Foundations of Financial Risk: An Overview of Financial Risk and Risk-based Financial Regulation, 2nd Edition

CHAPTER 3 Banking Regulation

Chapter 3 introduces bank regulation and outlines the impact regulations have on bank operations. This chapter discusses why banks need to be regulated, what regulatory processes are in effect, how international coop­eration helps shape bank regulation, and what role deposit insurance plays in banking stability. Chapters 1, 2, and 3 together provide a comprehensive foundation for the remaining chapters.

Chapter Outline

• 3.1 The Evolution of Risk Regulation in Banking
• 3.2 Foundations of Bank Regulation
• 3.3 International Regulation of Bank Risks
• 3.4 Deposit Insurance

Key Learning Points

• When a bank lacks the funds to repay its depositors on demand, the bank is in a liquidity crisis. The mere rumor of a liquidity crisis could lead to a bank run—when a large number of depositors demand a return of their deposits from one bank simultaneously. If a bank run spreads to other banks, there is a contagion that has the potential to spread further panic and runs on other banks.
• Bank regulation seeks to ensure that banks are operated prudently, that nonsystemic risk is reduced, and that there are systemwide support mechanisms to assist banks and provide stability before they reach a cri­sis. Bank regulation achieves these objectives using two main tools: licensing, the granting of the right to operate a bank; and supervision, regulatory and recurring monitoring of the bank's operations and activities.
• The Basel Accords are the international regulatory frameworks ...