What are Banking Regulations?
Banking regulations are a form of government regulation which place certain restrictions and requirements, and guidelines on individual banks. Banking regulations are instituted to effectively restrict financial institutions from engaging in predatory lending techniques or fraudulent techniques aimed to take advantage of customers or businesses who conduct transactions with the underlying bank
Objectives of Banking Regulations:
The basic objectives of banking regulations, and their particular emphasis, will vary between jurisdictions; countries will impose different banking regulations that are typically based off their macro-economic conditions and the overall stability of their markets.
The most common objectives of banking regulations are:
o Banking Regulations are placed on financial institutions to reduce the level of risk that bank creditors will be exposed to. These prudential regulations are imposed to protect individuals and business entities who deposit funds into banks; over-leveraging or an increased exposure to a shaky credit market could result in massive defaults.
o Banking regulations are also introduced to limit an institution’s systemic risk; this form of risk refers to disruption resulting from adverse trading conditions for banks which may cause major or multiple bank failures.
o Other forms of banking regulations will be placed on a financial institution to avoid misuse and to effectively reduce the risk of banks being used for criminal activities, specifically laundering the proceeds of criminal acts to bank accounts.
o Banking regulations may be instituted to protect banking confidentiality
o Lastly, banking regulations are imposed to properly allocate credit streams. Lending is a primary function of a bank; as a result, banking regulations are created to direct such liens of credit to more favorable sectors to limit the risk of default.
General Principles of Bank Regulations:
• Although banking regulations will vary widely across countries and jurisdictions, there are general principles of bank regulations that exist throughout the world
• Minimum Requirements: Banking regulations will impose minimum requirements as it pertains to capital ratios to promote the principle objectives of a bank.
• Market Discipline: Banking regulators will impose restrictions that will publicly disclose the financial information of a bank. This information is used by depositors and creditors to assess the level of risk of the underlying bank and to subsequently make investment decisions. As a result of this regulation, the bank will be subjected to market discipline and the agency imposing the banking regulations can use market pricing information as a direct indicator of the bank’s financial stability.
• Supervisory Review: Banking regulations will impose a licensing process on the underlying bank; such a license is required to carry on the everyday business of the bank. The regulator (agency who imposes the regulations) will supervise the licensing process to ensure that the underlying bank meets all compliance issues. If a bank fails to acquire a license or fails to adhere to such compliance issues, the regulatory agency will respond to the breach through obtaining undertakings, imposing penalties, giving directions, or revoking the bank’s ability to conduct business.