Regulation of Commercial Banking in the US - Case Study Example

Regulation of Commercial Banking: Why, How and to What Extent' The features of regulation of commercial banking and the extent to which banking regulations could be described are suggested here. The discussion deals with the different types of banking regulations in US, UK and other countries, the relevance of these regulations, the relations between financial institutions and government authorities and the role of banking regulations in bringing about financial stability of a region. The focus is on the regulations of commercial banking and institutions and the different aspects of these regulations, their use and application within a social or governmental system. The questions raised would be whether regulations are necessary, if so why and what are the features of such regulations, how do they differ between countries and how do governments use these baking regulations for their own gains. The purpose of such banking regulations, the justification for having such regulations and the extent to which these regulations are implemented in banking customs across the world are studied in some detail. Bank regulations comprise of government regulations that sets out certain requirements and rules, restrictions and guidelines, that banks, of different countries are supposed to follow to maintain the integrity of the financial system. Bank Regulations in the US is not as closely knit as in other countries and the regulators could be Federal Reserve Board, or other state regulatory bodies. The banking regulations across the world are focused not just on safety and security but also on privacy of customers, disclosure issues, anti money laundering issues, anti terrorism issues, promotion of lending to lower income groups, and fraud prevention. Different cities tend to have their own financial regulation laws and these laws are in place to allow governments and banks to work closely in matters related to national security and financial needs. The Bank Secrecy Act or BSA requires financial institutions to assist government agencies to detect money laundering practices. Financial institutions tend to keep records of cash purchases and file reports of transactions above a certain amount. These institutions are required to report suspicious activities of money laundering, fraud, privacy intrusion and tax evasion as well as other criminal activities to the government and appropriate authorities. Financial institutions are also required to invest in communities and a file must be maintained on the support provided to communities. Financial institutions are required to disclose data about home purchases, home finance, home purchase and pre-approvals, home improvement, and refinance applications as well as multifamily dwellings in accordance with the Home Mortgage Disclosure act. Apart from this and the Community Reinvestment Act, there are Reserve Requirements for certain Institutions. The reserve requirements indicate the minimum reserve that banks must have so that this money as deposits could come to some use during severe recession. Barrios and Blanco (2003) analyses the extent to which banking firms set their rates of capital equity over assets and have developed two theoretical models that tend to demonstrate capital ratio for firms which are affected and not affected by capital regulation. Freixas and Santomero (2002) use the regulatory theory to analyze the theory of banking regulation and consider the justifications of financial intermediation to identify market failures that would make certain banking regulations necessary. The analysis of regulation tends to compare within the domains of banking and industrial organization and shows why banking regulations act as a safety net for banks and why and how it should be structured in a way that could make banking systems more efficient. In a study by Hendrickson and Nichols (2001) annual bank insured data were utilized from 1936 through 1989 to evaluate bank regulations and bank risks with cross country comparisons. A bank tends to operate in a regulatory environment and determining these regulatory laws as well as associated risks would be important as well. Hendrickson and Nichols add that banking restrictions and deposit insurance are found to be detrimental to the stability of any banking system. In this context the authors highlighted the 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act that removed the legislative barriers that were present in interstate banking (Hendrickson and Nichols, 2001). The creation of risk based deposit insurance has been supported and deposit insurance tends to increase risk taking. International standardization of bank capital tends to be associated with risk taking in a banking system and supports the 1988 Basel Accord. Commercial banks set up some acceptance criteria for giving loans to its customers and these loan granting facilities generally consider regulatory requirements set up by the financial institutions (Bolt and Tieman, 2004). There are however advantages and disadvantages of presenting more lenient or liberal acceptance criteria for granting loans. In some cases banks may attract more demand for loans and people will be ready to take loans if the acceptance criteria are not too stringent, yet on the other hand there may be deterioration in the quality of loans or some hidden clauses that could bring in higher irks for the bank and also its customers. There are however stringent capital adequacy requirements and in accordance with banking regulations, banks may set up strict acceptance criteria for loans thus all banking transactions are generally guided by underlying banking regulations. Increased competition in the banking industry could lead to change in banking behavior and could also increase risks for any bank although risk adjusted regulations will have to be considered in these cases. Bolt and Tieman (2004) show a model in which it benefits a bank to hold more equity than prescribed by a regulator although issuing equity would be more effective for a bank than attracting deposits. Gomez and Recio (2007) discuss the role of banks and financial institutions during periods of social change and revolution and suggest that revolutions have important social and economic consequences and entrepreneurs and businesses have to cope with these changes. Revolutions can result in high levels of transactions, high transaction costs in banks, inflation and banks are responsible to maintain economic stability and help out the government authorities. Gomez and Recio (2007) discussed the impact of the Mexican Revolution on the banking sector and on the bank clients as most banks had to close during that period. Companies used non chartered banks and foreign financial institutions to maintain their day to day business operations despite the political chaos. Thus banks tend to play a regulatory role in all kinds of situations and bring in financial stability to a region helping its commercial organizations and businesses to conduct operations smoothly and effectively. Banking regulations have been effective and have considerable impact on certain factors including total factor productivity (TFP) growth and Tirtiroglu et al (1998) have claimed that the overall impact of TFP growth of regulation has been negative. The TFP growth has been negatively correlated to population growth and GDP growth although according to the paper, technological investment has been positively related to TFP growth. Banks and securities markets are thus subject to regulations and the primary reason for which banks are regulated seen to be avoidance of financial risks and crises and to maintain financial security. The purposes of regulation tend to be related to protection or security of investors as well as enhancing the efficiency of markets. This Allen and Herring (2001) suggested that avoidance of systemic risk, investor protection, and enhancement of efficiency of the financial markets seem to be the main reasons for which regulations are implemented in the financial sector. Regulations also help in having a greater impact such as broader social objectives, combating anti-social activities and pave the way for stronger and more effective newer regulations. Banking regulations primarily prevent systemic and financial risks in the market and provides financial stability to a region although certain regulation may be directed towards community achievement, efficiency enhancement and investor protection. Emerging markets have been plagued by several issues and banking regulations and securities markets bring out the nature of financial systems and liabilities. Any crises within emerging markets could be prevented with banking regulations and Allen and Herring (2001) suggest that Asian countries should rely on financial markets for raising funds and reduce the role of banks also highlighting the fact that securities market regulations should focus on systemic risks. Several studies have shown the role of competitive banking and financial instability and introduced capital requirement for the banking sector to assess the macroeconomic consequences. Tsomocos (2003) discuss a quantity theory of money that derives from the structure of interest rates and use an expectations and liquidity preference model. The fiscal and regulatory policies used for banks have real effects and due to the overarching necessity for capital requirements, regulatory policies are seen as important for efficiency. Tsomocos (2003) claims that policy analysis of situations and crisis prevention and management may help in reducing the costs and risks of financial instability in any situation. The focus of this discussion has been on the importance of banking regulations and financial control of governmental authorities in any country and the reasons for which regulations exist for commercial banking and why or how and to what extent these regulations could be useful or expiable in any situation. Regulations are seen as controlling financial crises, preventing security frauds and helping in bringing about financial stability to a region regulations are also necessary in every step to focus on community investment services and help in attracting investors and help in improving efficiency of banking systems. Regulations are needed in every sphere of financial management from lending out loans to home mortgage and general banking transactions and all transactions tend to affected by situational, social and political factors and regulations are in turn changed in accordance with these situations or have profound impact on these situations. Banking regulations are implemented primarily because of bringing in a system of efficiency and for protecting investors and providing customers with security and maintaining financial stability within a region. Regulations become important during periods of strife, during inflation and instability when banks are seen as protectors of the financial status of a region and even provide aid to government authorities. The role of commercial banks are thus protective generative and supportive towards individual and government organizations. Bibliography: Asher, Mukul G. (2007) Reforming governance and regulation of urban cooperative banks in India Journal of Financial Regulation and Compliance, Volume 15,'Number 1, pp. 20-29(10) Allen, F. and R. Herring, (2001) "Banking Regulation versus Securities Market Regulation", Wharton School Financial Institutions Center Working Paper 01-29 (July),: Barrios V.E.;'Blanco J.M. (2003) The effectiveness of bank capital adequacy regulation: A theoretical and empirical approach Journal of Banking and Finance, Volume 27,'Number 10, pp. 1935-1958(24) Booth J.R.;'Cornett M.M.;'Tehranian H. (2002) Boards of directors, ownership, and regulation Journal of Banking and Finance, Volume 26,'Number 10, pp. 1973-1996(24) Freixas, X. and A. Santomero, (2002) An Overall Perspective on Banking Regulation, Federal Reserve Bank of Philadelphia Working Paper 02-1 (February),: G'mez-Galvarriato, Aurora;'Recio, Gabriela (2007) The Indispensable Service of Banks: Commercial Transactions, Industry, and Banking in Revolutionary Mexico Enterprise and Society, Volume 8,'Number 1, pp. 68-105(38) Hendrickson J.M.;'Nichols M.W. (2001) How Does Regulation Affect the Risk Taking of Banks' A U.S. and Canadian Perspective Journal of Comparative Policy Analysis, Volume 3,'Number 1, pp. 59-83(25) Miles D. (1995) Optimal regulation of deposit taking financial intermediaries European Economic Review, Volume 39,'Number 7, pp. 1365-1384(20) Shull, Bernard (1999) The Separation of Banking and Commerce in the United States: An Examination of Principal Issues Financial Markets, Institutions & Instruments, Volume 8,'Number 3, pp. 1-55(55) Slovin M.B.;'Sushka M.E.M.E.;'Polonchek J.A. (1999) An analysis of contagion and competitive effects at commercial banks - borrowers as bank stakeholders Journal of Financial Economics, Volume 54,'Number 2, pp. 197-225(29) Tsomocos D.P. (2003) Equilibrium analysis, banking and financial instability Journal of Mathematical Economics, Volume 39,'Number 5, pp. 619-655(37) Bolt Wilko;'Tieman Alexander F. (2004) Banking Competition, Risk and Regulation Scandinavian Journal of Economics, Volume 106,'Number 4, pp. 783-804(22) Yamak, Sibel;'S'er, 'm'r (2005) State as a stakeholder Corporate Governance: International Journal of Business in Society, Volume 5,'Number 2, pp. 111-120(10) Tirtiroglu D.;'Daniels K.N.;'Tirtiroglu E. (1998) Total Factor Productivity Growth and Regulation in U.S. Commercial Banking During 1946-1995: An Empirical Investigation Journal of Economics and Business, Volume 50,'Number 2, pp. 171-189(19) Read More