Finance Notes: What is the Role of Financial Regulation

The economic prosperity of the 1920s created a turmoil of investment and credit among investors. Much of this was funded by margin, which implied that Americans took out money to finance their investment in the stock market. Nevertheless, this practice was not as pervasive as the effects of the crash. At the time, only 10% of the US population had invested in stocks, but almost 100% had been impacted. Why, then, was the destruction so widespread? The response to this is how banks worked during the golden era of investment hysteria.

Franklin Delano Roosevelt response

After Hoover’s term ended in 1933, Franklin Delano Roosevelt was elected as president and started to tackle these problems in a different manner. FDR and its cabinet have set up regulatory frameworks and judicial authorities that would help protect a further economic recession of this size. Security measures have been implemented, outlined below, to rebuild consumer confidence in the financial sector especially banks.

The analysis and implementation of financial policy by the FDR over these years remains an emblematic illustration of well-functioning market regulation. Three of the most major regulatory changes that have been made during his term of office include:

1. The Banking Act of 1933 (Glass-Steagall Act) which aimed to differentiate the functions of commercial and investment banks. This act made a legal distinction between these organizations, such that the savings of the ordinary person can never be used for speculative investment activities.

2. The Federal Deposit Insurance Corporation (FDIC), which was a regulatory authority that ensured that individual funds would be guaranteed by the government in the situation where the bank declares bankruptcy.

3. The Securities Act of 1933, which led to the creation of a regulatory authority called the Securities and Exchange Commission (SEC). The SEC is the agency of the U.S. federal government in charge of controlling and overseeing financial practices, as well as for the regulation of U.S. securities market laws.

Levels of Financial Regulation

Regulatory Role Players

Central Banks

Central banks correspond to financial institutions that are mainly focused on maintaining the monetary supply of the economy. Their major duties are of a regulatory nature, and their regulatory functions may be detailed as follows:

Securing deposits

By protecting and preserving such commercial deposits, central banks allow commercial lending (a vital business function) to persist (as deposits are used to finance loans).

Control of reserve requirements

Commercial banks will have much less cash to lend, essentially creating a currency supply shortfall that eventually causes the interest rate to increase given the impact of reduced supply and increased demand on prices. This feature is so fundamental to the operations of central banks that several central banks are identified as ‘reserve banks.’

Monitoring risks

Guarantees that commercial banks act within the secure limits set by the central bank to avoid extra risk-taking.

Preventing discrimination

Banks are not permitted to discriminate against creditors on the basis of color, gender, religious background, or other non-financial factors – a procedure dubbed ‘redlining.’

Monitoring of conflicts of interest

They control or monitor credits granted by commercial financial institutions to companies that may be perceived ‘close’ to executives of the banks in question.

Four Regulatory Institutions

  1. The International Monetary Fund (IMF)
  2. The Bank for International Settlements (BIS)
  3. Financial Stability Board (FSB)
  4. World Trade Organization (WTO)

Types of Regulation and their Objectives

The Process of Regulation

The Process of Regulation

A few clarifications

As discussed at the beginning of this article, this process is defined at a high level and is simplified to give a general overview of the creation and application of the regulation. This is not a universally accepted system and this means not all regulations can be formulated following this process.

The method laid out above requires certain assumptions. This means that an inclusive democracy exists, in which culture and business as a whole are empowered to collaborate with their government in the development of solutions. This may not be the case, for example, under certain authoritarian regimes.

The details of this process will also vary according to the vast array of governmental frameworks around the world.

The methodology applied by the Japanese government is distinct from that practiced by the United Kingdom government and that of the United Kingdom government is distinct from that of the United States government, and so on. Definitely, this would have an effect on the tempo, efficiency, and overall control of the applicable legislation.

The Role of Ethics in Financial Regulation

Regulation versus Deregulation

Deregulation – Pros

(a) Reduce expenses

Regulation is costly – soon after the financial crisis of 2008 the IMF predicted that the various legislation introduced would have the following effect on the rise in lending rates:

1. Europe – 17 basis points (bps)

2. Japan – 8 basis point (bps)

3. USA – 26 basis points (bps)

It meant lenders would charge huge interest on loans between 0.08 per cent and 0.26 percent due to the resulting compliance costs passed on to the customer.

(b) Greater Market participation

(c) Increased response rate

Market players enjoy higher flexibility in their adaptability to market environment changes. The pace at which a corporation could even react to a major opportunity or threat is significantly different because it’s not required for them to expend valuable effort and time seeking regulatory approval.

(d) Rate of advancement

Regulation – Pros

(a) Inequality reduction

Deregulation favors inequality. Financial regulation minimizes inequality, lowers bank failure risks, and decreases the loss of funds.

(b) Justice and accountability

With the enactment of the Financial Institutions Reform and Enforcement Act, convictions for financial fraud can obviously be seen rising, demonstrating that merely enacting regulations is inadequate because dishonest actors could conduct their actions until enforcement is implemented. However, financial fraud litigation continued to decline during the years after the 2008 financial crisis. It was largely attributed to the out-of-court arbitration by guilty parties (the major investment banks).

Accountability is a crucial component in avoiding a possible resumption of the past. The regulation seeks to hold those guilty of their criminal acts accountable. In the end, we can not have any form of justice without regulation.

(c) Consumer protection

Regulation seeks to put into effect checks and balances such that financial market actors do not allow their income interest to overtake their duty towards their clients.


It’s necessary to consider the context of every case. Regulation or deregulation does not lend itself to effective regulatory policies in its own interests. One should also consider the complexity of the market, the economic and political environment, and eventually the individuals impacted by the decision.


MORRISON, Alan D. et WHITE, Lucy. Level playing fields in international financial regulation. The Journal of Finance, 2009, vol. 64, no 3, p. 1099-1142.

OGUS, Anthony. Regulatory institutions and structures. Annals of Public and Cooperative Economics, 2002, vol. 73, no 4, p. 627-648.

AWREY, Dan, BLAIR, William, et KERSHAW, David. Between law and markets: Is there a role for culture and ethics in financial regulation. Del. J. Corp. L., 2013, vol. 38, p. 191.

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