Bank regulation Need for banking regulation? Banks’ fragility

Bank regulation

Need for banking regulation? Banks’ fragility Systemic risk Protection of depositors

Fragility of banking business $1 m deposit cash i1 % i1 %- i2 % Trust and safety i2 % loans

Simplified balance sheets of a Financial Institution Secondary securities Primary securities Risk intermediation

E.g. 1. Deposits’ Withdrawals and Systemic Risk

Cash deficit

Cash deficit $1 m deposit cash i1 % i1 %- i2 % Trust and safety i2 %

Bank panic and bank runs $1 m deposit cash i1 % i1 %- i2 % Trust and safety i2 %

E.g.2. Deterioration of loans quality

Deterioration of loan quality Loan quality deteriorates Bank capital as a cusion against losses

Role in Economy: Transmission of Monetary Policy Open market operations (T-bills) Borrowing of the last resort Reserve requirements M1 M2

Summary FIs are a delegated monitor over the borrowers 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

Central Banks 1991 1913 1998 1864

Regulation

Banks supervision: central banks Control over money supply Prudential control Open market operations Reserve requirements Minimization of financial crisis Lender of the last resort

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

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

Banks supervision: assessment of risk management

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

Regulation NOT TO REGULATE NOT TO REGULATE

Calculate risk asset ratio Under Basel I bank capital requirement: Risk-asset ratio =