UGA FHCE 3100 - Ch.13 (8 pages)

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Ch.13



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FHCE 3100 1st Edition Lecture 22 Current Lecture Credit Loans and Debt Warning Signs Debt collectors and Creditor Rights o Debts are what is owed Examples of debts are bonds notes mortgages and other forms of paper evidencing amounts owed and payable on specified dates or on demand o A debtor is a person who owes money Reasons for Bank Regulation Banks are less stable than other businesses because o Bank debts tend to be short term many depositors could withdraw their funds with little notice Remember consumer deposits are loans to banks thus they pay us interest on these loans Usually cash paycheck Friday withdrawal Monday o The behavior of depositors depends on their confidence that the bank is sound and this confidence can be easily shaken Bank regulation An overview Primary bank regulators in the US o Office of the Comptroller of the Currency OCC Part of the US Department of Treasury o Federal Reserve System the US central bank o Federal Deposit Insurance Corporation FDIC o State bank regulators Exam What year did OCC start What about Federal Reserve System and FDIC What President was in during the implementation of each of these Federal Deposit Insurance Exam 3 or more questions about role of FDIC in banking collapse The US Congress in the Federal Deposit Insurance Corporation FDIC in 1933 after the bank failures in the Great Depression Today the FDIC guarantees each bank depositor up to a maximum of 250 000 These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute FDIC Insurance is funded by a small fee paid by banks based on their deposits Banks cannot opt out of FDIC have to pay fee Exam Know how FDIC allows banks to be bad Incentive Effects of Deposit Insurance A Closer Look Deposit insurance increases the supply of deposits from consumers within the insurance coverage limits o Incentive to put money in the bank Banks attract deposits pay lower interest rates on their deposits even as they pursue risky strategies that increase the risk of bank failure As a result deposit insurance reduces banks incentives to avoid risk If covered by FDIC no risk Capital Requirements Also known as Regulatory Control When there s deposit insurance banks have an incentive to hold too little capital Therefore the government imposes capital requirements to ensure that banks hold sufficient capital Also considered the ratio of the bank s equity to its debt Bank Examinations Banks are visited on a regular schedule by bank examiners from the OCC the Federal Reserve System the FDIC or other agencies Bank examiners review the bank s financial statements and its confidential accounts The results are summarized in a CAMELS rating given to the bank Bank Examinations Know for exam CAMEL o Capital adequacy o Asset quality o Management o Earnings o Liquidity o Sensitivity to market risk Camel Ratings EXAM 1 Sound in every aspect 2 Fundamentally sound but with modest weaknesses that can t be corrected 3 Moderately severe to unsatisfactory weaknesses vulnerable if there s a business 4 Many serious weaknesses that have not been addressed failure is possible but not imminent 5 High probability of failure in the short term Bank Examinations CAMELS ratings are disclosed to bank management but not to the public If the CAMELS rating for a bank is unfavorable regulators can take actions like these o Require banks to disclose unfavorable information in their public financial statements o Issue a cease and desist order requiring the bank to stop doing things that cause financial troubles and to correct problems o Impose fines up to 1 million a day Regulating Banking Truth in Lending Act o Requires financial institution to reveal annual percentage yield rate fees charged information about the loan balance payment due total amount charged Federal Deposit Insurance Corporation o Government insurance of banks or savings and loans accounts currently up to 250 000 per depositor per bank What can go wrong Bank failure the bank goes out of business o Bank depositors might lose some of their funds o Bank creditors might lose some of their investment o Bank owners lose their capital The bank suffers significant losses the government might have to help Banking Crisis 1930s Two reasons for bank failure o The value of bank assets investments holdings falls so assets liability o Deposit outflow a large number of depositors withdraw their funds from the bank exhausting the bank s cash reserves and other liquid assets Baking Crisis 1930s The bank collapse of the 1930s and the ensuing Great Depression had introduced some institutional changes aimed at making banking system less fragile These were o Central bank as lender of last resort o Deposit insurance o Separation of commercial banking and investment banking Glass Steagall Act 1933 Most economics thought that this would be sufficient to produce safety and to prevent large scale banking crisis It was not Why In order to answer question we first have to discuss moral hazard Moral Hazard Exam General insight agents who are insured will tend to take fewer precautions to avoid the risk they are insured against The insurance provided by central bank and governments gave bankers strong incentives to take more risks To counter this authorities have to supervise and regulate They did this for most of the post war period The Banking Crisis of the 1980s Starting in the late 1970s banks grew fast with lots of loans to businesses o Poor quality loans o Too many loans to risky firms High cost of funds o Large share of funds borrowed from other banks Magnitude of the Crisis From 1980 through 1994 over 2 900 banks and S L s failed On average a bank or S L failed every 15 days from 1980 to 1994 During this period about one out of every 6 banks or S Ls holding a total of over 20 of the assets of the system was closed or received government assistance Causes of the 1980s Crisis changes in regulation The banking industry was partially deregulated in the early 1980s o S L s had mostly been restricted to home mortgage lending before but now they were allowed to invest in commercial real estate and stocks Causes of the 1980s Crisis As a result S L s held more risky assets resulting in huge loan losses Since S L deposits up to 100 000 were protected by federal deposit insurance depositors had little incentive to monitor S L risks Bank s Troubles o By 1984 bank s nonperforming loans loans on which payments


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