HISTORICAL BACKGROUND OF DIDMCA
Depository Institutions Deregulation and Monetary Control Act Research Paper:
Until the 1970s, the Federal Reserve System did not enjoy sufficient control on the money markets in the United States, and despite the high level of regulation, especially of banks that were member of the system, the Fed had little if any information on depository institutions that were not members of the system. This is not to mention that the Fed did not have any control over these institutions, and accordingly, much of the monetary function of the Fed was flawed and loose.
During the late 1970s, the economic environment changed in several ways that compounded the problems that financial institutions and their regulators faced. High inflation and high interest rates increased the opportunity cost of holding deposits whose returns were regulated. In other words, depository institutions that earned regulated returns on deposits were making less profit when there were more profitable opportunities in other segments of the market.
At the same time, The consumers’ cost of developing substitutes for bank deposits was lowered through technological advances and new savings devices. Due to the combined effects of high rates and technological advances, the number of nonbanks that supplied bank-like services increased sharply. All these developments implied that federally regulated depository institutions were operating at a serious disadvantage in contrast to other institutions, partly because they were limited by the ceilings imposed by the Fed, and partly because they were not legally allowed to diversify in order to meet the new types of competition that developed as a result of increasing inflation and advancing technology.
In addition to this, high rates of inflation induced many firms to gamble that prices would chart a similar course in the future. A large number of banks expanded their lending to energy and agricultural interests on the assumption of rising commodities prices, and thus, higher risks were accordingly taken. In addition, a few large banks broadened their portfolios to include more loans to Latin American countries based on the expectation of continuing inflation and low real interest rates, once again increasing the risks of federally regulated depository institutions.
Because of the shifts in the economic environment after the end of the 1970s, banks and the thrift industry experienced more competition, came to the verge of bankruptcy, and became more vulnerable to disinflationary policies.
The late 1970’s was by all means a period of fast transition. This period witnessed the extraordinary growth of money market mutual funds. Savers earning fixed and relatively low interest rates on deposits subject to Regulation Q started to withdraw their funds and invested in alternative instruments paying market rates. In the face of all these changes and developments, new regulations had to be enacted in order to deal with the fast expansion of the industry and the severe limitations on federally regulated depository institutions, many of which were operating at a disadvantage, or even facing the risks of bankruptcy.
THE ENACTMENT OF DIDMCA
For regulators to meet the mandate to limit or prevent bank failures which grew from public concern about failures and their cost to deposit insurers, some deregulation was necessary.
In response to these serious financial difficulties, in 1980, Congress passed the Depository Institution Deregulation and Monetary Control Act (DIDMCA). It was called, “…the most significant banking legislation before the Congress since the passage of the Federal Reserve Act in 1913” one member of the U.S. Congress said.
With the passage of the DIDMCA, banks assumed that interstate branch banking would soon be forthcoming, and some banks and Bank Holding Companies (BHCs) took steps to place themselves in a more favorable position should this occur. Some BHCs bought minority interests in banks, or established Edge Act offices across state lines.
The Act began the process of lifting the old legal ceiling on the interest rates banks could offer their depositors. The new law sought to deregulate banking and promote more competition to benefit consumers. The Act also sought to tighten monetary control by extending Federal Reserve requirements to all commercial banks, both member and nonmember, and also to thrift institutions offering NOW accounts. Finally, to shore up confidence in depository institutions as a whole, the Act raised the FDIC ceiling on insured deposits from $40,000 to $100,000.
PROVISIONS OF DIDMCA
The Monetary Control Act of 1980, enacted on March 31,1980, was designed to improve the effectiveness of monetary policy by applying new reserve requirements set by the Federal Reserve Board to all depository institutions that held transaction accounts.
The most important provisions of this Act included the following:
¾Authorized the Federal Reserve to collect reports from all depository institutions offering transaction accounts. The objective of this provision was to empower the Federal Reserve with respect to the information it had at hand such that its ability to formulate monetary policies and controls was boosted.
¾Extended access to Federal Reserve discount and borrowing privileges and other services to non-member depository institutions. This provision had three major objectives. First of all, it aimed at increasing competitiveness in the financial and thrift industries by giving players equal opportunities and access to funds. Secondly, by providing new and additional sources of funds, the Fed thus maintained a higher level of liquidity in the financial industries. And thirdly, the Fed thus provided financial institutions with better and more diversified means to protect their financial positions in the face of unexpected shortages of cash or funds.
¾Required the Federal Reserve to set a schedule of fees for Federal Reserve services and to recover the costs of those services from depository institutions.
¾Provided for the gradual phase-out of deposit interest rate ceilings, coupled with broader powers for thrift institutions. This provision was of ultimate importance. While on the one hand the Fed was imposing additional regulations on the industry by requiring non-member institutions to report to the Fed and to meet federal reserve requirements, this provision implied that the entire industry would be deregulated. By giving thrift institutions the right to impose the interest rates that they wanted, the Fed thus deregulated the industry and left the forces of demand and supply, as well as the operations of thrift institutions to determine the interest ceiling in the economy. Ultimately, this gave thrift institutions more opportunities to become more competitive by having the flexibility they needed to manage their interest rates. In addition to all this, this provision gave thrift institutions the ability to protect themselves against the impacts of inflation and disinflation, mainly by allowing them to increase or decrease their interest rates depending on the situation of the economy.
In 1980, statewide branch banking was permissible in twenty-three states and the District of Columbia. Limited branch banking was allowed in sixteen states. Ten of these states that allowed limited branching also allowed multi-bank companies, where it normally was prohibited. The law of thirteen states prohibited branch banking of any kind in 1980. In six of the unit banking states, multi-bank companies were allowed. Single bank holding companies are more important in the states that allow statewide branching, while multi- bank holding companies are more important in those with limited branching and in unit banking states.
CONTROVERSIAL ISSUES RELATED TO DIDMCA
The Monetary Control Act of 1980 (DIDMCA) and corresponding regulations imposed, for the first time, reserve requirements that had to be met by state nonmember banks. Those reserve requirements ignored and, in many cases, conflicted with the reserve provisions of the laws of a number of states, specifically the Missouri state laws.
Such conflicts make computation of reserves by state nonmember banks a burden for these banks. In fact, many banks have complained that these conflicts place state nonmember banks at a disadvantage with member banks as to the amount of reserves which must be kept. This inequality suggested the need for an alteration in the interpretation of state policy on reserves. It is believed that this rule provides the alteration needed and that this proposal is justified on a number of grounds. Reserve requirements imposed by state law are not designed for monetary purposes and, therefore, have been commonly considered to be held for liquidity purposes. However, to the degree that they are needed to pay incoming cash letters and other obligations and to compensate for correspondent services, the demand balances due from other banks are, in reality, the least liquid assets of a commercial bank. Furthermore, balances would be maintained at fairly constant levels even in the absence of reserve requirements. The Monetary Control Act of 1980 and Regulations A and D suggest that a bank’s short-term liquidity needs are to be satisfied through the money markets, established borrowing sources and the Federal Reserve discount window.
A reduction in the officially required level of reserves will not adversely affect the liquidity of any bank. In addition, the inequality between state and national banks deriving from the Monetary Control Act has led to pressures for action on the part of the commissioner of finance and the State Banking Board to eliminate the disadvantage accruing to state nonmember banks. However, no such action has ever been taken or considered.
Yet, although no express language is contained in the Monetary Control Act of 1980, the conflicts between that Act and some state reserve requirements suggest the possibility that the state reserve requirements have been legally preempted and are of no further effect.
DIDMCA is by all means one of the landmarks in legislation related to monetary policy and the Federal Reserve System function, power and operation. This law has enabled the Fed to exert more control on the monetary policy of the United States, but more important were its deregulatory implications. The availability of additional funds and options to access funds for thrift institutions contributed to a significant increase in the capital and liquidity potentials of these institutions. Moreover, DIDMCA helped consolidate and expand the thrift industry by permitting non-bank institutions to compete with traditional banking institutions for services such as providing deposits. Consumers and investors were the major winners as a result. Firstly, thrift institutions became more competitive and even more flexible, thus offering their depositors better and safer investments and more flexible interest returns. The most important impact of DIDMCA, however, was that it revolutionized the thrift industry. The industry was no longer restricted to banks or banking institutions, and competition eventually meant that institutions had to diversify their products and offerings, as well as their strategies in order to grow faster and reach new horizons. Among the consequences of such a situation were the development of new and innovative products, a stimulation of fast advancement in banking and thrift technology, an eventual reduction of costs for institutions and consumers, and finally, the stimulation of the tendency for consolidation of various thrift institutions in the industry.
DIDMCA, however it has to be mentioned, was not the last or final deregulation of the thrift industry in the US. Other laws were enacted in 1982 and later on in the early 1990s, but these were more relevant to specific sectors of financial markets and industries, and they were all basically based on the deregulatory spirit of DIDMCA.
It is no exaggeration to state that the power and domination enjoyed by the American thrift industry worldwide today owes much of its existence to the enactment of DIDMCA, a law which was by all means a sound response to changes and new expectations at the time.