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Banking I. In General A. Breakdown of Glass-Steagall i. The 1999 Gramm-Leach Bliley Act culminated the destruction of the GlassSteagall firewall after a long period of erosion by regulatory actions. a) Repealed Glass-Steagall's anti-affiliation provisions and permitted banks to affiliate through specially qualified bank holding companies called "financial holding companies" with companies engaged in the full range of financial activities:
? Activities included (1) underwriting, dealing in, and brokering securities; (2) acting as an investment advisor; (3) merchant banking (i.e., making long-term equity investments for which no public market exists); and (4) underwriting and selling insurance.
? To qualify as a financial holding company, its subsidiary FDIC-insured depository institution must be (1) well-capitalized and adequately managed and (2) have satisfactory community-reinvestment records. b) Two key Glass-Steagall provisions remain in force:
? (1) A bank can underwrite and deal in only a limited range of securities (e.g. government bonds). 12 U.S.C. SSSS 24(Seventh), 335, 378(a)(1).
? (2) The same firm cannot both accept deposits and underwrite securities. 12 U.S.C. SS 378(a)(1). B. Breakdown of Distinction Among Different Types of Financial Institutions i. A Bank vs. A Thrift a) Three Key Differences
? (1) Thrifts generally have more constrained investment powers than banks.
? Thrifts generally cannot have more than 20% of their assets in commercial loans
? Any commercial loan exceeding 10% of assets must be to small businesses
? Loans secured by nonresidential real property generally cannot exceed four times a thrift's capital
? (2) Thrifts must meet a "qualified thrift lender test" by keeping a certain percentage of their assets in investments like home mortgages
? If not, risk being regulated as banks and their holding companies as bank holding companies
? (3) The Bank Holding Company Act generally does not apply to a thrift holding company if the company owns no banks and the company's subsidiary thrifts all meet the qualified thrift lender test b) A thrift holding company that acquired a thrift after May 4, 1999 can engage only in the sort of activities permissible for financial holding companies C. What is a Bank?
i. Definitions 1
a) (1) Legal Form: A bank is a firm with a commercial bank charter b) (2) Services: A firm that accepts deposits withdrawable by check and makes loans c) (3) Economic Function: A financial intermediaries that provide transaction services to customers
? Financial Intermediary
? Financial intermediaries take money from investors, pool it, and invest the pooled money in other enterprises
? Includes depository institutions, life insurance companies, mutual funds, pension funds, etc.
? Benefits: (1) diversification, (2) Enable investors to enjoy economies of scale, (3) expertise, (4) ability to convert illiquid assets into liquid assets
? Transaction Services
? Provide an accounting system of exchange - a means of transferring wealth through bookkeeping entries
? debiting (-) buyer's account and crediting (+) seller's account
? Includes depository institutions and mutual funds
? UNDER the functional definition of a bank, some mutual funds might be characterized as banks as they (1) take money from investors, pool it, and invest the pooled money in other enterprises, and (2) some allow customers to effect redemptions by writing checks on the fund payable to third parties.
? Functional difference between banks and mutual funds is that demand accounts at banks represent demand debt (the bank agrees to repay whatever sum the customer had on deposit) whereas demand accounts at mutual fund represent demand equity (the mutual fund agrees to repay not a sum certain but only the customers' proportional share of the fund's net assets) ii. Demand Deposits a) Transaction Accounts: any account from which a customer may withdraw money by check, electronic transfer, or similar means for payment to others
? Demand Deposit: you have the legal right to withdraw the money upon demand
?????Traditional checking account
? NOW Account: "negotiable order of withdrawal"
? Checks drawn on a NOW account look and work like a check payable upon demand BUT the bank technically has the right to demand seven days' notice of any withdrawal
? This would make no sense to do as no bank would expect to stay in 2
business by operating in this manner
? The bank's right to require notice is merely a legal fiction to circumvent the rule against paying interest on demand deposits.
? NOW accounts are in practice payable upon demand b) Fractional Reserves
? Banks need only keep a fraction of total deposits on reserve and can expect (based on the law of large numbers) no more than a small percentage of deposits to be withdrawn at any given time D. Leverage i. Leverage = Debt/Equity a) The more debt relative to equity, the more highly leveraged the firm is ii. Return on Equity = Net Income/Equity a) Net Income = Operating Income less taxes and interest expense iii. Three Key Points re Leverage a) (1) Leverage increases the potential profitability of equity b) (2) Leverage increases risk c) (3) Leverage benefits a firm's owners when the firm's return on assets disregarding interest expense (i.e., its operating income minus any income taxes, divided by total assets) exceeds the interest paid on the debt iv. Reasons for High Leverage in banks a) (1) Banks have a more predictable return on assets than industrial firms b) (2) banks can readily obtain short-term loans from other banks or from the Federal Reserve c) (3) Federal Deposit Insurance helps banks to raise cash by attracting deposits E. Bank Runs, the Money Supply, and the Payment System i. Banks differ from other firms in three important respects: (1) susceptibility to bank runs, (2) role in the money supply, (3) role in the payment system a) Susceptibility to Bank Runs
?????Depository Institutions: susceptible to bank runs, but deposit insurance has made this rare
? Money Market Funds: panic may occur where they "break the buck" (i.e.,
< $1 net asset value = (total assets - total liabilities)/# of shares)
? Rare as they generally invest in safe, liquid, short-term securities
?????However, during the financial crisis, they did indeed "break the buck" and had to be covered by deposit insurance to prevent run
? Mutual Funds: redemptions do not appreciably increase the risk that other shareholders will suffer loss as each redemptions are at net asset value (redemptions do not create a liquidity crisis in contrast to fractional reserve banking) - demand equity rather than demand debt b) Role of Banks in the Money Supply
? Any breakdown in the banking system will affect the money supply
? Banks have a special role as they create money when they make loans and destroy money when they accept repayment of loans 3
The process of creating money is greatly slowed where borrowers hold money as cash rather than in a checking account
? High-powered money
? Cash and Federal Reserve accounts (the Federal Reserve adds reserves) constitute high-powered money because adding them to the banking system creates money in a multiple of their face amount, and decreasing them destroys money in that same multiple c) Role of Banks in the Payment System
? Banks play a key role (along with the Federal Reserve) in operating the U.S. payment system - the system for transferring wealth through bookkeeping entries, notably by clearing checks and transmitting electronic payments II. Getting Started A. Entry into banking i. Forming a Bank a) Six Steps
? (1) Having settled on the charter type, you form an organizing group of at least five individuals
? "Each organizer must have a history of responsibility, personal honesty, and integrity."
? The organizers must have "experience, competence, willingness, and ability" to direct the bank's affairs safely and soundly.
? The group should "include diverse business and financial interests and
[evince] community involvement." 12 C.F.R. SS 5.20(g)(1).
? (2) Have a prefiling meeting with the OCC's regional office
? (3) File an application
? The most important part of application package is the business plan
? Must (1) identify the proposed bank's sources of capital, (2) set forth its business strategy, (3) analyze earning prospects, (4) include projected balance sheets and income statements, and (5) show how the bank will satisfy and soundly meet its community's banking needs. 12 C.F.R. SS 5.20(h)(2), (5).
? In addition to reviewing the business plan, the OCC considers whether the proposed bank has "organizers . . . familiar with national banking laws"; will have "competent management, including the board of directors, with ability and expertise relevant to the types of services" the bank plans to provide; will have capital "sufficient to support the projected volume and type of business"; is likely to remain profitable; and will operate safely and soundly. 12 C.F.R. SS 5.20(f)(2).
? The OCC also considers how the bank will meet "the credit needs of its entire community, including low- and moderate-income neighborhoods" as required by the Community Reinvestment Act. 4
?(4) Receive preliminary conditional approval (5) Follow up by filing with the OCC an organization certificate and articles of association, electing the initial board of directors and fulfilling any other conditions imposed by the OCC
? (6) Receive final approval ii. Judicial Review of Chartering Decisions a) An applicant may seek judicial review of chartering decision b) Camp v. Pitts
? The appropriate standard of review is whether the Comptroller's determination was "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law" as provided by 5 U.S.C. SS 706(2) (A). Camp v. Pitts
? In applying this standard, the focal point for the review is the administrative already in existence. Camp v. Pitts
? BUT If there was a failure to explain, the remedy is not to have a de novo hearing to create a whole new record but to obtain from the agency, either through affidavits or testimony, additional explanation of the reasons for the agency as may prove necessary. Camp v. Pitts
? If the finding by the agency is not sustainable on the administrative record made, then the Comptroller's decision must be vacated and the matter remanded to him for further consideration. Camp v. Pitts iii. Changes in Control a) If a corporation wants to acquire an existing FDIC insured bank, it must get approval for the acquisition from the Federal Reserve, under the Bank Holding Company Act b) If an individual wants to acquire a bank, he will need to comply with the Changes in Bank Control Act, 12 U.S.C. SS 1817(j)
? The Act defines "control" as "the power, directly or indirectly, to direct the
[bank's] management or policies" or to vote 25% of more of any class of the bank's voting shares. 12 U.S.C. SS 1817(j)(8)(B).
? The individual must:
? give the bank's primary federal regulator written notice of the proposed acquisition and a specified set of information. 12 U.S.C. SS
? describe his or her "personal history, business background and experience," including his or her "material business activities and affiliations during the past five years" and any past or present legal troubles
? provide financial statements for the past five years.
? disclose the terms of the acquisition, the his or her source of funds, and any plans he or she may have to liquidate or merge the bank, sell its assets, or "make any other major change in its business or corporate structure or management. 12 U.S.C. SS 1817(j)(6). 5
? must investigate the individual's "competence, experience, integrity," and financial strength and solicit public comment on the proposed acquisition." 12 U.S.C. SS 1817(j)(2).
? If the bank has a state charter, the agency notifies the appropriate state supervisor
? may disapprove the acquisition if, inter alia, (1) the acquisition would be anticompetitive; (2) the individual's financial condition "might jeopardize the [bank's] financial stability" or prejudice the interests of depositors; (3) the individual or the individual's management team's "competence, experience, and integrity" are such that the acquisition would not be in the public interest or the interest of depositors; or (4) the acquisition would adversely affect the deposit insurance fund. 12 U.S.C. SS 1817(j)(7).
? If the agency disapproves the acquisition, you may obtain a formal hearing before the agency and, if rebuffed yet again, may seek judicial review. 12 U.S.C. SS 1817(j)(4)-(5). c) Where someone attempts to acquire control of a bank by having multiple people each purchase a portion of the stock, the Changes in Bank Control Act will govern the situation as it covers anyone who acquires control "acting directly or indirectly or through or in concert with one or more other persons."
? Thus, you must file notice and provide the required information about each acquirer
? BUT, by your actions, you may have unwittingly formed a partnership by operation of law whereby you would need approval from the Federal Reserve. 12 U.S.C. SSSS 1841(b), 1842(a)(1). B. Dual Banking System i. National banks, state banks, and federal and state thrift institutions have largely the same powers, so the choice of charter is preeminently a choice of regulators ii. Primary Regulators a) National Banks: OCC b) State Banks: State Regulators c) Federal Thrifts: The Federal Reserve d) State Thrifts: State Regulators e) State Chartered Banks that DO NOT join the Federal Reserve System: FDIC iii. Back-Up Regulator a) FDIC (For all FDIC insured banks and thrifts) C. Fundamental Changes i. Charter Conversion a) Banks can and do convert from one sort of charter to another
? A bank may even switch from a state charter to a federal or vice-versa b) A new charter is very likely to be granted UNLESS it appears that the bank is seeking to convert for some improper purpose, such as to avoid regulatory 6
action by the bank's current supervisor ii. Merger and Consolidation a) The National Bank Act provides a framework for reorganization transactions, including (1) mergers or consolidations or of national banks into state banks, 12 U.S.C. SS 214a; (2) consolidations of national or state banks under the charter of a national bank, 12 U.S.C. SS 215; and (3) mergers of national or state banks into a national bank, 12 U.S.C. SS 215a. b) Any such transaction must be (1) approved by the boards of directors od all institutions, (2) be ratified by a two-thirds vote of the shareholders of each institution (or a higher percentage in the case of a state bank if state law so requires), and (3) receive the approval of the Comptroller. iii. Mutual and Cooperative Organization a) Some banking institutions have long been held in a "mutual" form of ownership b) A mutual institution operates without common stock; ownership rights inhere in the depositors c) Nearly all thrift institutions were held in mutual form at one point iv. Dissolution a) In the case of a National Bank, if the dissolution is pursuant to a merger or consolidation and the board of directors determines that dissolution is in the best interests of the institution, 12 U.S.C. SS 181 requires a two-thirds vote of the dissolving banks shareholders, and, if the result of the dissolution will be the purchase of its assets and assumption of deposit liabilities by another bank, the deal must also be approved by two-thirds of the acquiring bank's shareholders (unless the Comptroller determines that an emergency justifies dispensing with these votes) D. Interaction Between Federal and State Law i. General Preemption Rules - Comes from Art. VI, clause 2 a) ANALYSIS:
? THRESHOLD QUESTION: Does the state law conflict with federal law?
? Step 1: Validity of Federal Law
? Question: Is the federal law constitutional?
? [IF YES = Go to Step 2]
? [IF NO = Federal Law in Invalid]
? Step 2: Express Preemption or Nonpreemption
? Question: Has Congress indicated that the federal law does, or does not, preempt the state law?
? [IF YES = Follow Congressional Intent]
? IF express preemption, federal law preempts state law
? IF nonpreemotion (and the state law is otherwise valid), you must comply with both laws.
? [IF NO = Go to Step 3]
? Step 3: Field Preemption 7
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