Chapter Five

CHAPTER 5
The Financial Sector Regulations

Introduction
• The financial services industry has always been
politically sensitive and, consequently, heavily
regulated.
• The banking industry, for instance, relies on public

confidence.
2
The Nature of Financial System Regulation
• A good financial system with a well-functioning competitive
market as well as a well-supporting financial institution is an
essential ingredient for sustainable economic growth.
• Developing sound Financial Markets requires the establishment
of public confidence in the institutions that constitute the
Finance Sector.
• Confidence can only be maintained if these institutions deliver
services as promised. Thus one of the duties of Governmental
Authorities is to preserve the long term stability of the
financial system and reliability of its components.
3
Why regulation?
• prevent issuers of securities from
defraudingby concealing relevant information
investors
• promote competition and fairness in the
trading of financial securities
• promote stability of financial institutions
• restrict activities of foreign concerns in domestic
markets and institutions
• control the level of economic activity
4
A. Asymmetric information, moral hazard, and
adverse selection explain the regulatory
environment in banking.
B. Restrictions on Asset Holdings
─Regulations limit the type of assets banks may
hold as assets. For instance, banks may not hold
common equity.
─Even with regulations in place, the 2007–2009
global financial crisis still occurred. Perhaps more
regulation is needed?
5
C. Bank Capital Requirements
─Banks are also subject to capital requirements.

Banks are required to hold a certain level of
capital (book equity) that depends on the type
of assets that the bank holds.
6
D. Financial Supervision: Chartering and Examination
 Reduces the adverse selection problem of risk-
takers or crook owning banks.
 Examinations assign a CAMELS rating to a bank,
used to justify cease and abstain from orders for
risky activities.
 Periodic reporting and frequent examinations.
 If examiners are’t happy, bank can be declared a
“problem bank” and subject to more frequent
examinations.
7
E. Assessment of Risk Management
Past examinations focused primarily on the quality
of assets. A new trend has been to focus on whether
the bank may take excessive risk in the near future.
 Four elements of risk management and control:
1. Quality of board and senior
management oversight
2. Adequacy of policies limiting risk activity
3. Quality of risk measurement and monitoring
4. Adequacy of internal controls to prevent fraud
F. Disclosure Requirements
─ Better information reduces both moral hazard
and adverse selection problems
G. Consumer Protection
─ Standardized interest rates
─ Prevent discrimination
─ The 2007–2009 revealed further need for
consumer protection (from themselves?) as
consumers took out loans where they clearly
didn't understand the terms
H. Restrictions on Competition
─ Branching restrictions, which reduced
competition between banks
I. E-finance: electronic banking and regulation
• Electronic banking has created new issues in regulation, particularly security
and privacy.
• An incident in Russia (1995) highlights this, where a computer programmer

moved millions in assets from Citibank accounts to personal accounts.
• Electronic banking creates the need to assess the technical skills of banks to
handle transaction securely and safely.
• Privacy is also a problem. There are laws protecting consumers from the
sharing of information, but this regulation is likely to evolve over time.
Types of Financial Regulations
• To protect the public and the economy from financial
panics, the governments are implementing a number
of regulations.
• These regulations are taking the form of
 Restrictions on Entry
 Disclosure
 Restrictions on Assets and Activities
 Deposit Insurance
 Limits on Competition and
 Restrictions on Interest Rates.
Restrictions on Entry
• Governments endorse very tight regulations governing
who is allowed to set up a financial intermediary.
Individuals or groups that want to establish a financial
intermediary, such as a bank or an insurance company
must obtain a charter from the state or the Federal
Government.
Disclosure
• There are stringent reporting requirements for financial
intermediaries. Their bookkeeping must follow certain strict
principles, their books are subject to periodic inspection, and
they must make certain information available to the public.
Restrictions on Assets and Activities

• There are restrictions on what financial intermediaries are
allowed to do and what assets they can hold. Before you put
your funds into a bank or some other such institution, you
would want to know that your funds are safe and that the bank
or other financial intermediary will be able to meet its
obligations to you. One way of doing this is to restrict the
financial intermediary from engaging in certain risky activities.
Deposit Insurance
• The government can insure people’s
deposits so that they do not suffer any
financial loss if the financial intermediary
that holds these deposits fails. All
commercial and mutual savings banks,
with a few minor exceptions, are
required to enter deposit insurance,
which is used to pay off depositors in
the case of a bank’s failure.
Limits on Competition;
• Politicians have often declared that uncontrolled
competition among financial intermediaries
promotes failures that will harm the public.
Although the evidence that competition does this
is extremely weak, it has not stopped the state and
federal governments from imposing many
restrictive regulations.
Restrictions on Interest Rates;
• Competition has also been inhibited by regulations
that impose restrictions on interest rates that can
be paid on deposits and loans.
Reasons for the Regulation of Banks
• Protection of the Safety of the Public’s Savings
• Control of the Supply of Money and Credit
• Ensure Equal Opportunity and Fairness in Access
to Credit
• Promote Public Confidence in the Financial System
• Avoid Concentration of Power
• Support of Government Activities
• Help for Special Segments of the Economy
The End of Chapter 5
Thank you!!!

Chapter Five

Uploaded by

Copyright:

Available Formats

Chapter Five

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter Five

Uploaded by

Copyright:

Available Formats

CHAPTER 5

The Financial Sector Regulations

• The banking industry, for instance, relies on public

─Banks are also subject to capital requirements.

• An incident in Russia (1995) highlights this, where a computer programmer

Restrictions on Assets and Activities

You might also like