LECTURE NOTES, PART ONE:

Overview / Trends
Risk Management Overview
Operational Risk
Measuring bank profitability

How do Banks differ from non-bank firms?

a) Types of assets & liabilities

Simplified Balance Sheet:

Assets Liabilities

Rank the following by aggregate loan popularity:

Real Estate =40%

Consumer = 19%
Commercial = 29%

What makes up the largest component of the remainder of bank assets?

Treasury securities / cash / PP&E / fed reserves

What purpose do these serve?

b) Banks promote economic stability. Need for regulation to ensure industry

stability.

c) Banks differ in regard to the type of risk that affects the firms. How so?

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 I. What are Banks?

Why do we need to know what is and what is not a bank?

Not technically "banks": Credit unions (not insured by FDIC), finance companies (GE
Capital), mutual fund companies (deposits can be withdrawn upon demand), investment
banks.

Banca (it): bench - a place where transactions took place.

US Banks in the1800s: Different banks, all with their own currencies, often little
supervision, insufficient assets to back currencies, currencies not uniformly accepted as
legal tender.

BHC 1956: Banks – two tier definition… Accepts DEMAND deposits and make
COMMERCIAL loans.

(Loophole: Nonbank banks – offer no commercial loans.) Loophole closed by CEBA

(1987).

Some banks also “de-banked” by providing an optional “lag” whereby “demand

deposits” would not be available upon “demand”, and hence, did not meet the legal
definition of demand deposits.

CEBA 1987: Generalized to…Accepts deposits and makes loans. (Recent addition to
definition: firm must have been granted banking powers by state or federal government.)

2004 definition: A financial institution that is owned by stockholders, operates for a

profit & engages in lending activities

Note the trend to define banks in a more GENERAL manner, thus reflecting the increased
diversity in their lines of business.

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 II. TYPES OF BANKS (classified by markets they serve)

A) WHOLESALE vs. RETAIL Banking:

Retail: Most US Banks
Wholesale: I.e., US Trust Co.

B) Limited Purpose bank: Focus on one product (often credit for automobiles or credit
cards) Examples of some wholesale and limited purpose Banks:

LP or WH Bank Name State City Ch No. Decision Date

LP Dillard National Bank AZ Gilbert 18777 2/13/1996

LP Direct Merchants Credit Card Bank, N.A. AZ Scottsdale 22734 3/19/1996

LP Bank of America, N.A. (USA) AZ Phoenix 22106 3/9/1998

WH Wells Fargo HSBC Trade Bank, N.A. CA San Francisco 22897 1/8/1996
WH Northern Trust Bank of CA, N.A. CA Los Angeles 17751 1/15/1997
WH J. P. Morgan Trust Company, N.A. CA Los Angeles 23470 2/19/1998
California First National Bank (f/k/a Hutton National
WH CA Santa Ana 23925 4/13/2000
Bank)

WH Superior Savings of New England, N.A. CT Branford 24099 6/13/2000

WH U.S. Trust Company, N.A CT Greenwich 22413 6/6/1996

LP MBNA America Bank, N.A. DE Wilmington 22381 1/5/1996
Bank One, Delaware, N.A., (f/k/a First USA Bank,
LP DE Wilmington 17762 8/7/1997
N.A., f/k/a FCC National Bank)
LP TCM Bank, N.A. FL Tampa 23363 9/11/1997
WH Pacific National Bank FL Miami 20010 1/16/1996
Deutsche Bank Florida, N.A. f/k/a Bankers Trust
WH FL Palm Beach 17112 4/16/1996
Florida, N.A.
WH Pinebank, N.A. FL Miami 23181 12/12/1996
LP Infibank, N.A. GA Atlanta 24308 11/15/2001
LP First North American National Bank GA Kennesaw 22196 2/8/1996
LP Cedar Hill National Bank GA Lawrenceville 23323 9/11/1997
LP Belk National Bank GA Lawrenceville 23726 9/11/1998
WH Bank of China (Federal Branch) NY New York 80028 10/18/1996

C) GLOBAL, INTERNATIONAL or MONEY CENTER Banks: Serve markets

through out the world.
E.g., Citicorp, JP Morgan, Wells Fargo.

D) Correspondent banks: Banks which offer financial services to other banks

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e) Internet banks: Operation exclusively or predominantly on the internet. Some may have
ATMs or Kiosks.

III. What do Banks Do?

a) Payment (or transaction) services: Movement of funds, checking services,

electronic banking, wire transfers, credit card transactions, "making change" &
foreign currency conversion.

b) Intermediation ("inter" "med" = )

Why we do need intermediaries to channel funds from depositors to

lenders? (ie: What services do they provide in doing so?)

c) Other Services & non-bank activities:

Fee income - stand-by letters of credit for guaranteeing other party's performance
of a derivative type of contract – banker’s acceptance for international trade

Brokerage Services

Trust services

Insurance Products

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 IV. Size, Market Share, Trends

A. Facts & Figures:

Largest Bank in the World: Mizuho Financial Group (Jap) approx. 1.3 trillion in assets

Largest US Bank?_________________________
Morgan (621.7), Bank of America (574.4), Citibank (514.8), Wachovia Bank (323.8)

Why have banks lost market share since 1980?

B. Trends and Recent History

1) Double digit inflation & interest rates in the 1980s

a) S&L and Bank failures:

(long term assets with fixed rates, implicit interest on deposits, TBTF, Zombie institutions
and liquidity crises)

Statistics S&Ls numbered 4,613 in 1980 & 1,345 in 1990. Just over nine percent of
banks failed between 1980 & 1994.

b) debanking to avoid costly regulations (esp. Reg Q)

2) Securitization (a.k.a. securitisation) techniques used for transforming illiquid

sources of cash flow into tradable securities – i.e., sell off loans. Illiquid Sources of Cash
Flow may include Home Loans (Mortgages), Credit Card Accounts, Car Loans,
Consumer Loans, Corporate Bank Loans, Illiquid Bonds, Aircraft Leases, and many more
asset and receivable types

CLO: Collateralized Loan Obligations

CDO (CBO): Collateralized debt (or bond) obligations: Bonds (or debt) backed by
given assets (such as a portfolio of loans)

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Special Purpose Vehicle company (SPV): Company set up solely to buy the assets used
to back the CLO or CDOs. The company issues securities to fund the purchase of the
assets. The assets are then removed from the bank’s balance sheet.

It is more usual that the SPV issues several tranches of investment, each of which has a
different claim on the cash flows that come into the SPV. Usually there is a hierarchy
where some classes have access to the cash before others.
The 'Senior Classes' have first claim on the cash that the SPV receives, the more junior
classes only start receiving repayment after the more senior classes have repaid. Because
of the cascade effect, these arrangements are often referred to as a cash flow waterfall.
There are usually three different waterfalls in these types of transaction, with different
groups of investors having different rights:
Revenue distribution during the normal life of the securities, i.e. when there has been no
default in the underlying asset *portfolio
• Scheduled principal repayment
• Distribution of funds after a default
This means that each class of investor has a different 'payment risk' and will therefore
receive a different return.
• The most junior class (often called the 'equity class')
is the most exposed to payment risk.
In some cases, this is a special type of instrument which is retained by the originator as a
potential profit flow. In the extreme version, the equity class receives no coupon (either
fixed or floating), just the residual cash flow (if any) after all the other classes have been
paid. There may also be one other special class which will absorb early repayments in the
underlying assets. This is often the case where the underlying assets are mortgages
which, in essence, are repaid every time the property is sold. Since any early repayment is
passed on to this class, it means the other investors have a more predictable cash flow.
(Source: Wikipedia.org. For more info, see http://en.wikipedia.org/wiki/Credit_derivative )

credit tranches, By setting a subordinated tranche or subordinating one risk-taker's

position to another, an issuer can create various cascading credit qualities within one
single type of risk. E.G.,
o Tranche A absorbs the first 25% of losses on the portfolio
o Tranche B absorbs the next 25% of losses
o Tranche C the next 25%

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 o Tranche D the final 25%
• Tranches B, C and D are sold to outside investors
• Tranche A is bought by bank itself

What do collateralized loans have in common?

Why are loans securitized?

3) Consolidation of the banking industry (fewer small banks - banks are larger on
average)

What term describes an industry whereby larger firms are more profitable (or more cost-
efficient?)

ECONOMIES OF …(choose one) SCOPE or SCALE ?

How is this measured?

Why the trend to consolidation now?

4) Globalization of the Banking industry

Why the trend toward Globalization?

Does globalization increase or decrease the risks within the banking industry? [Could it
potentially have either effect?]

5) Direct Finance (vs. Intermediated Transaction)

Commercial Paper (what is this) is cheaper than bank borrowings.

What kinds of firms issue commercial paper? Larger firms or smaller firms?

Exg: prime rate = 8.25% in 1999 vs. 5.98% for commercial paper.

Do the most credit-worthy of borrowers pay the prime rate?

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6) Deregulation

What has been deregulated?

a) Types of products

b) Geographic Location

c) Rates paid on deposits

Does it make sense to "deregulate" in response to numerous bank failures?

Did the regulations promote stability or instability?

What is still regulated (if anything)?

Are there any regulations that been strengthened in the recent past?

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 V. Bank Risk Management (the short version)
Risk: From the Latin, risicum, meaning “barrier reef”

Overall objective:
Ensure outcomes of risk-taking activities are within the company’s risk tolerance
Ensure there is an appropriate balance between risk & reward to max stock price.

Enterprise Risk Management (ERM) (a.k.a. integrated risk management, enterprise-wide risk
management, holistic risk management, global risk management.): The process of assessing
and addressing an organization’s risk from all sources, from those that threaten the achievement
of strategic goals to those representing opportunities for achievement

A. Credit Risk:

Managed through credit derivatives

CLO (Collateralized loan obligations / tranches)

B. Interest Rate Risk: (balance sheet example)

C. Liquidity Risk

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D. Price Risk

E. Foreign Exchange Risk

F. Strategic Risk (AKA. operational risk)

{AllFirst Article Discussion}

Causes:

Inadequate segregation of duties.

Insufficient training
Lack of management supervision
Inadequate auditing procedures
(example: Trading in markets that are open when bank is closed.)
Inadequate security measures

Events:

Internal Fraud
External Fraud
Employment Practices / workplace safety (theft / disaster)
Damage to physical assets
Banks in major cities / hurricane / earthquake or areas of other natural disasters
Need for contingency plans
Business disruption & System failures
Execution, Delivery & Process management

Consequences:

Legal liability
Regulatory, compliance and penalties
Loss / damage to assets
Restitution
Write-downs

Can lead to reputation loss

Business interruption

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Lessons from Storms: Katrina and Rita’s impact
214 financial institutions affected (100 by Katrina, 87 by Rita, 27 by both)
30 institutions w/ $6 B in assets significantly affected by these hurricanes

Problems:
ATMs flooded
Roads closed
Fuel shortages
Confiscation of supplies by FEMA (including gas to run generators & generators)

Typical institution responses:

• expeditious check-cashing services
• waiver of (late) fees
• suspension on interest on credit accounts
• extension of grace periods
• expedited increases in credit lines
• automatic forbearances in affected areas

What worked:

* Deployment of cash from FED to affected areas. (Why was this necessary?)
• Financial institution cooperation (shared facilities)
• Most banks worried about fraud later

What didn’t work:

• FEMA debit card program
• Coordination with charities
• Communications systems
• Energy / Power (generators sometimes confiscated by FEMA)
• Some loss of public confidence
Lessons:
• The disaster you plan for is not the one you get – but plan anyway
• Mobile ATMs are important
• Telecommunications are a priority (Satellite phones)
• Value of regional coalitions

G. Compliance Risk

G.1 Capital Adequacy Risk

General idea: Loan loss reserve covers expected losses. Capital (equity) covers unexpected losses
(99% of time, capital should be sufficient to cover these.)

Risk-based capital regulations:

Basel I
Basel IA
Basel II

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Basel II: Allow banks to assess their own capital requirements based on sophisticated means of
measuring / managing risk. However, capital can’t be less than 95% of what it was under old
Basel requirements. (This percentage is reduced, over time).

(Relevant for largest 10 banks…optional for others)

“The Basel Committee has expressly designed the New Accord to provide tangible
economic incentives for banks to adopt increasingly sophisticated risk management
practices”
- William J. McDonough (former chair of the Basel Committee and Pres and CEO of the FRB in
NY.)

Problem: How do the regulators assess “increasingly sophisticated risk management practices?

Conflict:
Regulators want high capital to protect depositors (deposit insurance fund…equity is like the
“deductible” of deposit insurance)
Bankers want low capital, because leverage increases ROE.

G.2 Other Regulatory Risks

H. Reputation Risk:

Agency-Recognized Risks differ by Regulatory Agency

FRB: Credit, Market, Liquidity, Operational, Legal & Reputation

OCC: Credit, Interest Rate, Liquidity, Transaction, Price, Reputation, Compliance, Strategic,
Foreign Exchange
FDIC: Credit, Market, Liquidity, Operational, Legal, Settlement, Interconnection
[Insider joke: FDIC = forever demanding increased capital.]

Major Bank & Investment Bank losses:

Barings Bank – 1.5B

Daiwa Bank – 1.1B
Long Term Capital Management Hedge Fund – 4.5B (“When Genius Failed”)
Allfirst Bank – 691 M (2002: Rogue trader (Rusnak), hid currency option losses by claiming to
trade on markets where trade could be verified only when bank was closed. Bullied employees so
they never verified his work. Exceeded trade limits. Forged paperwork to confirm profitable
activity. His compensation package tied his pay heavily to his trade profits.)

Enron – 30+ lost value / lenders

Mutual Fund Losses
Bank of America/Fleet – 675M
Alliance Capital – 600M
Sun Life – 225 M
Putnam Investments – 110M

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 Chapter 2

The Dual Banking System: Banks can choose a national or a state bank charter. State-
chartered banks can elect to be members of the Fed.

Regulatory Authority: What can regulators do if a bank is not in compliance with

regulations?

A. Memorandum of understanding: Outlines needed changes

B. Cease and desist order: Prohibit bank (or person) from continuing a particular
course of action
C. Bank Closure

CAMEL(S) - system of rating banks by risk category.

C: Capital Adequacy
A: Asset Quality - How "overdue" must a loan be to be removed from the balance sheet?
• open ended loans: 180 days past due
• closed-ended loans: 120 days past due

M: Management (including board of directors)

E: Earnings: Profitability of the bank, taking risk into account
L: Liquidity
S: Sensitivity to market risk

Scale 1 to 5, 1=Best, 5=Worst

Regulatory Patterns:

A) Proposal & enactment of regulation.

B) Attempts by banks to avoid regulation they find restrict profits.
C) Adjustment of regulation in response to avoidance. (Go to B, unless regulation is
eliminated)

A.K.A. Regulation, Regulatory Avoidance, Re-regulation/Deregulation.

Question: Why is it important to maintain safety within the banking industry? Aren’t
regulated industries less (cost) efficient? Note that even the airline industry has been
largely deregulated.

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Question: What problems does the consolidation of the financial services industry create
for regulators?

Question: What steps do you believe are most important in maintaining the safety of the
banking industry? Why?

Question: What are the problems in regulating "Virtual Banks" – i.e., those banks run on
a computer network. These may have scattered operations, internet operations, or work
on a satellite network. Should such an institution be regulated?

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 Chapter 3: Measuring Bank Performance

Bank Balance Sheet:

Assets:

Cash assets
Interest-bearing bank balances
Fed funds sold:

US Treasury & Agency securities

Municipal securities
All other securities
Net loans & leases
Real estate
Commercial
Individual
Agricultural
Other loans & leases
Less (Reserve for loan and lease losses)

Premises, Fixed assets and capitalized leases

Other real estate

Liabilities & Net Worth:

Demand deposits
NOW and ATS Accounts
MMDA accounts
Other savings deposits
Time < 100 K (book incorrectly lists as 100 M)
Time deposits > 100K (CDs > 100,000 - secondary market)

Fed funds purchased

Other borrowings
Banker's Acceptance
Subordinated notes and debentures

Common & preferred equity

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 Income Statement:
Revenue & Expenses:
Interest & fees on loans
Income from lease
TOTAL INCOME ON LOANS & LEASES

US Treasury & Agency income

Municipal income (tax exempt)
Other security Income
INVESTMENT INTEREST INCOME

Interest fed funds sold

Interest due from banks

TOTAL INTEREST INCOME

Interest on CDs > 100K

Interest on other deposits
Interest on Fed funds and repos
Interest on borrowed money
Interest on mortgages and leases
Interest on subordinated debt & notes

TOTAL INTEREST EXPENSE

Net Interest Income (Interest income - Interest expense)

Non-interest Income

Adjusted Operating Income (Net interest income + non-interest income)

-Overhead expense
-Provision for loan & lease losses
=Pretax operating income

+ Security gains(losses)
= Pretax net operating income

- Income Taxes

= Net Operating Income

- Net extraordinary items

= Net Income

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Analyzing Bank Performance:The ROE Decomposition Model

Purpose of the model:

ROE = ROA x Equity Multiplier

Equity Multiplier = Total Assets / Total Equity

Equity Multiplier measures:

ROA = Net Income / Total Assets =

Profit Margin x Asset Utilization Ratio =

(Net Income/Operating Revenue = PM)

x (Operating Revenue/Total assets = AU) =

Profit Margin Measures:

If PM is substandard, examine…

Asset Utilization Measures:

If AU is substandard, examine….

Query: Is it easy to improve the PM without affecting the AU? Similarly, is it easy to
improve the AU without adversely affecting the PM? Explain.

Other Ratios:

Net Interest Margin =

Net Interest Income / Average earning assets

Note: Interest income must be expressed in tax-equivalent form. For tax exempts, the tax
equivalent yield = i/(1-t)
Where i=tax exempt interest ($)

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Harmonization: Uniform international banking regulations

Capitalization Ratios: What does this refer to?

Equity Multiplier

Ratio Must be
{Tier I capital}/Risk-weighted assets > 4%

{Tier I + Tier 2 Capital} / Risk weighted assets > 8%

Tier I capital / Total Assets > 3%

Risk weighted assets only include a given proportion of assets.

Multiply weight by $ Book value of asset, and sum over all assets, to get risk-weighted
assets. Note cash and some gov't securities get a weight of "0". In other words, they're not
counted in risk-weighted assets.

Mortgage backed securities, security claims on gov't agencies get weights of 20%,
Mortgages with 80% loan to value ratio get 50% weight, and commercial loans get
weights of 100%

Tier I capital:
Common equity, ret. Earnings, non-cumulative preferred.

Tier II capital:
Allowance for loan & lease losses, other preferred, subordinated debt.

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Asset Quality Ratios:
Provision for loan loss ratio: PLL/Total loans & leases

Measures: Exposure to credit risk

Charge-offs: loans which are deemed to be uncollectable

Reserve for loan losses(RLL) (time=1) =

RLL (time=0)
- gross charge offs
+ PLL
+ Recoveries

Management may set a minimum RLL, so the more charge-offs, the more likely the
management may boost PLL to maintain their desired RLL

* Other capitalization ratios may examine charge offs or recoveries measured relative to
loans & leases.

Operating Efficiency Ratios

• Examine specific expenses as either a percentage of total operating expenses or as a

percentage of Adjusted Operating Income (See ratios that affect the profit margin)

Liquidity Ratios

1) Government securities/Assets

2) Temporary Investments ratio:

The numerator defines "temporary investments"

[Fed Funds sold + < 1-yr investments + Due from banks]
Total assets

A [high / low] value indicates high liquidity (a.k.a. low liq risk)?

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• Volatile Liability Dependence: Measures extent to which riskiest assets are funded
by most unstable liabilities.

[Total volatile Liabilities - Temporary Investments]

Net Loans & leases

Volatile liabilities are "hot" or "unstable" funds that can disappear from a bank,
overnight. These include brokered deposits, jumbo CDs, deposits in foreign offices, fed
funds purchased, other uninsured borrowings. "Brokered" deposits are a typical last resort
for sources of funds.

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 Chapter 4: Bank Valuation

Which of the following are valid firm objectives? Consider each separately.

Minimize risk

Maximize profits

Maximize dividends

Maximize stock price

Maximize shareholder wealth

P-E Ratios: What do they tell us?

Price / EPS = P-E

Can these ratios be negative? What does this imply?

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 A synopsis of Bank M&A activity

What is the difference between a merger and an acquisition?

Statistic: 1985 to1995, financial services M&As accounted for 44% of global M&A
activity.

Who are the winners & losers in bank m&a?

Target s/hs: Gain 11.5% (+ 5.76% for cash transactions)

Bidder s/hs: Lose 1-2%. Losses greater when the bidder & target bank were similar in
size.

Why do bidders bid when, on average, their s/h's lose?

Long run profit potential?

• Hubris
• Winner's curse
• Make firm larger (or more diverse)?

Note: Increase in size (scale) and diversity of activities (scope) has been occurring
simultaneously in the banking industry. Why?

• CEOs of more diverse firms enhance reputation

• Due to uncertainty in the industry, increasing size and scope may be necessary to
reduce risk.

Could mega-mergers (and international mega-mergers) result in a re-instatement of

TBTF?

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Supplement #1

The Underinvestment Problem

ASSETS LIAB + EQ

Cash 500 DEPOSITS (gov’t insured) 9,000

LOANS 3,000 Equity 0+
T-bills 4,000 9,000+
PP&E 500
TOTAL 8,000

The firm has THE FOLLOWING project available to them:

50% chance to increase assets by $2000

50% chance to increase assets by $1500

Cost of project = 1000 (to be obtained from an equity issue

NPV = .5 x [2000-1000] + {.5 x (1500-1000)} = 500+250 = 750

E[EQ] =
50% chance:
ASSETS LIAB + EQ

Cash 500 DEPOSITS (gov’t insured) 9,000

Project = Equity
LOANS 3,000
T-bills 4,000
PP&E 500
TOTAL

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 50% chance:
ASSETS LIAB + EQ

Cash 500 DEPOSITS (gov’t insured) 9,000

Project = Equity
LOANS 3,000
T-bills 4,000
PP&E 500
TOTAL

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Supplement #2: Asset Substitution

QUESTION: When are NEGATIVE NPV projects acceptable to shareholders?

ANSW: When they increases the value of their equity.

EXG:

Assets Liabilities + Equity

3,000 Cash 9500 Debt (uninsured)

7,000 Other assets 500 Equity

10,000 Total 10,000 Total

The firm is considering a project, which they would finance using $3000 from cash. The project would
increase the value of the assets to $18,000 (with 20% likelihood) or decrease the value of the assets to
$7000 (with 80% likelihood).

NPV of project = (.2 x 8000) + .8 x -3000 = 1600 + (-2400) = -800

Upside of project (likelihood = 20%)

Assets Liabilities + Equity

18,000 9500 Debt (uninsured)

8500 Equity

18,000 Total 18,000 Total

Assets Liabilities + Equity

7,000 7000 Debt (uninsured)

0+ Equity

7,000 Total 7,000 Total

E[EQ] = .2 x 8,500 + (.8 x 0+) = 1,700

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Supplement #3 Double Leverage

Double Leverage Example:

How to run a bank with fewer shareholder-contributed dollars & meet regulatory requirements:

Current Law: Required equity/assets is a function of the risk of the assets. Does this make sense? Why?

BHC Balance Sheet – owns 100% of bank sub shares

Assets Liabilities + Equity

10,000 Shares of bank stock 5000 Bonds
5000 HC equity (stock)

Bank Subsidiary Balance Sheet

Assets Liabilities + Equity

100,000 90,000 deposits

10,000 bank sub. equity

What is the equity/assets ratio of the BHC?

What is the equity/assets ratio of the bank?

What is the ratio of original shareholder contributed equity/assets of the bank?

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Supplement #4 – Relatively Recent Bank Regulations
Important Banking Acts since 1980:
1) Deposit Institutions Deregulation & Monetary Control Act (1980)

• Standardized some regulations with respect to ALL types of depository

institutions
1. Reserve Reqmts at Fed
2. Fed check clearing services (for a fee to all depository
institutions).

• Phase-out of Reg Q (as of 3/86) – authorized NOW Accounts

• Raised limit of deposit insurance to $100K per person (200K for joint accounts),
per bank.

2) Garn-St, Germain Dep Inst Act (1982)

• Authority to acquired failed banks/S&Ls based on priority with respect to

location (priority given to firms in same state acquiring same type of institution;
lowest priority given to firms in a different state trying to acquire a different type
of institution.)

3) Financial Institutions Reform, Recovers and Enforcement Act (1989)

• Act tried to reduce the bank and S&L failures

• Renaming/redistricting of regulatory agencies
• Increased capital requirements – absolute min equity/assets = 3% for all banks no
matter how risky their assets, but each bank’s min equity ratio differs depending
on the risk of their assets (mostly default risk).
• Limits on amount lent to single borrower / limits on extent of commercial real
estate lending
• Source of strength doctrine for BHCs – healthy bank subsidiaries must be used to
support failing ones. Can’t let one subsidiary fail, and continue with others

4) FDIC Improvement ACT (1991)

• End of too big to fail policy
• Expanded power to regulators to close failed or failing banks/thrifts

5) Riegle-Neal Interstate Banking and Efficiency Act (1994)

• By 1997, most restrictions on interstate banking eliminated. Led to wave of

M&As.

6) Fin. Services Modernization Act of 1999

• Ended prohibition of the combination of investment banking / commercial

banking within a given firm (or BHC).

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7) Sarbanes-Oxley (2002)

• External audit restrictions, independent board

• Financial statement certification by CEO/CFO
• Material off-balance sheet transactions must be disclosed in fin stmts
• Internal control attestation
• Financial expert member of audit committee

8) Corporate “Best Practices”

• Hire & promote knowledgeable & honest management team

• Separate individual’s personal interests from institution’s best interests
• Provide independent reviews
• Avoid preferential transactions involving insiders
• Apply financial transparency
• Design deliberate & controlled decision-making process

9) Basel II (2006/2007)
Overview:
Credit Risk (Bank supplies inputs, goes into regulatory model)
Market risk (VAR: Value at risk): internal measure
Operational Risk (internal models)

Fundamental Objectives:
Encourage disciplined risk management
Better assessment of capital charges in relation to underlying risk
Potential ability to leverage further, with better risk management

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