Finance 4000

Money and Capital Markets

Eleventh class

• Administrative matters

  
  
  
  
  

  • The website is http://www.DwyerEcon.com

    
    
    

    • capital letters are for clarity

      
      
      
      
      

  • The final is May 7

    
    
    
    
    

  • Material for the rest of the semester

    
    
    
    
    

    • today 4/13/99 Chapters 15 and 16
    • 4/20/99 Chapters 20 and 21
    • 4/27/99 Chapter 22

      
      
      
      
      

    • We are skipping chapters 17, 18 and 19

• Thrifts

  
  
  

  • Savings and loan associations

    
    
    

  • Mutual savings banks

    
    
    

  • Credit unions

    
    
    

  • All are special-purpose banks

    
    
    

  • Not special-purpose commercial banks

• Savings and loan associations and Mutual savings banks

  
  
  

  • Savings and loan associations

    
    
    

    • Federal government charters

      
      
      

  • Mutual savings banks

    
    
    

    • State government charters in the Northeast

      
      
      

    • Similar institutions exist in many other states

      
      
      

      • Building societies

        
        
        

      • Building and loan associations

        
        
        

  • Historically had savings accounts and certificates of deposit

    
    
    

  • Historically made and held mortgage loans

    
    
    

  • Often mutual associations

    
    
    

  • Deposit insurance by some entity or other after 1934
• Credit unions

  
  
  

  • Originally for people with employment who had difficulty borrowing from commercial banks or setting up checking accounts

    
    
    

    • Credit unions started in the early 1900s when most people had no connection with banks

      
      
      

    • Credit unions were not started because commercial banks exist to serve commerce, not the working class, because that is where the profits are (Mishkin and Eakins, p. 390)

      
      
      

    • Why would banks not want to go into the business of dealing with typical workers in the early 1900s?

      
      
      

  • Characteristics

    
    
    

    • Mutual associations

      
      
      

    • Nonprofit

      
      
      

    • Common bond

      
      
      

    • Historically, employer related

      
      
      

    • Historically, volunteer labor
  • Advantages and disadvantages compared to banks

    
    
    

    • Advantages

      
      
      

      • Often work closely with employer, which makes loss less likely

        
        
        

      • Liable to know the borrower personally

        
        
        

      • Nonprofit

        
        
        

      • Can have lower costs due to volunteer labor

        
        
        

    • Disadvantages

      
      
      

      • Lack of diversification of depositors and borrowers

        
        
        

      • Can have less professional labor

        
        
        

      • Diseconomies of scale

        
        
        

        • Can be overcome partly by having several common bonds for one credit union

          
          
          

        • Also by joint purchasing -- trade associations

          
          
          

• Why are Banks Regulated?

  
  
  

  • Standard economic rationales for regulation -- "Consumer protection"

    
    
    

    • Externalities

      
      
      

    • Public goods

      
      
      

  • Additional or alternative rationale

    
    
    

    • Regulation may be designed to protect consumers rather than consumers

      
      
      

    • "Producer protection" rather than "consumer protection"

      
      
      

    • Increase profits of producers (banks) by

      
      
      

      • Restricting entry by others

        
        
        

      • Suppressing substitutes and promoting complements

        
        
        

      • Providing subsidies

• What are the regulations that apply to banking?

  
  
  

  • Entry

    
    
    

  • Branching

    
    
    

    • Types of branching

      
      
      

      • Unit banking
      • Limited-branch banking
      • Statewide branch banking
      • Nationwide branch banking
        • without restrictions
        • or with restrictions

          
          
          

    • National legal framework

      
      
      

      • McFadden Act of 1927
      • Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994

        
        
        

  • Federal Reserve System as lender of last resort

    
    
    

  • Deposit insurance

    
    
    

  • Supervision and regulation

    
    
    

  • Community Reinvestment Act

    
    
    
    
    
    
    

• Consumer protection explanations of regulation

  
  
  

  • Lender of last resort and Deposit insurance

    
    
    

    • due to banking panics which have external effects

      
      
      

      • adverse effects on the economy

        
        
        

      • possible externality in banking panics themselves

        
        
        

  • Supervision and regulation

    
    
    

    • Prevent fraud

      
      
      

    • Prevent opportunistic, risky behavior given deposit insurance

      
      
      

      • Use regulation rather than prices to induce optimal risk-taking behavior

        
        
        

      • Implicitly taking improper pricing for deposit insurance as given

        
        
        

• • Entry

    
    
    

    • Given deposit insurance and its pricing, prevent entry by those who would be more expensive to regulate

• • • • That is, those who would engage in riskier activities

        
        
        

  • Branching

    
    
    

    • Empirical evidence indicates that branching restrictions are loosened when banking failures occur and new entry is not that likely

      
      
      

    • This indicates that branching restrictions are changed in response to costs imposed on consumers

      
      
      

  • Community Reinvestment Act

    
    
    

    • Banks invest less than the optimal amount in some areas because of a lack of information

      
      
      

    • Regulation can induce them to provide more loans in these areas

      
      
      
      
      
      
      
      
      
      
      
      
      

• Producer Protection explanation of regulation

  
  
  
  
  

  • Entry restriction

    
    
    

    • Reduce competition

      
      
      
      
      

  • Branching restriction

    
    
    

    • Reduce competition

      
      
      

      • Some transfer from larger to smaller institutions

• • Lender of last resort and Deposit insurance

    
    
    

    • As exist today, subsidies to banks

      
      
      

      • Possibly some transfer from smaller to larger banks

        
        
        

      • Too big to fail

        
        
        

      • prompt, corrective action

        
        
        

    • Banks can fail in banking panics

      
      
      

      • Banks are better off if they don't fail under such circumstances

        
        
        

  • Supervision and regulation

    
    
    

    • Auditing services

      
      
      

  • Community Reinvestment Act

    
    
    

    • A transfer of some of the banks' economic rents to people outside the industry

      
      
      

    • A payoff in exchange for the regulation