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May 10, 2019updated 14 Jul 2021 12:10pm

What is financial regulation and why is it important?

By Asena Degirmenci

In order for the economy, a business and its consumers to operate effectively, a well-functioning financial system must first be established.

Financial regulations are fixed rules that protect you from risk and fraud.

But how exactly do these regulations protect our savings?

What is financial regulation? A clear definition 

Definition: Financial regulations refer to a form of regulation or supervision of financial markets and institutions.

From an EU perspective, financial regulation is the main point of reference for the principles and procedures governing the establishment, implementation and control of the EU budget.

It was only after the 2008 financial crisis where regulators took aggressive action towards regulation. Governments around the world were authorized to make global markets safer by providing transparency of transactions in order to stabilize the financial system.

Financial regulation may also be handled by government or non-government organisations.

Why is it important?

One of the key purposes of establishing financial regulations is to maintain the integrity of the financial system.

When a bank fails, it is unable to meet its obligation to depositors or other creditors, which can cause problems for the wider economy.

Financial regulations aims to: enforce applicable laws; prosecute cases of market misconduct; license providers of financial services; protect clients; investigate complaints; and maintain confidence in the financial system.

In some such way, we all depend on the financial system—from saving and accessing money, borrowing money to maintain business, taking out mortgage or insurance, to getting claims paid when something goes wrong.

How does it work?

There are two facets to financial regulation: prudential regulation and consumer protection:

Prudential regulation: ensuring that firms have the funding necessary to trade safely and have the appropriate risk control in place and are properly governed.

Consumer protection: enduring that firms treat customers fairly from the sales process to how complaints are managed.

Authorisation is an important part of prudential regulation. This means that only firms are allowed to operate in the financial system one they have met the requirements.

Rules for consumer protection are also established, which informs firms how they should treat their clients.

Supervision, enforcement and regulation

Firms must be supervised to make sure they follow the rules of regulation.

In order to make sure financial service providers are following the rules, supervision is often strict and intrusive.

Risk-based supervision refers to how closely firms are supervised on the basis of how much of a risk they pose to the financial system.

Enforcement works to mitigate poor behaviour in the financial services sector. When a firm has not been adhering to the rules, steps are taken to make sure rules are regulated.

Lastly, there’s resolution— this refers to the process in which a financial institution is restructured in a way that prevents it from doing any more harm to the economy.

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