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Do banks need more regulation?

Updated on May 28, 2012

Banking regulation

Ask the top bankers in America if they wants more regulation and they will likely say no. Of course the answer may be a bit different if you ask someone on main street as they watch the financial system struggling even after the 2008 financial crisis.

The fact is banks do not necessarily need more regulation, they do however need better regulation because they simply cannot be trusted to govern themselves accordingly. Better regulation is important because society needs to have faith in the financial system. If there is no trust in our banks then the financial system cannot function efficiently and liquidity cannot be created in order to continue economic growth.

The function and brief history of banking

The innovation of banking sole purpose is to create liquidity in an economy which translates into growth in an efficient banking system. Banking can be traced back to the 1400's in Italy, the first one was called the Medici Bank created in 1397 by Giovanni Medici.

Banking took on various forms in different countries. In Britain a Goldsmith was the first form of the banking business. People would need to store their gold, the goldsmith would issue them a note with payback instructions and as proof of deposit. This soon turned into a way for people to use the note to purchase items, in return the note would be signed over to the merchant so they could claim the gold. The goldsmith that had the gold also realized they could lend out some of their inventory to generate a return on their holdings.

Of course banking today has some of the same principals people deposit their money and the bank lends it our in the form of a mortgage, loan etc. The bank sets the terms for the money to be paid back while earning and profiting from the spread of interest collected while lending and paying some interest to the depositor. However banking today is much more complicated and therefore requires complex regulation to keep them in check.

Current banking regulations

The Basel accord is an international committee that meets in Basel Switzerland and come up with recommendations on banking regulations.

There is Basel I, II and III that recommend various regulations for banks to abide by. Basel I set out some ground rules that still apply in the latest Basel III. The first Basel accord was in 1988 and focused on credit risk for banking assets. Each of the assets were given a weighting, based on the banks holdings then capital requirements could be calculated. Assets of banks were classified and grouped in five categories according to credit risk, carrying risk weights of zero as is the case for sovereign debt, ten, twenty, fifty, and up to one hundred percent for most corporate debt or commercials loans.

Basel II was set up in 2004 and was not fully implemented largely due to an anti regulatory environment politically. Of course once the financial crisis of 2008 hit regulation was not such a bad word any longer. Thus began Basel III which has yet to be implemented and probably won't be fully integrated until 2019. This of course calls for highly capital requirements for banks to avoid the bail outs that were so prominent during the 2008 crisis. Stronger capital requirements should take more risk off of the table and create a stronger bank, although critics of this will say this will slow lending and force banks to raise more capital thus making them less efficient.

Other regulations include the Dodd-Frank bill which adds many regulations to Wall Street, as well the Volker rule which would ban proprietary trading for commercial banks using client deposits.

Jaime Dimon CEO of JP Morgan questioning Ben Bernake about regulation

Jaime Dimon admits he was wrong about JPM trade that lost $2 billion

Banks need better regulation

There is no question that banks needs better regulation to prevent further financial crisis down the road. The challenge will be to still give them enough leeway to prevent a lack of innovation and thus impeding their business. Banks do serve a common good as they provide liquidity and foster economic growth under the right circumstances. Of course this needs to be balanced with common sense and practical regulation that keeps these institutions in check. Perhaps it is time to break up these large behemoth banks in order to simplify the process of regulation. Breaking up the big banks of course is another topic which I will discuss at a later date.

Do banks need more regulation

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    • harshad2011 profile image

      harshad2011 5 years ago from India

      Good one. Keep going