Banking regulation and supervision
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Banking regulation and supervision refers to a form of financial regulation which subjects banks to certain requirements, restrictions and guidelines, enforced by a financial regulatory authority generally referred to as banking supervisor, with semantic variations across jurisdictions. By and large, banking regulation and supervision aims at ensuring that banks are safe and sound and at fostering market transparency between banks and the individuals and corporations with whom they conduct business.
Its main component is prudential regulation and supervision whose aim is to ensure that banks are viable and resilient ("safe and sound") so as to reduce the likelihood and impact of bank failures that may trigger
Semantics
Banking supervision and regulation are closely intertwined, to the extent that in some jurisdictions (particularly the United States) the words "regulator" and "supervisor" are often used interchangeably in its context. Policy practice, however, makes a distinction between the setting of rules that apply to banks (regulation) and the oversight of their safety and soundness (prudential supervision), since the latter often entails a discretionary component or "supervisory judgment". The global framework for banking regulation and supervision, prepared by the Basel Committee on Banking Supervision, makes a distinction between three "pillars", namely regulation (Pillar 1), supervisory discretion (Pillar 2), and market discipline enabled by appropriate disclosure requirements (Pillar 3).[citation needed]
Bank licensing, which sets certain requirements for starting a new bank, is closely connected with supervision and usually performed by the same public authority. Licensing provides the licence holders the right to own and to operate a bank. The licensing process is specific to the regulatory environment of the jurisdiction where the bank is located. Licensing involves an evaluation of the entity's intent and the ability to meet the regulatory guidelines governing the bank's operations, financial soundness, and managerial actions. The supervisor monitors licensed banks for compliance with the requirements and responds to breaches of the requirements by obtaining undertakings, giving directions, imposing penalties or (ultimately) revoking the bank's license. Bank supervision may be viewed as an extension of the licence-granting process. Supervisory activities involve on-site inspection of the bank's records, operations and processes or evaluation of the reports submitted by the bank.[2] Arguably the most important requirement in bank regulation that supervisors must enforce is maintaining capital requirements.[3]
As banking regulation focusing on key factors in the financial markets, it forms one of the three components of
History
Banking regulation and supervision has emerged mostly in the 19th century and especially the 20th century, even though embryonic forms can be traced back to earlier periods. Landmark developments include the inception of U.S. federal banking supervision with the establishment of the Office of the Comptroller of the Currency in 1862; the creation of the U.S. Federal Deposit Insurance Corporation as the first major deposit guarantee and bank resolution authority in 1934; the creation of the Belgian Banking Commission, Europe's first modern banking supervisor in 1935; the start of formal banking supervision by the Bank of England in 1974, marking the eventual generalization of the practice among jurisdictions with large financial sectors; and the emergence of supranational banking supervision, first by the Eastern Caribbean Central Bank in 1983 and the Banking Commission of the West African Monetary Union in 1990 and then, at a much larger scale, with the start of European Banking Supervision in 2014.
Objectives
Given the interconnectedness of the
The objectives of bank regulation, and the emphasis, vary between jurisdictions. The most common objectives are:
- prudential—to reduce the level of risk to which bank creditors are exposed (i.e. to protect depositors)[6]
- systemic risk reduction—to reduce the risk of disruption resulting from adverse trading conditions for banks causing multiple or major bank failures[7]
- to avoid misuse of banks—to reduce the risk of banks being used for criminal purposes, e.g. laundering the proceeds of crime
- to protect banking confidentiality
- credit allocation—to direct credit to favored sectors
- it may also include rules about treating customers fairly and having corporate social responsibility.
Among the reasons for maintaining close regulation of banking institutions is the aforementioned concern over the global repercussions that could result from a bank's failure; the idea that these bulge bracket banks are "too big to fail".[8] The objective of federal agencies is to avoid situations in which the government must decide whether to support a struggling bank or to let it fail. The issue, as many argue, is that providing aid to crippled banks creates a situation of moral hazard. The general premise is that while the government may have prevented a financial catastrophe for the time being, they have reinforced confidence for high risk taking and provided an invisible safety net. This can lead to a vicious cycle, wherein banks take risks, fail, receive a bailout, and then continue to take risks once again.
Instruments and requirements
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Market risk |
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Credit risk |
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Counterparty credit risk |
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Operational risk |
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Capital requirement
The capital requirement sets a framework on how banks must handle their
This updated framework is intended to be more risk sensitive than the original one, but is also a lot more complex.Reserve requirement
The reserve requirement sets the minimum
Reserve requirements have also been used in the past to control the stock of
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, and 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:
- to be a body corporate (i.e. not an individual, a partnership, trust or other unincorporated entity)
- 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
- to have a minimum number of directors
- to have an organizational structure that includes various offices and officers, e.g. corporate secretary, treasurer/CFO, auditor, Asset Liability Management Committee, Privacy Officer, Compliance Officer etc. Also the officers for those offices may need to be approved persons, or from an approved class of persons
- 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.
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, in the US for example the
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.[11]
Credit rating requirement
Banks may be required to obtain and maintain a current credit rating from an approved
European
Large exposures restrictions
Banks may be restricted from having imprudently large exposures to individual counterparties or groups of connected counterparties. Such limitation may be expressed as a proportion of the bank's assets or equity, and different limits may apply based on the security held and/or the credit rating of the counterparty. Restricting disproportionate exposure to high-risk investment prevents financial institutions from placing equity holders' (as well as the firm's) capital at an unnecessary risk.
Activity and affiliation restrictions
In the US in response to the
Bank supervisors
Most jurisdictions designate one public authority as their national prudential supervisor of banks: e.g. the
European Union
The
United States
The United States relies on state-level bank supervisors (or "state regulators", e.g. the New York State Department of Financial Services), and at the federal level on a number of agencies involved in the prudential supervision of credit institutions: for banks, the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation; and for other credit institutions, the National Credit Union Administration and Federal Housing Finance Agency.
See also
- List of Swiss financial market legislation
- United Kingdom banking law
- Financial repression
- Money creation
- Moral hazard
- Too big to fail
- BIC
References
- ISBN 978-0-19-884465-5.
- ^ Richard Apostolik, Christopher Donohue, and Peter Went (2009), Foundations of Banking Risk. Hoboken, New Jersey: John Wiley and Sons, p. 62-63.
- ^ Investopedia:Capital Requirement
- ^ Joanna Benjamin, Financial Law (2007, Oxford University Press), 7
- SSRN 3198092.
- ^ Federal Deposit Insurance Corporation. "Risk Management Manual of Exam Policies, Section 1.1". Archived from the original on 13 January 2020. Retrieved 17 August 2011.
- ^ Section 115, Dodd–Frank Wall Street Reform and Consumer Protection Act. "Pub. L. 111-203" (PDF). Archived (PDF) from the original on 8 July 2011. Retrieved 17 August 2011.
{{cite web}}
: CS1 maint: numeric names: authors list (link) - ISBN 9781400828319.
- ^ "Basel II Comprehensive version part 2: The First Pillar – Minimum Capital Requirements" (PDF). November 2005. p. 86.
- ^ Oxley, Michael G. (2002-07-30). "H.R.3763 - 107th Congress (2001-2002): Sarbanes-Oxley Act of 2002". www.congress.gov. Retrieved 2021-03-06.
- ^ Section 404, Management's Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports. "Final Rule". Retrieved 18 October 2011.
{{cite web}}
: CS1 maint: numeric names: authors list (link) - ^ The Guardian (22 August 2011). "Ratings agencies suffer 'conflict of interest', says former Moody's bos". London. Retrieved 19 February 2012.
- ^ M. Nicolas J. Firzli, "A Critique of the Basel Committee on Banking Supervision" Revue Analyse Financière, Nov. 10 2011 & Q2 2012
- ^ Carpenter, David H. and M. Maureen Murphy. "The “Volcker Rule”: Proposals to Limit “Speculative” Proprietary Trading by Banks". Congressional Research Service, 2010.
External links
- Middle East Banking & Finance News – ArabianBusiness.com
- Banking & Finance News – BankingInsuranceSecurities.com