Why Do We Need Financial Regulation?


[1]  “The purpose of financial regulation is to improve upon the performance of financial markets relative to how they would perform driven solely by the forces of the private marketplace.” Banking is one of the most highly regulated industries within the United States.  We can understand the impact of regulation by taking a look at the history and evolution of the banking system through to the present day.

The Early Banking System

Since the early days of banking, the industry has faced many changes in regulation due to different needs arising throughout the years.  In the early days, government control was not favored among most of the original settlers who had come from countries where too much federal control was exerted.  Therefore the early banking system comprised of a multitude of different small banks printing their own currency, which would often fail and leave customers with lost funds.

It wasn’t until the First Central Bank of the United States was formed in 1791 that structure was brought to the system through direct involvement and backing of the federal government.  Unfortunately due to political pressure it failed, as did the second Central Bank for similar reasons.

The Dual Banking System » Regulation

The first major milestone in banking occurred in 1862 with the implementation of the National Bank Act.   [2]“The National Bank Act created a system of banks throughout the United States that were chartered by the federal government.  In 1865, an amendment to the act placed a tax on state bank notes, bringing all banks in the United States under federal supervision. However, a number of banks were exempt from the tax and continued under their state charters.”  The Act addressed four major provisions aimed directly at solving the most pressing problems of the time.  [3]“It (1) created national banks, (2) created the Office of the Comptroller of the Currency (OCC), (3) introduced the national banknote, and (4) established a system of required reserves.”  While the National Bank Act solved a lot of the problems evident throughout the early banking system, it wasn’t until the Federal Reserve Act of 1913 that issues addressing check clearing were addressed and the spread of federal reserve districts were established, which allowed for easier access to reserve funds.

Over the years it was apparent that regulations seemed to react from events that had happened prior and they were enforced to correct and maintain the system.  It wasn’t until the Great Depression, which followed the stock market crash of 1929 that specific laws were enacted to strengthen the banking system and re-instill ‘trust’ with the public.  The Glass-Steagall Act of 1913 [4] “created the Federal Deposit Insurance Corporation to provide insurance to depositors and restore confidence in the banking system.”  Further regulation continued with the Banking Acts of 1933 and 1935, “which attempted to reform various banking abuses.”

De-Regulation » Regulation » De-Regulation

By the 1980s, banks were finding difficulty in competing with other non-traditional financial organizations that weren’t subjected to the same amount of regulation.  Certain laws were passed to assist the industry including the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Depository Institutions Act of 1982.  Both of these forms of de-regulation “diminished the distinctions between banks and other financial institutions in the United States.”  Some have argued that this lead to the failure of savings and loans institutions in the 1980s through deteriorating loan portfolios and narrowing interest spreads due to overall inexperience with new deposit and loan products.

A swing back to regulation occurred to address the problems from the 1980s through the financial Institutions Reform, Recovery and Enforcement Act which 3“completely restructured the S&L insurance system to restore the public’s confidence in the S&L industry.”  This was followed by the Federal Deposit Insurance Corporation Act of 1991 (FIRREA) to further improve the S&L industry.

Competing in the Modern World

Further de-regulation occurred at the end of the 20th century in the form of The Gramm Leach Bliley Act of 1999.  [5]The Act was introduced to facilitate affiliation among banks, securities firms and insurance companies.  It repealed many of the provisions set out by the Glass Steagall Act allowing for greater flexibility in providing a broader range of financial services.

The idea behind providing non-traditional services is in an effort to build a ‘one-stop shop’ for all financial needs.  This would range from the traditional functions of loans and deposits, to home and car insurance, sale of securities, retirement plans, and many other areas.  The Gramm Leach Bliley Act also would give smaller banks the opportunity to form ‘affiliate’ partnerships with other organizations.  For example a bank could offer financial advisory services, insurance, retirement plans through another corporations partnered under one roof in a mutual profitable agreement.

The Future of Banking and Regulation Laws

Many larger financial institutions and recently through outsourcing community banks are following in the online services environment.  Electronic banking has become the fore-front of modern financial services almost to the point where the customer expects his or her financial institution to either offer 24 hour telephone-banking or online services.  Technology is becoming cheaper and easier to implement and even though for some banks it may not be as profitable as hoped, many see the web as a defensive strategy.  So where does this leave regulation that has so greatly effected the banking system in the past?  The OCC has released “regulation regarding electronic banking activities by National Banks’ on their website.  This is still a very new area and no doubt we will see many changes in years to come.

One area of concern is the alarming rate of hacking and ‘Identity Theft’ cases surfacing across the country.  “Phishing is one of the latest cons used by high-tech criminals to facilitate one of America’s leading forms of fraud – Identify Theft.”  Unfortunately most of the victims who fall prey to such scams are older people or those with little exposure to the technology.  Other changes in the industry are currently ongoing due to technology.  The recent enactment of “check 21” which legalizes an electronic signature and facilitates the electronic transfer of checks along with other changes in the future will be effected by both regulation and political pressure in general.  Historically regulation has reacted to many events which prompted a need for some legislation, it will be interesting to watch how events unfold in the future of the financial services industry.


  • [1] Assessing the impact of regulation on bank cost efficiency – http://www.findarticles.com/p/articles/mi_m3888/is_n2_v22/ai_20950037
  • [2] Banking in the United States – http://en.wikipedia.org/wiki/United_States_Banking
  • [3] An Overview of the financial Services Industry
  • [4] Law and Banking Principles
  • [5] Gramm Leach Bliley: Summary of Provisions – http://banking.senate.gov/conf/grmleach.htm

About the author

Ian Carnaghan

I am a software developer and online educator who likes to keep up with all the latest in technology. I also manage cloud infrastructure, continuous monitoring, DevOps processes, security, and continuous integration and deployment.

About Author

Ian Carnaghan

I am a software developer and online educator who likes to keep up with all the latest in technology. I also manage cloud infrastructure, continuous monitoring, DevOps processes, security, and continuous integration and deployment.

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