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The Vicious Circle of Regulation

March 7, 2016

Regulatory efforts change the structure of financial markets, and market changes trigger further regulatory efforts.  Recent developments highlight this cycle. 

 

First there was the regulatory effort.

 

Concerned that banks were "too big to fail," regulators launched capital and other requirements in order to change bank business models and to stimulate the economy. Now, further untested territory is being contemplated: worldwide regulators are at least discussing the possibility of negative interest rates, if not going there directly, as Japan’s central bank did at the end of January and the European Central Bank did in 2014. In the U.S., the Federal Reserve itself will assess the resilience of big banks using a negative interest rate.

The upshot of these regulatory efforts will be to push market participants into new products and service providers. For example, the Alternative Investment Management Association recently called for a reduction of barriers preventing non-bank financing from developing in the E.U. Lending is a highly regulated activity; however, much of today’s regulation is focused on "banking entities."

 

If other financial services providers, such as alternative funds, continue to push into the area, they will soon face an onslaught of new regulation. Because, of course, regulators will be concerned that market participants are not adequately protected under the “new” market structure.

And so the cycle continues, with regulatory efforts leading to market changes that, in turn, lead to more regulatory requirements. We don't see it ending any time soon.

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