Question

"You are invited to speak to a group of young professionals who are interested in joining the financial industry. The organizer requests that you speak on the importance of financial regulation. Using at least two real world historical situations, explain why it is important for financial institutions to be regulated."

Answer 1

Regulation of financial institution is very important. Financial institutes includes, Banks, Stock Broker, Investment Banks, NBFCs etc.

Below are 2 example in which it shows that regulation of financial institute is utmost important.

Central Bank of any country need to regulate banks in a country. In USA federal reserve is the central bank. It regulates the banks by giving the instruction for Reserve Ratio, Statutory Liquidity Ratio, KYC norms, Loanable fund percent. A commercial bank will try to maximize their profit by increasing maximum amount of loan but it should not default when depositor ask for money. 2008 Banking crisis was caused by loosening the credit policy. Before that credit policy allows securitization of multi layer mortgage loan. Hence, it primary borrower defaults, entire chain defaults. A bank must understand the default probability and should have a good credit policy. Hence, bank need to regulated to avoid such circumstances.

Terror financing is prohibited by any form specially through financial institution. Federal Reserve regulates institutions to avoid money laundering and also to avoid terror financing. Few days back Habib bank has been fined millions of dollar and had to shut down it's operation for terror financing. Central Bank and other regulatory authority created rules and guidelines to avoid such instances.