Bank regulation

From Wikipedia, the free encyclopedia

Jump to: navigation, search
This article needs additional citations for verification. Please help improve this article
by adding citations to reliable sources. Unsourced material may be challenged and
removed. (September 2008)

Bank regulations are a form of government regulation which subject banks to certain
requirements, restrictions and guidelines. This regulatory structure creates transparency between
banking institutions and the individuals and corporations with whom they conduct business,
among other things. Given the interconnectedness of the banking industry and the reliance that
the national (and global) economy hold on banks, it is important for regulatory agencies to
maintain control over the standardized practices of these institutions. Supporters of such
regulation often hinge their arguments on the "too big to fail" notion. This holds that many
financial institutions (particularly investment banks with a commercial arm) hold too much
control over the economy to fail without enormous consequences. Others advocate deregulation,
or free banking, whereby banks are given extended liberties as to how they operate the
institution.

Contents
 [hide] 

 1 Objectives of bank regulation

 2 General principles of bank regulation
o 2.1 Minimum requirements
o 2.2 Supervisory review
o 2.3 Market discipline
 3 Instruments and requirements of bank regulation
o 3.1 Capital requirement
o 3.2 Reserve requirement
o 3.3 Corporate governance
o 3.4 Financial reporting and disclosure requirements
o 3.5 Credit rating requirement
o 3.6 Large exposures restrictions
o 3.7 Activity and affiliation restrictions
 4 By country
 5 See also
 6 External links
o 6.1 Reserve requirements
o 6.2 Capital requirements
o 6.3 Agenda from ISO
 o 6.4 Various Countries
 6.4.1 Israel
 6.4.2 References

[edit] Objectives of bank regulation

The objectives of bank regulation, and the emphasis, vary between jurisdictions. The most
common objectives are:

1. Prudential—to reduce the level of risk to which bank creditors are exposed (i.e. to protect
depositors)[1]
2. Systemic risk reduction—to reduce the risk of disruption resulting from adverse trading
conditions for banks causing multiple or major bank failures[2]
3. Avoid misuse of banks—to reduce the risk of banks being used for criminal purposes,
e.g. laundering the proceeds of crime
4. To protect banking confidentiality
5. Credit allocation—to direct credit to favored sectors

[edit] General principles of bank regulation

Banking regulations can vary widely across nations and jurisdictions. This section of the article
describes general principles of bank regulation throughout the world.

[edit] Minimum requirements

Requirements are imposed on banks in order to promote the objectives of the regulator. Often,
these requirements are closely tied to the level of risk exposure for a certain sector of the bank.
The most important minimum requirement in banking regulation is maintaining minimum capital
ratios.

[edit] Supervisory review

Banks are required to be issued with a bank license by the regulator in order to carry on business
as a bank, and the regulator supervises licenced banks for compliance with the requirements and
responds to breaches of the requirements through obtaining undertakings, giving directions,
imposing penalties or revoking the bank's licence.

[edit] Market discipline

The regulator requires banks to publicly disclose financial and other information, and depositors
and other creditors are able to use this information to assess the level of risk and to make
investment decisions. As a result of this, the bank is subject to market discipline and the
regulator can also use market pricing information as an indicator of the bank's financial health.
[edit] Instruments and requirements of bank regulation
[edit] Capital requirement

Main article: Capital requirement

The capital requirement sets a framework on how banks must handle their capital in relation to
their assets. Internationally, the Bank for International Settlements' Basel Committee on Banking
Supervision influences each country's capital requirements. In 1988, the Committee decided to
introduce a capital measurement system commonly referred to as the Basel Capital Accords. The
latest capital adequacy framework is commonly known as Basel III. This updated framework is
intended to be more risk sensitive than the original one, but is also a lot more complex.

[edit] Reserve requirement

Main article: Reserve requirement

The reserve requirement sets the minimum reserves each bank must hold to demand deposits and
banknotes. This type of regulation has lost the role it once had, as the emphasis has moved
toward capital adequacy, and in many countries there is no minimum reserve ratio. The purpose
of minimum reserve ratios is liquidity rather than safety. An example of a country with a
contemporary minimum reserve ratio is Hong Kong, where banks are required to maintain 25%
of their liabilities that are due on demand or within 1 month as qualifying liquefiable assets.

Reserve requirements have also been used in the past to control the stock of banknotes and/or
bank deposits. Required reserves have at times been gold coin, central bank banknotes or
deposits, and foreign currency.

[edit] Corporate governance

Corporate governance requirements are intended to encourage the bank to be well managed, and
is an indirect way of achieving other objectives. As many banks are relatively large, with many
divisions, it is important for management to maintain a close watch on all operations. Investors
and clients will often hold higher management accountable for missteps, as these individuals are
expected to be aware of all activities of the institution. Some of these requirements may include:

1. To be a body corporate (i.e. not an individual, a partnership, trust or other unincorporated

entity)
2. To be incorporated locally, and/or to be incorporated under as a particular type of body
corporate, rather than being incorporated in a foreign jurisdiction.
3. To have a minimum number of directors
4. To have an organisational structure that includes various offices and officers, e.g.
corporate secretary, treasurer/CFO, auditor, Asset Liability Management Committee,
Privacy Officer etc. Also the officers for those offices may need to be approved persons,
or from an approved class of persons.
 5. To have a constitution or articles of association that is approved, or contains or does not
contain particular clauses, e.g. clauses that enable directors to act other than in the best
interests of the company (e.g. in the interests of a parent company) may not be allowed.

[edit] Financial reporting and disclosure requirements

Among the most important regulations that are placed on banking institutions is the requirement
for disclosure of the bank's finances. Particularly for banks that trade on the public market, the
Securities and Exchange Commission (SEC) requires management to prepare annual financial
statements according to a financial reporting standard, have them audited, and to register or
publish them. Often, these banks are even required to prepare more frequent financial
disclosures, such as Quarterly Disclosure Statements. The Sarbanes-Oxley Act of 2002 outlines
in detail the exact structure of the reports that the SEC requires.

In addition to preparing these statements, the SEC also stipulates that directors of the bank must
attest to the accuracy of such financial disclosures. Thus, included in their annual reports must be
a report of management on the company's internal control over financial reporting. The internal
control report must include: a statement of management's responsibility for establishing and
maintaining adequate internal control over financial reporting for the company; management's
assessment of the effectiveness of the company's internal control over financial reporting as of
the end of the company's most recent fiscal year; a statement identifying the framework used by
management to evaluate the effectiveness of the company's internal control over financial
reporting; and a statement that the registered public accounting firm that audited the company's
financial statements included in the annual report has issued an attestation report on
management's assessment of the company's internal control over financial reporting. Under the
new rules, a company is required to file the registered public accounting firm's attestation report
as part of the annual report. Furthermore, the SEC added a requirement that management
evaluate any change in the company's internal control over financial reporting that occurred
during a fiscal quarter that has materially affected, or is reasonably likely to materially affect, the
company's internal control over financial reporting.[3]

[edit] Credit rating requirement

Banks may be required to obtain and maintain a current credit rating from an approved credit
rating agency, and to disclose it to investors and prospective investors. Also, banks may be
required to maintain a minimum credit rating. These ratings are designed to provide color for
prospective clients or investors regarding the relative risk that one assumes when engaging in
business with the bank. The ratings reflect the tendencies of the bank to take on high risk
endeavors, in addition to the likelihood of succeeding in such deals or initiatives.[4] The rating
agencies that banks are most strictly governed by, referred to as the "Big Three" are the Fitch
Group, Standard and Poor's and Moody's. These agencies hold the most influence over how
banks (and all public companies) are viewed by those engaged in the public market.

[edit] Large exposures restrictions

Banks may be restricted from having imprudently large exposures to individual counterparties or
groups of connected counterparties. This may be expressed as a proportion of the bank's assets or
equity, and different limits may apply depending on the security held and/or the credit rating of
the counterparty. Restricting disproportionate exposure to high risk initiatives allows regulatory
agencies to prevent financial institutions from placing investor (as well as the firm's) capital at
unnecessary risk.

[edit] Activity and affiliation restrictions

In 1933, during the first 100 days of President Franklin D. Roosevelt’s New Deal, the Securities
Act of 1933 and the Glass-Steagall Act (GSA) were enacted, setting up a pervasive regulatory
scheme for the public offering of securities and generally prohibiting commercial banks from
underwriting and dealing in those securities. GSA prohibited affiliations between banks (which
means bank-chartered depository institutions, that is, financial institutions that hold federally
insured consumer deposits) and securities firms (which are commonly referred to as “investment
banks” even though they are not technically banks and do not hold federally insured consumer
deposits); further restrictions on bank affiliations with non- banking firms were enacted in Bank
Holding Company Act of 1956 (BHCA) and its subsequent amendments, eliminating the
possibility that companies owning banks would be permitted to take ownership or controlling
interest in insurance companies, manufacturing companies, real estate companies, securities
firms, or any other non-banking company. As a result, distinct regulatory systems developed in
the United States for regulating banks, on the one hand, and securities firms on the other.[5]