Impact of Government Regulation

Question

“Impact of Government Regulation”Please respond to the following:

Take a position on whether the banking industry needs more or less government regulation. Support your position with two (2) examples of the impact of regulation.

Sample paper

Banking Industry Regulation

The banking industry is one of the most important in supporting economic growth and development of a country. Banks play a critical role in the economy. Their actions have profound impacts to various sectors of the economy. As such, there is need for more government regulation of the banking sector. Wallison (2006) identifies three major reasons why there is need for governments to regulate the banking industry. The major reason for regulation is consumer protection through federal deposit insurance. This involves protecting the consumers’ savings. There exists a moral hazard cost as well as an agency cost. The moral hazard cost arises because depositors cannot be able to tell about the solvency of banks (sss). Agency costs arise due to agency-principal interactions.

The government through the Federal Reserve acts as the lender of last resort to banks. As the lender of last resort, the Federal Reserve gives loans to commercial banks that are facing financial difficulties. Another role is to offer protection against the risk that occurs when banks transfer funds. The Federal Reserve Banks acquire the risk that occurs when banks transfer funds among themselves. If a bank collapses before repaying the amount to another bank, the Fed takes up the risk. There are other reasons why the government should regulate the banking industry. According to Benston (2000), regulating the banking industry helps to protect the economy from the impacts of bank insolvencies. A bank insolvency may have devastating consequences to the economy of the country. For instance, insolvency of a particular bank may have negative impacts to contractual parties that include employees, investors, communities where the bank is located, and other parties.

The government must regulate the baking industry in order to control money supply in the economy. The government, through the Federal Reserve, adjusts the interest rates in the economy in order to control money supply as well as the inflation rates in the economy (Benston, 2000). By maintaining control over banks, the government is able to regulate the direction of the economy. The popularly elected government officials use banks to regulate the economy. The political leaders may use banks to steer the economy away from periods of recession or depression.  For instance, some business people may make requests to the government to have low-interest loans availed to them. The political actors in liaison with the bank would ensure this is effected by adjusting rates to the specific groups.

An example of the impact of regulation concerns the JP Morgan Chase Bank. In 2012, JP Morgan Chase lost over $2 billion in risky investments conducted over a period spanning about six years. The investments began in 2005 when the bank established the Chief Investment Office (CIO), a department charged with investing excess deposits the bank had accrued (Levin & McCain, 2013). From 2006, the bank engaged in trading synthetic credit derivatives. This was a new form of trading in the market. In 2012, the bank made a serious mistake whereby instead of disposing the risky assets, the management decided to add more long credit derivatives (Levin & McCain, 2013). This increased the risk for loss on customer deposits. Only the government can address such a moral hazard by setting risk levels for banks. As such, government regulation protects consumers against the moral hazard.

Another example of the impact of regulation is the U.S. government role in mitigating the impacts of the financial crisis in the 2008/2009 period. The U.S. government in conjunction with Treasury and the Federal Reserve System applied the lender of last resort efforts to mitigate the negative impacts of the financial crisis (Fischer, 2016). For instance, Fed and JP Morgan Chase saved Bear Stearns Bank from collapse in the wake of the recession.

References

Benston, G. J. (2000). Is government regulation of banks necessary? Journal of Financial            Services Research, 18(2), 185-202. doi:10.1023/A:1026590704616

Fischer, S. (2016). The lender of last resort function in the United States. Board of Governors of the Federal Reserve System. Retrieved from             https://www.federalreserve.gov/newsevents/speech/fischer20160210a.htm

Levin, C., & McCain, J. (2013). JPMorgan chase whale trades: a case history of derivatives risks             and abuses. Retrieved from           http://online.wsj.com/public/resources/documents/JPMWhalePSI.pdf

Wallison, P. J. (2006). Why do we regulate banks? Regulation, 28(4), 14-19.

Related:

Long-Term Investment Decisions-Managerial Economics And Globalization

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