US & European Banking Regulation History: 1900-Present

Posted on Mar 28, 2025 in Economy

USA Banking Regulation: 1900-1920

Federal Reserve Act (1913)

  • Composed of 12 Federal Reserve Banks.
  • Established the Fed as the lender of last resort.

McFadden Act (1927)

Introduced geographical restrictions to the banking business.

Western Europe Banking: 1900-1920

Post-First World War Period

A flourishing period followed the peace treaty signature, but a recession occurred in 1920-1921.

Key Characteristics:

  • Close links between banks and industrial corporations.
  • Prevalence of the universal banking model.

Differences Between Countries Based On:

  • Relationship between the banking system and the industrial sector.
  • Severity of the economic depression.
  • Central bank intervention policies.

The Regulatory Period: Post-Crisis Reforms

The regulatory systems established in the USA and Europe were largely a consequence of the financial crisis of the 1930s and prevailed until the 1980s.

USA Regulatory Landscape (1930-1980)

Glass-Steagall Act (1933)

  • Created the FDIC (Federal Deposit Insurance Corporation) to protect depositors in domestic banks.
  • Suppressed interest payments on current accounts.
  • Mandated the segregation of investment banks from commercial banks.

Regulation Q (1935)

  • Imposed caps on deposit interest rates.
  • Created the FSLIC (Federal Savings and Loans Insurance Corporation) for S&L deposit protection.

Bank Holding Company Act (1956)

  • Prevented acquisitions of banks outside the state where bank headquarters were located.
  • Prevented bank acquisitions of non-financial companies.

Bank Mergers Act (1960)

Introduced competition considerations for authorizing mergers.

International Banking Act (1978)

  • Established the same regulatory, supervisory, and accounting requirements for foreign banks operating in the US.
  • Extended FDIC and Lender of Last Resort (LoLR) coverage to foreign institutions operating in the US.

Goal: Equalizing foreign and domestic banks.

Western Europe Regulatory Landscape (1930-1980)

Common Regulatory Elements:

  • Bank definition and creation conditions.
  • Definition of equity and minimum capital requirements.
  • Solvency and liquidity ratios.
  • Rules for mergers and acquisitions.
  • Supervisory frameworks.

Treaty of Rome (1957)

  • Initiated a trend towards deregulation and financial services harmonization in the EU.
  • Led to the First Directive on Banking Coordination (1977).

USA Deregulation and Consequences (1980-2000)

1980: Withdrawal of ceilings on deposit interest rates and increase in deposit insurance coverage.

1982: Savings & Loan (S&L) deregulation, contributing to the Savings and Loans Crisis.

1991: New regulations were implemented (as a consequence of the difficult situation in the 1980s), such as an increase in the deposit insurance premium, establishment of limitations to the “too big to fail” policy, and compulsory FDIC precautionary action.

1999: The Glass-Steagall Act was eliminated.

Modern Re-regulation Efforts

  • 2002-2003: Introduction of codes of good governance.
  • 2004: Circular 4/2004 (Bank of Spain) regarding new IFRSs.
  • 2004-2008: Basel II implementation.
  • 2008: Markets in Financial Instruments Directive (MiFID).
  • 2009: Solvency II framework.
  • 2010: SEPA (Single Euro Payments Area) established.
  • 2010: Dodd-Frank Act enacted in the US.
  • 2013-2019: Basel III implementation.

How will the current financial crisis impact future financial regulation?

Regulation: Market Structure and Competition

Restrictions Include:

  • Banking activity requirements.
  • Branching restrictions.
  • Holding company restrictions.
  • Merger regulations.

Regulation: Safety and System Stability

Deposit Insurance (e.g., FDIC): Protects depositors (see unit 2). Cost implication: Potential for Moral Hazard.

Deposit Interest Rate Ceilings: Historically used to limit bank costs/risk.

Regulatory Monitoring: Regular supervision from governmental agencies, plus external and internal audits.

Capital Requirements: Act as a buffer to absorb unexpected losses and avoid excessive risk-taking (e.g., BIS Ratio).

Portfolio Restrictions: Separation between commercial and investment banking (e.g., Glass-Steagall Act in the USA).

Limitations on Significant Risks: Risk exposure to a specific customer or group typically cannot exceed a percentage (e.g., 25%) of the bank’s equity.

Regulation: Consumer Protection

Regulation against usury and caps on loan interest rates.

Information requirements regarding credit conditions must be made publicly available.

Regulation: Credit Allocation

  • Compulsory investment coefficients.
  • Tax allowances for specific loan types (e.g., home loans, student loans, social programs).

Regulation: Monetary Control

  • Legal reserve requirements.
  • Central bank acting as the Lender of Last Resort (LoLR).

Regulation: Capital Requirements Explained

  • Minimum capital requirements upon bank creation.
  • Regulatory capital: Ongoing minimum capital levels.

Basel Accords:

  • Basel I: Introduced Tier 1 and Tier 2 capital definitions.
  • Basel II: Based on three pillars:
    • Pillar 1: Minimum capital requirements (Standardized and IRB approaches).
    • Pillar 2: Supervisory review process.
    • Pillar 3: Market discipline (disclosure).
  • Basel III: Further strengthened capital and liquidity requirements post-2008 crisis.