Chapter 5

Regulations of Financial Systems

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 What is financial regulation

 Financial regulation is a form of supervision,

which subjects financial institutions and
markets to certain
◦ requirements,
◦ restrictions &
◦ guidelines,
aiming to maintain the integrity of the
financial system.

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 Cont’d

 Regulationsof financial systems differ from

one country to another.
 Thefinancial regulations are delineated by the
gov’t authorities of countries.
 The principal objective of these authorities is
to regulate the financial activities in the
country.

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 Cont’d
 The regulatory bodies control the
◦ stock markets,
◦ bond markets,
◦ foreign exchange markets, and
◦ various other segments of financial markets &
financial institutions.

 The financial regulations are laid out for the

purpose of
◦ creating a fair & customer-friendly environment
in the financial system of a country.

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Objectives of financial Regulation
The statutory objectives of the regulatory bodies
include the ff:
 Market confidence/integrity
 Consumer protection
 Competition regulation /Eliminating financial
crime
 Public awareness

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 Forms of Regulation

 Toprotect the public and the economy from financial

panics, gov’ts are implementing a number of
regulations.
 Regulations are taking the ff forms:
◦ Restrictions on Entry;
◦ Disclosure requirement;
◦ Restrictions on Assets & Activities;
◦ Deposit Insurance;
◦ Limits on Competition; and
◦ Restrictions on Interest Rates.
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 Principles of Regulation

1. Competitive Neutrality
Competitive neutrality requires that the regulatory burden
applying to a particular financial commitment or promise apply
equally to all who make such commitments.

2. Transparency
Transparency of regulation requires that all guarantees be made
explicit and that all purchasers and providers of financial
products be fully aware of their rights and responsibilities.

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Principles ….cont’d
3. Flexibility

 While it is not possible to forecast with any certainty the precise

impact that technology will have on the shape of financial services
and service delivery, it is certain that the impact will be
considerable. These developments make flexibility critical.
4. Accountability
 Regulatory agencies should operate independently of sectional

interests and accountable to its stakeholders and subject to regular

reviews of its efficiency and effectiveness.

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 Arguments of FS Regulations

 According to the laissez-faire theory

◦ markets are efficient, and hence can operate
without any legal intervention, but in reality
they are not.
 According to market failure theory
◦ the government controls a feature of the
economy that the market mechanisms of
competition & pricing could not manage
without help (where it cannot fulfill all
competitive situations)

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Arguments of FS Regulations cont’d
Why regulation?
 prevent issuers of securities from defrauding
investors by concealing relevant information
 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

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 Cont’d

 Arguments against regulation

 Creates moral hazard
 causes depositors as well as banks to behave less
cautiously on the belief that the central bank is there to
protect them
 Agency capture
 regulators are ex-practitioners who share the same value
as practitioners, and hence may be biased towards banks
rather than depositors

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 Cont’d

 increases cost of financial services

 it has cost and financial institutions may pass it on to
clients
 gives room for monopolies to emerge
 cost of regulation may restrain entry and exit
 leads to market inefficiency
 prevents mergers and acquisitions and allows inefficient
firms to stay in business

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Authority by Country

 The following is a short listing of regulatory

authorities in various jurisdictions:
 United States;

◦ U.S. Securities and Exchange Commission (SEC)

◦ Commodity Futures Trading Commission (CFTC)
◦ Federal Reserve System ("Fed")
◦ Federal Deposit Insurance Corporation (FDIC)
◦ Office of the Comptroller of the Currency (OCC)
◦ National Credit Union Administration (NCUA)
◦ Office of Thrift Supervision (OTS),

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END OF THE CHAPTER! ! !

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 Always remember

Intelligience plus character are

the goal of true education!
(M.L. King)