Finance and Financial Markets

Third Edition

by Keith Pilbeam

Chapter 18 - Regulation of the Financial Sector

Find an overview and useful learning resources below to accompany Finance and Financial Markets chapter eighteen.

Chapter Introduction

No analysis of financial markets and institutions can be complete without an examination of the regulatory environment in which they operate. Not only does regulation have a major impact upon the operation and developments of financial markets, regulation itself is often revised and adjusted in response to changes in market structure, financial market developments, new financial instruments and the occasional financial scandal or crisis. Effective regulation is seen by the authorities not only as a means of exerting some degree of control over the markets, but also as a means of maintaining confidence and stability in the financial system.

In this chapter, we look at the rationale for government intervention in financial markets including a brief cost–benefit analysis. Throughout, the main emphasis is on the banking sector which has traditionally been the most regulated part of the finance industry. We look at the objectives and various types of government regulation of financial markets. We then focus on three key pieces of UK legislation, followed by some analysis of European regulation and finally a look at global regulation in the form of the Basel Accords. We finish by looking at regulatory issues raised by the credit crunch.

Learning Objectives

In this chapter you will learn about:
  • ​The rationale for government intervention in the financial sector
  • Different types of government intervention
  • Key pieces of UK and European legislation
  • The respective roles played by the Financial Services Authority (FSA) and the Securities Exchange Commission (SEC)
  • The Basel I and Basel II Accords
  • Regulatory issues arising as a result of the credit crunch

Further Reading

Buckley, R. (2008) International Financial System: Policy and Regulation, Kluwer Law International.

Busch, A. (2009) Banking Regulation and Globalization, Oxford University Press.

Eatwell, J. and Taylor, L. (2001) Global Finance at Risk: The Case for International Regulation, New Press.

Padoa-Schioppa, T. (2004) Regulating Finance: Balancing Freedom and Risk, Oxford University Press.

Schooner, H. and Taylor, M. (2010) Regulation of Global Banking: Principles and Policies, Academic Press.

Palaez, C. (2010) Regulation of Banks and Finance: Theory and Policy After the Credit Crisis, Palgrave.

Spencer, P.D. (2000) The Structure and Regulation of Financial Markets, Oxford University Press.

Steinherr, A. (1992) The New European Financial Market Place, Longman.

Revision Questions

  1. Discuss the rationale for government intervention in financial markets, making reference to the problems of externalities, asymmetric information, moral hazard and the principal–agent issue.
  2. Briefly discuss the differences between structural, prudential and investor protection regulations.
  3. Discuss the different types of regulations that are imposed on banks by the regulatory authorities.
  4. What are the pros and cons of self-regulation compared to statutory regulation of financial institutions?
  5. What were main provisions of the Second Banking Directive of 1989 and what new concept did it introduce compared to the First Banking Directive of 1977?
  6. What were the main provisions of the 1988 Basel Accord and what criticisms have been levelled against the Accord?
  7. What is the key thinking behind the Basel II Accord?
  8. Discuss four key issues for regulatory reform in the light of the credit crunch.

Multiple Choice Questions

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