1
Chapter 5
Financial market regulation
1 of 18
Chapter contents
government's role in financial markets
theory of regulation
financial regulation in the US and EU
2 of218
of 18
5.1 Government's role in financial markets
The government can play one or more of the
following roles in financial markets:
provide a level playing field for financial
markets by promoting their development.
participate in the financial markets by running
state-owned financial institutions
provide a regulatory framework that ensures
safety and soundness of the financial system.
3 of318
of 18
5.1 Government's role in financial markets
Government regulation
according to the laissez-faire theorem markets
are efficient ,and hence can operate without any
legal intervention, but in reality they are not.
the government controls a feature of the
economy that the market mechanisms of
competition and pricing could not manage
without help (market failure theory-where it
cannot fulfill all competitive situation)
4 of418
of 18
5.1 Government's role in financial markets
Why regulation?
prevent issuers of securities from
defrauding investors by concealing
relevant information
promote competition and fairness in the
trading of financial securities
promote stability of financial institutions
5 of518
of 18
5.1 Government's role in financial markets
Why regulation?...
restrict activities of foreign concerns in
domestic markets and institutions
control the level of economic activity
6 of618
of 18
5.1 Government's role in financial markets
Types of regulations
(1) disclosure regulations-problem of
asymmetric information and agency
problem
(2) financial activity regulation-about traders
of securities and trading on financial
assets.
Examples. Rules on trading by corporate
insiders- insider trading
7 of718
of 18
5.1 Government's role in financial markets
Types of regulations…
(3) regulation of financial institutions-
restricting activities of financial
institutions in the area of lending,
borrowing and funding
(4) regulation of foreign participants-limit the
roles of foreign firms on domestic markets
and their ownership control of financial
institutions
8 of818
of 18
9
5.2 Theory of regulation
Arguments against regulation
Creates moral hazard-causes depositors as
well as banks to behave less cautiously on the
belief that the central bank is there to protect
them
Agency capture-regulators are ex-practitioners
who share the same value as practitioners, and
hence may be biased towards banks rather
than depositors
Instr. Dr. Dagnu L. 1/6/21 9 of 18
10
5.2 Theory of regulation
Arguments against regulation…
increases cost of financial services-it has cost
and financial institutions may pass it on to
clients
gives room for monopolies to emerge-cost of
regulation may restrain entry and exit
leads to market inefficiency-prevents mergers
and acquisitions and allows inefficient firms
to stay in business
Instr. Dr. Dagnu L. 1/6/21 10 of 18
5.3 Financial regulation in the US and
EU
Financial regulation in the US
Federal reserve Act(1913)
established federal reserve system
McFaden Act(1927)
banned branching of banks in other states
It was repealed/amended later by Riegel-Neal act in 1994
Glass-Stegall Act(1933)
established FDIC(federal Deposit Insurance corporation) and
separated banking and non-banking business
was repealed latter by Gramm-leach-Blealey act(1999)
11 of
1118
of 18
5.3 Financial regulation in the US and
EU
Financial regulation in the US
Sarbanes Oxlay Act(2002)
public accounting reform and investor protection act
American energy, commodities, and
services company
Established in 1985
Employed 20,000 workers
Had annual Revenue of $101bill in
2000
Was among the 100 best companies in
the US in 2000
12 of
1218
of 18
5.3 Financial regulation in the US and
EU
Financial regulation in the US
Sarbanes Oxlay Act(2002)…
public accounting reform and investor protection act
Is a Telecommunication company
Established in 1983
13 of
1318
of 18
5.3 Financial regulation in the US and
EU
Financial regulation in the EU
although the Treaty of Rome (1957) laid down
the foundation for free movement of capital and
goods across the borders of EU member
countries, it became effective only through the
issuance in 1988 of Single European Act(SEA)
14 of
1418
of 18
5.3 Financial regulation in the US and
EU
Regulation of the banking business
First Banking Directive of 1977
required member states to establish systems for
authorizing and supervising DTIs (deposit taking
institutions)
allowed banks to conduct business in other member
countries provided that they were authorized by the
host government and complied with the conditions and
supervision applied to local banks
15 of
1518
of 18
5.3 Financial regulation in the US and
EU
Regulation of the banking business
Directive on the Supervision of Credit
Institutions on a Consolidated Basis(1983)
established the common principle for supervision of
bank activities, based on their world-wide activities.
Second Banking Co-ordination Directive of
1989
allowed banks to operate in countries across Europe
using a single license and accepted universal banking.
host countries retained the right to control bank
liquidity 16 of
1618
of 18
5.3 Financial regulation in the US and
EU
Regulation of the securities markets in the
EU
Directive Co-ordinating the Conditions for
the Admission of Securities to Official Stock
Exchange Listing(1979)
set out the minimum conditions to be met by issuers of
securities, including minimum issue price, a
company’s period of existence, free negotiability etc.
17 of
1718
of 18
5.3 Financial regulation in the US and
EU
Regulation of the securities markets in the
EU
Investment Services Directive(1992)
extended the single passport principle to non-bank
investment firms
Capital Adequacy Directive (1993)
required non-bank securities firms to maintain a
minimum required capital
18 of
1818
of 18
5.3 Financial regulation in the US and
EU
Regulation of insurance services in the EU
First Non-Life Insurance Directive(1973)
allowed non-life insurance companies to operate in
other members states
The First Life Insurance Directive(1979)
allowed life insurance companies to operate in other
members states
19 of
1918
of 18
End of Chapter 5
20 of
2018
of 18
