Bank Management,

Management 5th edition.

Timothy W. Koch and S. Scott MacDonald
Copyright © 2003 by South-Western, a division of Thomson Learning

BANK ORGANIZATION
AND REGULATION

Chapter 2
Government agencies that regulate commercial
banks have had to balance the banking system’s
competitiveness with general safety and
soundness concerns.
 Historically, regulation has limited who can:
 open or charter new banks and
 what products and services banks can offer.
 Imposing barriers to entry and restricting the
types of activities banks can engage in
clearly enhance safety and soundness, but
also hinder competition.
 Historical regulation, which limits the number
of banks and types of activities, has three
drawbacks
1. It assumed that the markets for bank products, largely bank loans
and deposits, could be protected and that other firms could not
encroach upon these markets.
 Not surprisingly, investment banks, hybrid financial companies,
insurance firms, and others found ways to provide the same
products as banks across different geographic markets.
2. It discriminated against U.S.-based firms versus foreign-based
firms.
 For example, prior regulations prohibited U.S. banks from
underwriting securities for firms in the U.S.
 In contrast, foreign banks are generally not restricted as to their
domestic corporate structure and thus have long been able to
circumvent U.S. restrictions on under-writing activities.
 Such restrictions place U.S. banks at a competitive
disadvantage.
3. Historical regulation has penalized bank customers who do not
have convenient access to the range of products they demand.
 In addition, such restrictions generally raise prices above those
obtained in a purely competitive marketplace.
 The U.S. operates using a “dual banking system.”

 Individual states as well as the federal government

issue bank charters.
 The Office of the Comptroller of the Currency (OCC)
charters national banks
 Individual state banking departments charter state banks
and savings institutes.
 The Office of Thrift Supervision (OTS) charters federal
savings banks and savings associations.
 The Federal Deposit Insurance Corporation (FDIC)
insures the deposits of banks and savings
associations up to $100,000 per account.
Bank regulation and supervision
…conducted by four federal agencies (OCC, OTS,
FDIC, and the Federal Reserve) as well as fifty
state agencies.

 Although this is a complicated system, it

allows for a separation of duties as well
as “competition” among the various
regulatory agencies to produce a safe
and efficient banking system.
Credit unions represent another type of
depository institution.
 Even though credit unions perform some of the same functions as a
bank, they are cooperative nonprofit financial institutions that exist
for the benefit of members.
 To join a credit union, one must share a “common bond” with
other members.
 The definition of common bond, however, has expanded to
incorporate a “community” and hence the differences between
credit unions and banks are disappearing as well.
 Credit unions often operate in subsidized office space with
subsidized labor and do not pay corporate or state income taxes.
 This tax-exempt status puts them at a competitive advantage
over other banking institutions.
 Credit unions were first chartered at the state level in 1909.
 By 1934, the federal government began to charter credit unions
under the Farm Credit Association, and created the
National Credit Union Administration (NCUA) in 1970.
 A dual credit union regulatory system exists as well today as both
states and the NCUA charter credit unions today.
 National versus a State bank charter
 Before issuing a new charter, the chartering
agencies ensure that the (de novo) bank will
have the necessary capital and management
expertise to ensure soundness and allow the
bank to meet the public’s financial needs.
 The agency that charters the institution is the
institution’s primary regulator with primary
responsibility to ensure safety and soundness
of the banking system.
 All banks obtain FDIC deposit insurance
coverage as part of the chartering process.
 While national banks are regulated only by federal
regulatory agencies, state-chartered banks also have a
primary federal regulator.
 The Federal Reserve is the primary federal regulator of
an FDIC-insured state bank, which is a member of the
Federal Reserve System, while the primary regulator of
state non-Fed member banks is the FDIC.
Charter Class by their Primary Federal Regulator Primary
(thousands of dollars): June 2001 # # Federal
Charter Class Institutions Offices Deposits* Regulator
Commercial Banks 8,178 72,167 3,566,835,641
National Charter 2,176 34,691 1,890,611,980 OCC
State Charter 6,002 37,476 1,676,223,661
Federal Reserve Member 975 13,845 769,802,155 Fed
Federal Reserve Nonmember 5,027 23,631 906,421,506 FDIC
Savings Institutions 1,561 13,888 755,422,190
Federal Charter Savings Associations 896 9,020 526,156,002 OTS
State Charter Savings Institutions 665 4,868 229,266,188
FDIC-Supervised Savings Banks 520 4,325 210,542,336 FDIC
OTS-Supervised Savings Associations 145 543 18,723,852 OTS
U.S. Branches of Foreign Banks 18 18 4,069,399
Total 9,757 86,073 4,326,327,230
* Includes deposits in domestic offices (50 states and DC), Puerto Rico, and U.S. Territories
 In contrast to federally regulated national banks,
state-chartered banks have generally had
broader powers.
 Many states allow securities underwriting and
brokerage; real estate equity participation,
development, and brokerage; and insurance
underwriting and brokerage.
 Still, regulations for banks are more restrictive than
those that apply to thrift institutions.
 While thrifts must maintain at least 65 percent of
their assets in housing-related investments and
cannot have more than 10 percent in loans to
businesses, they have historically been allowed
nationwide branching and full-service underwriting
and brokerage activities in insurance, real estate,
and corporate instruments.
 For many years, commercial banks were
viewed as a special type of financial
organization.
 They were the only firms allowed to issue demand deposits and
thus dominated the payments system
 Prior to 1980, interest-bearing checking accounts did not exist
except at credit unions.
 Because of this status, authorities closely regulated bank
operations to control deposit growth and to ensure the safety of
customer deposits.
 Among other restrictions, government regulators required:
 cash reserves against deposits,
 specified maximum interest rates banks could pay on deposits,
 set minimum capital requirements, and
 placed limits on the size of loans to borrowers.
 In addition to regulatory constraints, federal banking law further
limited bank operations to activities closely related to banking and,
in conjunction with state laws, prohibited interstate branching.
Historically, banks, savings associations,
and credit unions each served a different
purpose and a different market.

 Commercial banks mostly specialize in short-term

business credit, but also make consumer loans and
mortgages, and have a broad range of financial
powers.
 Banks accept deposits in a variety of different
accounts and invest these funds into loans and
other financial instruments.
 Their corporate charters and the powers granted to
them under state and federal law determines the
range of their activities.
 Savings institutions, savings and loan
associations and savings banks, have historically
specialized in real estate lending; e.g., loans for
single-family homes and other residential
properties.
 Savings associations are generally referred to as “thrifts”
because they originally offered only savings or time deposits
 They have acquired a wide range of financial powers over the
past two decades, and now offer checking accounts, make
business and consumer loans, mortgages, and offer virtually
any other product a bank offers.
 Savings institutions must maintain 65% of their assets in
housing-related or other qualified assets to maintain their
savings institution status.
 This is called the “qualified thrift lender” (QTL) test.
The number of thrifts has declined
dramatically during the last two decades.
 The savings and loan crisis of the 1980s forced many
institutions to close or merge with others, at an
extraordinary cost to the federal government.
 Due to liberalization of the QTL, however, there was a
resurgence of interest in the thrift charter and many
insurance companies, securities firms, as well as
commercial firms acquired a unitary thrift holding
company in order to own a depository institution and
bypass prohibitions in the Glass Steagall Act and the
Bank Holding Company Act.
 This resurgence of interest stopped with the
passage of Gramm-Leach- Bliley, which eliminated
the issuance of new unitary thrift charters.
Credit unions are nonprofit institutions with an
original purpose to encourage savings and
provide loans within a community at low cost to
their members.
 A “common bond” defines their members, although this
common bond can be loosely defined.
 The members pool their funds to form the institution’s deposit
base and the members own and control the institution.
 Credit unions accept deposits in a variety of forms.
 All credit unions offer savings accounts or time deposits,
while the larger institutions also offer checking and money
market accounts.
 Credit unions have similarly expanded the scope of products
and activities they offer to include almost anything a bank or
savings association offers, including making home loans,
issuing credit cards, and even making some commercial loans.
 Credit unions are exempt from federal taxation and sometimes
receive subsidies, in the form of free space or supplies, from
their sponsoring organizations.
 Although credit unions tend to be much smaller than banks or
savings associations, there are several very large credit unions.
 The largest federal and state chartered banks:
(thousands of dollars, 2001)
A. Largest Federally Charter Commercial Banks
Total Equity
Rank Name State Total Assets Total Loans Total Deposits Equity to Assets
1 Bank of America NA NC 551,691,000 314,167,000 391,543,000 52,624,000 9.54%
2 Citibank NA NY 452,343,000 284,809,000 306,923,000 37,623,000 8.32%
3 First Union NB NC 232,785,000 123,754,000 147,749,000 16,133,000 6.93%
4 Fleet NA Bk RI 187,949,000 126,301,000 132,464,000 19,012,000 10.12%
5 US Bk NA OH 166,949,055 115,108,238 108,364,026 18,449,335 11.05%
6 Bank One NA IL 161,022,572 83,639,674 107,377,268 10,990,222 6.83%
7 Wells Fargo Bk NA CA 140,675,000 95,264,000 79,077,000 16,186,000 11.51%
8 Wachovia Bk NA NC 71,555,121 46,996,841 46,311,053 13,670,966 19.11%
9 Keybank NA OH 71,526,246 56,410,074 42,731,060 4,878,880 6.82%
10 PNC Bk NA PA 62,609,780 40,452,019 46,385,132 4,887,661 7.81%

B. Largest State Chartered Commercial Banks

Rank Name State Total Assets Total Total Deposits Total Equity
Loans Equity to Assets
1 JPMorgan Chase Bk NY 537,826,000 178,169,000 280,473,000 33,273,000 6.19%
2 Suntrust Bk GA 102,377,306 73,515,248 67,995,077 8,687,049 8.49%
3 HSBC Bank USA NY 84,230,380 40,801,836 58,220,243 6,898,796 8.19%
4 Bank of New York NY 78,018,745 37,309,076 55,810,439 6,466,422 8.29%
5 Merrill Lynch Bk USA UT 66,092,639 12,464,394 59,954,429 3,551,022 5.37%
6 State Street B&TC MA 65,409,590 5,979,937 38,855,475 4,187,956 6.40%
7 Branch Bkg&TC NC 54,700,008 35,731,083 32,103,069 4,742,168 8.67%
8 Southtrust Bk AL 48,849,559 34,249,117 32,965,152 4,165,712 8.53%
9 Bankers Trust Co NY 42,678,000 12,804,000 21,423,000 6,822,000 15.98%
10 Regions Bank AL 42,001,585 31,508,932 31,536,453 3,242,973 7.72%
Largest savings institutions and credit unions (thousands of dollars, 2001)

C. Largest Savings Institutions

Rank Name State Total Total Total Loans Total Equity
Assets Deposits Equity to Assets
1 Washington Mutual Bank, FA S&L CA 206,571,184 92,054,318 132,506,691 12,562,515 6.08%
2 World Svgs Bk, FSB S&L CA 58,443,622 34,651,936 41,505,114 4,701,922 8.05%
3 California Federal Bank S&L CA 56,555,539 25,906,314 42,726,581 4,124,022 7.29%
4 Charter One Bank, SSB S&L OH 38,165,417 25,222,939 26,104,926 2,343,285 6.14%
5 Sovereign Bank S&L PA 35,631,606 22,378,274 20,994,865 3,642,986 10.22%
6 Citibank, FSB S&L CA 31,868,249 22,679,455 21,041,103 2,707,701 8.50%
7 Washington MSB SB WA 31,639,000 16,806,000 19,981,000 2,044,000 6.46%
8 Dime Savings Bank of NY S&L NY 27,971,169 15,188,948 22,092,378 2,384,304 8.52%
9 Astoria FS&LA S&L NY 22,463,688 11,144,443 12,266,238 1,506,548 6.71%

D. Largest Credit Unions

Rank Name STATE Total Total Total Total Equity
Assets Loans Deposits Equity to Assets
1 U. S. CENTRAL CREDIT UNION KS 26,217,598 1,264,461 20,962,788 1,428,725 5.45%
2 WESTERN CORPORATE CA 12,446,130 266,338 10,108,679 820,696 6.59%
3 NAVY VA 11,188,619 8,590,064 9,075,588 1,365,675 12.21%
4 STATE EMPLOYEES' NC 6,301,035 5,207,140 5,645,651 488,698 7.76%
5 BOEING EMPLOYEES WA 3,385,160 1,701,495 2,610,982 276,596 8.17%
6 SOUTHWEST CORPORATE TX 3,313,673 145,774 2,594,040 313,924 9.47%
7 PENTAGON VA 3,243,137 2,406,415 2,882,056 338,609 10.44%
8 MID-STATES CORPORATE IL 2,987,051 159,173 2,574,479 259,016 8.67%
9 UNITED AIRLINES EMPLOYEES' IL 2,852,330 1,354,201 2,498,722 341,144 11.96%
10 AMERICAN AIRLINES TX 2,583,594 1,269,927 2,302,387 229,820 8.90%
 Number and total assets of various depository
institutions: 1970 – 2001.

Annual
(Monetary Amounts Are in billions of Dollars) Growth Rate
1970 1980 1989 1993 1997 2001 1980-2001
Commercial Banks
Number 13,550 14,163 12,410 10,957 9,144 8,080 -1.65%
Total assets $517.40 $1,484.60 $3,231.10 $3,705.90 $5,014.90 $6,569.24 8.54%
(% of Total Assets) 66.0% 63.6% 65.3% 73.9% 78.5% 78.7%
a
Thrift Institutions
Number 5,669 4,594 3,011 2,327 1,779 1,533 -4.13%
Total assets $249.50 $783.60 $1,516.50 $1,024.50 $1,026.20 $1,299.01 5.47%
(% of Total Assets) 31.8% 33.6% 30.7% 20.4% 16.1% 15.6%
Credit Unions*
Number 23,819 21,930 15,205 12,720 11,238 10,145 -2.76%
Total assets $17.60 $67.30 $199.70 $283.50 $351.17 $477.21 11.43%
(% of Total Assets) 2.2% 2.9% 4.0% 5.7% 5.5% 5.7%
Commercial banks play an important role
in facilitating economic growth.
 On a macroeconomic level, they represent the primary
conduit of Federal Reserve monetary policy.
 Bank deposits represent the most liquid form of
money such that the Federal Reserve System’s
efforts to control the nation’s money supply and
level of aggregate economic activity is
accomplished by changing the availability of credit
at banks.
 On a microeconomic level, commercial banks
represent the primary source of credit to most small
businesses and many individuals.
 A community’s vitality typically reflects the strength
of its major financial institutions and the innovative
character of its business leaders.
 There has been a fundamental shift in the structure
of financial institutions over the past two decades.
 In particular, depository institutions’ share of U.S. financial assets has
systematically declined relative to assets held by other financial
intermediaries.

Percent of Total, Depository Institutions

Percent of Total, All Others

20.0% 65.0%

18.0% 60.0%
16.0%
55.0%
14.0%
50.0%
12.0%
10.0% 45.0%

8.0% 40.0%
6.0%
35.0%
4.0%
30.0%
2.0%
0.0% 25.0%
1970 1975 1980 1985 1990 1995 2000
Dec-70 Dec-75 Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-01
Monetary authority 5.1% 4.6% 3.5% 2.9% 2.4% 2.8% 2.4% 2.4%
Insurance Companies 16.8% 14.1% 13.9% 12.8% 14.6% 14.9% 11.6% 11.4%
Pension and Retirement Funds 7.0% 7.3% 8.2% 9.1% 8.6% 8.4% 7.2% 6.7%
Mutual Funds 0.6% 0.6% 1.7% 4.9% 7.6% 10.2% 11.8% 12.5%
Finance companies 4.5% 4.2% 4.9% 4.9% 4.7% 3.8% 4.0% 3.8%
Mortgage related 1.3% 2.2% 3.6% 6.3% 10.8% 11.8% 12.2% 12.8%
Other 4.2% 4.9% 5.3% 7.4% 8.6% 12.4% 18.8% 19.6%
Depository Institutions 60.5% 62.1% 58.9% 51.8% 42.8% 35.7% 31.9% 30.7%
Year
Consolidations, new charters and bank
failures
 The number of failed banks increases sharply
from 1980 through 1988
 This period coincides with economic problems
throughout various sectors of the U.S. economy
ranging from agriculture to energy to real
estate.
 As regional economies faltered, problem loans
grew at banks and thrifts that were
overextended and subsequent losses forced
closings.
 New charters representing the start-up of a
new bank’s operations declined from 1984 to
1994, increased through 1998, and then
decreased through 2001.
The major force behind consolidation has been
mergers and acquisitions in which existing banks
combine operations in order to cut costs,
improve profitability, and increase their
competitive position.
 Bankers who either lose their jobs in a merger
or choose not to work for a large banking
organization often find investors to put up the
capital needed to start a new bank.
 Both mergers and new charters slowed
dramatically in late 1998 as a result of a 25
percent fall in stock values at the largest bank
holding companies and in 2001 with the
continuing market decline.
 Structural changes among FDIC-insured
commercial banks, 1980–2001

700

600
Mergers
500
Number of Banks

400

300
New Charters

200

100 Failures

0
1980 1983 1986 1989 1992 1995 1998 2001
The Central Bank
…Congress created the Federal Reserve System in
1913 to serve as the central bank of the United
States and to provide the nation with a safe, flexible
and more stable monetary and financial system
 The Fed's role in banking and the economy has
expanded over the years, but its primary focus has
remained the same.
 The Fed’s three fundamental functions are:
1. conduct the nation’s monetary policy,
2. provide and maintain an effective and efficient payments
system, and
3. supervise and regulate banking operations.
 All three roles have a similar purpose, that of maintaining
monetary and economic stability and prosperity.
 The Federal Reserve System (The Fed)
 A decentralized central bank, with
 12 districts reserve banks and branches across
the country,
 Coordinated by a Board of Governors in
Washington, D.C.
 The Board of Governors are appointed by the

president of the United States and confirmed by

the Senate for staggered 14-year terms.
 The seven-members of the Board Governors are

the main governing body of the Federal Reserve

System.
 The Board is charged with overseeing the 12

District Reserve Banks and with helping

implement national monetary policy.
Monetary Policy
 The Federal Reserve conducts
monetary policy through actions
designed to influence the supply of
money and credit in order to promote
price stability and long-term sustainable
economic growth.
 There are basically three distinct
monetary policy tools:
1. open market operations,
2. changes in the discount rate, and
3. changes in the required reserve ratio.
Open market operations
… are conducted by the Federal Reserve Bank of
New York under the direction of the
Federal Open Market Committee (FOMC).
 The sale or purchase of U.S. government securities in the
“open market” or secondary market is the Federal Reserve’s
most flexible means of carrying out its policy objectives.
 Through the purchase or sale of short-term government
securities, the Fed can adjust the level of reserves in the
banking system.
 Fed open market purchases increase liquidity, hence reserves in
the banking system, by increasing a bank’s deposit balances at
the Fed.
 Fed open market sales of securities decrease bank reserves and
liquidity by lowering deposit balances at the Fed.
Changes in the discount rate
…directly affect the cost of borrowing
 Banks can borrow deposit balances, or required reserves,
directly from Federal Reserve Banks (in its role as lender
of last resort).
 The discount rate is the interest rate that banks pay.
 When the Fed raises (decreases) the discount rate it
discourages (encourages) borrowing by making it more
(less) expensive.
 Many economists argue that the Fed changes the discount
rate primarily to signal future policy toward monetary ease
or tightness rather than to change bank borrowing activity.
 Changes in the discount rate are formally announced and
trumpeted among the financial press so that market
participants recognize that the Fed will likely be adding liquidity
or taking liquidity out of the banking system.
 Changes in reserve requirements
…directly affect the amount of legal required reserves and
thus change the amount of money a bank can lend out.
 For example, a required reserve ratio of 10 percent means
that a bank with $100 in demand deposit liabilities
outstanding
 must hold $10 in legal required reserves in support of
the DDAs.
 The bank can thus lend only 90 percent of its DDAs.
 When the Fed increases (decreases) reserve
requirements, it formally increases (decreases) the
required reserve ratio that directly reduces (raises) the
amount of money a bank can lend.
 Thus, lower reserve requirements increase bank
liquidity and lending capacity while higher reserve
requirements decrease bank liquidity and lending
capacity.
Organizational form of the banking industry
 The organizational structure of banking has
changed significantly over the past two
decades but changed most dramatically in the
later half of the 1990’s due primarily to:
 the impact of interstate branching,
 the Federal Reserve System’s relaxation of
securities powers restrictions using a clause in
the Glass-Steagall Act and most recently
 with the Gramm-Leach-Bliley Act of 1999.
 Banks can now branch across state lines and
acquire insurance and securities firms by
forming a Financial Holding Company under
the provisions of Gramm-Leach-Bliley.
Commercial banks are classified either as unit banks,
with all operations housed in a single office, or as
branch banks with multiple offices.
 Prior to the enactment of the Riegle-Neal Interstate Banking
and Branching Efficiency Act of 1994, which allow of
nationwide interstate branch banking, state law determined
the extent to which commercial banks could branch.
 Any organization that owns controlling interest in one or
more commercial banks is a bank holding company (BHC).
 Control is defined as ownership or indirect control via the power
to vote more than 25 percent of the voting shares in a bank.
 Prior to the enactment of interstate branching, the primary
motivation behind forming a bank holding company was to
circumvent restrictions regarding branching and the products
and services that banks can offer.
 Today, the primary motive is to broaden the scope of products
the bank can offer.
Unit versus Branch banking
…The current structure of the commercial banking system
as well as the dramatic changes in the number of banks has
been heavily influenced by historical regulations which
prevent branching to one degree of another.
 One of the primary reasons the number of
banks has declined almost 50 percent since
the mid 1980’s is the relaxation of branching
restrictions provided by Riegle-Neal
Interstate Banking and Branching Efficiency
Act of 1994.
 Since the mid 1980’s, the number of banks
has fallen about 50 percent while the
number of branches has increased by 50
percent.
 Changes in the number of banks and bank branc
hes, 1960 – 2001

80,000

70,000

All U.S. Banking Offices

60,000
(Main Offices plus Branches)
Number of U.S. Banking Offices

50,000

40,000

30,000 Branches

20,000

10,000 Main Offices

0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2001*

Branches 10,556 15,872 21,839 30,205 38,738 43,293 50,406 56,512 64,079 63,989
Banks 13,126 13,544 13,511 14,384 14,434 14,417 12,347 9,942 8,315 8,178
The number of interstate branches
increased dramatically after interstate
branching became fully effective in 1997.
Unit banks each have their own board of directors, a
complete staff of officers, and separate documents and
technology for conducting business.
 Operating expenses are generally higher for the parent
company that owns multiple independent banks as
compared to branches of the “lead” bank.
 the relaxation in branching restrictions and economic
efficiencies is a primary motivating factor for a bank to form a
bank holding company.
 Risk in the banking industry is considered higher with
restrictive branching because individual banks were less
diversified and more prone to problems
 Not surprisingly, states with the highest bank failure rates
historically restricted branching.
 Branching generally reduces the number of competitors,
lowers expenses, allows greater asset diversification,
and expands each bank’s consumer deposit base
 Each of these factors decreases the chances of failure,
everything else being equal.
Organizational form
 Independent Banks
 The term independent bank normally refers to
a bank that is not controlled by a multibank
holding company or any other outside
interest.
 Bank Holding Companies
 A bank holding company is essentially a shell
organization that owns and manages
subsidiary firms.
 Bank holding companies
 Bank holding companies are firms that control at least
one bank subsidiary.
 They typically also own several non-bank
subsidiaries--leasing or data processing firms.
 They generate earnings from fees, interest income,
and dividends from equity in subsidiaries.
 They pay interest on borrowings and have
administrative expenses.
 Control is defined as ownership or indirect control
via power to vote more than 25 percent of the voting
shares in a bank.
 Prior to nationwide interstate branching, the primary
motivation was to circumvent restrictions regarding
branching and the products and services that banks
can offer.
 Today, the primary motivation is to expand the
scope of products the bank can offer.
Like commercial banks, bank holding companies
are heavily regulated by states and the federal
government.

 The Bank Holding Company Act stipulates that

the Board of Governors of the Federal Reserve
System must approve all holding company
formations and acquisitions.
 One-bank holding companies (OBHCs) control
only one bank and typically arise when the
owners of an existing bank exchange their
shares for stock in the holding company.
 Multibank holding companies (MBHCs) control
at least two commercial banks.
 The Gramm-Leach-Bliley Act of 1999 also gave
regulatory responsibility over Financial Holding
Companies to the Federal Reserve.
 The Glass-Steagall Act effectively separated commercial banking
from investment banking but left open the possibility of banks
engaging in investment banking activities through a Section 20
affiliate so long as the bank was not “principally engaged” in
these activities.
 Commercial banks received permission (in 1987) from the
Federal Reserve to underwrite and deal in securities through
Section 20 subsidiaries.
 The Fed resolved the issue of “principally engaged” initially
by allowing banks to earn only 5 percent of the revenue in
their securities affiliates. This was raised to 10 percent in
1989 and to 25 percent in March of 1997.
 The Gramm-Leach-Bliley Act of 1999 repeals the restrictions on
banks affiliating with securities firms
 The law creates a new financial holding company, authorized
to engage in: underwriting and selling insurance and
securities, conducting both commercial and merchant
banking, investing in and developing real estate and other
"complimentary activities."
 Financial holding companies (FHC) are distinct
entities from bank holding companies (BHC).
 A company can form a BHC or a FHC or both.
 The primary advantages to a banking organization to
forming a FHC is that they can engage in a wide range
of financial activities not permitted in the bank or with in
a BHC.
 Some of these activities include:
 insurance and securities underwriting and agency activities,
 merchant banking and
 insurance company portfolio investment activities.
 activities that are "complementary" to financial activities
also are authorized.
 The primary disadvantage to forming a FHC or
converting their BHC to a FHC is that the Federal
Reserve may not permit a company to form a financial
holding company if any of its insured depository
institution subsidiaries are not well capitalized and well
managed, or did not receive at least a satisfactory rating
in their most recent CRA exam.
 Nonbank activities permitted bank holding
companies
 The Federal Reserve Board regulates allowable
nonbank activities that are “closely related to
banking” in which bank holding companies may
acquire subsidiaries.
 Restrictions came about for three reasons.
1. It was feared that large financial conglomerates would
control the financial system because they would have
a competitive advantage.
2. There was concern that banks would require
customers to buy nonbank services in order to obtain
loans.
3. Some critics simply did not believe that bank holding
companies should engage in businesses that were not
allowed banks because these businesses were less
regulated and thus relatively risky.
Organizational structure of financial
services company

Financial Services
Holding Company

Bank Thrift Securities Real

Holding Holding Insurance Estate
Company Subsidiaries Subsidiaries Subsidiary
Company

Subsidiaries
Nonbank
and Service
Subsidiaries
Companies
Organizational structure of the OBHC

One-Bank Holding Company

Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries

The bottom four levels have Each subsidiary has a

the same organizational form president and line officers.
as the independent bank.
Organizational structure of the MBHC.

MultiBank Holding Company

Board of Directors

Parent Company

Bank Subsidiaries Nonbank Subsidiaries Bank Subsidiaries

 Citigroup (Parent Company Only)
Assets 2001 2000
Cash and balances due from depository institutions:
Citicorp's Multibank Holding Company Consolidated Balance Sheet for Parent Company Only

Balances with subsidiary depository institutions. $ 6,000 $ 78,000

Citicorp's Balances with unrelated depository institutions.

Securities:
21,000 7,000

multibank Government agencies, corporations and political subdivisions

securities 48,000 0

holding Other debt and equity securities

Net Loans and leases
1,439,000
0
0
0

company Investments in and receivables due from subsidiaries

Premises and fixed assets (including capitalized leases)
120,622,000 87,404,000
15,000 17,000

consolidated Goodwill
Other assets
368,000
368,000
381,000
491,000
balance sheet Total Assets 122,887,000 88,378,000

for parent Liabilities and Equities

Borrowings with a remaining maturity of < one year:
company only Commercial paper.
Other borrowings.
481,000
5,804,000
496,000
3,000,000
(millions $) Other borrowings with a remaining maturity of >one year
Subordinated notes and debentures
25,168,000
4,250,000
10,947,000
4,250,000
Other liabilities 113,000 616,000
Balances due to subsidiaries and related institutions:
Subsidiary banks. 100,000 28,000
Nonbank subsidiaries 5,714,000 2,835,000
Related bank holding companies 10,000 0
Equity Capital:
Perpetual preferred stock (including related surplus) 1,525,000 1,745,000
Common stock (par value) 55,000 54,000
Surplus (exclude all surplus related to preferred stock) 23,196,000 15,635,000
Retained earnings . 69,803,000 58,012,000
(millions $)

Accumulated other comprehensive income -844,000 973,000

Other equity capital components -12,488,000 -10,213,000
Total Equity 81,247,000 66,206,000
Total liabilities and Equities 122,887,000 88,378,000
Citicorp's multibank holding company consolidated income Citigroup (Parent Company Only)
2001
Operating Income:
Income from bank subsidiaries :
Dividends $0
Interest 0
Management and service fees 0
Other 0
Total 0
statement for parent company only (millions $)

Income from nonbank subsidiaries:

Dividends 2,586
Interest 5
Management and service fees 0
Other 1
Total 2,592
Income from subsidiary bank holding companies:
Dividends 6,426
Interest 1,220
Management and service fees 0
Other 0
Total 7,646
Securities gains/(losses) . 0
All other operating income. 53
Total operating income 10,291
Operating expense:
Salaries and employee benefits 225
Interest expense 1,876
Provision for loan and lease losses. 0
All other expenses. 35
Total operating expense 2,136
Income (loss) before taxes and undistributed income 8,155
Applicable income taxes -322
Extraordinary items, net of tax effect -7
Income (loss) before undistributed income of subsidiaries and associated companies 8,470
Equity in undistributed income (losses) of subsidiaries:
Bank 0
Nonbank 2,440
Subsidiary bank holding companies 3,216
Net Income (loss) 14,126
Large and small banks
…When many of us think of banks, we think of the
largest banks in the country such as Bank of America,
Citibank, Chase Manhattan Bank, First Union National
Bank, Morgan Guaranty Trust Company, Fleet National
Bank, Wells Fargo Bank, and Bank One.
 Of the approximate 8,100 commercial banks
operating in the United States, however, only
about 80 are greater than $10 billion in assets.
 The vast majority of banks are small banks (about
5,000), under $100 million in assets with a legal
lending limit of less than $1 million.
 In fact, almost 96% of all banks have total assets
less than $1 billion.
 Still, the largest banks (over $10 billion) hold
almost 70 percent of
Banking business models
…The business models followed by the majority
of banks (small banks) is generally different
that that of largest banks.
 Historically, small banks have been called
independent or community banks while large
banks have been labeled large holding company
banks, multibank holding companies, or even
money center banks.
 Never the less, banks of the same size, however,
often pursue substantially different strategies
Business model structure of
commercial banking
 The organizational structure of commercial
banks can be characterized as banks falling
into one of the following categories based on
the range of products and services offered and
the different geographic markets served:
 Global banks
 Nationwide banks
 Super Regional banks
 Regional banks
 Specialty banks
 limited region
 limited product line
Organizational structure of an
independent bank
 Five fundamental objectives
of bank regulation
 Ensure the safety and soundness of banks and
financial institutions
 The Federal Reserve System uses regulation to
provide monetary stability
 To provide an efficient and competitive
financial system
 Protect consumers from abuses by credit-
granting institutions
 To maintain the integrity of the nation’s
payments systems.
Three separate federal agencies along with
each state's banking department issue and
enforce regulations
 The Federal Reserve
 The Federal Deposit Insurance Corporatio
n (FDIC)
 Office of the Comptroller of the Currency (
OCC)
Most regulations can be classified in one of
three basic categories:
1. supervision, examination, deposit
insurance, chartering activity, and
product restrictions are associated with
safety and soundness
2. branching, mergers and acquisitions,
and pricing are related to an efficient and
competitive financial system
3. consumer protection.
 Depository institutions and their regulators
Type of Commercial Bank
Insured state Noninsured state Bank holding
Type of Regulation National State member
nonmember nonmember companies
Safety and Soundness
Supervision and Federal Reserve FDIC and state
Comptroller State authority Federal reserve
Examination and state authority authority
State insurance
Deposit Insurance FDIC FDIC FDIC Not applicable
or none
Federal Reserve
Chartering and Licensing OCC State authority State authority State authority
and state authority
Efficiency and Competitiveness
Federal Reserve FDIC and state Federal Reserve
Branching Comptroller State authority
and state authority authority and state authority
Federal Reserve FDIC and state Federal Reserve
Mergers and Acquisitions Comptroller State authority
and state authority authority and state authority
Federal Reserve Federal Reserve Federal Reserve
Federal Reserve
Pricing New Products and state and state and state Not applicable
and state authority
authority authority authority
Federal Reserve, Federal Reserve
Federal Reserve
Consumer Protection Federal Reserve FDIC, and state and state Not applicable
and state authority
authority authority
Supervision and Examination
… Regulators periodically examine individual banks and
provide supervisory directives
 The OCC and FDIC assess the overall quality
of a bank's condition according to the CAMELS
system:
 Capital adequacy
 Asset quality
 Management quality
 Earnings quality
 Liquidity
 Sensitivity
 Regulators assign ratings from 1 (best) to 5
(worst) for each category and an overall rating
for all features combined.
 Deposit insurance
…The Federal Deposit Insurance Corporation (FDIC)
insures the deposits of banks up to a maximum of $100,000
per account holder while almost all credit unions are insured
by the National Credit Union Share Insurance Fund
(NCUSIF), which is controlled by the NCUA.
 The FDIC was created by the Banking Act of 1933, in response to the
large number of bank failures that followed the stock market crash of
1929.
 Originally the FDIC insured deposits up to $5,000.
 Fundamentally, all newly chartered banks must obtain FDIC
insurance.
 The FDIC also acts as the primary federal regulator of state-chartered
banks that do not belong to the Federal Reserve System.
 State banks who are members of the Federal Reserve System have
that agency for their primary federal regulator.
 The FDIC also has backup examination and regulatory authority over
national and Fed-member banks.
 The FDIC is also the receiver of failed institutions.
 The FDIC declares banks and savings associations insolvent and
handles failed institutions by either liquidating them or selling the
institutions to redeem insured deposits.
Two insurance funds under the FDIC:
 The Bank Insurance Fund (BIF) for banks and
the Savings Association Fund (SAIF).
 The BIF and SAIF funds are scheduled to be
merged but this has not occurred as of mid
2002.
 The OCC and state banking authorities
officially designate banks as insolvent, but the
Federal Reserve and FDIC assist in closings.
 The Federal Reserve also serves as the federal
government's lender of last resort.
 When a bank loses funding sources, the Federal
Reserve may make a discount window loan to
support operations until a solution appears.
Federal Reserve bank regulations
Interstate Branches as a Percentage of Total Offices for FDIC-

The Riegle-Neal Interstate Banking

and Branching Efficiency Act, 1994,
mandates interstate branch banking,
superseding state banking pacts
Nonbank banks
…most large banking organizations have
established nonbank affiliates
 Edge Act corporations
 Edge Act corporations provide a full range of
banking services but, by law, deal only in
international transactions
 There are two types of Edge corporations: banks
and investment companies
 Loan production offices (LPOs)
 make commercial loans but do not accept deposits
 Consumer banks outside their home state
 Consumer banks accept deposits but make only
consumer loans
 Consumer Protection.
 State legislatures and the Federal Reserve have
implemented numerous laws and regulations to protect
the rights of individuals who try to borrow.
 Regs. AA, B, BB, C, E, M, S, Z, and DD apply
specifically to consumer regulation.
 Equal credit opportunity (Reg. B), for example, makes
it illegal for any lender to discriminate against a
borrower on the basis of race sex, marital status,
religion, age, or national origin.
 Community reinvestment prohibits redlining in which
lenders as a matter of policy do not lend in certain
geographic markets.
 Reg. Z requires disclosure of effective rates of interest,
total interest paid, the total of all payments, as well as
full disclosure as to why a customer was denied credit.
Trends in federal legislation and
regulation
 The fundamental focus of federal banking
legislation and regulation since 1970 has been
to define and ultimately expand the product
and geographic markets served by depository
institutions, and to increase competition.
 Subsequent problems with failed savings and
loans and commercial banks raised concerns
that only a few large organizations would
survive because all financial institutions would
eventually have the same powers and large
firms would drive small firms out of business.
Today, the banking and financial services
industry is evolving into a new and exciting
industry full of challenges and
opportunities.
 Smaller banks appear to have opportunities
in providing specialized products and
services.
 Larger banks have expanded their product
mix and have blurred the distinction
between a bank and a securities firm.
Key legislative and regulatory changes
have attempted to address three basic
issues

1. What is a bank?
2. Where can banks conduct business?
3. What products can banks offer and what
interest rates may be charged or paid?
 Key Legislation: 1980 - 2002
 Depository Institutions Deregulation and Monetary Control
Act of 1980
 Garn-St. Germain Depository Institutions Act of 1982
 The Tax Reform Act of 1986
 Competitive Equality Banking Act of 1987
 The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 (FIRREA)
 The Federal Deposit Insurance Corporation Improvement
Act of 1991
 Market value accounting and FASB 115
 Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994
 The 1998 Credit Union Membership Access Act
 Financial Services Modernization Act (Gramm-Leach-Bliley
Act of 1999)
 USA Patriot Act of 2001
Financial Services Modernization Act
(Gramm-Leach-Bliley Act of 1999)
 The repeal of restrictions on banks affiliating
with securities firms clearly tops the list of
provisions of Gramm-Leach-Bliley.
 The Act, however, was more comprehensive
and addressed new powers and products of
banks and the financial services industry,
functional regulation of the industry, insurance
powers, the elimination of new charters for
unitary savings and loan holding companies
and even consumer privacy protection.
 In fact, it is the privacy section of the bill that
has some of the most far reaching beyond
banking.
Bank Management,
Management 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2003 by South-Western, a division of Thomson Learning

BANK ORGANIZATION
AND REGULATION

Chapter 2