FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

Student Name

Capella University

FIN-FPX5710 Economic Foundations for Financial Decision Making

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Date

Regulatory Analysis

Banks serve a crucial role in the functioning of local, state, national, and international economies. They provide consumers with a secure place to store their money and use those funds to offer loans for productive investments. Various types of banks exist, each offering essential services that help maintain the smooth operation of the economy. Due to their importance in economic health, banks are subject to stringent government regulations to ensure the security of the money supply. Many of these regulations have arisen in response to significant banking failures that triggered recessions or financial market stress. This report will review the history of these regulatory actions, current regulations, and the potential impact on Midwest Global Investment Bank as it goes public under these regulations.

Regulatory Legislation

Over the years, numerous regulatory measures have been implemented to ensure the protection of consumer, business, and federal funds. Banks are arguably the most regulated industry in the United States. Early on, the need for banking regulations was recognized, but it took nearly two centuries to establish the current regulatory system. In the 1790s, the federal government attempted to create the first regulatory entity, the Bank of the United States, which acted as both a private and central bank (Mishkin, 2019). This attempt to regulate state banks faced opposition and was short-lived. In 1816, the government tried again with the Second Bank of the United States, aimed at addressing the abuses of state banks and supporting the government in raising funds during wars (Mishkin, 2019). This, too, faced resistance and was repealed. Throughout much of the 1800s, commercial banks were chartered by states and often failed due to corruption or insufficient funds (Mishkin, 2019). Federal attempts to regulate the banking system were unsuccessful until the early 1900s.

In 1913, the Federal Reserve, the current central bank of the United States, was established to create a safer banking system and maintain control over the economy’s money supply. All national banks were required to become members of the Federal Reserve and adhere to its regulations (Mishkin, 2019). State banks had the option to join, but many opted to remain independent to avoid restrictions. However, after a decade, significant regulations were introduced following the Great Depression, during which over 9,000 banks failed (Mishkin, 2019). The Federal Deposit Insurance Corporation (FDIC) was created to protect consumers’ and businesses’ bank deposits. All federal banks were required to purchase insurance and comply with additional regulations, with state banks also opting in (Mishkin, 2019). The FDIC protects depositors’ funds, up to a certain limit, even if the bank fails.

FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

The Sarbanes-Oxley Act of 2002 aimed to prevent fraud, enhance the accuracy of financial reporting, and restore investor confidence in the banking industry (Wagner & Dittmar, 2006). This act is mandatory for all public organizations, regardless of size, and mandates accurate financial reporting. Management and auditors are responsible for ensuring the complete and honest disclosure of financial information (soxlaw, 2008). The act includes internal control requirements, which mandate that leadership review financial reports within 90 days of their release (soxlaw, 2008). Criminal penalties, including up to 20 years in prison, are imposed for falsifying, concealing, altering, or destroying documents (soxlaw, 2008). While critics argue that this act places an undue burden on banks that have not engaged in dishonest behavior, particularly smaller institutions, it has significantly improved transparency between banks and their clients (Wagner & Dittmar, 2006).

Many regulatory measures have been implemented following major banking failures. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was passed in response to the 2008 financial collapse, which was blamed on risky banking loan practices. The act established several government agencies tasked with overseeing different aspects of the financial system (Kenton, 2019). For instance, the Financial Stability Oversight Council and the Orderly Liquidation Authority monitor financial stability and can dismantle banks deemed too large (Kenton, 2019). The Consumer Financial Protection Bureau was also established to prevent mortgage companies from offering high-risk loans that might default and to make mortgage terms clearer for consumers (Kenton, 2019). While the need for these regulations is evident, some critics argue that they make U.S. banks less competitive internationally and impose unnecessary burdens on community banks that were not involved in the 2008 collapse (Kenton, 2019).

Economic Implications

Banks are the primary channel through which money flows in an economy, making them arguably the most important financial intermediaries. Commercial banks allow consumers to open savings and checking accounts, take out loans, and purchase certificates of deposit (McConnell, Brue, & Flynn, 2018). These services give consumers access to larger sums of money for spending, which stimulates the economy, increases GDP, and provides opportunities for economic growth. Commercial banks are subject to strict regulations due to their role in managing public funds. Historically, these banks were often corrupt, as they operated without oversight. Today, commercial banks are limited in the types of assets they can hold and the loans they can offer.

Investment banks, like Midwest Global, act as financial intermediaries for corporations and governments. They primarily deal in buying and selling stocks and bonds to support corporate growth and economic expansion (McConnell, Brue, & Flynn, 2018). Investment banks also advise on mergers and acquisitions and offer brokerage services (McConnell, Brue, & Flynn, 2018). While investment banks contribute significantly to economic growth, they also pose a higher risk due to their ability to take on riskier assets. Regulations limit the extent to which these banks can take risks to protect the economy.

Regulatory Considerations

As Midwest Global prepares to go public, it will need to comply with all relevant regulations, which will result in significant changes to its structure and costs. Regulations restrict how banks can invest and earn revenue, and failing to comply can result in severe financial penalties. One such restriction involves limiting banks’ holdings of risky assets, such as common stocks (Mishkin, 2019). While risky assets can yield higher returns, banks are now limited in their exposure to such assets to protect taxpayers (Mishkin, 2019). Regulations also promote diversification by limiting the amount banks can loan in high-risk categories, thereby reducing the potential for bank failure due to risky investments (Mishkin, 2019).

Banks are now required to hold substantial amounts of equity capital to ensure that public funds are protected. This requirement discourages risky behavior, as banks have more to lose if they fail. Midwest Global will need to calculate its leverage ratio, the amount of capital divided by total assets (Mishkin, 2019). A leverage ratio below 3% results in additional regulatory restrictions, and the Basel Accords mandate that banks hold at least 8% of their risk-weighted assets as capital (Mishkin, 2019). While these regulations are costly to implement, they are designed to prevent the practices that led to the Great Recession.

The Sarbanes-Oxley Act will introduce the most significant regulatory change for Midwest Global as it transitions to a publicly traded company. As mentioned earlier, the act mandates strict financial reporting requirements, necessitating the implementation of internal controls to ensure accurate information dissemination. Midwest Global will need to allocate more resources to public relations and management to comply with regulatory policies. Transparent financial reporting will build trust with clients, making the bank more attractive to investors and borrowers.

Cost of Regulations

The most significant challenge for banks in complying with regulations is not the rules themselves but the associated costs. Banks must navigate numerous regulatory bodies and comply with extensive requirements, which can be both confusing and costly. Many banks have established internal control boards to monitor compliance and facilitate communication with external regulators and the public. Additionally, banks have increasingly needed to hire legal firms to address regulatory questions and potential litigation. The time and money spent on compliance are considerable. In 2016, the banking industry spent over $100 billion on regulatory compliance, with the Dodd-Frank Act alone accounting for $36 billion (Groenfeldt, 2018). These costs are expected to continue rising as regulations remain in place.

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.

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

FIN FPX 5710 Assessment 3 Organizational Review of Regulatory Policies

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.