2.8 Definition and Meaning of Financial Regulations
Financial regulation is often reactive with new regulations
sealing up leakages in the financial system usually caused by a crisis. As a
result of this, it is recommended that regulators should focus on the principal
issues that the regulation is intended to address.
Financial regulations are laws and rules governing financial
institutions such as banks and
investment companies. Financial regulations
aim at maintaining orderly markets, enforcing
applicable laws, prosecuting cases of market misconducts,
licensing providers of financial services, protecting clients, promoting
financial stability and maintaining confidence in the financial system.
However, note that the principal aim of financial regulation is to protect
investors who may not be able to protect themselves if left on their own. All
these centre on the fact that the recurrent theme in every regulatory report on
the causes of the global crisis is the role of lax risk management controls
within financial institutions. As such, current financial regulation helps in
policing the amount of risk that can be incurred by a financial institution and
how that institution manages that risk. The regulatory activities range from
setting minimum standards for capital and conduct to making regulatory
inspections to investigating and prosecuting misconduct.
Some prominent key advisers (economists, journalists and
business leaders) including President Barack Obama have succeeded in
introducing a series of regulatory proposals. They also succeeded in mapping
out a number of steps that need to be taken in revamping these regulatory
systems dealing with financial institutions. Some of these regulatory proposals
include consumer protection, expanded regulation of the shadow banking system
and bank financial cushions. These are bent on minimizing the impact of the
current global financial crisis as well as to try to prevent its recurrence in
the nearest future.
The present financial crisis portrayed the inadequacies of
financial regulations both at the national and global levels because they
failed to license and supervise the financial services providers at all times.
A case in point is the boom and collapse of the shadow banking system which
according to Krugman, was the core of what happened to cause the crisis. He
argued that the shadow banking system expanded to rival conventional banking in
importance. As such, politicians, as well as some government officials should
have realized they were recreating the kind of financial vulnerability looked
upon in the 1930s as one of the causes the Great Depression. This implies these
government officials should have responded by
extending some regulations and financial safety so as to
protect the new institutions. Therefore, financial regulations should have at
least been imposed on all banking-like activities. As if that is not enough,
the IMF Managing Director (Dominique Strauss-Kahn) also added that the
financial crisis originated as a result of failure on the part of financial
regulations to guard against excessive risk-taking in the financial system.
Never the less, excessive regulation has also been cited as a possible cause of
the crisis. For instance, the Basel II accord has been criticized for requiring
banks to increase their capital when risks rise which might result in their
decreasing lending when capital becomes scarce. As such, the financial markets
only survived after extensive and costly public rescues from the governments
and some big banks.
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