TNB And The Regulatory Dialectic

Back in the 1980s Professor Edward Kane coined the term regulatory dialectic to capture the dynamics of how regulated financial institutions found innovative ways to circumvent regulations designed to restrict their behavior.

For example, banks adopted the one-bank holding company form in the late 1960s to avoid the restrictions on permissible activities. They subsequently used that device to create non-bank banks that also enabled them to cross state lines, avoiding the restrictions on interstate banking. The process led to a new era of nationwide banking that we now take for granted. Similarly, when Regulation Q restricted the rates that depository institutions could pay retail customers, money market mutual funds came into existence to solve that problem. And when federal law capped the amount of Federal Deposit Insurance an individual could receive to $250K per account, Promontory Financial Group (now a subsidiary of IBM), formed by former Comptroller of the Currency Eugene Ludwig and former Federal Reserve Board Vice Chairman Alan Blinder, found a way to pool accounts to expand deposit insurance coverage for large depositors far beyond the $250K limit.

The most recent example of the regulatory dialectic was the subject of an American Enterprise Institute program on December 2 in Washington, devoted to what is known as The Narrow Bank (TNB). The recently retired executive vice president of the Federal Reserve Bank of New York, Dr. James McAndrews, is now chairman of a newly licensed, uninsured, special-purpose wholesale bank in the State of Connecticut that has applied to the Federal Reserve Bank of New York for a master account. TNB would only do one thing: It would accept deposits from large accredited investors, namely the GSEs, Federal Home Loan Banks, money market mutual funds and selective other large investors; deposit those funds in the master reserve account at the Federal Reserve Bank of New York; receive an interest payment (known as interest on excess reserves [IOER]) from the Bank on those funds; and transfer all that interest to the depositing institutions, less a small fee for the service. So what is the regulatory avoidance? GSEs and Federal Home Loan Banks are permitted to hold deposits at the Fed, which serves as their fiscal agent, but they are not permitted to receive interest on those accounts.

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Disclaimer: The preceding was provided by Cumberland Advisors, Home Office: One Sarasota Tower, 2 N. Tamiami Trail, Suite 303, Sarasota, FL 34236; New Jersey Office: 614 Landis Ave, Vineland, NJ ...

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