CHAPTER 5

THE REGULATION OF FINANCIAL MARKETS AND

INSTITUTIONS
Outlines…..
 INTRODUCTION
OBJECTIVES OF FINANCIAL REGULATION
NATURE OF FINANCIAL SYSTEM REGULATIONS
ETHIOPIAN SCENARIO
 INTRODUCTION
• Financial regulation is a form of regulation or supervision, which subjects
financial institutions to certain requirements, restrictions and guidelines,
aiming to maintain the integrity of the financial system. This may be handled
by either a government or non-government organization. Financial regulation
has also influenced the structure of banking sectors, by decreasing borrowing
costs and increasing the variety of financial products available.
 Cont’d…
• Financial institutions are one of the most heavily regulated of all businesses
in the modern world.
• Around the globe, these financial service firms face stringent government
rules limiting the services they can offer, the territories they can enter, the
make-up of their portfolios of assets, liabilities and capital and even how
they price and deliver services to the public.
• Variety of reasons have been offered for government intrusion in to the
financial institutions sector, including protecting the public saving, fighting
inflation, insuring that consumers receive an adequate quantity and quality
of reasonably priced financial services, and protecting the privacy of the
public’s financial records.
 Cont’d…
• Many economists, financial analyst and financial institution have argued over
the years that regulation has done more harm than good for both financial
institutions themselves and for the public themselves. In particular,
government restrictions allegedly have allowed less regulated financial service
firms to invade the market place and capture many of the customers of highly
regulated financial institutions, who are not sufficiently free to compete
effectively, more over regulations are often back ward looking addressing
problems that have long since disappeared and they may compound this
problem of “ relevancy” by changing more slowly than the free marketplace,
in habiting the ability of regulated financial firms to stay abreast of new
technologies and changing customer tastes.
 Cont’d…
• Other observers, however, argue that government regulations have
achieved positive results in the financial institutors sector, redoing the
member of failed financial firms, promoting more stable financial markets,
and reducing the incidence of racial, religious, age and sex discrimination in
the public’s access to financial services.
 OBJECTIVES OF FINANCIAL REGULATION
• The objectives of financial regulators are usually:
 Market confidence – to maintain confidence in the financial
system
 Financial stability – contributing to the protection and
enhancement of stability of the financial system
 Consumer protection – securing the appropriate degree of
protection for consumers.
 Reduction of financial crime – reducing the extent to which it
is possible for a regulated business to be used for a purpose
connected with financial crime.
Regulating foreign participation in the financial markets.
 Cont’d…
• Reasons behind Regulations of Financial Institutions and Markets:
 Concern for the safety of the public’s funds.
 To promote public confidence in the system.
 To ensure equal opportunities and fairness in the public’s access to
financial services.
 To prevent excessive money creation, and hence excessive inflation.
 To aid “disadvantaged” economic sectors.
 To ensure that important financial services are provided reliably and at a
reasonable cost.
 Cont’d…
 Regulations provide the following benefits to FIs & FMs:

• Regulations subsidize the growth of financial institutions and protect them

from competition.
• Regulations tend to increase public confidence.
• Regulations spawn innovative escapes (regulatory dialectics) through
loopholes in the regulations.
 Regulations harm the FIs & FMs in the following respects:

• Regulatory dialectics are not the most productive form of innovation.

• The time and energy spent on regulatory compliance activities are costly.
 NATURE OF FINANCIAL SYSTEM REGULATIONS
A. Regulation of Commercial Banks:

• Due to their importance in the financial system, commercial banks are

typically the most regulated of all financial institutions.
• Responsibility for regulating U.S. banks today is divided among four
federal banking agencies –
• Federal Reserve System,
• Controller of the Currency,
• Federal Deposit Insurance Corporation – and
• state banking commissions of the 50 states.
 Cont’d…
i. Federal Reserve System:
• Supervises and regularly examines all member banks operating in the U.S.
• Imposes reserve requirements on deposits held by all depository
institutions and grants temporary loans of reserves.
• Must approve all applications of member banks to merge, establish
branches, or exercise trust powers.
• Supervises international banking corporations organized by U.S. banks
and foreign banks operating in the U.S.
• Regulates and examines all bank and financial holding companies in the
U.S.
• Conducts monetary policy to control the growth of money and credit in
the financial system.
 Cont’d…
ii. Controller of the Currency:
• Issues charters for new national banks.
• Must approve all national banks’ applications for
new branch offices, trust powers, mergers, and
consolidations.
• Regulates and regularly examines all national
banks.
• Declares insolvent national banks closed.
 Cont’d…
iii. Federal Deposit Insurance Corporation:

• Insures deposits of savings institutions and banks conforming to its

regulations up to $100,000, and acts as receiver for all national banks
declared insolvent and for state banks if requested by a state banking
commission.
• Must approve applications by insured banks to set up branches, merge or
exercise trust powers
• Requires all insured banks to submit reports on their financial condition.
 Cont’d…
iv. State Banking Commissions:

• Issue charters for new state banks.

• Supervise and regularly examine all state-chartered banks.
• Approve applications by state banks to form a holding company,
acquire subsidiaries, or establish branches.
 Cont’d…
B. Regulation of Non-Bank Institutions: Non-bank Thrifts such as Savings &
Loans Associations, insurance companies, and Credit Unions face regulations
in respect of:
• Chartering
• New Branches
• Mergers & Acquisitions
• Deposit Insurance
• Supervision
a. Regulation of Insurance Companies: While not quite as heavily regulated
as commercial banks, insurance intermediaries face tough regulatory rules
that are imposed primarily by state insurance commissions.
 Cont’d…
b. Regulation of Pension Funds: Because pension funds have risen rapidly to hold
the bulk of the retirement savings of workers, they are heavily regulated by the
courts and government agencies today.

c. Regulation of Finance Companies: The bulk of regulation of finance companies

is at the state level and focuses principally upon the making of consumer loans.

d. Regulation of Investment Companies and Mutual Funds: Investment

companies or mutual funds are regulated predominantly by the federal
government in the U.S., through the Securities Exchange Commission.
 ETHIOPIAN SCENARIO
Regulatory and Monitoring Authority vested in the central bank (National
Bank of Ethiopia) by means of exclusive Proclamation. Proclamations are
issued on:

• Banking Companies

• Insurance Companies

• Micro Finance Institutions

 Cont’d…
• NBE as a Monetary Regulator: As a regulator of the Monetary System of
the country, NBE does the following:

• Coin print or cause to be coined, printed and circulated the legal tender
currency

• dispose or cause to be disposed coins and notes issued legally

• regulate and determine the supply and availability of money and credit as
well as the applicable interest rates and other charges
 Cont’d…
• NBE – as a Custodian of Forex Res(foreign exchange reserve)
• formulate and implement exchange rate policy
• manage and administer the international reserves of Ethiopia
• set limits on gold and silver bullion and foreign exchange assets which
banks and authorized dealers can hold
• Set limits on the net foreign exchange position and on the terms and the
amount of external indebtedness of banks and other financial institutions.
 Cont’d…
• NBE – as a Regulator of FIs
• license and supervise banks, insurers and other financial institutions;
• Create favorable conditions for the expansion of banking, insurance and
other financial services.
• NBE – as a protector & facilitator
• make short term and long term refinancing facilities available to banks and
other financial institutions as might be necessary
• take such steps to establish, modernize, conduct, monitor, regulate and
supervise payment, clearing and settlement systems
• establish and manage deposit insurance fund
 Cont’d…
• NBE- Other Roles
• collect data from any person and prepare periodic economic studies, on
the balance of payments, money supply, price forecasts and other
relevant statistical indicators for analysis and for the formulation and
determination of monetary, saving and exchange policies as are useful to
Ethiopian economy
• Act as banker, fiscal agent and financial advisor to the Government
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