Bank Regulation Essay

2828 words - 11 pages

Bank Regulation

Before the advent of the Federal Deposit Insurance Corporation (FDIC) in 1933 and the general conception of government safety nets, the United States banking industry was quite different than it is today. Depositors assumed substantial default risk and even the slightest changes in consumer confidence could result in complete turmoil within the banking world. In addition, bank managers had almost complete discretion over operations. However, today the financial system is among the most heavily government- regulated sectors of the U.S. economy. This drastic change in public policy resulted directly from the industry’s numerous pre-regulatory failures and major disruptions that produced severe economic and social hardship. Although the regulated United States banking industry has not fallen victim to bank crises since the Great Depression, this relative healthiness of the industry comes only with substantial costs. Many laws and regulations have restricted banking activity, precipitating a relative decline in the importance of the traditional banking sector. In addition, the introduction of money market mutual funds, commercial paper, junk bonds, and securitization into the financial industry created more lucrative alternatives that further reduced the role of traditional banking. In an effort to survive and maintain profitability under the changing economic environment, banks attempted to evade regulation through innovation and a process known as loophole mining. Recently, the same concerns that led governments to regulate domestic banks, such as uncertainty and instability, are pressuring policy makers to harmonize banking regulation internationally, while the limitations and problems encountered by domestic regulation have caused such proposals to be met with much controversy. In addition, the current unregulated globalization of the economy is increasing prosperity and economic welfare worldwide. Differences in banking regulations across borders permit the most efficient channeling of funds from lenders to borrowers, leading to increased investment and thus increased GDP. Therefore it is imperative that policy makers prudently evaluate the possible consequences and benefits of harmonized banking regulations, as demonstrated by similar regulations instituted domestically, before any such endeavor is embarked upon.

During the 1930s, the most prominent reason for U.S. banking regulation was to prevent bank panics and more economic disaster like those that had been experienced during the Great Depression. Later deregulation and financial innovation in industrialized countries during the 1980s eroded banks monopoly power, thus weakening their banking systems and seeming to embody the fears of post-Depression policy makers who instituted regulation in the first place. Fear that individual bank failures could spread across international borders creates pressure to harmonize bank regulation worldwide. One advocate...

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