Financial deregulation

In a broad sense, the concept of financial deregulation refers to the gradual elimination of the financial regulation that was born out of the Great Depression and the early post- war period, particularly as applied to interest rates, exchange rates and international flows of capital. The concept also refers to the application of many other controls over financial markets, for example regulations on commissions that can be earned in stock markets or on the conditions of stock and bond issuance. Also covered by this concept are the removal of controls on the specialization and size of financial intermediaries, as well as on the geographic space of markets, including the lifting of controls over the expansion of cross-border financial transactions.

Financial deregulation is a process that has occurred in almost all countries, but usually as a reaction to what is happening in other markets, because policy makers have considered that financial regulations impose competitive disadvantages. During the 1980s, the deregulation of interest rates, both on the assets and liabilities sides, was promoted largely as a response to the unregulated operation of several large institu- tions in the London-based Euromarket. During the same years, many of the existing capital controls began to be lifted in the largest North Atlantic financial markets, and by the 1990s the widespread mobility of capital began to be characterized as financial globalization.

The most widely-cited arguments in favour of financial deregulation have been offered by McKinnon (1973) and Shaw (1973), who consider that financial regulation represses the growth of savings and inefficiently distributes financing. Therefore, financial deregu- lation - particularly the removal of controls on interest rates and exchange rates - would promote efficient and competitive financial markets. In the same vein, authors such as Kaminsky and Schmuckler (2003) have hailed the great advances in financial deregulation.

Over the same period, a number of critics pointed to the prominent role that financial deregulation played in causing financial crises, notably as regards the occurrence of the latter in the developing world during the 1990s (Correa, 1998; Stallings and Studart, 2003). Likewise, the US financial crisis that erupted in 2007 highlighted banks' role in fuelling speculative activity by credit expansion and fraud. The fundamental role that banks play in creating and nurturing these elements that converge into financial crises is most famously synthesized by Kindleberger (1989). The report published by the Financial Crisis Inquiry Commission (2011) shows in great detail how bank-led specula- tive mania, fraud, and leverage all played decisive roles in the genesis and transmission of crises.

Within this historical framework, ideas regarding the regulation and deregulation of financial markets have been actively debated during the past 40 years since the move- ment toward financial deregulation began. As a result of the financial crises witnessed during the first years of the twenty-first century, issues of financial regulation have been addressed by the Group of 20 countries (G20), seeking to reach agreements on national and international commitments to prevent future global financial crises. Among the most important elements that have been considered are:

(1) rules on capitalization for financial institutions, so that capital and reserve require- ments increase commensurate with greater risk taken;

(2) concerted government responses in anticipation of the possible failing of systemically important global financial entities, known as effective resolution regimes for finan- cial institutions;

(3) regulations on the issuance of securities with underlying mortgages (Principles of sound residential mortgages underwriting practices); and

(4) regulation of ratings agencies (Principles for reducing reliance on CRA ratings) and enhanced cooperation between governments in order to alleviate future international financial crises (Principles for cross-border cooperation on crisis management).

However, the most critical authors on financial deregulation (Guttmann, 1997; Correa, 1998; Stiglitz, 2003; Kregel, 2010; Wray, 2011; Epstein and Crotty, 2013), who consider the latter as an important factor in contributing to global financial crises, have debated other important points pertaining to regulation, such as:

(1) controlling the size of financial institutions and limiting their international exposure;

(2) prohibiting some of those financial instruments such as collateralized debt obliga- tions that have proved to be sources of enormous volatility in markets;

(3) increasing transparency of off-balance-sheet operations of all financial intermediar- ies, regulating the shadow banking sector and its transactions;

(4) introducing financial transaction taxes; and

(5) introducing capital controls, and even constructing a new international financial architecture, such as that suggested in the Stiglitz Report (United Nations, 2009).

Going forward, issues of how much deregulation or re-regulation should take place, who should be in charge of such changes, and what degree of global coordination will be nec- essary, will certainly continue to be debated. However, the main objective lies in creating and maintaining stable financing to sustain investment and employment.

See also:

Basel Agreements; Capital controls; Financial crisis; Financial transactions tax; Reserve requirements; Systemically important financial institutions.