Question

In the United States, the Dodd-Frank Act, passed in 2010, requires bank holding companies with more than $50 million in assets to abide by stringent capital and liquidity standards and it sets new restrictions on managerial incentive compensation.

Critically evaluate the arguments for and against the stringent capital and liquidity standards and restrictions on managerial incentive compensation in the banking sector.

Answer 1

The Dodd-Frank Act,passed in 2010,was a financial reform legislation that the Obama Administration and Congress passed in 2010 in response to the 2008 financial crisis.The Financial Crisis Inquiry Commission, or FCIC cited "profound lapses in regulatory oversight” that contributed to the crisis. They found many underlying causes of the crisis, and one of them was managerial incentives.

• These standards and restrictions aims at making banks safe & more resilient some of these are:

1.Improved governance & risk management & a greater ability of individual banks to withstand future economic downcycles due to higher capital & liquidity levels.

2.Potentially reduced vulnerability of the banking industry to systemic risks due to lower aggregate leverage and higher liquidity buffers.

3.Improved market transparency & efficiency for investors due to more comprehensive broker-dealer regulations and enhanced rating agency accountability

4. Additional protections for consumers from misleading financial products & services.

5.Potential improvement in the stability of the macro economy due to a reduction in the likelihood that a future crises will exacerbate a broader recession.

• The provisions of the said Act, however ,could also give rise to a range of unintended consequences for US banks,financial markets and consumers,some of them are as follows:

1. Decreased industry profitability and financial flexibility may result from higher capital & liquidity requirements as well as increased regulatory cost for banks.

2.Potential shift of capital and business activity from US banks to less-regulated firms in the United States or abroad.

3.Potentially decreased credit availability for consumers & SMEs,including reduced appetite for banks to introduce new products,particularly for segments with historically poor credit performance.

The protection of investors must serve as the first principle guiding our financial regulations. We should think of those regulations not as a burden to be repealed or picked apart haphazardly, but as the essential nutrient for flourishing capital markets, for a growing economy, and, yes, for the continued vibrancy of the American Dream.