The Federal Reserve Bank's role in bank holding companies

Federal Reserve Bank's Role In Bank Holding Companies

Banking was very different before the Federal Reserve was created. Now, of course, there is a centralized banking system consisting of only twelve banks, but before, there was no centralized system to be found at all. The purpose of this paper is to discuss the differences between now and then and create an understanding of the many significant differences that were created by the Federal Reserve System, and also to look at the minor role that system plays in bank holding companies.

In 1908, the National Monetary Commission was established through Congress. They did this because there had been a large number of financial problems in the country, and people were panicking about money. The purpose of the Commission was to study the problems and recommend what should be done to fix them. This took a few years, but they finally agreed on a solution, and the Federal Reserve Act was signed in December of 1913. The act was not able to prevent the Great Depression from taking place, but it was able to keep inflation at a reasonable rate, and is still able to do this through controls and governance. Federal control over banking is still needed, since it helps to keep the rate of inflation realistic and to prevent the bank failures and suspensions that were a problem in the years before 1914 (Wells, 1987).

The Truth in Lending Law

Federal laws are extremely important in the banking industry. They not only regulate what banks can do, which it is important in itself, but they also detail the rights that consumers have if they think that they have been wronged or treated improperly by a bank or other lending institution. This is the main purpose that the federal laws have as they relate to banks, and consumers who have filed complaints would probably feel that the federal laws designed to protect them were of the most serious form of importance.

For example, these federal laws give consumers the right to withhold a payment on their credit card if they are disputing the charges. Federal laws also protect many people by making sure that credit reporting agencies keep accurate information on all consumers, seeing that consumers are not discriminated against based on several criteria such as race or sex, and striving to ensure that debt collection practices that are designed to be harassing to the consumer are prohibited by law (Pippidis, 1996).

The law which remains the topic of this particular section is often called Regulation Z. Consumers know it more commonly as the Truth in Lending Act. This Act was created to protect consumers from unfair credit practices at the hands of both banks and other lenders. Before this law came into effect, a lot of banks and lending institutions would advertise rates and then explain to the consumer when he or she arrived that it would be necessary to charge a higher rate because of some reason that was likely not legitimate at all.

Many consumers did not understand much about how banking and loans really worked, so they assumed that if the bank stated they needed to charge the consumer a higher rate, then there was an honest reason for that. Many consumers were cheated out of a great deal of money because of this. It is similar to "bait and switch" ideas that stores used to use when they would say they had an item for a certain price and then when the consumer arrived in the store, the salesperson would say they were out of that item, but they had something comparable at a higher price that the customer could see. Since the customer was already there, he or she often bought the higher priced item. This was also the case with lending until the Truth in Lending Act was finally put into law.

The Truth in Lending Act was originally created and put into law by the U.S. Congress back in 1968. It has been through revisions since then; and the most notable of these came in 1980 when it was reworked and included as a part of the Depository Institutions Deregulations and Monetary Control Act. The Truth in Lending Act was implemented by the Federal Reserve Board, and it deals only with credit as it applies to consumers, and not businesses. Credit that is given for businesses, agricultural purposes, or other commercial ventures does not come under Regulation Z, although that does not mean these businesses will not have any protection against unfair credit practices that are designed to cheat them (Legal, 2003).

As has already been mentioned, the Federal Reserve Board is the group responsible for implementing the Truth in Lending Act, and for ensuring that banks and other lending institutions remain in good compliance with the Act. Consumers who think that a particular institution is not in compliance should contact the Federal Reserve Board and have them investigate the charges. There are high penalties for noncompliance, including requiring the creditor to pay back double the amount of the finance charge if they are found to be guilty. They are also often required to pay the attorney's fees and the court costs to the consumer who they wronged. The consumer who feels he or she was treated unfairly has one calendar year to sue the creditor on a Truth in Lending Act violation (Legal, 2003).

The Federal Reserve Board is not the only agency, however, who can keep track of compliance with the Truth in Lending Act. For example, organizations like the Veterans Administration, Department of Housing and Urban Development, and Department of Transportation all have regulations for certain types of businesses. In the case of the Department of Transportation, there are certain Truth in Lending regulations which are applicable to the airline industry. The Truth in Lending Act does not give standard requirements as to how all creditors must compute their credit charges. What it does do, though, is to make sure that enough information is offered to the consumer from each institution to which they are applying so that they can determine exactly how much the credit will end up costing them (Legal, 2003).

As for which of the federal agencies regulate national, state, or state member banks, most of these are regulated by a Federal Reserve Bank that serves the particular district in which the bank is located. For banks which are not regulated by the Federal Reserve Bank in their district, they are regulated by the Federal Deposit Insurance Corporation, commonly called the FDIC (Bankers, 2003).

The Federal Reserve Bank

Before 1863 there were just two banks, and the government owned one-fifth of each one of them. This caused many political problems and resentments, and the twenty-year charters that these banks had were not renewed. Once this took place all banks were chartered by different states, and none went across state lines. Some were not even allowed to branch at all, and that held true within the same state. This made for a confused and disorganized system, and the banking regulations from one state to another state were often quite different. Because many banknotes ended up very far from their point of origin, they were sold at a heavy discount. Individuals who worked in the banking business tried to keep the country informed when it came to the prices of these notes, but there was a serious time delay between when the information was known and when other people heard about it. Dishonest people often took advantage of this delay (Rolnick & Weber, 1982).

Along the Eastern seaboard, it was the Suffolk Bank that operated in the Boston area. It had a clearinghouse to prevent the smaller regional banks from issuing too many banknotes, and it worked very well. It was generally just called the Suffolk System, and banks that joined it were guaranteed proper value for the notes that they collected, instead of having to take a much lower price for many of them. The only problem with this kind of banking system is that most banks had to hold state bonds that were equal in value to the banknotes they issued to consumers. The prices were often rapidly changing, and a lot of times banks did not really have what they needed to protect holders of all the notes that were out there (Rolnick & Weber, 1982).

A note guarantee system was finally established by six of the states in an effort to stop fears about banknotes that could not be redeemed at their face value and had to be sold for less (FDIC, 1953). If banks had enjoyed the freedom to hold the type of assets that they preferred to hang on to, and if they had been able to branch out in ways that they wanted to, this guarantee system very likely would not have even been necessary.

Bank Holding Companies

Eventually, a national banking system was established as a way to help fund the Civil War. The new government banks put heavy taxes on state banks, and they were forced to go under. After this, the government had a monopoly on banking and money again, and they used it to the fullest extent possible. One of the main problems with the banking system, though, was that there were still a lot of cash flow problems and other weaknesses that led to panics for individuals who were holding onto bank notes (Wells, 1987). There were many restrictions placed on new banks, and they could do virtually nothing. This was very frustrating for them, and they were not able to do anything that actually worked to help the economy in any way. Part of this came from a lack of branching out, but most was related to the strict control that was held over them.

Allowing the branching out of banks would have made things run more smoothly, as branching out did not require a new charter in the way that opening an entirely new bank would have. There would not be any need for all the red tape, a naming of officers, and everything else that would come along with the opening of a new bank. Branching made things a lot simpler for everyone involved, and it also allowed money to be distributed and collected more easily than separate banks would have allowed for (Dunbar, 1917). By branching out and restructuring themselves carefully, the banks could take advantage of different legal statuses and get tax breaks and other things that they otherwise would have missed, but they would need to turn themselves into bank holding companies, which would then acquire various banks as part of their business model. These banks would be managed by a company, which is different from the way that a normal bank is usually managed.

Another problem that the banks were facing was that they were required to hold a certain amount of money which could be used to secure the banknotes that they had issued. Being required to keep a lot of money on hand made things difficult for them, as they were quickly limited as to how many banknotes they could issue. If they had been allowed to keep a lower ratio of money to banknotes, they would have been in a much better position with both the government and those who held the banknotes.

Clearinghouses were becoming more popular as more banks struggled to keep a proper balance between the collateral they had to hold and the banknotes they wanted to loan. These clearinghouses worked by allowing banks to use a loan certificate to pay their debts instead of using their actual currency. These banks had to have a lot of collateral that they could use to pledge to get the certificates, but this was generally not seen as a problem. This helped to stretch the amount of currency that was available, and banks that had plenty would take the certificates because they could earn an interest rate of six percent on them (Timberlake, 1984).

In the present day, the banking system is made up of twelve member banks that belong to a more centralized system. In 1951, the Federal Reserve was officially established as a separate entity, apart from any other type of governing body. It has gone from taking a role in things that was very passive to being highly active within the monetary system of the United States. Even the past Federal Reserve Chairman Alan Greenspan has admitted that the Reserve had learned a lot in the eighty-three years that it had been in existence, but there was still more to learn, and there was always the chance of making mistakes, even after learning all that one can learn from the past and those experiences (Crutsinger, 2002).