Banking - Case Study Example

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This essay stresses that the McFadden Act 1927 was a law that was passed to govern the geographical spreading of commercial banks. In the years before 1927, only chartered banks that were affiliated to the government were allowed to spread and open several operational areas in different locations…
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8th November Banking The McFadden Act of 1927 was a law that was passed to govern the geographical spreading of commercial banks. In the years before 1927, only chartered banks that were affiliated to the government were allowed to spread and open several operational areas in different locations. In 1927, Congressman Louis McFadden moved a bill that was later enacted into law. This new law allowed commercial banks to spread and open more branches to the extent that was permitted by the laws of the state in which it was operating. This meant that if the laws of a state allowed opening of new branches in any location within the state, then the bank was allowed to do so. In another instance, if a state’s laws allow opening of branches within the current city of location, then a commercial bank was not allowed to open branches in other cities. However, this Act did not allow commercial banks to open branches across different states. This Act had the effect of allowing for geographical growth of commercial banks and they were able to compete with federal-owned banks (Johnston).
The Glass-Steagall Act of was also known as the Banking Act. This Act got its name from its sponsors who were Congressmen Carter Glass and Henry Steagall. The major implication of this Act to the banking sector was introducing a separation between commercial banks and investment banks. The sponsors of this Act were motivated by the events that were happening then in the banking sector. It was after the economy had experienced a crisis in the stock market sector of the economy which was followed by the Great Depression. It had been previously discovered that monies had been borrowed from mainstream commercial banks for speculation purposes in the stock market. After the stock market crisis, many banks went at a loss and it was discovered that there was need to separate the two areas of the trade. The Glass-Steagall Act made into law that commercial banks will only deal with deposits and loans while investment banks will deal with only stock trading (David).
Below is a sample of a typical commercial bank’s balance sheet, otherwise called a statement of financial position.
Liabilities and Net Worth
Physical Assets
Transaction Deposits
Loans-Consumer Loans
-Business Loans
Other deposits
Savings Accounts
Cash Reserves- Vault
Federal Deposits
Certificates of Deposits
Other Deposits
Investment Securities-Treasury
Other Liabilities
Other Banks Loans
Federal Reserve Loans
Total Liabilities
Net Worth
Total Assets
Total Liabilities and Net Worth
The above balance sheet can be basically divided into two columns; one for total assets and the other for total liabilities and net worth. Assets refers to what the bank owns and liabilities refers to what the bank owes. Net worth is the banks equity or what the bank owes it shareholders. The total sum of the assets has to be equal to the total sum of liabilities and net worth as shown by the basic accounting equation of;
Asset = total liabilities + net worth
The theory of asymmetrical information is when one party in a borrower-lender agreement does not have perfect knowledge on the transaction. The result of this is two forms of risk which are adverse selection and moral hazard. Adverse selection occurs when a high risk borrower is given priority over a low risk borrower. Moral hazard occurs when the lender does not have information on the use of borrowed funds thus creating a risk of default. Asymmetrical information has led to rising of commercial banks because the premium they charge for the risk represents an income to the banks. This is usually in the form of interest received by the commercial bank (Hubbard).
Works Cited
David, Charles Suresh. "The Aftermath of Recession: The Road to Recovery." Journal of Finance, Accounting and Management 2.1 (2011).
Hubbard, Glen R. Asymmetric Information, Corporate Finance, and Investment. Chicago: Unversity of Chicago, 2009.
Johnston, Verle . "The McFadden Act: a look back." FRBSF Economic Letter 1983. Read More
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