Role of Banks in the Economy
FIN FPX 5710 Assessment 3 Banks have a vital role to play in the local, state, national, and global economies by offering a secure environment for consumers to keep their money and using that money to extend loans for productive investment. There are different types of banks, each offering important services that enable the economy to function smoothly. As they are responsible for playing a central role in economic stability, banks face stringent government regulation to safeguard the money supply. The majority of these regulations came into being because of severe banking failures that had led to recessions or financial market distress. This paper will examine the history behind these regulatory needs, current regulation in place today, and possible impacts on Midwest Global Investment Bank as it enters the market.
Historical Overview of Regulatory Legislation
Over history, there have been many regulatory measures aimed at safeguarding consumer, business, and federal funds.
Banks are likely more heavily regulated business entity in the United States.
There was a need for banking regulation early on, but it was not until nearly two centuries that the current system of regulation was established. The initial regulation effort was in the 1790s when the Bank of the United States was established as a private and central bank (Mishkin, 2019). The effort was highly opposed and ultimately collapsed. In 1816, the Second Bank of the United States was created to check state banks’ excesses and assist the government in financing wars (Mishkin, 2019). Unfortunately, this attempt also drew opposition and was revoked. Through most of the 1800s, banking institutions were state-chartered, which often led to failures due to corruption or lack of financing (Mishkin, 2019). Federal regulation of banking had no success before the early 1900s.
FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies
Over history, there have been many regulatory measures aimed at safeguarding consumer, business, and federal funds.
Banks are likely more heavily regulated business entity in the United States.
There was a need for banking regulation early on, but it was not until nearly two centuries that the current system of regulation was established. The initial regulation effort was in the 1790s when the Bank of the United States was established as a private and central bank (Mishkin, 2019). The effort was highly opposed and ultimately collapsed. In 1816, the Second Bank of the United States was created to check state banks’ excesses and assist the government in financing wars (Mishkin, 2019). Unfortunately, this attempt also drew opposition and was revoked. Through most of the 1800s, banking institutions were state-chartered, which often led to failures due to corruption or lack of financing (Mishkin, 2019). Federal regulation of banking had no success before the early 1900s.
Key Regulatory Measures
The Sarbanes-Oxley Act of 2002 was established to prevent fraud, enhance financial reporting accuracy, and re-establish investor trust in the banking sector (Wagner & Dittmar, 2006).The act covers all public organizations, small or large, and demands accurate financial reporting.Accountants and auditors have the obligation of ensuring full and fair disclosure of financial information (soxlaw, 2008). The act has internal controls that mandate that leaders are to examine financial reports in 90 days from the date of release (soxlaw, 2008).
Altering, concealing, destroying, or tampering with papers is also punishable with severe penalties, such as 20 years in prison (soxlaw, 2008).
FIN FPX 5710 Assessment 3 Critics argue that this act unduly burdens banks that have not been fraudulent, particularly minor banks; it has, nonetheless, made a significant effort towards increased transparency between banks and customers (Wagner & Dittmar, 2006). There has been a range of regulatory reactions to significant bank failures. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was passed in response to the 2008 financial crisis, which resulted from risky lending within the banking sector. The act established several government agencies tasked with regulating various aspects of the financial system (Kenton, 2019). For example, the Orderly Liquidation Authority and the Financial Stability Oversight Council manage financial stability and can also dismember banks that are too large (Kenton, 2019). The Consumer Financial Protection Bureau was created to prevent mortgage businesses from extending high-risk mortgages that will default, as well as interpreting mortgage terminology for consumers (Kenton, 2019). Even though the necessity of such regulations appears evident, their critics argue that they render U.S. banks less competitive on the global market and impose excessive burdens on community banks that were not involved in the 2008 financial crisis (Kenton, 2019).
Economic Implications
Importance of Banking Services
Banks are the main avenue of money flow in an economy and hence are major financial intermediaries.Commercial banks assist consumers in opening savings accounts and checking accounts, borrowing loans, and purchasing certificates of deposit (McConnell, Brue, & Flynn, 2018).Commercial banks assist consumers in accessing money to spend more in bulk, thus stimulating the economy, creating GDP, and providing avenues for economic growth.Commercial banks, being of utmost importance in handling public money, are regulated very stringently.Historically, commercial banks would operate uncontrolled, and hence subject to corruption.Today, many commercial banks are regulated in terms of the assets they can take and the loans they can give.Investment banks, such as Midwest Global, act as financial brokers between governments and corporations. Their primary activities involve selling and buying stocks and bonds to facilitate corporate growth and economic development (McConnell, Brue, & Flynn, 2018). In addition, investment banks provide mergers and acquisitions advisory services and brokerage services (McConnell, Brue, & Flynn, 2018). While investment banks do a great deal in economic growth, they also have more risk as they deal with riskier assets. Regulations have been made to assist in curbing the extent of these risks so that they do not undermine the economy.
Regulatory Challenges for Midwest Global
When Midwest Global goes public, it has to abide by all applicable rules, and this results in immense changes to its organization and expense. Rules impose restrictions on the manner in which banks can invest and generate revenues, and if they don’t comply, it can lead to enormous financial penalties.
One of these is capping banks’ holdings of risky assets, such as common stocks (Mishkin, 2019).While riskier assets offer the promise of higher returns, banks are now capped on how much exposure they can get from these assets in order to protect taxpayers (Mishkin, 2019).Regulations also encourage diversification by capping what the banks can lend in high-risk categories and, as such, prevent bank failure due to reckless investments (Mishkin, 2019).
Banks must maintain large buffers of equity capital to guarantee the protection of public funds. This is a deterrent to risky behavior, as banks will lose more in the event of failure. Midwest Global will need to calculate its leverage ratio, i.e., the capital over total assets (Mishkin, 2019). A leverage ratio below 3% draws additional regulatory restrictions, and the Basel Accords require banks to maintain at least 8% of their risk-weighted assets in the form of capital (Mishkin, 2019). While it is costly to enforce these regulations, they are designed to prevent the behavior that led to the Great Recession. The Sarbanes-Oxley Act will be the most dramatic regulatory change for Midwest Global when it becomes a publicly traded firm. As noted above, the act imposes stringent financial reporting requirements that need to establish internal controls for accurate information dissemination. Midwest Global will be forced to allocate additional resources for management and public relations to comply with regulatory policies. Ethical financial reporting will create customer trust, hence making the bank more inviting for investors and borrowers.
Cost of Regulatory Compliance
Financial Burden of Compliance
The largest obstacle to banks in complying with regulations is not necessarily the rules themselves, but the expense. Banks must contend with multiple regulatory agencies and comply with long lists of mandates, which can be both complicated and expensive.
Most organizations have put internal control boards in place to offer control and facilitate better communications with external regulators and the public.Additionally, banks find it more helpful to employ legal firms to manage regulatory issues and possible litigation.The compliance investments in money and time are huge.In 2016, the financial industry invested over $100 billion in compliance expenses for rules, with the Dodd-Frank Act coming in at $36 billion alone (Groenfeldt, 2018).The expenses are going to rise even more as existing laws continue to reign supreme.
References
Groenfeldt, T. (2018). The high cost of financial regulation compliance. Forbes. Retrieved from https://www.forbes.comKenton, W. (2019). Dodd-Frank Wall Street Reform and Consumer Protection Act. Investopedia. Retrieved fromhttps://www.investopedia.com McConnell, C. R., Brue, S. L., & Flynn, S. M. (2018). Economics: Principles, problems, and policies (21st ed.). McGraw-Hill Education.
FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies
The economics of money, banking, and financial markets (12th ed.). Pearson.
Wagner, J., & Dittmar, L. (2006). The impact of Sarbanes-Oxley on small banks. The CPA Journal, 76(4), 16-21.
