Unit 1 : The Role of Financial Regulation

Background Context

1. The USA was prospering in the 1920s despite world war I. European countries were taking
its toll due to WW I whereas American industrialist movement was in full swing.
2. NYSE grew from $27 billion to $87 billion between 1925 and 1929.
3. The US economy has grown to be the largest in the world.
4. On Oct 24th 1929, known as Black Thursday saw one of the most significant stock market
crashes in US history. Sell off continued for weeks and reached its lowest point in mid
November.
5. 40% of the stocks value has been erased due to panic selling. Banks were among the most
affected. People withdrew their savings from saving deposits due to fear of losing. => 744
banks closed due to this in 10 months.
6. This led to the 12 year long Great Depression in the USA. 11000 banks were closed and 1 in
4 people that were employed were now jobless.
7. The issue involved was faulty regulatory foundations of US financial systems.

Banking practices during the Golden Era

1. Prosperity of the 1920s led to frenzy among investors for investment and credits. Americans
were taking out loans to finance their investment in the stock market.
2. But this was not the reason for the crash. Only 10% of the US population had invested in
stocks at the time, but nearly 100% were affected. Answer lies in the way banks were
operating during the investment frenzy of the golden era.
3. Commercial banks had the ability to take client’s saving deposits and use that capital
to invest in speculative opportunities. So, there was no guarantee of security for money in
the bank.
4. Until now, it was not a common practice for the federal government to safeguard deposits,
with the thought process that it will lead to a socialist relationship between the
government and the people. This was the primary reason for mass withdrawal of savings
and the subsequent bank failures.
5. President Herbert Hoover(1929-1933) taken political stance to minimise federal government
intervention. He did not want to nationalise key industries, nor offer state backing for banks.
Instead he promoted collaboration between market participants with the thought process that
it would create a healthier longer term answer to the financial downturn by enabling them to
lift themselves out of Depression.

FDR’s regulatory response

1. Roosevelt who was elected after Hoover created regulatory framework and oversight bodies
that would prevent an economic downturn of that magnitude to ever happen again. Also
added safeguards, which restored investors confidence in the banking sector :
 1. Banking Act of 1933(Glass-Steagall Act) separated the role of commercial and
investment banks. This led to legal distinction between entities so that savings of the
ordinary person could not be used for speculative investment purposes.
2. Federal Deposit Insurance Corporation(FDIC), a regulatory body was set up that
guaranteed that savings of individuals would be backed by the government in the
event a bank failed.
3. Securities and Exchange Commissions(SEC) was set up as part of the Securities
Act of 1933 which will act as an agent of the USA’s federal government responsible
for monitoring and regulating market activities, as well as enforcing laws related to
American securities markets.
2. Once these regulations were put in place, American economy recovered. This gave great
insights of the effects of regulation
1. Shows a direct and powerful correlation between social well being and finance well
being.
2. Both presidents enacted regulations to control the Great Depression but the
difference between them was the ability to assess the market and social environment
and implement the right kind of regulations at that point in time. => Hoover tried to let
people get themselves out of their own jam. FDR built more roads and avenues so
that they could.

Unit 2 : Levels of Financial Regulation

Regulatory Role Players

The US congress established the SEC as well as the act but they do not oversee the
implementation of the SEC’s regulations.

1. Central Banks - The regulatory functions for central banks are as follows :
 1. The security of deposits - Guarantee commercial bank deposits and to maintain
fiscal stability in times of financial turmoil. This allows commercial credit lending
to continue.
2. Controlling reserve requirements -
1. Reserves refers to % of commercial bank deposits that banks must
maintain with the central bank at a given time ie. % of their clients’
deposits that must be deposited with the central bank.
2. Central bank can control the interest rate by controlling the amount of
capital that must be held in reserve. Central bank can raise interest rates
by increasing reserve requirements for commercial banks => inc.
reserves => Less cash with commercial bak => shortage of monetary
supply => More demand less supply.
3. Monitoring risk -
1. Oversight and regulation of commercial banks’ risk related features via
regular audits and asset/liability valuation.
2. Identifies risk that would otherwise be unknown or unquantified.
3. Ensures commercial banks operate within the safe risk limit that is set out
by the central bank.
4. Continuous investigation & oversight by central banks promotes
transparency in the banking sector.
4. Prevention of discrimination -
1. Mandate banks to disallow discrimination against creditors on race,
ethnicity, religion, etc. => A practice called ‘redlining’.
2. Essential as cases have been found where commercial bank have
charged higher interest rates to clients based on their ethnicity or race.
5. Monitoring of conflict of interest -
1. Monitors conflict of interest within the commercial bank sector.
2. Regulate or monitor loans issued by commercial banks to businesses that
may be ‘close’ to senior executives of that bank.
2. Four Regulatory Institutions
1. International Monetary Fund(IMF) :
1. Created in 1945 under Bretton-Woods Agreement.
2. Primary function is related to lending, technical assistance and
surveillance.
3. Through lending, the IMF seeks influence on lenders(countries here) to
introduce some form of financial or structural reforms.
4. The IMF is not a regulatory authority, but due to its International reach
and size it is able to instigate regulation in countries to which it lends
funds.
2. Bank for International Settlements(BIS) :
1. Founded in 1930 as a vehicle for repatriation of assets after WW I.
2. Once original function was complete, became forum for financial
cooperation among its members that are primarily central banks(total :
60)
3. Described today as ‘central bank for central banks’ with primary function
to support central banks in their ‘lender of last resorts’ function through :
1. Providing the central bank with access to liquidity in exchange of
traceable instruments at competitive rates.
2. Offering research and statistics related to financial issues.
3. Providing member central banks with access to gold and foreign
exchange transactions.
 4. Acting as a holder of reserves for central banks.
3. Financial Stability Board(FSB) :
1. Forum to bring together participants from regulatory bodies, central banks
and finance ministries from around the world.
2. Coordinates formation and spreading of regulatory policies and practices
with the aim of creating standards for international regulation and policies
that are aligned to the represented parties.
3. Have great influence over financial sectors of respective countries as it
brings financial markets to the same table and encourages them to
debate and agree on policy and regulatory direction.
4. World Trade Organisation(WTO) :
1. Intergovernmental institution that governs the rules of trade between its
member nations. => has 164 member countries.
2. Employs lawyers, economists and analysts that ensure that trade
regulations are upheld by members.
3. Other functions :
1. Trade negotiations
2. Dispute resolutions
3. Trade capacity development
4. Outreach

Unit 3 : Types of Regulation and their Objectives

The Process of Regulation

Phase 1 : Identification of the need for change

1. Any sort of regulation depends on identification of specific and necessary changes that
the regulation seeks to address.
2. It doesn’t start with the assumption that regulations are needed. It is a response to
undesirable market conditions.
3. The creation, formulation, implementation and monitoring of regulation is costly in terms
of money and time. => Parties attempt to create regulation for which there is a need.
4. During this phase, the regulatory party experiences the need in terms of significant
discomfort under the current system. Discomfort usually comes from :
1. Obstacles in the market that prevent a desired outcome. Eg: Excessive legal
requirements to start a business.
2. Activities in the market that prevent a desired outcome. Eg: discrimination of
investors on race or ethnicity.

Phase 2: Proposal for Change

 1. Once the need is brought to light, initiators are required to provide a proposed solution to
their identified need. In this phase both problem and solution are shaped and take their
first form.
2. Stakeholders must first address the need in detail by :
1. Clearly defining the problem.
2. Identifying who the issue affects and to what degree these parties are affected.
3. Proposing policy that may address this issue.
4. Drafting proposal for the implementation of the regulation.

Phase 3: Research Gathering

1. The 2nd and 3rd phase overlap due to information requirements presented by the
second phase where a draft is submitted for deliberation.
2. Though research compilation is a part of the proposal phase, it is distinct and goes
beyond simply compiling the original draft proposal.
3. The legislative body oversees the conceptualises regulatory process with independent
research initiative aimed at :
1. Identifying social, business, technological and financial impact of problem vs
impact of proposed solution.
2. Verifying the information contained in the draft proposal submitted.
4. During this phase, proposals will be made accessible to the public for public comment
and to industry members for broad consultations.

Phase 4: Drafting and vetting of regulation

1. Once sufficient research has been collected and both society and industry members
have provided input, draft proposal will be assessed again for feedback provided.
2. Any incorrect data in the original proposal will be amended.
3. At this phase, proposal should contain the following key elements(with data) :
1. Clear problem definition
2. Stakeholder identification
3. Proposed solution
4. Value proposition
5. Budgetary requirements
4. Once key elements are present and substantiated by research, a proposal is sent to the
appropriate legislative body.
5. Following can happen :
1. If changes are recommended, stakeholders will be required to engage public,
legal experts again with amended proposals.
2. If regulation is rejected, stakeholders can take rejection on appeal and fight the
rejection via relevant court.
3. If regulation is accepted, then published in a gazette so that all parties are
informed of the change and the required timelines for implementation.
Phase 5: Implementation and oversight

1. This phase is only reached once a regulation has been accepted. The overseeing body
needs to implement regulation in the relevant markets. In case of no overseeing body,
one will require to be set up.
2. Overseeing body will establish and monitor the standards with following activities :
1. Reporting requirement => What information
2. Frequency of reporting => Monthly/quarterly/annually
3. Format of reporting => Type of reporting required
4. Punitive measure for non compliance => Which punishment for which issue.

Unit 4 : The Role of Ethics in financial regulation

Regulation vs Deregulation

Deregulation - An argument ‘for’

1. Lower costs : Regulation is expensive. Eg: After the 2008 financial crisis, lending rates
were increased which led to consumer pay between 0.08 to 0.26% more interest for
credit.
2. Market participation : Fewer rules means fewer hurdles to jump to get to market with
product or services => Greater market participation => Increased competition => Lower
prices => More saving for consumers.
3. Increase response rate : Companies can move faster when they don’t have to spend
crucial time and effort getting regulatory approval.
4. Rate of advancement : Deregulated environment => Faster rates of advancement. It
allows businesses to focus on doing what they do best without distractions, constraints
and cost of regulation.

Regulation - An argument ‘for’

1. Inequality reduction : Regulations have reduced inequality, reduced the rate of bank
failures and reduced deposits lost(graph).
2. Less selfishness : Period of deregulations tends to result in significantly higher average
wages for individuals employed in ‘deregulated’ sector. => Financial sector against
regulation due to self interest as regulations means commission, salary and bonuses are
negatively impacted.
3. Justice and accountability : Rate of prosecution of financial crime in US increased
post passing of regulations to enforce accountability :
4. Consumer protection : Financial scandals happen when greed goes unchecked.
Regulations seek to put checks and balances in place so that participants in financial
markets do not let their pursuit of profits overrule their responsibility to clients.