Bank regulation

1. Bank regulation

2. Need for banking regulation?

• Banks’ fragility
• Systemic risk
• Protection of depositors

3. Fragility of banking business

In 1 month
In 3 months
In one year
Withdrawals of
$1 mln deposit
-$300,000
-$400,000
-$300,000
Deposit balance
$700,000
$300,000
$0
loans
i2 %
i1 %
$1 m
deposit i1 %- i2 %
cash
Trust and safety

4. Simplified balance sheets of a

Financial Institution
Assets
Liabilities & Equity
CASH
LOANS
DEPOSITS
OWNERS’ CAPITAL
Secondary securities
Primary securities
Risk intermediation

5. E.g. 1. Deposits’ Withdrawals and Systemic Risk

6.

today
In 1 months
In 3 months
-$300,000
-$400,000
$1,000,000
$700,000
$300,000
today
In 1 month
In 3 months
$700,000
$300,000
$1,000,000
$700,000
$300,000
today
In 1 months
In 3 months
-$700,000
-$300,000
$1,000,000
$300,000
0
today
In 1 month
$1,000,000
-$400,000
Withdrawals of a
$1 m deposit
Deposit balance
Cash
$1,000,000
Loans
Deposits
Withdrawals of
deposit
Deposit balance
Cash
Loans
Deposits
$700,000
$1,000,000
$300,000
Cash deficit

7.

today
In 1 months
In 3 months
-$700,000
-$300,000
$1,000,000
$300,000
0
today
In 1 month
$1,000,000
-$400,000
Withdrawals of
$1 m deposit
Deposit balance
Cash
Loans
Deposits
$700,000
$1,000,000
$300,000
i2 %
i1 %
$1 m
deposit i1 %- i2 %
cash
Trust and safety
Cash deficit

8. Bank panic and bank runs

i2 %
i1 %
$1 m
deposit i1 %- i2 %
cash
Trust and safety

9. E.g.2. Deterioration of loans quality

10. Deterioration of loan quality

Loans
Deposits
today
In 1 month
$1,000,000
$800,000
$1,000,000
Net loss
$-200,000
today
Loans
$1,000,000
Loan quality
deteriorates
$1,000,000
Deposits
$ 700,000
Capital
$ 300,000
In 1 month
$800,000
$700,000
$100,000
Bank capital
as a cusion
against losses

11. Role in Economy: Transmission of Monetary Policy

Open market
operations (T-bills)
Borrowing of the
last resort
Reserve
requirements
M1
M2

12. Summary

• FIs are a delegated monitor over the
borrowers when there is:
– Economies of scale in information costs
– Benefits of economies of scale > cost of delegation
• FIs are risky because of:
– Assets transformation
– Maturity intermediation
– Denomination intermediation
• FI are important in economy since they
– facilitate payment transactions
– allocate investments
– are transmitters of central banks’ monetary policy

13. Central Banks

1991
1913
1864
1998

14. Regulation

Monitoring by Central Bank
Guarantee funds (FDIC, SIPC, KDIF)
Minimum capital requirement (6% of
total assets)
Investment diversification (max. size of
loan is 10% of a bank’s owners’ capital)

15. Banks supervision: central banks

Control over
money supply
• Open market
operations
• Reserve requirements
Prudential
control
• Minimization of
financial crisis
• Lender of the last
resort

16. Deposits insurance

• Federal Deposit Insurance Corporation
(FDIC)
– Established in 1934
– Resulted in decline of bank failure rate from
28.16% in 1933 to 0.27% in 1934
• Insurance size:
– $250,000 in the USA
– £75,000 in the UK
– €100,000 in the most of EU

17. Banks supervision: restriction on entry

• Chartering and licenses
• Minimum capital requirements:
– UK: £5 mln.
– KZ: KZT 10 bn.
– EU: €5 mln.
• Basel I, Basel II, Basel III capital
requirements: Equity to Total assets ratios

18. Banks supervision: assessment of risk management

C
Capital adequacy
A
Assets
M Management capability
E
Earnings
L
Liquidity
S Sensitivity to market risk

19. Regulations

• Consumer protection:
– Community Reinvestment Act (CRA): banks
must serve local communities
– Home Mortgage Disclosure Act (HMDA):
prohibited discrimination on the basis of age,
race, sex, or income

20. Regulation

NOT TO REGULATE
NOT TO
REGULATE

21. Calculate risk asset ratio

• Under Basel I bank capital requirement:
Capital
4%
Risk-asset ratio =
RiskWeight edAssets
Asset
Risk rate
Cash
Government
bills
0%
0%
Mortgages
Commercial
loans
50%
100%
amount
$1,600
$1,500
$14,000
$12,000