FIN FPX 5710 Assessment 3

Regulatory Analysis 

Role of Banks in the Economy 

Banks have a crucial role to play in the local, state, national, and international economy by offering a secure place for money to be kept by consumers and leveraging those funds to lend for productive investments. There is a range of banks, and each offers essential services that ensure that the economy works smoothly. Because they have an important role to play in stability in the economy, banks fall under strict regulation by the government to safeguard the money supply. The majority of these regulations had been put into place because of banking failures that previously had caused recession or financial distress in the marketplace. This article will examine the historical context of those regulatory requirements, current regulation available today, and possible impacts upon Midwest Global Investment Bank as it enters the marketplace. 

Historical Overview of Regulatory Legislation 

Historically, there have been many different regulatory measures passed to safeguard consumer, commercial, and federal funds.

Banks are likely the most regulated business in America.

The necessity for banking regulation was actually acknowledged quite early, yet it wasn’t until nearly two centuries later that the current regulatory framework was established. The initial move to regulate came in the 1790s with the formation of the Bank of the United States, which was both a private and a central bank (Mishkin, 2019). The move was vigorously opposed and failed in the long run. A Second Bank of the United States was formed in 1816 to control state banks’ excesses and finance wars for the government (Mishkin, 2019). Unfortunately, this move was also challenged and was annulled. In most of the 1800s, state-chartered commercial banks were operating, which quite often led to failure due to corruption or inadequacy in funding (Mishkin, 2019). Federal supervision of the banking sector had failed before the beginning of the early 1900s. 

 FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies  

It wasn’t until 1913 that the Federal Reserve, now America’s central bank, emerged as a tool for improving the stability of the banking system and gaining control over the money supply in the economy.

All the national banks needed to join the Federal Reserve and come under its regulation (Mishkin, 2019).

The state banks could join but did not want to be regulated, so they continued to function independently.

Several decades later, radical regulatory changes were implemented after the Great Depression when over 9,000 banks had failed (Mishkin, 2019). The Federal Deposit Insurance Corporation, or FDIC, came into being for insuring business and consumer deposits, and they made all of the federal banks insured and followed additional regulations while providing the chances for state banks to become insured as well (Mishkin, 2019). FDIC makes deposits by depositors insured, in case of default by the banks, up to a certain level.

Key Regulatory Measures 

The Sarbanes-Oxley Act of 2002 was implemented to prevent fraud, enhance the accuracy of financial reporting, and restore investor confidence in the banking sector (Wagner & Dittmar, 2006). The act applies to all public organizations, small or large, and mandates accurate financial reporting. Accountants and auditors have the duty of ensuring full and accurate disclosure of financial information (SOX Law, 2008). The law has internal control provisions that dictate that leaders are to examine financial reports within 90 days of release (SOX law, 2008).

Tampering, hiding, destroying, or altering documents carries severe penalties, including 20 years in prison (SOX Law, 2008).

Opponents argue that this legislation imposes an unreasonable burden on non-deceptive banks, particularly small banks; it has, nonetheless, played a great role in increased transparency between banks and clients (Wagner & Dittmar, 2006). A range of regulatory reactions have been made in the aftermath of large bank failures. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was passed in response to the financial meltdown of 2008, which resulted from risky lending in the banking sector. The act established several government agencies tasked with regulating various segments of the financial system (Kenton, 2019). For example, the Orderly Liquidation Authority and the Financial Stability Oversight Council manage financial stability and can also dismantle banks that are too large (Kenton, 2019). The Consumer Financial Protection Bureau was also created to prevent mortgage businesses from lending high-risk mortgages that will default, as well as to interpret mortgage terminology for consumers (Kenton, 2019). While the necessity for such regulations appears to be obvious, their opponents argue that they render U.S. banks less competitive in the international arena and subject community banks not involved in the 2008 financial crisis to excessive burdens (Kenton, 2019).

Economic Implications 

Importance of Banking Services 

Importance of Banking Services Banks serve as the most important mechanism of money flow in an economy and hence are financial intermediaries in the first instance. Commercial banks assist consumers to open savings and checking accounts, acquire loans, and purchase certificates of deposit (McConnell, Brue, & Flynn, 2018). Commercial banks assist consumers in accessing money so that they spend it in large amounts, thus propelling the economy, creating GDP, and opening economic growth opportunities. Commercial banks, as they are responsible for managing public money, are controlled extremely tightly.

Earlier, commercial banks commonly operated under no control and therefore were more vulnerable to corruption.

Today, commercial banks are bound by what they can own and lend.

Investment banks, such as Midwest Global, are financial middlemen for governments and companies. They primarily sell and buy shares and bonds in order to facilitate corporate growth and economic development (McConnell, Brue, & Flynn, 2018). In addition, investment banks provide mergers and acquisition advisory services and brokerage services (McConnell, Brue, & Flynn, 2018). As much as investment banks contribute to economic growth, they also expose people to greater risk because they deal with more risky assets. Regulations have been implemented to ensure the level of such risks is contained so that it does not jeopardize the economy.

Regulatory Challenges for Midwest Global 

As Midwest Global becomes public, it must comply with all applicable regulations, which results in substantial changes to its structure and expenses. Regulations restrict the manner in which banks can invest and generate income, and noncompliance can lead to enormous financial penalties. One such limitation is capping banks’ holdings of risky assets, such as common stocks (Mishkin, 2019). Although riskier assets hold the promise of higher returns, banks are now capped in their exposure to these assets to protect taxpayers (Mishkin, 2019). Regulations also encourage diversification by capping what banks can lend within high-risk buckets and, as such, limiting the possibility of bank failure due to reckless investments (Mishkin, 2019). Banks must maintain large amounts of equity capital to guarantee protection of public funds. This requirement deters risky behavior, as banks have more to lose in the event of failure. Midwest Global will be required to calculate its leverage ratio, or the capital to total assets (Mishkin, 2019). A leverage ratio below 3% draws additional regulatory restrictions, and the Basel Accords require banks to hold at least 8% of their risk-weighted assets as capital (Mishkin, 2019). While enforcing these regulations is costly, they are designed to prevent the activities that led to the Great Recession. The Sarbanes-Oxley Act will be the most significant regulatory change for Midwest Global as it goes public. As stated earlier, the law is stringent when it comes to financial reporting, whereby internal controls will be set in place to facilitate proper information flow. More funds will have to be redirected toward management and public relations for compliance with regulatory policy. Integrity in financial reporting will instill customers’ trust in the bank and hence make it attractive to both borrowers and investors. 

Cost of Regulatory Compliance 

Financial Burden of Compliance 

The largest obstacle to banks in compliance with regulations is not so much the regulations themselves but the expense.

Banks must contend with multiple regulatory bodies and comply with extensive lists of demands, which can be both cumbersome and expensive. Most institutions have implemented internal control boards to offer supervision and enable smoother communication with external regulators and the public. Furthermore, banks increasingly find it convenient to outsource legal firms to manage regulatory issues and possible litigation. The time and money spent on compliance is considerable. In 2016, the financial sector spent over $100 billion in compliance expenses for regulations, and the Dodd-Frank Act alone was at $36 billion (Groenfeldt, 2018). The expenses are going to rise even more because existing rules continue to prevail.