Categories of Regulation
Despite its ubiquity, financial regulation is not an undifferentiated mass of governmental intervention in the provision of financial services. There are a few important categories that can help in the understanding of the whys and the wherefores of financial regulation.
Prudential regulation. This type of regulation is reserved primarily for depository institutions (i.e., commercial banks, savings institutions, and credit unions), insurance companies, and defined-benefit pension plans (i.e., those in which a company has promised a retiree a specified monthly or annual sum).3 The goal of prudential regulation of these institutions is to maintain their solvency, so that their claimants will remain whole4 and so that the institutions themselves can function as major providers of credit to the rest of the US economy. The important comparison between a healthy (solvent) bank and an insolvent bank, shown in Tables 1 and 2, illustrates the goal of prudential regulation: maintain banks in the condition shown in Table 1, and avoid having banks incur losses so as to arrive in the condition shown in Table 2.
|US$100 (loans, bonds, investments)||US$92 (deposits)|
|US$8 (net worth, owners’ equity, capital)|
|US$80 (loans, bonds, investments)||US$92 (deposits)|
|−US$12 (net worth, owners’ equity, capital)|
Consumer safety regulation. This encompasses prudential regulation (as consumers often have their savings in banks, etc.) but goes substantially beyond, and includes disclosure requirements, limits on what can and cannot be sold, and licensing requirements for who can do the selling. Such requirements can apply to financial advisors, brokers, dealers, and accountants, as well as to the banks and other financial institutions.
“Economic” regulation. This usually involves limits on prices and/or profits and/or entry or exit. Examples include usury limits (i.e., a maximum interest rate that can be charged on a loan), limitations on where a bank can establish locations, and restrictions on what kinds of products or services a bank (or other financial institution) can offer. The motives underlying “economic” regulation are usually complex, sometimes encompassing antitrust and consumer protection considerations, but sometimes also just reflecting the successful lobbying of incumbents who fear competition (but who usually “dress up” their arguments in the language of consumer protection).