Banking Regulation around the World: Patterns, Determinants, and Impact essay
The US has historically been a state based on the principles of free market and perfect competition. However, increasing economic growth and increasing interdependence among countries resulted in regional, in the first place, and then global crisis. For example, the Great Depression was the starting point for the development of the economic theory of John Maynard Keynes deriving from the fact that the market is not able to come to equilibrium independently. Later criticism of Keynes’s paper led to the rejection of some of its provisions, but the idea of the state as a third party regulating the market has remained. As Robert Lucas stated in 2009: “I guess everyone is a Keynesian in the foxhole” (Rouse, 2013).
Indeed, certain points of the program of state regulation today cause special dissatisfaction on the part of supporters of free market principles. Denying, however, the need for external support, although costly, would be, at least, impractical because the calculated potential losses from the crisis would exceed the most expensive plan for economic recovery.
Assessing the borderlines of government intervention
Initially, liberalization of the financial sector in the early 2000’s by eliminating Glass-Steagall Act and reducing the interest rate of the Fed to 1% caused a rapid growth of the US economy for the past eight years. However, market deregulation allowed many commercial banks to buy short-term profitable but risky assets at the expense of their depositors, while need to involve more people into the system prompted banks to start issuing mortgages even to less reliable households without requiring any fee or proof of income, which in the end led to massive defaults on the mortgage and financial crisis. In the situation where the discount rate already tends to zero, the US economy was actually on the verge of a liquidity trap when further reduction of the discount rate does not affect the behavior of market agents (Li, 2007). As a result, the Federal Reserve has not coped with the tasks of control leading to the need for greater government intervention, in particular the enactment of Dodd-Frank Wall Street Reform and Consumer Protection Act.
The Dodd-Frank Act suggest activity in six areas: improving accountability and increasing transparency of financial institutions, rejection of the principle of rescuing systemically important financial institutions (“too big to fail”), search for alternatives to rescuing bankrupt companies at the expense of state aid, i.e. taxpayers, consumer protection, introduction of the Volcker Rule, and regulation of the market of precious metals. In addition to reforming the financial legislation, much has been done through direct state intervention in the financial sector (Dodd-Frank Wall Street Reform and Consumer Protection Act). The main ways to stimulate the economy at the moment are: the Fed financial programs, tests assessing the state of major banks, financial assistance to banks through TARP, Recovery Act, the Term Asset-Backed Securities Loan (TALF), organizations such as AIG, Freddie Mac and Funnie Mae, preventing foreclosure of the mortgaged property, as well as the activities of the Small Business Administration (SBA).
Acting together, these measures involve a significant reduction in the risk of major default. Indeed, the presence of short-term capital debt declined from 62% in 2007 to 37% in 2013, increasing the stability of financial institutions (Rouse, 2013). At the same time, banks have increased their own capital by about $450 billion, which now serve as the airbag in the event of new economic shocks, reduce dependence on credit and can be spent on investments in long-term projects. In addition, while by March 2009, banks participating in the TARP program and receiving funding had to pay out $238 billion, 99% of this amount was already repaid in April 2013 (Rouse, 2013). Moreover, investments of some programs of the Fed and TARP returned to the state budget as additional revenues, which certainly shows the effectiveness of the state support. However, it is not all as rosy as it might seem at first glance.
First, Dodd-Frank Act may be regarded as a return to the past due to the use of one of the principles of the Glass-Steagall Act (Banking Act of 1933), repealed in 1999, namely the Volcker Rule which delineates the activities of banks dealing with consumer credit with government guarantees and investment banks (Dodd-Frank Wall Street Reform and Consumer Protection Act). This decision is likely to lead to further restriction of liquidity and size of the financial market. In addition, state intervention significantly limits the ability of financial institutions, especially large ones, markedly increasing their responsibility. However, such a rigid legislative regulation will complicate a quick exit from the recession and will prevent the rapid development of the banking sector. In turn, the increase in the share of banking assets controlled by the state reduces the rate of development of financial non-banking sector and the stock market. In general, government regulation associated with rising costs, in fact, voluntarily overtakes the unnecessary long-term risks (Rouse, 2013).
Moreover, analysis data from 54 countries show that there is an inverse relationship between the proportion of state involvement in banks and financial development: a large proportion of state involvement in the banking system leads to slowing of economic development, moreover, none of the limits reduces the probability of banking crisis (Li, 2007). At the same time, the most acute problem with the introduction of a new regulatory legislation is related to its procyclicality: the law hinders economic development during the recession limiting the abilities of financial institutions, and during the phase of recovery, its most rigid principles will be eliminated, which can lead to another liberalization of financial markets and the economy overheating.
Conclusion
On the one hand, the imposition of restrictions and strengthening of control over certain types of banking activity reduces the efficiency of the whole sector. On the other hand, the modern-day banking regulation in the US is a necessary measure in response to the weakening of market discipline, loss of caution and skepticism, which should be common to investors putting up their capital in a particular company. Regulating the banking sector, the state today operates in a versatile way: it tries to help investors, “pull” systemically important financial institutions, and stimulate small business. To a certain extent, based on the experience of the recent crisis, today it is difficult to imagine a situation of full liberalization of the financial market; and in our opinion, we should not expect weakening of state intervention in the management of the banking system in the short term, because it is the most important tool for managing the entire economy, reflects the ownership structure of the state and its economic goals. In this case, the main task of the state is effective limiting of the growth of the financial sector at the peak stage of overall economic development, so that the smoothing of the business cycle allowed surviving the possible subsequent recession without the deep decline and without the heavy pressure on the state budget.
Do you like this essay?
Our writers can write a paper like this for you!
(No Ratings Yet)
Loading...