3:16 pm - Sunday January 21, 2948

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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