Running head: REGULATIONS IN THE FINANCIAL SECTOR 1

Assess and explain critically the need for regulation of the financial sector and discuss the

mechanisms for bank regulation in your country/countries of your choice.

Regulations in the Financial Sector in USA

Name
Institutional Affiliation
REGULATIONS IN THE FINANCIAL SECTOR 2

Regulations in the Financial Sector in USA

The financial sector has evolved significantly over the decades to become a reliable

institutions not only in the country, but across the world as well. In particular, the financial sector

has managed to gain people’s trust and confidence over the years, hence the reason people still

rely on it. However, the financial sector has exhibited a number of challenges over the years,

which have led to its destruction entirely, which brings into question its susceptibility to

uncertainties. Subsequently, the government has had to regulate the financial sector entirely to

protect customers against risks inherent to its operations. As a result, this report will critically

assess and evaluate the regulations of the financial sector as well as explain bank regulation

mechanisms adopted by the United States of America.

Financial Regulations of Financial Institutions
Regulations play a significant role in the financial sector by bringing in sanity and

reducing any uncertainties inherent with the institution. However, in many cases, the government

and associated institutions must strike a balance in their regulation’s extent to ensure that the

financial institutions can function optimally. Too much regulations are likely to make it

impossible for banks and other institutions to invest within their economy, whereas less stringent

regulations will lead to the extortion of customers. For example, prior to enacting the Sarbanes-

Oxley Act in 2002, there was an increase in the number of financial scandals, which meant that

customers were offered poor services. An evaluation of the current regulations in the financial

sector provides a better understanding of the conventions in place.

According to Sahni and Bryne (2019), the banking sector in the United States plays an

important role in the allocation of credit, as well as operation of the payment system. Core

among its regulations is in the fact that the banking sector within the United States is the “dual

banking system” where it is chartered wither federally or through the state. To ensure that they

serve their role effectively, banks are usually owned by the bank holding companies (BHCs) and
REGULATIONS IN THE FINANCIAL SECTOR 3

are not allowed to control other entities closely related to banking. In most of the cases, these

regulations are meant to protect customers, in compliance with the Consumer Protection Act

(Dodd-Frank Act) (Gordon & Muller, 2011). This regulatory initiative was devised in 2010 in

response to the 2007-2009 financial crisis. In the 2007-2009 crisis, the financial institutions

played a significant role in its manifestation especially since they were perceived as “too-big-to-

fail”. In addition to the Dodd-Frank Act, other financial regulations have been complementarily

working together to create sanity in the industry (Gordon & Muller, 2011).
Regulatory frameworks development by individual countries must be in unison with the

global framework to enable global market to be conducive for investors. The 2008-2009 crisis

demonstrated that the financial institutions of varied nations are intertwines after the housing

market of the U.S spilled over to other economies (Hanson, Kashyap & Stain, 2011). Therefore,

the integrity of financial systems across the world are important in case it can be controlled

globally. To that end, different regulatory framework were compared by different nations in the

post crisis period to identify the most effective one to use. In general, this was a comparison of

the United States multiple regulatory framework to the United Kingdom’s single regulator model

(Hanson et al., 2011).

In this case, there are two main types of regulations used to control the activities of the

financial industry – rule-based regulations, as well as the principle-based regulations. In this

case, the rule-based financial regulations are those that emphasize on directly controlling the

regulated institutions and tend to work best within emerging communities. On the other hand,

principle-based regulations, which are more suited to developed or advanced markets and

encourages the regulated to adhere to the regulation’s spirit. The principle-based regulations are

more open and they encourage the industry to be more creative and to address arising needs of its

consumers. However, considering that these approaches were already being used in some of the
REGULATIONS IN THE FINANCIAL SECTOR 4

main economies across the world, they proved insufficient in dealing with the arising challenges

across the world. Therefore, reforms were devised to oversee the development of regulations that

could protect the interests of different people in the society.

To oversee the development of these principles, a number of core principles would be

incorporated within the new regulatory framework. These principles are as explained: -

a) Capital requirement regulations

The first principle of importance, in this case, was the higher capital requirements. Different

countries, including the U.S has developed the principle capital requirement and liquidity to

make it work (Agenor, Alper & da Silva, 2013). In this case, the capital requirement for the

financial system is designed to create stability in the system and ensure that banks do not become

insolvent over time. In fact, the capital requirement, in this case, is made such that it protects

against firms that pose a threat to the general stability of the industry in a country (Barr, 2012).

However, this regulation must not dissuade multinational companies from investing in the

economies by being too high.

b) Accounting standards

Accounting standards are designed such that they can withstand the countercyclical effect of

increased capital requirements. Such an increase is likely to cause financial distress in the

economy, which needs to be limited. Accounting standards ensure that the banking institutions

report accurate information that can be used as a basis for decision making for investors and

other external stakeholders (Barr, 2012). However, the accounting standards not only control the

operations of the financial sector but of all related industries.

c) Liquidity risk and leverages

Financial regulatory frameworks are also designed to overcome future crises and

challenges in the future. In other words, the regulators adjust their conception of the process to
REGULATIONS IN THE FINANCIAL SECTOR 5

help manage risks. These financial liquidity risk and leverage not only concern the banks, but

financial institutions as well (Barr, 2012). The regulatory oversight over liquidity risk and

leverage will help ensure that the financial institutions will not fail at the peril of the entire

industry.

d) Increasing transparency

The financial system is only as important as its capacity to deliver its consumers with

value. This is especially since the financial institutions deal with financial instruments including

the derivative product and exchanges, which need transparency incase investor will trade in it.

Over-the-counter (OTC) derivatives traded with less transparency are more likely to attract

systemic risks (Hanson et al., 2011). As a result, strategies to standardize the derivatives are

developed to improve the technical trading infrastructures and increase the firm’s transparency

when dealing with the different instruments.

e) Resolution Mechanisms in case of Failing Financial Institutions

Despite these principles and mechanisms meant to streamline the financial institutions, there is a

chance that they might still fail. In this case, the government and other regulating institutions

must have contingency plans to salvage failing financial institutions. This is in the form of

bailouts from the government during economic crises (Rutledge et al., 2012). Government

backing is important for the financial institution to operate efficiently especially since they deal

with challenges like moral hazards. The financial system is uncertain in nature, therefore, in case

the institutions are to fail, the government needs to have a plan to prevent its effects from spilling

over.

Role of Macroeconomic Policies in Promoting the Financial Stability

REGULATIONS IN THE FINANCIAL SECTOR 6

Financial stability is only assured through the financial policies developed both at the

national and global levels. This relationship is unidirectional in that the financial institutions also

affect the effectiveness of the macroeconomic policy. The macroeconomic policies are

distinguished into either monetary or fiscal policies.

Monetary Policies

Monetary policies are meant to control the supply of money within the economy. The

monetary policies control the supply and circulation of cash and the interest rates within a

country. The monetary policies are either used to check or stimulate the growth of an economy

by incentivizing people to spend, as well as borrow money (Smets, 2014). This is by restricting

expenditures, as well as incentivizing the population to save to avoid getting into a recession or

boom. In the U.S, the federal research uses the monetary policy to control the open market

operations. For example, the Federal Reserve injects money into the economy by purchasing

government bonds and restricts these operations by selling the government bonds (Smets, 2014).

Fiscal Policies

On the other hand, a country may use fiscal policies to enhance the stability of the

financial market. When the fiscal policies are poor, the government is affected adversely

especially if its borrowing exceed the optimal. Such a situation makes the economy unstable by

making the monetary framework unstable, thus, making it impossible for the central bank to

control its performance. In cases where there are fiscal deficits, the financial institutions are

likely to succeed since there is reduced fiscal space to revive an economy.

Financial Regulations in the U.S.

REGULATIONS IN THE FINANCIAL SECTOR 7
REGULATIONS IN THE FINANCIAL SECTOR 8

References

Agénor, P. R., Alper, K., & da Silva, L. P. (2013). Capital regulation, monetary policy and

financial stability. International Journal of Central Banking, 9(3), 193-238.

Barr, M. S. (2012). The financial crisis and the path of reform. Yale J. on Reg., 29, 91.
Gordon, J. N., & Muller, C. (2011). Confronting Financial Crisis: Dodd-Frank's Dangers and the

Case for a Systemic Emergency Insurance Fund. Yale J. on Reg., 28, 151.
Hanson, S. G., Kashyap, A. K., & Stein, J. C. (2011). A macroprudential approach to financial

regulation. Journal of economic Perspectives, 25(1), 3-28.

Rutledge, V., Moore, M., Dobler, M., Bossu, W., Jassaud, N., & Zhou, J. (2012). From bail-out to

bail-in: mandatory debt restructuring of systemic financial institutions. Journal

Issue, 2012, 3.
Sahni, R. A. & Bryne, T. J. (2019). Banking Regulation 2019. Global Legal Insight. Retrieved

from https://www.globallegalinsights.com/practice-areas/banking-and-finance-laws-and-

regulations/usa
Smets, F. (2014). Financial stability and monetary policy: How closely

interlinked?. International Journal of Central Banking, 10(2), 263-300.