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
The Government and the Financial Industry
How does government regulation affect the financial industry? ›
Financial regulation affects the federal budget directly through spending on programs that support the stability of financial institutions as well as through the revenues generated by the taxes and fees that those institutions pay.
What is the impact of government regulation on the economy? ›
Regulations impact the economy by establishing fair pricing rules. Economic regulations are regulations that place restrictions on what businesses and employees of businesses are allowed to do with regard to monetary and economic gain.
How do government regulations affect business? ›
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.
How does the government influence finance? ›
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.
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.
What are the negative results of government regulation of the economy? ›
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 is the government affecting 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.
What regulatory role does the government play in our economy? ›
Government can regulate private economic activity—for example, through minimum-wage laws. It can also provide goods and services that private businesses produce in insufficient quantities—for example, health care for the poor.
Thomas notes that regulations often burden low-income households disproportionately, either by increasing costs of goods and services, lowering wages, or both. Consequently, the most vulnerable households have less money on hand to implement the choices that would improve their welfare the most.
What is the purpose of government regulation? ›
Government regulations serve an important role in ensuring a safe, fair economy for small businesses and consumers alike, preventing them from being drained by larger corporations and unfair business tactics.
What are the advantages and disadvantages of regulation? ›
Regulations can help to protect the public interest, promote competition and innovation, and ensure that businesses operate in a fair and ethical manner. However, regulations can also be costly and time-consuming for businesses to comply with, and can stifle innovation and competition.
How does government regulation impact market activity? ›
Government regulation is used to control the choices of private firms or individuals. Regulation may constrain the freedom of firms to enter or exit markets, to establish prices, to determine product design and safety, and to make other business decisions. It may also limit the choices made by individuals.
What role can government regulation play in an industry? ›
Public safety:From ensuring food safety to regulating dangerous chemicals, government regulations protect consumers from harmful products and practices. Environmental protection: Unrestrained industry can lead to pollution, deforestation, and resource depletion.
Which of the following is a negative effect on businesses of government regulation? ›
Answer and Explanation: The correct answer is c) Additional expenses and inefficiency are experienced. Government regulation has several advantages but some attached disadvantages too.
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 government regulation impact supply? ›
Government regulations can affect supply and demand in a number of ways. For example, government subsidies decrease production costs and may play a role in increasing supply of a commodity. When a good or commodity is taxed by the government, the price for the consumer goes up which may lead to a decrease in demand.
How can the US government control financial institutions? ›
Passing laws: The government can pass laws that regulate and control the activities of financial institutions. For example, they can create laws to ensure fair lending practices or to protect consumers from fraudulent activities.
