Essay: Regulation of Banks

Pages: 15 (6320 words)  ·  Bibliography Sources: 8  ·  Level: Master's  ·  Topic: Economics  ·  Buy This Paper


[. . .] Investment banks also underwrite stock offerings just as they do bond offerings. In the stock offering process, a company sells a portion of the equity (or ownership) of itself to the investing public. The very first time a company chooses to sell equity, this offering of equity is transacted through a process called an initial public offering of stock (commonly known as an IPO). Through the IPO process, stock in a company is created and sold to the public. After the deal, stock sold in the U.S. is traded on a stock exchange such as the New York Stock Exchange (NYSE) or in India on the National Stock Exchange (NSE). The equity underwriting process is another major way in which investment banking differs from commercial banking.[footnoteRef:6] [6: Allen, F. And Douglas, G. 2000.]

Regulation and the Scope of Applicable Law

Until 1979, there was no domestic legislation that regulated the conduct of banking business in the United Kingdom.[footnoteRef:7] Indeed, insofar as the banking business comprises the making of loans and advances to customers, the absence of regulation remains a significant feature of the current legislation. Until 1979, the Bank of England operated an informal system of supervision which relied upon an expectation of compliance and the general influence of the central bank in the financial sphere. At that point, however, Parliament passed the Banking Act of 1979, which required that the acceptance of deposits from the public should be subject to prior authorization by the Bank of England. The Act was passed in order to give effect to this country's obligations under the First European Community Banking Directive, which required a formalized system of authorization and supervision for the banking sector. The regulatory framework was subsequently revised and extended by the Banking Act 1987. The main consequences of the 1987 Act were (i) a streamlining of the authorization process, (ii) the introduction of a 'large exposures' reporting system, and (iii) the Bank of England was given greater powers to demand information and to carry out investigations. A notable feature of the 1987 Act - especially when compared with the current legislation - is that the Act regulated who could carry on a deposit-taking business but, subject to minor exceptions - it did not regulate how that business should be carried on, in the sense that there were very limited rules dealing with the conduct of business.[footnoteRef:8] [7: Penn, G.A. And Wadsley, J. 2000. The Law and Practice of Domestic Banking. Sweet & Maxwell: London, UK.] [8: Penn, G.A. And Wadsley, J. 2000.]

It was at this point of time that the incoming tide of European legislation began to become more evident. In 1989, the EC Council adopted its Second Council Directive on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions, which was implemented in the United Kingdom by means of the Banking Coordination (Second Council Directive) Regulations of 1992. These regulations gave effect to the Community's 'passporting' scheme, under which it would no longer be necessary for an EC-based institution to be separately authorized in each of the EC Member States in which it had a branch or provided services. Instead, it would be permitted to establish a branch and undertake local activities in those other countries in reliance on its home State authorization. Although these particular regulations have now been repealed, the passporting system remains in effect through later directives and their implementing regulations, and this forms one of the key pillars of EU banking law.[footnoteRef:9] [9: Penn, G.A. And Wadsley, J. 2000.]

In addition, the Community began to introduce further directives intended to implement the capital adequacy and other prudential requirements laid down by the 1988 Capital Accord published by the Basel Committee on Banking Supervision. The further initiatives included the Own Funds Directive, the Solvency Ratio Directive and two directives dealing with capital adequacy issues. All of these directives have subsequently been consolidated and amended in the light of further recommendations by the Basel Committee in the field of capital adequacy. So it will be seen that the early 1990s saw a significant 'Europeanization' of British banking, mainly as a harmonizing measure with a view to completing the EC's 'single market'.[footnoteRef:10] [10: Caprio, G. And Honohan, P. 2001.]

More recently in a move which was not dictated by considerations of Community law, the government determined that the functions of the central bank should be separated from those of the market regulator and the task of banking supervision. This formed part of a larger plan to provide for unified supervision of the financial markets as a whole by a single regulator. Given the interdependence of the different segments of the financial markets (banking, insurance, fund management, and other businesses) it was argued that this was an appropriate step, although the wisdom of removing bank supervision from the Bank of England has been questioned by some commentators in the wake of the recent financial crisis. The final legislative result of this decision was the Financial Services and Markets Act 2000 (FSMA). It has been pointed out that the 2000 Act succeeded in being both a formidable, and yet at the same time inchoate, piece of legislation. The Act itself answers few of the practical questions to which the scheme of regulation gives rise on a daily basis. Instead, it confers upon the Financial Services Authority a broad rule-making power, and it will almost invariably be necessary to refer to those rules in order meaningfully to deal with any issues that may arise. As noted earlier, the legislation deals not merely with banking but also with other aspects of the financial markets.[footnoteRef:11] [11: Penn, G.A. And Wadsley, J. 2000.]

Therefore, currently banking regulation in the UK can be seen as involving three organizations, the Financial Services Authority (FSA), the Bank of England and the Treasury. Until the banking crisis, UK banking regulation could be described as light-touch - in other words, regulators do not engage in aggressive regulation, preferring to intervene only when necessary, and only in limited ways. In order to protect depositors and to maintain financial stability, the Banking Act of 2009 gave those organizations responsible for banking regulation the collective powers to deal with the crisis in the banking system. One of these powers is the ability to put a failing bank under temporary public ownership. It is noteworthy that the 2009 Turner Review, issued by the Chairman of the FSA, published the findings of his review into the banking crisis and recommended more coordinated international banking regulation, especially the creation of a pan-European regulator to ensure that: 1. Banks hold more assets; 2) Regulation of liquidity; 3) More information to be collected from those institutions that are part of the shadow banking system, like hedge funds; 4) More regulation of overseas banks by host countries - this recommendation is largely in response to the collapse of the Iceland banks, who were unregulated by the UK regulators, but UK citizens suffered large losses; 5) Control of bank employees remuneration and lastly 6) A review of bank's accounting practices. In short, the current UK banking law is in a state of tremendous flux as it learns and adopts the lesson from the Global Sovereign Debt Crisis.[footnoteRef:12] [12: Financial Services Authority. 2009. The Turner Review: A Regulatory Response to the Global Banking Crisis. Accessed 20 Jan 2012. URL: ]

Advantages and Disadvantages of Bank Regulation

Banking regulation is often reactive. Regulatory reform closes gaps in the financial system usually following a crisis, shifts in the markets or other change that threatens financial stability. Market participants are constrained by market regulation in setting prices because they have strong incentives to generate revenues and avoid bankruptcy. This means that in order to satisfy their interests, customers usually avoid high prices whilst service providers set prices that generate revenue. Market discipline can be exerted by market participants if they have sufficient information and if they have the incentives and ability to assess bank risk.[footnoteRef:13] Direct market discipline means that market participants can directly influence banks' behavior: uninsured debt holders are at risk and as they bear losses in case of bank failure they require a rate of return which increases with the risk they perceive. If they correctly assess banks' risk, the raise of the funding cost following an increase in risk should restrain excessive risk taking. Indirect market discipline generates a signal about banks' risk which can be used by supervisors into banking supervision in order to better allocate resources.[footnoteRef:14] [13: Macey, J.R. And O'Hara, M. 2003.] [14: Barth, J.R.., Caprio, G. And Levine, R. 2001. "Banking Systems Around the Globe: Do Regulations and Ownership Affect Performance and Stability?" In Prudential Supervision: What Works and What Doesn't, ed. Frederic S. Mishkin. University of Chicago Press: Chicago, IL. ]

Effect of Regulation on Banking Behavior

The Moral Hazard Problem


Bank of America a Leader in the Banking Industry Research Paper

Bank Profitability Term Paper

Bank Finance Management Book Report

Money and Banks. The Book Essay

Bank Insure That the Level of Money Literature Review Chapter

View 1,000+ other related papers  >>

Cite This Essay:

APA Format

Regulation of Banks.  (2012, January 20).  Retrieved August 23, 2019, from

MLA Format

"Regulation of Banks."  20 January 2012.  Web.  23 August 2019. <>.

Chicago Format

"Regulation of Banks."  January 20, 2012.  Accessed August 23, 2019.