FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

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Capella university

FIN-FPX5710 Economic Foundations for Financial Decision Making

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Date

Regulatory Analysis

Role of Banks in the Economy

Banks play an essential part in the local, state, national, and international economies by providing a safe space for consumers to store their money and utilizing those funds to grant loans for productive investments. A variety of banks exist, each delivering critical services that facilitate the smooth functioning of the economy. Given their significant influence on economic stability, banks are subjected to rigorous government regulations to safeguard the money supply. Many of these regulations have been implemented in response to notable banking failures that led to recessions or financial market distress. This report will examine the historical context of these regulatory measures, the current regulations in effect, and the potential implications for Midwest Global Investment Bank as it prepares to go public.

Historical Overview of Regulatory Legislation

Over the years, a multitude of regulatory measures has been introduced to safeguard consumer, business, and federal funds. Banks are arguably the most heavily regulated industry in the United States. The necessity for banking regulations was acknowledged early on; however, it took nearly two centuries to develop the current regulatory framework. The first attempt at regulation came in the 1790s with the establishment of the Bank of the United States, which functioned as both a private and central bank (Mishkin, 2019).

This effort faced significant opposition and was ultimately short-lived. In 1816, the Second Bank of the United States was created to address the abuses of state banks and assist the government in raising funds during wartime (Mishkin, 2019). Unfortunately, this initiative also encountered resistance and was repealed. Throughout much of the 1800s, commercial banks were chartered by states, often leading to failures due to corruption or inadequate funding (Mishkin, 2019). Federal efforts to regulate the banking sector did not succeed until the early 1900s.

FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

In 1913, the Federal Reserve, now the central bank of the United States, was established to enhance the safety of the banking system and maintain control over the money supply in the economy. All national banks were mandated to become members of the Federal Reserve and comply with its regulations (Mishkin, 2019). State banks could opt to join but many chose to remain independent to avoid restrictions.

However, after a decade, significant regulatory changes were implemented following the Great Depression, during which over 9,000 banks collapsed (Mishkin, 2019). The Federal Deposit Insurance Corporation (FDIC) was created to protect consumers’ and businesses’ deposits, requiring all federal banks to obtain insurance and adhere to additional regulations, with state banks also having the option to participate (Mishkin, 2019). The FDIC ensures that depositors’ funds are safeguarded, up to a certain limit, even if a bank fails.

Key Regulatory Measures

The Sarbanes-Oxley Act of 2002 was introduced to prevent fraud, enhance the accuracy of financial reporting, and restore investor confidence in the banking sector (Wagner & Dittmar, 2006). This legislation is mandatory for all public organizations, regardless of size, and mandates precise financial reporting. Management and auditors are held accountable for ensuring the complete and truthful disclosure of financial information (soxlaw, 2008). The act includes requirements for internal controls, which stipulate that leadership must review financial reports within 90 days of their release (soxlaw, 2008). Falsifying, concealing, altering, or destroying documents incurs severe penalties, including up to 20 years in prison (soxlaw, 2008). Critics argue that this act imposes an undue burden on banks that have not engaged in dishonest practices, particularly smaller institutions; however, it has significantly enhanced transparency between banks and their clients (Wagner & Dittmar, 2006).

Numerous regulatory measures have been enacted in the aftermath of significant banking failures. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was established in response to the 2008 financial collapse, which was attributed to risky lending practices within the banking sector. This legislation created several government agencies tasked with overseeing various aspects of the financial system (Kenton, 2019). For example, the Financial Stability Oversight Council and the Orderly Liquidation Authority monitor financial stability and possess the authority to dismantle banks deemed too large (Kenton, 2019).

The Consumer Financial Protection Bureau was also founded to prevent mortgage companies from providing high-risk loans that may default, while also clarifying mortgage terms for consumers (Kenton, 2019). Despite the evident need for these regulations, critics argue that they render U.S. banks less competitive on a global scale and impose unnecessary burdens on community banks that were not involved in the 2008 financial crisis (Kenton, 2019).

Economic Implications

Importance of Banking Services

Banks serve as the primary conduit for money flow within an economy, making them vital financial intermediaries. Commercial banks facilitate consumers in opening savings and checking accounts, acquiring loans, and purchasing certificates of deposit (McConnell, Brue, & Flynn, 2018). These services enable consumers to access larger sums of money for expenditure, thereby stimulating the economy, increasing GDP, and fostering opportunities for economic expansion. Due to their critical role in managing public funds, commercial banks face strict regulations. Historically, these institutions often operated without oversight, leading to corruption. Presently, commercial banks are limited in the types of assets they can possess and the loans they can issue.

Investment banks, such as Midwest Global, act as financial intermediaries for corporations and governments. Their primary functions involve buying and selling stocks and bonds to facilitate corporate growth and economic development (McConnell, Brue, & Flynn, 2018). Additionally, investment banks provide advisory services for mergers and acquisitions and offer brokerage services (McConnell, Brue, & Flynn, 2018). While investment banks significantly contribute to economic growth, they also carry higher risks due to their involvement with riskier assets. Regulations have been established to limit the extent of these risks in order to safeguard the economy.

Regulatory Challenges for Midwest Global

As Midwest Global prepares for its public offering, it must comply with all pertinent regulations, resulting in substantial changes to its structure and expenses. Regulations impose restrictions on how banks can invest and generate revenue, and noncompliance can lead to significant financial penalties. One such limitation involves capping banks’ holdings of risky assets, such as common stocks (Mishkin, 2019). Although risky assets can offer higher returns, banks are now constrained in their exposure to these assets to protect taxpayers (Mishkin, 2019). Regulations also encourage diversification by restricting the amounts banks can lend in high-risk categories, thus minimizing the potential for bank failure due to reckless investments (Mishkin, 2019).

Banks are mandated to maintain considerable amounts of equity capital to ensure the protection of public funds. This requirement discourages risky behavior, as banks have more to lose in the event of failure. Midwest Global will need to calculate its leverage ratio, which is the capital divided by total assets (Mishkin, 2019). A leverage ratio below 3% incurs additional regulatory restrictions, and the Basel Accords require that banks maintain at least 8% of their risk-weighted assets as capital (Mishkin, 2019). While implementing these regulations can be costly, they are designed to prevent the practices that led to the Great Recession.

The Sarbanes-Oxley Act will represent the most significant regulatory change for Midwest Global as it transitions into a publicly traded entity. As previously noted, the act imposes stringent financial reporting requirements, necessitating the establishment of internal controls to ensure the accurate dissemination of information. Midwest Global will need to allocate additional resources for public relations and management to comply with regulatory policies. Transparent financial reporting will foster trust with clients, rendering the bank more appealing to both investors and borrowers.

Cost of Regulatory Compliance

Financial Burden of Compliance

The most significant obstacle for banks in adhering to regulations is not necessarily the rules themselves, but the associated costs. Banks must navigate multiple regulatory bodies and comply with extensive requirements, which can be both intricate and expensive. Many institutions have established internal control boards to oversee compliance and facilitate communication with external regulators and the public. Furthermore, banks increasingly find it necessary to engage legal firms to address regulatory inquiries and potential litigation. The financial and temporal investments required for compliance are substantial. In 2016, the banking sector incurred over $100 billion in regulatory compliance costs, with the Dodd-Frank Act alone accounting for $36 billion (Groenfeldt, 2018). These expenses are projected to continue rising as existing regulations remain in effect.

References

Groenfeldt, T. (2018). The high cost of financial regulation compliance. Forbes. Retrieved from https://www.forbes.com

Kenton, W. (2019). Dodd-Frank Wall Street Reform and Consumer Protection Act. Investopedia. Retrieved from https://www.investopedia.com

McConnell, C. R., Brue, S. L., & Flynn, S. M. (2018). Economics: Principles, problems, and policies (21st ed.). McGraw-Hill Education.

FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

Mishkin, F. S. (2019). The economics of money, banking, and financial markets (12th ed.). Pearson.

Wagner, J., & Dittmar, L. (2006). The impact of Sarbanes-Oxley on small banks. The CPA Journal, 76(4), 16-21.

soxlaw. (2008). Sarbanes-Oxley Act: A guide to compliance.