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FEDERAL RESERVE BANK
OF CHICAGO
CHANGING FINANCIAL STRUCTURE AND ITS IMPLICATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Vanderbilt University
April 3, 1991
THE CHANGING FINANCIAL STRUCTURE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Analyze banks' changing role
Examine why their role has changed
Discuss future changes
Reform regulation
THE CHANGING ROLE OF COMMERCIAL BANKS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
2
FINANCIAL INTERMEDIATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
FINANCIAL INTERMEDIARIES
Assets
Liabilities
Cash
Deposits
Securities
Other borrowings
Loans
Capital
3
FINANCIAL INTERMEDIATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
ASSET
HOUSEHOLDS
BUSINESSES
Deposits
Deposits
Mutual funds shares
Mutual funds shares
Life insurance reserves
Commercial paper
Pension funds reserves
FINANCIAL INTERMEDIARIES
Assets
Liabilities
Cash
Deposits
Securities
Other borrowings
Loans
Capital
4
FINANCIAL INTERMEDIATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
ASSET
HOUSEHOLDS
BUSINESSES
Deposits
Deposits
Mutual funds shares
Mutual funds shares
Life insurance reserves
Commercial paper
Pension funds reserves
FINANCIAL INTERMEDIARIES
Assets
Liabilities
Cash
Deposits
Securities
Other borrowings
Loans
Capital
HOUSEHOLDS
BUSINESSES
Mortgage loans
Commercial loans
Auto loans
Commercial mortgages
Credit card loans
LIABILITY
5
TOP CONSUMER LENDERS: 1987
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
$ Millions
GMAC
$55,050
Citicorp
44,399
Ford Credit
38,147
American Express
28,884
Sears
26,068
Chase Manhattan
16,752
Prudential
14,795
Chrysler
12,236
Manufacturers Hanover
11,652
Security Pacific
10,798
6
1
BANKS VS. NONBANKS IN CONSUMER LENDING
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Market share (percent)
70
60
58%
55%
20 bank
holding
companies
50
40
30
Nonbanks
20
10
o-1982
1988
7
CONSUMERS SAVE LESS AT BANKS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
0.80
0.75
0.70
0.65
0.60
0.55
0.50
1976
'78
'80
'82
'84
'86
'88
'90
8
TOP COMMERCIAL LENDERS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
$ Millions
Citicorp
$41,603
GE
$35,939
GMAC
$28,462
Manufacturers Hanover
$27,545
Chase Manhattan
$25,251
Prudential
$27,333
Aetna
$22,681
Security Pacific
$18,828
Chemical
$18,802
TIAA
$17,330
9
BANK LENDING TO CORPORATIONS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
85
80
75
Banks' share of
intermediated debt
70
65
60
1976
'78
'80
'82
'84
'86
'88
COMMERCIAL PAPER VS. BANK LOANS FOR LARGE MANUFACTURING FIRMS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
80
Commercial paper to
short-term debt
60
40
',
'-----"\
20
~- ...
~
~
, .... ...,4'
~---,
\
,
Bank loans to
,_ •
, , total short-term debt
0
1976
'78
'80
'82
'84
'86
'88
'90
11
INCREASED IMPORTANCE OF NONTRADITIONAL ACTIVITIES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Standby letters of credit
Loan commitments
Securitization
Loan sales
12
TRADITIONAL CREDIT PROCESS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Identify potential buyers
Make credit evaluation
Fund the loan with bank deposits
Service the loan
13
LOAN COMMITMENTS AND STANDBYS PERMIT NONBANKS TO
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Originate, fund and service loans
But bear only a portion of the risk
14
LOAN COMMITMENT
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Loan
Borrower
..-;;~=~l[l::=:=:YRL-:=:::w.-:-:::::=:'-:::❖:'-:-: : :=: : :=:=:❖- :=P.:
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::::::::::~::::::-;:::«:x::x:::.::;::::x::x:;-;P""J.:::::;;~r:t::~--
Lender
___________.
.___
Repayment
Bank
(Issues commitment)
15
STANDBY LETTER OF CREDIT
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Loan
_ _A_c_c_o_un_t_p_a_rt_Y_~I
~=:; I____
Be_n_e_fi_c_ia_rY_ _
Repayment
~
1'
#"' • Repayment
l'
guarantee
#'
Bank
(Issues SLOG)
16
IMPACT OF OFF-BALANCE-SHEET GUARANTEES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
45
40
35
Traditional products only
30
25
1976
1978
1980
1982
1984
1986
17
SECURITIZATION AND LOAN SALES PERMIT BANKS TO
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Originate and service loans
While others supply funds and bear some credit risk
18
SELLING LOANS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
COMMERCIAL
LOANS
.~.,/
/£.,,
With recourse
rt
Assets remain in
organization 's balance sheet
Without recourse
®
Assets move off of
organization's balance sheet
19
C&I LOANS SOLD TO NONBANKS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Billions of dollars
20
Loans sold to nonbanks
15
10
5
0
3/31/87
6/30/80
6/30/89
6/30/90
20
TURNING LOANS INTO SECURITIES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
BUSINESSES
FINANCIAL
INSTITUTIONS
Loans are bundled
and sold as securities
Pay-throughs
,@
Securities are collateralized
debt obligations of issuers
® Assets remain on originator's
Asset-backed bonds
@
® Assets remain on originator's
balance sheet
m: Payments of principal and interest
passed through to investors
Securities are collateralized
debt obligations of issuers
Pass-th roughs
r.i Security represents ownership
in underlying asset pool
@
Assets removed from originator's
balance sheet
@
Payments of principal and
interest passed through to investors
balance sheet
@,
Payments of principal and interest
passed through to investors
21
ASSETS HELD AS ASSET-BACKED SECURITIES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
40
37.0%
30
20
10
0.2%
0
Residential Credit card
mortgages receivables
Trade
credit
Auto
loans
Other
Business
consumer debt loans
22
THE CHANGING PROFITABILITY OF COMMERCIAL BANKS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
23
CHANGES IN PROFITABILITY - INDUSTRY AVERAGES
Return on assets (basis points)
80
69
65
Ii
Ii
60
40
55
~
20
0
1980-82
1987-89
All banks
!I
1980-82
1987-89
Ex energy states
24
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
CHANGES IN PROFITABILITY
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Return on assets
1.2
1.0
0.8
0.6
0.4
0.2
0.0
0-9
10-24
25-49
50-99
100-300
3001,000
Asset size (millions of dollars}
1,00010,000
>10,000
25
WHY ARE THESE CHANGES OCCURRING?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Burden of regulation
Declining capital of U.S. money center banks
Increased competition
Retail banking
Wholesale banking
26
REGULATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
i ~~p~;~\ti,~j,i ~
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I
RESERVE REQUIREMENTS TAX
Basis points (per dollar of assets)
50
Burdensome in the 70s
Reduced between 1980
and 1986 by DIDMCA
40
Further reduced in 1990
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
30
20
10
0
1976
'78
'80
'82
'84
'86
'88
'90
28
CAPITAL REQUIREMENT TAX
Basis points (per dollar of assets)
30
Debt and equity treated
differently for tax purposes
25
Equity capital requirements
for low-risk loans higher
than without regulation
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Capital requirements tax
20
15
10
5
0
1976
'78
'80
'82
'84
'86
'88
'90
29
DEPOSIT INSURANCE PREMIUMS
Basis points (per dollar of assets)
50
Not risk-based
Reflects the health
of the FDIC
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
40
I
I
I
I
I
I
I
30
Deposit insurance
premiums
20
10
0
1976
'78
'80
'82
'84
'86
'88
'90 1/91 6/91 '92
30
THE BURDEN OF REGULATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Basis points (per dollar of assets)
70
60
Total regulatory taxes
50
' ------
40
30
''
''
20
'-... .._
',
Capital requirements tax
'
------- --, ,
10
______ __
Reserve requirement tax
0
'76
'78
'80
'82
'84
'86
'88
'90
31
PRESSURES ON CAPITAL DURING THE 80s
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Loan loss reserves as a percent of total loans
2.5
2.0
1.5
1.0
0.5
0.0
1980
'81
'82
'83
'84
'85
'86
'87
'88
'89
'90
32
IMPLICATIONS OF POOR CAPITAL
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Growth slows
Risk increases
Borrowers seek alternatives
Uninsured depositors leave
Guarantees are less attractive
Ability to trade reduced
33
CAPITALIZATION OF MONEY CENTER BANKS AND COMPETITORS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Foreign
banks
Have nots
Haves
U.S. regional
banks
U.S. money
center banks
0
2
4
6
8
10
12
14
16
Market capitalization as a percent of assets
18
20
34
FOREIGN BRANCH SHARES OF SLOCS AND C&I LOANS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
60
53.0%
50
40
30
20
10
0
1980
1984
1988
35
IMPACT OF MARKET CAPITALIZATION ON DOMESTIC BANKING
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Growth in assets (1980-89)
35
30
•
Regional banks
·@
Money center banks
•
•
•
25
•• • •
• • • •
••
•
20
15
10
5
0
-5
0
2
4
16
14
12
10
6
8
Market capitalization as a percent of assets
18
20
36
DECLINING UNDERWRITING COSTS PUT PRESSURE ON C&I LENDERS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
5
4
Gross spread as a
percent of offer price
3
2
1
0
1980
'81
'82
'83
'84
'85
'86
'87
'88
'89
37
JAPANESE BANKS HAD A CAPITAL WINDFALL
Index, 1978=100
1,800
1,500
I
,
,
,,
Market capitalization I
of Japanese banks I
1,200
900
I
I
I
I
1
I
, .,,. ,
600
300
-----
I
I
I
,,'
I
Market capitalization
of U.S. banks
0
1979
'81
'83
'85
'87
'89
38
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
AS A RESULT, C&I LOAN SP~~DS DECLINEP
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(Adjusted for regulatory taxes)
154
128
1984
1989
39
INCREASED COMPETITION IN RETAIL BANKING
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Alternative to banks
Technology
Deregulation
40
DEREGULATION OF RETAIL BANKING
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Elimination of Regulation Q
Easing of branching restrictions
Interstate banking
41
IMPACT OF DEREGULATION ON PROFITABILITY - EX ENERGY STATES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Return on assets
1.2
1980-82
1.0
0.8
0.6
0.4
0.2
0.0
0-9
10-24
25-49
50-99
100-300
3001,000
1,00010,000
> 10,000
Asset size (millions of dollars)
42
SIZE AND COST CONTROL - THE KEYS TO EFFICIENCY
Average cost (percent)
5
3
2
•JJ!~
Average
1
0-10
10-25
25-50
50-100
100-300
300-1 bil.
Asset size (millions of dollars)
43
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
COST-CARELESS BANKS SUFFER
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Percent
300
Cost-conscious
250
Stock price 200
performance
I
,"~
I
,J
•
150
, 1-..
~
\
'
\
I''
1
"
,_.,
Cost-careless I
100
1984
1985
i
,, ' ·-
,
,,
,.I;
I
45% price
difference
I,..-\
1986
1987
1988
44
CHANGES IN THE 90s
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
45
STILL TOO MANY SMALL BANKS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Asset size
$0-"1 0 million
Actual
Baseline
624
77
$"10-25
2,4"15
378
$25-50
2,5"19
903
$50-"100
2,"102
"1 ,057
Total
7,660
2,4"15
46
SMALL BANKS - A VANISHING BREED
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Number of banking organizations
13,000
12,385
11 ,000
9,640
9,000
7,000
4,600 (upper limit)
5,000
3,000
1980
'81
'82
'83
'84
'85
'86
'87
'88
'89
47
I
MONEY CENTERS - VICTIMS OF CIRCUMSTANCE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(Basis points)
$129
79
(Billions of dollars)
1988
1992
HLTs
down
1988
1992
Commercial
construction down
1988
1992
Regulatory
taxes up
48
SAVINGS FROM BRANCH CONSOLIDATION
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(Number of branches)
1,364
1,270
Wells-Crocker merger reflected
a broader trend
1987
1989
Los Angeles county
664
660
No broad trend
in New York
1987
1989
Manhattan
1987
1989
Westchester
49
I
RESTRICTIONS ON BANKS LIKELY TO EASE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Investment banking
Insurance
Combinations with commercial firms
50
HIGH FAILURE RATE FOR ACQUISITIONS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
75%
50%
Related fields
Unrelated fields
51
WHY ACQUISITIONS SUCCEED
52
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
RETAIL FINANCIAL SERVICES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Conducive to long run profitability, but. ..
ingredients for success differ
Banking - convenience and economies of scale
Brokerage - personal service and customer identification
Individual insurance - screening customers and hard sell
53
MARKETING SYNERGIES LIMITED
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(Percent of households)
69%
~;::{iW'.WTI1f(:
ii
37%
Trust
4%
services t-d wf:-=-n
Banking
Mortgage
origination
t
62%
60%
Brokerage
Securities
services
Individual
insurance
8%
-Annuities
Life
insurance
Property
insurance
54
IMPLICATIONS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Financial supermarkets overrated
Cross-industry combinations unlikely to succeed
Need to consider other alternatives
Internal growth
Information sharing
Taking a pass
55
THE RETAIL TRACK RECORD
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Many experiments have failed
American Express
Sears Financial Centers
Discount brokerage
56
THE RETAIL TRACK RECORD
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
A few successes
Merrill Lynch 's CMA
Insurance I mortgage banking
57
WHOLESALE SERVICES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Commercial banking
Underwriting
Trading
58
UNDERWRITING IS COMPETITIVE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Expertise and customers are footloose
Leaders are losing share
Profitability has declined
59
BUT BANKS HAVE CERTAIN ADVANTAGES
'
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Unique information
Experience in underwriting debt
(i()
TRADING SECURITIES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
No barriers to entry
Hard to use inside information
61
THE WHOLESALE TRACK RECORD
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Acquisitions have been costly
Prudential - Bache
GE - Kidder Peabody
Citicorp - Scrimgeor Vickers
The Big Bang
62
THE WHOLESALE TRACK RECORD
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Success through internal growth
J.P Morgan
Bankers Trust
Private placement
63
IMPLICATIONS FOR FUTURE STRUCTURE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Biggest successes on the wholesale side
Internal expansion the best bet
Other countries no guide
64
REGULATORY REFORM
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
65
BANKING REGULATION IN THE LATE l 980s
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Glass-Steagall restrictions eased
Risk-based capital guidelines
FIRREA
66
MISPRICED GOVERNMENT SAFEGUARDS
Unwarranted advantage in raising funds
Greater bank risk
Increased cost of providing safeguards
Adverse economic effects
67
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
SAFETY NET
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Federal deposit insurance
Discount window
Guaranteed payments system
68
A BAD DECADE FOR DEPOSIT INSURANCE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Thrifts bounced a $200 billion check
BIF is bust - or at least illiquid
69
LOSSES RIVAL DEPRESSION LEVELS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Losses as a percent of all deposits
2.4
1978-'89
1.8
•
I
I
1.2
,,
0.6
I
I
I
,,
'
4
0.0
1922
1978
'23
'79
'24
'80
'25
'81
'26
'82
'27
'83
---
'28
'84
'29
'85
922-'33
'30
'86
'31
'87
'32
'88
'33
'89
70
APPROPRIATENESS OF CURRENT SAFETY NET
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Enabled U.S. banking system to function smoothly
Minor low-cost modifications would increase efficiency
71
FLAT-RATE DEPOSIT INSURANCE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Moral hazard problem on part of bankers
Depositors have no incentive to monitor banks
Banks given comparative advantage in market
for high-risk assets
72
RELAXATION OF RESTRICTIONS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Insurance fund's exposure expanded
Nonbanks subject to unfair competition
Extension of safety net inconsistent with
free market economy
73
BANKS' ROLE IN ECONOMY
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Who decides?
Preserve "traditional" role?
Ensure safety?
Separate commerce and banking?
74
NEW REGULATORY STRUCTURE
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Comprehensive understanding of banking industry
Limit distortions caused by regulation
Piecemeal approach inefficient
75
PRINCIPLES FOR REGULATORY REFORM
'
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Accomodate expanded range of activities for banking firms
Foster fair competition between bank and nonbank
financial services providers
Endeavor for system stability, not survival of individual firms
Price safety net appropriately
Supervision necessary but not a substitute for regulation
Better failure resolutions to limit excessive risk-taking
Corporate separateness necessary but not sufficient to
limit risk exposure of banks
76
ROLE OF FEDERAL RESERVE SYSTEM
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Ultimately responsible for financial system
Needs ready access to information
Needs on-going supervisory role
77
A COMPARISON OF MAJOR PROPOSALS
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Riegle
Proposal
Gonzalez
Proposal
Treasury
Proposal
FDIC
Proposal
BenstonKaufman
Proposal
None
None
Unlimited
Unlimited
Unlimited
Unlimited
No
?
Yes
Yes
Yes
Yes
Banks
No
No
No
No
Yes
No
Subsidiaries of banks
No
No
Yes
Yes
Yes
No
Affiliates of banks
No
No
Yes
Yes
Yes
Yes
Holding company a
source of strength
Yes
Yes
No
No
No
?
Consolidated
oversight
No
Yes
No
No
No
No
Restrict coverage
Yes
No
No
No
?
No
Early intervention
Yes
Yes
Encouraged
No
Yes
No
Risk-based premiums
Yes
Yes
Maybe
No
No
No
New financial
powers granted
Commingling of banking
and commerce
Narrow
Bank
Proposal
New powers for
78
CHICAGO PROPOSAL
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Implement a comprehensive risk-based capital plan
Require banks to maintain subordinated
debt-to-assets and equity-to-assets
ratios of at least 4 percent
Impose restriction on bank risk-taking
79
RISK-BASED CAPITAL
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Sets minimum capital levels commensurate with
riskiness of banking firm
Imperfect, but step in right direction
Further modifications may be necessary
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SUBORDINATED DEBT CUSHION
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Federal Reserve Bank of St. Louis
Minor modifications to current risk-based
capital guidelines
Require 4 percent subordinated debt-to-assets ratio
Subordinated debt needs to possess
certain characteristics
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SUBORDINATED DEBT CHARACTERISTICS
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Federal Reserve Bank of St. Louis
Dividends restricted when core equity falls
below a certain level
Bank ownership converts to the subordinated
debtholders upon insolvency
Creditors convert to common shareholders of "new entity"
Warrants distributed to former common shareholders
"New" bank would be required to raise new subordinated
debt, find an acquirer, or liquidate within a year
Subordinated debt issued with staggering
maturities of five years or more
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ADVANTAGES OF SUBORDINATED DEBT CUSHION
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Federal Reserve Bank of St. Louis
Probability of bank run is small
Subordinated debtholders are truly subordinated
Allow insurance fund to eliminate implicit coverage
of all deposits of large banks
Early resolution of bank failures
Market discipline
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BANK RISK-TAKING
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Federal Reserve Bank of St. Louis
When banking firm's solvency is questionable,
no dramatic changes in bank's risk profile
Bank powers restricted to direct credit
and related activities
Nonbanking financial activities conducted by
holding company affiliates of bank
Nonfinancial activities prohibited
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IMPORTANT FIREWALLS
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Federal Reserve Bank of St. Louis
Limit lending by a bank to nonbank affiliates
to 20 percent of bank's capital
Require bank to demonstrate capability to operate
separately from the rest of the holding company
Require separate Boards of Directors for bank and
bank holding company
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DO FIREWALLS WORK?
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Federal Reserve Bank of St. Louis
Drexel Burnham Lambert - broker/dealer insulated
Campeau - Ralph 's Grocery Stores insulated
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CAN FIREWALLS WORK IN BANKING?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Subordinated debtholders will enforce firewalls
Balance benefits of firewalls against efficiency
loss of multiproduct production and marketing
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SUPERVISORY ISSUES
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Federal Reserve Bank of St. Louis
"Super regulator" not necessary
Well-defined allocation of regulatory responsibility
and intergovernmental cooperation
Consolidated oversight responsibility of Fed
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IN CONCLUSION ...
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Federal Reserve Bank of St. Louis
Current bank regulatory structure is outmoded
Bank profits from traditional activities have fallen
Bank management incentives are distorted
Bank closures are complex and expensive
Broader array of banking services are efficient
Chicago proposal relies on market discipline to reduce
distortions from safety net mispricing
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YOU ARE THE POLICYMAKER
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1. What role do you think banks should play in the economy?
2. What powers should they and shouldn't they have?
3. Would you make any legal distinction between banks and
their nonbank affiliates (i.e. would you erect "firewalls")?
4. What powers should nonbank affiliates of banks have?
5. Who would regulate banking firms? One regulator?
Various regulators according to function?
6. Would you change the deposit insurance system?
•
Would you reduce coverage from the
current $100,000 per account?
•
Would you institute a risk-based
deposit insurance system?
•
Would you explicitly and implicitly not
insure all liabilities? How?
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YOU ARE A BANKER
'
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1. How do you prepare to compete in a deregulated industry?
2. How do the growth of securitization and long term financing
affect your long run profitability?
3. What kind of banks do you acquire?
4. How tough do you want regulators to be on poorly
capitalized banks?
5. How do you respond to growing number of competitors
that are falling on hard times?
6. How much capital do you hold?
7. What kind of deposit insurance system is best for you?
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