Banking Regulations – Benefits and Importance of Regulation

Introduction

In most countries, the government appoints a regulatory authority and grants it the mandate to monitor and control the operations of commercial banks in a country. Banking regulation has evolved significantly. For instance, in the 1970s the regulation focused on controlling both the borrowing and lending rates and structures of the commercial banks. In the recent years, the regulations focus on market variables. Thus, regulation is a response to market failure (Gabii, 2012). This paper seeks to discuss the rationale for regulation. Secondly, it also discusses the benefits gained from regulations. Thirdly, it also looks at the importance of the regulatory bodies. Finally, it discusses the impact of future regulations on the banking industry.

Rationale for regulation within the commercial banking system

Regulation within the commercial banking system is necessary for a number of reasons. To start with, regulation reduces the risk that the bank depositors are exposed to. From a microeconomic point of view, banking regulations ensure that banks monitor the risks that arise from lending. Regulation ensures that the banking sector maintains a certain liquidity ratio and this minimizes the possibility of panic withdrawals (Biggar & Heimler, 2005). From a macroeconomic perspective, the regulations ensure that the banking sector is stable enough to survive a crisis in the economy. In turn, it enhances stability of the economy because it reduces the risks that arise from adverse market conditions. Secondly, regulation within the commercial bank minimizes the abuse of the banks. Without regulations banks can be vulnerable to crime. For instance, regulation minimizes the ability of banks to channel proceeds from crime (such as the sale of prohibited drugs or stolen money from the government) into the economy. Money laundering can destabilize the economy. Therefore, regulations minimize transmission of criminal activities. Thirdly, regulations aid in the achievement of economic growth in a country. For instance, the government point out that investment in certain sectors can enhance economic growth and development. Thus, regulation can direct credit to such sectors. Further, regulations promote confidentiality within the banking industry. The confidentiality safeguards the interest of consumers and boosts consumer confidence. This promotes investment and economic growth.

Benefits gained from the main regulatory bodies

Different countries across the world have different frameworks for banking regulation. The United States has about eight regulatory bodies that oversee the operations of the banking sector. The first body is Securities & Exchange Commission (SEC). The SEC was set up to oversee the operations of the stock exchange. The agency ensures that all public companies including banks submit various periodic reports such as the annual and the quarterly reports. Thereafter, the agency makes public the financial reports of the banks. This helps in minimizing fraud and insider trading. The second body is the Commodity Futures Trading Commission (CFTC). CFTC oversees the operations of the markets for options and futures. Since banks are key players in these markets, the body ensures efficiency and honesty in the clearing process. Thus, they protect the interest various market players. The third body is the Federal Deposit Insurance Corporation (FDIC). Apart from insuring deposits and warranting the protection of depositor’s accounts, FDIC inspects a number of banks. It also carries out roles that are related to consumer safety and destitutions of banks.

The fourth body is the Financial Industry Regulatory Authority, Inc. (FINRA). The body regulates procedure of arbitration in the New York Stock Exchange (NYSE). Therefore, it oversees the operation of firms including banks that carry out operations in the NYSE. The fifth body is the Office of the Comptroller of the Currency (OCC). The body directly regulates the operations of the banking system in the United States. It ensures well-being and dependability of the banking system, stimulates competition in the banking industry, promotes fair distribution of banking services in the country, and enforces various laws among other duties. The body also monitors assets, liquidity and capital of the commercial banks. The sixth body is the National Credit Union Administration (NCUA). The body oversees the operations of the credit unions. The body manages the insurance fund that covers account holders in the various credit unions. Thus, it protects the citizens from failure of credit unions. The last body is the Consumer Financial Protection Bureau (CFPB). The body oversees the safety of consumers in relations to the products and services offered by the financial institutions. Apart from inspecting the banks and other financial institutions the agency receives and tracks complaints received from customers. Thus, it can be observed that the role of these bodies directly affects the operations and decision making process of the commercial banks.

How current and future banking regulations will impact on the industry

For instance, the Financial Stability Board and Basel Committee for Banking Supervision recommended for tighter standards on capital and liquidity. The report suggested that banks should increase the amount of capital and liquid assets in their balance sheets. The increase in the amount of capital and liquid assets impacts on the banking sector positively because it increases the well-being and dependability of the world banking system. This in turn results in a long-term stream of benefits that arises from economic growth and stability in the financial sector. On the other hand, the increase in the minimum capital and liquid asset will result in a decline in the amount that commercial banks can lend. Also, it will result in an increase in the cost of implementing the new standards. However, it was established that the gain from the regulation outweighs the costs associated with the regulation. Secondly, implementation of Basel II (capital adequacy framework) was expected to benefit the banks because it is risk sensitive.

Therefore, it allows banks to align their operations with the framework. However, implementation of Base II framework in big multinational banks may be quite costly (Dow Jones & Company, Inc., 2013). Secondly, the Community Reinvestment Act required banks to extend credit facility to low income earners. This regulation targeted the underserved areas in terms of banking services. The regulation resulted in an increase in the profitability of banks. However, the Act resulted in additional cost of data-reporting requirements. Finally, there have been significant changes in the Bank Secrecy Act since its implementation in 1970. Several regulations that relate to sanctions have been implemented and they have benefited the banking system by minimizing criminal abuse of the banking system and threats to national security. Some of these regulations are expected to be implemented in the future. On the contrary, the compliance cost of these regulations is quite high because in some instances, the regulation requires overhaul of internal processes and purchase of software (Robert, Canner, Mok & Sokolov, 2005).

Future regulations or economic conditions

The banking sector and the economies of various countries are emerging from the global financial crisis that began in 2008. The banking sector is recovering at a slower pace than the other sectors in the economy. This can be attributed to loss of consumer confidence. The regulators across the world have tightened their regulation of commercial banks. Base III (capital adequacy framework) will be introduced and banks will be expected to comply within four years. This signifies an increase in the minimum capital that the commercial banks must hold. Also, the liquidity ratios have been increased further (KPMG, 2013). These new regulations exert a lot of pressure on the operations and profitability of the commercial banks because it reduced the ability of the commercial banks to offer credit facilities and earn profit. These changes in regulation require banks to come up with strong actions that will enable them to comply with the changes and still remain profitable in the industry. The economic conditions and the new regulations may not favour banks because, first, the banks have to restore the trust that was lost during the financial crisis. Secondly, the commercial banks have to alter their internal operations and strategies to enable them to comply with the regulators’ requirements. Besides, the commercial banks have to assess the impact of the new regulations on the costs of operation and profitability. It is also worth noting that the regulators have increased the penalties that arise from non-compliance with the new rules (KPMG, 2013). Thus, it is expected that very few banks may survive tighter regulations and the few that will survive will be quite profitable.

Conclusion

The paper carried out an evaluation of the rationale of regulations within the commercial banks. It can be noted that the regulation seeks to achieve two main objectives these are, financial stability and efficiency. The discussion above reveals that banking regulation generates a number of positive and negative results both within the banking sector and the entire economy. However, the benefits of the regulation outweigh the costs because the trade-off between stability of the financial system and efficiency is positive. Thus, banking regulation is important because it ensures soundness in the banking system in the economy.

References

Biggar, D., & Heimler, A. (2005). An increasing role of competition in the regulation of banks. Web.

Dow Jones & Company, Inc. (2013). Basel: Bank rules won’t hurt growth. Web.

Gabii, G. (2012). The nature of banking and the rationale for regulation. Web.

KPMG. (2013). Evolving banking regulation 2013. Web.

Robert, A., Canner, G., Mok, S., & Sokolov, D. (2005). Community banks and rural development: Research relating to proposals to revise the regulations that implement the community reinvestment act. Federal Reserve Bulletin, 91(1), 202-35.