Chapter:02

The Impact of
Government Policy &
Regulation on Banking
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Banks are in essence the "kids" with
the strictest parents in the block.

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The Principal Reasons Banks Are Subject
to Government Regulations.
 To protect the safety of the public’s savings
(Cameras, guards, periodic examinations and
audits, support from CB reserves).

 To control the supply of money & credit in order

to achieve a nation’s broad economic goals
(growth, inflation).

 To ensure equal opportunity & fairness in the

public’s access to credit & other vital financial
services to avoid discrimination and hence
concentrations of financial power in the hands of a
few individuals & institutions. 3
 To promote public confidence in the
financial system, so that savings flow
smoothly into productive investment.
 To provide the government with credit, tax
revenues & other services (cheap credit, tax
revenues, conducting economic policy,
collecting taxes, dispensing government
payments).
 To help sectors of the economy that have
special credit needs

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 Meet the “Parents”:Federal Reserve System
(FRS)

The FRS is the central bank and monetary policy

authority of the United States. It was founded in1913
to provide the country with a safe, flexible, and stable
monetary and financial system. The Fed has a board
that is comprised of seven members. There are also
12 Federal Reserve banks with their own presidents
that represent a separate district.
The Fed's main duties include conducting national
monetary policy, supervising and regulating banks,
maintaining financial stability, and providing banking
services.

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Meet the “Parents”:Office of
Comptroller of the Currency (OCC)
 The OCC founded in 1863, charters,
regulates, and supervises both national and
foreign banks operating in the U.S.
 Appointed by the president, the OCC is
funded by the banks themselves that must
pay examination and processing fees.
 Powers: The ability to deny applications for
new bank branches, remove bank directors,
and even take supervisory actions against
the banks.
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Meet the “Parents”:Federal Deposit Insurance
Corporation (FDIC)

 The FDIC founded in 1933, is an

independent federal agency insuring
deposits in U.S. banks and thrifts in the
event of bank failures up to $250,000.
 Requires all insured depository
institutions to submit reports on their
financial condition.

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Meet the “Parents”: Securities and Exchange
Commission (SEC)
 The SEC is a U.S. government oversight agency
responsible for regulating the securities markets and
protecting investors.
 It was created by Congress in 1934 as the first
federal regulator of the securities markets.
 The SEC can itself bring civil actions against
lawbreakers (insider trading, accounting fraud,
providing false/misleading information), and also
works with the Justice Department on criminal cases.
 Must approve public offerings of debt and equity
securities by banking and NBFIs.

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Meet the “Parents”:Commodity Futures
Trading Commission (CFTC)

 The CFTC is an independent federal agency

established in 1974 that regulates the
derivatives markets, including futures
contracts, options, and swaps, in the United
States.
 Its goals include the promotion of competitive
and efficient markets and the protection of
investors against manipulation, abusive trade
practices, and fraud.
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The Central Banking System: Its Impact on the
Decisions & Policies of Individual Banks
 Monetary Policy: Control over money,
credit & interest rates to achieve a nation’s
economic goals. The policy has two basic goals:
1. To promote “maximum” sustainable output &
employment. &
2. To promote “stability” in price level.

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The Central Banking System: Its Impact on the Decisions & Policies
if Individual Banks---Contd

 What do maximum sustainable output and

employment mean?
In the long run, the amount of goods and services
the economy produces (output) and the number of
jobs it generates (employment) both depend on
factors other than monetary policy. These factors
include technology and people's preferences for
saving, risk, and work effort. So, maximum
sustainable output and employment mean the
levels consistent with these factors in the long run.

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The Central Banking System: Its Impact on the Decisions & Policies
if Individual Banks---Contd

 What's so bad about higher inflation?

High inflation is bad because it can hinder
economic growth, and for a lot of reasons. For one
thing, it makes it harder to tell what a change in
the price of a particular product means. For
example, a firm that is offered higher prices for its
products can have trouble telling how much of the
price change is due to stronger demand for its
products and how much reflects the economy-
wide rise in prices.

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 The Central Bank’s Principal Task: Making &
Implementing Monetary Policy
1. The Open Market Operations Policy (OMO):
– To reduce the money supply in the economy, Central bank sells
securities in the open market.
– To increase the money supply, Central bank repurchase the
securities sold earlier from the market.

2. The Discount Rate Policy: Discount rate is the rate at which the
central bank lends money to the scheduled banks or discounts the
bills of the commercial banks.
– To reduce the money supply in the economy, Central bank raises
the discount rate.
– To increase the money supply in the economy, Central bank
reduces the discount rate.

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The Central Bank’s Principal Task: Making & Implementing
Monetary Policy----Contd

3. Changing Reserve Requirements on Deposits & other Bank

Liabilities:
– Raising reserve requirements, banks must set aside more of each
incoming deposits into required reserves, & less money is
available to support making new loans.
– Lowering reserve requirement, releases reserves for additional
bank lending.
{What are bank reserves?
Banks and other depository institutions (for convenience, we'll refer to
all of these as "banks") keep a certain amount of funds in reserve to
meet unexpected outflows. Banks can keep these reserves as cash in
their vaults or as deposits with the Fed. In fact, banks are required to
hold a certain amount in reserves. But, typically, they hold even more
than they're required to in order to clear overnight checks, restock
ATMs, and make other payments. }

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The Central Bank’s Principal Task: Making & Implementing
Monetary Policy----Contd

4. Other Policy Tools:

a) Moral Suasion: The Central bank tries to bring
psychological pressure to bear on individuals &
institutions to conform the central bank’s policies,
using telephone calls or letters to bankers, making
speeches explaining the Central bank’s policies, &
testifying before parliament to explain what the CB is
doing & to clarify it.
b) Margin Requirements: An investor buying certain
listed securities must use his or her own funds to
cover a specified percentage of the securities’
purchase price, the rest of that price may be
borrowed, using the purchased securities as
collateral.
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 Impact of Fiscal Policy on Banks
 Increases in government spending usually lead to increase
in business & households incomes, which increases both
bank deposit & loan demand, eventually accelerating the
pacer of economic activity - & perhaps inflation as well.
 Increases in government spending must be financed by
added government borrowing, the tendency is to push
interest rates higher as government credit demands are
added to private credit demands, placing banks under
increased pressure to meet all of their customers’ funding
needs.
 Decisions by parliament to raise taxes & reduce budget
deficits normally lead to decreases in Treasury borrowings
& eventually push interest rates lower. Private sector
incomes, bank deposits, & loan demand are also likely to
fall.
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 Prudential Regulations of Bangladesh Bank
(updated 31-12-2006)

1. Policy On Capital Adequacy Of Banks

2. Policy On Loan Classification And Provisioning
3. Corporate Governance In Bank Management
4. Restriction On Lending To Directors Of Private
Banks
5. Rules And Regulations For Appointment Of Chief
Executive And Advisor In Banks
6. Constitution Of The Board Of Directors And Fit And
Proper Test For Appointment Of Bank Directors
7. Constitution Of The Audit Committee Of Board Of
Directors
8. Disclosure Requirements For Banks

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Prudential Regulations of Bangladesh Bank (updated 31-12-
2006)------Contd.

9. Policy On Single Borrower Exposure

10. Policy For Rescheduling Of Loans
11. Policy For Loan Write Off
12. Large Loan Restructuring Scheme (LLRS)
13. Requirement For Obtaining Information On Large
Loan From Credit Information Bureau
14. Payment Of Dividend By Bank Companies
15. Loan Against Shares, Debentures Etc
16. Interest Rates On Deposit And Lending
17. Bank Charges
18. Bank Deposit Insurance Scheme
19. Guidelines On Managing Core Risks In Banking
20. Credit Rating

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