Question

2. Please list and discuss at least 3 main provisions of the Dodd-Frank Act of 2010 that are designed to prevent the next crisis or make it less severe.

Answer 1

Dodd Frank Act came in July 21, 2010 to strengthen the financial system and rules governing it, so as to reduce such severe financial crisis that happened in 2007-08. The law places strict regulations on lenders and banks in an effort to protect consumers and prevent another all-out economic recession. Dodd-Frank also created several new agencies to oversee the regulatory process and implement certain changes. It put in place stricter regulations on the activities of financial institutions as well as better protections for consumers.

Three provisions of Dodd Frank Act are -

1. Volcker Rule -The Volcker rule is named after former Federal Reserve Chair Paul Volcker, who said to include such a measure as part of financial reform. The Volcker Rule intends to prevent commercial banks from engaging in speculative activities and proprietary trading for profit. In particular, it limits banks investments in hedge funds and private equity funds. This happened during 2007-08 financial crisis, where Banks engaged in proprietary trading and derivatives that risks depositor’s money.

2. Capital & Liquidity Requirements - The Federal Reserve set new defined standards for the amount and type of capital that banks and other depository institutions must have to protect against their exposures. This will help strengthen the credit system and liquidity requirements. The banks took excess leverage during financial crisis to maximize their profits & when the Mortgage Backed securities begin to fall in value, Assets and liability mismatched leading to wipe out of bank's equity, resulted in Federal Reserve to rescue banks with recapitalisation.

3. Derivatives Regulation - The Dodd-Frank Act provided the SEC and the Commodities Futures Trading Commission (CFTC) authority to regulate Over-the-Counter (OTC) derivatives trading. Over the Counter refers to a type of trades where the terms of the contract is negotiated between private parties and does not involve Stock Exchange, such as Nifty50 or the New York Stock Exchange (NYSE). The Act mandated the firms to buy and sell derivatives contracts with use of clearinghouses only. Clearinghouses are intended to reduce overall risk in the market by using "collateral deposits" and monitoring the credit-worthiness of firms engaged in derivatives trades. Clearinghouses are strongly capitalized in order to pay out losses if a firm defaults on its obligations.