The major regulatory involvements of the government in the banking sectors are to maintain economic stability in their respective economies. Zharni and Hassouna (2018) affirm that government regulations aim to serve the interests of the public and in particular meeting the needs of the bank service consumers. Agents possess much faith in the regulations of the banking sectors by the public authorities simply because of the inexistence of contractual relationships with the banking industry. Credits decommissioning, open markets, foreign exchange liberalizations, and the increase in volatility rates are some of the factors, which are increasing the unprecedented market activity vulnerabilities (Zgarni & Hassouna, 2018). Thus, the government's regulations in this sector are to meet the public interests through controlling the banking risks.
The economic deterioration is increasing the risks for the banks by posing a great challenge in the realization of profits especially from their traditional activities, solidity maintenance while still achieving satisfactory levels of profits hence, influencing the high risk-taking activities in the markets (Zgarni & Hassouna, 2018). According to Jamal, Hamidi and Karim (2012) banks are dependent on each other, with the bankruptcy of one of them adversely affecting the others. Therefore, the above considerations explain the need for a supervisory body to regulate the banking industry, which conquers with the deregulation processes that aims at upholding the financial market integrity while still maintaining stability in the banking sector. This paper discusses the reasons behind the heavy regulations of the financial institutions while elaborating on the authorities' cautionary attitudes on the bank failures to the local and national economies.
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Reasons behind Heavy Banks Regulations
Financial regulations in most cases are implemented as a means of preserving the stability of the banking system while still protecting the consumers. According to Beck, Carletti and Goldstein (2015) financial regulations are concerned with the protection of intermediaries and the functions the financial institutions perform in the economy. The financial regulations aim to address failures existing in the financial industry, which are likely to cause the financial crisis and their disruptive results to the real economy (Zgarni & Hassouna, 2018). Financial stability is achievable through preventing the systematic dangers that occur due to a bank malfunctioning (Panico, Pinto, Anyul, and Suarez, 2013). The regulations aim to minimize the consequences that occur due to the failure of a single bank entity. Therefore, financial regulations are directed towards minimizing panics and runs in case of a financial crisis.
The banking sectors are regulated towards finding an optimum balance between risk sharing, offering credit services, and the fragility nature of the financial sectors. According to Beck, Carletti and Goldstein (2015), limiting and overall stopping of the banks from their risk-taking nature is an inefficient move, which limits credits provisions, thus, curtailing creativity and innovations. The banks can only play their key function in the economy by taking a variety of risks and fragility. Embracing the risk-taking aspects of the banks, financial liberalization was implemented in the 1970s in the majority of the countries.
Regulations are meant to minimize the inefficiencies from the information asymmetries and the market pecuniary externalities (Beck, Carletti & Goldstein, 2015). The bank regulations aim to protect the consumers and ensure the safe provision of products and services necessary for society. Beck, Carletti and Goldstein (2015) assert that the structure of the banking regulations currently is a combination of answers to the crisis that have occurred in the past thus, no clear regulatory design is being implemented. The market failures justify regulations of financial institutions. Regulation tends to be more beneficial with market results, which are socially inefficient in such a way that the costs of regulation are less compared to the outcomes.
History of bank failures in the US
The period, between 1980 and early 1990 marks a struggle period in the US when it’s banking industry had the largest number of bank failures since the great depression (Panico et al., 2013). During this period, the FDIC insurance company resolved almost 1650bank cases federally insured. More so, the problem with savings and loan institutions was enormous, with a bailout cost amounting to $151 billion for the 1,320 institutions under crisis (Panico et al., 2013). Following the financial system failures during 1980-1990, policymakers, and regulatory agencies stepped up to implement resolutions aimed at restoring the financial health of the US as well as instill the financial stability of the banking sector.
During the 1970s, the period before the crisis, the US’ commercial banks operated in a highly protective and fragmented environment. There were around 4360 thrifts, and 14,430 savings and commercial banks operational during this period (Panico et al., 2013). According to Barth, Phumiwasana and Lu (2008), the large number of intermediaries led to the federal and state laws governing the intrastate and the interstate financial activities that limited the branching processes of banks nationwide. For example, the 1927 McFadden Act banned the branching processes of banks while requiring the conformity of the large banks to inter-state branching laws. The regulation Q put into practice in 1933 also limited banks rates accruing on the deposit products while still barring interest pay on the demand deposits. According to Barth, Phumiwasana and Lu, (2008), regulations on branching together with inhibitions on interstate banking operations led to the high cases of fragmentation in the financial sector, which created less competitive small thrifts and banks thus, causing inefficiency in the financial sector.
The late years of the 1970s are marked by banking restrictions effectiveness resulting from technological developments and advances, increasing interest rates, and financial innovations (Samad, 2012). The commercial banks and thrift failure in the financial market towards the end of the 1970s are a result of declining market share to the depository organizations that could offer more attractive products and services. The disintermediation aspect is responsible for the lower profits and lowers net interest to the thrifts and commercial banks by minimizing their cost advantages in offering loans and raising money.
The I970s is an era whose economic conditions were very unfavorable to the financial institutions. According to Samad (2012) inflationary forces that came into play in the 1960s obliged the federal bodies to implement various policy regulations to govern the financial industry. To combat inflation pressures, the federal body implemented a tight monetary stance whose consequences inflated the interest rates to unparalleled levels. Samad (2012) pinpoints 1979 as the year when the Federal Reserve announced the adoption of new techniques in their operations whereby their target changed to non-borrowing reserves and money which was a development from the funds' rates. This new approach aimed to improve money control; however, the early 1980s is marked by extraordinary interest rates movements and high levels of volatility (Samad, 2012). Therefore, the volatility surge of the interest rates exerted magnificent pressures on the financial institutions, with the S&L suffering the most due to their large investments on the long-dated assets with fixed interest rates including the real estate and mortgages.
To encourage better competition in the new financial market for the banks and thrifts, legislators implemented the DMCA (Depository Institutions Deregulation and Monetary Control Act) in 1980, which was followed by Garn-St. German Depository Institutions Act in the year 1982 (Samad, 2012). These two regulations were created to allow the S&L institutions to offer appealing interest rates thus able to compete better with the commercial institutions. Moreover, the new regulations faced out regulation Q and expanded deposit instruments creating an enabling environment for depositories to compete with the mutual funds.
The evaluation of the Regulatory Policies Success
The officials of the government, as well as the members of the public, are interested in understanding how effective the regulatory policies are working. According to Panico et al., (2013), any regulatory policy aims to improve the overall outcome of the regulatory organizations and their members. Any form of a regulation objective is to influence behavioral changes to obtain the desired goals or outcomes. A form of regulation is effective when it reduces, solves, or ameliorate the problems that prompted the government institutions in adopting it in the first place. According to Samad (2012), the world is made up of various causal relationships that are responsible for various economic and social problems, thus regulations target each level on the causes pathway that is responsible for those problems. Assessing the cases of the automobile industry, a safety regulation from the government targets automobile accidents to reduce the cases of injuries, fatalities, or property damage. Accidents from the automobile scenario originate from road conditions, driver errors, and the mechanical malfunction. Therefore, a regulation in this scenario targets the various causes of accidents thus, implementing various requirements to minimize the occurrence such as driver training, engineering design as well as vehicle operations.
The core features of any regulation related to the behavior and results (outcome) which, dictate the functioning of the regulation (Jamal, Hamidi and Karim, 2012). In the evaluation process of any regulations policies assessing the relationships between the development of the policy and its implementation and the overall outcome is necessary. According to Samad (2012), the regulations not only involve the rules but also the impacts the enforcements and implementations, which influence the overall outcome. The regulatory processes influence both the laws and their implementations, which induce behavioral changes that result in various outcomes. Barth, Phumiwasana and Lu (2008), incorporate the following steps in evaluating the effectiveness of a certain regulation policy;
A regulatory institution that makes the regulatory decisions, which can be a ministry or the government
The regulatory policy- the procedures, rules, and functions that are related to the regulatory policy. This step involves all activities relating to planning and analysis before the decision on regulation.
The regulation of interests
Implementation- The evaluators seek to know how the rules were put into action. This stage also shows that other externalities affect regulations such as social, community and economic pressures
Behavioral change- the effects of regulations to the targets, evaluators ought to consider other factors that could influence the outcome
Intermediate outcomes-which refers to the initial changes following directly from behavioral improvements
Ultimate outcomes –it refers to the achievement of the solution that prompted the regulation, for instance, reducing market problems in the banking sectors
Reasons why bank regulators are much concerned with capital adequacy
The base assets of a bank influence greatly their returns on assets (Berger, Hunter and Timme, 1993). According to Dao and Ankenbrand (2014) the profits of banks can originate from either the internal microeconomic structure or the industry-specific external views. Capital and profits available forms the most important aspect of a bank to conduct its operations. Dao and Ankenbrand (2014) affirm that lack of enough capital, creates a difficult environment for the bank to attract new investors, thus, unable to expand their business operations. More so, with enough capital that increases profits, the financial institutions can increase the confidence of their future shareholders, stakeholders as well as their depositors while remaining competitive in their financial markets.
The level of adequate capital influences the bank’s ratio of equity risky assets. Berger, Hunter and Timme (1993) assert that an efficient banking sector with a high capital base is likely to promote high economic growths, whereas the systematic crisis is likely to originate from banks with credit insolvencies. The bank capital has a positive correlation with the owner's equity risky assets. This factor relates to how effective a bank can meet its dues to its depositors in case it is declared bankrupt (Davis, 2012). In cases whereby, the risks are thought to increase for some reason the large capital base of the banks allows them to effectively adjust the risky ventures to sensible levels thus, minimizing the risks on capital.
A large amount of capital is very effective during the capital risk controlling activities. Dao and Ankenbrand (2014) affirm that a competent, profitable and well managed financial institution with large assets enables a country and its economy to remain competitive while still withstanding negative shocks available in the environment. A large capital base attracts an enormous amount of profits, which provide a good base for conduction of efficient business organization as they create a stable financial system thus, protecting a state from various undesirable waves that can damage their financial operations.
The responsibilities of various Bank Agencies
Myriad agencies are operating under the state and federal governments to oversee and regulate the financial institutions as well as their markets (Davis, 2012). Each agency perform a particular set of roles which allows them to systematically work independently, although moving towards accomplishing similar goals and objectives
The Federal Reserve System (FRS)
The FRS forms the regulatory agency that is well recognized compared to other regulatory bodies. The FRS was established in the year 1913. A board of governors, who are appointed by the president to serve for 14 years heads the FRS (Spong, 2000). The FRS role is to supervise state-chartered banks (Jordana and Ramio, 2010). More so, it reviews the applications of membership from the various state banks. It also regulates and supervises the financial and bank holding companies. In conjunction with the banks, FRS is responsible for supervising the banking sector and reviewing the expansion proposals of these financial institutions (Spong, 2000). The FRS can either levy fines, order termination, revoke membership as well as issue the desist orders in their supervisory regulations.
The State banking agencies
Every state is entitled to a regulatory agency to facilitate the supervisions activities of its banks. More so, the state agencies in control of the state banks also regulate other financial organizations in that particular state. According to Spong (2000), banks operating under the state laws ought to follow all the state rules and regulations. The state directories are quite lenient to banks with membership in various Federal Reserve. Regardless of the state-specific regulations, the state bank conference provides a forum of discussion of common interest issues to the various regulators and ensures the various states possess banking departments favoring efficient and effective work (Spong, 2000). The state banking agencies rule on the various proposed bank branches, merger requests, issuance of bank charters, formulate, and enforce the banking regulations and conducting of bank examinations (Spong, 2000). More so, they are capable of imposing sanctions, revoking of state’s bank charter, levy fines, sack the bank officials, and can issue the cease and desists orders.
Compare and Contrast the history and regulation of the US and European Community
The US and EU, product market regulations, and antitrust analysis show that the two factors are responsible for the reduced competition, and concentration in the financial markets for the last 20 years (Gutierrez & Philippon, 2018). The changes tend to occur slowly and become visible only after a decade thus, the reason they exist unnoticed.
The wide reforms in the European Union began in 1985, with only one particular market plan, which then accelerated with the introduction of the Lisbon Strategy in 2000 (Gutierrez & Philippon, 2018). The strategy’s objective was to create free markets to competition through creating an environment conducive to entry, and exits, and overall removal of obstacles to allow competition among the member states. The Lisbon strategy led to a variety of market reforms although it failed in some aspects. Following the extensive deregulation in the 1980s, the US became the leader country in PMR, occupying the second position after Britain. This period was marked by a drastic decrease in PMR in all EU economies leaving the US stable. However, the case changed for the US too later, such that in 2013, only a few countries scored less than the US. The EU is implementing more reforms than the US in recent years, as their way of reducing regulatory barriers.
Antitrust enforcement incorporates the trade-off activities between innovation and the current surpluses to consumers. In this case, the consumers are not likely to commit to future benefits on capital returns. (Gutierrez & Philippon, (2018) explain that the regulators are unlikely to understand the effect innovations pose on the welfare of consumers and in some cases underestimating the efficiency benefits accruing to the large firms. Firm lobbying provides crucial information to the regulators, which is likely to increase value. According to Gutierrez and Philippon (2018), the stronger enforcement of antitrust could be responsible for the low rates of innovation in the EU compared to the US. However, the US’ controls are responsible for the technological development that tends to affect the rates of profits (Jordana and Ramio, 2010). More so, these controls in the US influence the equilibrium concentrations, which affects the interest of pursuing cases across various regions.
Overall, banks occupy a dominant position in the economies of the world. They are the cornerstone of all economies and form the foundation for all financial mechanisms. Bearing in mind the major role of banks, supervisors are likely to face major challenges especially in cases of intense competition, deregulation, disintermediation, excessive risks taking, and diversification in the bank environments. The bank regulations aim to preserve the stability of the banking system while still protecting the consumers. They aim to find an optimum balance between risk sharing, offering credit services, and the fragility nature of the financial sectors. More so, they aim to minimize the inefficiencies from the information asymmetries and the market pecuniary externalities. The federal and state agencies work independently although moving towards accomplishing similar goals and objectives. Most of the regulations in the financial sectors are concerned about capital adequacy because of the base assets of a bank influence greatly their returns and influence the bank's ratio of equity risky assets. Moreover, a large amount of capital is very effective during the capital risk controlling activities.
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