How does regulation help or hinder banks

The Office of the Comptroller of the Currency also monitors and regulates about savings and loan institutions. There are over 6, credit unions in the U.

The Federal Reserve also has some responsibility for supervising financial institutions. When the supervision of banks and bank-like institutions such as savings and loans and credit unions works well, most banks will remain financially healthy most of the time.

If the bank supervisors find that a bank has low or negative net worth, or is making too high a proportion of risky loans, they can require that the bank change its behavior—or, in extreme cases, even force the bank to be closed or sold to a financially healthy bank. Bank supervision can run into both practical and political questions.

These issues can become even more complex when a bank makes loans to banks or firms in other countries, or arranges financial deals that are much more complex than a basic loan. The political question arises because the decision by a bank supervisor to require a bank to close or to change its financial investments is often controversial, and the bank supervisor often comes under political pressure from the owners of the bank and the local politicians to keep quiet and back off.

A similar unwillingness to confront problems with struggling banks is visible across the rest of the world, in East Asia, Latin America, Eastern Europe, Russia, and elsewhere. In the United States, laws were passed in the s requiring that bank supervisors make their findings open and public, and that they act as soon as a problem is identified.

However, as many U. Back in the nineteenth century and during the first few decades of the twentieth century around and during the Great Depression , putting your money in a bank could be nerve-wracking.

In this situation, whoever withdrew their deposits first received all of their money, and those who did not rush to the bank quickly enough, lost their money. Depositors racing to the bank to withdraw their deposits, as shown in Figure 1 is called a bank run. The risk of bank runs created instability in the banking system. Even a rumor that a bank might experience negative net worth could trigger a bank run and, in a bank run, even healthy banks could be destroyed.

When the bank had no cash remaining, it only intensified the fears of remaining depositors that they could lose their money. Moreover, a bank run at one bank often triggered a chain reaction of runs on other banks. In the late nineteenth and early twentieth century, bank runs were typically not the original cause of a recession—but they could make a recession much worse. To protect against bank runs, Congress has put two strategies into place: deposit insurance and the lender of last resort.

Deposit insurance is an insurance system that makes sure depositors in a bank do not lose their money, even if the bank goes bankrupt. About 70 countries around the world, including all of the major economies, have deposit insurance programs. Banks pay an insurance premium to the FDIC. Bank examiners from the FDIC evaluate the balance sheets of banks, looking at the value of assets and liabilities, to determine the level of riskiness. The FDIC provides deposit insurance for about 6, banks as of the end of Since the United States enacted deposit insurance in the s, no one has lost any of their insured deposits.

This will mean there will be fewer bank failures in the future. View more You may also be interested in Would you like to give more detail? Press Spacebar or Enter to select. Our use of cookies We use necessary cookies to make our site work for example, to manage your session. Necessary cookies Analytics cookies Yes Yes Accept recommended cookies Yes No Proceed with necessary cookies only Necessary cookies Necessary cookies enable core functionality on our website such as security, network management, and accessibility.

Analytics cookies We use analytics cookies so we can keep track of the number of visitors to various parts of the site and understand how our website is used. Skip to main content. Home KnowledgeBank Why do we regulate banks? Why do we regulate banks? We want to keep the financial system stable and individual banks safe. When a bank fails, it can create problems for the wider economy. But why do banks fail? Banks can fail for a number of reasons, for example: If they make poor investment decisions and not enough profits so they go bust just like any company.

If people and companies who have put their money in a bank account take it out quicker than the bank can manage. How does regulation help? When the music stops, in terms of liquidity, things will be complicated.

A few months later, the music had stopped and a global financial crisis had taken hold. Can you stop a bank from going bust? What risks do banks take? The number of Central Bank staff doing this job has increased rapidly in recent years, leading to more in-depth supervision. How closely firms are supervised is based on how much risk they present to the financial system or to consumers.

The greater the potential harm, the closer the supervision. This is why we call it "risk-based supervision". Having rules and laws, and making sure financial services providers follow them, are the first two pieces to understanding financial regulation. Enforcement and resolution is the third. Where a firm is found not to be in compliance with the rules, we can take a number of steps. In serious cases, this can lead to the firm facing enforcement proceedings.

Having the credible threat of enforcement is essential to deter poor behaviour in the financial services sector. Finally, there are times when resolution is the only outcome. Resolution is the process of winding down or restructuring a financial institution in a way that minimises harm to the economy. Home Consumer Hub Explainers What is financial regulation and why does it matter? Explainer - What is financial regulation and why does it matter?

A well-functioning financial system is vital for the economy, businesses and consumers. What is financial regulation? These rules have strengthened significantly since the financial crisis Why is financial regulation important?