Requirements for Bank Regulations - Essay Example

Bank Regulations By Lecturer’s and Bank Regulations: Introduction Ever since the start of the bankingbusiness, governments have tried to regulate and lay down policies that enable fair banking and business practices. Banking regulation is a branch of financial regulation that governments apply to ensure sanity and fairness in the financial sector. Banking regulation involves regulation and supervisions that ensure that banks adhere to guidelines and regulations that aim to promote integrity in the banking sector. Regulation therefore ensures the banks are open and transparent with their customers to prevent cases of dishonesty. Banks are big players in the financial sector of governments in the world. Because of that, banks affect the countries economically and hence their operations must be monitored. Some banks are very large that they are considered, “too big to fail” (Andrew, 2010). That means that such banks would cause a lot of economic problems if they were to go down. Such banks are very sensitive to their country’s economy as it is partially dependent on them. In the instance the banks crumble, it takes the government to provide funds to bail them out. If the government were to fail to do so there would be a financial crisis in the country. Bank regulation was put in place to achieve some aims. The aims and objectives vary from country to country but there are those that stand out and are common in many countries. Some of the aims are systemic risk reduction, protecting bank confidentiality, increasing credit allocation to deserving clients and to decrease fraud in banks. Systemic risk reduction ensures that the financial system of a country does not fail completely due to irregular trading conditions of banks (Alexander, 2006, p.184). Protecting bank confidentiality ensures that the information that a bank is entitled to rightfully withhold from the public is not leaked. Credit allocation ensures that the right and deserving entities can access loans from the banks. Decreasing fraud ensures that banks are not used to perform financial malpractices like money laundering. Bank regulation occurs by applying certain principles that vary from country to country. Some principles are however common in most of the countries. The general principles of bank regulation therefore include supervisory review, market discipline and minimum requirements. Supervisory review involves licensing and monitoring of banks. For banks to operate they need to be licensed and this is done by the financial regulator. The Bank regulators after licensing banks monitor them to ensure they adhere to the laid down rules and regulations. If the banks breach the terms and conditions for operation as stipulated by the regulator, punitive actions are taken against them. Some of the punitive actions include penalties and revoking of bank license (Donato, 2012, p.506). Minimum requirements are the requirements a bank must meet for them to operate as banks. The requirements are laid down by the regulators and they help to ensure that the regulators attain their objectives. The requirements ensure that there is risk reduction in the banking sector and one major requirement is the minimum capital ratio. Banks need to operate with minimum capital ratio in order to adhere to the regulators rules (Leonard, 1994, p.109). Market discipline encourages transparency in the banking sector. Banks need to offer some information to the creditors and depositors for them to know the financial status of the bank from time to time. From this information, people can deduce the level of risk faced by investing in the bank and make informed decisions regarding investments. Requirements for Bank Regulations Bank regulations have certain requirements which also differ from region to region but are common in a number of ways. One of the common requirements is the capital requirement. The capital requirement dictates how much capital a bank must have and how they should handle it with relation to the assets they hold. An international body known as the Bank for International Settlements Basel Committee on Banking Supervision stipulates the capital requirements of each country. In the late 1980’s the committee came up with the Basel Capital Accords. This was a capital measurement system that assisted in influencing and measuring capital requirements of different countries. The other requirement of bank regulation is the reserve requirement (Grey, 2002, p.38). The reserve requirement ensures a bank holds minimum reserves for it to ask for deposits and bank notes. However, many regulators these days do not ask for minimum reserve ratio because of the capital requirement which has overshadowed it. This is because reserve requirements put more emphasis on liquidity than safety. Some locations however still hold a minimum reserve ratio and an example is Hong Kong. There, the banks are encouraged to convert 25% of the liabilities due in a month’s time to liquefiable assets. Reserve requirements were therefore used to determine the deposits made in banks. Reserves in banks are held in different form like foreign currency, gold or central bank notes. Another requirement of bank regulation is cooperate governance requirements. This requirement ensures that banks and financial institutions are well managed so that bank regulators can operate easily. The banks have a lot of branches and sectors and it is important for the management to ensure they monitor all practices in the bank. If the bank engages in malpractices, the investors and client of the bank will most likely accuse the management. This is why the management needs to ensure they are in charge and know all the operations of the banks. Some of the requirements under cooperate governance are; the bank must be a corporate that is in cooperated in the country of operation. The bank must have directors who exceed a certain set number (Chiara, 2014, p.37). The requirements also require a bank to have a good organizational structure and a constitution that ensures everyone works in the best interest of the bank. Another requirement of financial regulation is financial reporting and disclosure requirements (Charles, 2010, p.162). The regulators under these requirements ensure that a bank discloses its financial status to the public after a stipulated amount of time. This serves to ensure that all the bank’s stake holders know the banks financial situation. In the United States a body known as Securities and Exchange Commission ensures that banks prepare and publish financial statements (Nancy, p.1). These statements are required to follow the financial reporting standard and should be audited before they are published for the public. In addition the body requires that the management of a bank indicate through a report their internal control over the financial reporting. The report indicates the responsibility of the management in maintaining internal control of transparent financial reporting. The report also reveals the management’s assessment on the transparency and accuracy of the financial reports given. The report must also contain an attestation report from the registered auditing firm that audited the banks financial records that the management’s assessment of the internal control over financial reporting of the bank is okay. Regulators also require banks to meet credit rating requirements that are determined by credit rating agencies. The banks must also disclose the credit ratings to current and prospective investors. The information helps the bank’s current and probable future clients to decide on the risk of investing with the bank. Speculation and fears of conflict of interest however have arisen regarding the credit rating agencies. Banks pay the agencies to determine their current credit rating which contradicts the agencies objectives to inform the public of the credit ratings of the banks. Banks are also allowed by the regulators to have large exposure restrictions. This stipulation allows banks to restrict and limit exposure of information to the public. The level of restriction is proportional to the bank’s assets and equity. It prevents the investors and stakeholders of the bank from experiencing unwanted risks. One major purpose of regulating banks is to prevent the major repercussions that occur from banks failing. The concept that some banks are to “big to fall”, which means that some banks falling would mean a subsequent fall in the economy of a country is therefore the major reason for regulation. Regulation ensures that there are no situations where a bank fall would result in the crumble of the economy by laying down policies and regulations that dictate bank operations. By doing this, the regulators prevent moral hazards. This means that the regulators ensure that the banks don’t engage in risky transactions with the thought that the government will help them if they fall. If the regulators were fail to do this, the banks would always engage in risky transactions oblivious of crumbling and failing as they would be sure they have government support. That would bring a cycle of moral hazard which is dangerous for the economy (Nicolas, 2010, p.170). The role of bank regulation has been discussed and its significance has been seen. Bank regulation therefore generally plays the role discussed above. In the year 2008, the world faced a financial crisis that greatly affected the economies of the world (May, 2010, p.3). The financial crisis was greatly linked to the ineffective bank regulatory measures and policies that were in place prior to the financial crisis. The 2008 financial crisis was the worst financial crisis that occurred in the world since the great depression that occurred in the 1930’s.The crisis triggered the crumble of financial institutions including banks which suffered insolvency. The governments came to the rescue of the banks by providing financial assistance to the banks preventing total collapse of the banks and a worse hitting economic crisis in the countries. Housing market was the major casualties of the crisis with foreclosures, evictions and unemployment occurring in the market. Stock markets around the world also dropped drastically. The financial crisis was associated to the failure of businesses and the loss of wealth and assets to the tune of trillions of dollars by the consumers (Thomas, 2013, p.24). The crisis later led to a rapid decrease in economic activities in the world due to reduced wealth and liquidity which led to the post 2008 international recession. The crisis also led to the European sovereign-debt crisis which is a debt crisis that affected multiple European states after the crisis. The European states were not able to pay government debt or assist to bail out banks that were in debt without financial aid from other institutions. The states thus obtained assistance from the institutions such as ECB and the IMF and are still indebted to them. The financial crisis is majorly linked to the falling of the housing market in the United States (Caprio, 2012, p.556). This occurred when real estate values in the country suddenly dropped contrary to projected expectations. The occurrence negatively affected financial organizations including banks worldwide and led to the recession. Prior to the crisis, the United States government had come up with policies that encouraged and propagated home ownership among its citizens. The government through financial institutions therefore increased access of subprime loans to encourage people to get homes. The loans were later refinanced to adjustable rate mortgages to pay the loans with the prediction that house prices would continue going up in the country. More and more people therefore continued to obtain the adjustable rates to invest and obtain houses and the banks continued to obtain loans to finance this from other international banks and organizations. The real estate developers however build many houses and supply exceeded demand which led to the falling of the house prices. The adjustable fixed mortgages price also went up. Because of this, the mortgage price exceeded the house price and borrowers were unable to service the mortgage. The banks therefore became insolvent and there was an economic crisis. The event led to foreclosures, homelessness and lack of jobs. Investors withdrew their money from banks to invest it in more dependable investing opportunities like bonds due to bank insolvency. The occurrence led to a credit crunch and drop in stock prices (Robert, 2012, p.367). All of these events were the chain reaction events that led to the financial crisis and the global recession. After the financial crisis different countries developed more stringent regulations in the financial sector. The financial regulations included bank regulations that were supposed to govern and control banks to prevent future cases of financial crisis. The bank regulations therefore were policies that were laid down after the crisis in the country to closely monitor banking operations and limit them to safe practices. This was done to ensure that the bank operations and undertakings would not be responsible for another global crisis. Some of the governments that developed new policies are the United States. After the financial crisis and great recession that occurred in the world in the first decade of the 21st century, pressure mounted on international governments to take action to prevent future risks. In the United States there was a public outcry to change the bank regulatory bodies operations. The Obama administration responded by passing the Dodd –Frank Wall Street Reform and Consumer Protection Act (Michael, 2011). President Obama signed the Act into a federal law in 2010 and it contained the major changes in financial and banking regulation since the finance regulation reforms done in 1930.The act brought a drastic change to bank regulatory system in the country and affected all financial institutions in the United States. The law triggered mixed feelings among the people with some predicting it was not strong enough to deal with future crisis. Another divide saw the law as draconian and that restricted financial institutions including banks from operating freely. The law was initiated as a result of efforts by the Obama administration to correct the financial situation by proposing bills that were taken to congress. Improved versions of the proposed bills were later introduced in the House of Representatives and senate by Frank and Dodd respectively. The bill which was later passed to an Act and was subsequently named after them due their efforts in pushing it in congress. The Dodd Frank act was an all-inclusive act that contained many sections that were supposed to provide provisions to ensure that financial institutions did not engage in risky behaviour. The Act contains 16 titles and required bank regulators to come up with 243 rules and to conduct 67 studies (Gup, 2011, p.1). The regulators were also supposed to 22 periodic reports. The main objective of the law was “To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end too big to fail, to protect the American tax payer by ending bailouts, to protect consumers from abusive financial services practices and for other purposes”. The act influenced the alteration of existing regulatory structures and amended the Federal Reserve Act that had been passed in the past(Alfred,2011,p.10). The act provided consumer protection from irregular financial transactions by banks and advocated for transparency in the financial sector. The act also ensured that there would be no scenario in the future where tax payer’s money would be used to assist the banks from their self-inflicted problems. The Act was supposed to achieve these objectives by forming new regulatory agencies or transferring power from some agencies to others. Some regulatory agencies that were incompetent and had not acted in the events that led to the financial crisis were also abolished. Some of the financial regulatory bodies that were formed included; Financial Stability Oversight Council and the Office of Financial Research. These agencies were supposed to report to congress regularly on their current tasks that they undertaking to eliminate chances of future financial crisis. The regulatory agency that was abolished was the Office of Thrift Supervision. As has been discussed the Act had 16 titles that tackled the regulatory reform process conclusively minimizing any chances of loop holes. The first title of the Act was the financial stability Act of 2010 (Mike, 2012).The title stipulated the creation of two financial regulatory agencies which were Office of Financial Research and Financial Stability Oversight Council. The treasury secretary was charged with chairing the Financial Stability Oversight Council while a president appointee who was supposed to be approved by the Congress would chair the office of financial research. The task of the council was to identify risks in the United States financial environment and deal with them accordingly. The council was also supposed to promote transparency and encourage market discipline. Office of financial research was formed as a department of treasury that would support the council by providing technical, administrative and other support that they needed. The director of the Office of Financial Research held Subpoena power that enable them to retrieve any data from financial institutions that he requires at any time. The second title involves Orderly liquidation Authority (Cisse, 2013, p.143). It stipulates the orderly method of liquidation of financial institutions. The institutions include banks, securities companies and insured depository firms. The title therefore provides procedures for liquidation of financial institutions to add to those stipulated by the FIDC and the SIPC. Title 3 of the act is also known as Enhancing Financial Institution Safety and Soundness Act (Congress, 2010, p.172). The subsection was supposed to deal with overlaps and sharing of tasks between regulators and that eliminate completion amongst them. It did this by abolishing the Office of thrift supervision and sharing its roles to different agencies. State savings associations was given to the FDIC, Federal Reserve Systems was given power over holding companies and remaining thrifts to Comptroller of the currency. Title four of the Act was also known as Private Fund Investment Advisers Registration Act of 2010 (Fuchita, 2010, p.76).The subsection stipulated investment advisors who were previously unregistrable as advisors to register as Investment advisors. This was to be done in accordance to the Investment Advisers Act of 1940.Some of the advisors that were required to register included hedge fund managers. The section encourages financial reporting by the investment advisers. Title 5 is also known as the Federal Insurance Office Act (Viral, 2010). The subsection allowed the formation of a Federal insurance Office as a department of Treasury. The office was charged with monitoring the insurance industry and make sure that faults that could lead to financial crisis are obtained and worked on. The office also ensured that marginalized groups and needy people had insurance and that they coordinated with international insurance firms. Title 6 is also known as Bank and Savings Association Holding Company and Depository Institutions Regulatory Improvement Act. The subsection stipulates that banks should not have private fund equity that exceeds 3% of entire ownership interest. This clause therefore reduces speculative investments on big institutions balance sheets. Title 7 is also called the Wall Street Transparency and Accountability Act. The subsection ensures that over the counter swaps are well regulated. Some of the transactions regulated under this act are the credit derivative and the credit default swap. This transactions were part of the cause of the financial crisis and hence to be regulated. Title 8 is titled the Payment, Clearing and Settlement Supervision Act (Willke, 2013, p.136). The subsection generally ensures financial stability in the country. The provision does that by giving powers to the Federal Reserve to enable it come up with policies and structures to reduce risk of financial crisis and increase financial stability. It also does that by making sure Board of Governors have powers to reduce risk by supervising payment, settlement and clearing tasks in financial firms. Title 9 is also called Investor Protections and Improvements to the Regulation of Securities (Jacobus, 2012). The subsection generally stipulates the relationship between broker dealers and customers and revises powers of credit rating organizations. Title 10 is also known as Consumer Financial Protection Act (Larry, 2013). The subsection ensures that the consumer financial products meet federal law standards. It does that through the establishment of Bureau of Consumer Financial Consumer Protection which is a body tasked with the task. The bureau has a director who is appointed by the president with the affirmation of the senate. Title 11 is also known as Federal Reserve System Provision (Orice, 2011, p.2). The provision stipulates the creation of Vice chairman of Supervision in the Board of Directors. The vice chairman serves in the absence of the chairman and comes up with policy for the regulation of financial institutions. Title 12 is also known as the Improving Access to Mainstream Financial Institutions (Rezaee, 2011, p.130. The subsection provides for low and middle income people to access and participate in financial systems. It does this by providing incentives and ensures the people can access micro loans and financial guidance and counselling. Title 13 is also known as the Pay it Pack Act and seeks to amend the Emergency Economic Stabilization Act. The act generally reduced the funds allocated to counter the financial crisis by 225 billion dollars. It also stipulated that the unused cash funds would not be used in any other programs. Title 14 was also known as the Mortgage Reform and Anti Predatory Lending Act (Shear, 2009, p.2). The subsection generally guides on data collection methods and stipulates that Mortgage lenders offer their loans to only people who are able to repay them. Title 15 and 16 are miscellaneous sections that have been added to the Act and also reduce chances of financial crisis by upholding financial regulation. The passing of the reforms of the financial regulatory systems led to mixed reactions and was observed to have various advantages and disadvantages. Some of the disadvantages are that the new regulations would make it harder for people to start new businesses and enterprises. This was because the new rules were too stringent and people would not be able to get funds easily from financial institutions. Small banks will also be affected negatively due to the law as they will not be able to issue loans and mortgages easily to clients in a bid to comply with the new laws. This is because the laws emphasizes on a lot of scrutiny of the clients by the banks before they give loans. This would affect small banks and lenders who would suffer reduced business and be forced to close down. Some of the advantages of the law include that it came up with policies that reduces the chances of another financial crisis. It did this by laying down stringent measures that prevented financial malpractices that led to 2008 financial crisis. The laws also led to a reduction in fraud cases which ensured people and institutions did not lose their money unfairly. The Office of Management and Budget came up with a way to quantify the benefits arising from the new regulation laws. The firm found that the benefits of the regulation annually were 136 to 650 billion dollars. The figure was too much compared to 44 to 66 billion dollars that was annual cost arising from the regulations meaning the new financial regulations bring more good than harm. Reference list Andrew, S. (2010). Too Big to Fail: Inside the Battle to Save Wall Street. New York: Penguin Books. Alexander, K. (2006). Global Governance of Financial Systems: The International Regulation of Systemic Risk. 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