Bank Operation
BNKG 1303
Session 2 - The Evolution of Banking
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Consider the discussion on pages 24-25 about the "Change in Philosophy". The market place was no longer satisfied with what was in place. Consumers wanted to participate in the Stock Market - but without assuming all the risk associated with the purchase of a single stock. They came to realize that it might be better to invest in a fund - that invested in stocks. In that way they could get most of the benefits of the Stock Market - while somewhat protecting themselves from changes in the market. The funds - came to be known as Mutual Funds. This new investment opportunity - not subject to either interest rate limitations or banking regulation - could and did provide a much higher rate of return that typical - and regulated - bank deposits. The outflow of funds from banks is what is known as disintermediation. From the first session - you will remember that banks are financial intermediaries. So now - it makes sense that a large amount of funds flowing from one type of institution or investment type - to another is disintermediation. In order to compete with these new 'Mutual Funds' - banks were given new authorities - some of which worked backward to what the regulatory agencies were trying to accomplish. |
| The text - starting on page 27 - attempts
to deal with the "Thrift Crisis", but does so without any mention
of the effects of Reg "Q" on the reason why thrifts sought and
then used expanded authorities.
Regulation "Q" has an interesting history. This is the regulation that has been responsible, since 1933, for setting an arbitrary interest rate maximum that financial institutions have been permitted to pay on any savings or deposit account. While the rate has changed since 1933, for many years the rate allowed by banks was .25% less than a similar rate available to either Savings and Loans or Credit Unions. This was explained as a method to allow these 'Thrifts' to compete for deposit dollars with the banks, since the banks had checking accounts (with 0%) and the thrifts did not have checking account authority. For most of the time from the 30's till the 70's, inflation remained substantially under control. Further, people with excess money had limited 'savings' vehicles available. They could either invest in the Stock Market (often considered 'risky') or they could place their funds in a savings account - either at the bank where their checking account was - or the local S&L or CU that paid a bit higher rate of interest. This being the case, there was little reason to give any financial institution additional methods to attract funds. In the late 70's and early 80's - a new investment vehicle came into being - the "Mutual Fund". Developed by the stock broker industry - this 'investment' was not one stock or bond - but a fund comprised of a relatively large number of stocks or bonds. In this way, the risk associated with fluctuations of one stock was minimized. The result was that this became a very popular option for savers and was one of the primary causes of the 'dis-intermediation' that occurred during this period. The regulators responded to the increasing pressure on all financial institutions from this new threat by continually authorizing increases in the Reg "Q" interest rates and terms, until in the early 1980's the maximum interest rate authorized for a S&L was 16.55% for a certificate of deposit with a 10 year term. |
| Banks did not exist prior to 1600 - there was no 'credit' nor any concept of 'interest'. |
| Inflation may have been bad in this century - but in the 1770's shoes could cost $5,000 and a suit might have a $1,000,000 price tag. |
| Early banks issued their own currency - backed by their gold or silver reserves. Frost Bank in downtown San Antonio has a display on its lobby walls of currency issued by that bank prior to the turn of the century. |
| As early as the 1820's it was recognized that inflation could be affected by controlling the amount of money in circulation. |
| The history of attempts to establish a 'National" bank or currency continued the fight that had existed on other fronts between those that wanted a strong federal government and those that resisted any attempt to take power from the states. |
| The 'modern' banking era began in 1863-64 with the "National Banking Act" - that single-handedly created most of the structure that exists today for bank regulation. |
| The Glass-Steagal Act of 1933 was the next major revision of the banking environment. As a result of the "Bank Holiday" and the depression, many of the activities of banks were substantially limited and new controls were put in place. |
| Garn - St. Germain Act of 1982 - created new "Money Market Deposit Accounts" - in an attempt to allow regulated financial institutions to compete with the unregulated brokerage business. This combined with Regulation "Q" interest rate limits contributed significantly to the financial crisis of the 1980's. |
| FIRREA - The Financial Institutions Reform, Recovery, and Enforcement Act was passed in 1989 in order to 'fix' the problems with both the FSLIC that were caused by S&L failures during the late 1980's. |
| The Federal Deposit Insurance Corporation Improvement Act of 1991 was passed to re-capitalize the FDIC insurance fund and a result of the number of bank failures that resulted for the same financial situation that put many S&L's into receivership. The reason that the banking industry did not experience financial problems as early as the S&L's is related to the difference in lending products and corresponding terms utilized by the different industries. Thrifts, traditionally made home loans with terms from 20 to 30 years while banks made personal or commercial loans - with terms usually less than 5 years. |
| Interstate banking was approved in 1994. This allows single - much larger banks - to offer services in multiple areas. Prior to this time - banks were limited to either one location - in many states - or state wide locations. Now it is common to find banks with branches in nearly every state. |
| With the current strong economy, Congress is in the process of relaxing laws put into place with the Glass - Steagall Act. Even as you are taking this class, Banks are taking ownership interests in insurance and brokerage companies that had been prohibited for more that 60 years. The long term impact of this further 'deregulation' will only be determined in the future. |
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Session Internet Resources
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| Overview of Banking |
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There is NO specific assignment for this session. |
| For each session, you must answer completely ONE of the questions provided, and email your response to the instructor by midnight the Friday of the session week. While answers should be developed fully, it is anticipated that each answer should be approximately one page in length. |
| Was the Monetary Control Act of 1980 an act of regulation or deregulation - and why? |
| How would a period of disintermediation effect banks? |
| What conditions led to the Glass-Steagall Act? |