Question

What was Regulation Q? How did this regulation lead to disintermediation in the 1970s? How did banks react to this competitive threat? Did these reactions help stabilize or destabilize the banking system?

Answer 1

Regulation Q is the Federal Reserve Board rule that sets minimum capital requirements and capitak adequacy standards for board regulated institutions in USA.It imposes restrictions on the payments of interest on checking accounts.The rule was adopted in 1933and prohibits Ba ks from paying interest to its customers for holding checking accounts.The aim is to motivate the customers to release funds from their checking accounts.There has been a long report over this.

Disintermediation ,withdrawls of funds from interest bearing deposit accounts such as money market funds,stocks,bonds.Disintermediation was at peak at 1966when regulation Q prevents banks and savings institutions from competing effectively with nondepository institutions such as brokers and lenders.When interest rates are high investors often recieve a higher return.The US financial system is very marke dominated.Dominance of non bank has not always in the case ofUS bank system.But by the end of 1980s the US financial system was heavily market oriented.Regulatipon Q led to the emergence of money market funds.It allows the banks that are the members of the federal reserve there by mitigating any credit illiquidity. It increased the competition for customers deposits,Q defines types of time deposits, maximum rate of interest and similar limitations to all federally insured banks.
So, there is a practical impact on the banking bussiness since interest rates were below the regulation. Smaller deposits,remined subject to Regulation Q interest rate. But it further iroded the regulatory spread. The depository institutions tend to increase the quantity of convinience and service they provided. Banks started greater automation. They have increased service charges and the service recieved by the customer. Banks are not as traditional banking services,attentive to gain to authorise as new approach. In 1984 the regulators proposed that the capital guidelines be uniform for all sizes of banks.