The Alphabet Soup of Bank Regulation

My parents always told me that the stock market crash of 1929 was the cause of the Great Depression. With a different perspective I have come to realize that the Stock Market Crash of 1929 was a symptom of an economic system in trouble and was not the cause of the Great Depression. The real cause of the Great Depression was the failure of the banking system in 1930 – 1931. The banking system is where the vast majority of citizens interfaces with the monetary system. If the banking system fails then citizens do not have access to money either theirs or someone else’s (that is called borrowing). It is that simple. With that in mind and given that the banking system in the US is in considerable turmoil, I thought it would be interesting to review the regulation of the banking system in the US. As a former banker I am quite familiar with the regulatory environment, but for those that do not work in the industry I think it seems confusing.

Commercial banks in the US are some of the most heavily regulated businesses in the US. For those that are not involved in the day-to-day workings of a bank it is often confusing as to how banks are regulated and who does what. In addition the press often talks about one regulatory agency as if they have all the power, while neglecting all the others as unimportant. Nothing could be further from the truth. For example, one always hears about the Federal Reserve Board (the Fed) in the press concerning banks, when in reality it is the Office of the Comptroller of the Currency (OCC) that exerts more power over the operations of the banks.

After going through the various agencies one will soon realize that the Great Depression was a watershed period for bank regulation. Up until that time only two regulatory agencies existed that still exist today, the Fed and the OCC, and they excerpted limited power over the banking system. The banking system as we know it basically came into existence during the Great Depression. This resulted from the realization that the banking system is the primary financial intermediary in which the citizens come in contact with the monetary system. Having a strong banking system is key to having a strong functioning economy.

A bank's primary federal regulators are the Federal Deposit Insurance Corporation (FDIC) the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS).

Which agencies regulate a bank is a function of the type of charter the bank has and its organizational structure. There are two types of charters: national and state. In simple terms there are two types of organizational structure: banks and savings and loans (the latter includes S& Ls and savings banks). National banks are regulated by the OCC and state chartered banks are regulated by the state regulatory agency. National S&Ls or savings banks (and some state chartered S& Ls) are regulated by the OTS.

Let us go through the various agencies to get a better idea what they do.

OCC – formed in 1863 to charter, regulate, and supervise all national banks. It also manages the federal agencies and branches of foreign banks in the US. The primary duties of the OCC is to ensure the safety and soundness of the national banking system, allows banks to offer new products, and ensures fair and equal access to financial services. The OCC monitors credit, asset quality, earnings, liquidity, computer systems, market risk, and community reinvestment of all banks under its supervision. Anyone working in banking understands that the OCC exerts more control over the day-to-day operations of a bank then any other group, but most people don’t even know they exist.

FDIC – formed in 1933 provides insurance for depositors against the inability of a bank to return a customers deposits. The insurance premiums that the FDIC charges is a function of the amount of deposits being insured and the risk of the institution purchasing the insurance. The FDIC insures the deposits of both banks and the S&Ls.

FRB – formed in 1913, is the central bank for the US. Its primary responsibilities are to control the money supply, set the rate charged for loans at the discount window, set the rate for federal funds (fed funds rate), and to regulate and monitor the reserves that a bank must hold against withdrawals (fractional reserve system).

OTS – formed in 1989 in response to the S&L crisis is the equivalent of the OCC for S&Ls.

There are a couple of laws worth mentioning that have strongly affected the banking industry over time.

The Glass-Steagall Act of 1933 not only formed the FDIC, it separated commercial and investment banks, and restricted the types of companies that a bank could own, namely securities and insurance companies. The Gramm-Leach-Bliley Act of 1999 repealed some of the provisions of the Glass-Steagall Act, specifically the prohibition of banks or their holding companies to own insurance and securities companies.

The Bank Holding Company Act of 1956 governs the type of financial and non-bank companies that a holding company may own if that holding company also owns a bank. Most banks are in fact held by a holding company. The holding company for larger businesses holds the banks, securities, and insurance companies as separate entities under the holding company. The regulation of the bank holding company falls under the responsibility of the FRB. Therefore, it is possible for the FRB to regulate the holding company and the OCC to regulate the bank held by the holding company.

The holding company distinction is important because oftentimes there may be a portion of a holding company that is not performing well. For example, say an insurance company has high losses, but the bank of the holding company may be performing very well. The holding company makes certain that a non-bank business does not torpedo a well performing bank due to bad performance of the insurance company. As the saga of a number of poorly performing holding companies continues (i.e. Citigroup) the corporate segregation under the holding company will become an important factor in their survival.