Bank Regulation

Updated on March 19, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Bank Regulation?

Bank regulation refers to the formulation and implementation of rules and restrictions by the government or central bank to regulate banking institutions. The requirements, restrictions, and guidelines ensure consumer protection and operational transparency.

Bank Regulation

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A healthy financial system is essential for a country’s economy. Banks are a major part of it. Regulations not only control the functions of these financial institutions but also provide a framework within which they have to work. Regulations explain how banks are regulated and supervised.

Key Takeaways

  • Bank regulation is developing and implementing rules and restrictions to control banking institutions. 
  • It explains how banks are regulated and supervised. Regulations and supervisions are essential in ensuring the smooth and fair functioning of banking institutions and the country’s financial system’s stability and preventing banks from collapsing under pressure.
  • Regulations establish rules on licensing, liquidity regulation, foreign investment requirements, and liquidation procedures.
  • Regulations prevent financial institutions from making risky investments and ensure financial system stability, guarantee consumer protection, and deter crime.

Bank Regulation Explained

Bank regulation is the process of developing policies or establishing guidelines to enforce rules and regulations on the banking system. Such regulations oversee, control, and aid the day-to-day functions of banks and other financial institutions. They are put in place to ensure a country’s financial system’s stability. A strong financial system keeps the economy intact and prevents it from collapsing under pressure. 

Apart from encouraging the economy’s growth, these regulations are made by the country’s respective central banks to promote safe banking practices. The banking guidelines have provisions that limit how much capital the bank has to keep in its custody and with a country’s central bank. The limits are put in place to cover risks and regulate the money flow in the economy. Not being restricted to the points mentioned above, the regulations also ensure that consumers have access to information about their rights and choices, preventing banks from engaging in unfair or deceptive activities and stopping them from misleading customers. 

Rules and regulations differ from one country to the next. Each country has its Bank Regulation Act, according to which financial activities are supervised. The Bank Regulation and Supervision Survey is a one-of-a-kind source of comparative economy-level information on global bank regulation and supervision. The World Bank conducts it.

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Objectives of bank regulation are:

  • Regulation: The foremost objective of establishing regulations is to control the activities and functions of the bank and other financial institutions. These institutions grow and develop new ideas to make their services better and meet the growing demand. Since financial institutions’ offerings are increasing and diversifying, regulations are needed more than ever.
  • Governance and core risk management: Governance and core risk management principles guarantee the implementation, operation, and effectiveness of fundamental risk management, governance expectations, and robust internal controls. In addition, these principles work intending to prevent the economy from collapsing.
  • Compliance: The central banks of the respective countries lay down rules for the minimum lending and borrowing rates, along with statutory liquidity ratio and cash reserve ratio requirements. They are executed through the Bank Regulation Act; regulations through the act ensure smooth cash flow inside the economy.
  • Consumer protection: Consumer protection is one of the regulations’ objectives. It is because, in the run for profit, financial institutions may employ deceptive and unfair practices affecting innocent consumers.
  • Anti-money laundering and other fraudulent activities: Financial institutions, such as banks, have access to funds that can be used for good and bad. While the government uses it for welfare programs, others may use it for self-interest. As a result, money laundering and other fraudulent activities can have a detrimental effect on the economy and society and, therefore, must be prevented.
  • Capital, liquidity, and financial stability: Financial institutions and banks regulate the flow of money in the economy through lending and borrowing. Lending money to the general public encourages investment. Investments generate employment, and employment provides wages. When people have money to spend, they buy goods and services. It will, in turn, lead to more economic activity as the cycle continues. Banks ensure this cycle is smooth and continuous; the regulations empower them.


In accordance with contemporary trends in banking and finance, regulations establish rules on licensing, liquidity regulation, foreign investment requirements, and liquidation procedures. A sound financial system facilitates payments, provides credit to borrowers, and mediates financial activity, among other key economic functions. Conversely, an unstable financial sector makes the economy’s future growth prospects unstable. Therefore, financial stability is a crucial policy goal for the efficient operation of an economy. 

Financial restrictions are required for financial stability. It will make it possible for banks to create robust financial safety nets. Contrarily, stringent rules can cause the financial system to become unstable. Excessive regulations burdening the system with difficulties could result in greater implicit costs for expanding financial institutions. Moreover, it might make it more difficult for banks to give sectors in need of financial support, thus impairing economic growth. Therefore, regulations must be carefully planned and implemented according to the economy’s needs.

Bank Regulations In The United States

Both federal bank regulations and state laws govern banking in the United States. A banking organization may be subject to many state and federal bank regulations depending on the type of charter it has and its organizational structure. The Federal Reserve Act of the U.S. does not work with the typical central bank concept. Instead, it has a central banking system with three salient features:

 (1) A centralized governing body;

(2) a decentralized operating structure of 12 Reserve Banks

(3) A mix of public and private characteristics.

The Federal Reserve Board of Governors (Board of Governors), the Federal Reserve Banks (Reserve Banks), and the Federal Open Market Committee (FOMC) are the three major organizations that make up the Federal Reserve System. The general direction for the system and management of the 12 Reserve Banks are provided by the Board of Governors, an entity of the federal government that is directly accountable to and reports to Congress.

Pros And Cons

Pros of banking regulations are:

  • Trust and confidence: When rules are laid down to regulate funding activities in the economy, it gives the people confidence about being part of the system. For example, The FDIC (Federal Deposit Insurance Corporation) is an independent agency of the U.S. government that protects against the loss of insured deposits. In addition, regulations ensure legal actions against violation. 
  • Contributes to economic growth: When consumer confidence exists, people willingly put money in banks instead of saving idly with them. The money deposited in banks aids in the creation of employment opportunities by increasing cash flow in the economy and investments. 
  • Credit management: A further significant benefit of banking regulation is credit control. It stops the production of excessive credit by regulating loans and investments.

The cons of regulations are:

  • Less revenue: Unnecessary control and stringent regulation may make it difficult for banks to operate freely. Thus, banks may be unable to make profits as much as they expect. 
  • Failure: Bank failures cannot be prevented by banking regulation; they only can curtail wasteful financial activities.
  • Time-consuming and expensive: Bank regulation is a time-consuming process as a lot of thought goes into structuring the path of financial growth.

Frequently Asked Questions (FAQs)

What is an example of bank regulation?

Reserve requirement is an example of banking regulation. The amount of cash that a bank must have in reserve to pay its obligations in the event of unforeseen withdrawals is known as the reserve requirement. The central bank can change reserve requirements to adjust the amount of cash in the economy and control interest rates.

Can bank regulation be used to reduce inflation?

Strong bank regulation and supervision will likely lessen the correlations between credit growth and asset price rise. As the asset-price bubble expands, stricter liquidity restrictions on borrowers, adequate regulation, and effective credit evaluation methods reduce the likelihood of higher expenditure and, subsequently, higher inflation.

What is bank regulation vs. supervision?

Regulating the banking system entails establishing rules and regulations, whereas bank supervision is a supervisory duty tasked with ensuring the overall safety and soundness of the banking system. Bank regulation and supervision are interconnected; therefore, supervision will be based on rules laid by regulations.

This has been a guide to what is Bank Regulations. We explain its objectives, importance, pros, cons, and regulations in the United States. You can learn more about it from the following articles –