Enhance the quality of financial regulation - the need of the hour.
The purpose of any regulation is for solving problems that stakeholder or business alone cannot solve, as well as for making trade-offs among different objectives.
Year 2008 will definitely go down in the history as the year of the greatest financial crisis. And also as a year of distinct demarcation. Prior to and including year 2008, the financial regulations in most countries were focused on the principle of non-interference but suddenly from the final months of year 2008, the chorus and focus has been on more financial regulation to ensure continuity, safety and strength of markets.
Regulatory issues are often extremely complex and interdependent. The regulatory process is no less complicated, commonly involving overlapping reviews at periodic intervals.
Some of the proposed reforms in financial regulations that are discussed and expected to protect the financial services industry are:
Caps on leverage
Liquidity cushions
Increases to required capital reserves
Enhanced disclosures around valuations
Stronger regulation of credit rating agencies
Supervisory colleges of cross border regulators
Central clearing for over the counter derivatives
Greater disclosures of off balance sheet vehicles
Greater clarity about where regulatory responsibilities lie
Enhanced valuation processes for complex or illiquid assets
Reform of compensation systems (e.g. bonus payment structures)
Expansion of regulatory oversight to other areas of financial services not currently regulated.
These reforms by way of increased financial regulations are expected to bring in the following benefits and new initiatives. However, they all depend on the ability of the regulators to comprehensively cover these reforms and also ensure total compliance.
Restore trust in the banking system
Mandate greater disclosure from hedge funds
Maintain overall stability of the financial system
Co ordinate work of regulatory bodies across borders
Monitor risks associated with shadow banking system
Implement effective guidance on liquidity management
Monitor credit rating agencies and prevent conflicts of interest
Ensure that off balance sheet vehicles are reflected in minimum capital requirements
Implementation of compensation policies to support long term shareholder value creation
Put in place sufficient skills and expertise to keep pace with innovation in the banking system.
If one could look at these reforms closely, these regulatory tightening would be very effective in preventing financial crises in the future by focusing on the key measures.
Counter party risk
Loan to deposit ratios
Related party lending
Absolute lending limits
Liquidity management
Increased capital requirements
Limits on compensation and bonuses
Higher statutory levels of liquid reserves
Speed of growth (e.g. Branch approvals)
New Products development and introduction
Prescriptive approaches towards these new products
More international cooperation in regulating banking system
Implementation of advanced capital management vis-à-vis Basel II
More timely and thorough disclosures of market, credit, liquidity risks
Accounting rules to limit or prohibit the use of off-balance sheet vehicles
More frequent government reviews of banks’ risk management policies and practices
Strict limits on the use of financial instruments such as securitized assets and derivatives.
Understanding regulatory issues in extreme detail is a prerequisite not only for anticipating risks and opportunities but also for building mutually beneficial relationships, based on trust and transparency, with regulators. Usually the hunt for a detailed understanding should start with an exercise to throw more light on the key regulatory issues that could impact business – now and later.
Ideally this exercise should examine the level of uncertainty, the positions of major stakeholders and the value at stake for each regulatory issue as these implications could impact investment decisions, price and service, productivity, tax issues and employment levels.
Let us hope that the depth and reach of evolving financial regulation (either an overdose or by lack of it) should not be accused of causing the next financial crisis.
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