assumed added importance with the growing com- plexity of the financial system and the recent passage of major banking legislation. The other major reason for studying banking regulation is to ensure that this regulation both protects the public and fosters an efficient, competitive banking system. The actual benefits and costs of banking regulation, in fact, are a concern of many differ- ent groups. This attention originates from a number of factors, 2BANKING REGULATION Chap1.qxd 12/21/00 4:53 PM Page 2 including the overall importance of the banking industry to the economy and the financial problems encountered by some bank and thrift organizations in past years. Another concern is whether credit and other banking services flow evenly to different segments of the population. In addition, some contend that banking regu- lation may impose excessive cost burdens that hinder banks in pro- viding services to their customers and in competing with other financial institutions. The benefits and costs of banking regulation are also drawing attention because of many recent industry changes, such as elec- tronic and internet banking, improved communications and data processing systems, and the development of new and more com- plex financial instruments and risk management practices. These revolutionary, technological changes are bringing banking closer to its customers, altering the way financial transactions and banking operations are conducted, and expanding the variety of services banks can provide. All of these factors are prompting much debate over the appro- priate regulatory framework for banks and the types of financial services banks should be able to offer. This debate is also focusing attention on what the basic objectives of bank regulation should be and how existing and proposed regulations will affect our finan- cial system in the future. The purpose of this book is to describe the current regulatory system and look at its influence on banks and their customers. The book further provides a perspective on how banking regulation developed and the specific reasons or purposes for regulating banks. In addition, it outlines many of the changes taking place in banking today and their implications for banking regulation. Chapter 1 addresses the question of why banks are regulated in order to establish the basic purposes, rationale, and goals for bank- ing regulation, and to provide a framework for evaluating bank regulations. Chapter 2 traces the history and development of U.S. banking regulation. Examined in this chapter are events that Introduction 3 Chap1.qxd 12/21/00 4:53 PM Page 3 helped create the present regulatory structure and the laws and reg- ulations that were implemented in response to these events. Chapter 3 looks at what banks, bank holding companies, and financial holding companies are, while Chapter 4 discusses who regulates banks and covers the structure, general powers, and func- tions of the bank supervisory authorities. Chapters 5, 6, and 7 examine many of the regulations that cur- rently apply to banks. Each of these chapters is organized around one of the basic regulatory purposes presented in Chapter 1. The chapters discuss the major regulations serving each purpose, as well as how these regulations achieve their objectives and what consid- erations led to their implementation. Current issues and possible alternatives to these regulations are also explored. While the organ- ization of these chapters provides a convenient means of present- ing the material, the chapters should not be viewed as strict divisions between the various banking regulations. Some regula- tions are discussed in more than one chapter either because they serve more than one purpose or because their purpose has changed over time. These chapters and their organization, consequently, should be viewed as a means of identifying each regulation’s place in the overall regulatory framework. Finally, Chapter 8 reviews ongoing trends and unresolved issues in banking and its regulation. It then discusses what these devel- opments might mean in the future for bank regulation and the supervisory process. Although the book covers major banking regulations and many of their provisions, it provides neither detailed analyses nor specific interpretations of individual regulations themselves. In addition, since numerous changes are taking place in banking and its regu- lation, a number of regulations are likely to be revised in coming years. A note is made in the text covering revisions already known or proposed. Otherwise, regulations should be viewed as effective November 2000. 4BANKING REGULATION Chap1.qxd 12/21/00 4:53 PM Page 4 [...]... States met the same fate as its predecessor, and its charter was not renewed in 1836 The federal government thus removed itself from banking regulation and left the Treasury to attend to all federal banking functions until the national banking system was started nearly three decades later With a rapid expansion of state banks after 1836 and an increase in bank note problems and bank failures, states... financial disruption in its community Chap2.qxd 12/21/00 24 4:50 PM Page 24 BANKING REGULATION Other banking changes were also incorporated into the Banking Acts of 1933 and 1935 First, insured banks were prohibited from paying interest on demand deposits, and provisions were made for the Federal Reserve Board and the FDIC to limit the interest rates banks could pay on time deposits Interest ceilings... over the formation and operation of one-bank holding companies The amendments also set public benefits standards for the approval of nonbanking activities and applied the same closely related to banking test to activities performed by one-bank holding companies With this regulatory framework in place, large bank holding companies continued to expand their banking and permissible nonbanking activities,... operated for profit and bankers are free to make many decisions in their daily operations, banking is commonly treated as a matter of public interest Banking laws and regulations extend to many aspects of banking, including who can open banks, what products can be offered, and how banks can expand Consequently, a familiarity with regulatory objectives and goals is essential for understanding how the U.S... federal and state bank chartering, the myriad of federal and state banking authorities, and the large number of small banks, might not be included Nevertheless, the current system offers several advantages, such as widespread private ownership of banks and a diversity of banking services, and it has worked to the general satisfaction of much of the public Because of its gradual development, U.S banking. .. multi-office banking much more feasible and desirable, thus helping to foster rapid banking consolidation and allow banking organizations to expand into new markets — either on an intrastate, interstate, or international basis These recent advances have also enabled bankers to maintain better and more timely information on their operations and risk exposures, while creating a wider set of tools and instruments... urging of Alexander Hamilton, Congress created the Bank of the United States This bank operated under regular commercial banking principles but also assumed some functions of a central bank Eighty percent of its stock was privately owned, and most of its income came from commercial banking Under its central banking functions, the Bank of the United States acted as the principal depository and fiscal agent... Equality Banking Act of 1987, which provided $10.8 billion to recapitalize the thrift insurance fund, tightened several thrift and bank regulatory provisions, expanded emergency acquisition powers with regard to failing banks and thrifts, and reaffirmed that the full faith and credit of the United States backs insured deposits at banks and thrifts • The Financial Institutions Reform, Recovery, and Enforcement... acts opened chartering to political favoritism, however, and public opinion eventually led to passage of “free banking acts The first free banking acts were passed in Connecticut, Michigan, and New York in 1837 and 1838, and other states later passed similar acts Essentially incorporation laws, they allowed anyone meeting certain standards and requirements to secure a bank charter To protect bank... manner and designing note and deposit insurance systems Between 1836 and 1863, state bank supervision primarily consisted of obtaining and reviewing bank statements of condition Banks were seldom examined unless they were near insolvency Most states required that bank notes and deposits be partially backed by gold and silver holdings, but some were lax in Chap2.qxd 12/21/00 18 4:50 PM Page 18 BANKING . BANKING REGULATION Its Purposes, Implementation, and Effects Fifth Edition Kenneth Spong Division of Supervision and Risk Management Federal. on its role in monitoring developments within banking and promoting a stable and competitive financial system. The fifth edition of Banking Regulation: Its