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Course BUSI1459: Fdn Scholarship/Research Course School/Level BU/PG

Coursework Topic/Subject Review Assessment Weight 100.00%
Tutor EJ Lethbridge Submission Deadline 14/04/2010

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000583525 Ngoc Nguyen

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1. Introduction

Financial intermediaries have the vital function of transmitting funds from

households, organizations, governments that have surplus budgets to those who are
being in deficit of funds because they want to spend more than their income. In other
words, it is important for every national economy to promote the role of financial
intermediaries in order to produce distribution of capital effectively and contribute to
more successful production and effectiveness for the overall economy of each country.
Structure of the financial system as well as financial intermediaries differs across
countries but one key fact emerges: banks are a fundamental component of the
financial system and are also active participators in financial markets. Many studies
asserted the link between the banking and financial system and economic
development. Therefore, the management and administration of an effective banking
industry is an extremely important objective for each country. This paper will take a
comprehensive look at the control of the United States (the US) banking system
because the US banking system plays a highly important role not only to the US
economy, but also to the global economy. Undeniably, the activities of the US
banking system can influence and have strong impact on the global economy. The
financial crisis 2007 – present can be considered a typical example. Therefore, all
countries focus much of their attention on the US economy because In addition, the
structure of the US banking system has many special characteristics that are different
from other central banks all over the world. The goal of this paper is to provide an
overview with regard to features, classification, structure, and regulation as well as
control of the US banking system.

2. Overview of the US banking system

2.1. The nature

As mentioned above, the characteristics of the US banking system are very different
from that of other countries. At the first sight, the number of banking institutions in
the US is very large. Though in recent years, the number of banks has reduced
considerably, mostly through mergers and acquisitions, it still remained a total of
6,893 commercial banks at the end of December 2009, down from 7,283 at the end of
2007(Federal Deposit Insurance Corporation, 2009). Secondly, there are sets of law
that limit the extent of the US banks as well as restriction that on banks’ capability to
broaden their operation from their home state s to other states within the country. This
is one of the most important reasons why from 1960s onward, some major banks from
New York – financial centre of the US- decide to start their branches overseas. These
branches played an important role in the growth of the Eurocurrency market. Thirdly,
banks in the US can be chartered either by state or federal which is “a dual banking
system”. With the passage of the National Banking Act of 1863, banks in the US
which are chartered by federal government are known as “national banks”,
simultaneously, they are members of the Federal Reserve System (the FED); while
banks chartered by state government are known as “state banks” that can be members
of the FED or not. Fourthly, because many significant events occurred in the 20th
century, there were other restrictions on the operation of banks. The Glass – Steagall
Act of 1933, which drew a very clear distinction between investment banks and
commercial banks, could be one of the most significant laws. However, this act was
revoked in 1999, from then on; commercial banks were authorized to undertake some
activities of investment banks. Finally, the most special feature of the US banking
system is its central bank. The central bank was not established until the Federal
Reserve Act of 1913. In 1971 and 1816, Congress had tried to establish a central bank.
But members of Congress thought that a central bank not only became too powerful
but also did not benefit the general population, so that they just tried to charter a
central bank only to supervise the charters expire. Yet in 1913, after 50 years of the
National Banking Act of 1863, realizing the necessity of a fundamental reform of the
nation’s banking system, the central bank was founded. It was not a single institution
but a system of 12 Federal Reserve Banks overseen by a Board in Washington DC.

2.2. The Classification

The US depository institutions (referring to the banks) are financial intermediaries that
accept deposit from individuals, organizations, and institutions and make loans. These
institutions include commercial banks; thrift institutions: saving and loans
associations, saving banks; and credit unions. Table 1 provides a discussion of the
depository institutions that fit into these categories by describing their primary
liabilities (source of funds) and assets (uses of funds).
Table 1: Primary Assets and Liabilities of Depository Institutions

Type of Depository Primary Liabilities Primary Assets

Institutions (source of funds) (use of funds)
Business and consumer loans,
Commercial Banks Deposits mortgages, US government
securities and municipal bonds.
Thrift institutions:
- Saving and loans
Deposits Mortgages
- Saving banks
Credit unions Deposits Consumer loans
(Source: Federal Reserve Flow of Funds Accounts:

 Commercial banks obtain funds chiefly by issuing checkable deposits (deposits

on which checks can be written), saving deposits (deposits that are payable on demand
but do not allow their owner to write checks), and time deposits (deposits with fixed-
term to maturity). These funds then are used to make a variety of financial activities
including: commercial, consumer and mortgage loans, buying US government
securities and municipal bonds and so on. In brief, commercial banks are largest
financial intermediary and have the most diversified portfolios of assets.
 Thrifts consist of savings & loan associations (S&Ls) and saving banks. These
depository institutions, of which there are 1,173, also raise funds mainly through
saving deposits, time deposits and checkable deposits. However, the term of thrifts’
assets and liabilities is longer than that of commercial banks. In the past, these
institutions were constrained in their activities and mostly made mortgage loans for
residential housing. Overtime, these restrictions have been loosened so that the
distinction between thrifts and commercial banks has blurred. These intermediaries
have become more alike and are now more competitive with each other.
 Credit unions: this sector is considerably small in relation to other depository
institutions. Numbering about 7,950, they are typically cooperative financial
institutions chartered by the federal government and owned by their members. Federal
credit unions provide provident means for their members with a safe place to save and
a reasonable rate on loans. With such functions, credit unions also contribute to
maintaining the stability of the national credit structure. Surplus income is returned to
members in the form of dividends.

3. The regulation of the US banking system

The banking system is given as one of the most important sectors in the US economy
and therefore, it is subject to more regulation and governmental supervision in
comparison with other sectors in the financial market. Regulators take responsibility
for chartering, oversight, and examining operations of banks. This section describes
the principal agencies that are responsible for regulating commercial banks (national
and state-chartered banks), thrifts, and credit unions. Table 2 indicates the key
regulatory agencies of the US banking system which will be discussed thorough in the

Table 2: Principal Regulatory agencies of the US banking system

(Arranged in chronological order)

Regulatory Agency Historical legislation of Subject of Regulation

The Office of the The National Currency Act -Federally chartered
Comptroller of the of 1863 and National commercial banks
Currency (the OCC) Banking Act of 1864 -Foreign banks
The Federal Reserve The Federal Reserve Act All depository institutions
System (the FED) of 1913
The Federal Deposit The National Banking Act All FDIC-insured
Insurance Corporation (the of 1933 commercial banks and
FDIC) thrift institutions
The National Credit Union 1970 Federally chartered credit
Administration (the unions
The Office of Thrift 1989 All thrift institutions
Supervision (the OTS)

3.1. The Office of the Comptroller of the Currency (the OCC)

The passage of the National Currency Act of 1863 and National Banking Act of 1864
established a new system of national banks and a new government agency: the OCC.
The OCC was founded in 1863 as a Bureau of the US Department of the Treasury. It
was the first federal organizational agency in US history that was created to regulate
financial institutions. The OCC has missions of chartering, regulating, and supervising
all national banks and examining the books as well as operations of them. It also
supervises the federal branches and issues charters to foreign banks wishing to operate
US branches as national banks. The OCC now supervise more than 1500 federally
chartered commercial banks and about 50 federal branches and agencies of foreign
banks in the UK, comprising nearly two – thirds of the assets of the commercial
banking system.

In regulating national banks, the OCC has power to:

- Examine and report on banks operations and financial conditions.

- Approve or deny application for new charters, branches, capital or other
changes in corporate or banking structure.
- Take supervisory actions against banks that do not comply with laws and
regulations or that otherwise engage in unsound banking practice. The agency
can remove offices and directors, negotiate agreements to change banking
practices, and issues cease or desist order as well as civil money penalties.
- Issue rules, regulation and interpretations on governing banks investments,
lending and other practices.
3.2. The Federal Reserve System (the FED)

Of all the central banks in the words, the Federal Reserve System, also known as the
FED, probably is the most important central bank in the world. It was established by
the Federal Reserve Act of 1913. The FED is an independent organization, responsible
only to the US Congress and have a duty to report to the Committee of Financial
services, the House of Representatives. The FED has intimate and extensive
relationships not only with other central banks but also international financial
regulators and market participants. These relationships make it possible for the FED to
collaborate its performances with those of other nations in order to manage
international finance. As the US central bank, in general, the FED has supervisory and
regulatory authority over a wide range of financial institutions and activities. Other
federal and state supervisory authorities have mission to work with the FED to ensure
the safety and soundness of financial institutions, stability in the financial markets,
and fair and equitable treatment of consumers in their financial transactions.

The Federal Reserve has responsibility for supervising and regulating the following
segments of the banking industry to ensure safe and sound banking practices and
compliance with banking laws:

- Bank holding companies, including diversified financial holding companies

formed under the Gramm-Leach-Bliley Act of 1999 and foreign banks with
US operations.
- State-chartered banks that are members of the Federal Reserve System (state
member banks).
- Foreign branches of member banks.
- Edge and agreement corporations, through which US banking organizations
may conduct international banking activities.
- US state-licensed branches, agencies, and representative office of foreign
- Nonbanking activities of foreign banks
(Source: )
In comparison with other central banks all over the world, the FED probably has the
most unusual structure. The FED framework is designed to have a comprehensive
viewpoint of the US economy and all economic activities. This primary mission has
led to the composition of the FED, including the following units: the Federal Reserve
Banks; the Board of Governors; the Federal Open Market Committee (the FOMC); the
Member Banks; the Advisory Council.

 The Federal Reserve Banks

The Federal Reserve Banks was considered as tools of operations for the US central
banking system. For the purpose of carrying out these timely operations of the FED,
the nation has been subsided into twelve Federal Reserve Districts with Banks in New
York, Philadelphia, Boston, Richmond, Chicago, Atlanta, Cleveland, Kansas City,
Minneapolis, St. Louis, Dallas, and San Francisco. Twenty-five branches of these
banks serve particular areas within each district.

The Federal Reserve Banks offer depository institutions and the government many
financial services, so that they are regarded as Banker’s bank. Main activities of the 12
Federal Reserve Banks include:

- Collecting and processing millions of check among banks in particular district

each day
- Maintaining reserve requirements of depository institutions and making loans
to them
- Issuing new currency and regulating the currency in circulation
- Supervising and examining bank holding companies and state chartered
member banks to insure safety and soundness of the banking system.

The Federal Reserve Banks also conduct buying and selling governmental securities
in order to finance government expenditure. In addition, they organize researches and
monitor regularly general economic situation of their areas. These reserve banks also
involve in the setting of monetary policy which is the primary duty of the FED.

 The Board of Governors

The Board of Governors is the headquarters of the FED and allocated in Washington,
DC. It consists of seven governors appointed by the President and approved by the
Congress. The governors serve 14 years and maybe reappointed by if the first term is
not a full term. The terms overlap to maintain continuity and it take two years on
average to make reappointments each time. Chairman and vice chairman have four
year term selected in the seven members. Current chairman is Ben Bernanke, who
succeeded Alan Greenspan from 01/01/2006.
General duties of the Governors are proposing monetary policy, research and analysis
of economic data and financial domestics as well as worldwide. Simultaneously, the
Board of Governors monitor all financial services, set some rules to ensure the public
interest and check payment systems in the US.

All seven governors are members of the Federal Open Market Committee (the FOMC)
which have only 12 voting members. Therefore, the most important task or the
governors is involved in voting on the making open market operations which can
directly affect the money supply and hence, influence on interest rates. In addition to
monetary policy duties, the Board has substantial regulatory and supervisory
responsibilities over the US banking system. It also approves bank mergers and
applications for new activities, specifies the permissible activities of banks holding
companies, and supervises the activities of foreign banks in the US.

 The Federal Open Market Committee (the FOMC)

This is the most important part of the FED. This division is responsible for research
and monetary policy to maintain price stability and economic growth of developing.
The FOMC usually meets eight times per year to discuss the economic situation of the
US, conduct open market operations, and select measures and appropriate monetary
policy for each period.

The voting members of the FOMC consist of 12 members, including seven governors
of the Board of Governors, President of Federal Reserve Bank of New York, and four
other presidents which are chosen alternatively from remaining Federal Reserve
Banks. All other Federal Reserve Banks’ presidents are entitled to participate in
discussion but not vote. Chairman of the Board of Governors chairs the FOMC
meeting. Because open market operations are the most important policy tool that the
FED can use to control the money supply, the FOMC is a very important point for
policymaking in the FED.

 The Member Banks

Currently, 37% of the commercial banks and investment banks in the US are members
of the FED. All national banks are members. The state charted commercial banks can
be members if they want to. The member banks are shareholders of their regional
Federal Reserve Bank and thus, they must subscribe to stock in an amount equal to 6
percent of their capital and surplus, half of which must be paid in while the other half
is subject to call by the Board of Governors.

Other financial institutions, though they are not members of the Fed but still have to
follow rules set by the FED on a number of activities. In addition, member and
nonmember banks have the same requirements to keep deposits at the FED .
Moreover, all depository institutions were given access to the Federal Reserve
facilities, such as the discount window that is the facility at which they can borrow
reserves from the Federal Reserve, and FED check clearing, on an equal basis. These
provisions helped to reduce the distinction between member and nonmember banks.

 The Advisory Committees

The Advisory Committees are used by The FED in order to carry out its varied
responsibilities. These committees are composed of three councils including: the
Federal Advisory Council, the Consumer Advisory Council, and the Thrift Institution
Advisory Council. Members of these councils are drawn from the member banks of
the Federal Reserve System, usually meets from two to four times a year in order to
set out advice for the Board of Governors. The Advisory Committees represent the
interests of all elements related to financial activities in the US.

3.3. The Federal Deposit Insurance Corporation (the FDIC)

On June 1933, at the height of the Great Depression and with more than 4,000 bank
failures already that year, the Federal Deposit Insurance Corporation (the FDIC) was
established as a temporary agency to raise the confidence of the US public in the
banking system. FDIC deposit insurance goes into effect on January 1934. Only nine
banks failed during the first year that the FDIC begin insuring banks. Over the years,
FDIC continues to develop its missions to preserve, maintain and promote public
confidence in the US financial system by:

- Insuring deposits in banks and thrifts institutions for at least $ 250,000 as of

08/2008 (the new basic limit on deposit insurance risen from $ 100,000 as of
- Examining and supervising financial institutions for safety and soundness and
consumer protection.
- Managing receiverships.

By so doing, the FDIC can identify, monitor and address risks to the deposit insurance
funds and limit the effect on the economy and the financial system when a bank or
thrift institution fails.
The FDIC is the primary federal regulator of state-chartered banks that are not
members of the FED. The FDIC also serves as the back-up supervisors for the
remaining insured banks and thrift institutions.

3.4. The National Credit Union Administration(the NCUA)

Commercial banks and saving institutions take deposit from savers and make loans to
borrowers, conversely, US credit unions were unique depository institutions because
their operations are not for profit, but to serve members as credit cooperatives. With
the upswing of the US economy in the 1920s, the credit union movement became
increasingly popular. In 1934, with the passing of the Federal Credit Union Act, a
national system to charter and supervise federal credit union was established. Credit
unions grew steadily in the 1940s and 1950s, and by 1960, there were over 10,000
federal credit unions. In 1970, an amendment to the Federal Credit Union Act of 1934
was passes. The National Credit Union Administration was created and became an
independent, federal agency. It has missions to charter, insure, supervise and examine
federally chartered credit unions. Besides, it manages the National Credit Union Share
Insurance Fund which was also formed in 1970 to insure members’ deposits. During
the 1990s and into the 21st century, credit unions have been healthy and growing.

3.5. The Office of Thrift Supervision (the OTS)

In 1989, congress passed the Financial Institutions Reform, Recovery, and

Enforcement Act that dramatically restricted the banking business, dissolved the
Federal Savings and Loans Insurance Corporation, moved deposit insurance for
saving associations to the FDIC and established the Office of Thrift Supervision (the
OTS) to supervise, charter and regulate the thrift industry. The OTS is an office within
the Department of the Treasury. It is the federal bank regulator and supervisor of a
dynamic industry of saving associations across the nation. The OTS also oversees the
holding companies that own these thrift institutions. It examines each saving
association every 12 to 18 months to assess the institution’s safety and soundness, and
compliance with consumer protection laws and regulations. In addition, the OTS
monitors the condition of thrift through off-site analysis of regulatory submitted
financial data and regular contact with thrift personnel. OTS examinations and its
ongoing supervisory oversight are tailored to the risk profile of each institution.

4. Conclusion

Despite the occurring of extensive deregulation from its establishment, banking

system is highly regulated in the US as it is in most countries. Overall, the network of
regulation that surrounds US banks is very restricted and full of requirements.
Commercial banks have to follow the instruction as well as regulations of the federal
government and states. Three federal regulator including: the Federal Deposit
Insurance Corporation, the Office of the Comptroller of the Currency, and the Federal
Reserve System have separate authorities from each other; however, their jurisdiction
also overlap with respect to commercial banks. Saving and loan associations, saving
banks that are other categories of depository institutions normally are insured by the
Federal Deposit Insurance Corporation and controlled by the Office of Thrift
Supervision. Saving banks also can be regulated by state authorities. In most cases,
credit unions are insured by the National Credit Union Share Insurance Fund and
regulated by the National Credit Union Administration. During the financial crisis
started in 2007, the US banking regulation has recognized that it needs to be more
effective than in the past. Regulators, especially the Federal Reserve, are working with
each other within the nation and abroad to improve their performance at multiple


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