Chapter 10 Financial Regulation and Financial Innovation 10.1 The Regulation of Markets and Institutions Financial system is one of most intensely regulated sectors of the U.S economy. econo The reasons for regulation promoting competition protecting individual consumers assuring financial system stability facilitating monetary policy 10.1.2 The regulation of financial market in the U.S. Much of the regulation if U.S. financial markets is driven by the desire to protect individual investors and the philosophy that the best protection is the information about the securities in the marketplace. 1.The regulation of the primary market 2.The regulation of the secondary market 10.1.3 The regulation of commercial banks in the U.S. 1.The U.S. Banking Regulatory Structure Federal Deposit Insurance Corporation (FDIC) Regulations of nondepository financial intermediaries v How nondepositoryfinancial intermediaries are regulated depends very much on the types of liabilities they issue. v The Employee Retirement Income Security Act (ERISA) 2.Regulations to protect individual depositors and financial system stability Bank Examination Deposit Insurance Risk-Based Capital Requirements Prompt Corrective Action Risk-Based Deposit Insurance Premiums 3. Regulations of nondepository financial intermediaries Hownondepositoryfinancial intermediaries are regulated depends very much on the types of liabilities they issue. The Employee Retirement Income Security Act (ERISA) 10.1.4Where Securities Market and Banking Regulation Meet: The Glass-SteagallAct, A Collapsing Barrier The Genesis of Glass-Steagall The Erosion of Glass-Steagall The Risk of Universal Banking 10.2 The Causes of Financial Innovation The financial system has changed a great deal in recent years. Financial innovation has spawned new institutions, and new markets, thereby transforming conservative, old- fashioned industries like banking and insurance into the new and highly sophisticated financial services industry. 10.2.1 Circumventing Regulation qFinancial innovation is a means of avoiding regulation. qThe development of the Eurobond market also stems from regulation avoidance. qCircumventing regulatory constrains has been an important element in stimulating recent financial innovation. 10.2.2 Double-digit Inflation The double-digit inflation if the late 1970s and early 1980s had profound social and economic consequences, including stimulating innovations that have shaped the financial environment ever since. Fixed-rate mortgages →floating rate mortgages Zero-coupon bonds The development of widespread trading in the financial futures Interest rate swaps 10.2.3 Legislative Encouragement Regulative factors for negative reasons provided a stimulus to the financial innovation. However, government is not always such a negative force, in recent years, government has also made positive contributions to financial innovation. 10.2.4The Philosophy of Deregulation At least part of the credit (or blame) for the burst of financial innovation at this point in history must go to the widespread acceptance of what has come to be known as the philosophy of deregulation. 10.2.4 Technological change Technology is the traditional stimulus to change, and it is as powerful in financial markets as anywhere else. 10.2.6 necessity is the mother of invention New financial institutions, products, and markets come into use and remain there because of a demand for them.