BANK ORGANIZATION AND REGULATION

Chapter 2

Bank ManagementBank Management, 5th edition.5th edition.Timothy W. Koch and S. Scott MacDonaldTimothy W. Koch and S. Scott MacDonaldCopyright © 2003 by South-Western, a division of Thomson Learning

Government agencies that regulate commercial banks have had to balance the banking system’s competitiveness with general safety and soundness concerns. Historically, regulation has limited who can:

open or charter new banks and what products and services banks can offer.

Imposing barriers to entry and restricting the types of activities banks can engage in clearly enhance safety and soundness, but also hinder competition.

Historical regulation, which limits the number of banks and types of activities, has three drawbacks

1. It assumed that the markets for bank products, largely bank loans and deposits, could be protected and that other firms could not encroach upon these markets. Not surprisingly, investment banks, hybrid financial

companies, insurance firms, and others found ways to provide the same products as banks across different geographic markets.

2. It discriminated against U.S.-based firms versus foreign-based firms. For example, prior regulations prohibited U.S. banks from

underwriting securities for firms in the U.S. In contrast, foreign banks are generally not restricted as to

their domestic corporate structure and thus have long been able to circumvent U.S. restrictions on under-writing activities.

Such restrictions place U.S. banks at a competitive disadvantage.

3. Historical regulation has penalized bank customers who do not have convenient access to the range of products they demand. In addition, such restrictions generally raise prices above

those obtained in a purely competitive marketplace.

The U.S. operates using a “dual banking system.”

Individual states as well as the federal government issue bank charters. The Office of the Comptroller of the Currency (OCC)

charters national banks Individual state banking departments charter state banks

and savings institutes. The Office of Thrift Supervision (OTS) charters federal

savings banks and savings associations. The Federal Deposit Insurance Corporation (FDIC)

insures the deposits of banks and savings associations up to $100,000 per account.

Bank regulation and supervision…conducted by four federal agencies (OCC, OTS, FDIC, and the Federal Reserve) as well as fifty state agencies.

Although this is a complicated system, it allows for a separation of duties as well as “competition” among the various regulatory agencies to produce a safe and efficient banking system.

Credit unions represent another type of depository institution. Even though credit unions perform some of the same functions as

a bank, they are cooperative nonprofit financial institutions that exist for the benefit of members. To join a credit union, one must share a “common bond” with

other members. The definition of common bond, however, has expanded to

incorporate a “community” and hence the differences between credit unions and banks are disappearing as well.

Credit unions often operate in subsidized office space with subsidized labor and do not pay corporate or state income taxes. This tax-exempt status puts them at a competitive advantage

over other banking institutions. Credit unions were first chartered at the state level in 1909.

By 1934, the federal government began to charter credit unions under the Farm Credit Association, and created the National Credit Union Administration (NCUA) in 1970.

A dual credit union regulatory system exists as well today as both states and the NCUA charter credit unions today.

National versus a State bank charter

Before issuing a new charter, the chartering agencies ensure that the (de novo) bank will have the necessary capital and management expertise to ensure soundness and allow the bank to meet the public’s financial needs.

The agency that charters the institution is the institution’s primary regulator with primary responsibility to ensure safety and soundness of the banking system.

All banks obtain FDIC deposit insurance coverage as part of the chartering process.

While national banks are regulated only by federal regulatory agencies, state-chartered banks also have a primary federal regulator.

The Federal Reserve is the primary federal regulator of an FDIC-insured state bank, which is a member of the Federal Reserve System, while the primary regulator of state non-Fed member banks is the FDIC.

Charter Class by their Primary Federal Regulator (thousands of dollars): June 2001

Charter Class #

Institutions #

Offices Deposits*

Primary Federal

Regulator

Commercial Banks 8,178 72,167 3,566,835,641 National Charter 2,176 34,691 1,890,611,980 OCC State Charter 6,002 37,476 1,676,223,661 Federal Reserve Member 975 13,845 769,802,155 Fed Federal Reserve Nonmember 5,027 23,631 906,421,506 FDIC Savings Institutions 1,561 13,888 755,422,190 Federal Charter Savings Associations 896 9,020 526,156,002 OTS State Charter Savings Institutions 665 4,868 229,266,188 FDIC-Supervised Savings Banks 520 4,325 210,542,336 FDIC OTS-Supervised Savings Associations 145 543 18,723,852 OTS U.S. Branches of Foreign Banks 18 18 4,069,399 Total 9,757 86,073 4,326,327,230 * Includes deposits in domestic offices (50 states and DC), Puerto Rico, and U.S. Territories

In contrast to federally regulated national banks, state-chartered banks have generally had broader powers.

Many states allow securities underwriting and brokerage; real estate equity participation, development, and brokerage; and insurance underwriting and brokerage.

Still, regulations for banks are more restrictive than those that apply to thrift institutions. While thrifts must maintain at least 65 percent of

their assets in housing-related investments and cannot have more than 10 percent in loans to businesses, they have historically been allowed nationwide branching and full-service underwriting and brokerage activities in insurance, real estate, and corporate instruments.

For many years, commercial banks were viewed as a special type of financial organization.

They were the only firms allowed to issue demand deposits and thus dominated the payments system Prior to 1980, interest-bearing checking accounts did not exist

except at credit unions. Because of this status, authorities closely regulated bank

operations to control deposit growth and to ensure the safety of customer deposits.

Among other restrictions, government regulators required: cash reserves against deposits, specified maximum interest rates banks could pay on deposits, set minimum capital requirements, and placed limits on the size of loans to borrowers.

In addition to regulatory constraints, federal banking law further limited bank operations to activities closely related to banking and, in conjunction with state laws, prohibited interstate branching.

Historically, banks, savings associations, and credit unions each served a different purpose and a different market.

Commercial banks mostly specialize in short-term business credit, but also make consumer loans and mortgages, and have a broad range of financial powers.

Banks accept deposits in a variety of different accounts and invest these funds into loans and other financial instruments.

Their corporate charters and the powers granted to them under state and federal law determines the range of their activities.

Savings institutions, savings and loan associations and savings banks, have historically specialized in real estate lending; e.g., loans for single-family homes and other residential properties.

Savings associations are generally referred to as “thrifts” because they originally offered only savings or time deposits

They have acquired a wide range of financial powers over the past two decades, and now offer checking accounts, make business and consumer loans, mortgages, and offer virtually any other product a bank offers.

Savings institutions must maintain 65% of their assets in housing-related or other qualified assets to maintain their savings institution status. This is called the “qualified thrift lender” (QTL) test.

The number of thrifts has declined dramatically during the last two decades.

The savings and loan crisis of the 1980s forced many institutions to close or merge with others, at an extraordinary cost to the federal government.

Due to liberalization of the QTL, however, there was a resurgence of interest in the thrift charter and many insurance companies, securities firms, as well as commercial firms acquired a unitary thrift holding company in order to own a depository institution and bypass prohibitions in the Glass Steagall Act and the Bank Holding Company Act. This resurgence of interest stopped with the

passage of Gramm-Leach- Bliley, which eliminated the issuance of new unitary thrift charters.

Credit unions are nonprofit institutions with an original purpose to encourage savings and provide loans within a community at low cost to their members. A “common bond” defines their members, although this

common bond can be loosely defined. The members pool their funds to form the institution’s deposit

base and the members own and control the institution. Credit unions accept deposits in a variety of forms.

All credit unions offer savings accounts or time deposits, while the larger institutions also offer checking and money market accounts.

Credit unions have similarly expanded the scope of products and activities they offer to include almost anything a bank or savings association offers, including making home loans, issuing credit cards, and even making some commercial loans.

Credit unions are exempt from federal taxation and sometimes receive subsidies, in the form of free space or supplies, from their sponsoring organizations.

Although credit unions tend to be much smaller than banks or savings associations, there are several very large credit unions.

A. Largest Federally Charter Commercial Banks

Rank Name State Total Assets Total Loans Total Deposits Total

Equity Equity

to Assets 1 Bank of America NA NC 551,691,000 314,167,000 391,543,000 52,624,000 9.54% 2 Citibank NA NY 452,343,000 284,809,000 306,923,000 37,623,000 8.32% 3 First Union NB NC 232,785,000 123,754,000 147,749,000 16,133,000 6.93% 4 Fleet NA Bk RI 187,949,000 126,301,000 132,464,000 19,012,000 10.12% 5 US Bk NA OH 166,949,055 115,108,238 108,364,026 18,449,335 11.05% 6 Bank One NA IL 161,022,572 83,639,674 107,377,268 10,990,222 6.83% 7 Wells Fargo Bk NA CA 140,675,000 95,264,000 79,077,000 16,186,000 11.51% 8 Wachovia Bk NA NC 71,555,121 46,996,841 46,311,053 13,670,966 19.11% 9 Keybank NA OH 71,526,246 56,410,074 42,731,060 4,878,880 6.82%

10 PNC Bk NA PA 62,609,780 40,452,019 46,385,132 4,887,661 7.81%

B. Largest State Chartered Commercial Banks

Rank Name State Total Assets Total Loans

Total Deposits Total Equity

Equity to Assets

1 JPMorgan Chase Bk NY 537,826,000 178,169,000 280,473,000 33,273,000 6.19% 2 Suntrust Bk GA 102,377,306 73,515,248 67,995,077 8,687,049 8.49% 3 HSBC Bank USA NY 84,230,380 40,801,836 58,220,243 6,898,796 8.19% 4 Bank of New York NY 78,018,745 37,309,076 55,810,439 6,466,422 8.29% 5 Merrill Lynch Bk USA UT 66,092,639 12,464,394 59,954,429 3,551,022 5.37% 6 State Street B&TC MA 65,409,590 5,979,937 38,855,475 4,187,956 6.40% 7 Branch Bkg&TC NC 54,700,008 35,731,083 32,103,069 4,742,168 8.67% 8 Southtrust Bk AL 48,849,559 34,249,117 32,965,152 4,165,712 8.53% 9 Bankers Trust Co NY 42,678,000 12,804,000 21,423,000 6,822,000 15.98%

10 Regions Bank AL 42,001,585 31,508,932 31,536,453 3,242,973 7.72%

The largest federal and state chartered banks: (thousands of dollars, 2001)

C. Largest Savings Institutions

Rank Name State Total Assets

Total Deposits

Total Loans Total Equity

Equity to Assets

1 Washington Mutual Bank, FA S&L CA 206,571,184 92,054,318 132,506,691 12,562,515 6.08% 2 World Svgs Bk, FSB S&L CA 58,443,622 34,651,936 41,505,114 4,701,922 8.05% 3 California Federal Bank S&L CA 56,555,539 25,906,314 42,726,581 4,124,022 7.29% 4 Charter One Bank, SSB S&L OH 38,165,417 25,222,939 26,104,926 2,343,285 6.14% 5 Sovereign Bank S&L PA 35,631,606 22,378,274 20,994,865 3,642,986 10.22% 6 Citibank, FSB S&L CA 31,868,249 22,679,455 21,041,103 2,707,701 8.50% 7 Washington MSB SB WA 31,639,000 16,806,000 19,981,000 2,044,000 6.46% 8 Dime Savings Bank of NY S&L NY 27,971,169 15,188,948 22,092,378 2,384,304 8.52% 9 Astoria FS&LA S&L NY 22,463,688 11,144,443 12,266,238 1,506,548 6.71%

D. Largest Credit Unions

Rank Name STATE Total Assets

Total Loans

Total Deposits

Total Equity

Equity to Assets

1 U. S. CENTRAL CREDIT UNION KS 26,217,598 1,264,461 20,962,788 1,428,725 5.45% 2 WESTERN CORPORATE CA 12,446,130 266,338 10,108,679 820,696 6.59% 3 NAVY VA 11,188,619 8,590,064 9,075,588 1,365,675 12.21% 4 STATE EMPLOYEES' NC 6,301,035 5,207,140 5,645,651 488,698 7.76% 5 BOEING EMPLOYEES WA 3,385,160 1,701,495 2,610,982 276,596 8.17% 6 SOUTHWEST CORPORATE TX 3,313,673 145,774 2,594,040 313,924 9.47% 7 PENTAGON VA 3,243,137 2,406,415 2,882,056 338,609 10.44% 8 MID-STATES CORPORATE IL 2,987,051 159,173 2,574,479 259,016 8.67% 9 UNITED AIRLINES EMPLOYEES' IL 2,852,330 1,354,201 2,498,722 341,144 11.96%

10 AMERICAN AIRLINES TX 2,583,594 1,269,927 2,302,387 229,820 8.90%

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Annual Growth Rate

1970 1980 1989 1993 1997 2001 1980-2001

Commercial Banks

Number 13,550 14,163 12,410 10,957 9,144 8,080 -1.65% Total assets $517.40 $1,484.60 $3,231.10 $3,705.90 $5,014.90 $6,569.24 8.54% (% of Total Assets) 66.0% 63.6% 65.3% 73.9% 78.5% 78.7%

Thrift Institutionsa

Number 5,669 4,594 3,011 2,327 1,779 1,533 -4.13% Total assets $249.50 $783.60 $1,516.50 $1,024.50 $1,026.20 $1,299.01 5.47% (% of Total Assets) 31.8% 33.6% 30.7% 20.4% 16.1% 15.6%

Credit Unions*

Number 23,819 21,930 15,205 12,720 11,238 10,145 -2.76% Total assets $17.60 $67.30 $199.70 $283.50 $351.17 $477.21 11.43% (% of Total Assets) 2.2% 2.9% 4.0% 5.7% 5.5% 5.7%

(Monetary Amounts Are in billions of Dollars)

Number and total assets of various depository institutions: 1970 – 2001.

Commercial banks play an important role in facilitating economic growth. On a macroeconomic level, they represent the primary

conduit of Federal Reserve monetary policy. Bank deposits represent the most liquid form of

money such that the Federal Reserve System’s efforts to control the nation’s money supply and level of aggregate economic activity is accomplished by changing the availability of credit at banks.

On a microeconomic level, commercial banks represent the primary source of credit to most small businesses and many individuals. A community’s vitality typically reflects the

strength of its major financial institutions and the innovative character of its business leaders.

There has been a fundamental shift in the structure of financial institutions over the past two decades.

In particular, depository institutions’ share of U.S. financial assets has systematically declined relative to assets held by other financial intermediaries.

0.0%

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1970 1975 1980 1985 1990 1995 2000

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Monetary authority 5.1% 4.6% 3.5% 2.9% 2.4% 2.8% 2.4% 2.4%

Insurance Companies 16.8% 14.1% 13.9% 12.8% 14.6% 14.9% 11.6% 11.4%

Pension and Retirement Funds 7.0% 7.3% 8.2% 9.1% 8.6% 8.4% 7.2% 6.7%

Mutual Funds 0.6% 0.6% 1.7% 4.9% 7.6% 10.2% 11.8% 12.5%

Finance companies 4.5% 4.2% 4.9% 4.9% 4.7% 3.8% 4.0% 3.8%

Mortgage related 1.3% 2.2% 3.6% 6.3% 10.8% 11.8% 12.2% 12.8%

Other 4.2% 4.9% 5.3% 7.4% 8.6% 12.4% 18.8% 19.6%

Depository Institutions 60.5% 62.1% 58.9% 51.8% 42.8% 35.7% 31.9% 30.7%

Dec-70 Dec-75 Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-01

Consolidations, new charters and bank failures

The number of failed banks increases sharply from 1980 through 1988 This period coincides with economic problems

throughout various sectors of the U.S. economy ranging from agriculture to energy to real estate.

As regional economies faltered, problem loans grew at banks and thrifts that were overextended and subsequent losses forced closings.

New charters representing the start-up of a new bank’s operations declined from 1984 to 1994, increased through 1998, and then decreased through 2001.

The major force behind consolidation has been mergers and acquisitions in which existing banks combine operations in order to cut costs, improve profitability, and increase their competitive position.

Bankers who either lose their jobs in a merger or choose not to work for a large banking organization often find investors to put up the capital needed to start a new bank.

Both mergers and new charters slowed dramatically in late 1998 as a result of a 25 percent fall in stock values at the largest bank holding companies and in 2001 with the continuing market decline.

Structural changes among FDIC-insured commercial banks, 1980–2001

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The Central Bank …Congress created the Federal Reserve System in 1913 to serve as the central bank of the United States and to provide the nation with a safe, flexible and more stable monetary and financial system

The Fed's role in banking and the economy has expanded over the years, but its primary focus has remained the same.

The Fed’s three fundamental functions are:1. conduct the nation’s monetary policy,

2. provide and maintain an effective and efficient payments system, and

3. supervise and regulate banking operations. All three roles have a similar purpose, that of

maintaining monetary and economic stability and prosperity.

The Federal Reserve System (The Fed)

A decentralized central bank, with 12 districts reserve banks and branches across

the country, Coordinated by a Board of Governors in

Washington, D.C. The Board of Governors are appointed by the

president of the United States and confirmed by the Senate for staggered 14-year terms.

The seven-members of the Board Governors are the main governing body of the Federal Reserve System.

The Board is charged with overseeing the 12 District Reserve Banks and with helping implement national monetary policy.

Monetary Policy

The Federal Reserve conducts monetary policy through actions designed to influence the supply of money and credit in order to promote price stability and long-term sustainable economic growth.

There are basically three distinct monetary policy tools: 1. open market operations, 2. changes in the discount rate, and 3. changes in the required reserve ratio.

Open market operations… are conducted by the Federal Reserve Bank of New York under the direction of the Federal Open Market Committee (FOMC).

The sale or purchase of U.S. government securities in the “open market” or secondary market is the Federal Reserve’s most flexible means of carrying out its policy objectives.

Through the purchase or sale of short-term government securities, the Fed can adjust the level of reserves in the banking system. Fed open market purchases increase liquidity, hence reserves in

the banking system, by increasing a bank’s deposit balances at the Fed.

Fed open market sales of securities decrease bank reserves and liquidity by lowering deposit balances at the Fed.

Changes in the discount rate …directly affect the cost of borrowing Banks can borrow deposit balances, or required

reserves, directly from Federal Reserve Banks (in its role as lender of last resort). The discount rate is the interest rate that banks pay.

When the Fed raises (decreases) the discount rate it discourages (encourages) borrowing by making it more (less) expensive.

Many economists argue that the Fed changes the discount rate primarily to signal future policy toward monetary ease or tightness rather than to change bank borrowing activity. Changes in the discount rate are formally announced and

trumpeted among the financial press so that market participants recognize that the Fed will likely be adding liquidity or taking liquidity out of the banking system.

Changes in reserve requirements …directly affect the amount of legal required reserves and thus change the amount of money a bank can lend out.

For example, a required reserve ratio of 10 percent means that a bank with $100 in demand deposit liabilities outstanding must hold $10 in legal required reserves in support of

the DDAs. The bank can thus lend only 90 percent of its DDAs.

When the Fed increases (decreases) reserve requirements, it formally increases (decreases) the required reserve ratio that directly reduces (raises) the amount of money a bank can lend. Thus, lower reserve requirements increase bank

liquidity and lending capacity while higher reserve requirements decrease bank liquidity and lending capacity.

Organizational form of the banking industry

The organizational structure of banking has changed significantly over the past two decades but changed most dramatically in the later half of the 1990’s due primarily to: the impact of interstate branching, the Federal Reserve System’s relaxation of

securities powers restrictions using a clause in the Glass-Steagall Act and most recently

with the Gramm-Leach-Bliley Act of 1999. Banks can now branch across state lines and

acquire insurance and securities firms by forming a Financial Holding Company under the provisions of Gramm-Leach-Bliley.

Commercial banks are classified either as unit banks, with all operations housed in a single office, or as branch banks with multiple offices. Prior to the enactment of the Riegle-Neal Interstate Banking

and Branching Efficiency Act of 1994, which allow of nationwide interstate branch banking, state law determined the extent to which commercial banks could branch.

Any organization that owns controlling interest in one or more commercial banks is a bank holding company (BHC). Control is defined as ownership or indirect control via the power

to vote more than 25 percent of the voting shares in a bank. Prior to the enactment of interstate branching, the primary

motivation behind forming a bank holding company was to circumvent restrictions regarding branching and the products and services that banks can offer.

Today, the primary motive is to broaden the scope of products the bank can offer.

Unit versus Branch banking…The current structure of the commercial banking system as well as the dramatic changes in the number of banks has been heavily influenced by historical regulations which prevent branching to one degree of another.

One of the primary reasons the number of banks has declined almost 50 percent since the mid 1980’s is the relaxation of branching restrictions provided by Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994.

Since the mid 1980’s, the number of banks has fallen about 50 percent while the number of branches has increased by 50 percent.

Changes in the number of banks and bank branches, 1960 – 2001

0

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Branches 10,556 15,872 21,839 30,205 38,738 43,293 50,406 56,512 64,079 63,989

Banks 13,126 13,544 13,511 14,384 14,434 14,417 12,347 9,942 8,315 8,178

1960 1965 1970 1975 1980 1985 1990 1995 2000 2001*

Main Offices

Branches

All U.S. Banking Offices

(Main Offices plus Branches)

The number of interstate branches increased dramatically after interstate branching became fully effective in 1997.

Unit banks each have their own board of directors, a complete staff of officers, and separate documents and technology for conducting business. Operating expenses are generally higher for the parent

company that owns multiple independent banks as compared to branches of the “lead” bank. the relaxation in branching restrictions and economic

efficiencies is a primary motivating factor for a bank to form a bank holding company.

Risk in the banking industry is considered higher with restrictive branching because individual banks were less diversified and more prone to problems Not surprisingly, states with the highest bank failure rates

historically restricted branching. Branching generally reduces the number of

competitors, lowers expenses, allows greater asset diversification, and expands each bank’s consumer deposit base Each of these factors decreases the chances of failure,

everything else being equal.

Organizational form

Independent Banks The term independent bank normally refers to

a bank that is not controlled by a multibank holding company or any other outside interest.

Bank Holding Companies A bank holding company is essentially a shell

organization that owns and manages subsidiary firms.

Bank holding companies

Bank holding companies are firms that control at least one bank subsidiary. They typically also own several non-bank

subsidiaries--leasing or data processing firms. They generate earnings from fees, interest income,

and dividends from equity in subsidiaries. They pay interest on borrowings and have

administrative expenses. Control is defined as ownership or indirect control

via power to vote more than 25 percent of the voting shares in a bank.

Prior to nationwide interstate branching, the primary motivation was to circumvent restrictions regarding branching and the products and services that banks can offer. Today, the primary motivation is to expand the

scope of products the bank can offer.

Like commercial banks, bank holding companies are heavily regulated by states and the federal government.

The Bank Holding Company Act stipulates that the Board of Governors of the Federal Reserve System must approve all holding company formations and acquisitions. One-bank holding companies (OBHCs) control

only one bank and typically arise when the owners of an existing bank exchange their shares for stock in the holding company.

Multibank holding companies (MBHCs) control at least two commercial banks.

The Gramm-Leach-Bliley Act of 1999 also gave regulatory responsibility over Financial Holding Companies to the Federal Reserve.

The Glass-Steagall Act effectively separated commercial banking from investment banking but left open the possibility of banks engaging in investment banking activities through a Section 20 affiliate so long as the bank was not “principally engaged” in these activities. Commercial banks received permission (in 1987) from the

Federal Reserve to underwrite and deal in securities through Section 20 subsidiaries.

The Fed resolved the issue of “principally engaged” initially by allowing banks to earn only 5 percent of the revenue in their securities affiliates. This was raised to 10 percent in 1989 and to 25 percent in March of 1997.

The Gramm-Leach-Bliley Act of 1999 repeals the restrictions on banks affiliating with securities firms The law creates a new financial holding company,

authorized to engage in: underwriting and selling insurance and securities, conducting both commercial and merchant banking, investing in and developing real estate and other "complimentary activities."

Financial holding companies (FHC) are distinct entities from bank holding companies (BHC).

A company can form a BHC or a FHC or both. The primary advantages to a banking organization to

forming a FHC is that they can engage in a wide range of financial activities not permitted in the bank or with in a BHC. Some of these activities include:

insurance and securities underwriting and agency activities,

merchant banking and insurance company portfolio investment activities. activities that are "complementary" to financial activities

also are authorized. The primary disadvantage to forming a FHC or

converting their BHC to a FHC is that the Federal Reserve may not permit a company to form a financial holding company if any of its insured depository institution subsidiaries are not well capitalized and well managed, or did not receive at least a satisfactory rating in their most recent CRA exam.

Nonbank activities permitted bank holding companies

The Federal Reserve Board regulates allowable nonbank activities that are “closely related to banking” in which bank holding companies may acquire subsidiaries.

Restrictions came about for three reasons. 1. It was feared that large financial conglomerates would

control the financial system because they would have a competitive advantage.

2. There was concern that banks would require customers to buy nonbank services in order to obtain loans.

3. Some critics simply did not believe that bank holding companies should engage in businesses that were not allowed banks because these businesses were less regulated and thus relatively risky.

Organizational structure of financial services company

Bank Holding

Company

ThriftHolding

Company

SecuritiesSubsidiaries

InsuranceSubsidiaries

Real Estate

Subsidiary

NonbankSubsidiaries

Subsidiariesand ServiceCompanies

Financial ServicesHolding Company

Organizational structure of the OBHC

The bottom four levels have the same organizational form

as the independent bank.

Each subsidiary has a president and line officers.

One-Bank Holding Company

Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries

Organizational structure of the MBHC.

MultiBank Holding Company

Board of Directors

Parent Company

Bank Subsidiaries Nonbank Subsidiaries Bank Subsidiaries

Citigroup (Parent Company Only)Assets 2001 2000

Cash and balances due from depository institutions:Balances with subsidiary depository institutions. 6,000$ 78,000$ Balances with unrelated depository institutions. 21,000 7,000Securities:

Government agencies, corporations and political subdivisions securities 48,000 0Other debt and equity securities 1,439,000 0Net Loans and leases 0 0

Investments in and receivables due from subsidiaries 120,622,000 87,404,000Premises and fixed assets (including capitalized leases) 15,000 17,000Goodwill 368,000 381,000Other assets 368,000 491,000

Total Assets 122,887,000 88,378,000

Liabilities and EquitiesBorrowings with a remaining maturity of < one year:Commercial paper. 481,000 496,000

Other borrowings. 5,804,000 3,000,000Other borrowings with a remaining maturity of >one year 25,168,000 10,947,000

Subordinated notes and debentures 4,250,000 4,250,000Other liabilities 113,000 616,000Balances due to subsidiaries and related institutions:

Subsidiary banks. 100,000 28,000Nonbank subsidiaries 5,714,000 2,835,000Related bank holding companies 10,000 0

Equity Capital:Perpetual preferred stock (including related surplus) 1,525,000 1,745,000Common stock (par value) 55,000 54,000Surplus (exclude all surplus related to preferred stock) 23,196,000 15,635,000Retained earnings . 69,803,000 58,012,000Accumulated other comprehensive income -844,000 973,000Other equity capital components -12,488,000 -10,213,000

Total Equity 81,247,000 66,206,000Total liabilities and Equities 122,887,000 88,378,000

Citicorp's multibank

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Total 0

Dividends 2,586Interest 5Management and service fees 0Other 1

Total 2,592

Dividends 6,426Interest 1,220Management and service fees 0Other 0

Total 7,646Securities gains/(losses) . 0All other operating income. 53Total operating income 10,291

Operating expense:Salaries and employee benefits 225Interest expense 1,876Provision for loan and lease losses. 0All other expenses. 35

Total operating expense 2,136Income (loss) before taxes and undistributed income 8,155Applicable income taxes -322Extraordinary items, net of tax effect -7Income (loss) before undistributed income of subsidiaries and associated companies 8,470

Bank 0Nonbank 2,440Subsidiary bank holding companies 3,216

Net Income (loss) 14,126

Equity in undistributed income (losses) of subsidiaries:

Citigroup (Parent Company Only)

Income from bank subsidiaries :

Income from nonbank subsidiaries:

Income from subsidiary bank holding companies:

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Large and small banks…When many of us think of banks, we think of the largest banks in the country such as Bank of America, Citibank, Chase Manhattan Bank, First Union National Bank, Morgan Guaranty Trust Company, Fleet National Bank, Wells Fargo Bank, and Bank One. Of the approximate 8,100 commercial banks

operating in the United States, however, only about 80 are greater than $10 billion in assets. The vast majority of banks are small banks

(about 5,000), under $100 million in assets with a legal lending limit of less than $1 million.

In fact, almost 96% of all banks have total assets less than $1 billion.

Still, the largest banks (over $10 billion) hold almost 70 percent of

Banking business models…The business models followed by the majority of banks (small banks) is generally different that that of largest banks.

Historically, small banks have been called independent or community banks while large banks have been labeled large holding company banks, multibank holding companies, or even money center banks.

Never the less, banks of the same size, however, often pursue substantially different strategies

Business model structure of commercial banking

The organizational structure of commercial banks can be characterized as banks falling into one of the following categories based on the range of products and services offered and the different geographic markets served: Global banks Nationwide banks Super Regional banks Regional banks Specialty banks

limited region limited product line

Organizational structure of an independent bank

Five fundamental objectives of bank regulation

Ensure the safety and soundness of banks and financial institutions

The Federal Reserve System uses regulation to provide monetary stability

To provide an efficient and competitive financial system

Protect consumers from abuses by credit-granting institutions

To maintain the integrity of the nation’s payments systems.

Three separate federal agencies along with each state's banking department issue and enforce regulations

The Federal Reserve

The Federal Deposit Insurance Corporation (FDIC)

Office of the Comptroller of the Currency (OCC)

Most regulations can be classified in one of three basic categories:

1. supervision, examination, deposit insurance, chartering activity, and product restrictions are associated with safety and soundness

2. branching, mergers and acquisitions, and pricing are related to an efficient and competitive financial system

3. consumer protection.

Type of Commercial Bank

Type of Regulation National State member Insured state nonmember

Noninsured state nonmember

Bank holding companies

Safety and Soundness Supervision and Examination

Comptroller Federal Reserve

and state authority FDIC and state

authority State authority Federal reserve

Deposit Insurance FDIC FDIC FDIC State insurance

or none Not applicable

Chartering and Licensing OCC State authority State authority State authority Federal Reserve

and state authority Efficiency and Competitiveness

Branching Comptroller Federal Reserve

and state authority FDIC and state

authority State authority

Federal Reserve and state authority

Mergers and Acquisitions Comptroller Federal Reserve

and state authority FDIC and state

authority State authority

Federal Reserve and state authority

Pricing New Products Federal Reserve

and state authority

Federal Reserve and state authority

Federal Reserve and state authority

Federal Reserve and state authority

Not applicable

Consumer Protection Federal Reserve Federal Reserve

and state authority

Federal Reserve, FDIC, and state

authority

Federal Reserve and state authority

Not applicable

Depository institutions and their regulators

Supervision and Examination… Regulators periodically examine individual banks and provide supervisory directives

The OCC and FDIC assess the overall quality of a bank's condition according to the CAMELS system: Capital adequacy Asset quality Management quality Earnings quality Liquidity Sensitivity

Regulators assign ratings from 1 (best) to 5 (worst) for each category and an overall rating for all features combined.

Deposit insurance…The Federal Deposit Insurance Corporation (FDIC) insures the deposits of banks up to a maximum of $100,000 per account holder while almost all credit unions are insured by the National Credit Union Share Insurance Fund (NCUSIF), which is controlled by the NCUA.

The FDIC was created by the Banking Act of 1933, in response to the large number of bank failures that followed the stock market crash of 1929. Originally the FDIC insured deposits up to $5,000. Fundamentally, all newly chartered banks must obtain FDIC

insurance. The FDIC also acts as the primary federal regulator of state-chartered

banks that do not belong to the Federal Reserve System. State banks who are members of the Federal Reserve System have

that agency for their primary federal regulator. The FDIC also has backup examination and regulatory authority

over national and Fed-member banks. The FDIC is also the receiver of failed institutions.

The FDIC declares banks and savings associations insolvent and handles failed institutions by either liquidating them or selling the institutions to redeem insured deposits.

Two insurance funds under the FDIC:

The Bank Insurance Fund (BIF) for banks and the Savings Association Fund (SAIF). The BIF and SAIF funds are scheduled to be

merged but this has not occurred as of mid 2002.

The OCC and state banking authorities officially designate banks as insolvent, but the Federal Reserve and FDIC assist in closings.

The Federal Reserve also serves as the federal government's lender of last resort. When a bank loses funding sources, the Federal

Reserve may make a discount window loan to support operations until a solution appears.

Federal Reserve bank regulations

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The Riegle-Neal Interstate Banking and Branching Efficiency Act, 1994, mandates interstate branch banking, superseding state banking pacts

Nonbank banks …most large banking organizations have established nonbank affiliates

Edge Act corporations Edge Act corporations provide a full range of

banking services but, by law, deal only in international transactions

There are two types of Edge corporations: banks and investment companies

Loan production offices (LPOs) make commercial loans but do not accept deposits

Consumer banks outside their home state Consumer banks accept deposits but make only

consumer loans

Consumer Protection.

State legislatures and the Federal Reserve have implemented numerous laws and regulations to protect the rights of individuals who try to borrow.

Regs. AA, B, BB, C, E, M, S, Z, and DD apply specifically to consumer regulation.

Equal credit opportunity (Reg. B), for example, makes it illegal for any lender to discriminate against a borrower on the basis of race sex, marital status, religion, age, or national origin.

Community reinvestment prohibits redlining in which lenders as a matter of policy do not lend in certain geographic markets.

Reg. Z requires disclosure of effective rates of interest, total interest paid, the total of all payments, as well as full disclosure as to why a customer was denied credit.

Trends in federal legislation and regulation

The fundamental focus of federal banking legislation and regulation since 1970 has been to define and ultimately expand the product and geographic markets served by depository institutions, and to increase competition.

Subsequent problems with failed savings and loans and commercial banks raised concerns that only a few large organizations would survive because all financial institutions would eventually have the same powers and large firms would drive small firms out of business.

Today, the banking and financial services industry is evolving into a new and exciting industry full of challenges and opportunities. Smaller banks appear to have opportunities

in providing specialized products and services.

Larger banks have expanded their product mix and have blurred the distinction between a bank and a securities firm.

Key legislative and regulatory changes have attempted to address three basic issues

1. What is a bank?

2. Where can banks conduct business?

3. What products can banks offer and what interest rates may be charged or paid?

Key Legislation: 1980 - 2002

Depository Institutions Deregulation and Monetary Control Act of 1980

Garn-St. Germain Depository Institutions Act of 1982 The Tax Reform Act of 1986 Competitive Equality Banking Act of 1987 The Financial Institutions Reform, Recovery and

Enforcement Act of 1989 (FIRREA) The Federal Deposit Insurance Corporation Improvement

Act of 1991 Market value accounting and FASB 115 Riegle-Neal Interstate Banking and Branching Efficiency

Act of 1994 The 1998 Credit Union Membership Access Act Financial Services Modernization Act (Gramm-Leach-

Bliley Act of 1999) USA Patriot Act of 2001

Financial Services Modernization Act (Gramm-Leach-Bliley Act of 1999)

The repeal of restrictions on banks affiliating with securities firms clearly tops the list of provisions of Gramm-Leach-Bliley.

The Act, however, was more comprehensive and addressed new powers and products of banks and the financial services industry, functional regulation of the industry, insurance powers, the elimination of new charters for unitary savings and loan holding companies and even consumer privacy protection.

In fact, it is the privacy section of the bill that has some of the most far reaching beyond banking.

BANK ORGANIZATION AND REGULATION

Chapter 2

Bank ManagementBank Management, 5th edition.5th edition.Timothy W. Koch and S. Scott MacDonaldTimothy W. Koch and S. Scott MacDonaldCopyright © 2003 by South-Western, a division of Thomson Learning