This document discusses the history and rationale for regulations of financial institutions. It notes that regulations were established in response to bank failures during the Great Depression and financial crises to increase stability and protect consumers. However, regulations have also increased costs for banks. The Dodd-Frank Act aimed to prevent another crisis and protect consumers, but critics argue regulators failed to prevent the 2008 crisis. Overall, the document analyzes the reasons for financial regulations and their impacts.

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Regulations of Financial Institutions
Merranda Taunah
Cameron University
Money and Banking
April 24, 2015

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Abstract
Why, exactly, must banks be regulated? Part of the answer lies in the history of the banking system.
What is the Federal Deposit Insurance Corporation (FDIC)? What are the benefits and costs of
these banking regulations, and are these regulations protecting the public’s best interest? What role
did regulations play in the financial crises of 2008? In this paper I will analyze and discuss all
these issues and questions, along with various other topics regarding bank regulations.

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Why should financial institutions be regulated? Well, one would think that in order to raise
the safety and soundness of the banking system we would need to increase the minimum capital
and liquidity requirements from their current levels. In turn, this would lead to longer term
financial stability and more stable economic growth. The Dodd-Frank Act was put into place to
help decrease some of these risks in the United States financial system. This Act is also used to
help protect U.S. consumers against some of the abuses of power that contributed to the 2008
financial crises.
Banking has undergone so much change throughout the years, but banking’s central
purpose has always remained the same. Use the community’s surplus of funds to lend to consumers
to purchase personal property, to start a new business, to put children through college, and several
other reasons. For millions of consumers, banks are the primary choice for borrowing, investing
and saving.
The first bank, Bank of the United States, was established in 1792 in Philadelphia (Gordon,
John. A Short Banking History of the United States). This bank provided the country with a regular
money supply, however because the Federalists continued to lose power, the bank’s charter was
not renewed in 1811. Eventually President Madison realized the necessity of a central bank and a
second bank was established in 1816. During these times bankers tended to be cautious about
whom they lent to and for how long. To make sure they had enough money available to meet
unexpected demands from consumers, bankers normally only made thirty to sixty day loans. The
onset of the worldwide depression in 1929 was a disaster for the banking system. Banks began
failing, as borrowers defaulted and bank assets declined. This led fear throughout the country, with
long lines of consumers lining up before dawn in hopes of withdrawing their cash before the bank
had no more to pay out. (Gordon, John. A Short Banking History of the United States). The day

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after taking office, President Roosevelt declared March 5, 1933 as a bank holiday, and closed all
the U.S. banks until they could be inspected and allowed to reopen or permanently closed for
liquidation. In 1933, the Federal Deposit Insurance Corporation was created. Accounts were
covered for up to $2,500 per depositor (Gordon, John. A Short Banking History of the United
States). This was created in response to thousands of bank failures, with the objective of limiting
risks to banks and reassuring the consumer that banks were, and would remain, safe and sound. In
the late 2000’s a liquidity shortfall in the U.S. banking system resulted in the collapse of large
financial institutions, the bailout of banks by national governments, and downturns in stock
markets. In 2006, the housing bubble collapse caused the values of securities tied to U.S. real estate
prices to plunge, damaging banks globally. Economies worldwide slowed during this period, as
credit tightened and international trade declined. This resulted in numerous evictions, foreclosures
and prolonged vacancies, and led to a severe global economic recession in 2008. Due to this huge
financial crises, and to help restore trust in the banking system, Congress expanded the FDIC
insurance limit to $250,000. In 2010 the Obama administration enacted The Dodd-Frank Wall
Street Reform and Consumer Protection Act (Fontinelle, Amy. What Is the Dodd-Frank Act? How
Does It Affect Me?). This act is the most comprehensive change to financial regulation in the
U.S. and affects all Federal financial regulatory agencies and nearly every aspect of the nation's
financial services industry.
Bank regulations are a form of government regulation which place certain restrictions,
obligations, and rules on banks. Banking regulations are established to effectively restrict financial
institutions from engaging in predatory lending or fraudulent practices aimed to take advantage of
customers or businesses who conduct transactions with the bank. So why are banks so special that
they need regulation? Well the answer is simple, because the risks they take are carried, in large

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part, by taxpayers and the economy as a whole, and bankers must be strictly limited in the kinds
of risk they are allowed to take on. As illustrated in the above paragraph, history proves that
banking is and always has been subject to occasional panics and crises, which can wreak havoc
with the economy. These regulations create transparency between banking institutions and the
individuals and businesses with whom they conduct business with. Unfortunately, these new
regulations have cost the six largest U.S. banks nearly $70.2 billion as of the end of 2013. A lot
of these costs come from capital costs, interchange fee restrictions, FDIC premiums, and
supervisory assessments. (Chaudhuri, Saabira. The Cost of New Banking Regulation: $70.2
Billion)
The Dodd-Frank Wall Street Reform and Consumer Protection Act is a huge piece of
legislation, which was passed by the Obama administration in 2010, after the financial crises of
2008. This act is believed to help prevent another financial crises and to protect consumers from
abuse of power by certain businesses. The Financial Stability Oversight Council and Orderly
Liquidation Authority is a government agency that oversees the financial stability of major
businesses whose failure could have a negative outcome for the economy. This agency also
provides organized liquidations or restructuring if these businesses become too weak financially.
The Consumer Financial Protection Bureau was implemented to prevent predatory mortgage
lending and to make it easier for everyday people to understand the terms of their mortgages, this
bureau also monitors credit and debit card lending and addresses consumer complaints. According
to Amy Fontinelle, “some critics of the Dodd-Frank Act believe the act will be ineffective in
achieving its intended goals and that it doesn’t make sense to put faith in the same regulators who
failed to prevent the 2008 crises.” Because this act is still very new and is slowly being
implemented, it will certainly take years before we know the full effect of this act.

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The financial crises of 1997 and 2008 both prove to have similar causes, which strongly
suggest these repeated mistakes were made by financial professionals. The beginning of the crises
broke in mid-August 2007, when the market suddenly stopped funding to several significant
financial entities (Poole, W. Causes and Consequences of the Financial Crises of 2007-2009). The
conditions that led to this included the federal government encouraging growth of subprime
mortgages in order to increase the population of families who owned their own homes. This
resulted in banks knowingly overextending themselves to U.S. borrowers who offered inadequate
guarantees of repayment (Chabel, P. (2013). The 1997 and 2008 Financial Crises Causes and
Consequences Compared.
So the questions now is, can banking clean up its act? According to Lionel Barber, editor
for the “Financial Times” bankers have given themselves the reputation of being “greedy, self-
serving, amoral or actually dangerous.” Financial professionals continue to be held responsible for
financial crises. Unfortunately the big wigs at the top, don’t know, nor do they care what’s going
on down below them. Banks today are operating in a whole new world and disappointingly this
will reduce their profit margins and return on equity. The resolution to the crises is creating even
larger banks than before, this in turn is going to increase the “too big to fail” problem and moral
hazard. As Mr. Barber suggest, “we cannot turn bankers into saints, however we also cannot
eliminate risk taking.” Bankers have begun cleaning up their act, but only time will tell if things
have truly changed.
Central banks have been at the center of all financial crises, but have also been recognized
as guiding the way out of it. The view before the disaster was that price and financial stability
reinforce one another. This has been proven wrong, we now know that price stability does not
guarantee financial stability. “Pure inflation targeting is inadvisable and the mandate of central

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banks should extend beyond price stability to include bank regulation and supervision, financial
stability, and preventing asset price bubbles” (Subbarao, D. Redefining Central Banking). The
central bank is solely a financial authority, with banking regulations and supervision entrusted in
another agency. The new and upcoming view is that the financial crises was caused in part by a
lack of organization and communication between central banks and their supervisors. Therefore,
in the interest of financial stability, it is only necessary to entrust regulation and supervision of
banks to the central banks. However, there is not a just right, perfect answer. Each country and
each central bank will have to settle these issues according to their explicit situations.

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References
Barber, Lionel. (2014). Can Banking Clean Up Its Act?. Vital Speeches of the Day, 80(7), 243-
246.
Chabel, P. (2013). The 1997 and 2008 Financial Crises Causes and Consequences Compared.
Public Administration & Regional Studies, 6(2), 5-14.
Chaudhuri, Saabira. The Cost of New Banking Regulation: $70.2 Billion. The Wall Street
Journal. Dow Jones & Company, Inc., 30 July 2014. Web.
Fontinelle, Amy. What Is the Dodd-Frank Act? How Does It Affect Me? Investopedia.
Investopedia, LLC., 14 Jan. 2013. Web.
Gordon, John. A Short Banking History of the United States. The Wall Street Journal. Dow Jones
& Company, 10 Oct. 2008. Web.
Poole, W. (2010). Causes and Consequences of the Financial Crises of 2007-2009. Harvard
Journal of Law & Public Policy, 33(2), 421-441.
Subbarao, D. (2010). Redefining Central Banking. Finance & Development, 47(2), 26-27.