Financial regulation relates to laws and rules that govern what financial institutions such as banks, brokers and investment companies can do. These may be set though legislation or be stipulated by the relevant regulatory agency, for instance the FSA in the UK . Regulation is needed to ensure consumer’s confidence in the financial sector . It does this by providing smaller retail clients with protection against potential losses and by protecting consumers against monopolistic exploitation , e.g. makes sure product pricing doesn’t happen.
There are several types of regulation . Systematic Regulation is concerned with the safety and soundness of the financial system. It relates to Deposit insurance , which is a guarantee that all or part of the amount deposited in a bank will be paid if the bank fails . Also, it relates to the Lender of last resort , in its role as a LOLR the central bank will provide reserves to a bank experiencing serious financial problems caused by a sudden withdrawal of funds by depositors , or when the bank cannot find liquidity anywhere else .However, these kind of safety-net arrangements create moral hazard. With 100% deposit insurance , depositors won’t be concerned about the bank’s behaviour and the belief that LOLR will bail them out , can encourage institutions to take greater risks when lending.
Prudential Regulation is concerned with consumer protection . It relates to monitoring and supervision of financial institutions( asset quality and capital adequacy ). It is undertaken by the FSA and aims to ensure that firms a financially sound , e.g. specifying standards covering risk management .
Finally , Conduct of Business Regulation focuses on how banks conduct their business. It establishes rules to reduce the likelihood that consumer receive bad advice , supplying institutions become insolvent before contract matures , contracts turn out to be different from what the customer was anticipating ,...