Banking Regulations - Understanding the Dodd-Frank Act and the Basel Accord
International Journal of Finance 2020
10 Pages Posted: 9 Feb 2021
Date Written: November 2, 2020
Regulators of financial institutions in most parts of the globe are making impressive achievement in terms of regulating the behavior of banks on the level of risk they can take in making investment decisions. Professionals in the finance industry have made a huge impact in trying to regulate these too-big-to-fail banks by drawing close lens in their lending activities. Aside from the reserve requirements of banks, there is also a capital requirement that caught the eyes of the Basel accord.
This accord is extended from basel1 to basel2 and basel3. It came into existence as a result of the financial crisis in 2007. This crisis exposes a significant number of flaws in the financial system.
Before this crisis, banks did not want to hold the excess reserve and so there was hardly any excess reserve in most banks. As a result of this, the money market multiplier exemplifies and works quite well since the amount of reserve was just around 10% to 15% of transactions in most countries. Apart from the capital requirement they now hold up to 25% of liquid assets as reserve requirement which is included in the Basel three accords, which is the recent regulatory document of the Basel accord. The Basel accord required banks to hold capital as a fraction of their risk-weighted assets. This initially created disturbances in the United States and the G20 countries because the Basel accord is similar to credit rating in many countries. This credit rating was abolished by the Dodd-Frank act of 2010 and so most governments especially the United States were no longer making use of regulations related to credit rating.
Banks are required by the Basel accord to put a system in place that will regulate their loan facilities before they face a situation of negative capital. It is captured in this paper that the Basel accord will cut down on asymmetric information, externalities, and market power to avoid market failure. The off-balance sheet items are also taken into consideration by the Basel accord to reduce the high level of bank risk.
Keywords: Negative capital, Basel accord, excesses reserve, Dodd-Frank act, regulations, Liquid assets, credit rating.
JEL Classification: G01, G15, G21, G28, G32, G38
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