Government regulation affects the financial services industry in many ways, but the specific impact depends on the nature of the regulation. Increased regulation typically means a higher workload for people in financial services, because it takes time and effort to adapt business practices that follow the new regulations correctly.
While the increased time and workload resulting from government regulation can be detrimental to individual financial or credit services companies in the short term, government regulations can also benefit the financial services industry as a whole in the long term. The Sarbanes-Oxley Act was passed by Congress in 2002 in response to multiple financial scandals involving large conglomerates such as Enron and WorldCom.
Key Takeaways
- Government regulation can affect the financial industry in positive and negative ways.
- The major downside is that it increases the workload for people in the industry who ensure regulations are adhered to.
- On the positive side, some regulations help hold companies accountable and increase internal controls, such as the 2002 Sarbanes-Oxley Act.
- The SEC is the main regulatory body for the stock market, protecting investors from mismanagement and fraud, which boosts investor confidence and investment.
The act held senior management of companies accountable for the accuracy of their financial statements, while also requiring that internal controls be established at these companies to prevent future fraud and abuse. Implementing these regulations was expensive, but the act gave more protection to people investing in financial services, which can increase investor confidence and improve overall corporate investment.
Regulations That Affect the Stock Market
The Securities and Exchange Commission (SEC) regulates the securities markets and is tasked with protecting investors against mismanagement and fraud. Ideally, these types of regulations also encourage more investment and help protect the stability of financial services companies. This does not always work, as the financial crisis of 2007 demonstrated. The SEC had relaxed the net capital requirement for major investment banks, allowing them to carry significantly more debt than what they had in equity. When the housing bubble imploded, the excess debt became toxic and banks started to fail.
There's a fine line between over and underregulation, where overregulation hampers innovation and underregulation can lead to widespread mismanagement.
Regulations Affecting the Financial Industry
Other types of regulation do not benefit financial services or asset management at all but are intended to protect other interests outside of the corporate world. Environmental regulations are a common example of this. The Environmental Protection Agency (EPA) often requires a company or industry to upgrade equipment and to use more expensive processes to reduce environmental impact. These types of regulations often have a ripple effect, causing tumult in the stock market and overall instability in the financial sector as the regulations take effect. Companies often try to shift their increased costs to their consumers or customers, which is another reason why environmental regulations are often controversial.
Government regulation has also been used in the past to save businesses that would otherwise not survive. The Troubled Asset Relief Program was run by the United States Treasury and gave it the authority to inject billions of dollars into the U.S. financial system to stabilize it in the wake of the 2007 and 2008 financial crisis. This type of government intervention is typically frowned upon in the U.S., but the extreme nature of the crisis required quick and strong action to prevent a complete financial collapse.
The Government and the Financial Industry
The government plays the role of moderator between brokerage firms and consumers. Too much regulation can stifle innovation and drive up costs, while too little can lead to mismanagement, corruption, and collapse. This makes it difficult to determine the exact impact government regulation will have in the financial services sector, but that impact is typically far-reaching and long-lasting.
FAQs
Too much regulation can stifle innovation and drive up costs, while too little can lead to mismanagement, corruption, and collapse. This makes it difficult to determine the exact impact government regulation will have in the financial services sector, but that impact is typically far-reaching and long-lasting.
How does government regulation affect the industry? ›
Government regulations are necessary for businesses to protect employees, consumers, and the public and ensure compliance with market rules. Regulations such as tax codes, employment and labor laws, antitrust regulations, and advertising regulations are essential for businesses to operate ethically and responsibly.
What effect does government regulation have on businesses responses? ›
Explanation: The effect of government regulation on businesses is that it takes away some economic freedom from businesses to ensure economic freedom for consumers. This means that the government imposes laws and regulations on businesses to protect consumers and ensure fair competition.
What are the arguments for and against the regulation of the financial industry? ›
Stiglitz holds the view that “a better-regulated financial system would actually be more innovative in ways that mattered”. An argument against regulation is that it makes firms less efficient because they have to bear the cost of compliance.
How and why does the government affect the operation of a financial institution? ›
The government affects financial institutions through regulations and monetary policy, controlling the money supply and interest rates to ensure stability and protect consumers. An example is the role of the Federal Reserve in setting policy and supervising banks.
How does the government regulate the finance industry? ›
Federal, state and local governments have agencies that regulate and oversee all financial markets. These financial regulators enforce applicable laws, work to prevent market manipulation, test the competence of financial service providers, conduct regular inspections, and investigate and prosecute misconduct.
What is the government's role in regulating financial markets? ›
Governments play a substantial role in the financial world. They can issue currency, change interest rates, and issue bailouts, In addition, governments impose regulations, subsidies, and taxes. All of these measures can have immediate and long-lasting impacts on companies, industries, and markets at large.
How does government regulation or involvement impact the economy? ›
Governments influence the economy by changing the level and types of taxes, the extent and composition of spending, and the degree and form of borrowing. Governments directly and indirectly influence the way resources are used in the economy.
Why is it important for the government to regulate businesses? ›
The Purpose of Government Regulation of Business
The U.S. government has set many business regulations in place to protect employees' rights, protect the environment and hold corporations accountable for the amount of power they have in a very business-driven society.
What are the negative effects of government regulations? ›
Many regulations directly increase the cost of employing workers and thereby act like a hidden tax on job creation and employment. Among such regulations are minimum wage laws and federal labor laws.
While there are benefits to being regulated, including the protection of workers and the promotion of competition and innovation, there are also drawbacks, including the costs of compliance and the potential for stifling innovation and competition.
Why is the financial industry so regulated? ›
Monitors safety and soundness of chartered institutions. Ensures that financial institutions are operating within the law. Protects their communities from illegal and predatory practices. Promotes local economic growth.
What are the arguments against government regulation? ›
Examples of common complaints include the claim that minimum wage laws impose high labor costs, that onerous regulation makes it difficult for new entrants to compete with existing business, and that bureaucratic processes impose high overhead costs.
How does the government impact banks? ›
Regulators have broad powers to intervene in troubled banks to minimize disruptions. Regulations are generally designed to limit banks' exposures to credit, market, and liquidity risks and to overall solvency risk.
What are the financial factors that impact the financial condition of a government? ›
Financial factors include intergovernmental constraints such as tax and debt limits, access to major revenue sources (such as sales tax), and mandated expenditure requirements. These fiscal constraints often limit the choices available to local officials in managing their budgets.
Why does the government regulate financial markets for two main reasons? ›
As studied in Chapter 2, governments regulate financial markets primarily to promote the provision of information and to ensure the soundness of the financial system. This regulation is extensive in the United States and in all other highly industrialized economies.
Why does the government regulate industry? ›
The Purpose of Government Regulation of Business
The U.S. government has set many business regulations in place to protect employees' rights, protect the environment and hold corporations accountable for the amount of power they have in a very business-driven society.
How does government regulation affect the food truck industry? ›
Regulations and Restrictions
The food you plan to serve needs to be approved by the health department. If your kitchen is insufficient to safely prepare your chosen menu items, you won't be able to sell it. Food trucks must obey all local laws and posted road signs just like any other vehicle.
Why is it important that the industry is regulated? ›
Regulatory compliance is essential because it helps ensure businesses operate legally and ethically. It also protects customers, stakeholders, and the environment from harm caused by non-compliant activities.
