The Cost of Bank Regulation

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Abstract This paper aims to analyze the impact of bank regulations on consumers of bank services. It clearly explains how these regulations negatively affect the delivery of bank services to the consumers and the cost they impose on consumers. The research also reveals why it is productive for bank regulations to be in place for the benefit of bank customers and the entire banking system. Data used in this research was sourced from Richard L. Peterson the author of The Costs of Consumer Credit Regulation and the President of Federal Reserve Bank of Philadelphia, Anthony M.Santomero and other Internet sources. It also suggests what should be done to ensure that these bank regulations are a success. i. Introduction ii. Body a) Definition of a bank, and bank regulation b) Reasons for Bank Regulation c) Types of financial services offered by banks d) Are the benefits of bank regulations outweighing the costs to both individuals and non-financial business corporations? e) Conclusion Bank regulation has become an important practice in global financial systems because banks rank high on the means used to accumulate, store and transfer susceptible yet crucial resources between people hence the need to protect, and secure these resources. A bank is a financial institution used to receive, lend, exchange, and safeguard money, issue notes (sometimes) and transact other financial business.1 Banks are useful in resource allocation, wealth accumulation, risk management, money transfer, credit and payment services.3 As financial institutions, banks offer several services to the customers in question. The magnitude of services offered however depends on the potency of the bank driven by its capital base and structural investment. Most commercial banks offer personal and business services to individuals. These include; savings accounts, credit and debit card accounts, automatic transfer services, and, among others.2 Regulations as sets of principles, rules or laws that are designed to control conduct. Therefore bank regulations are principles or laws that are designed to control bank operations.3 Examples of such regulations in the United States include the Equal Credit Opportunity, which prohibits creditors from discriminating against credit applicants, Prohibition against Payment of Interest on Demand Deposits, Truth in Lending_ and the Reserve Requirement, which imposes uniform reserve requirements on all depository institutions with transaction accounts or non-personal time deposits among others.4 Regulations are put in place to ensure that banks are ethical in transacting business while maintaining the highest standard in the banking systems with a purpose of securing a stable, effective and sound economy. Regulators' focus is on limiting the individual institution's risk exposure and insulating the financial system from contagion, should an individual institution falter. They concentrate on limiting the effects by imposing prudent rules on institutions and providing deposit insurance and other guarantees on liabilities as a way of reducing faults in financial institutions.5 The answer to whether the benefits of bank regulation are outweighing the costs to individual and non-business bank clients is very contentious. This is because bank regulation generates very rational benefits to consumers and the economy, as they deal with limitations that are likely to negatively affect the delivery of bank services. But an in-depth analysis of their impact exposes an overwhelming number of loopholes that they generate in practice. In his article, The Cost of Consumer Credit Regulation Richard L.Peterson (1979) explains that costs unfold in two dimensions, pegged on a timeframe. “In the short-run commercial banks and taxpayers bear the costs of the regulations and enforcement.” It is consumers who bear various costs of regulation in the longer-run. He further breaks the costs down as direct compliance and indirect compliance. “Direct compliance costs include costs associated with developing, implementing and operating loan application, processing, granting and collection procedures that are in compliance with applicable laws and regulations. Indirect costs associated with consumer credit regulations show up in the form of efficiency losses.” Peterson identifies the Equal Credit Opportunity Act (ECOA) as a good example of an indirect cost. That Act prohibits the collection of certain "sensitive" information from credit applicants unless the information is used for statistically sound affirmative action purposes.6 Bank managers who find consumer loan activities more costly, less efficient and, therefore, less profitable to operate will either curtail such operations and divert their capital to more profitable operations or else take steps to increase the profitability of their consumer loan operations. Profit increasing steps would likely include either raising consumer loan charges or reducing credit losses by rationing credit only to the best credit risks among their consumer loan applicants. Eventually, consumers will either have to pay more to obtain credit in the more highly regulated environment or, forego essential commodities they may wish to acquire because they have filed to secure credit.7 Peterson also argues that since some regulations are enforced with tax increases, some banks will be forced to compensate for profitability by levying higher bank fees and charges. Consumers who are affected by such decisions end up with reduced income. At the end of the day, even shareholders who have stakes in institutions that are affected by the increase in fees and bank charges will take home, reduced profits and lose some wealth. But for any bank to be a in the best position to offer these services to their customers without any form of exploitation, some economists argue that it is important that they adhere to certain principles that guide their operations. As much as bank regulations are a source of a stable and secure banking system, they cannot work in the interest of government or one party. Policies that bend the financial sector to better serve one constituency inevitably divert it from serving other constituencies. Choosing among policies amounts to allocating costs and benefits among competing interests. Those are political decisions for each country to make. Regulations cannot work to achieve success if they don't serve the interests of both the bankers and cus

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