This essay discusses the developments in banking regulation that are currently being discussed and put in place on account of the global financial and economic crises. With banks, primarily in the United States but also in other developed nations, being the epicentre of the global banking crisis, recent years have been marked by extreme concern among individuals and organisations across the globe on the causes of the economic crisis, the role of banks in the financial crisis, the reasons behind the collapse of huge and well regarded banks, and the existing and proposed banking regulatory system (Dam, 2010, p 581). This essay investigates the reasons behind the financial crisis, the contribution of banks to the crisis, the regulatory failures and gaps that led to the development and exacerbation of various problems, and the regulatory changes that are underway in order to ensure appropriate safeguarding from such crises in future.
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The study also analyses the merits and demerits of the implemented and proposed changes and suggestions for the improvement of effectiveness of banking regulation in future. The study is structured into sequential sections that take briefly detail the developments leading to the financial crises, the regulatory failures and gaps that facilitated the development of the crises, the changes that are being brought about in the regulatory environment and areas that need to be considered whilst making such regulatory changes.
The sub-prime crisis developed mainly because of the unsuitable and perilous usage of financial processes like securitisation, a method used by commercial and investment banks to club their loans, switch them into saleable assets, and thereafter transfer these loans, irrespective of their risk element, to others (Kling, 2009, p 21). Banks earn substantial money from the interest on their loans but need to tie up their capital for long periods of time in such assets (i.e. interest bearing loans) (Kling, 2009, p 21). Securitisation, widely perceived to be the single most significant financial innovation of contemporary times, enables banks to offload their risk and exponentially enhance their cash flows (Kling, 2009, p 21). The availability of the securitisation route led banks to engage in indiscriminate lending to borrowers with doubtful repayment capabilities (Kling, 2009, p 21). Banks, in order to engage in extensive lending to such people, not only borrowed extensively but also engaged in diverse types of investment banking that concerned the purchase, sale and trade of risks (Kling, 2009, p 21). The collapse of the housing bubble in the United States resulted in erosion of confidence in banks and numerous banking collapses, not just in the fraternity of investment banks whose members had low deposit bases, but also among larger banks that had very substantial capital reserves (Robinson &
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