Commercial Banking Spring 2014 Fin 4324 Exam 1 Study Guide Introduction (2 questions) Internal and external funding: - US Manufacturing Firm 70% internally generated funds and 30% externally generated funds - Of external funding, 69% is from new loans (Banks), 39% is from new bond issuance and 2% is from equity The Role of Banks: - Loans (act as a source of external funds) - Accept demand deposits - Issue bank drafts and checks - (Safety deposit boxes) Sources of Banking Profits: - Purchase assets that are riskier, longer term, and less liquid o Expecting to earn a higher return - Issue securities that are low risk, short term, highly liquid o Banks pay a lower return : ( ) ( ) Key Banking Laws (7 Questions) - Glass-Steagall defines a commercial bank as a bank that accepts demand deposits and makes commercial loans. Glass Steagall viewed securities underwriting and other activities as too risky for banks. - Riegle-Neal permits banks to branch across state lines nation-wide but only through the acquisition of an existing bank. o Permits full interstate banking o States may “opt out” of the legislation Internal Funding 70% External Funding 30% Sources of Funding of US Manufacturing Firms Sales of New Shares of Equity 2% Sales of New Bonds 29% New Loans 69% External Funding- McFadden makes both Federal and state chartered banks subject to state branch banking laws and prohibits branching across state lines. o Allowed national banks the same branching ability as state banks o Prohibited interstate branching - Dodd-Frank establishes the Financial Stability Oversight Council to identify and supervise systemically important financial institutions (SIFIs). Creates Globally Systemic Important Bank (GSIB) risk buckets, which requires different banks to hold additional capital. o No bail outs of any individual banks, only banking system o Better measure of risk  stress testing for SIFIs & measures of systemic risk o SIFIs must increase capital on hand - Gramm-Leach-Bliley Acts permits banks to affiliate with investment banking, securities, insurance and real estate subsidiaries through the formation of financial holding companies. Key Regulators and Regulations (9 Questions) Bank Charter & Dual Banking System: - Banks must obtain a charter to operate. A newly chartered bank is called a “Do Novo” bank - Dual Banking refers to a bank’s ability to receive a State Charter or a Federal Charter o State Charters are granted by a state agency o Federal charters are granted by the Office of the Comptroller of Currency State Charter: - “state charters can serve as laboratories of state innovation” o Policies can be tested on a small scale before adopted nationally - Application to appropriate state agency - No Federal requirement that they join Fed or have FDIC deposit insurance o However, all states require state chartered banks to have FDIC deposit insurance o A small but growing number of state chartered banks elect to join the Fed - Primary Regulator  Joined Fed FED then State Agency  Not Joined Fed  State Agency then Fed Federal Charter - “test and evaluate adaptation of uniform standards” o Test and evaluate efficiencies on a national level - Application to OCC (office of comptroller of currency) - Required to join the Fed (cost is an annual fee & cost of regulation) - Required to have FDIC Deposit insurance - Primary Regulator—OCC Determining Charters: - Costs associated:o State charters are less costly (for both direct costs and compliance costs with regulations) - Type and quality of regulation: o States will be more lenient o Which charter will be consistent with the business model  (smaller banks can’t be able to operate with the same controls as national banks) - Consistency of Regulators o Single state banks may prefer state charter o Multi-state banks may prefer national charter OCC—Office of the Comptroller - The OCC considers the following factors for acceptance of a proposed bank o Who—whether the organizers are familiar with laws & competent o Capital—access to liquidity, capitalization, & risk management o Profit—expected to achieve and maintain profitability o New—new services that will meet the convenience and needs of the community o Also consider low income accommodation & safety of bank operations Bank Holding Companies History - Early limitations on the ability of banks to branch and the ability of banks to offer non-banking services created a demand for Bank Holding Companies (BHCs) o Prior to the McFadden Act of 1927, states create their own branch banking laws for state chartered banks. The McFadden Act makes all branch banks (including Federally Chartered Banks) subject to laws within the states they operate. o Since many states prohibit or limit branch banking, banks create Multi-Bank Holding Companies in order to circumvent these rules and expand branching o In 1956, the Bank Holding Act of 1956 made the Fed responsible for approval of formation of Bank Holding Companies as well approval of any new banks acquired by a bank holding company  Douglas Amendment makes BHCs able to acquire banks across state lines if states approve  When BHCs begin to acquire non-bank subsidiaries, the Amendment to Bank Holding Company Act (Regulation Y) made the Fed responsible for approval of non-bank subsidiaries Definition & General - A corporation that limits its business to the ownership of stock in and the supervision of management of other corporations o A holding company is organized specifically to hold the stock of other companies and ordinarily owns such a dominant interest in the other company or companies that it can dictate policy. o Own 25% or more of the bank’s voting stock or control a majority of the bank’s directors- Most banks are subsidiaries of BHCs o 84% of commercial banks are part of a Bank Holding Company o Approximately 75% of small banks with assets of <$100m. Are owned by BHCs o 100% of large banks with >$10 b. in assets are owned by BHCs - Banks can engage directly in, or acquire subsidiaries that engage in nonbanking activities closely related to banking. o Defined by the Fed as: Mortgage Banking, Leasing, Consumer and Commercial Financing, Collection Agency, Trust Company, Real Estate appraisal, etc. - Banks cannot be directly affiliated with: o Investment banking firms,