Running head: REGULATIONS IN THE FINANCIAL SECTOR 1

Regulations in the Financial Sector in the United States

Name

Institutional Affiliation
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Regulations in the Financial Sector in USA

The financial sector has evolved significantly over the decades to become a reliable

institutions not only in the country, but across the world as well. In particular, the financial sector

has managed to gain people’s trust and confidence over the years, hence the reason people still

rely on it. However, the financial sector has exhibited a number of challenges over the years,

which have led to its destruction entirely, which brings into question its susceptibility to

uncertainties. Subsequently, the government has had to regulate the financial sector entirely to

protect customers against risks inherent to its operations. As a result, this report will critically

assess and evaluate the regulations of the financial sector as well as explain bank regulation

mechanisms adopted by the United States of America.

Financial Regulations of Financial Institutions

Regulations are important to the financial sector since they bring in sanity and reducing

any uncertainties inherent with the institution. However, in many cases, the government and

associated institutions must strike a balance in their regulation’s extent to ensure that the

financial institutions can function optimally (WIPO, 2016). Too much regulations limit the bank

and other financial institutions from investing within an economy, whereas less stringent

regulations will lead to the extortion of customers. For example, prior to enacting the Sarbanes-

Oxley Act in 2002, there was an increase in the number of financial scandals, which meant that

customers were offered poor services. An evaluation of the current regulations in the financial

sector provides a better understanding of the conventions in place.

According to Sahni and Bryne (2019), the banking sector in the United States helps in the

allocation of credit, as well as operation of the payment system. Core among its regulations is in

the fact that the banking sector within the United States is the “dual banking system” where it is
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chartered wither federally or through the state. To ensure that they serve their role effectively,

banks are usually owned by the bank holding companies (BHCs) and are not allowed to control

other entities closely related to banking. In most of the cases, these regulations are meant to

protect customers, in compliance with the Consumer Protection Act (Dodd-Frank Act) (Gordon

& Muller, 2011). This regulatory initiative was devised in 2010 after the recent financial crisis.

In the 2007-2009 crisis, the financial institutions played a significant role in its manifestation

especially since they were perceived as “too-big-to-fail”. In addition to the Dodd-Frank Act,

other financial regulations have been complementarily working together to create sanity in the

industry (Gordon & Muller, 2011).

Regulatory frameworks development by individual countries must be in unison with the

global framework to enable global market to be conducive for investors. The 2008-2009 crisis

demonstrated that the financial institutions of varied nations are intertwines after the housing

market of the U.S spilled over to other economies (Hanson, Kashyap & Stain, 2011). Therefore,

the integrity of financial systems across the world are important in case it can be controlled

globally. To that end, different regulatory framework were compared by different nations in the

post crisis period to identify the most effective one to use. In general, this was a comparison of

the United States multiple regulatory framework to the United Kingdom’s single regulator model

(Hanson et al., 2011).

In this case, there are two main types of regulations used to control the activities of the

financial industry – rule-based regulations, as well as the principle-based regulations. In this

case, the rule-based financial regulations are those that emphasize on directly controlling the

regulated institutions and tend to work best within emerging communities. On the other hand,

principle-based regulations, which are more suited to developed or advanced markets and
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encourages the regulated to adhere to the regulation’s spirit. The principle-based regulations are

more open and they encourage the industry to be more creative and to address arising needs of its

consumers. However, considering that these approaches were already being used in some of the

main economies across the world, they proved insufficient in dealing with the arising challenges

across the world. Therefore, reforms were devised to oversee the development of regulations that

could protect the interests of different people in the society (Duffie, 2017).

To oversee the development of these principles, a number of core principles would be

incorporated within the new regulatory framework. These principles are as explained: -

a) Capital requirement regulations

The first principle of importance, in this case, was the higher capital requirements. Different

countries, including the U.S has developed the principle capital requirement and liquidity to

make it work (Agenor, Alper & da Silva, 2013). In this case, the capital requirement for the

financial system is designed to create stability in the system and ensure that banks do not become

insolvent over time. In fact, the capital requirement, in this case, is made such that it protects

against firms that pose a threat to the general stability of the industry in a country (Barr, 2012).

However, this regulation must not dissuade multinational companies from investing in the

economies by being too high.

b) Accounting standards

Accounting standards are designed such that they can withstand the countercyclical effect of

increased capital requirements. Such an increase is likely to cause financial distress in the

economy, which needs to be limited. Accounting standards ensure that the banking institutions

report accurate information that can be used as a basis for decision making for investors and
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other external stakeholders (Barr, 2012). However, the accounting standards not only control the

operations of the financial sector but of all related industries.

c) Liquidity risk and leverages

Financial regulatory frameworks are also designed to overcome future crises and

challenges in the future. In other words, the regulators adjust their conception of the process to

help manage risks. These financial liquidity risk and leverage not only concern the banks, but

financial institutions as well (Barr, 2012). The regulatory oversight over liquidity risk and

leverage will help ensure that the financial institutions will not fail at the peril of the entire

industry.

d) Increasing transparency

The financial system is only as important as its capacity to deliver its consumers with

value. This is especially since the financial institutions deal with financial instruments including

the derivative product and exchanges, which need transparency incase investor will trade in it.

Over-the-counter (OTC) derivatives traded with less transparency are more likely to attract

systemic risks (Hanson et al., 2011). As a result, strategies to standardize the derivatives are

developed to improve the technical trading infrastructures and increase the firm’s transparency

when dealing with the different instruments.

e) Resolution Mechanisms in case of Failing Financial Institutions

Despite these principles and mechanisms meant to streamline the financial institutions, there is a

chance that they might still fail. In this case, the government and other regulating institutions

must have contingency plans to salvage failing financial institutions. This is in the form of

bailouts from the government during economic crises (Rutledge et al., 2012). Government

backing is important for the financial institution to operate efficiently especially since they deal
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with challenges like moral hazards. The financial system is uncertain in nature, therefore, in case

the institutions are to fail, the government needs to have a plan to prevent its effects from spilling

over.

Role of Macroeconomic Policies in Promoting the Financial Stability

Financial stability is only assured through the financial policies developed both at the

national and global levels. This relationship is unidirectional in that the financial institutions also

affect the effectiveness of the macroeconomic policy. The macroeconomic policies are

distinguished into either monetary or fiscal policies.

Monetary Policies

Monetary policies are meant to control the supply of money within the economy. The

monetary policies control the supply and circulation of cash and the interest rates within a

country. The monetary policies are either used to check or stimulate the growth of an economy

by incentivizing people to spend, as well as borrow money (Smets, 2014). This is by restricting

expenditures, as well as incentivizing the population to save to avoid getting into a recession or

boom. In the U.S, the federal research uses the monetary policy to control the open market

operations. For example, the Federal Reserve injects money into the economy by purchasing

government bonds and restricts these operations by selling the government bonds (The National

Academics of Sciences, Engineering, and Medicine, 2017).

Fiscal Policies

On the other hand, a country may use fiscal policies to stabilize the financial market.

When the fiscal policies are poor, the government is affected adversely especially if its

borrowing exceed the optimal. Such a situation makes the economy unstable by making the

monetary framework unstable, thus, making it impossible for the central bank to control its
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performance. In cases where there are fiscal deficits, the financial institutions are likely to

succeed since there is reduced fiscal space to revive an economy.

Financial Regulations in the U.S.

Regulatory Agencies in U.S.

Before analyzing the financial regulations that control the country’s banking and financial

sectors, an understanding of the regulatory agencies that control operations is needed. Some of

the main regulatory agencies include: -

a) The Board of Governors of the Federal Reserve System

This Federal Reserve System is the country’s core central banking system and is involved in the

development of monetary policies. It supervises and controls the activities of banks registered

within the country (Sahni & Bryne, 2019).

b) Federal Deposit Insurance Corporation (FDIC)

This agency is responsible for the regulation all state-chartered banks that do not fall under the

Federal Reserve System. The agency has receivership power over banks and can also insure

them in other situations (Sahni & Bryne, 2019).

c) Consumer Financial Protection Bureau (CFPB)

This is also an important financial regulator in the industry whose main responsibility is to

protect consumers. Its regulations apply to both banking and non-banking institutions and require

that all the firms comply (Sahni & Bryne, 2019).

d) Financial Stability Oversight Council (FSOC)

Just like the name suggest, this is an oversight council whose main responsibility is to ensure that

there is stability in the financial system. It comprises of the secretary of the U.S. Treasury

alongside eight financial regulators and an independent member with vast experience in
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insurance (Sahni & Bryne, 2019). This council makes it possible to supervise non-bank financial

institutions and ensure stability in the system.

In addition to these agencies, a number of statutes have been developed to make this system

operate more effectively. Some of the main statutes, in this case, include: -

 The National Bank Act (1863).

 The Federal Reserve Act 1914.

 The banking Act of 1933.

 The Federal Deposit Insurance Act (FDI Act).

 The bank Holding Company Act of 1956 (BCS Act).

 The Gramm-Leach-Bliley Act (1999).

 The Dodd-Frank Act (20100.

 And the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA)

(Sahni & Bryne, 2019).

Recent Regulatory Development

Over the last few years, different developments in the country have led to the evolution of the

regulatory environment. Some of the recent factors that have led to the development of the

regulatory environment includes political change, innovations, and cybersecurity (Sahni &

Bryne, 2019).

a) Political changes

Financial regulations have been developed in response to the political climate of a country. The

election of President Trump led to the adjustment of the regulatory environment. On May 24,

2018, EGRRCPA was signed into action by President Trump, which was expected to make the

financial regulations of the Dodd-Frank Act become less stringent (Sahni & Bryne, 2019).
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b) Cybersecurity

Increased attention has been placed on cybersecurity over the last few years especially since

online activities have increased. The New York State Department of Financial Services

(NYSDFS) currently requires financial institutions to meet some security measures that protects

companies and their customers (Sahni & Bryne, 2019).

c) Addressing Innovation Needs

Constant innovations around the country are leaving some of the companies less regulated. As a

result, the regulatory framework needs to be updated consistently to ensure that it addresses all

the needs of the market. One of the recent areas that require innovative regulatory frameworks to

be developed is the financial technology companies (Fintech) (Arner, Barberis & Buckley,

2016). In such case, the regulatory environment is considering setting a special bank charter for

the companies, which will ensure that the company complies with the national standards set.

Bank Capital Requirements in U.S

Since the 2008-2009 financial crisis, the regulatory agencies realized that the financial

institutions must be controlled stringently to avoid such a situation in the future. Different

frameworks and regulatory oversight agencies, different standards, especially pertaining to

capital requirements have been developed (Labonte, 2017). For example, the Revised Capital

Framework, as well as the Basel Framework have been used for this matter. The Revised Capital

Framework intended to integrate the provisions of the Basel Commission to the Dodd-Frank Act

regarding standardized methodologies, as well as requirement (Cohen & Scatigna, 2016).

Though the Revised Capital Framework was only put into action in 2015, it is being updated

constantly to come up with a fool proof system that can promote sanity and stability within the

financial sector.
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Harmonizing Basel Framework to the revised Capital Framework has had significant

repercussions on factors like the Components of Capital, minimum capital ratios, G-SIB

Surcharge, risk-weighted assets, market risk capital charge, leverage ratio, and so forth. For

example, the Revised Capital Framework has prescribed the minimum risk-based capital ratios

for Common Equity Tier 1 Capital (CET1) at 4.5%, Tier 1 Capital at 6%, and the total capital at

8% (Cohen & Scatigna, 2016). Firms that fail to maintain capital beyond the minimum capital

ratios requirement are compelled to ay discretionary executive bonuses, as well as make capital

distributions, as well. The G-SIB Surcharge refers to additional capital charges on the global

systematically important banks within the states. This refers to 8 of the main banks in the U.S.

and the amount of the surcharge depends size, substitutability, interconnectedness, complexity,

cross-jurisdictional activity, and funding (Teslik, 2018).

Risk weighted assets within the banking sector presented a unique challenge for the

financial regulators. This resulted from the fact that the Basel Framework, Revised Capital

Framework, and the Dodd-Frank Act differed in some aspects (Sahni & Bryne, 2019). The use of

external credit ratings was inconsistent with the Revised Capital Framework, as a result of

prohibitions of the Dodd-Frank Act. In an approach to standardize this process, the Standardized

Approach to Counterpart Credit Risk (SA-CCR) was proposed by the U.S. federal banking

agencies to calculate risky derivatives. Another important source of contention for the new

regulatory framework regarded the market risk capital charge. As a result, the Basel Committee

has proposed new standards to be enacted in 2022 for this purpose (Sahni & Bryne, 2019). The

Revised Capital Framework also prescribes and suggests how the leverage ratio is determined

within the country’s financial sector. In general, this capital requirement has been designed such

that it is not prone to risks inherent with financial institutions, especially in developed countries
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(Baker & Wurgler, 2015). However, an important lesson to learn is that the standards are

constantly changing as the regulatory agencies try to cover arising issues and protect key

stakeholders and the economy in general.

The Securities and Exchange Commission (SEC)

When analyzing the country’s financial regulatory agencies it is impossible to leave out

SEC considering the role that it plays for the industry. This is a government agency that works

independently and oversees the country’s security market and associated laws (Hornuf &

Schwienbacher, 2017). It has been operations for decades helping streamline the security market

and protect investors from unscrupulous operatives (Johnston & Pettachi, 2017). It compels

organization including financial and non-financial institutions to publish annual reports in

accordance with the accounting standards. The SEC enforces the seven acts highlighted above

including the Credit Rating Agency Reform Act and the Sarbanes-Oxley Acts to regulate the

financial market. Firms including banks that go contrary to its requirements are compelled to pay

fines or even charged in the civil cases for the violation of security laws (Christl, Woodcock &

Kozlowski, 2017). The SEC has managed to keep a majority of the firms in check over the

decades by enforcing laws and regulations developed to streamline the financial system of the

country.

Conclusion

From this discussion, a number of things are evident. For example, regulations in the

financial institutions have played an effective role over the years, especially after the 2008-2009

crisis. Consumers can hardly do anything to protect themselves against such corporations,

therefore, the government through the mechanisms at its disposal are expected to protect all the

stakeholders involved. This discussion has explained why the financial system needs to be
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regulated in the context of developed and emerging economies. The report cites the spill-over

effect that resulted from poor regulation of financial institutions in the period before the 2008-

2009 crisis. The discussion has also identified specific mechanisms utilized within the U.S to

control and protect the economy and consumers from another crisis in the future.
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