Bank Regulation: What's Its Effect On The Economy?

A solid system of bank regulation is necessary to ensure that no one bank or financial institution has such a concentrated amount of risk that could prove to be detrimental to the banking and financial system. Many individuals depend on the sound functioning of our banking system in order to pay bills, save, invest, and provide for their future. When banks are unable to fulfill their duties to the economy due to over speculation or poor risk assessment, it is the role of the regulators to step in and right the ship.

Need for Change

Changes are always contemplated to the system of bank regulation to clarify roles, eliminate duplications and provide a clear system of requirements and expectations. The need for these changes is constant and necessary to ensure that a collapse of the financial markets never occurs.  These changes can take the form of new regulations to react to changes in the banking system as well as the elimination of those rules that are archaic and ineffective in controlling behavior.

Reason for Bank Regulation

Bank regulation has been around since the 1930s. It provided a system of rules and guidelines under which banks can operate. This is important for customers in order to instill confidence in the banking system and preventing any activities that may threaten the supply of money. Because people rely on banks for loans, savings and checking accounts and other products and services, bank regulations help ensure that these services are provided.

Effects of Bank Regulations

It can be argued that regulation prevents innovation and growth. This hurts growth and curtails efforts by banks to engage in more profit making schemes. Others argue that regulation is necessary to prevent abusive practices and ensure fair access for everyone. This allows increased opportunities for lending to poor and underserved communities, as in the case of the Community Reinvestment Act of 1971. Both sides have valid arguments to this question. The test of whether bank regulation is necessary or required is in how well the economy performs.  

It is possible to both over-regulate and under-regulate banks. Congress can put in place too many banking rules and regulations that increases administrative costs for banks and increases profitability, causing banks to fail. The regulators may become too lax in their oversight roles and fail to enforce basic provisions of the banking law. This undisputedly led directly to the subprime mortgage crisis of mid-2000.

The Role of Government

It is the role of the government and Congress to strike the proper balance between regulation and laissez-faire or leaving banks alone, in order to positively affect the economy. The best set of regulations seeks to walk the middle road and allow banks the freedom to maintain a healthy flow of money while tempering that freedom with responsibility.

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