Banking regulation and supervision
Bank (prudential) supervision is a form of "microprudential" policy to the extent it applies to individual credit institutions, as opposed to macroprudential regulation whose intent is to consider the financial system as a whole.
Policy practice, however, makes a distinction between the setting of rules that apply to banks (regulation) and the oversight of their safety and soundness (prudential supervision), since the latter often entails a discretionary component or "supervisory judgment".
Licensing involves an evaluation of the entity's intent and the ability to meet the regulatory guidelines governing the bank's operations, financial soundness, and managerial actions.
The belief is that without this aid, the crippled banks would not only become bankrupt, but would create rippling effects throughout the economy leading to systemic failure.
The general premise is that while the government may have prevented a financial catastrophe for the time being, they have reinforced confidence for high risk taking and provided an invisible safety net.
This type of regulation has lost the role it once had, as the emphasis has moved toward capital adequacy, and in many countries there is no minimum reserve ratio.
An example of a country with a contemporary minimum reserve ratio is Hong Kong, where banks are required to maintain 25% of their liabilities that are due on demand or within 1 month as qualifying liquefiable assets.
Investors and clients will often hold higher management accountable for missteps, as these individuals are expected to be aware of all activities of the institution.
These ratings are designed to provide color for prospective clients or investors regarding the relative risk that one assumes when engaging in business with the bank.
The ratings reflect the tendencies of the bank to take on high risk endeavors, in addition to the likelihood of succeeding in such deals or initiatives.
The rating agencies that banks are most strictly governed by, referred to as the "Big Three" are the Fitch Group, Standard and Poor's and Moody's.
In essence, they forced European banks, and, more importantly, the European Central Bank itself, to rely more than ever on the standardized assessments of "credit risk" marketed aggressively by two US credit rating agencies – Moody's and S&P, thus using public policy and ultimately taxpayers' money to strengthen anti-competitive duopolistic practices akin to exclusive dealing.
Ironically, European governments have abdicated most of their regulatory authority in favor of a non-European, highly deregulated, private cartel.
Restricting disproportionate exposure to high-risk investment prevents financial institutions from placing equity holders' (as well as the firm's) capital at an unnecessary risk.
As a result, distinct regulatory systems developed in the United States for regulating banks, on the one hand, and securities firms on the other.
The European Union and United States have more complex setups in which multiple organizations have authority over bank supervision.
