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Regulation Checklists

Principles of Financial Services Regulation


Checklist Description

This checklist looks at the regulation of financial services, the principles involved, and how they can be effectively monitored and maintained.

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Definition

Financial regulations attempt to ensure that financial institutions adhere to specific requirements, restrictions, and guidelines that aim to maintain the integrity of the financial system and which may be legislated or exist as a voluntary or obligatory code of conduct.

Primarily, financial regulation should attempt to follow these three strategic principles:

  1. Promote efficient, fair and orderly markets.

  2. Help retail customers obtain a fair deal.

  3. Improve business capability and regulatory effectiveness of the financial overseer.

A financial overseer or regulatory body usually regulates most financial services markets, exchanges, and firms in its country, setting standards that financial institutions must meet. This body can take action against companies that fail to meet those standards. For example, in the UK, the Financial Services Authority (FSA) has been the single financial services regulator since 2001. Its powers were (and are) not all encompassing, but have grown since inception. For example, mortgage business has been regulated since November 2004, and general insurance activities since January 2005.

A regulatory body typically has wide-ranging powers to make and enforce rules, and to carry out investigations in order to attain the principles of financial services regulation. The regulator will attempt to assess and monitor the risk of an activity or a firm and ascertain whether it has the potential to cause harm in one of the following areas:

  • Market confidence;

  • Public awareness;

  • Consumers;

  • Financial crime.

The regulator is charged with maintaining confidence in the financial system; maintaining and raising public understanding of the financial system; protection of consumers; preventing and/or reducing financial crime; and negating the ways in which a business could be used for financially criminal activities. A regulator’s remit is broad, and as achieving one hundred percent compliance is nigh on impossible, it must prioritize its activities. Building on the three principles, a financial regulator must use its often limited resources in the most efficient and economic manner. The regulatory body typically produces regular reports on various aspects of a country’s financial systems; these may result in recommendations for changes in legislation or regulations, where loopholes or faults have been shown to exist.

In terms of companies themselves, the senior management is usually responsible for the business activities and ensuring compliance with the regulations, including risk management and internal controls, such as Chinese Walls. This principle has the objective of preventing unnecessary intrusion by the regulator into the business of a firm.

Financial regulation within a country is, of course, complicated by the international overlap of financial laws and markets. Thus, each country’s financial regulator must seek cooperation with those of other countries and reach joint agreement with international standards.

During the global economic turmoil of 2008, UK Prime Minister Gordon Brown appealed to world leaders to back the premise of an international supervisory body to restore order to the chaotic markets. His appeal was part of a long campaign to win support for more effective regulation of global capitalism.

Regulators must achieve all these goals while maintaining aspects of healthy competition, minimizing the cost to companies of compliance, and considering competition and innovation that can improve financial services for everyone.

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Further reading

Books:

  • Hood, Christopher, Henry Rothstein, and Robert Baldwin. The Government of Risk: Understanding Risk Regulation Regimes. Oxford: Oxford University Press, 2004.
  • Mishkin, Frederic S., and Stanley G. Eakins. Financial Markets and Institutions. 7th ed. New York: FT Prentice Hall, 2011.
  • Mills, Annie. Essential Strategies for Financial Services Compliance. Chichester, UK: Wiley, 2008.

Websites:

  • Federal Financial Institutions Examination Council (FFIEC; US): www.ffiec.gov
  • Financial Services Authority (FSA; UK): www.fsa.gov.uk
  • Securities and Exchange Commission (SEC; US): www.sec.gov

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