Global Financial Regulatory Reform

By M. Isi Eromosele

In the face of the continuing global economic crisis, the global financial regulatory structure in the United States needs to be entirely reorganized in order to be more integrated and efficient. A global crisis necessitates a wholesomely global solution. The United States financial system is an integral part of the general global system.

It is imperative that there needs to be close collaboration between U.S. regulators and their regional and international counterparts. The need for this cooperation is irreproachably clear. The financial crisis occurred because of the lack of effective regulations. The banking sector is one of the most regulated areas of the financial industry. However, those regulations were not effectively applied.

The needed reforms should be focused on two areas - regulatory effectiveness and regulatory coverage. These reforms would need to be based on fundamental financial principles rather than on political expediency. A major goal would be reduce systemic risk. When an important institution within the financial system is at the risk of failure, especially if this would trigger a disastrous domino effect, there could be instances when a rescue would be affected with public funds.

The following are recommendations on improvements that would be the basis for the necessary financial regulatory reforms:

Amend Capital Requirements

The performance of capital regulations in place during the recent financial crisis was weak and inefficient. The plan and matter of the regulatory capital framework in place is flawed. The structure of this plan could not prevent the failure of numerous financial institutions both in the United States and in other developed nations around the world. In fact, it was the basic leverage ratio that was debatably a more reliably constraint on the crisis being more severe, rather than the complex Basel II system. Thus, it can be stated that complicated regulations do not make effective regulations. Capital requirements regulations are a firewall against bank failures and a trigger waning for systematic risk. An improved capital regulation, in combination with strong supervision and market discipline would be the appropriate mechanism.

Alter Financial Resolution Procedures

The bankruptcy process should not be the only option available for solving the liquidation of financial institutions. The structure for banks needs to be expanded to cover other financial institutions and their holding companies. A better process would be to give the resolution of financial institutions in the hands of regulators rather than bankruptcy judges. This would provide a more flexible approach to systematically keep significant institutions buoyant.

It also ensures a more reasonable approach to handling the remedy of counterparty exposures to derivatives through the use of safe harbors. Additionally, it will allow, like bankruptcy, the reorganization of an institution through the purging of equity and the reorganization of debt, to arrange for the sale of the financial institution to new investors.

Regulation of Non-Bank Financial Institutions

The present framework has significant gaps in the scope and coverage of regulation - gaps that could increase the resultant possibility of upset in the financial system. There had been no supervision of hedge funds and private equity firms. The supervision of investment banks by regulators has been woefully ineffective. As a result, some major investment banks have failed and others have been acquired or become bank holding companies. There is an absolute need for a complete move to regulating systemic risk in the financial sector, to avoid catastrophic events in the future.

There has to be particular focus toward regulating hedge funds and banks that engage in hedge fund and private equity firms. Hedge fund companies and banks that engage in hedge fund activity need to be closely supervised, with requirements that commit them to reporting their activities to regulators at set intervals. Large private equity firms should be subjected to regulatory oversight and required to report to regulators periodically to confirm that they are engaged only in the private equity business.

There needs to be improved regulation of money market mutual funds (MMMFs), which comprise approximately $3.8 trillion of the more than $9 trillion in the mutual fund industry. The MMMF plays a significant role in the United States financial system, serving as both an investment vehicle and a cash management device.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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