Felix I. Lessambo The U.S. Banking System Laws, Regulations, and Risk Management The U.S. Banking System Felix I. Lessambo The U.S. Banking System Laws, Regulations, and Risk Management Felix I. Lessambo School of Business Central Connecticut State University New Britain, CT, USA ISBN 978-3-030-34791-8 ISBN 978-3-030-34792-5 (eBook) https://doi.org/10.1007/978-3-030-34792-5 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2020 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifcally the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microflms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specifc statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland CONTENTS 1 Overview of the US Banking System 1 Part I The Legal Background 2 Banking Laws 9 3 The Crypto-currency Regulations 21 4 Anti-Money Laundering Laws 37 Part II Actors: Regulators and Banks 5 The Regulators 69 6 Commercial Banks and Savings Banks 93 7 Investment Banks 99 8 Merchant Banks 115 v vi CONTENTS 9 Credit Union 125 10 Public Bank—Bank of North Dakota 139 Part III Risks and Banking Regulation 11 Risks in the Banking Industry 159 12 Banking Regulation Principles 177 13 Banks’ Capital Adequacy 185 14 Comprehensive Capital Analysis and Review (CCAR) and the Dodd–Frank Stress Testing 209 Part IV Financial Statements and Statement Analysis 15 Commercial Banks’ Financial Statements 243 16 Commercial Bank’s Financial Ratios Analysis 259 Part V Auditing and Bankruptcy 17 Bank Audit Systems 279 18 Bank Bankruptcy 297 Glossary 317 Bibliography 323 Index 329 ACRONYMS AIRB Advance Internal Rating-Based Approach AMA Advanced Measurement Approach BCBS Basel Committee on Banking Supervision CCAR Comprehensive Capital Analysis and Review CCF Credit Conversion Factors CECL Current Expected Credit Loss CET1 Common Equity Tier 1 CFPB Consumer Financial Protection Bureau CFTC Commodity and Futures Trading Commission CLF Central Liquidity Facility CRA Community Re-investment Act CSBC Conference of State Bank Supervisors DFA Dodd–Frank Act DFAST Dodd–Frank Act Stress Testing EBA European Bank Authority ECL Expected Credit Loss EL Expected Loss ERBA External Ratings-Based Approach FDCPA Fair Debt Collection Practices Act FDIC Federal Deposit Insurance Corporation FED Federal Reserve Bank FFIEC Federal Financial Institution Examinations Council FinCEN Financial Crimes Enforcement Network FOMC Federal Open Market Committee FRBNY Federal Reserve Bank of New York FSOC Financial Stability Oversight Council vii viii ACRONYMS GSIB Global Systemically Important Banking Organization IRBA Internal Rating-Based Approach (for credit risk) ISDA International Swaps and Derivatives Association LCR Liquidity Coverage Ratio LIBOR London Inter-Bank Offered Rate LGD Loss Given Default MBS Money Services Business NCU National Credit Union NCUSIF National Credit Union Share Insurance Fund OCC Offce of the Comptroller of the Currency OFAC Offce of Foreign Assets Control OTS Offce of Thrift Supervision PD Probability of Default RW Risk Weight RWAs Risk-Weighted Assets SA Standardized Approach SAR Suspicious Activity Reporting SDR Special Drawing Rights SEC Securities and Exchange Commission SIPA Securities Investment Protection Act SMA Standardized Measurement Approach SOMA System Open Market Account TDF Term Deposit Facility LIST OF FIGURES Fig. 10.1 Total loan portfolio (Source BND Financial Statements [2018]) 142 Fig. 10.2 Agricultural loan portfolio (Source BND Financial Statements [2018]) 144 Fig. 10.3 Business loan portfolio (Source BND Financial Statements [2018]) 145 Fig. 10.4 Home loan portfolio (Source BND Financial Statements [2018]) 146 Fig. 10.5 Student loan portfolio (Source BND) 147 Fig. 13.1 Calibration of the capital framework (Source BIS) 200 Fig. 13.2 Basel 3-Phase-in arrangements (Source BIS) 201 Fig. 14.1 Unemployment in severely adverse and adverse scenarios 211 Fig. 14.2 GDP growth in severely adverse and adverse scenarios 214 Fig. 14.3 Aggregate common equity capital ratio/CCAR 2018 226 Fig. 15.1 Stylized bank balance sheet 244 Fig. 18.1 Bank closing summary (Source FDIC [2019]) 298 Fig. 18.2 FDIC Resolutions (Source FDIC [2019]: Resolutions Handbook) 301 ix LIST OF TABLES Table 7.1 Top investment banks in the world 101 Table 12.1 CAMELS 179 Table 12.2 Five evaluation methods 182 Table 13.1 Standardized approach 191 Table 13.2 Business lines/Beta factor 191 Table 14.1 Bank holding companies 227 Table 14.2 EU tested banks 232 xi LIST OF CITED CASES – CFTC v. McDonnell and CDM, EDNY (08/23/2018). – Securities and Exchange Commission v. REcoin Group Foundation, et al., Civil Action No Securities and Exchange Commission v. Reginald, Case 1:19-CV-04625-CBA-RER.17-cv-05725 (E.D.N.Y., fled September 29, 2017). – Securities and Exchange Commission v. Tambone, 550 F.3d 10 6 (1st Cir. 2008). – Securities and Exchange Commission v. Reginald, Case 1:19-CV-04625-CBA-RER. – Securities and Exchange Commission v. KIK Interactive Inc. Case 1:19-cv-05244. – United States v. Nurgio, SDNY (September 19, 2016). – United States v. Velastegui, 199 F.3d 590, 593 (2d Cir. 1999). xiii CHAPTER 1 Overview of the US Banking System 1.1 GENERAL The US banking system is one of the oldest, largest, and most important sectors of our overall economy. There were no modern banks in colonial America nor American banks as late as 1781.1 By the 1830s, to get away from the politicization and corruption involved in legislative charter- ing, a few states began to enact “free banking” laws. Without a central bank to provide oversight of banking and fnance, the expanding bank- ing system of the 1830s, 1840s, and 1850s suffered from some major problems, even as it supplied the country with ample loans to fnance economic growth. One problem was fnancial instability. Banking crises occurred in 1837, 1839–1842, and 1857 years when many banks had to suspend convertibility of their banknotes and deposits into coin because their coin reserves were insuffcient. A good number of these banks failed or became insolvent when borrowers defaulted on their loan payments. The banking crises led to business depressions with high unemployment.2 The passage of the Federal Reserve Act in 1913 was a watershed in US banking history. In 1913, after three-quarters of a century without 1 Richard Sylla: The US Banking System: Origin, Development, and Regulation, the Gilder Lehrman Institute of American History (2009–2019). 2 Richard Sylla: The US Banking System: Origin, Development, and Regulation, the Gilder Lehrman Institute of American History (2009–2019). © The Author(s) 2020 1 F. I. Lessambo, The U.S. Banking System, https://doi.org/10.1007/978-3-030-34792-5_1 2 F. I. LESSAMBO a central bank and a period punctuated by a number of banking crises, Congress created a new central bank, the Federal Reserve System. In 1927, Congress passed the McFadden Act, which allowed national banks to become competitive with state banks by granting them jurisdiction to branch out within the state they were originally located to the extent that state law permitted. The banking architectural was strengthened with the Banking Act of June 1933 (“the Glass–Steagall Act”) introduced federal deposit insurance, federal regulation of interest rates on deposits, and the separation of commercial banking from invest- ment banking. Further, the Glass–Steagall Act strengthened the Federal Reserve’s powers. The American bank regulatory system is based upon the concept of dual oversight by federal and state agencies, and the primary regulators differ based upon a specifc bank’s charter. The structure and regulation of the US banking system differs from the rest of the world. The US system is made of big commercial and small banks coexisting, with more small banks holding the larger share in number. In contrast to the US system, other developed countries such as Japan, Germany, France, and Canada’s banking systems tend to favor larger national institutions.3 The US banking industry also is less highly concentrated than the banking industries in many other industrial countries. A study on “industry con- centration ratio” by the Bank for International Settlements concluded that the fve largest banks’ US ratio was 26.6%, while the ratio for Canada was 77.1%, France stood at 70.2%, and Switzerland at 57.8%. In 1999, Congress repealed the Glass–Steagall Act that had effectively separated commercial and investment banking. The business of banking, long stifed by regulation, suddenly became more exciting. Increasingly, banks were not limited in their lending by the size of their deposit bases. They could obtain more funding to make more loans and purchase new forms of securities by accessing the Wall Street and international money markets.