Government Regulation in the Banking Business

Government Regulation in the Banking Business

        The economic volatility of today’s banking industry has raised concern about the long-term well-being of banks. China’s devaluation of currency and economic slowdown, Russia’s economic woes, the “Eurozone” crisis, the U.S.’s fear of another recession and the net reverberation that these events (and others) have had on the world’s economy is causing banks to realign incentives and yield to administrative regulations. Rising credit risk (TED spread), artificially-lowered interest-rates, and government legislation (Dodd-Frank Act) can all negatively affect the banking industry. Internally-regulated bank stress testing has provided benchmarks and capital reserve requirements that can be effective in simulating potential financial crises; however, bank stress testing before the 2008 economic meltdown wasn’t enough in preventing the financial downfall that occurred. This knowledge has spurred the intervention and supervision of banks by higher authorities. The establishment of government legislation was intended to benefit consumers, but this legislation has consequently created risk to banks.

The Dodd-Frank Act, which was passed to end “too-big-to-fail” and endorse financial stability, has done its job for the most part. However, “The banks deemed too big [in 2010] are more than 30% bigger than before the Act was passed in 2010, and 80% bigger than before the banking crisis of 2008. The six largest US financial institutions now have assets of some $10 trillion, amounting to almost 60% of GDP; and they control nearly 50% of all bank deposits.”1 An important obligation of the Dodd-Frank Act is the breaking-up of financial institutions that become too large. This legislation threatens and can discourage banks from making important developmental decisions. What incentives for growth does a large bank have if the government decides to break-up its allocation of assets because it is deemed “too big?”