Question

A banker was overheard to say the following: “If only the government did not regulate us so heavily, we could do more for the economy and our shareholders.” A bank regulator was overheard to say, “banks complain about us but if we did not raise minimum capital requirements after the 2007-09 financial crisis, the industry would be in much worse shape to deal with the COVID-19 crisis.” Which of these positions is correct and why? Why does the government regulate banks? What objectives is the government trying to meet with bank regulation? What are some of the important ways in which we regulate banks? Does regulation go too far? How would you change the current system of government supervision and regulation? Defend your answer.

Answer 1

Position of the bank regulator is more correct, because bank regulations help not only to save the depositors and investors, but also it prevents banks from doing speculative investments and sub prime lending as it was seen during 2008 financial crisis. It is the reason for bank regulators to be more strict since 2008 crisis. If banks are left on their own, then they will involve moral hazard, speculative investments and more greed that will cause more harm than the good to the economy. Afterwards, these banks will ask for the bail-out packages.

Government regulates banks, because it makes then work in a manner that brings financial stability and inclusive growth, without involving into those activities that are driven by speculation and greed to earn more interest. Besides, government wants to protect depositors and investors. So, they regulate. The objectives to meet are, putting depositing and lending business to separate, protect depositors and investors, bring inclusive growth and achieve financial stability in the economy.

One important way to regulate is to decide what banks can do and what they cannot do. The second important way is to raise capital requirements and protect consumers from the misdeeds done by bankers. It is done via consumer protection act. The third way is to promote financial stability and reforms that is done by Dodd–Frank Wall Street Reform act.

Regulators have not gone too far, but they want to protect those who have trusted these banks. Before, 2008 crisis, banks were deregulated in different aspects, but they used it to expand their moral hazard behavior and caused huge losses to the depositors and investors. It created poor confidence among the consumers and it is not good for the economy as a whole. So, regulators have to be strict afterwards.

In the current, regulations, there should be more focus upon accountability of the top management of the banks so that they cannot take any risky investment behavior that harms the economy.