Essay on the Banking System and Risk Management

Banking can be defined as an industry that handles credits, cash, and other financial transactions. They provide a haven to keep extra credit and money. They also offer certificates of deposits, saving accounts, and checking accounts. Banks use deposits to make loans such as business loans, home mortgages, and car loans (Amadeo, 2017). Banking is one of the primary drivers of the economy in the U.S.A because they provide liquidity required for businesses and families to invest for the future. This offers families an opportunity to join college even if they had not saved the cash needed to enter higher education institutions. Moreover, companies get a chance to begin hiring immediately to build for future expansion and demand.

Banks function through borrowing funds- usually by borrowing or accepting deposits from the money markets. They borrow from businesses, individuals, government savings, and financial institutions ("The role of banks," 2017). Afterward, they use those deposits and borrowed money to give loans or buy securities. Banks offer loans to individuals, businesses, governments and other financial institutions that require the funds to make an investment or use it for other services (Amadeo, 2017). The process of taking deposits, giving loans, and responding to the signals provided by interest rates enables the banking sectors to channel money from savers to borrowers in an efficient manner. In my view, without banking, we would be forced to pay everything in cash, and we would lack somewhere to save our money, and this would be perilous. The cost of borrowing would be very costly since savers and borrowers would be required to meet each other personally and this would require a solicitor to draw up the contract. In this case, savers would lose money if the borrower is unable to pay the loan. This is not the case currently because banks absorb the losses when the borrower is unable to pay.

U.S. implemented Dodd-Frank Act to deal and curb financial crisis like the one which occurred in 2008. The Act caused limited alteration of the regulatory units. For instance, the Office of Thrift Supervision (OTS) that focused on controlling the banking sector that dealt with real estate lending, was dissolved. A systemic risk council of regulators and new consumer financial protection agency was formed. The Systemic Risk Regulation Act gives an early warning system by identifying market activities and identifying risks in corporations to facilitate an oversight of the financial system to harmonize prudential standards in all agencies. The Federal Reserve has more power over systemically important bank holding firms and non-bank financial firms that are viewed as vital in the financial system by the council. The Consumer Financial Protection Act gives the council involved the power to exercise the policies under to the law to protect all individual who are covered (Guynn & Polk, 2010). The banking organizations with assets worth over $10 billion and above have to face an exclusive rule-making and examination under the federal consumer financial law.

The reforms have been effective because they have highly increased the capital that banks should hold to make sure that taxpayers will never bail out any financial institution. Banks have started holding substantial higher liquid assets that will enable them to survive liquidity induced stress like the one experienced in 2007. Systemic Risk Regulatory Scheme employed threes ways to deal with financial risks. First, Systemically Important Bank Holding Companies Act states that bank holding firms assets worth $50 billion and over will automatically be subject to prudential standards. Second, Systemically Important Nonbank Financial Companies Act states that all non-bank financial forms should be identified and be treated as bank holding companies because they pose a significant threat to financial stability in the country. Lastly, Enhanced Prudential Standards Act requires the Federal Reserve to have a risk-based capital and a liquidity system, resolution plans, risk management system, and credit exposure reporting system that will apply to all systemically important firms (Guynn & Polk, 2010).

All banking companies are expected to comply with Acts that were formulated after 2008 economic crisis because nobody would like to witness the financial crisis experienced at that time. Financial institutions are to be fined in case they fail to comply with the set regulation. Most of the fine is in monetary terms, and many organizations have received small fines for failing to comply with the regulations over the years (regulations Conference & Challenge, 2017). The risks of prosecutions do not only lay on the financial institutions only, but individuals of the institutions can be prosecuted and be imprisoned where necessary. Although banks look at their liquidity and leverage level to avoid running out of business, they are faced with stiff competition which lures them to avoid complying with such requirements. Competition can make them start lending imprudently and even go ahead to lend more than what their assets can cater for in case of crisis (Cao, 2015). In my view, due to competition, some banks will not comply with the regulations in the long run, and this will make credit risk to build up in the system. It is the responsibility of the regulators to ensure that the policies are adhered to throughout the course of doing business.

The government should ensure that financial services companies continue to operate in a highly regulated environment to avoid an economic crisis from creeping back. The government should formulate policies that will be able to cater for financial institutions operating both locally and internationally. This would be a great move in preventing any financial crisis in this era where money is being transferred electrically worldwide.

References

Amadeo, K. (2017). Can You Imagine the World Without Banks?. The Balance. Retrieved from https://www.thebalance.com/what-is-banking-3305812

Cao, J. (2015). Insolvency Uncertainty, Banking Tax, and Macroprudential Regulation. Taxation and Regulation of the Financial Sector, 89-114.

Guynn, R., & Polk, D. (2010). The Financial Panic of 2008 and Financial Regulatory Reform. Corpgov.law.harvard.edu. Retrieved from https://corpgov.law.harvard.edu/2010/11/20/the-financial-panic-of-2008-and-financial-regulatory-reform/

Regulations?. W., 12-16, L., Conference, T., & Challenge, T. (2017). What happens when businesses don't comply with AML/KYC?. Trulioo: Global Identity Verification.

The role of banks. (2017). ING.com. Retrieved from https://www.ing.com/About-us/Profile-Fast-facts/The-role-of-banks.htm