What is financial regulation and why does it matter?

Financial regulation has become a matter of great public interest after the financial crisis, though it has always been a key (but rather ‘technical’) public policy. It pursues a variety of objectives, the most important of which is to preserve financial stability. The global financial crisis highlighted some problematic issue, which have only partly been addressed by the regulatory reforms that followed the crisis

Financial regulation refers to the rules and laws firms operating in the financial industry, such as banks, credit unions, insurance companies, financial brokers and asset managers must follow. However financial regulation is more than just having rules in place – it’s also about the ongoing oversight and enforcement of these rules. Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions, and guidelines, aiming to maintain the stability and integrity of the financial system. This may be handled by either a government. Financial regulation has also influenced the structure of banking sectors by increasing the variety of financial products available.

The objectives of financial regulators are usually

• Market confidence – to maintain confidence in the financial system
• Financial stability – contributing to the protection and enhancement of stability of the financial system
• Consumer protection – securing the appropriate degree of protection for consumers.

Why is financial regulation important?

All of us depend on the financial system in one way or another. For example, savers rely on banks to have their money available when they need it. Businesses need to be able to borrow to maintain and develop their business. Consumers taking out a mortgage or insurance may need to get advice on the best product for them. In the case of insurance companies, policyholders rely on getting claims paid when something goes wrong.

Poorly regulated financial institutions have the potential to undermine the stability of the financial system, harm consumers and can damage the prospects for the economy. That’s why strong financial regulation is important – to put rules in place to stop things from going wrong, and to safeguard the wider financial system and protect consumers if they do go wrong.

How does financial regulation work?

Ensuring firms have the funding to trade safely, have the appropriate risk controls in place and are appropriately governed is known as “prudential regulation”.

Ensuring firms treat customers fairly from the sales process to how complaints are managed, is known as “consumer protection”.

An important part of prudential regulation is authorization. We call this our “gatekeeper role” and means we only allow firms to operate in the financial system once they have fulfilled a number of criteria, including governance and risk control.

Consumer protection rules are also in place. These spell out how firms must treat their customers when selling them financial products. So for example, a regulated firm must ensure that it “acts honestly, fairly and professionally in the best interests of its customers and the integrity of the market”.

What about supervision?

To make sure firms abide by the rules of regulation, they have to be supervised. The supervision work is intrusive, and allows regulator to monitor financial service providers to make sure they are following the rules.

Central Bank staff review and report on all aspects of firms’ businesses to judge whether they are being run in a safe and sound manner. They also go on-site in firms to meet key decision-makers and inspect aspects of the business. The number of Central Bank staff doing this job has increased rapidly in recent years, leading to more in-depth supervision.

How closely firms are supervised is based on how much risk they present to the financial system or to consumers. The greater the potential harm, the closer the supervision. This is why we call it “risk-based supervision”.

Enforcement and resolution

Having rules and laws, and making sure financial services providers follow them, are the first two pieces to understanding financial regulation. Enforcement and resolution is the third.

Where a firm is found not to be in compliance with the rules, we can take a number of steps. In serious cases, this can lead to the firm facing enforcement proceedings. Having the credible threat of enforcement is essential to deter poor behaviour in the financial services sector.

Ghana’s financial services sector can be classified into three main categories i.e., banking, insurance and capital markets. The sector has shown significant development over the past decade.