Credit Analysis & Research Ltd. (CARE),

Credit Analysis & Research Ltd. (CARE), incorporated in April 1993, is a credit rating, information and advisory services company promoted by Industrial Development Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and other leading banks and financial services companies. In all CARE has 14 shareholders.

CIBIL : Credit Information Bureau (India) Ltd

(CIBIL in association with Dun & Bradstreet & Transunion)
The Credit Information Bureau (India) Ltd (CIBIL) has been launched for banks, FIs and other financiers to share retail and commercial customer information. The bureau, the first of its kind in India, will provide both positive and negative information on bank borrowers.

Until today, banks had no way of checking the credit worthiness of retail customers while the scene was a bit better on the corporate lending front since competitor banks, vendors, suppliers helped in understanding the worthiness of the borrower.

Satish Mehta, managing director (CIBIL), said, ``Banks have already started accessing the credit records on customers. Currently 5.5 million records of retail customers have been generated. CIBIL will help banks take speedier and more objective credit decisions possibly at a lower price. At a systemic level, it should help bring down NPAs currently pegged at Rs 70,000 crore.''
CIBIL provides data on the current total outstanding debt. It gives both positive data such as the address of the customer and loan repayment records as well as negative data like penalties and defaults. As of now, only 13 out of 87 members have shared their entire customer data with CIBIL. The challenge is in getting valid information particularly from PSU banks many of which are not fully computerised and do not maintain accurate MIS reports.
Neeraj Swaroop, head-retail, HDFC Bank, said, ``This is a great step forward for the banking system and we will soon start accessing records from CIBIL. However, the data may become rich only over 3-6 months as more players share data.'' For a bank to access the CIBIL database of customers, it can post a query through the Internet, through lease lines or in the CD format. CIBIL will respond in a matter of seconds through the same mode.

CIBIL, promoted by HDFC and State Bank of India, will work on the principle of reciprocity. Only those members who provide data will have access to information from CIBIL.

Listing gains

the return on the IPO scrip at the close of listing day over the allotment price

Pure Spin-Offs

In a pure spin-off, a parent company distributes 100% of its ownership interests in a subsidiary operation as a dividend to its existing shareholders. After the spin-off, there are two separate, publicly held firms that have exactly the same shareholder base. This procedure stands in contrast to an initial public offering (IPO), in which the parent company is actually selling (rather than giving away) some or all of its ownership interests in a division. The spin-off process is a fundamentally inefficient method of distributing stock to people who may not necessarily want it. For the most part, investors were investing in the parent companies business. Once the shares are distributed, often they are sold without regard to price or fundamental value. This tends to depress the stock initially. In addition, institutions typically are sellers of spin-off stocks for various reasons (too small, no dividend, no research, etc.). Index funds are forced to sell the spin indiscriminately if the company is not included in a particular index. This type of selling can create excellent opportunities for the astute investor to uncover good businesses at favorable prices. Often, after the spin, freed from a large corporate parent, pent-up entrepreneurial forces are unleashed. The combination of accountability, responsibility, and more direct incentives (stock options) typically shows up in the operating performance post spin.

Options

Options - An option is the right, but not the obligation, to buy (call option) or sell (put option) a financial asset at a predetermined price (called the exercise price or strike price) at some particular date in the future. The option price will depend on the prospects of changes in the price of the underlying security to which it relates.In a 'European' option the buyer only has the right to exercise the option on the expiry date, whereas an 'American' option may be exercised at any time up to the expiry date. In both cases, however, they can be traded rather than exercised at any time.

Types of Investors

Investors are broadly devided into two types :--

a) Retail Investors or Individual Investors - Individual investors who buy and sell securities for their personal account, and not for another company or organization

b) Instutional investors : A non-bank person or organization that trades securities in large enough share quantities or dollar amounts that they qualify for preferential treatment and lower commissions. Institutional investors face fewer protective regulations because it is assumed that they are more knowledgeable and better able to protect themselves.

Financial Derivatives

Derivatives is a generic term for a variety of financial instruments. Unlike financial instruments such as stocks and bonds, a derivative is usually a contract rather than an asset. Essentially, this means you buy a promise to convey ownership of the asset, rather than the asset itself. The legal terms of a contract are much more varied and flexible than the terms of property ownership. In fact, it's this flexibility that appeals to investors. "A good toolbox of derivatives allows the modern investor the full range of investment strategy" and "the sophisticated management of risk," according to the derivatives specialists at NumaWeb.
Futures and options are two commonly traded types of derivatives. An options contract gives the owner the right to buy or sell an asset at a set price on or before a given date. On the other hand, the owner of a futures contract is obligated to buy or sell the asset.

Note : Derivative Securities are niether Debt nor Equity type of security.

Fidelity Bond

A fidelity bond is a form of protection that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees.
While called bonds, these obligations to protect an employer from employee-dishonesty losses are really insurance policies. These insurance policies protect from losses of company monies, securities, and other property from employees who have a manifest intent to cause the company loss.

USA PATRIOT Act

USA PATRIOT Act.
A 2001 U.S. federal law containing anti-money laundering provisions that require financial institutions to
(1) verify the identification of financial account holders;
(2) establish internal anti-money laundering programs that meet specified minimum standards;
(3) cooperate with other financial institutions to deter money laundering; and
(4) report suspected money laundering transactions.

Also known as the Patriot Act.

Title Insurance

Title insurance is insurance against loss from defects in title to real property and from the invalidity or unenforceability of mortgage liens. It is available in many countries but it is principally a product developed and sold in the United States. It is meant to protect an owner's or lender's financial interest in real property against loss due to title defects, liens or other matters. It will defend against a lawsuit attacking the title as it is insured, or reimburse the insured for the actual monetary loss incurred, up to the dollar amount of insurance provided by the policy.
Typically the real property interests insured are fee simple ownership or a mortgage. However, title insurance can be purchased to insure any interest in real property, including an easement, lease or life estate. Just as lenders require fire insurance and other types of insurance coverage to protect their investment, nearly all institutional lenders also require title insurance to protect their interest in the collateral of loans secured by real estate. Some mortgage lenders, especially non-institutional lenders, may not require title insurance.

For more details visit : http://en.wikipedia.org/wiki/Title_insurance

Escrow capitalization

Many borrowers feel that they are entitled to share the interest that the lender earns by investing these tax and insurance funds in the escrow account. If an escrow account were not required, a borrower could deposit tax and insurance money in an interest-bearing account until a payment was due.

There is one method of escrow collection in which the portion of the borrower’s monthly payment required to pay taxes and insurance is deducted each month from the balance owed on the mortgage. Then, when the institution makes a tax or insurance payment for the customer, the amount of the payment is added back to the principal balance. Since this reduces the amount of loan interest that a customer pays, it amounts to earning interest on escrow balances at the same rate of interest as on the mortgage loan. This method is sometimes called escrow capitalization and, although beneficial to consumers, it is seldom used by lending institutions today because of its high cost.

Mortgage Escrow Account

This is an amount of money maintained at a lending institution in order to pay
the annual taxes and insurance on mortgaged property. Approximately one-twelfth of
the estimated annual cost of taxes and insurance is paid into the account each month
from the borrower’s monthly mortgage payment. Then the lending institution pays the
taxes and insurance from this account when they are due. An escrow account is
required by many lending institutions in order to insure that the taxes and insurance
premiums are paid on time.
It is, in a sense, a budgeting device which requires borrowers to set aside
enough money to pay their taxes when due. If there is not enough money in the
customer’s escrow account at the time of tax payment, sometimes lenders will advance
the funds at no charge, and allow the customer to pay back the advance through higher
escrow payments.
Escrow accounts also reduce tax collection costs for local governments. The
lending institution usually makes one large tax payment to each tax collector, which
saves the government the cost of collecting many small checks from individual
borrowers over a period of time.

Reverse Merger

One of the options available to small- to medium-sized privately held companies that are looking to raise additional capital or to make acquisitions is the reverse merger. The reverse merger originated as an alternative to the traditional initial public offering (IPO) process for companies that want the benefits of being a public company without the expense and complexities of the
traditional IPO.

In a reverse merger a private company merges with a publicly listed company that
doesn’t have any assets or liabilities. The publicly traded corporation is called a “shell”
since all that remains of the original company is the corporate shell structure. By
merging into such an entity the private company becomes public.

Mortgage-Backed Securities (MBS)

Mortgage-backed securities (MBS) are debt obligations that represent claims to the cash flows from pools of mortgage loans, most commonly on residential property. Mortgage loans are purchased from banks, mortgage companies, and other originators and then assembled into pools by a governmental, quasi-governmental, or private entity. The entity then issues securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool, a process known as securitization.
Most MBSs are issued by the Government National Mortgage Association (Ginnie Mae), a U.S. government agency, or the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), U.S. government-sponsored enterprises. Ginnie Mae, backed by the full faith and credit of the U.S. government, guarantees that investors receive timely payments. Fannie Mae and Freddie Mac also provide certain guarantees and, while not backed by the full faith and credit of the U.S. government, have special authority to borrow from the U.S. Treasury. Some private institutions, such as brokerage firms, banks, and homebuilders, also securitize mortgages, known as "private-label" mortgage securities.
Mortgage-backed securities exhibit a variety of structures. The most basic types are pass-through participation certificates, which entitle the holder to a pro-rata share of all principal and interest payments made on the pool of loan assets. More complicated MBSs, known as collaterized mortgage obligations or mortgage derivatives, may be designed to protect investors from or expose investors to various types of risk. An important risk with regard to residential mortgages involves prepayments, typically because homeowners refinance when interest rates fall. Absent protection, such prepayments would return principal to investors precisely when their options for reinvesting those funds may be relatively unattractive.

Understanding Liquid Funds

1) Meaning : Liquid Funds are basically debt funds which invest in near risk free instruments
like call money & commercial papers.

2) Returns : Liquid funds in the last one year , has given a return of 7% ( as of July 07).

3) Risk : Investing in Liquid Funds can nearly assure your invested capital.

4) Maturity : While analysing Fund portfolio, just check its average maturity.For instance, 15
days denotes that the fund holds instruments maturing in 15 days.

5) Expense Ratio : Expense ratio of liquid funds is usually less than 1% p.a.

6) Taxation : The recent budget (2007) had proposed that liquid and money market funds
pay a dividend distribution tax (DDT) of 25% ; previously it was 12.5 %.

7) Dividend or Growth : One can buy either Dividend or Growth options of Liquid Fund.

Passive vs Active Mutual Funds

Would you put money into an actively managed equity fund or would you rather prefer to plough your money into passively managed index funds.
What’s the difference you would prefer to ask? Here’s one of the major difference. While an index fund puts your money into the benchmark index – sensex or Nifty, a diversified fund would invest into the broader market.
As a thumb rule, index funds are likely to deliver returns inline with the benchmark indices and are therefore preferred by dynamic investors during volatile times. Passively managed funds do not try to beat the index, but simply aim to track it by investing in companies precisely in accordance with the constituents of an index. The managers of the fund have far lower expenses, and the charges to investors are lower than for active funds.
While investing in passive mutual funds or index funds investors should not choose just any fund. Not all passively managed funds in India fail to deliver returns in line with the benchmarks. An ETIntelligence Group study since the beginning of the bull run showcases that almost half the passively managed funds under performed the benchmarks by a margin larger than acceptable. A little deviation is okay. But more than say 1-2% per annum is too much. Some of this underperformance could be due to expense ratios, which are 1% to 1.5%. This is too large compared to international trends. In the US, passive funds charge around 0.5%. This is fair, since passive funds are not required any active fund management. So there is no reason they should charge high fees, which are not too different from active funds.
Blame that on the tracking errors. To that add loads and you make a little less than 12%, on an average, of what the benchmarks deliver. This is true under various periods of time). Is this fair?
On the other hand, pick the right active fund and you could rake in a moolah. Take for instance Reliance Growth – if you invested Rs 10,000 in April 2003, just when the bull run started, it would now be a staggering 8 times more. And over varied periods of times, diversified funds have outperformed, though out performance seems to have declined in these volatile times. In the West, where markets are matured, its seen that out performance by actively managed diversified mutual funds is minimal. Most of these actively managed funds actually under perform too. But, in India, its seen that actively managed funds always out perform the benchmarks by huge margins. One important element to note here is the fact that many sectoral funds or small and mid cap funds, which may out perform during a bull phase may start showcasing negative returns in volatile times when the sector starts under performing. These may be high risk high gain funds. Therefore, an ac- diversified fund is haps the best bet for a lay investor.
Whatever may be the case, the difference is huge when you look at returns from passive funds and the actively managed ones. So what are active funds and how do these active fund managers work? Active funds attempt to meet the goal of out performing benchmark indices through the right mix of asset allocation, stock picking and market timing. Many fund managers talk about focusing on the ‘bottom-up’ stock picking approach. In short this means, selecting stocks on the basis of each individual company’s strengths rather than a sectoral approach considering what is happening in the wider economy.
Finally, what’s the conclusion? Its simple. Those investors who want a product that closely mirrors a major index, such as the Nifty or the Sensex, a passive fund is probably the wisest move. But, the question is why pay fund managers for getting mediocre returns?

Liberalization Provision - Insurance

Most Commercial and Personal insurance policies contain a liberalization clause or condition. When an insurance company offers enhanced benefits for policies newer than the one you hold, the liberalization clause adds those enhancements automatically. Examples of enhancements include dollar amount increases, or coverage of additional property.
There’s no additional premium charge for enhancements. Because individual states regulate insurance, enhancements come into effect only after your state implements the changes.

Leverage

Leverage is a notion whose meaning has evolved as a result of financial innovation during recent decades. Traditionally, leverage related to the relative proportions of debt and equity funding a venture. The higher the proportion of debt, the more leverage. A leveraged venture entailed more risk and potential reward for equity holders.

Consider a stylized example. A corporation is established by ten investors. Each puts up USD 100 in equity. There is no debt. After one year, the corporation will be liquidated. At that time, if its net assets are worth USD 900, each equity investor will realize a –10% return. If assets are worth USD 1100, each investor will realize a 10% return.

Now consider the same corporation, but financed differently. The same ten investors each put up USD 100, but only five of them hold equity. The other five hold debt. Debt holders are guaranteed to receive USD 105. At the end of the year, if the corporation's assets are worth USD 900, there will be USD 375 left over after paying debt holders. Each equity investor will realize a –25% return. If, on the other hand, the corporation's assets are worth 1100 at year end, there will be USD 575 left over after paying debt holders. Each equity investor will realize a 15% return.

As the examples illustrate, debt financing magnifies the risk as well as the possible reward for equity holders. Traditionally, the word "leverage" referred to the use of debt financing. In recent decades, that meaning has shifted to encompass any technique that similarly magnifies risk and reward for an investor.

United States Financial Regulation

Until 1863, US banks were regulated by the states. The Federal Government had twice established a national bank, but abandoned both efforts. In 1863, the Civil War had been raging for two years, and the Federal Government was desperately short of cash. Secretary of the Treasury Salmon P. Chase came up with an innovative source of financing. The Federal Government would charter national banks that would have authority to issue their own currency so long as it was backed by holdings in US Treasury bonds. The idea was implemented as the National Currency Act, which was completely rewritten two years later as the National Banking Act. The act formed the Office of the Comptroller of the Currency (OCC) with authority to charter and examine national banks. In this way, a dual system of banking was launched, with some banks chartered and regulated by the states and others chartered and regulated by the OCC.

The 1913 Federal Reserve Act formed the Federal Reserve System (the Fed) as a central bank and lender of last resort. The system included several regional Federal Reserve Banks and a seven-member governing board. National banks were required to join the system, and state banks were welcome to. Federal Reserve notes were introduced as a national currency whose supply could be managed by the Fed. The notes were issued to reserve banks for subsequent transmittal to banking institutions as needed. The new notes supplanted the OCC's purpose related to currency, but that organization continued to be the primary regulator of national banks.

Prior to 1933, US securities markets were largely self-regulated. As early as 1922, the New York Stock Exchange (NYSE) imposed its own capital requirements on member firms. Firms were required to hold capital equal to 10% of assets comprising proprietary positions and customer receivables.
By 1929, the NYSE capital requirement had developed into a requirement that firms hold capital equal to:
5% of customer debits;
a minimum 10% on proprietary holdings in Treasury or municipal bonds;
30% on proprietary holdings in other liquid securities; and
100% on proprietary holdings in all other securities.
During October 1929, the US stock market crashed, losing 20% of its value. The carnage spilled into the US banking industry where banks lost heavily on proprietary stock investments. Fearing that banks would be unable to repay money in their accounts, depositors staged a “run” on banks. Thousands of US banks failed.

During October 1929, the US stock market crashed

Dow Jones Industrial Average: 1929The Roaring ‘20s were over, and the Great Depression had begun. During this period, the US Congress passed legislation designed to prevent abuses of the securities markets and to restore investors’ confidence.
The 1933 Banking Act combined a bill sponsored by Representative Steagall to establishing federal deposit insurance with a bill sponsored by Senator Glass to segregate the banking and securities industries.

> More commonly known as the Glass-Steagal Act, it distinguished between:
> commercial banking, which is the business of taking deposits and making loans,

and investment banking, which is the business of underwriting and dealing in securities.
All banks were required to select one of the two roles and divest businesses relating to the other. Chase National Bank and the National City Bank both dissolved their securities businesses. Lehman Brothers dissolved its depository business. The First Bank of Boston split off its securities business to form First Boston. JP Morgan elected to be a commercial bank, but a number of managers departed to form the investment bank Morgan Stanley.

Glass-Steagall also formed the Federal Deposit Insurance Corporation (FDIC) to provide deposit insurance for commercial banks. All member banks of the Federal Reserve were required to participate. Other banks were welcome to participate upon certification of their solvency. The FDIC was funded with insurance premiums paid by participating banks. Deposits were insured up to USD 2,500—if a bank failed, the FDIC would make whole depositors for losses on deposits up to USD 2,500. That insurance level has since been increased to USD 100,000.
Two other acts addressed the securities markets. The 1933 Securities Act focused on primary markets, ensuring disclosure of pertinent information relating to publicly offered securities. The 1934 Securities Exchange Act focused on secondary markets, ensuring that parties who trade securities—exchanges, brokers and dealers—act in the best interests of investors. Certain securities—including US Treasury and municipal debt—were exempted from most of these acts' provisions.
The Securities Exchange Act established the Securities and Exchange Commission (SEC) as the primary regulator of US securities markets. In this role, the SEC gained regulatory authority over securities firms. Called broker-dealers in US legislation, these include investment banks as well as non-banks that broker and/or deal non-exempt securities. The 1938 Maloney Act clarified this role, providing for self regulating organizations (SRO’s) to provide direct oversight of securities firms under the supervision of the SEC. SRO’s came to include the National Association of Securities Dealers (NASD) as well as national and regional exchanges. Commercial banks continued to be regulated by the OCC or state regulators depending upon whether they had federal or state charters.
In 1938, the Securities Exchange Act was modified to allow the SEC to impose its own capital requirements on securities firms, so the SEC started to develop a Net Capital Rule. Its primary purpose was to protect investors who left funds or securities on deposit with a securities firm. In 1944, the SEC exempted from this capital rule any firm whose SRO imposed more comprehensive capital requirements. Capital requirements the NYSE imposed on member firms were deemed to meet this criteria.
An investment company is a mechanism for investors to pool money to be invested by professional managers. The company sells shares to the investors and a manager invests the proceeds on their behalf. The notion includes both open-end and closed end-mutual funds. Investment companies became popular in the 1920s. A number of incidents of abuse prompted Congress to pass the Investment Company Act in 1940. With a few exceptions—which encompass most of today's hedge funds—this granted the SEC regulatory authority over investment companies.
Between 1967 and 1970, the NYSE experienced a dramatic increase in trading volumes. Securities firms were caught unprepared, lacking the technology and staff to handle the increased workload. Back offices were thrown into confusion trying to process trades and maintain client records. Errors multiplied, causing losses. For a while, this “paperwork crisis” was so severe that the NYSE reduced its trading hours and even closed one day a week. In 1969, the stock market fell just as firms were investing heavily in back office technology and staff. Trading volumes dropped, and the combined effects of high expenses, decreasing revenues and losses on securities inventories proved too much for many firms. Twelve firms failed, and another 70 were forced to merge with other firms. The NYSE trust fund, which had been established in 1964 to compensate clients of failed member firms, was exhausted.

The US stock market declined through 1969.

Dow Jones Industrial Average: 1969

In the aftermath of the paperwork crisis, Congress founded the Securities Investor Protection Corporation (SIPC) to insure client accounts at securities firms. It also amended the Securities Exchange Act to require the SEC to implement regulations to safeguard client accounts and establish minimum financial responsibility requirements for securities firms.
As a backdrop to these actions, it came to light that the NYSE had failed to enforce its own capital requirements against certain member firms at the height of the paperwork crisis. With its trust fund failing, it is understandable that the NYSE didn’t want to push more firms into liquidation. This inaction marked the end of SROs setting capital requirements for US securities firms.

In 1975, the SEC updated its capital requirements, implementing a Uniform Net Capital Rule (UNCR) that would apply to all securities firms trading non-exempt securities. As with earlier capital requirements, the capital rule’s primary purpose was to ensure that firms had sufficient liquid assets to meet client obligations. Firms were required to detail their capital calculations in a quarterly Financial and Operational Combined Uniform Single (FOCUS) report.
During the Great Depression, the Fed had implemented Regulation Q that, among other things, capped the interest rates commercial banks could offer on savings account deposits. The intent was to prevent bidding wars between banks trying to grow their depositor bases. Rising interest rates during the 1970s contributed to a migration of larger institutional deposits to Europe, where interest rates were not limited by Regulation Q. The emergence of money market funds, which pooled cash to invest in money market instruments, caused further erosion of bank deposits.
In 1980, Congress passed the Depository Institutions Deregulation and Monetary Control Act. Among other things, this terminated the Regulating Q ceiling on savings account interest rates, effective in 1986. In response to this and an ongoing decline in bank capital ratios, bank regulators implemented minimum capital requirements for banks. There was some debate about what should be included in a bank's capital. This was resolved by defining two classes of capital. A bank's primary capital would be a bank's more permanent capital. It was defined as owners' equity, retained earnings, surplus, various reserves and perpetual preferred stock and mandatory convertible securities. Secondary capital, which was more transient, included limited-life preferred stock and subordinated notes and debentures. In 1981, the Fed and OCC implemented one capital requirement, and the FDIC implemented another. Generally, these specified minimum primary capital ratios of between 5% and 6%, depending on a bank's size.
Because these requirements were based on a bank's assets, they were particularly susceptible to regulatory arbitrage. Various modifications were made to the primary capital requirements, but it was soon clear that basing capital requirements on a capital ratio was unworkable. In 1986, the Fed approached the Bank of England and proposed the development of international risk-based capital requirements. This led to the 1988 Basel Accord, which replaced the asset-based primary capital requirements for US commercial banks. The concepts of primary and secondary capital were incorporated into the new accord as tier 1 and tier 2 capital.
As time went on, the Glass-Steagal separation of investment and commercial banking was gradually eroded. Some of this stemmed from regulatory actions. Much of it stemmed from market developments not anticipated by the act.
Glass-Steagall did not prevent commercial banks from engaging in securities activities overseas. By the mid 1980s, US commercial banks such as Chase Manhatten, Citicorp and JP Morgan had thriving overseas securities operations. Currencies were not securities under the Glass-Steagall Act, but since exchange rates were allowed to float in the early 1970s, they have entailed similar market risk. In 1933, futures markets were small and transacted primarily in agricultural products, so they were not included in the legal definition of securities. Also, depression era legislators did not anticipate the emergence of active OTC derivatives markets, so most derivatives did not fall under any definition of securities. By the early 1990s, commercial banks were taking significant market risks, actively trading foreign exchange, financial futures and OTC derivatives. They did so while enjoying FDIC insurance and membership in the Federal Reserve system. Neither of these benefits was available to the investment banks with whom they were increasingly competing.
Commercial banks focused on the prospect of repealing Glass-Steagal and related legislation. This would open the door to the creation of financial supermarkets that combined commercial banking, investment banking and insurance. Due to the nature of their business, commercial banks generally had more robust balance sheets than investment banks, and they could expect to dominate such a new world. There would be profits from cross-selling deposit taking, lending, investment banking, brokerage, investment management and insurance products to a combined client base. There would also be troublesome conflicts of interest.
While he was chairman of the Federal Reserve, Paul Volker fought efforts to ease the separation between commercial and investment banking. Allen Greenspan replaced Volker in 1987, and he brought with him a more accommodating attitude. Section 20 of the Glass-Steagall Act had always granted modest exemptions allowing commercial banks to engage in limited securities activities as a convenience to clients who used the bank’s other services. Tentatively under Volker, but aggressively under Greenspan, the Fed reinterpreted Section 20 to expand that authorization. In various rulings during the late 1980s, the Fed granted certain commercial banks authority under Section 20 to underwrite commercial paper, municipal revenue bonds, mortgage-backed securities and even corporate bonds. In October 1989, JP Morgan became the first commercial bank to underwrite a corporate bond, floating a USD 30MM bond issue for the Savannah Electric Power Company. A flood of commercial bank underwritings followed.
The Fed also allowed commercial banks to acquire investment bank subsidiaries through which they might underwrite and deal in all forms of securities, including equities. These became known as Section 20 subsidiaries. There were limitations on the use of Section 20 subsidiaries. The most restrictive was a cap on the revenue a commercial bank could derive from securities activities under Section 20. In 1986, the Fed had set this cap at 5%. It was expanded to 10% in 1989 and again in 1996 to 25%.
Congress attempted to repeal Glass-Steagall in 1991 and again in 1995. Both attempts failed, but the stage was set. The Fed had already gutted much of Glass-Steagall. Commercial banks were deriving considerable revenues from investment banking activities. Their lobbyists had arrayed considerable forces in Congress ready to make another attempt. Glass-Steagall was teetering, and all that was needed was for someone to step forward and topple her.
That is what John Reed and Sanford Weill did. Reed was CEO of Citicorp, a large commercial bank holding company. Weill was CEO of Travelers Group, a diverse financial services organization. It had origins in insurance but had recently acquired the two investment banks Salomon and Smith Barney and merged them into a single investment banking subsidiary. In 1998, Reed and Weill merged their firms, forming Citigroup, a financial services powerhouse spanning commercial banking, investment banking and insurance. This was an aggressive move that could easily have been blocked by regulators. A permissive Fed was supportive of the deal, which forced the hand of Congress. In 1956, Congress had passed the Bank Holding Company Act, which had supplemented Glass-Steagall by limiting the services commercial banks could offer clients. The Citicorp-Travelers merger violated the 1956 act, but there was a loophole. The Holding Company Act allowed for a two-year review period—with an optional extension to five years—before the Fed would have to act. The newly formed Citigroup was the world's largest financial services organization, but it was operating under a five-year death sentence. If Congress didn't pass legislation during those five years, Citigroup would have to divest some of its businesses.
Pressure on Congress was immense. In 1999, they passed the Financial Services Modernization Act, and President Clinton signed it into law. The act is also known for the names of its sponsors—the Gramm-Leach-Bliley Act—but detractors have called it the Citigroup Authorization Act. This sweeping legislation finally revoked the Glass-Steagall separation of commercial and investment banking. It also revoked the 1956 Bank Holding Company Act. It permitted the creation of financial holding companies (FHCs) that may hold commercial banks, investment banks and insurance companies as affiliated subsidiaries. Those subsidiaries may sell each others products. Within a year of the new act's passage, five hundred bank holding companies formed FHCs.
Although it was sweeping, the Financial Services Modernization Act was, in some respects, a half measure. It dramatically transformed the financial services industry, but it did little to transform the regulatory framework. Prior to the act, commercial banks, investment banks and insurance companies had been separate, and they had oversight from separate regulators—the Fed and OCC for commercial banks, the SEC for investment banks, and state regulators for insurance companies. Who would now oversee the new FHCs that combined all three industries? The answer is no one. The act adopted a "functional" approach to regulation. The Fed and OCC now regulate the commercial banking functions of FHCs. The SEC regulates their investment banking functions. State insurance regulators regulates their insurance functions. The act has opened the door to abuses across functions, but no regulator is clearly positioned to identify and address these.
At the same time that Glass-Steagall was being torn down, dramatic growth in the OTC derivatives market led to concern that there was no regulator with clear authority to oversee that market. A 1982 amendment to the Securities Exchange Act specified that options on securities or baskets of securities were to be regulated by the SEC. This left structures such as forwards and swaps outside the SEC's jurisdiction. It also excluded derivatives on interest rates or foreign exchange. A regulator with authority most relevant to these derivatives was one whose original purpose was unrelated to financial markets. This was the Commodity Futures Trading Commission (CFTC).
Congress formed the CFTC under the 1974 Commodity Exchange Act (CEA). It had exclusive jurisdiction to regulate commodity futures and options. Whether this authority encompassed OTC financial derivatives was not legislatively clear and motivated several law suits.
As a debate raged over how OTC derivatives should be regulated—or if they even should be regulated—there was pressure for the the CFTC to act. Because its authority was not clear, the CFTC hesitated, and market participants were generally opposed to the CFTC intervening. Position papers were written by industry groups and government agencies. Inevitably, there were some turf skirmishes as different regulatory agencies tried to position themselves for a role in any new regulatory regime. A strong argument against increased regulation of OTC derivatives was that it would drive the market overseas—as had happened 20 years earlier to the market for USD deposits.
Finally, Congress acted in 2000 by passing the Commodity Futures Modernization Act (CFMA). This amended the 1974 Commodity Exchange Act, exempting all OTC derivatives. The CFTC was not to regulate OTC derivatives. The market was to remain largely unregulated.
Overheated technology stocks formed a bubble that collapsed during 2000. In 2001, the broader market also fell sharply. On September 11 of that year, terrorists hijacked airliners, slamming two of them into New York's World Trade Center. Another hit the Pentagon in Washington, and a fourth fell in a Pennsylvania field. With the terrorist attacks, the bad news seemed to accelerate. Within weeks, the Wall Street Journal was reporting on a brewing scandal at energy trading powerhouse Enron. The firm had been using accounting gimmicks and outright deception to inflate profits and hide debt. In December, it filed for bankruptcy—the largest in US history. In 2002, that record was broken by the bankruptcy of telecommunications firm WoldCom, which had inflated its 2000-2001 income by a whopping USD 74.4 billion. Enron and WorldCom were just the two most prominent in a slew of bankruptcies and accounting scandals, which included Global Crossing, Tyco, Rite Aid, Xerox, and others. In 2002, Accounting firm Arthur Andersen was convicted of a single charge stemming from its lackluster auditing of Enron. That action forced Andersen, one of the largest and most respected auditors in the world, to go out of business. In 2005, the US Supreme Court overturned the decision, concluding that the presiding judge had given the jury faulty instructions. This decision came too late to save Arthur Andersen.
There was plenty of blame to go around. Corporate executives had cooked books while lining their pockets. Analysts at investment banks had recommended stocks they knew were dogs in a quid pro quo that ensured banking business from those same firms. Accounting firms had been cross-selling consulting services to audit clients. Increasingly, their auditors had shied away from challenging management of firms so as to not jeopardizing those lucrative consulting engagements.

Amidst the gloom and finger-pointing, Congress passed the 2002 Sarbanes-Oxley Act, fondly known as "sox." This is a sweeping law that increases management accountability, mandates a variety of internal controls at firms, and strengthens the role of auditors. Accounting firms are largely prohibited from simultaneously auditing and consulting to any given client. A new federal agency, called the Public Company Accounting Oversight Board, (PCAOB or Peek-a-Boo), is to oversee accounting firms. Corporations must test internal controls regularly. To avoid conflicts, those tests must be performed by an outside firm other than the external auditor. Sarbanes-Oxley has been variously described as ineffective, overly costly to corporations, or too demanding. Maybe some of the criticism is reasonable—or maybe not. Time will tell.
In 2004, the Basel Committee finalized its new Basel II accord on bank regulation. US regulators perceive this as primarily relevant for internationally active banks. They intend to apply it to just ten of the largest US banks. Another ten will have the choice to opt-in. Other US banks will remain subject to existing US regulations, including those adopted under the original Basel Accord.