The Role of Regulation of Financial Institutions in 2007 – 2009 Global Financial Turmoil

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Investors lost confidence in the financial institutions after the financial crisis, so regulation should aim at protecting consumers and increasing their confidences. With the implementation of 2010 Wall Street Reform and Consumer Protection Act, Financial Services Oversight Council was established to oversee the systemic risks of large financial institutions. In this way, managers of large banks cannot involve in some highly risky investment activities. Measures were also taken on to prevent or discourage institutions from becoming too large in scale. The 2010 Wall Street Reform and Consumer Protection Act gives government power to break up financial institutions, so government could prevent institutions from becoming too large to have huge systemic risks (Saunders & Cornett, 2014).

Regulations were also issued to oversee non-bank financial institutions. The key objective of 2010 Wall Street Reform and Consumer Protection Act is to ensure any financial firm whose failure could pose threat to financial stability would be under supervision (PwC, 2011), and non-bank institutions identified as systemically important by Financial Stability Oversight Council are also regulated by the Act. To improve transparency and standardization of financial products, regulations required some over-the-counter derivatives traded on exchange or through clearinghouses (Saunders & Cornett, 2014). Thus investors could have a better understanding of the financial products and avoid financial abuse.

Other regulations played a role in enhancing stability of financial institutions. The U.S. government lunched the TARP program to help institutions build capital during the crisis. Basel Committee launched Basel 2.5 and Basel III to solve the weaknesses with Basel II. The new regulations raise the level of minimum capital requirements to enhance banks’ abilities of absorbing loss. Basel III includes minimum leverage ratio, liquidity requirements and countercyclical capital buffer to enhance the stability of financial institutions. Banks are promoted to build excessive capital during the booming period to form buffer for recessions (Basel Committee, 2010).

Problematic regulations on financial institutions could be causes of the recent financial crisis. However, new regulations issued during the crisis played a significant role in the recovery process by building investors’ confidences and enhancing stability of financial institutions.

Number of pages: 4

Number of words: 979

Graph 1

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Source: D'Hulster (2009)

References

Basel Committee (2010). The Basel Committee’s response to the financial crisis: report to the G20. Retrieved October 25, 2014 from http://www.bis.org/publ/bcbs179

Butler, P. (2009). Learning from financial regulation’s mistakes. Retrieved November 1, 2014 from http://www.mckinsey.com/insights/public_sector/learning_from_financial_regulations_mistakes

D'hulster, K. (2009). The Leverage Ratio, A New Binding Limit on Banks. Retrieved October 25, 2014 from http://www.worldbank.org/financialcrisis/pdf/levrage-ratio-web.

Kim, T., Koo, B. & Park, M. (2013). Role of financial regulation and innovation in the financial crisis. Journal of Financial Stability, 9 662-672.

Pwc (2011). The FSOC SIFI Designation Proposal for Nonbank Financial Companies . Retrieved November 1, 2014 from http://www.pwc.com/en_US/us/financial-services/regulatory-services/publications

Saunders, A. & Cornett, M. M. (2014). Financial Institutions Management, A Risk Management Approach. New York: McGraw Hill.