Learning Objectives
By the end of this section, you will be able to do the following:- Discuss the relationship between bank regulation and monetary policy
- Explain bank supervision
- Explain how deposit insurance and lender of last resort are two strategies to protect against bank runs
A safe and stable national financial system is a critical concern of the Federal Reserve. The goal is not only to protect individuals’ savings but to protect the integrity of the financial system itself. This esoteric task is usually behind the scenes but came into view during the 2008–2009 financial crisis, when, for a brief period of time, critical parts of the financial system failed and firms became unable to obtain financing for ordinary parts of their business. Imagine if suddenly you were unable to access the money in your bank accounts because your checks were not accepted for payment and your debit cards were declined. This gives an idea of what a failure of the payments/financial system is like.
Bank regulation is intended to maintain the solvency of banks by avoiding excessive risk. Regulation falls into a number of categories, including reserve requirements, capital requirements, and restrictions on the types of investments banks may make. In Money and Banking, we learned that banks are required to hold a minimum percentage of their deposits on hand as reserves. On hand is a bit of a misnomer because, while a portion of bank reserves are held as cash in the bank, the majority are held in the bank’s account at the Federal Reserve, and their purpose is to cover desired withdrawals by depositors. Another part of bank regulation is restrictions on the types of investments banks are allowed to make. Banks are allowed to make loans to businesses, individuals, and other banks. They are allowed to purchase U.S. Treasury securities but, to protect depositors, they are not permitted to invest in the stock market or other assets that are perceived as too risky.
Bank capital is the difference between a bank’s assets and its liabilities. In other words, it is a bank’s net worth. A bank must have positive net worth; otherwise it is insolvent or bankrupt, meaning it would not have enough assets to pay back its liabilities. Regulation requires that banks maintain a minimum net worth, usually expressed as a percent of their assets, to protect their depositors and other creditors.
Link It Up
Visit this website to read the brief article, Stop Confusing Monetary Policy and Bank Regulation.