Banking Regulations

The banking industry has far-reaching effects on the whole of the economy. A systemic collapse in the banking system can spread throughout the economy, making it essential for all governments to regulate and supervise the banking industry with measures that suit the respective economies. The increased globalization and interconnection of business and finance provides good reason to create international banking regulations. In addition, numerous banking and financial crises in the past two decades have had wide-ranging repercussions around the world.

Basel II: Revolution Disguised as Regulation

The original Basel Accord was agreed upon in 1988 by the Basel Committee on Banking Supervision. By ensuring higher capital adequacy ratios Basel 1 helped make the international banking system sound and stable. The first draft of Basel II was released in January 2001. This is a revised form of the existing framework, which aims to make it more risk sensitive and representative of modern banks' risk management practices. There have been four revisions to the implementation schedule now planned for late 2007.

The three pillars on which the Basel II banking regulations are based on are as follows

Pillar I: This sets out minimum regulatory capital requirements, the minimum amount of capital that banks must hold against risks is specified.

Pillar II: This describes the process for the supervisory review of risk management framework and its capital adequacy.

Pillar III: This focuses on the ability of banks to meet market requirement and promotes prudent management by enhancing the degree of transparency in banks’ public reporting with a greater insight into the adequacy of their capitalization and risk management principles.

The progress in implementation varies significantly across regions. European, Canadian and Australian banks have stolen a march on their competitors in the US and Asian regions. Europe’s progress reflects the more proactive approach taken by the region’s regulators. The incentive of lower regulatory capital requirements for banks employing more sophisticated risk management approaches seems to be working, as the majority of banks plan to adopt Advanced-IRB (AIRB) by 2010.

The new Basel Accord will be implemented in the EU through the Capital Requirements Directive, (CRD). It will directly affect banks and building societies and certain types of investment firms. Given the differences in results for different types of exposures, the effects of the new capital rules also vary significantly depending on the types of banks.

Domestic Banking Regulations

Until 1863, US banks were regulated by the State. The federal government licensed national banks giving them the authority to issue their own currency as long as it was backed by holdings in US treasury bonds. The 1933 Banking Act combined a bill sponsored by Representative Steagall to establish a federal deposit insurance with a bill sponsored by Senator Glass to segregate the banking and securities industries. Generally known as the Glass-Steagall Act, it distinguished between commercial banking, which is the business of taking deposits and making loans, and investment banking, which is the business of underwriting and dealing in securities. In 1999, Congress passed the Financial Services Modernization Act, this landmark legislation eliminated the Glass-Steagall’s separation of commercial and investment banking.

UK banking and financial institutions are subject to multiple banking regulations. The primary UK statute is the Financial Services and Markets Act 2000, (FSMA). Other UK primary and secondary banking regulations are derived from EU directives relating to banking, securities, investment and sales of personal financial services. The banking industry in the UK is particularly exposed to the tensions between competing policy objectives. At least six government departments and agencies take a particular interest in the banking industry and how it interacts with the wider economy:

• HM Treasury
• Office of Fair Trading
• Bank of England
• Financial Services Authority
• Social Exclusion Unit
• Performance and Innovation Unit
(the last two bodies are both part of the Cabinet Office).

Banks continue to play a predominantly transitional role in the emerging markets region. However, they vastly differ in size, growth rates, profitability, productivity, degree of automation and range of products from country to country. As a result, the regulatory framework and supervisory control also differs

Regulatory framework—India: The Reserve Bank of India (RBI), the Central Bank, was created in 1935 through the Reserve Bank of India Act, 1934. It was followed up by the Banking Regulations Act in 1949. These acts granted the RBI wide ranging powers for the licensing, supervision and control of banks.

Regulatory framework—China: The Peoples Bank of China (PBC) was designated as the Central Banking authority in 1995. It is charged with the functions of making and implementing monetary policy, safeguarding overall financial stability, and providing financial services.

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