Importance of Investment Banks Regulations


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Investment banks have been one of the major drivers of economic development of nations for decades. The banking industry has experienced tremendous growth. Investment banking business involves a lot of risk taking and these risks evolve over time. Due to the risks involved and the evolution of these risks the industry has  been subjected to various legislative regulations.
More often than not, investment banks receive the blame for any major economic crises — they are blamed more than the economic policies formulators. 

For instance, investment banks were blamed for the Great Depression of 1933 and the global economic meltdown of 2008/2009. The collapse of many investment banks during the Great Depression of 1933 necessitated the promulgation of  investment banking law under  the Glass Steagall Act of  1933. Over the years, there have been other regulatory acts guiding the activities of investment banks in different countries. Some of these laws are universal while some are peculiar to some countries.

Investment Banks Regulations and Laws

Bellow are investment banks regulatory laws in the United and in Nigeria. 

  • Glass Steagall Act of 1933
  • Security and Exchange Commission Act
  • The Investment Advisers Act
  • Securities Investment Protection Act
  • The Gramm-Leach-Biley Act
  • Basel 3 Requirements
  • Volcker Rule
  • Banks and Other Financial Institutions Act of 2010

Why Investment Banks Need to be Regulated

As a very important sector of an economy, needs to be regulated. The reason for the enactment of the above regulations were the reasons why investment banks need to be regulated and they are as follows:
  • To prevent investment banks failure
  • To protect depositors
  • To protect investors
  • To prevent and fight corrupt in the system
  • To prevent conflict of interest
  • To maintain economic stability

To prevent Investment Banks Failure
After the 2008 global economic meltdown, many countries introduced minimum fixed capital base for investment, merchant banks and other banks. In USA, the Base 3 Requirements were introduced. 
The Basel 3 requirements were brought into place after the 2008 collapse. The Basel 3 requirements worked on the assumption that the crisis happened because banks were recklessly issuing fixed income securities. Hence, they increased the amount of capital that has to be kept in reserve when fixed income securities are issued. This made it more expensive for banks to issue these securities. Since the distribution of these securities formed a major portion of the income earned by investment banks, their income has also been affected by the Basel 3 regulations.

To Protect Depositors
The Glass Steagall Act provided that commercial banks and investment banks be separated from each other. This is because it was believed that the crash of 1929 was caused due to the excessive money pumped in by commercial banks, and the money used belonged to the depositors. 
Prior to the Glass Steagall Act, it was common for commercial banks to make unsound loans to certain companies. These loans were then supplemented by the share purchase of those same companies by the investment banking department of the banks. The main idea behind the Glass Steagall Act was to ensure that the funds raised by the banks are used for lending rather than for speculative purposes. This act continued to be in place for almost 70 years until 1999. It was then repealed by another act. However, it would be fair to say that the investment banking industry has been deeply shaped by the Glass Steagall Act.

The Nigerian BOFIA prohibits the investment banks from receiving saving and current account deposits from natural and legal persons, honoring cheques, issuing and deploying ATM which are the functions of deposit money banks. the law also provides that any commercial bank intending to go in to investment banking operation must establish a separate subsidiary of the bank with core responsibility of investment banking services subject to approval by the CBN.

To protect Investors

To Ensure they Stick to Their Functions
The Central Bank Prudential Guidelines for Deposit Money Banks also regulates investment and merchant banks. The regulatory power of the central bank in issuance of licenses and in setting operational standards  ensures that the investment institutions are qualified to run such business, and ensure that investment banking services do not become all comers business. It ensures that investment banks and other financial institutions maintain banking and financial services ethics. The fear of being sanctioned, makes the financial institutions to operate within the confide of the regulatory laws and guidelines. Without the central bank the investment banking and indeed the financial sector of an economy will become an all comers business.

To Prevent and Fight Corrupt Practices 
Security and Exchange Commission is established with the intention of overseeing the activity of various market participants in the primary market as well as the secondary market. So the Securities and Exchange Commission  has oversight and regulatory purview over investment banks to the extent that it relates to their capital market activities. Intermediaries like investment banks are supposed to register with the Securities and Exchange Commission before they can participate in market activities. Also, since investment banks are major players in the securities market, their activities are scrutinized by the Securities and Exchange Commission until today. Over the years, the Securities and Exchange Commission has come to regulate each and every aspect of the investment banking operation which includes licensing, accounting, product offerings, etc to ensure that they are qualified to carry such activities and to prevent sharp practices

To Prevent Conflict of Interest
Investment bank regulatory authorities in their oversight functions ensure that investment banks do not arrange to finance for a client whom they are also advising in a transaction. The genuineness of the advice may be compromised since the investment bank also stands to gain from the financing, make investments which go against the advice which the institution gives to clients, and take on a client who is a competitor or a threat to an existing client and advising them against the other.

To Create Confidence
Regulations and guidelines mandating investment banks to submit reports on their reserves, transactions and risks assessment to central bank SEC are aimed at creating confidence in the financial sector of the economy.

Economic Stability
Central Bank issues guidelines from time to time on banking, money market and other financial instruments to ensure liquidity in the financial sector and indeed the economy, to protect the depositors, investors from any sharp practices of the deposit money banks, others. It protects the bank customers from unwholesome, fraudulent and unethical practices of the financial institutions. It checkmates the excesses of financial institutions. 

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