Describe the rationale for regulating banks and financial market

Rationale for regulating Banks Why do we regulate banks? Do banks provide dangerous instruments that could harm people? Or the banks deal with dangerous material that could cause plagues on people? No! But banks are being considerably regulated and supervised in every corner of the world. Banking is also a business, and why we should concern more about the bank than we concern of any other ordinary business! It is because banking business is the business of receiving funds from the public through the acceptance of money deposits and use of such funds for investments or any other operation either authorized by law or by customary banking practice. To protect such depositors, banks should not be allowed to take any risk which could lead them to fail. Therefore banks must be properly regulated by an authorized body and it is a duty of a government to ensure that monetary and banking policy of banks are directed to protect the financial system of the country and the public interest. Therefore reasons for regulating the banks are mainly link with the protection of depositors, guaranteeing the functioning and protection against the systemic risk.

However, the basic reason for regulating the banks is to maintain confidence of the public in the banking system and to ensure that banks can be relied upon to meet depositors request for withdrawals. If the people are not in confident of the banking system they might all try to withdraw their funds at once, and the banks will collapse on sudden disposal of assets to meet the withdrawals. When depositors all withdraw money at once, it is said that there is run on bank. Some depositors will lose their money as the bank holds only a fraction of the total funds reserve. Then the bank has no option without going out of the business.

Hence it is governments job to ensure that the banks are holding adequate capital to bear the cost of losses. This capital requirement has to be imposed on bank through the regulations However capital requirement is the most important minimum requirement in the banking regulations and it could set a frame work on how a bank should handle their capital. Then every bank should comply with this capital adequacy to start and maintain their banking business. In addition, Bank must publicly disclose their financial and other information so that depositors could use this information to assess the level of risk. To make the banks to follow this guideline, it should be imposed on bank through the regulations. On the other hand these regulations enable the regulator to supervise whether the banks are complied with the prudential regulation and ultimately make a decision to revoke the banks license.

Rationale of regulating financial market Financial markets work best when investors are fully informed and the markets are free of fraud and manipulation. They also work better when there isnt a breakdown of management control at companies, or the threat of failure of one financial institution leading to the failure of others and in turn a possible collapse in the market. These are not problems that can be solved by individuals self-interests working things out in the marketplace. Instead this is where the government is needed to make markets more stable and improve the way they work.

In an unregulated market, investors will not have enough information to guide their investments, which should not be based on rumor and hearsay. Companies have incentives not to share information, such as bad news about themselves or information about others that is not already known in the marketplace. Thats why regulators require companies to fully disclose information. That way, the entire market is better informed. This results in a greater willingness of firms or individuals to invest. Better rules are needed now to improve disclosure, especially in financial transactions such as derivatives, which are complex financial contracts whose values are derived from the price of something else such as a commodity or security.

Fraud and the manipulation of market prices rob investors of a fair return on their money and this discourages investment and harms the entire economy. But possible gains from cheating apparently have become more of an incentive to many than the loss of a good reputation, so destructive activities continue. A large share of financial markets is not covered by anti-fraud and anti-manipulation prohibitions. Strict rules against fraud and manipulation are needed that apply to all financial transactions, even those that occur outside the formal securities exchanges.

Another reason regulation are important Is because risks taken by one brokerage firm can harm not only that firm but other companies as well. When a business fails it harms not only its employees, clients, vendors and creditors but also the firms that lent money to the creditors, clients and vendors. Yet this potential loss to others does not restrain firms from taking greater risks

In order to limit harm to others, better regulations are needed.

Regulation of Banks and Financial Markets, impacts on Economic Conditions Increased regulation of the financial system will generate a decrease in profitability rates. According to a study by McKinsey (2010), the new regulatory measures will cause the industrys profitability rates to decrease by between 5 and 6 percentage points in its return on equity (RoE), basically due to the changes in capital deductions and a higher Core Tier 1, which will affect all banking segments. According to this study, investment banking will be the most affected (9 percentage points) due to the imposition of a risk-weighting approach for its trading book assets. Furthermore, excessive regulation will result in capital flight from the banking system to other less regulated sectors. In addition, the need to comply with all the regulations and the search for returns will result in decreased credit exposure to meet capital ratio and liquidity requirements and also in an increase in spreads, spreading the impact of these measures to the real economy through greater financial costs and lower remuneration for savings. In emerging markets, the adjustment would not be through greater costs, but rather, through less access to credit, since access to capital will be diminished, and the most affected will be the micro and small business sectors, due to their informal nature.

Different types of regulation for bank and financial market

Regulation is "prudential" When it is aimed specifically at protecting the financial system as a whole as well as protecting the safety of small deposits in individual institutions. When a deposit-taking institution becomes insolvent, it cannot repay its depositors. If it is a large institution, its failure can undermine confidence enough so that the banking system suffers a run on deposits. Therefore, prudential regulation involves the government in attempting to protect the financial soundness of the regulated institutions. Prudential regulation is relatively difficult, intrusive, and expensive because it involves understanding and protecting the core health of an institution. "Non-prudential" rules Encompass regulations about the institutions business operations, and as such do not have the ultimate aim of protecting the entire financial system. These rules tend to be easier to administer because government authorities do not have to take responsibility for the financial...

Different types of regulation for bank and financial markets in Pakistan

The regulation and governance of Pakistan's financial market and corporate sector have been substantially strengthened with the commencement of operations of the Securities and Exchange Commission of Pakistan (SEC) in 1999. The SECs role was further enhanced when it was assigned regulatory responsibility for the insurance industry, non-banking finance companies (NBFCs) and private pension schemes in 1999 and 2000, respectively. The non-bank financial sector has undergone major consolidation and is emerging on strong footing to act as a productive agent of allocating resources. It is, therefore, of utmost importance That the capacity of the regulator is further enhanced in terms of skills, systems and procedures, to meet the challenges in todays dynamic financial markets.

PRUDENTIAL REGULATIONSFOR CORPORATE / COMMERCIAL BANKING in Pakistan (Updated on January 31, 2011) REGULATION-I REGULATION-II. REGULATION-III. REGULATION-IV. REGULATION-V. REGULATION-VI. REGULATION-VII. REGULATION-VIII. REGULATION-IX. REGULATION-X. REGULATION-XI. REGULATION-XII. REGULATION-XIII. REGULATION-XIV. REGULATION-XV. REGULATION-XVI. REGULATIONLimit on banks exposure to a single person. Limit on liabilities. Limit on advances. banks banks exposure exposure against against contingent unsecured

Linkage between a borrowers equity and total borrowing form banks. Maintenance of debt-equity ratio. Financing facilities against shares. Dealing with Directors, major Share-holders and Employees of the banks. Classification and provisioning for loans and other assets. Management. Bank charges. Opening of accounts. Prevention of criminal use of banking channels for the purpose of money laundering and other unlawful trades. Service charge on PLS deposit accounts. Payment of dividend. Undertaking of cash payments outside the banks authorised place of business. Window dressing. Minimum conditions for grant of financing facilities.

REGULATION-XVII. Assuring obligations on behalf of NBFIs.

XVIII. REGULATION-XIX. REGULATION-XX. REGULATION-XXI. REGULATION-XXII. REGULATIONXXIII. Half yearly data on financing facilities under Automated Performance Appraisal System (APAS). Contributions and donations for charitable, socio educational, and public welfare purposes. Fund management services. Reconciliation of Pak-account/inter-branch accounts and settlement of suspense account entries. Postings/transfers of Officers/Executives in branches operating abroad. All Banks & Financial Institutions covered Under Section 3A of BCO, 1962. Credit Rating Of The Financial Institutions

REGULATION XXIV Maintenance Of Assets in Pakistan. REGULATION XXV PRUDENTIALXXVI

Different types of financial regulation for Banks and Financial Markets in UK

Prudential Regulation in UK Regulators, too, were responsible. Regulation of such firms failed to be sufficiently robust or challenging, and was not based on a sufficiently deep understanding of risk in firms and across the system as a whole. This gap is one of the key issues the Government is seeking to address through its regulatory reforms. As the Government set out in A new approach to financial regulation: judgment, focus and stability, the fundamental defining characteristic of the new Prudential Regulation Authoritys (PRA) regulatory in UK approach will be the greater use of supervisory judgments. PRA supervisors will focus on developing a clear understanding of the financial soundness of firms and risks to their business models, informed by an assessment of exposure to other financial firms given failure for each firm, including the exposure of public funds. The PRAs proposed objective Both the PRA and Financial Conduct Authority (FCA) will work to their own strategic objectives and a set of operational objectives.

The PRA will have a strategic objective focusing on financial stability, with an operational objective that highlights the role of the PRA in promoting the soundness of firms in a way that does not rule out the possibility of firm failure

Different types of Regulation for Banks and Financial Markets in USA

U.S. financial regulation has traditionally made functional and institutional regulation roughly equivalent. However, the gradual shift away from GlassSteagall and the introduction of the Financial Modernization Act (FMA) generated a disorderly mix of functions and products across institutions, creating regulatory gaps that contributed to the recent crisis. PRUDENTIAL REGULATION in US Prudential regulation in the United States initially concentrated on ensuring the redemption value of private bankers circulating promissory notes. The failure to reconfirm the Second Bank of the United States as the national bank of the United States in 1832, and the introduction of the Independent Treasury System based on payments by the federal government in gold, relinquished the means of payment function to private sector financial institutions that could only be created under state charter and regulation.

Limitations of Regulation for Financial markets and Banks

 Moral hazard is a situation in which a party insulated from risk

behaves differently from how it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions. For example, a person with insurance against automobile theft may be less cautious about locking his or her car, because the negative consequences of vehicle theft are (partially) the responsibility of the insurance company. Economists explain moral hazard as a special case of information asymmetry, a situation in which one party in a transaction has more information than another. In particular, moral hazard may occur if a party that is insulated from risk has more information about its actions and intentions than the party paying for the negative consequences of the risk. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information. Moral hazard also arises in a principal-agent problem, where one party, called an agent, acts on behalf of another party, called the principal. The agent usually has more information about his or her actions or intentions than the principal does, because the principal usually cannot completely monitor the agent. The agent may have an incentive to act inappropriately (from the viewpoint of the principal) if the interests of the agent and the principal are not aligned Forbearance is a special agreement between the lender and the borrower to delay a foreclosure. The literal meaning of forbearance is holding back. Loan borrowers sometimes have problems making payments. This may cause the lender to start the foreclosure process. To avoid foreclosure, the lender and the borrower can make an agreement called "forbearance". According to this agreement, the lender delays his right to exercise foreclosure if the borrower can catch up to his payment schedule in a certain time. This period and the payment plan depend on the details of the agreement that are accepted by both parties. Forbearance is usually for temporary financial problems. If the borrower has more serious problems, for example if it is a variable-rate mortgage and the interest rate becomes unaffordable for the borrower, then forbearance is usually not a solution. When a lender offers forbearance, please note they are taking the control of the situation so they can maneuver whichever way best serves the lender. The borrower is still responsible for the total monthly payment due each month, though

they will accept the agreed forbearance amount. When the forbearance period is over the total amount of the original payments for that period is still due.

Conclusion
However it is important to know that the banks are the repositories of the liquidity of an economy and providing a strength backbone to the financial and payment system of a country. Therefore every state intervenes to protect the banking system from systemic risk by authorizing a government agent to operate monitoring and supervision over the banks. Generally Central bank is authorized to monitor the work of the commercial banks and maintain the supervision over the banks to ensure that the functions of banks are complied with the standards of prudential regulations. Strict rules against fraud and manipulation are needed that apply to all financial transactions, even those that occur outside the formal securities exchanges. Another reason regulation are important Is because risks taken by one brokerage firm can harm not only that firm but other companies as well. When a business fails it harms not only its employees, clients, vendors and creditors but also the firms that lent money to the creditors, clients and vendors. Yet this potential loss to others does not restrain firms from taking greater risks

In order to limit harm to others, better regulations are needed.