The United States banking system has a rich and complex history, with a multitude of regulations and laws in place to ensure its stability and protect the interests of its stakeholders. Over the years, the US has experienced significant banking crises, such as the Great Depression in the 1930s and the 2008 financial crisis. These events prompted significant policy responses, including the establishment of the Federal Reserve System in 1913 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. While the US banking system differs from other jurisdictions due to its unique regulatory framework, it remains one of the largest and most influential financial sectors globally.
Banking in the US is governed by a dual banking system, where banks can either be chartered by the federal government or by individual states. This system enables banks to offer various financial products and services, such as accepting deposits, making loans, and providing payment services. However, this flexibility also exposes banks to various risks, including credit, market, liquidity, operational, and legal risks. Banks must manage these risks prudently to maintain stability and avoid financial distress or failures.
Banking regulation in the US plays a crucial role in maintaining the safety and soundness of the financial system. Regulatory agencies, such as the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), work together to establish rules and guidelines to ensure that banks maintain adequate capital, engage in sound risk management practices, and adhere to consumer protection laws.
Despite stringent regulations, the US banking sector has several weaknesses, including the potential for systemic risk, increased complexity, and the existence of “too-big-to-fail” institutions. These weaknesses can create uncertainty for account holders and other creditors, potentially leading to financial losses or bank failures. Furthermore, the interconnectedness of global financial markets can exacerbate these weaknesses, posing challenges for regulators and policymakers.
US Banking Law
The National Bank Act (1863): Established the national banking system and provided for the issuance of national banknotes.
The Federal Reserve Act (1913): Created the Federal Reserve System, the central banking authority in the US, responsible for monetary policy and financial stability.
The Glass-Steagall Act (1933): Separated commercial and investment banking activities and established the FDIC to insure deposits.
The Bank Holding Company Act (1956): Regulated bank holding companies and their subsidiaries.
The Community Reinvestment Act (1977): Encouraged banks to meet the credit needs of their communities, particularly low- and moderate-income neighborhoods.
The Gramm-Leach-Bliley Act (1999): Repealed parts of the Glass-Steagall Act, allowing banks to engage in a broader range of financial activities.
The USA PATRIOT Act (2001): Enhanced anti-money laundering and counter-terrorism financing measures.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010): Introduced comprehensive financial reforms to improve the stability and transparency of the financial system and enhance consumer protection.
Regulatory agencies can impose various administrative sanctions on banks, including cease and desist orders, fines, or the removal of directors and officers. These actions aim to address violations of banking laws and regulations, ensure compliance, and deter future misconduct. Additionally, regulators have the authority to take corrective actions, such as requiring banks to increase capital or divest certain assets to maintain financial stability.
The US cooperates with foreign regulators and international organizations, such as the Financial Action Task Force (FATF) and the Basel Committee on Banking Supervision, to ensure that banks adhere to global standards and best practices. This cooperation facilitates information sharing, joint investigations, and enforcement actions against cross-border financial crimes, money laundering, and terrorist financing.
Bank Resolution Procedures in the USA
Bank resolution procedures in the US aim to restore a failing bank to a viable financial condition or facilitate its orderly liquidation to minimize the impact on the financial system and protect taxpayers. The FDIC, as the primary resolution authority, has several tools at its disposal, such as purchase and assumption transactions, bridge banks, or the single point of entry strategy. These tools allow the FDIC to transfer assets and liabilities to a healthy institution, maintain critical services, and ensure continuity for customers and counterparties.
When a bank becomes insolvent, the FDIC steps in as the receiver to manage the bank’s assets and liabilities, protect depositors, and minimize the cost to the Deposit Insurance Fund (DIF). The FDIC has the power to sell the bank’s assets, assume certain liabilities, and pay depositors and other creditors according to their priority in the creditor hierarchy. Insured depositors have the highest priority, followed by general unsecured creditors, subordinated debt holders, and finally shareholders.
Historic Events: Failed US Financial Institutions
Several high-profile bank failures in the US provide insights into how banking law and resolution procedures can protect account holders and other stakeholders. Notable cases include:
Washington Mutual (2008): Washington Mutual’s (WaMu) failure was primarily due to its aggressive lending practices, particularly in the subprime mortgage market, which led to significant losses when the housing market collapsed. Additionally, the bank faced a massive loss of confidence as customers withdrew over $16 billion in deposits within a 10-day period in September 2008. The Office of Thrift Supervision (OTS) seized WaMu on September 25, 2008, and appointed the FDIC as the receiver. The same day, the FDIC brokered a deal with JPMorgan Chase to acquire WaMu’s assets and deposits in a purchase and assumption transaction. Account holders did not face any write-downs on their balances, as JPMorgan Chase assumed all deposits, preventing any losses for customers.
IndyMac Bank (2008): IndyMac Bank failed due to its high exposure to the housing market, particularly in the form of adjustable-rate mortgages and home equity loans. As the housing bubble burst, IndyMac faced mounting losses and a rapidly deteriorating capital position. On July 11, 2008, the OTS closed IndyMac, and the FDIC was appointed as the receiver. The FDIC established a bridge bank, IndyMac Federal Bank, FSB, to continue operations and maintain customer access to their deposits. In March 2009, the FDIC sold the assets and operations of IndyMac to OneWest Bank in a purchase and assumption transaction. Most account holders did not face write-downs, as the FDIC insured deposits up to $100,000 per depositor (raised to $250,000 later in 2008). However, uninsured depositors faced losses, as they only received an initial payout of 50% of their uninsured deposits.
Wachovia (2008): Wachovia’s troubles stemmed from its acquisition of Golden West Financial in 2006, which had a significant portfolio of option adjustable-rate mortgages (option ARMs). As the housing market deteriorated, Wachovia’s losses mounted, and its liquidity position weakened. In late September 2008, Citigroup initially agreed to acquire Wachovia’s banking operations in a deal facilitated by the FDIC, but the deal fell through. Subsequently, on October 3, 2008, Wells Fargo announced that it would acquire Wachovia in an all-stock transaction without FDIC assistance. The acquisition was completed on December 31, 2008. Wachovia’s account holders did not face any write-downs on their balances, as the acquisition by Wells Fargo ensured the continuity of their banking services and the safety of their deposits.
In each of these cases, banking law and resolution procedures played a critical role in protecting account holders, minimizing disruptions to the financial system, and maintaining public confidence.
Legal Framework for Creditors Impacted by US Bank Failure
Creditors impacted by a bank failure in the US can utilize the legal framework to recover their funds. The FDIC, as the receiver, is responsible for paying creditors according to the priority established by law. If a creditor’s claim is not fully satisfied through the resolution process, they may be entitled to share in the proceeds from the sale of the bank’s remaining assets. Furthermore, international creditors can rely on the cooperation between the US and foreign regulators to facilitate the enforcement of their claims across borders.
In conclusion, the US banking system, while robust and heavily regulated, is not immune to failures and weaknesses. International bank creditors must be aware of the complex legal framework governing the US banking sector and the protections it offers in case of bank failures. By understanding the principles of banking, regulatory enforcement, resolution and insolvency procedures, and the role of the FDIC, international creditors can better navigate the US banking landscape and minimize the risks associated with potential bank failures.