banking and bank regulation
DESCRIPTION
BANKING AND BANK REGULATION. Why do banks exist?. To intermediate Between lenders and borrowers Pooling resources for large-scale projects Between maturities (long vs short) Borrow short-term, lend long-term Between risk-takers and the risk-averse Pooling allows diversification - PowerPoint PPT PresentationTRANSCRIPT
Economic Forces in American History
BANKING AND BANK REGULATION
Economic Forces in American History
Why do banks exist?To intermediate– Between lenders and borrowers
• Pooling resources for large-scale projects
– Between maturities (long vs short)• Borrow short-term, lend long-term
– Between risk-takers and the risk-averse• Pooling allows diversification
– Between liquid and illiquid• Cash vs real estate etc.
Economic Forces in American History
TYPES OF BANKSWe will analyze four types of banks:
1. Merchant Banks – e.g. The House of Rothschild.
2. Commercial Banks – i.e. depository institutions
3. Investment Banks, including hedge funds
4. Central Banks – e.g. the U.S. Federal Reserve System, which we will cover in the separate Monetary Policy lecture.
Economic Forces in American History
MERCHANT BANKSHistorically, merchant banks antedated the
other types of banks on our list.
They were primarily:–Money changers– Bill brokers– Family affairs (Rothschilds, Medicis etc.)– They are provide system of payments– No large financing of anything (except govt
debt at times)
Economic Forces in American History
Antebellum banks
State-chartered: investors come together & petition for charterCharter:–Must pass state legislature– Specifies capital paid in etc.– Gives right to issue bank notes– Delimits area of investment (if any)– Specifies shareholder (voting) rights
Economic Forces in American History
What banks did
They focused on stuff that’s banned today:– Print their own money (bank notes)
• These circulate and are used for payment• Farther afield, they circulate at a discount• See Thompson’s Bank Note Reporter
– Lend money to insiders• Bank directors get preferential access
– Exploit charter-granted (local) monopolies• Financing local turnpikes or canals, roads etc.
Economic Forces in American History
More of what banks didThey solicit deposits from gullible suckers… er, esteemed depositorsLittle reporting to outsiders (incl. minority investors)Sometimes they overprint their own money and skip town
Economic Forces in American History
INVESTMENT BANKSInvestment banks, as we know them today, emerged
in the late 19th Century.
They are primarily involved in– Underwriting and– Trading on the stock exchange
Their trading activities have grown dramatically in the last three decades. Today, this trading is often conducted by hedge funds.
Because they do not take deposits, historically, investment banks have not been as regulated as commercial banks.
Economic Forces in American History
COMMERCIAL BANKSWhat do (commercial) banks do?
They provide financial intermediation.They “create” money.
How do they perform these two functions?By adjusting their “balance sheets.”
The bank balance sheet shows: Assets- e.g. reserves and loansLiabilities- e.g. depositsStockholder Equity- i.e. bank capital
Note that:Capital = Assets-Liabilities
Economic Forces in American History
Assets Liabilities & Stockholders’ Equity
The Balance Sheetof a Commercial Bank
Cash Reserves 300Loans 1,000Real Estate 100
Total Assets: $1,400
Savings Deposits 200
Checking Deposits 1,000Total Liabilities
$1,200
Bank Capital 200
Liabilities &Bank Capital: $1,400
Economic Forces in American History
Fractional reserve banking
FRB relies on the fact that depositors will not come all at once to withdraw depositsMost of the time, a sound assumption:This is what allows the intermediation:• Cash < Deposits (liabilities)• Assets less liquid than deposits• Loans are longer-term than deposits
Economic Forces in American History
Assets Liabilities & Stockholders’ Equity
The Balance Sheetof a Commercial Bank
Cash Reserves 300Loans 1,000Real Estate 100
Total Assets: $1,400
Savings Deposits 200
Checking Deposits 1,000Total Liabilities
$1,200
Bank Capital 200
Liabilities &Bank Capital: $1,400
Economic Forces in American History
Assets Liabilities & Stockholders’ Equity
The Balance Sheetof a Commercial Bank
Cash Reserves 300Loans 500Real Estate 100
Total Assets: $900
Savings Deposits 200
Checking Deposits 1,000Total Liabilities
$1,200
Bank Capital -300
Liabilities &Bank Capital: $900
Economic Forces in American History
Fractional reserve banking
FRB relies on the fact that depositors will not come all at once to withdraw depositsWhen they do, it’s a run:– Depositors run for their money– Bankers run for their lives– (Swindlers run for the hills)
Economic Forces in American History
Central banksHistorically central banks were essentially the government’s bank.– It was where govt deposited its money– It invested and traded in govt debt– It provided payment system for govt– It could occasionally be directed to certain
politically sanctioned investment projects
Such is the story of BoE, Austrian National Bank, Banque de France, 1BUSA & 2BUSA
Economic Forces in American History
Central banksHistorically central banks were essentially the government’s bank. However, modern central banks perform two main functions:– They serve as “lenders of last resort” – i.e. they
provide liquidity to the banking system during a crisis. In other words, they are the bankers’ bank.
– Through regulation of commercial bank reserves, central banks control the money supply. The Fed also audits commercial bank balance sheets.
Economic Forces in American History
A few ideas from US bank regulation history
State chartering (1789 - )Free banking (post-1836)Unit banking (19th – 20th centuries)Establishing the Fed (1913)FDIC (1933)The Chinese wall (1933)
Economic Forces in American History
Problems with banking regulationOngoing financial innovation– New financial products (investment banks, trusts, holding
companies, mutual funds, investment on margin, hedge funds, derivatives)
– Laws age fast & fight the last war; regulation gets circumvented
Information asymmetry– Insiders always know more– Private sector pays better (i.e. gets better people)
Regulatory capture– Regulators respond to incentives, too– Familiarity breeds alliances
Too big to fail & moral hazard
Economic Forces in American History
U.S. BANKING HISTORY
After the Revolution, states began chartering commercial banks.The first Bank of the United States was chartered by Congress in 1791.The second Bank of the United States was chartered in 1816.The second Bank’s charter expired after 1836; and it was not renewed.
Economic Forces in American History
LANDMARKS IN U.S. BANKING HISTORY (CONT.)
National Bank Acts were passed in 1863,1864, and 1865.Major bank panics occurred in 1833, 1837, 1839, 1857, 1873, 1893, 1907, 1930-1933.The Federal Reserve System was created in 1913.The FDIC was created in 1933.