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it is about the regulation of the financial institutions
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Regulation of Financial Institutions1-2
Regulation relates to the setting of specific rules of behavior that firms have to abide by – these may be set through legislation (laws) or be stipulated by the relevant regulatory agency
Monitoring of these regulations refers to the process whereby the relevant authority assesses financial firms to evaluate whether these rules are being obeyed
Supervision is a broader term used to refer to the general oversight of the behavior of financial firms
Regulation of Financial Institutions
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Financial institutions are one of the most heavily regulated businesses in the world.
Many economists, financial analysts, and financial institutions have argued that regulation has done more harm than good.
Other observers, however, argue that government regulations have achieved some positive results for the financial institutions as well as for the public.
The Reasons Behind the Regulation of Financial Institutions
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Concern for the safety of the public’s funds To promote public confidence in the system To ensure equal opportunities and fairness in
the public’s access to financial services To prevent excessive money creation, and
hence excessive inflation To aid ‘disadvantaged’ economic sectors To ensure that important financial services
are provided reliably and at a reasonable cost
Does Regulation Benefit or HarmFinancial Institutions?
Regulations can benefit financial institutions
Regulations subsidize the growth of financial institutions and protect them from competition
Regulations tend to increase public confidence
Regulations spawn innovative escapes (regulatory dialectics) through loopholes in the regulations
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Does Regulation Benefit or HarmFinancial Institutions?
Regulations can harm financial institutions
Regulatory dialectics are not the most productive form of innovation
The time and energy spent on regulatory compliance activities are costly
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Types of Regulation1-7
The financial services industry is a politically sensitive one and largely relies on public confidence, the failure of one institution can immediately affect others, i.e. vulnerable to systemic risk
This is known as bank contagion and may lead to bank runs
3 possible types of regulation: Systemic regulation Prudential regulation Conduct of business regulation
Types of Regulation1-8
Systemic regulation concerned mainly with the safety and soundness of the financial system
All public policy regulation designed to minimize the risk of bank runs that goes under the name of the government safety net, which encompasses two main features Deposit insurance Lender-of-last-resort
Types of Regulation1-9
Prudential regulation is mainly concerned with consumer protection Monitoring and supervision of financial
institutions with particular attention paid to asset quality and capital adequacy
Conduct of business regulation focuses on how banks and other financial institutions conduct their business Information disclosure, fair business
practices, competence, honesty and integrity of financial institutions and their employees
Arguments against Regulation1-10
Regulatory arrangements, in particular the ‘safety net’ arrangements create moral hazard Deposit insurance and the LOLR can cause
people to be less careful Too-big-to-fail (TBTF) and Too-important-to-fail
(TITF) cases Agency capture, the regulatory process can be
‘captured’ by producers (banks) and used in their own interest, e.g. Basle Capital Accord has had too much input from banking sector participants
Arguments against Regulation1-11
Regulation is a costly business and the cost of compliance with the regulatory process will be passed on to consumers, resulting in higher costs of financial services and possibly less intermediation business Regulatory costs may act as a barrier to entry in the
market and this may consolidate monopoly positions However, none of these criticisms is enough to
reject financial regulation as regulation is always about making judgments and considering trade-offs between costs and benefits
Causes of Regulatory Reform Financial scandals/crises and political
pressures generated Internationalization
Throughout the world financial liberalization has provided a passport for banks to offer services cross-border and hence the debate about convergence of rules
Globalization Risks to financial stability are less confined
to national borders and thus calls for greater coordination between national regulators
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Causes of Regulatory Reform Consolidation
The emergence of financial conglomerates Financial innovation
New financial products and services emerge and gain in market significance often call for new regulation
Firms innovate to get around regulations and the regulators are always one step behind the market – the regulatory dialectic
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Basel Committee – its main goals Improve the quality of banking supervision
worldwide
Promote more effective corporate governance
Close gaps in international supervisory coverage
Level the playing field among international banks
Establish a safer and sounder banking system as a precondition for sustainable growth of an economy
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Basle I
The purpose was to prevent international banks from building business volume without adequate capital backing
The focus was on credit risk Set minimum capital standards for
banks
Basel II
To provide the right incentives for sound risk management
To deliver a prudent amount of capital in relation to the risk that is run
To maintain a reasonable level playing-field for all banks to operate in
The Growing Importance of Capital Regulation
While Basle I was directed at measuring credit (default) risk primarily, Basle II brings in refined estimates of market risk exposure and adds new capital requirements for operational risk (i.e. the risk of losses banks can suffer from such events as crime and destructive weather, the breakdown of internal information systems, failed transactions processing, workplace hazards etc.)
Bank capital must be sufficient to offset all of these potential risk exposures.
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Unfinished Agenda for Banking Regulation
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Slowly, banking is experiencing an era of deregulation, as legal constraints are lifted on a variety of banking activities.
Supervision of financial institutions in the future will rest primarily upon: government examinations (of market
data and the firms’ risk management systems)
capital requirements market discipline
Trends in the Regulation1-19
Regulation seeks to promote the safety and stability of financial institutions in order to preserve the confidence of the public and avoid institutional failures.
However, regulation can become a costly burden that significantly increases the operating costs of financial institutions and limits the cleansing effects of failure and competition.
Trends in the Regulation1-20
Increasingly, Market discipline is playing a bigger role Regulators are cooperating more Focus of regulation is moving away from
control over the services offered and geographic expansion to controlling risk taking
Increasing attention to public disclosure
Regulation of Financial Markets Three Main Reasons for
Regulation
1. Increase Information to Investors
2. Ensure the Soundness of Financial Intermediaries
3. Improve Monetary Control
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Regulation Reason: Increase Investor Information
Asymmetric information in financial markets means that investors may be subject to adverse selection and moral hazard problems that may hinder the efficient operation of financial markets and may also keep investors away from financial markets
The Securities Commission (SC) requires corporations issuing securities to disclose certain information about their sales, assets, and earnings to the public and restricts trading by the largest stockholders (known as insiders) in the corporation
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Regulation Reason: Ensure Soundness of Financial Intermediaries
To protect the public and the economy from financial panics, the government has implemented six types of regulations: Restrictions on Entry Disclosure Restrictions on Assets and Activities Deposit Insurance Limits on Competition Restrictions on Interest Rates
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Regulation Reason: Improve Monetary Control
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Because banks play a very important role in determining the supply of money (which in turn affects many aspects of the economy), much regulation of these financial intermediaries is intended to improve control over the money supply
One such regulation is reserve requirements, which make it obligatory for all depository institutions to keep a certain fraction of their deposits in accounts with the central bank
Reserve requirements help the central bank exercise more precise control over the money supply
BAFIA 19891-25
BAFIA 1989 was passed in Parliament and came into force on Oct. 1, 1989. It has effectively replaced the Banking Act 1973 and the Finance Companies Act 1969.
It is a comprehensive act and extends comprehensive powers to BNM to supervise a larger spectrum of financial institutions, with the direct responsibilities to regulate and supervise all licensed institutions (commercial banks, finance companies, merchant banks, discount houses and money brokers) and also regulate scheduled and non-scheduled institutions.
Financial Services Act 2013
The FSA came into force on 30 June 2013 consolidating the regulatory and supervisory framework for Malaysia’s banking industry, insurance industry, payment systems and foreign exchange administration matters.
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