Banking Law Project

Banking Law Project, 2014

Page | 1

BANKING LAW PROJECT

A CRITICAL STUDY OF CENTRAL BANKING INSTITUTIONS AND

REGULATORY FRAMEWORK IN GLOBAL SCENARIO

SUBMITTED TO: Prof. Rajat Solanki

SUBMIITED BY: Kislay Kumar

(2011/BBA LL.B/027)

Riyanka Roy Choudhary

(2011/BBA LL.B/060)


Page | 2

TABLE OF CONTENTS

HYPOTHESIS ................................................................................................................................ 4

RESEARCH QUESTION ............................................................................................................... 4

SCOPE AND LIMITATIONS OF THE PAPER ........................................................................... 4

OBJECTIVE ................................................................................................................................... 4

RESEARCH METHODOLOGY.................................................................................................... 4

INTRODUCTION .......................................................................................................................... 5

SEMINAL SHIFT IN CENTRAL BANKS POLICY-MAKING ROLES ................................... 6

MEANING OF CENTRAL BANK ................................................................................................ 6

FUNCTION OF THE CENTRAL BANK ...................................................................................... 7

RESERVE BANK OF INDIA: THE CENTRAL BANK OF INDIA ............................................ 7

History......................................................................................................................................... 8

Central Board of Directors .......................................................................................................... 8

Governors and Supportive Bodies .............................................................................................. 8

Tools of RBI ............................................................................................................................... 9

Functions of RBI ....................................................................................................................... 10

RBIS ROLE IN SUPERVISION AND REGULATION ............................................................ 11

Maintaining Financiak Stability ................................................................................................ 12

BANK OF ENGLAND: U.K. CENTRAL BANK ....................................................................... 12

Introduction ............................................................................................................................... 12

History of the Bank ................................................................................................................... 12

Functions of The Bank .............................................................................................................. 13

REGULATORY FRAMEWORK OF BANK OF ENGLAND.................................................... 14

Financial Policy Committee ...................................................................................................... 15

The Financial Conduct Authority (FCA) .................................................................................. 16

FEDERAL BANK: CENTRAL BANK OF USA ........................................................................ 16

History of Central banking in the United States ....................................................................... 16

Purpose of the Federal Reserve System .................................................................................... 17

Functions of the Federal Reserve System ................................................................................. 17


Page | 3

Federal funds ............................................................................................................................. 18

REGULATORY FRAMEWORK OF FEDERAL BANK OF USA ............................................ 18

CONCLUSION ............................................................................................................................. 21

BIBLIOGRAPHY ......................................................................................................................... 23

Dictionary ................................................................................................................................. 23

Books ........................................................................................................................................ 23

Articles ...................................................................................................................................... 23


Page | 4

HYPOTHESIS

The art of central banking but which ,in changing world, is still in the process of evolution and

subject to periodical adjustment.

RESEARCH QUESTION

This paper seeks to elucidate that whether it is imaginable that there would be a strong political

dimension to the activities of Central Banks. Furthermore it tries to comprehend that while it is

comparatively straightforward to set a target for inflation, how does one measure financial

stability, and just what degree of financial instability is deemed acceptable?

SCOPE AND LIMITATIONS OF THE PAPER

The paper would explore the evolution of RBI, Bank of England and Federal Bank over the years

and the limitations imposed by the Regulatory Framework.

OBJECTIVE

The aim of the project is to present a detailed study of the Central Banking institutions and

Regulatory Bodies in a Global Scenario through detailed study of various writings, articles &

reports.

RESEARCH METHODOLOGY

The project is basically based on the doctrinal method of research. The project is made with the

help of secondary resources.


Page | 5

INTRODUCTION

History suggests that there is no constancy in the practice of central Banking. This implies that

there is no one size that fits all: we have to keep changing central banking functions as the need

changes. We need different horses for different courses.

- Rakesh Mohan former Deputy Governor RBI

The continuing financial and economic crisis have pushed central bankers middle of everyone's

attention and given them a role as heading on-screen characters, at the same time criticized as

begetters of the emergency and hailed as potential friends in need. It is not clear that all central

bankers welcome this move from participation of until now to a great extent unacknowledged

technocratic world class to an undeniably open part. Central bankers need to change in

accordance with an inexorably open and unmistakable position on the political stage. A principal

open deliberation about the position of focal keeping money and its relationship to government is

currently under way. The budgetary emergency has prompted respectable interlinked financial,

sovereign obligation and fiscal area turbulence. This has been joined by expanding instability in

the political coliseum and a precarious world against the scenery of a wholesale macroeconomic

worldwide change. Central bankers have achieved a new prominence and become pivotal

members of the policy-making establishments of both national and intergovernmental

organizations.

As a consequence of a developing obligation regarding budgetary steadiness, coupled with their

injection of massive amounts of liquidity into the financial system, national banks in numerous

purviews, have developed their forces and transmit past their universal "lender of last resort"

function. We suggest in this paper that this extension of powers is unlikely to be temporary and


Page | 6

may not be entirely desirable. It raises broad inquiries regarding the responsibility and

transparency of the chief exercises of central bankers. Notwithstanding their conventional

financial strategy and administrative keeping money parts, central banks have become national

and worldwide fire fighters with developing obligation regarding the flexibility of economies,

the solidness of monetary frameworks and singular budgetary establishments, macro-and micro

prudential regulation, and macroeconomic and quasi fiscal policy. While it is comparatively

straightforward to set a target for inflation, how does one measure financial stability, and just

what degree of financial instability is deemed acceptable? We will try to find the answers to

these questions through this paper.

SEMINAL SHIFT IN CENTRAL BANKS POLICY-MAKING ROLES

Money has been with us for more than 4,000 years; for most of that time, we managed without

central bankers. Throughout the previous 150 years in which Banks assumed a paramount part in

the financial lives of leading nations, Central Banks' impact has waxed and disappeared. But

since the eruption of the global financial crisis in 2007 and the accompanying large-scale

increase in government debt in the US, Europe and Japan, they have undergone a seminal shift

with few precedents. Central bankers have risen significantly in the economic rankings to

become a pivotal part of the policy-making establishment in both industrialized countries and in

emerging market economies. The new scene brings an extent of outcomes on a worldwide scale,

with repercussions on budgetary and business drills in numerous parts of the world. More

stupendous exposure to legislative issues and the media and crisp operational undertakings

oblige them to build assorted qualities of recruitment. In some cases, they are required to be

more market-orientated and focused on profitability while also being more aware of commercial

and financial risk.

MEANING OF CENTRAL BANK

In every nation there is one bank which goes about as the pioneer of the currency business sector,

administering controlling the managing the exercises of the business banks and other money


Page | 7

related organizations. It acts as a bank of issue and is in close touch with the government, as

banker, agent and adviser to the latter. Institution charged with the responsibility of managing the

expansion and contraction of the volume of money in the interest of general public welfare. It is

an establishment answerable for safe guarding the money cut of the nation.

FUNCTION OF THE CENTRAL BANK

The function of the central bank differs from country to country in accordance with the

prevailing economic situation. But there are certain functions which are commonly performed by

the central bank in almost all countries.

1. Monopoly of Note Issue

2. Custodian of Exchange Reserves

3. Banker to the government

4 Banker to Commercial banks

Broadly speaking, the central bank acts as the bankers bank in three different capacities:

a. It acts as the custodian of the cash reserves of commercial banks.

b. It acts as the lender of the last resort.

c. It is the bank of central clearance, settlement and transfer.

RESERVE BANK OF INDIA: THE CENTRAL BANK OF INDIA

The Reserve Bank of India (RBI) is the central banking institution of India and controls the

monetary policy of the Indian rupee. The institution was established on 1 April 1935 during the

British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934. Reserve

Bank of India has imperative impact in the improvement technique of the legislature. Reserve

Bank of India was nationalised in the year 1949. The general superintendence and direction of

the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four


Page | 8

Deputy Governors, one Government official from the Ministry of Finance, ten nominated

Directors by the Government to give representation to important elements in the economic life of

the country, and four nominated Directors by the Central Government to represent the four local

Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi.

HISTORY

The bank was established in 1935 to react to financial inconveniences after the first world war.

The Reserve Bank of India was set up on the proposals of the Royal Commission on Indian

Currency and Finance, otherwise called Hilton-Young Commission. The requisition submitted its

report in the year 1926; however the bank was not set up for an additional nine years. The

Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as to

regulate the issue of bank notes, to keep reserves with a view to securing monetary stability in

India and generally to operate the currency and credit system in the best interests of the country.

The Central Office of the Reserve Bank was at first settled in Kolkata, Bengal, however was for

all time moved to Mumbai in 1937.

CENTRAL BOARD OF DIRECTORS

The Central Board of Directors is the main committee of the central bank. The Government of

India appoints the directors for a four-year term. The Board consists of a governor, four deputy

governors, fifteen directors to represent the regional boards, one from the Ministry of Finance

and ten other directors from various fields1.

GOVERNORS AND SUPPORTIVE BODIES

The current Governor of RBI is Dr. Raghuram Rajan2. The Board of Financial Supervision

(BFS), formed in November 1994, serves as a CCBD committee to control the financial

1 Natarajan & Gordon:Banking Theory And Practicle, (2nd Ed.) 123

2 Reddy & Appanniah:Banking Theory And Practice, (6th Ed.) 115


Page | 9

institutions. It has four members, appointed for two years, and takes measures to strength the role

of statutory auditors in the financial sector, external monitoring and internal controlling systems.3

TOOLS OF RBI4

1) Bank Rate

Bank rate is official minimum rate of the Central Bank of the country to advances loan to

commercial bank. It is the rate at which RBI rediscounts the bills.

2) Repo Rate

Repo rate is the interest rate at which the Reserve Bank of India lends money to commercial

banks.

3) Reverse Repo Rate

Reverse Repo rate as the name suggests is the rate at which RBI borrows from other Commercial

banks.

4) Cash Reserve Ratio

Cash reserve Ratio (CRR) is the amount of funds that the banks have to maintain or keep with

RBI. If RBI decides to increase CRR percent then the available amount with the banks comes

down. RBI uses this method (increasing the CRR rate), to drain out the excessive money from

the banks.

5) Statutory Liquidity Ratio

SLR (Statutory Liquidity Ratio) is the amount a commercial bank needs to maintain in the form

of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers.

SLR rate is determined and maintained by the RBI in order to control the expansion of bank

credit.

3 Muranjan S.K.: Modern Banking in India, (6

th Ed.) pg. 225

4 Banking Law, S.N Gupta, Universal Law Publications.


Page | 10

FUNCTIONS OF RBI5

1) Issue of currency

The Reserve Bank of India is the nations sole currency issuing authority. Along with the

Government of India, RBI is responsible for the Design and production and overall management

of the nations Currency, with the goal of ensuring an adequate supply of clean and genuine

notes and coins.

2) Banker to the government

Reserve bank of India accepts deposits from government. It also advances short term loans to

govt. on request and provides foreign exchange resources to govt. to pay the external debt.6

3) Agent to the government

The RBI plays role of an agent for govt. It collects taxes and other payments on behalf of govt. It

represents the govt. in international financial institution like World Bank and IMF.7

4) Adviser to the government

RBI gives valuable advice to govt. on important issues like devaluation of currency, budgetary

policy, commercial policy, exchange rate policy.

5) Banker to the Bank

Like individual consumers, businesses and organizations of all kinds, banks need their own

mechanism to transfer funds and settle inter-bank transactionssuch as borrowing from and

lending to other banksand customer transactions. As the banker to banks, the Reserve Bank

satisfies this part.8 As a result, all banks working in the nation have accounts with the Reserve

5 Tannans Banking Law And Practice In India, M.L Tannan, 23rd Edition, Lexisnexis Publications. 6 Schuler, Kurt (1996) Should Developing Countries Have Central Banks? London: Institute of Economic Affairs.

7 Ricardo,David (1951) The Works and Correspondence of David Ricardo, Volume I: On the Principles of Political

Economy and Taxation. Cambridge: Cambridge University Press. 8 Rockoff, Hugh (1990) The Wizard of Oz as a Monetary Allegory. Journal of Political Economy, 98: (August), pp.

139-170.


Page | 11

Bank, in the same way that people and organizations have accounts with their banks.9 The

central bank acts as banker's bank in three different capacities:

Custodian of cash reserve of commercial banks.

Lender of last resort.

Bank of central clearance, settlement and transfer.10

6) Lender of last resort

At the point when commercial banks are not able to secure money related convenience from

different sources, then if all else fails, they can approach the central bank for essential facilities.11

The central bank, in such a case, will be ready to concede settlement against qualified securities.

By lender of last resort, the central ink assumes the responsibility of meeting directly or

indirectly all reasonable demands for funds in times of emergency.12

RBIS ROLE IN SUPERVISION AND REGULATION

Banks are fundamental to the nations financial system. The RBI has a critical part to play in

guaranteeing the well being and soundness of the banking system and in maintaining financial

stability and public confidence in this system. As the controller and manager of the banking

system the RBI prescribes expansive parameters of banking operations within which the

country's banking and financial system functions.13

Reserve Bank protects the interests of

depositors, ensures a framework for orderly development and conduct of banking operations

conducive to customer interests and maintains overall financial stability through preventive and

corrective measures like licensing supervise and control commercial and co-operative banks.

9 Rothbard, Murray N. (1962) The Panic of 1819: Reactions and Policies. New York: Columbia University Press.

10 Posen, Adam (1998). Do Better Institutions Make Better Policy? International Finance, 1 (October): 173-205.

11 Schwartz, Anna J. (2009) Origins of the Financial Market crisis of 2008. Cato Journal 29 (Winter): 19-23.

12 Selgin, George and Lawrence H. White (1999) A Fiscal Theory of Governments Role in Money. Economic

Inquiry 37 (January): 154-65. 13

Smith, Vera C. (1990; 1936) The Rationale of Central Banking and the Free Banking Alternative. Indianapolis:

Liberty Press.


Page | 12

MAINTAINING FINANCIAL STABILITY

Quest for nancial security has risen as a key discriminating strategy objective for the central

banks in the wake of the late worldwide nancial emergency. Central banks have a critical part

to play in accomplishing this destination. In 2009, the Reserve Bank set up a dedicated Financial

Stability Unit mainly to, put in place a system of continuous monitoring of the macro nancial

system14

. In December every year, quarterly Systemic Risk Monitors and monthly Market

Monitors are prepared to place before the Banks Top Management a more frequent assessment

of the risks to systemic stability of the economy. In the Union Budget for 2010-11, the Finance

Minister announced the establishment of Financial Stability and Development Council (FSDC)

to provide, among other things, a high level focus to nancial stability.15

BANK OF ENGLAND: U.K. CENTRAL BANK

INTRODUCTION

The Bank of England is the Central bank of the whole of the United Kingdom and is the model

on which most modern, large central banks have been based was established in 1694 to act as the

English Government's banker, nationalized in 1946. The Bank has a restraining infrastructure on

the issue of banknotes in England and Wales. The Bank's home office has been found in

London's primary fiscal area, the City of London, on Threadneedle Street, since1734.

HISTORY OF THE BANK

England's crushing defeat by France, the dominant naval power, in naval engagements

culminating in the 1690 Battle of Beachy Head, turned into the impetus to Britain revamping

itself as a worldwide power. England had no choice but to build a powerful navy if it was to

14

ODriscoll, Gerald P., Jr. (2012) Central Banks: Reform or Abolish? Unpublished manuscript, January 15. 15

Oatley T (1999). Central Bank Independence and Inflation: Corporatism, Partisanship, and Alternative Indices of

Central Bank Independence. Public Choice, 98: 399-13.


Page | 13

regain global power16

. As there were no public funds available, in 1694 a private institution, the

Bank of England, was set up to supply money to the King. 1.2m was raised in 12 days; half of

this was used to rebuild the Navy17

. More recently, in 2007 the Bank of England, in its role as

lender of last resort, helped support Northern Rock, a specialist mortgage lender that suddenly

became unable to rely on wholesale market borrowing to finance its lending operation following

the 2007 subprime mortgage crisis18

.

FUNCTIONS OF THE BANK

1) MONETARY STABILITY

Monetary policy is directed to achieving this objective and to providing a framework for non-

inflationary economic growth19

. As in most other developed countries, monetary policy operates

in the UK mainly through influencing the price at which money is lent, in other words the

interest rate20

. Stable prices and confidence in the currency are the two main criteria for

monetary stability. Stable prices are maintained by making sure price increases meet the

Government's inflation target21

.

2) FINANCIAL STABILITY

The money related framework is vital to the working of the economy and cutting edge life. The

framework handles a large number of general transactions - using in the shops, paying bills,

wages and funds - consistently.22

Monetary establishments, for example, banks, oversee

immense wholes of cash in the interest of people and organizations. Fiscal markets encourage

exchange over the world on a moment by-moment support - everything from organization shares

and things like oil, to complex money related instruments and, obviously, cash itself.

16

Mayer, Thomas (ed., 1990). Political Economy of Monetary Policy, Cambridge: Cambridge University Press. 17

Steil, Benn and Manuel Hinds (2009) Money, Markets and Sovereignty. New Haven and London: Yale University

Press. 18

Taylor, John B. (2009) Getting Off Track. Stanford: Hoover Institution Press 19

Temin, Peter (1969) The Jacksonian Economy. New York: W.W. Norton. 20

White, Lawrence H. (1989) Competition and Currency: Essays on Free Banking and Money. New York and

London: New York University Press 21

Lacker, Jeffrey M. (2012) Understanding the Interventionist Impulse of the Modern Central Bank. Cato Journal

32 (Spring/Summer): 247-53. 22

Carlstrom, Charles T. and Timothy S. Fuerst (2009). Central Bank Independence and Inflation: A Note.

Economic Inquiry, 47 (January): 182-186.


Page | 14

Furthermore expansive IT frameworks encourage payments between budgetary organizations,

organizations and people. One of the main purposes of the financial system is to bring together

savers and investors, and so put money to work23

. One person's savings are the finance for

another person's investment - for example, household savings are invested by pension funds in

shares issued by companies to expand their business24

.

REGULATORY FRAMEWORK OF BANK OF ENGLAND

In anticipation of legislation to create a Financial Policy Committee (FPC), outlined in the

Governments consultation document, A new approach to financial regulation: building a

stronger system, the Government and the Bank announced the establishment of an interim

Financial Policy Committee on 17 February 2011. The Bank of England is as of now

encountering its most critical institutional and useful changes in an era. Failings in pre-crisis

courses of action have incited the Government to acquaint wholesale changes with the UK

regulatory landscape which came into force in April 2013.

This administrative change has brought about the Bank picking up critical new obligations,

including for: micro prudential regulation of insurers, deposit-takers and major investment firms,

through the creation of the Prudential Regulation Authority; macro prudential regulation of the

financial system as a whole, through the creation of the Financial Policy Committee; and

supervision of some critical post-trade financial market infrastructure providers. The Financial

Services Act 2012 acquaints imperative progressions with the administrative skeleton of fiscal

administrations in the United Kingdom, a large portion of which influence the Bank of

England.25

The Financial Services Authority (FSA), which was awhile ago answerable for

regulation of monetary firms from both a "prudential" and "behavior" viewpoint, will cease to

exist26

.

23

Cukierman, A. S (1992). Central Bank Strategy, Credibility, and Independence: Theory and Evidence. The MIT

Press: Cambridge, MA. 24

Cukierman, A., S. Webb, and B. Neyapti (1992). Measuring The Independence of Central Banks and Its Effect on

Policy Outcomes. World Bank Economic Review, 6(3): 35398. 25

Cargill, Thomas F. and Takayuki Sakamoto (2008). Japan Since 1980. Cambridge University Press: New York. 26

Friedman, Milton (1962) Capitalism and Freedom. Chicago and London: University of Chicago Press.


Page | 15

The Prudential Regulation Authority will be a part of the Bank and will be answerable for the

micro prudential regulation of deposit-takers, insurers and major investment firms27

. This

includes setting standards and supervising financial institutions at the level of the individual firm

so as to promote their safety and soundness, seeking to minimise the adverse effects that they can

have on the stability of the UK financial system; and contributing to ensuring that insurance

policyholders are appropriately protected. The PRA will be a subsidiary of the Bank and will be

the United Kingdom's micro prudential controller for store takers, significant financing firms and

back up plans. The PRAs new role will be grounded in two statutory objectives28:

To promote the safety and soundness of all the firms it supervises. This will be achieved

primarily by minimising the harm that firms can cause to the stability of the UK financial

system, in particular the harm resulting from disruption to the continuity of provision of financial

services.

And, specifically for insurers, to contribute to the securing of an appropriate degree of protection

for those who are, or may become, policyholders. In addition to its statutory objectives, the PRA

must 'have respect' to an arrangement of administrative standards set out in the Act, including

effective utilization of its assets; transparency; proportionality; the allure of supportable

development in the economy of the United Kingdom; and the need to minimize any antagonistic

impact on rivalry emerging from the release of its functions29

.

FINANCIAL POLICY COMMITTEE

The essential statutory destination of the FPC is to practice its capacities with a perspective to

helping the Bank accomplish its budgetary security objective. The responsibility of the FPC in

achieving that objective relates primarily to the identification of, monitoring of, and taking of

action to remove or reduce systemic risks with a view to protecting and enhancing the resilience

of the UK financial system. The FPC's assignment won't be to accomplish versatility at any

expense, on the other hand it ought not act in such a route as to likely have 'an adverse impact on

27

Friedman, Milton (1961) The Lag in Effect of Monetary Policy. The Journal of Political Economy 69 (October):

reprinted in Friedman (1969): 237-60. 28

Ferrell, Robert H., ed. (2010) Inside the Nixon Administration: The Secret Diary of Arthur Burns, 1969-1974.

University Press of Kansas.

29 Ferguson, Niall (2009) The Ascent of Money. New York: Penguin Books.


Page | 16

the limit of the financial sector to help the development of the UK economy in the medium or

long term.

THE FINANCIAL CONDUCT AUTHORITY (FCA)

It is a separate institution from the Bank, which is responsible for ensuring that relevant markets

function well30

. In completing thus, it will intend to development the security of purchasers, the

uprightness of the UK monetary framework and push viable competition31

. It will be responsible

for the conduct regulation of all financial services firms. This includes acting to prevent market

abuse and ensuring that financial firms treat customers fairly. 32

FEDERAL BANK: CENTRAL BANK OF USA

HISTORY OF CENTRAL BANKING IN THE UNITED STATES

The first paper money issued in the United States was by the Massachusetts Bay Colony in

169033

. Soon other colonies began printing their own money as well. The demand for currency in

the colonies was due to the scarcity of coins, which had been the primary means of trade at the

time34

. A settlement's money was utilized to pay for its expenditures, and in addition an intends

to credit cash to the province's subjects. In 1791, which was after the US Constitution was

approved, the administration conceded the First Bank of the United States a sanction to work as

30 Friedman, Milton (1968) The Role of Monetary Policy. The American Economic Review 58 (March); reprinted

in Friedman (1969): 95-110. 31

Friedman, Milton (1969) The Optimum Quantity of Money and Other Essays. Chicago: Aldine. 32

Fry, M., D. Julius, L. Mahadeva, S. Roger, and G. Sterne (2000). Key Issues in the Choice of Monetary Policy

Framework. In L. Mahadeva and G. Sterne (eds), Monetary Policy Frameworks in a Global Context, Routledge:

London. 33

Fujiki, Hiroshi (1996). Central Bank Independence Indexes in Economic Analysis: A Reappraisal. Monetary and

Economic Studies, (December): 80-101. 41 34

Cargill, Thomas F. (2012) A Critical Assessment of Measures of Central Bank Independence. Economic Inquiry.

Online version published January 12, 2012 with journal version forthcoming.


Page | 17

the U.s'. national bank until 181135

. Unlike the prior attempt at a centralized currency, the

increase in the federal government's powergranted to it by the constitutionallowed national

central banks to possess a monopoly on the minting of U.S currency. Nonetheless, The First

Bank of the United States came to an end when President Madison refused to renew its charter36

.

PURPOSE OF THE FEDERAL RESERVE SYSTEM

The primary motivation for creating the Federal Reserve System was to address banking

panics37

. Other purposes are stated in the Federal Reserve Act, such as "to furnish an elastic

currency, to afford means of rediscounting commercial paper, to establish a more effective

supervision of banking in the United States, and for other purposes"38

. When the establishing of

the Federal Reserve, the United States experienced a few fiscal emergencies. An especially

extreme emergency in 1907 headed Congress to sanction the Federal Reserve Act in 1913.

Today the Fed has more extensive obligations than only ensuring the stability of the financial

system39

.

FUNCTIONS OF THE FEDERAL RESERVE SYSTEM

The current functions of the federal system include:

To address the problem of banking panics40

To serve as the central bank for the United States41

35

Bade, Robin and Michael Parkin (1988). Central Bank Laws and Monetary Policy. University of Western

Ontario, Unpublished Manuscript, http://economics.uwo.ca/faculty/parkin/, October. 36

Alesina, Alberto and Lawrence H. Summers (1993). Central Bank Independence and Macroeconomic

Performance: Some Comparative Evidence. Journal of Money, Credit and Banking, 25 (May): 151-162. 37

Cargill, Thomas F (1995b). The Bank of Japan and Federal Reserve: An Essay on Central Bank Independence. In

Kevin D. Hoover and Steven M. Sheffrin (eds), Monetarism and the Methodology of Economics: Essays in Honour of

Thomas Mayer. Edward Elgar Publishing Co.: England. 38

Kotlikoff, Laurence J. 2010. Jimmy Stewart Is Dead: Ending the Worlds Ongoing Financial Plague with Limited

Purpose Banking. Hoboken, NJ: John Wiley & Sons. 39

Schoenmaker, Dirk. 2013. Governance of International Banking: The Financial Trilemma. New York: Oxford

University Press. 40

Tarullo, Daniel K. 2013. Macroprudential Regulation. Speech at the Yale Law School Conference on Challenges

in Global Financial Services, New Haven, CT. September 20. Link

http://www.federalreserve.gov/newsevents/speech/ 41

Bulletin articles including Lambert, R (2005), Inside the MPC, Bank of England Quarterly Bulletin, Spring, pages

5665.


Page | 18

To strike a balance between private interests of banks and the centralized responsibility

of government42

To supervise and regulate banking institutions

To protect the credit rights of consumers

To manage the nation's money supply through monetary policy to achieve the sometimes-

conflicting goals of43

o maximum employment

o stable prices, including prevention of either inflation or deflation moderate long-

term interest rates

FEDERAL FUNDS

Federal funds are the reserve balances (also called federal reserve accounts) that private banks

keep at their local Federal Reserve Bank44

. These balances are the namesake reserves of the

Federal Reserve System45

. The reason for keeping funds at a Federal Reserve Bank is to have a

component for private banks to lend funds to one another. This market for funds plays an

important role in the Federal Reserve System as it is what inspired the name of the system and it

is what is used as the basis for monetary policy46

.

REGULATORY FRAMEWORK OF FEDERAL BANK OF USA

Bank regulation in the United States is exceedingly divided contrasted and other G10 nations,

where most nations have only one bank regulator47

. In the U.S., banking is regulated at both the

federal and state level48

. Depending on the type of charter banking organization has and on its

42

Rakesh Mohan, Diversity to combat groupthink, OMFIF May Bulletin, 18 May 2012, pp. 67. 43

Rakesh Mohan, Growth with Financial Stability, Central Banking in an Emerging Market, Oxford University Press,

2011, p. xvi. 44

New York Times (2010) Times Topics: Alan Greenspan, April 7. 45

www.treasury.gov/initiatives/ofr/research/Documents/OFR_AMFS_FINAL.pdf accessed on March 23, 2014 46

Campillo, Marta and Jeffrey A. Miron (1997). "Why does Inflation Diverge across Countries". In Christina D.

Romer and David H. Romer (eds), Reducing Inflation: Motivation and Strategy. University of Chicago Press:

Chicago. 47

Holmstrm, Bengt. 2008. Commentary: The Panic of 2007. Comment on a Paper by Gorton. Jackson Hole. Link:

http://www.kc.frb.org/publicat/sympos/2008/Holmstrom.03.12.09.pdf 48

Humphrey, Thomas M. 2010. Lender of Last Resort: What It Is, Whence It Came, and Why the Fed Isnt It. Cato

Journal 30 (2).


Page | 19

organizational structure, it may be subject to numerous federal and state banking regulations.49

Unlike Japan and the United Kingdom (where administrative power over the managing an

account, securities and protection commercial ventures is consolidated into one single fiscal

administration organization), the U.s. upholds separate securities, wares, and protection

administrative organizations separate from the bank administrative offices at the federal and state

level50

.

Regulatory Authority

A bank's primary federal regulator could be the Federal Deposit Insurance Corporation,

the Federal Reserve Board, or the Office of the Comptroller of the Currency51

. Within the

Federal Reserve Board are 12 districts centred around 12 regional Federal Reserve Banks, each

of which carries out the Federal Reserve Board's regulatory responsibilities in its respective

district52

. Credit unions are liable to most bank regulations and are regulated by the National

Credit Union Administration53

. The Federal Financial Institutions Examination Council (FFIEC)

creates uniform standards, norms, and report structures for alternate agencies54

Deposit Account Regulation

The United States was the second country to officially enact deposit insurance to protect

depositors from losses by insolvent banks55

. In 1933 the Glasssteagall Act secured the Federal

49

Kayshap, Anil K., Raghuram Rajan, and Jeremy C. Stein. 2002. Banks as Liquidity Providers: Explaining the Co-

Existence of Lending and Deposit-Taking. Journal of Finance 57 (1): 3373. 50

Blinder, Alan S. (1998) Central Banking in Theory and Practice. Cambridge, MA: The MIT Press. 51

Buchanan, James M. and Richard E. Wagner (1977) Democracy in Deficit: The Political Legacy of Lord Keynes.

New York: Academic Press. 52

Financial Stability Forum. 2000. Report of the Working Group on Capital Flows: Meeting of the Financial

Stability Forum. Link: http://www.financialstabilityboard.org/publications/r_0004.pdf

2001. Goodfriend, Marvin. 2013. The Elusive Promise of Independent Central Banking. 53

Gorton, Gary, and Andrew Metrick. 2009. Securitized Banking and the Run on Repo. 54

Ahsan A, Skully M, & Wickramanayake J. 2006. "Determinants of Central Ban Independence and Governance:

Problems and Policy Implications." Journal of Administration and Governance 1, 47-67. 55

Ahsan A, Skully M, & Wickramanayake J. 2008. "Central bank Independence and Governance: Definitions and

Modelling." In Central banking Governance: Issues and Perspectives, edited by Jain RK, Sohani AK, pp 59-73.

Hyderabad: The Icfai University Press.


Page | 20

Deposit Insurance Corporation (FDIC) to guarantee stores at commercial banks56

. In 1970

Congress established a separate fund for credit unions, the National Credit Union Share

Insurance Fund. The NCUSIF protects all federally chartered credit unions and many state-

chartered credit unions (98% as of 2009)57

. In 1978 foreign banks operating in the United States

were required to hold the same level of reserves under the specifications of the International

Banking Act58

. In 1934, Congress made the Federal Savings and Loan Insurance Corporation to

safeguard funds and credit stores. In the 1980s, throughout the funds and advance emergency,

the FSLIC got ruined and was canceled; its obligation was exchanged to the FDIC59

.

Central Banking Regulation

Extensions of Credit by Federal Reserve Banks (Regulation A) establishes rules

regarding discount window lending, the extension of credit by the Federal Reserve Bank to

banks and other institutions60

. The Federal Reserve Board made significant amendments to

Regulation A in 2003, including amendments to price certain discount-window lending at above-

market rates and to restrict borrowing to banks in generally sound condition61

. In amending the

regulation, the Federal Reserve Board noted that many banks had expressed their unwillingness

to use discount-window borrowing because their use of such a funding source was interpreted as

sign of the bank's financial weakness or distress62

. The Federal Reserve Board indicated its hope

56

Amtenbrink F. 2004. The Three Pillars of Central Bank Governance - Towards a Model Central Bank Law or a Code

of Good Governance? 57

Arnone M, Laurens BJ, Segalotto J-F, & Sommer M. 2007. Central Bank Autonomy: Lessons from Global Trends.

In: International Monetary Fund Working Paper WP/07/88 58

Bade R, Parkin M. 1988. Central Bank Laws and Monetary Policy. In: Department of Economics Working Paper,

University of Western Ontario, edited by. 59

Banaian K, Burdekin RCK, & Willett TD. 1995. "On the Political Economy of Central Bank Independence." In

Monetarism and Methodology of Economics: Essays in Honour of Thomas Mayer, edited by Hoover KD, Sheffrin

SM, pp 178-197. Aldershot, UK: Edward Elgar. 60

Adrian, Tobias, and Hyun Song Shin. 2010. Liquidity and Leverage. Journal of Financial Intermediation 19 (3):

41837. 61

Aghion, Philippe, and Enisse Kharroubi. 2013. Cyclical Macroeconomic Policy, Financial Regulation and

Economic Growth. Working Paper 434, December. Bank for International Settlements, Basel, Switzerland. 62

Bank of England. 2013a. A Framework for Stress Testing the UK Banking System. Bank of England discussion

paper, October.


Page | 21

that the 2003 amendments would make discount window lending a more attractive funding

option to banks.63

CONCLUSION

We reach three major conclusions:

The crisis has fundamentally changed the roles of central banks and central bankers, and

there will be no reversion to the previous status quo64

. Adjusting to an increasingly public

and prominent position on the political stage will be one of the lasting legacies for central

bankers65

. The role of the central banker has become inherently more powerful, more

complex and more contentious66

.

The price of extending the activities and powers of central banks is likely to be

restrictions on their hitherto sacrosanct independence67

. In many countries there will be a

growing and vigorous debate about the transparency of the activities of central bankers

and of accountability to government and the wider electorate68

.

Many central banks are confronting a new set of policy and operational challenges69. In a

palette of disciplines ranging from overall strategy and governance, through risk

management, and on to the core operational platform, there is much work to be done in

63

. Financial Stability Review. Issue no. 20. Link: http://www.bankofengland.co.uk/publications/

Documents/fsr/2006/fsrfull0606.pdf

64 Sterne G. 2002. Inflation Targets in a Global Context. In: Central Bank of Chile Working Paper 114.

65 Eijffinger SCW & Schaling E. 1992. "Central Bank Independence: Criteria and Indices." Tilburg University,

Research Memorandum, 548.

66Taylor, John B. (2009) Getting Off Track. Stanford: Hoover Institution Press.

67 Kuttner KN & Posen AS. 2001. "Beyond Bipolar: A Three-Dimensional Assessment of Monetary Frameworks."

International Journal of Finance & Economics 6, 369-387.

68 Temin, Peter (1969) The Jacksonian Economy. New York: W.W. Norton.

69 Lawshe CH. 1975. "A Quantitative Approach to Content Validity." Personnel Psychology 28, 563-575.


Page | 22

attaining organizational fitness to manage significantly increased and more complex

roles70

.

The paper argues that the role of central bankers is changing and will continue to change

fundamentally and irreversibly71

. There are multiple challenges, ranging from the grandly

philosophical and strategic to more prosaic concerns72

. Paradoxically, in the final analysis, it may

well be that expanded powers and responsibilities for central banks will lead to a full or partial

loss of the independence that has, particularly in the Western world, become the cherished

hallmark of central banking73

.

Although the origin of central banking may be dated back to 1694 when the The Governor and

the Company of Bank of England, the present day Bank of England was established, the art of

central banking assumed new dimensions only during the 20th

century74

. Central banking is

essentially a 20th

century phenomenon. It took nearly three centuries for the art of central

banking to attain the present day importance75. The role of central bank is continually

expanding. In the words of, De Kock, central banks have developed their own code of rules and

practices, which can be descriced as the art of central banking but which in changing world, is

still in the process of evolution and subject to periodical adjustment76

70 White, Lawrence H. (1989) Competition and Currency: Essays on Free Banking and Money. New York and

London: New York University Press

71 Lybek T. 2004. Central Bank Autonomy, Accountability, and Governance: Conceptual Framework. In: IMF

Seminar on Current Developments in Monetary and Financial Law, edited by. Washington, D.C: International

Monetary Fund.

72 ODriscoll, Gerald P., Jr. (2012) Central Banks: Reform or Abolish? Unpublished manuscript, January 15.

73 Office of Management and Budget, www.whitehouse.gov/omb/budget/Historicals, accessed 6/29/12.

74 Moser C & Dreher A. 2007. Re-Delegating Monetary Policy: Financial Market Reaction to Central Bank

Governor Changes. In: conference- Does Central Bank Independence Still Matter?, edited by. Milan, Italy.

75 Neyapti B. 2003. "Budget Deficit and Inflation: The Roles of Central Bank Independence and Financial Market

Development." Contemporary Economic Policy 21, 458-475.

76 Plosser, Charles I (2011). The Scope and Responsibilities of Monetary Policy, GIC 2011 Global Conference

Series Presentation, The Central Bank of Chile, Santiago, Chile, January 17.


Page | 23

BIBLIOGRAPHY

DICTIONARY

Blacks Law Dictionary, 9th Edition

BOOKS

Banking Law, S.N Gupta, Universal Law Publications.

Tannans Banking Law And Practice In India, M.L Tannan, 23rd Edition, Lexisnexis Publications.

Elingers Modern Banking Law, Ellinger Lomnicka Hare, 5th Edition, Oxford Publication.

Banks And Financial Crimes, Blair Brent, Oxford Publication.

Banking Law And Practice In India, 22nd Edition, N. R Kummarswamy Iyer, Lexisnexis.

Key Authorities In Banking Law, Christopher Harris, Sweet And Maxwell Publication.

Basu:Theory And Practice Of Development Banking, (4th Ed.) 235

Muranjan S.K. :Modern Banking In India, (3rd Ed.) 221

Reddy & Appanniah:Banking Theory And Practice, (6th Ed.) 115

Natarajan & Gordon:Banking Theory And Practicle, (2nd Ed.) 123

ARTICLES

Ahsan A, Skully M, & Wickramanayake J. 2006. "Determinants of Central Ban

Independence and Governance: Problems and Policy Implications." Journal of

Administration and Governance 1, 47-67.

Ahsan A, Skully M, & Wickramanayake J. 2008. "Central bank Independence and

Governance: Definitions and Modelling." In Central banking Governance: Issues and

Perspectives, edited by Jain RK, Sohani AK, pp 59-73. Hyderabad: The Icfai University

Press.

de Haan J, Amtenbrink F, & Eijffinger SCW. 1999. "Accountability of Central Banks:

Aspects and Quantification." Banca Nationale del Lavoro Quarterly Review 50, 169-193.


Page | 24

de Souza LV. 2002. Trade Effects of Monetary Integration in Large, Mature Economies:

A Primer on the European Monetary Union. In: Kiel Institute for the World Economy

Kiel Working Papers 1137, edited by.

Eggertsson G & Borgne EL. 2003. A Political Agency Theory of Central Bank

Independence. In: International Monetary Fund Working paper WP/03/144, edited by.

Eijffinger SCW & Schaling E. 1992. "Central Bank Independence: Criteria and Indices."

Tilburg University, Research Memorandum, 548.

Kuttner KN & Posen AS. 2001. "Beyond Bipolar: A Three-Dimensional Assessment of

Monetary Frameworks." International Journal of Finance & Economics 6, 369-387.

Lawshe CH. 1975. "A Quantitative Approach to Content Validity." Personnel

Psychology 28, 563-575.

Lybek T. 2004. Central Bank Autonomy, Accountability, and Governance: Conceptual

Framework. In: IMF Seminar on Current Developments in Monetary and Financial Law,

edited by. Washington, D.C: International Monetary Fund.

Moser C & Dreher A. 2007. Re-Delegating Monetary Policy: Financial Market Reaction

to Central Bank Governor Changes. In: conference- Does Central Bank Independence

Still Matter?, edited by. Milan, Italy.

Neyapti B. 2003. "Budget Deficit and Inflation: The Roles of Central Bank Independence

and Financial Market Development." Contemporary Economic Policy 21, 458-475.

Sinclair PJN. 2000. "Central Banks and Financial Stability." Bank of England Quarterly

Bulletin 19,377-391.

Sterne G. 2002. Inflation Targets in a Global Context. In: Central Bank of Chile Working

Paper 114

Bade R, Parkin M. 1988. Central Bank Laws and Monetary Policy. In: Department of

Economics Working Paper, University of Western Ontario, edited by.

Banaian K, Burdekin RCK, & Willett TD. 1995. "On the Political Economy of Central

Bank Independence." In Monetarism and Methodology of Economics: Essays in Honour

of Thomas Mayer, edited by Hoover KD, Sheffrin SM, pp 178-197. Aldershot, UK:

Edward Elgar.

Cukierman A & Webb SB. 1995. "Political Influence on the Central Bank: International

Evidence." World Bank Economic Review 9, 397-423.

Banking Law Project

Documents

Transcript of Banking Law Project