Regulation in the Banking Sector - Coursework Example

Regulation in the Banking Sector Outline i. Introduction ii. Nature of bank regulations iii. Objectives and impacts of the regulations iv. Disadvantages of regulations v. Conclusion Introduction The definition of a bank is derived from the activities which it undertakes. The definition of a bank is; an institution that accepts deposits from individuals and companies and repays the money in the long run. The banks use the money that has been deposited by lending it to other companies and individuals. The practice of banking is such that the banks borrow short and in turn lend long. Where it does this, it takes more interest from the money it has lent that the amount that it gives to depositors. Therefore, a bank can be defined as an intermediary between a saver and a borrower. The importance of banks in the economic life of a nation cannot be underestimated. A sound banking system is usually complemented by a healthy economy. Since banks do not create new wealth with their borrowing and lending, their major is the facilitation of production, consumption, exchange and distribution of wealth. Savings of people are mobilized for investment purposes and this makes banks very important partners in the economy. Banks are very important since if they were not available, large chunks of the capital present in a country would remain idle. Banks have also reduced the difficulties involved in international trade. Businesses between countries or exchanges between people in different nations would not be as easy were it not for banks. The subsequent discussion will discuss the regulations that have been set to supervise the banking sector. More important however is the fact that banks offer safe storage for money and other valuables. Nature of bank regulations Banking is regulated in many ways. Before any entity can be allowed to engage in banking, there has to be some form of licensure that has to be acquired at the very basic level. These licenses are meant to gauge a number of key factors that are meant to dictate the business in line with the regulations that are set by the many regulators. There is a need to determine the conduct of business, the amount of capital available and whether it is important to sustain a business and the competence of the management. These requirements are referred as the prudential regulations and are aimed at protecting the banks against insolvency, protecting it from the systemic risks that may present a scenario of widespread and major bank collapses and also protection of depositors1. In the current economic climate, no government can guarantee that a certain bank will not fall. Thus, the governments avoid the risk of having to pay customers of collapsed banks. In doing this, the government has to ensure that the banks have a sound capital base. Protection of depositors is up to £85,000 per saver per authorized institution in the UK and $100,000 in the US. If one has more money, then, they should spread it in banks if they feel uncomfortable about the banks position. Any amount beyond the refundable limit is considered to be in the “big boy” class and hence can take care of themselves2. The conduct of business regulations are aimed at ensuring that clients are treated in a fair manner and that there is no moral hazard that banks pose to their clients. For investment businesses, the conduct of business regulations are aimed at ensuring that the clients are all treated in the same way and that none is cheated out of the money while others benefit. It is compulsory that the investment business has a sound capital base as well that the members of the investment business are registered in a compensation scheme. There is no justification that is required for the regulations on a philosophical standpoint given the role that the banking sector plays in the modern society. Recently, there was the global economic crisis that had negative effects all over. The political pressure that resulted from this crisis means that the regulations for the banking sector will only increase to protect the investments of people. These issues are somewhat simplistic, but on close inspection, the regulation of an international business like a bank is anything but simple. Insolvency of such an institution that is the pillar for many other businesses may have unprecedented impacts not only on a national level but also on an international one. The irony of the situation is that the regulations for the banking sector that are meant to reflect the international nature of the business are dependent on existing national and legal structures. There is no proportion between the power of the national regulators and the scope of the international reach that the banks have. The banking business is divided into two. There is the deposit taking aspect of the business and investment business. The FSMA puts the definition of “deposit-taking” as merely the act of “accepting deposits”. Therefore, the act does not specify any prohibitions that are related to deposit-taking. However, the details of deposit taking are in the Regulated Activities Order. Article 5 of the order and section 19 of the FSMA raise fundamental points relating to deposits, their acceptance and the conduct of business. In order to determine whether a given sum of money is a deposit, one has to look at the contract that is existent between the parties involved. If the amount is prepaid with the intention of it being returned at a future date or with the person paying the money able to get it on demand, then, these parameters suggest that it is a deposit. Furthermore, the amount may or may not be accompanied by an interest or premium. Article 5 stipulates that the amount must strictly be repayable according to the terms of the contract and must be in full. The phrase “with or without interest or premium” suggests that the depositor must get his full amount back. The amount may however be more than he initially banked but must not be less. If the depositor gets an amount that is less than he initially deposited, then, the amount is not regarded as a deposit. The assumption is that a form of risk was involved in the deal and that the payer of the amount took the risk in the hope of a greater reward. The banker-customer relationship is a debtor-creditor one. Therefore, the depositor of cash should get it back in full depending on the terms of the contract regardless of the success of any venture that the bank may have been involved in. the exceptions from deposits are contained in article 5(2) b together with article 5(3) of the Regulated Activities Order and refers to payments that are referable to the transactions involving goods and services and also in the taking of security. Landlords taking dilapidations deposits from their tenants cannot be grouped as having taken deposits according to the order. Likewise, a broker who takes money from his clients cannot be said to take a deposit as the money is meant as a security for dealings in the financial future markets.3 After establishing whether an amount really is a deposit, the regulations seek to determine whether the person or body receiving the deposit is a accepting it for the purposes of the provisions. The money that is received may be lent to others signifying that the accepting party is itself a lender. This fact fulfils the first criterion in the determination. Another criterion has to do with whether the person or business accepting the deposit is financed wholly or at least in part by the interest accrued from the deposit or the capital arising from the deposits. Not all finances collected by means of debt finance constitute a deposit. Therefore, the exemptions that have been stated in the rules will have to be considered using all the facts available. An example is the monies that are received from an authorized institution and thus cannot amount to a deposit on the part of the borrowing entity. While making the necessary assessment, such monies cannot be considered as being deposits and thus the person receiving them cannot be considered to be doing so for the purposes of the Regulations Activities Order. The above regulations are specific to the United Kingdom and hence, they may not represent the case in other countries. In the discussion, a number of points emerge. First, the business that is in the business of deposit’-taking must be licensed. This means that it must fall under the supervision of the FSA and the bank of England.4 The person who gives the money must give it for the purpose of accessing the money at a later date. Additionally, the money that he does receive must be in cash or must be so redeemable. Furthermore, the amount deposited may have increased at the time of withdrawal but may not have decreased. Objectives and impacts of the regulations The reasons for bank regulation can be broadly classified as either being as a result of the prevention of the risk of a systematic crisis instigated by the banks consciously or otherwise and the assurance to depositors that their money is safely kept. In either case, the objective is protecting the customer from losses that might be incurred by investments that have been conducted by the bank. The customers are protected to a certain extent against the collapse of banks. Prudential regulations are the most basic forms of these regulations and are aimed at reducing the extent of risk to which the bank creditors are exposed to. This means that the depositors are protected from any activity that may have been carried out with their money. These regulations also serve to prevent the banks from failures. Disruptions may be common in the case of adverse trading conditions causing multiple failures in banks, some of which might be major. Thus, the regulations also help to protect them from such eventualities. Regulators concede that it is almost impossible to run a zero failure system for banks although the regulations strive towards that. In the modern society, there are very many illegal activities that generate a lot of dirty money. In an attempt to curb this trend, regulations have been put in order to ensure that banks are not used for this purpose. Money laundering is a way in which the banks may be used and as such, the regulations are meant to ensure that they are not. The information that is stored in banks and by them is very valuable. If it was to fall into the wrong hands, it could be used for negative purposes. Therefore, regulations have been put for the purpose of protecting the confidentiality of banks and their customers. Finally, the regulations are aimed towards the allocation of credit to the appropriate sectors. Disadvantages of regulations There are a few disadvantages that are associated with the regulation of banks. First, the regulations are meant to level the market for the banks. Banks in a given jurisdiction will feel that they must not be subject to severe regulation than other banks in other jurisdictions5. There is therefore a race to the bottom in a bid to ensuring that there is no loss in competitiveness and customers. What banks do not understand is that they are continuously targeted by international laws and therefore, in reality, the playing field is not level albeit the efforts by regulators to favor the banks in their jurisdictions. The second disadvantage of regulation is that the limits that are put will be what banks will adhere to. This is the tendency to migrate to the bottom. For example, the minimum capital base that the regulators have put for a bank will be what they will strictly adhere to and will not take initiative to do it any other way. This attitude, if it led to a collapse of the bank, would be alright since it was the action of the regulators that occasioned it. Therefore, banks do not show any initiative. Thus, regulation simply poses a moral hazard on the part of banks.6 The overprotective consumerism is another disadvantage. This is the where the regulations assume that customers are not smart. Here, the regulation seeks to protect only a sizeable part of ones deposits while ignoring the rest. The fact that no protection is leveled for deposits that are above £85,000 in the UK and $100,000 in the US is an unfair practice to the “big boys” who also deserve the same level of protection that is accorded to the others. Another disadvantage that is related to the conduct of business regulation and mostly involving investment banks is that the regulations are not detailed under criminal law. Therefore, any person that is accused of having acted unfairly in the course of business cannot be charged in a court of law as no criminal charges can be leveled against him but is only subject to a fine. This can lead to a carefree attitude in the banking sector which may lead the customer to incur losses. The formulation of regulations and their implementation in the industry is also a disadvantage. This is because the processes involved cost a lot of money. The taxpayer therefore has to bankroll the process of bank regulation adding on to his already full plate from all other obligations he has. Conclusion Regulation is very critical in the banking sector. The recent economic crisis proved that there is need for tighter regulations especially in investment banks. The federal reserve in America had to make special regulations to prevent a number of the banks from collapse by bailing them out which would d have had untold negative consequences to the already bad global economy. The regulations for the investment banks as well as those for the retail banking sector are in place to protect both their customers and the banks themselves. The policies that dictate the crafting and enforcement of these regulations stem from the desire of the respective governments and communities to create a conducive environment for conduct of business in these turbulent economic times. In conclusion, and considering the evidence that has been discussed in the paper, it is prudent to say that a regulated banking sector is better for the customers, the banks themselves and the economy of the host countries as compared to an unregulated sector. Bibliography Errico, L. & Alberto, M., "Offshore Banking: An Analysis of Micro- and Macro-Prudential Issues." IMF Working Paper (International Monetary Fund 1999) Goodhart, C., “Financial Integration and Prudential Control Segmentation: What Kind of Coordination Does Prudential Policy Need in the Integrated European Financial Market?” Financial Markets Group (London School of Economics 2002) Straub, T., Reasons for frequent failure in Mergers and Acquisitions: A comprehensive analysis (Deutscher Universitätsverlag 2007) Wood PR and Wood P, Law and practice of international finance, vol 2 (Sweet & Maxwell 1980) Read More