Banking Regulation: De Novo Financial Institutions

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Questions and Answers

Why do government chartering agencies believe financial-service providers need special scrutiny?

Because they hold the public’s savings, are at the heart of the payments process, and have the ability to create money through granting credit.

What is the purpose of demonstrating a public need for a new bank in a particular location?

To show that the proposed new institution will achieve adequate levels of profitability.

What do founder stockholders need to supply to start a new bank?

Enough start-up capital to cover several years.

What is the advantage of pursuing a federal bank charter?

The added prestige it conveys in the minds of customers, especially large depositors. Signup and view all the answers

Who can issue a charter of incorporation to start a new U.S. bank?

The banking commissions in each of the 50 states and the Office of the Comptroller of the Currency (OCC). Signup and view all the answers

Why do organizers often choose to pursue a federal bank charter?

For the added prestige it conveys in the minds of customers, especially large depositors. Signup and view all the answers

What is the difference between federal and state bank charters?

Federal standards for receiving a bank charter are more rigorous than the rules of state banking commissions. Signup and view all the answers

What do organizers need to consider when deciding between a federal or state charter?

The benefits and costs of each for the particular bank and its location(s). Signup and view all the answers

What is a characteristic of recently chartered banks?

They are financially fragile and more prone to failure. Signup and view all the answers

Why are new banks more vulnerable to failure?

They are more vulnerable to real estate crises. Signup and view all the answers

How are new banks generally supervised compared to established institutions?

They are more closely supervised by government regulators and tend to be examined more frequently. Signup and view all the answers

What is an important vehicle for market entry when an established financial institution wishes to enter new markets?

The creation of new branch offices. Signup and view all the answers

What determines the location, design, and services offered by a branch office?

The preferences of customers and the preferences of management and employees. Signup and view all the answers

Who is the branching leader in the United States?

The Bank of America. Signup and view all the answers

What is a desirable characteristic of a site for a full-service branch office?

Some specific characteristics, such as population demographics and accessibility. Signup and view all the answers

What is the purpose of Exhibit 4-1 in the text?

It shows the number of insured commercial bank and branch offices from 1935 to 2009. Signup and view all the answers

What is one benefit of applying for a federal charter for a bank?

It brings added prestige due to stricter regulatory standards that may attract larger deposits. Signup and view all the answers

What is an advantage of applying for a state charter for a bank?

It is generally easier and less costly to secure a state charter and supervisory fees are usually lower. Signup and view all the answers

What is one service that a state-chartered bank may be able to offer that a national bank may not?

Certain services that national banks may not be able to offer. Signup and view all the answers

What is one question that regulators might ask the organizers of a new bank?

What are the population and geographic boundaries of the primary service area (PSA) from which the new financial firm is expected to generate most of its account activity? Signup and view all the answers

Why might regulators want to know about competing banks in the proposed service area?

To understand the level of competition and ensure the new bank can be competitive and profitable. Signup and view all the answers

What is another question that regulators might ask the organizers of a new bank?

What are the number, types, and sizes of businesses in the area? Signup and view all the answers

Why might regulators be interested in traffic patterns in the area?

To assess the accessibility and convenience of the proposed bank location. Signup and view all the answers

What is the purpose of regulators asking these questions?

To assess the viability and sustainability of the proposed new bank. Signup and view all the answers

What are the two main considerations when evaluating possible locations for new branches?

The two main considerations are the variance around the expected return and the covariance of expected returns from the proposed new branch, existing branches, and other assets. Signup and view all the answers

What is W in the equation for a new branch's expected return (RB) on the offering institution's total return (RT)?

W is the proportion of total resources to be invested in the new branch. Signup and view all the answers

What does (1-W) represent in the equation for a new branch's expected return (RB) on the offering institution's total return (RT)?

(1-W) is the proportion of the offering institution's resources invested in all of its other assets (OA). Signup and view all the answers

What is the formula for calculating the marginal impact of a new branch on overall risk measured by the variance of total return (RT)?

The formula is: $σ^2_RT = W^2 * σ^2_B + (1-W)^2 * σ^2_OA + 2W(1-W)ρ_B,OΑ * σ_B * σ_OA$ Signup and view all the answers

What does ρ_B,OΑ represent in the formula for calculating the marginal impact of a new branch on overall risk?

ρ_B,OΑ represents the correlation coefficient between the expected return from the proposed new branch and the returns from other assets of the offering institution. Signup and view all the answers

What does σ_B represent in the formula for calculating the marginal impact of a new branch on overall risk?

σ_B represents the standard deviation of the proposed new branch's expected return. Signup and view all the answers

What does σ_OA represent in the formula for calculating the marginal impact of a new branch on overall risk?

σ_OA represents the standard deviation of return from other assets held by the financial firm. Signup and view all the answers

How can geographic diversification affect overall risk exposure?

Geographic diversification can reduce overall risk exposure. Signup and view all the answers

What are the two regulations that have made it more difficult to close full-service branch offices of depository institutions in the United States?

The FDIC Improvement Act of 1991 and The Community Reinvestment Act of 1977 Signup and view all the answers

What is the evolving role of branch offices today?

Sales orientation and cross-selling Signup and view all the answers

What is the advantage of in-store branching?

They are less costly to build and maintain and become profitable faster than stand-alone facilities Signup and view all the answers

What is unique about the hours of operation for in-store branches?

They operate for longer hours Signup and view all the answers

Why are in-store branches experiencing more traffic flow?

They are located inside supermarkets, shopping centers, and other retail establishments Signup and view all the answers

How do in-store branches typically staff?

With only a few employees Signup and view all the answers

Study Notes

Chartering a New Financial Institution

In most countries, government approval is required to start a financial firm, including banks.
The founder stockholders must supply sufficient start-up capital to cover several years and demonstrate that the proposed institution will achieve adequate levels of profitability.
Government chartering agencies scrutinize financial-service providers due to their role in holding public savings, supporting trade and commerce, and creating money through credit.

The Bank Chartering Process in the United States

Only the banking commissions in each of the 50 states and the Office of the Comptroller of the Currency (OCC) can issue a charter of incorporation to start a new U.S. bank.
Federal standards for receiving a bank charter are generally more rigorous than state banking commissions.
Organizers often seek a federal bank charter for added prestige and national authority.

Benefits of Applying for a Federal (National) Charter

Added prestige due to stricter regulatory standards, attracting larger deposits.
Technical assistance from national authorities in times of trouble, giving the bank a better chance to survive.
Federal rules can pre-empt state laws.

Benefits of Applying for a State Charter

Easier and less costly to secure a state charter.
Lower supervisory fees.
The bank need not join the Federal Reserve System.
State-chartered banks may be able to offer certain services that national banks may not.
Some states allow a bank to lend a higher percentage of its capital to a single borrower.

Questions Regulators Usually Ask the Organizers of a New Bank

What is the population and geographic boundaries of the primary service area (PSA)?
How many competing banks, credit unions, finance companies, and other competitors are located within the service area?
What are the number, types, and sizes of businesses in the area?
What are the traffic patterns in the area, adequacy of roads, and geographic barriers to the flow of traffic?

Establishing Full-Service Branch Offices

When an established financial institution wishes to enter new markets or when its valued customers move, an important vehicle for market entry is the creation of new branch offices.
Establishing branches is usually much cheaper than chartering new financial-service corporations.
The location, design, and services offered by a branch office depend upon the preferences of customers and management and employees.

Desirable Sites for Full-Service Branch Offices

Possess certain characteristics, such as high traffic flow, proximity to shopping centers, and ease of accessibility.

Other Considerations when Choosing Branch Locations

The variance around that expected return, due mainly to fluctuations in economic conditions in the area served by the branch.
The covariance of expected returns from the proposed new branch, existing branches, and other assets previously acquired by the offering institution.

The Impact of a New Branch on Overall Risk

The marginal impact of a new branch on overall risk measured by the variance of total return (RT) can be calculated.
Geographic diversification can reduce overall risk exposure.

Regulation and Evolution of Branch Offices

Recent regulation in the United States has made it more difficult to close full-service branch offices of depository institutions.
The roles played by branch offices are evolving, with a focus on sales orientation, cross-selling, and fee-generating service sales.
Branches are viewed as sources of profitable assets, rather than mere deposit gatherers.

In-Store Branching

A significant portion of financial-service branches are located inside supermarkets, shopping centers, and other retail establishments.
These retail-oriented service facilities have only a few employees, are highly sales-oriented, and operate for longer hours.
In-store branches are typically less costly to build and maintain, and tend to become profitable earlier than stand-alone facilities.

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Description

Learn about the regulations and approvals required to start a new financial institution, including de novo banks, and the necessary start-up capital and demonstration of public need.