Regulation of Financial System | Overview & Research Examples (2024)

...14 Financial regulation and supervision By the end of this chapter you should have an understanding of the key issues involved in global financial regulation and supervision, including: the reasons for regulating the financial industry and the importance of financial stability; the regulatory landscape in the main global financial centres of the UK, European Union, United States, Hong Kong, China and Singapore; regulation and supervision styles; anti-money-laundering and prevention of financial crime; complaints and dispute resolution. Introduction Financial regulations encompass a collection of regulations, laws, guidelines and policies to which financial institutions must adhere and in accordance with which they must conduct themselves. The regulations provide specific restrictions, requirements and guidelines, the aim being to maintain financial integrity and discipline within a country or a region. It is usually the government and the state bank in a particular country which are responsible for the domestic financial regulations, although in some countries there are non-governmental organizations tasked with their implementation; for example, the Financial Services and Markets Act 2000 in the UK. It is common for there to be numerous laws relating to financial institutions in existence within any country with a developed domestic financial system and all domestic and overseas financial institutions operating within the country’s domestic financial markets must adhere to these laws. The domestic financial regulators are there to enforce these laws and regulations and will have powers to sanction any individual or financial institution that fails to abide by them. The implementation and maintenance of this type of robust regulatory regime promotes financial stability within the country or region and allows problems to be addressed effectively...

...11 Regulation of financial services Patrick John Ring DOI: 10.4324/9781003227663-11 Key points summary There are three objectives of financial regulation: systemic stability, the soundness of individual firms and ensuring that markets work effectively (including appropriate consumer protection). The objectives and theory about how they may be achieved influence the structure of regulation. The main front-line tasks for regulators are to authorise appropriate firms to do business, police the perimeter between authorised and unauthorised firms and supervise and enforce compliance with specified rules. Consumer protection can take two forms: ex-ante protection focuses on preventing consumer detriment; ex-post protection provides routes for complaints and redress. Conventional regulatory measures may be supplemented with innovative approaches, such as ‘nudging’ consumer behaviour and trying to change the culture of firms. It is fair to say that, in recent years, events in the financial sector have cast a strong light upon the role of national and international regulators of the financial services industry. The Global Financial Crisis (GFC) that started in 2007 – described in Box 1.1 in Chapter 1 – drew attention to the failures of financial regulation, and subsequent financial scandals in many different countries have also drawn attention both to the challenges faced by consumers in navigating their way through an increasingly complicated financial landscape, and to the behaviour of certain individuals and the culture of the firms for which they worked. In this chapter, we begin by looking at the objectives of financial regulation and how that can influence the structure of national regulators. Thereafter, we focus upon the position in the UK, which itself illustrates many of the issues and dilemmas facing regulators around the world...

...The other main objectives of financial regulation – namely, maintaining market confidence, protecting consumers and reducing financial crime 14 – refer to conduct of business regulation and hence are not directly relevant from the perspective of this study. The following paragraphs identify the specific economic characteristics of the financial sector, and of banks in particular, that explain why financial stability is a public good in the strict sense of the term. 15 First, it is necessary to explain the vital importance of the financial sector and of banks in particular for any modern economy. As financial intermediaries, banks efficiently transfer liquidity from depositors and bondholders to individual, corporate and sovereign borrowers, allowing for economic growth and expansion. In fact, they generate liquidity, as they fund illiquid assets (loans) using the money deposited in them. 16 Indeed, by accepting deposits and relending the greatest part of them and then reaccepting the funds back and relending them, and so on, circulating money is multiplied several times. This is the so-called money multiplying effect, which explains the need for authorities charged with monetary policy to supervise the overall level of lending in the economy. 17 Other financial institutions also act as risk intermediaries, for instance, insurance firms. Moreover, banks operate a complex payment services system which facilitates the transactions of their private and corporate clients (inter alia) via cheques, credit cards, debit cards, cash cards, electronic purses, money transfers, and standing orders. In this way, banks can be said to resemble public utility firms providing an intangible network of essential importance for society as a whole. Banks and other financial institutions are also large employers, especially in countries like the UK where the financial sector accounts for nearly 10% of GDP...

...FIs should balance the expected benefits and expected costs of assuming various levels of risk. Initially, regulation encouraged market segmentation and, hence, regulation was segmented. Although segmented markets are breaking down, regulations have been slower to change. Either financial products or financial institutions can be regulated. The regulatory structure is in the process of ongoing change because of the evolution of the financial services industry. A Proposal to Overhaul the Financial Regulatory Structure The subprime lending crisis of 2008 that spread to the entire global financial system highlighted lapses in the financial regulatory system. Even before this crisis, policy makers recognized the need to overhaul an outdated regulatory system. The globalization of finance and the plethora of financial innovations had made the financial system very different from what it was a few decades earlier. In March 2007, the U.S. Treasury “convened a blue-ribbon panel to discuss U.S. capital markets competitiveness.” Out of this panel came the recognition that the competitiveness of the financial services industry was negatively impacted by an outdated regulatory structure. Therefore, in June 2007, the Treasury began work on a series of recommendations to modernize the regulatory system. On March 31, 2008, Treasury Secretary Henry Paulson released the “Treasury’s Blueprint for Financial Regulatory Reform.” a The blueprint proposes a new regulatory framework that would be composed of three regulators, each with a different function. The goal of regulating by function was to make the regulatory structure more resilient to innovations within the financial system that could render current regulations inadequate or obsolete. The first regulator would focus on financial stability across the entire financial system. This would protect against systemic risk, which is the risk that a collapse in one market will spread to the rest of the economy and result in a downturn...

...Although most banks are able to raise funding and manage reserves through financial markets, the central bank is often committed to be the lender of last resort if banks have difficulties in market funding. These standing facilities in the central bank thus provide desirable insurance for banks. It is probably not surprising that the banking sector is one of the most heavily regulated sectors in an economy, given its strategic position in an economic system and its systemic importance for real economy. As banks are important providers of financial resources to the real economy, banks need to follow the rules of the game, disciplines are necessary to avoid fraud and deceptions, and as firms in other industries, banks need to follow competition rules that prevent them from abusing their market power at the cost of competitors and consumers. As bank failure is often destructive for financial systems as well as the real economy, and public intervention to save the real economy out of banking crises costs taxpayers massively, it is thus also important for banking regulation to increase the resilience of banks ex ante by requiring banks to hold sufficient cushions and buffers, instead of fighting the costly last war ex post. However, what is more challenging for banking regulation is that banks are closely connected with each other through financial claims so that individual banks’ behavior may also affect the stability of the entire banking system; regulation thus also needs to be macroprudential and aims at reducing systemic distress, besides maintaining each individual bank’s resilience. Furthermore, as new regulatory issues arise from banking sectors’ evolution, and banks develop new services and products to get around regulatory rules, banking regulation needs to be regularly updated to catch up with developments in banking. The Banking Sector is Dynamic and Evolving The banking sector can be highly dynamic and evolve quickly...

...Whilst banking is always political to the extent that banks are fundamental to a country’s economy, countries such as the US and UK, with large financial sectors, will need political will to make changes for the benefit of society at an international level. Jurisdictional competition for financial services means that regulation of the shadow banking sector remains unlikely since co-operation at the international level remains a real difficulty. Other methods of improving financial stability will thus be investigated in this chapter. The Federal Reserve Board and institutional weaknesses during the financial crisis of 2007–9 The US regulatory structure Ben Bernanke, Chairman of the Federal Reserve Board between 2006 and 2014, said that ‘the Federal Reserve has become much more focused on financial stability’ (Bernanke 2013). The Federal Reserve Board is one of four prudential bank regulators in the US financial regulatory system. The other bank regulators are the Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC) and National Credit Union Administration. As prudential regulators, the overriding concept is prudent monitoring and regulating risks of banks (Murphy 2013). Two agencies are in charge of monitoring the information market players provide to customers: the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). The US financial regulatory system is complex, and there are regulatory overlaps between the agencies. For example, the bank regulators can regulate the disclosures of their chartered firms, whilst securities and derivatives regulators have some prudential responsibilities. An example is section 731 of the Dodd–Frank Wall Street Reform and Consumer Protection Act 2010 (‘Dodd–Frank Act’). It states that the SEC and CFTC can, after consultation with the prudential regulators, set capital requirements for major swap participants...

...We must, in particular, ensure that an effective global governance regime is in place to promote systemic financial stability. Such a system must ensure consistency in regulatory approach at the domestic level and needs to be able to contend with increasing calls in various jurisdictions to reduce regulatory burden so as to enhance financial and economic prosperity in one jurisdiction without appropriate regard given to the potentially global effects of risk arising from such an approach. The de Larosière Group review of the GFC and its impact on the EU usefully sets out a roadmap for reform, which identifies the important role of regulation: either directly, or through oversight of the financial sector: global financial services regulation did not prevent or at least contain the crisis as well as market aberrations. A profound review of regulatory policy is therefore needed. A consensus, both in Europe and internationally, needs to be developed on which financial services regulatory measures are needed for the protection of customers, the safeguarding of financial stability, and the sustainability of economic growth. This should be done being mindful of the usefulness of self-regulation by the private sector. Public and self-regulation should complement each other and supervisors should check that where there is self-regulation it is being properly implemented. This was not sufficiently carried out in the recent past. 174 174 de Larosière Report (n 7) 15 (internal citations omitted) The chapters that follow therefore consider whether we have adopted a global governance regime that is fit for purpose. In other words, we must review the global governance regime to see whether it effectively promotes systemic financial stability, including through effective implementation of macroprudential regulatory measures at a domestic level, so as to promote sustainable development. Bibliography Legislation, decisions and other primary sources 106 Cong. Rec. S265–266 (daily ed...

...Conventionally, the international standards relevant to financial stability are grouped into three areas. The first one regards the transparency of macroeconomic policies and data. It includes principles that should be adhered to in: i) compiling and disseminating economic, financial, and socio-demographic harmonized statistics; ii) adopting practices so as to provide a clear picture of the structure and finances of government; iii) ensuring transparency in the conduct of monetary and financial policies; and iv) producing and disseminating information in order to access international capital markets. 5 The second area focuses on financial regulation and supervision, and covers standards to define the framework for: i) the supervision of the insurance sector; ii) the sound prudential regulation and supervision of banks and banking systems; and iii) securities regulation protecting investors, reducing systemic risk, and ensuring that markets are fair, efficient, and transparent. 6 The third area covers institutional and market infrastructure, and comprises standards defining: i) independent auditors’ responsibilities; ii) the legal, institutional, and regulatory framework that influences corporate governance; iii) benchmarks to assess the quality of deposit insurance systems; iv) the features of systemically important payment systems, central securities depositories, securities settlement systems, central counterparties, and trade repositories as well as the responsibilities of the respective supervising authorities; v) the legal, regulatory, and operational measures for combating money laundering and the financing of terrorism; vi) ways to evaluate and improve insolvency and creditor/debtor regimes; and vii) a single set of accounting standards to be applied on a globally consistent basis. 7 On the other hand, if the international standards regime complemented by a pivotal forum bringing together the...