The Basic Objectives of Banking Regulations

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At various times, the U.S. government has decided to implement regulations of various financial sectors. After the onset of the Great Depression, many new banking regulations were created, and following the 2008 financial crisis, regulations affecting the banking sector and other areas of the financial marketplace were put into place. Many of these laws and regulations are complex and may be confusing. Understanding their objectives, however, can help you better understand the intended applications.

Confidence of Depositors

  • One of the primary objectives of the bank regulations enacted following the Great Depression was to ensure the confidence of depositors. One of the catalysts of the Great Depression was fear over the security of money deposited in banks. The lack of confidence led to runs on banks, which quickly ran out of financial reserves. By regulating the management of bank finances and the level of reserves a bank has on hand, the government seeks to ensure depositor confidence, avoid similar runs on banks and encourage active participation in the national financial system.

Prevention of Risky Behaviors

  • Banks make money by investing deposited funds in various activities, typically loans to businesses and individuals. Every loan carries some level of risk. The more risk involved in a financial transaction, the greater the potential reward. Those rewards can be very tempting for banks, and one objective of banking regulations is to restrict the level of risk to which a bank may expose itself. If a bank were to become involved in too many risky investments, it would endanger the money of depositors.

Prevention of Criminal Activity

  • Many bank regulations require banks to notify the government of deposits over a certain dollar amount or of any suspicious banking activity by the bank's customers. Money is a means and an end to many criminal activities, such as drug trafficking and international terrorism. By restricting the financial freedom of criminal and terrorist organizations, the government seeks to reduce the strength of such groups. Regulating banks to ensure they are not knowingly or unknowingly helping criminal groups hide or distribute money is one way of doing this.

Directing Credit

  • Many bank regulations require or encourage extension of credit to certain industries or classes of loans that are deemed socially desirable. For example, a bank regulation might provide incentives to encourage loans to minority-owned businesses or students pursuing higher education. Just as the tax code promotes social policy with preferential tax treatment of certain activities, bank regulations promote social policies that have certain requirements and incentives.

References

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