Regulation: The Double Edged Sword

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Financial Regulation - The Dodd-Frank Act
The Dodd-Frank Financial Regulatory Reform Bill was named after Senator Christopher J. Dodd and U.S. Representative Barney Frank. It restricts the types of proprietary trading activities that financial institutions will be allowed to practice. The Dodd-Frank Financial Regulatory Reform Bill was passed with the intent of preventing the collapse of major financial institutions such as Lehman Brothers from happening again. Photo: Gwydion M. Williams

The fundamental challenge that was seen after the global financial crisis of 2008 was the fact that there was a need for regulation. The same sentiment was heard when the banks started using dangerous strategies and trades in order to maximise their profit which was based on higher risk. Their preference for these strategies was undesirable, however, under the new rules and regulations, it was permissible and given the false sense of security by the markets, they did not need a second chance to invest and reap higher returns for their funds.

The bringing down of Glass-Steagall Act (1933) in the 1990’s mean those banks could also run investment banks and commercial banks under the same roof which meant that the greed of greater profits was the main focus. The need for regulation was needed and something had to be done to stop the bleeding. This time can be compared to post 9/11 America where some rule or law had to be put in place to correct the situation. There it was the Patriot Act and in this case it was the Dodd Frank Act. The effectiveness of the patriot Act was difficult to measure.

The long clean sweep that characterised its main characteristics did lead to more red tape in different areas; however, there is still doubt whether it has been helpful in the bigger picture. Comparing this to the Dodd Frank Act though it has one good point. The fact that the Patriot Act was passed and is in the books in the spirit and intent that it was meant for. Dodd Frank is not. The passing of this act has been laborious and filled with obstacles. From the way it was made toothless and ineffective over time on the Senate and House floor to how it has been passed has been a story in itself.

Still, it has been passed and it can be implemented by the different regulatory bodies in place. The slow process with which it is being implemented in another black mark against the regulatory bodies for not doing enough that is required right now. The crushing blow comes now when some of the rules and regulations have been enacted and the pain is being felt by the traders. The performances of banks and different institutions have been hit hard by the new laws and the shareholders are now raising concern about how the returns have plummeted in the recent years.

It seems that the investments being made are not leading to the same amount of return as they did before and it is not worth investing in a bank based on its dividend yield. Before the laws were put in place, banks were a dividend driven stock due to their safe price ranges and investors were satisfied with the returns from their investment. This has changed. Higher cost of capital requirements and structural changes that have been put in place have increased the cost structure for the banks and if this goes on any further, loans would be withdrawn or banks might have to be closed to cut down costs.

This is the cost of regulations that was feared by the capital markets when regulations were being thought about. The fact that it makes it more damaging is that the problem that caused the regulations to be put in the first place has still not been dealt with while investors are still paying the price for it. In addition to that, risk of higher cost and closing of branches adds chances of bank runs and makes investment even riskier.

Regulation is always a difficult task to carry out and there has to be a balance struck which makes sure that only the culprits are caught with low cost for the other stakeholders. In this case, regulators should also try to strike that balance before these laws are passed. The problem that lead to the financial crisis was not only due to the banks over reaching their limits, it was also due to other bodies pursuing their own interests. By scapegoating just one of the parties involved, the regulators would not be able to curb another crisis in the future while also losing support from the banking industry. They should go for a more holistic approach to this problem rather than for a short term solution in order to prevent another crisis in the future.

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