Current Trends in Global Bank Regulation - Essay Example

Bank Regulations By Key words: Global financial crisis Bank Regulation Introduction The global financial crisis that was first experienced from 2010 and initially offset by the bursting of the housing bubble in the US led to the discovery of a number of shortcomings relating to the practices and policies that were being employed by financial institutions at the time coupled with the supervisory and regulatory agencies involved (Boeckman 2013). The deficiencies exposed by the crisis showed for instance how the holdings of the financial institutions were inadequate with respect to capital of high quality, shortcomings relating to the supervisor of rudimentary micro-prudential, policies and practices of managing risk and the overall corporate governance. Additionally, there was a lack of appreciation of the magnitude and complexity of the workings relating to large financial institutions and trading banks with respect to those financial institutions that had more than one jurisdictions coupled with the difficult associated in dealing with the problem (Kawai 2013). There was also insufficient oversight of the derivative markets and a lack of clear visibility towards the magnitude of the linkages between the shadow and regulated banking sectors and the financial institutions. Banks are tasked with regulating money supply via the directive of the central bank. Some of the roles of banks include crating money, being the principle allocator of credit funds available to the public, they act as the managers of a country’s payment system and they are the depositories of the public in matters relating their financial savings (Connor 2005). The bank’s regulatory role is divided into three functions which include controlling the supply of money in the economy, meliorating matters regarding equity and efficiency of intermediation of finances and preventing systematic risk. The measures undertaken to regulate banks are because banks need to be streamlined in order to prevent them from using short term strategies to increase their returns and also to prevent firms from adopting bad behaviors that are against the moral code of conduct (Kolb 2011). The regulations also aid customers to develop a degree of confidence and comfort which can only be facilitated by the institution of the regulatory measures. Current trends in global bank regulation Three have been a wide variety of measures instituted globally in order to address regulatory reform to deal with the shortcomings highlighted by the effects of the global financial crisis. The main aim of the reform platform has been to find an optimum point where productive risks that are responsible for the growth of an economy can be developed while simultaneously addressing the issue of imprudent risk allocation (Gup 2010). The efforts of reform are to be established in four key areas-dealing with the issue of the risks associated with the shadow banking sector, dealing with the mentality that the financial sector is infallible, providing a safer environment for the derivative markets which can be achieved by empowering the financial market infrastructure roles and developing more resistant financial institutions with emphasis placed mostly on banks. It should however be noted that the current regulatory trends are beneficial in responding to the adverse effects of the global financial crisis but further work still remains in order to make the financial institution more resilient and stronger (Kolb 2011). At the international level, a lot of attention has been directed towards developing a new policy framework that will promote financial stability and curtail systematic risk. The international market responded to the crisis by adopting the regulatory reform that harmonizes some of the current standards and including new standards that would deal with the holes revealed by the crisis. There were four key areas initially identified and the issue relating to the notion that financial institutions were too big to fall, which could lead to a situation where financial institutions would be threatened systematically that would necessitate the relevant authorities to bail out the failing institutions by using public funds as evidenced by the austerity measures adopted by Greece that are heavily reliant on internal taxes (Nallari 2011). The other key area of reform would be dealt with by making the standards of the prudential regulations more strong which are known as Basel II (Peterson 2013). The other area addresses the issue of risks are a result of the shadow banking industry that covers the activities and entities which are beyond the jurisdiction of the banking system and are mainly involved with liquidity transformation and credit intermediation. The fourth reform measure would aim to reduce the effects and presence of contagion that results from the linkages between the OTC derivative markets and other counterparties. Strengths On a global front, there are a variety of advantages that can be enjoyed from implementing, internationally agreed and well developed reforms. A set of widely consistent requirements of regulation can assist the relevant authorities, customers and counterparties some much needed relief in the belief that the operating international entities are being regulated prudently in their jurisdictions coupled with firm regulation in both local and group levels. When international regulatory standards are consistently adopted and applied, it aids the financial bodies in developing and maintaining a high level of credibility with the investors at an international level (Ozcan 2012). Furthermore, a widely accepted set of minimum standards that are geared towards the regulation and supervision of the financial markets would help in minimizing the risk of regulation that is weaker in particular jurisdictions that may lead to the spillover of contagion to other previously unaffected jurisdictions and other spillover effects. Additionally, a common regulatory system and body of regulators on a global scale, individual regulators in individual countries can rely on the international regulators to deal with their own risks and prevent the collapse of the whole system. In essence, financial institutions can avoid imposing costly domestic requirements and relay on their international colleagues. Common standard also enable competition between financial service providers while simultaneously enabling the free flow of capital internationally (Desbordes 2014). Weaknesses It is very difficult to apply global reforms due to the diverse individual regulatory approaches and financial systems. There are bound to be many challenges faced especially with the way in which some of the international reform measures have been primarily adopted to deal with challenges that are specific to certain financial systems that are more aligned to the financial markets than others (Plunkett 2014). Such measures are definitely going to prove unpopular and unattainable by other differing countries. This phenomenon has led to calls of the adoption of more flexibility in the adoption of the reforms in order for the reforms to be useful in jurisdictions where the financial markets were not as much affected as others after the global financial crisis. Countries such as those in East Asia are in relatively good financial shape and it is appropriate that measures adopted by such countries are varied from the intensive measures adopted by countries like Greece, Portugal and Northern Ireland (Reynolds 2009). Financial systems and regulators are also faced with the problem of being able to be current in keeping up with the fast rate at which policy implementation and development is changing (Aizenman 2009). Currently, the global policy development is adequately sufficient to deal with the effects of the global financial crisis but additional measures are necessary to counter future crisis. Analysts have commented that even though the effects of the global crisis are beginning to subdue, there still remains undetectable contagion levels and in the absence of firm regulation and more stringent measures to regulate the financial activities of commercial banks, a financial crisis of a greater magnitude may be triggered. It should be noted that the slow pace by which national implementation of the reform agenda in the key areas identified might be the trigger that is required to result to a spiral. Case study The global financial crisis affected all financial sectors in the world and policy makers have for the last five years been developing new reform measures and regulations in order to combat the effects of the crisis and prevent future occurrence of such magnitude. Kenya is an emerging economy as noted by the World Bank Publication in 2010 and is by far the most developed country in East Africa with a well-developed financial system (Han 2013). In the last couple of years, the banking sector in Kenya has experienced major changes such as its improvement in asset quality, recapitalization of state owned banks and loan write offs. Additional changes are the presence of many liquid and capitalized commercial banks, a reduction in the spread of interest rates and reduced overhead costs and the emergence of the M-Pesa service that has had a major influence on the domestic market regarding remittances ranking billions of shillings in tax liability to the government (Mburu 2010). The crisis necessitated the need for improved and continued institutional reform mainly in the financial sector and adoption of sound micro management. Since banks play a vital role in the modern market economy it is prudent to note the many limitations that banks face in their bid to adhere to market regulations and discipline. Banks have dispersion in their creditors, they have many transformations and maturity levels relating their performance and their ability to change short term loans to medium and long term loans coupled with other additional sources of fragilities in the banking system. The banking system in Kenya and many other countries has been one of the highly regulated sectors in the economy (Nganga 2013). The regulation ranges from deposit insurance and specific instances of regime failure in banks to licensing requirements. The Central Bank of Kenya is tasked with supervising and regulating banks in Kenya and in the past years there have been many amendments to the Central Bank of Kenya Act, the Banking Act and other prudential measures and guidelines for the purpose of empowering the Central Bank in its supervisory role (Atandi 2010). The Central Bank of Kenya is responsible for regulating all financial institutions in the country and it has laid down a number of restrictions, guidelines and requirements that all banks should adhere to. The central bank develops a regulatory structure that should emphasizes on transparency between corporations, individuals and banks that they carry out their businesses. The banking sector is very connected and is heavily reliant on global and national economies as evidenced by how the effects of the European financial crisis affected economies outside the Euro area. It is therefore very crucial that regulatory bodies place emphasis on the maintenance of control with regards to standardized practices of financial institutions .Some of the objectives of the bank are to minimize the systematic risk of disruption that is caused by the adverse trading practices of the commercial banks that have been responsible for the failure of a number of banking institutions (Ghosal 2011). The financial institutions should also aim to reduce the risk level that bank creditors are exposed to and avoid misusing commercial banks through illegal activities like money laundering and fraud. The regulatory bodies should also aim to protect credit allocation and the confidentiality of banks .This is achieved by directing credit to sectors in the economy that are favorable and that offer the best customer service especially in the current competitive and volatile financial markets. Some of the major amendments made in the past have been in 1998, when the Central Bank increases capital requirements for commercial banks by improving the gearing ratios of banks from 5% to 7.5% and adopting the Basel 1 standards regarding capital adequacy. Additional measures over the years have included the institution of further capital adequacy ratios ranging from 8% to 12% relating to the core capital and the overall capital to risk weighted assets. These reforms were standardized to reflect the prevailing global capital requirements of financial banks in order to deal with the inherent financial risk in businesses (Mugo 2013). One measure that is still operational to date is the establishment of the Deposit Protection Fund Board whose mandate is very broad. Its main aim however has been to control the deposit insurance fund and facilitate the liquidation of financial institutions that are insolvent when they have been shut down by the Central Bank of Kenya. The process is conducted by winding up the targeted institution, recovering debt and repaying secured dividends and deposits to the creditors. The board also offers protection to customers who have deposits of ksh.100, 000 and less against the loss of their savings as a result of the closing down of a bank. Following the financial crisis however, the role of the DFPB was enhanced through the creation of a new and individual Kenya Deposit Insurance Corporation Act which will increase the board’s autonomy and therefore improve depositor confidence. Moreover, the DFPB will also be conferred upon powers that allow it to request the Central Bank of Kenya to conduct an investigation on an institution or member or have the Central Bank carry out the investigation itself. Following the global financial crisis a number of legal and regulatory reforms have been adopted such as the changes to the Banking Act (Cap 488) coupled with prudential guidelines aimed at improving and making the banking sector more resilient to change by implementing changes in the capital adequacy ratios, general risk management corporate governance and bank licensing. Deposit insurance in Kenya has been identified as a key factor in the overall financial safety as identified by many case studies conducted regarding the issue (The Banking Act 1968 [Kenya] 2012). It has been noted that, while the original purpose of deposit insurance is mainly for the purpose of inhibiting bank runs and protecting small savings, it contributes to the reduction in market discipline since it has the effect of disincentivizing depositors to discipline banks and monitor them adequately. This has led to mounting stress on supervisors which in the absence of a country with a strong supervisory and regulatory framework can lead to increased fragility of the financial sector as a whole. Kenya has continued to adopt even more vigorously its Vision 2010 especially after the occurrence of the global financial crisis. The country aims to ensure the transformation of the banking sector from many small banks to the inclusion of lesser banks that are larger and stronger (Otieno 2013). The aim of the transformation is to develop a globally competitive financial sector which will promote job creation and increased savings in the economy which will turn facilitate the investment needs of the country as a whole. The government has also adopted other reform strategies such as minimizing government borrowing and developing a stable and conducive micro economic environment in order to ease the borrowing rates and minimizing the spreads in the period following the global financial crisis. Bank capital requirements have been significantly improved and emphasis placed further on the limited deposit insurance scheme and campaigning vigorously against the provision of long term loans that are none performing and the results are evident. The measures employed by the government via the Central Bank have led to increased efficiency and improvement of intermediation that is evidenced by an increase in the government finances and decline in the overhead costs due to competition. Consolidation of the banking institutions may lead to gains in stability and efficiency in the future but it is reliant on the effects of the ownership and concentration for ownership. As of now, there aren’t any obvious adverse effects of outreaching the Kenyan banking system coupled with the niche banks’ consolidation efforts which may lead to a situation where the niche banks lose their customer base (Nyangosi 2012). Additionally, the effects associated with the consolidation of banks in Kenya rests on the future of the quality of improvements in the financial sector, government owned banks, credit registry development and the overall contractual framework. There have been more amendments on the Banking Act which have been geared towards the strengthening of the central bank’s role in supervisory financial institutions-commercial bank activities. There has been increased institution of prudential measures and their revisions for the purpose of promoting a standardized code of conduct for the employees, directors and chief executives in a bid to increase self-regulation (VanHoose 2010). The responsibilities and duties of external auditors have been revised in accordance with the law coupled with clear definition of what constitutes doubtful loans and advances. Recommendations There should be additional measures that are geared towards the mobilization of domestic savings via incentives and the appropriate legislation in order to reduce a country’s dependence on foreign capital. Countries should also institute measures that mandate the enforcement of certain rules on a legal basis such as the improvement in corporate governance, mandating disclosure for all companies, adopting transparency and accountability for all government authorities and the overall investment community (Metre 2014). Businesses should also practice safe and fair practices and enhance integrity and honesty among firma and their employees. Conclusion Banking regulation is more than just a functional measure; it is also an institutional measure meaning that unlike in the previous eras are not unique in their susceptibility to moral hazard and systemic risk as discussed earlier. It has become harder and harder to identify individual classes of regulatory objectives, techniques and targets that encompass the core seta of financial activity as evidenced by the fact that there is a mismatch between the institutional regulation and the regulation of bank functions (Nwogugu 2011). Some of the banking regulations that should be adopted include the consolidation of supervision, the centralization of the management of risk between diversified financial firms and the adoption of tactical techniques that categorize the varying types of risk (Fuchs 2008). Simply, bank regulations with reference to its institutional structure, should be assessed with regards to regulatory neutrality, economies of scope and prudential logic. There should be an individual prudential regulator which enhances the development of regulatory interface for problems so that the central bank can retain its responsibility of handling systemic risk while it diverges from the role of prudential supervision. It should be noted that combining functional integration regarding financial markets with globalization can lead to risk of cross functional and cross border spread of financial contagion from the evidenced obtained in the East Asian crisis. References Aizenman, J., & Pasricha, G., 2009. Selective swap arrangements and the global financial crisis analysis and interpretation. Cambridge, Mass.: National Bureau of Economic Research. Alexander, K., 2012. Research handbook on international financial regulation .Cheltenham: Edward Elgar Pub. Atandi, F., 2013. 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