So what does the Fed REALLY do for banks?

Posted by marathongal

Tue Jan 15th, 2008 09:46 AM

Much has been written lately about what the Fed does or might have done to assist banks. And some of this is misinformation. So to clarify, the Fed has two key objectives - (1) maintain monetary policy and (2) ensure the safety and soundness of banks.

And they do this in a way that's trying to be pro-active rather than re-active. So if the Fed takes an action that may have investors scratching their heads, Fed policymakers were probably thinking long-term impact on the economy as a whole (not just investors or homeowners - sorry!).

Noah & Co. have discussed the first point more at length on this site, so I'll focus on the second point - safety and soundness of banks.

A bank's charter (akin to a license) can be with a particular state or national. This is important because the Fed doesn't regulate all banks. It regulates state chartered holding companies and state-chartered banks that are members of the Federal Reserve System.

The Office of the Comptroller of the Currency (OCC), part of the US Dept of Treasury, regulates all nationally-chartered banks. The Office of Thrift Supervision (OTS) regulates all banks chartered as 'thrifts', and each state's banking department regulates the banks in its respective state.

Ok, got that?

Confusing as it might sounds, all regulations are the same, and each regulatory body uses the same criteria when evaluating banks. The regulators also work with each other to evaluate the same institution that might have >1 regulator (for example, Citigroup, a financial services holding company, is regulated by the Fed, but its main bank, Citibank, is nationally chartered and therefore regulated by the OCC).

Still with me?

Regulators audit banks about every year, sometimes more, evaluating them mainly for capital adequacy, liquidity, earnings, asset quality, management and risk management. In addition, banks are required to report key data to the regulators on a quarterly basis.

So what else do regulators do?

In this regard there seems to be even MORE confusion. As Noah mentioned in his post last week, Marketwatch's Herb Greenberg is guessing (perhaps facetiously) that the Fed was somehow behind the recent announcement for BofA to purchase Countrywide, and that the government would provide a guarantee to BofA against any loan losses as a result.


First of all, when a bank announces a merger deal, it is always subject to regulatory approval. BofA isn't even regulated by the Fed. The closest the Fed might have come to getting involved would have been to consult with both Bof A and CFC while they were negotiating the deal to find out if there would be any regulatory hurdles that might hamper the deal. Also, regulators appreciate knowing of any upcoming mergers that would have an impact on the markets.

Secondly, it would take an act of Congress or Executive Order by the President in order for the government to guarantee BofA against any losses incurred as a result of its purchase of Countrywide. The Fed certainly wouldn't do this, nor should it. It would be akin to a government bailout of CFC.

BofA wouldn't agree to the acquisition if the bank didn't think it could absorb CFC's losses and get some benefit. It's the market working itself out without any government influence - and that's a good thing.