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Bank regulation
1. Bank regulation
2. Need for banking regulation?
• Banks’ fragility• Systemic risk
• Protection of depositors
3. Fragility of banking business
In 1 monthIn 3 months
In one year
Withdrawals of
$1 mln deposit
-$300,000
-$400,000
-$300,000
Deposit balance
$700,000
$300,000
$0
loans
i2 %
i1 %
$1 m
deposit i1 %- i2 %
cash
Trust and safety
4. Simplified balance sheets of a
Financial InstitutionAssets
Liabilities & Equity
CASH
LOANS
DEPOSITS
OWNERS’ CAPITAL
Secondary securities
Primary securities
Risk intermediation
5. E.g. 1. Deposits’ Withdrawals and Systemic Risk
6.
todayIn 1 months
In 3 months
-$300,000
-$400,000
$1,000,000
$700,000
$300,000
today
In 1 month
In 3 months
$700,000
$300,000
$1,000,000
$700,000
$300,000
today
In 1 months
In 3 months
-$700,000
-$300,000
$1,000,000
$300,000
0
today
In 1 month
$1,000,000
-$400,000
Withdrawals of a
$1 m deposit
Deposit balance
Cash
$1,000,000
Loans
Deposits
Withdrawals of
deposit
Deposit balance
Cash
Loans
Deposits
$700,000
$1,000,000
$300,000
Cash deficit
7.
todayIn 1 months
In 3 months
-$700,000
-$300,000
$1,000,000
$300,000
0
today
In 1 month
$1,000,000
-$400,000
Withdrawals of
$1 m deposit
Deposit balance
Cash
Loans
Deposits
$700,000
$1,000,000
$300,000
i2 %
i1 %
$1 m
deposit i1 %- i2 %
cash
Trust and safety
Cash deficit
8. Bank panic and bank runs
i2 %i1 %
$1 m
deposit i1 %- i2 %
cash
Trust and safety
9. E.g.2. Deterioration of loans quality
10. Deterioration of loan quality
LoansDeposits
today
In 1 month
$1,000,000
$800,000
$1,000,000
Net loss
$-200,000
today
Loans
$1,000,000
Loan quality
deteriorates
$1,000,000
Deposits
$ 700,000
Capital
$ 300,000
In 1 month
$800,000
$700,000
$100,000
Bank capital
as a cusion
against losses
11. Role in Economy: Transmission of Monetary Policy
Open marketoperations (T-bills)
Borrowing of the
last resort
Reserve
requirements
M1
M2
12. Summary
• FIs are a delegated monitor over theborrowers when there is:
– Economies of scale in information costs
– Benefits of economies of scale > cost of delegation
• FIs are risky because of:
– Assets transformation
– Maturity intermediation
– Denomination intermediation
• FI are important in economy since they
– facilitate payment transactions
– allocate investments
– are transmitters of central banks’ monetary policy
13. Central Banks
19911913
1864
1998
14. Regulation
Monitoring by Central BankGuarantee funds (FDIC, SIPC, KDIF)
Minimum capital requirement (6% of
total assets)
Investment diversification (max. size of
loan is 10% of a bank’s owners’ capital)
15. Banks supervision: central banks
Control overmoney supply
• Open market
operations
• Reserve requirements
Prudential
control
• Minimization of
financial crisis
• Lender of the last
resort
16. Deposits insurance
• Federal Deposit Insurance Corporation(FDIC)
– Established in 1934
– Resulted in decline of bank failure rate from
28.16% in 1933 to 0.27% in 1934
• Insurance size:
– $250,000 in the USA
– £75,000 in the UK
– €100,000 in the most of EU
17. Banks supervision: restriction on entry
• Chartering and licenses• Minimum capital requirements:
– UK: £5 mln.
– KZ: KZT 10 bn.
– EU: €5 mln.
• Basel I, Basel II, Basel III capital
requirements: Equity to Total assets ratios
18. Banks supervision: assessment of risk management
CCapital adequacy
A
Assets
M Management capability
E
Earnings
L
Liquidity
S Sensitivity to market risk
19. Regulations
• Consumer protection:– Community Reinvestment Act (CRA): banks
must serve local communities
– Home Mortgage Disclosure Act (HMDA):
prohibited discrimination on the basis of age,
race, sex, or income
20. Regulation
NOT TO REGULATENOT TO
REGULATE
21. Calculate risk asset ratio
• Under Basel I bank capital requirement:Capital
4%
Risk-asset ratio =
RiskWeight edAssets
Asset
Risk rate
Cash
Government
bills
0%
0%
Mortgages
Commercial
loans
50%
100%
amount
$1,600
$1,500
$14,000
$12,000