Regulation of Banking and Financial Services
The Failure Process Imposed Upon Financial Institutions
The concept of systemic risk sprung to the foreground of the public’s consciousness during the financial crisis of 2007-8 as the Too Big To Fail (TBTF) banks were bailed out by the various US Federal Government agencies e.g., US Treasury via the Troubled Asset Relief Program (TARP) and the US Federal Reserve via Quantitative Easing (QE). However, as it turns out, the concept of systemic risk is not so easy to define in legal terms—as illustrated by the difficulty in nailing down the definition by US Congress via the Dodd-Frank legislation or by the US Treasury and the Federal Deposit Insurance Corporation (FDIC) via regulation (Horton, 2012). One thing is certain—the public has no stomach for any further bailouts, thus, the era of TBTF banks and non-bank financial companies has ended.
The FDIC, under new regulatory powers granted by Dodd-Frank, will resolve systemically important bank and non-bank financial institution failures i.e., bank and non-bank financial institutions that become insolvent (Horton, 2012). This process is similar to the way that the FDIC utilizes its traditional regulatory powers to resolve non-systemically important bank failures. However, non-systemically important non-bank financial institutions continue to be able to utilize bankruptcy as an option to resolve insolvency (Smith, 2011). While the FDIC has the regulatory power to resolve systemically important bank and non-bank financial institution failures it [the FDIC] will not be able to utilize them until the next financial crisis, which means the FDIC’s primary role will be to resolve non-systemically important bank failures (Guynn, 2012).
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...solidation in the U.S. banking industry since Riegle-Neal. Journal of Business & Economics Research, 9(9), 71–78.
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Horton, B. J. (2012). When does a non-bank financial company pose a “systemic risk”? A proposal for clarifying Dodd-Frank. Journal of Corporation Law, 37(4), 815–848.
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A resolution passed by Congress was the Financing Corp. (FICO), created in 1987 to provide funding to the FSLIC. FICO contributed $8.2 billion in financing. Then came the enactment of FIRREA, The Financial Institutions Reform, Recovery and Enforcement Act by Congress in 1989, which began the taxpayer’s involvement. The large number of failures overwhelmed the resources of the FSLIC, so US taxpayers were required to back up the commitment extended to insured depositors of the failed institutions. As of Dec. 31, 1999, the thrift crisis had cost taxpayers approximately $124 billion. ( Curry et al. 2000)
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“Too big to fail” is a theory that suggests some financial institutions are so large and so powerful that their failure would be disastrous to the local and global economy, and therefore must be assisted by the government when struggles arise. Supporters of this idea argue that there are some institutions are so important that they should be the recipients of beneficial financial and economic policies from government. On the other hand, opponents express that one of the main problems that may arise is moral hazard, where a firm that receives gains from these advantageous policies will seek to profit by it, purposely taking positions that are high-risk high-return, because they are able to leverage these risks based on their given policy. Critics see the theory as counter-productive, and that banks and financial institutions should be left to fail if their risk management is not effective. Is continually bailing out these institutions considered ethical? There are many facets that must be tak...
The presence of systemic risk in the current United States financial system is undeniable. Systemic risks exist when the failure of one firm may topple others and destabilize the entire financial system. The firm is then "too big to fail," or perhaps more precisely, "too interconnected to fail.” The Federal Stability Oversight Council is charged with identifying systemic risks and gaps in regulation, making recommendations to regulators to address threats to financial stability, and promoting market discipline by eliminating the expectation that the US federal government will come to the assistance of firms in financial distress. Systemic risks can come through multiple forms, including counterparty risk on other financial ...
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Companies whose success and continuous operation prove vital to the economy and financial systems should receive auditor scrutiny and regulation oversight. It is clear that Lehman Brothers required oversight and possible prohibition of its liabilities financing practices using repo borrowing. Likewise, AIG deserved more review of its credit swap business practices. The negligence of these institutions cost the United States and foreign economies billions of dollars. The federal government chose not to intervene on Lehman Brothers’ behalf, for reasons that some say are inconsistent with other bailout decisions (Smith, 2011). However, the government did find that an AIG failure would constitute systemic risk and chose to rescue the insurance company. The government created incentives to increase depositor confidence by guaranteeing market-based fund-raising. The financial crisis of 2008 offered lessons learned to both government and banking
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2) Davis, Gareth. The Destruction of the Second Bank of the United States Rationale and
There is a vast amount of literature available on the additional procyclicality of regulatory capital charges in Pillar 1 of Basel II. In this section, we shall briefly visit this literature and see if any conclusions can be drawn from this, before proceeding to the conclusion and mitigation of these procyclical effects. The majority of the literature, as expected, focuses primarily on the IRB approach, as this aspect of Basel II has drawn the most criticism from financial practitioners and academics alike. The greater part of this literature has found that there is an overwhelmingly substantial rise in procyclicality of minimum regulatory capital charges originating from the IRB approach. Gordy and Howells found that under the IRB approach, volatility in the capital charge, relative to the mean, is between 0.1 to 0.26 (Gordy & Howells, 2004). This follows another study by Kashyap and Stein, which shows that capital charges rose by 70-90% during the years of 1998 to 2002 dependant of the model used to calculate PD’s (Goodhart & Taylor, 2004).
The "subprime crises" was one of the most significant financial events since the Great Depression and definitely left a mark upon the country as we remain upon a steady path towards recovering fully. The financial crisis of 2008, became a defining moment within the infrastructure of the US financial system and its need for restructuring. One of the main moments that alerted the global economy of our declining state was the bankruptcy of Lehman Brothers on Sunday, September 14, 2008 and after this the economy began spreading as companies and individuals were struggling to find a way around this crisis. (Murphy, 2008) The US banking sector was first hit with a crisis amongst liquidity and declining world stock markets as well. The subprime mortgage crisis was characterized by a decrease within the housing market due to excessive individuals and corporate debt along with risky lending and borrowing practices. Over time, the market apparently began displaying more weaknesses as the global financial system was being affected. With this being said, this brings into question about who is actually to assume blame for this financial fiasco. It is extremely hard to just assign blame to one individual party as there were many different factors at work here. This paper will analyze how the stakeholders created a financial disaster and did nothing to prevent it as the credit rating agencies created an amount of turmoil due to their unethical decisions and costly mistakes.
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