Banking law and regulation have significantly shaped the present-day banking system in the United States. These laws have worked to protect the interests of consumers, reduce system risk in the financial markets, and maintain financial institution stability. This section examines the major banking laws, their historical contexts, objectives, and impacts.
Following the Panic of 1907, also known as the Knickerbocker Crisis, from a failed attempt to corner the copper market, the US responded with the Federal Reserve Act in 1913.
Knickerbocker Trust, one of the largest New York trust banks at the time, provided uncollateralized loans to stockbrokers, who used the money as collateral for call loans from other banks.
The system worked as long as the stock market was flourishing. However, the stockbrokers used the money to manipulate shares of the United Copper Company and corner the copper market. Their plan failed, and since Knickerbocker Trust played a significant role in providing liquidity to the financial market during that period, filing for bankruptcy caused a panic.
Consequently, other regional banks attempted to withdraw their money from other trust banks. But the banks’ low deposit-to-cash ratio triggered a national bank run, and many federal and state banks became insolvent.
The Federal Reserve Act was part of the reforms following the crisis. The Act created the Federal Reserve System (The Fed) as the central bank. The Fed oversees the banking sector and requires banks to hold part of their deposits as reserves, called federal funds. The Federal Reserve establishes a target interest rate for banks to lend these funds, called the fed funds rate. Today, the Fed controls inflation with interest rates.
After the Great Depression, several laws and policies, including the Glass-Steagall Act, also known as the Banking Act, were introduced to reform the financial market. The Act created the Federal Deposit Insurance Corporation and required banks to separate commercial and investment banking activities to eliminate conflict of interest and reduce risk.
Commercial banks were prohibited from trading securities, while investment banks could not take deposits.
Though the strict separation of investment and commercial banking activities faded over time, the FDIC remains today. FDIC insures deposits and supervises financial institutions.
Privacy laws protect consumers' personal information from being misused by financial institutions. Some of these laws are —
The Dodd-Frank Wall Street Reform and Consumer Protection Act was part of reforms following the 2007 - 2008 financial crisis.
The Act established the Consumer Financial Protection Bureau (CFPB) and introduced various regulatory changes and oversight institutions to strengthen the financial system, such as ––
The Uniting and Strengthening America Patriot Act has significant provisions for financial institutions following the September 11th, 2001 terrorist attacks. For banking law, it increased information sharing between financial institutions and more elaborate Know Your Customer (KYC) requirements. The Act also provides for heavier penalties for enabling money laundering and terrorist financing and requires reporting of suspicious activities to the Financial Crimes Enforcement Network (FinCEN).
The Act, enforced by FinCEN, expands the responsibility of banks to report suspicious activities to prevent money laundering, tax evasion, and other financial crimes.
Enacted in 1977 to motivate financial institutions to address the credit needs of their communities, focusing on low- and moderate-income neighborhoods.
US banking laws focus on consumer protection and promoting fair practices in the financial sector. Many regulations, such as the Dodd-Frank (Consumer Protection) Act and the establishment of the Consumer Financial Protection Bureau (CFPB), emphasize the importance of safeguarding consumers from predatory lending approaches, fraud, and other financial risks. Others, such as the Federal Reserve Act, the Dodd-Frank (Wall Street Reform) Act, the USA Patriot Act, and the Bank Secrecy Act, provide structures for transparency and accountability in bids to insulate the financial system from criminal abuse and address emerging risks that may pose a threat to the financial stability of the country.