Question

What are the six types of regulations the government employs in an attempt to ensure the soundness of our financial intermediaries? Explain

Answer 1

Who is a financial Intermediary: Definition from Investopedia- A financial intermediary is an institution or individual that serves as a middleman among diverse parties in order to facilitate financial transactions. Common types include commercial banks, investment banks, stockbrokers, pooled investment funds, and stock exchanges.

So any entity that is involved as a middleman between two parties for the purpose of financial transaction is regulated by certain laws and must follow them. These laws or regulations ensure the soundness of the financial intermediaries and the overall Financial system.

Below are the Regulations that are employed by the Govt in order to ensure financial soundness.

1. Prudential Regulation. This regulation is focused upon risk management and risk mitigation. Firms are required to maintain sufficient capital and have adequate risk controls in place. Examples of Prudential Regulation are capital requirements for banks. .The Prudential Regulation Authority (PRA) at the Bank of England is responsible for this prudential regulation and supervision of around 1,500 banks, building societies, credit unions, insurers and major investment firms. For example, in the case of insurers, if they are not protecting policyholders adequately, close supervision ensures that if things are not going in a safe and sound way, then govt can step in in order to regulate the way things are operating.

Prudential regulation may also lead to:

(a) Taxpayers Protection - Prudential Regulations ensure that Bank Failure do not drain out the DIF

(b) Consumer protection - Prudential Regulations ensure that insurance firms are able to honor policyholders' claims

(c) Financial stability - Lead to financial stability in the whole financial system eg, by ensuring ensure that firm failures do not lead to bank runs

2.  Disclosure and Reporting. Financial intermediaries are subject to various Disclosure and regulatory requirements. These requirements ensures that all relevant financial information is accurate and available to the public and regulators. This information will then be used by the stakeholders and regulators to make well-informed financial decisions and to effectively monitor activities of the financial institutions. Disclosure is used to achieve the goals of consumer and investor protection, as well as market efficiency and integrity.

3. Standard Setting. Regulators prescribe standards for products, markets, and professional conduct. Regulators set permissible activities and behavior for market participants. For eg., The World Bank develops international standards in areas of direct operational relevance to its mandate of promoting financial sector development. In collaboration with other standard-setting bodies, it has developed international standards for insolvency and creditors rights, financial infrastructure (e.g.. international remittances services, credit reporting systems), and public debt management. - Source (https://www.fsb.org/work-of-the-fsb/about-the-compendium-of-standards/wssb/)

4. Competitive Regulation - The law ensures that the financial intermediaries do not exercise undue monopoly power and engage in collusion or price fixing. The firms should also not take a dominant position to influence Prices in specific markets. The legal system can reduce the number of failures of financial intermediaries by weakening the competitive forces operating on those institutions. If there is no competition, the intermediary may be able to earn some monopoly. Examples of regulations which hinder monopoly are antitrust policy, anti manipulation policies, concentration limits, and the approval of takeovers and mergers. Regulators promote competitive markets to support the goals of market efficiency and integrity and consumer and investor protections. Within this area, a special policy concern related to financial stability is ensuring that no firm is "too big to fail."

5. Price Regulations : The government regulates the upwards or downwards movements in Prices set by the intermediaries for their services.The price cap regulation is intended to replicate the discipline of competitive market forces. In an ideal competitive market, The firm should pass the productivity gains to the customers in terms of lower profits, after accounting for unavoidable increases in input prices. & 6. Rate Regulations: Regulators set maximum or minimum prices, fees, premiums, or interest rates. An example at the federal level is the Durbin Amendment, in which there is a cap on the debit interchange fees for large banks.