The topic of bank regulation and financial regulation can be extremely confusing and indeed very overwhelming. In fact, it's probably impossible for any one person to be an expert in all of this. However, in order for us to understand key regulatory initiatives and other pieces of news that we hear about financial regulation, it's probably gonna be extremely useful to us to understand what are the key objectives of financial regulation.

Well, the overriding objective of financial and bank regulation is efficient credit allocation. We wanna create a system that efficiently allocates credit out into the market. And we want that credit allocation to be based on proper economics. We want the credit to be allocated where the money does the most good. In other words, we want the financial and bank system to effectively grease the wheels of the financial and capitalist system, ensuring that capital ends up where it does the most good. In order to ensure this efficient credit allocation there are a number of sub objectives that we need to observe. The first one, we called others. Well, this is clearly a very broad classification. But in others, we include things like treating customers fairly and making sure that all market participants are treated fairly. Do I deal with all my customers in the same way, or do I favor some? Imagine that I favor some customers. That means that other customers would be unfairly treated, right? And if other customers are unfairly treated then they're less likely to participate in the financial markets at all. And that's certainly not efficient credit allocation. So we gotta create systems where customers are treated fairly and everyone feels that they can participate in the financial markets on an even playing field. The second broad objective is confidentiality. And confidentiality is an old principle in bank regulation. We simply want to create a situation where people feel that when they deal with a bank, other people do not find out about it. In essence, we allow bank customers and other players to keep their business their business. No one else will know how much money you have in the bank. Now, confidentiality has been around forever in bank regulation, and if anything at the moment, we're probably in a situation where we're striking a balance here because we know, for example, that law enforcement agencies and tax authorities want to have some insight, into what's going on in inside the banks and what customers they're dealing with. And that's probably a good thing. A third factor is the avoidance of misuse. What does this mean? Well, it simply means that we want to avoid a situation where the financial system is used in a bad way, in bad credit allocation if you want. Examples of that bad credit allocation would be things like terrorism financing. Should be obvious to anyone that we wanna avoid a situation where banks contribute to terrorism financing. Another key piece of avoiding misuse here is to avoid money laundering. That's to say to put proper anti-money laundering procedures in place. You need to know your customer, in order to ensure that that customer has a clean background. A fourth objective is to, look at systemic risk, systemic risk control. And systemic risk control means that we're trying to create a situation where problems or a bankruptcy or a bank run in one financial player, is not going to spread like wildfire through the financial system. Another way of putting this is, we wanna avoid the risk of a collapse in one player in the market to threaten the entire market as a system which would be of course, incredibly serious. And it would certainly not be efficient credit allocation when markets participants pull their capital out of the market for the simple fear of one player's problem spreading to all the others. And finally, the fifth key sub objective here is what we call prudential oversight. Prudential oversight means that we're looking at financial institutions, banks and insurance companies and we're trying to make sure that they are managed in a prudent way. And what does this mean, managed in a prudent way? Where we want those players to have sufficient capital buffers in place for banks that's equity, et cetera, et cetera, in order to protect themselves against future losses. And on top of that we want more risky institutions to have bigger buffers because of course, more risky institutions run bigger risks of making bigger losses. So there you have it. Treat your customers fairly, create a level playing field. Have a system where you can trust the confidentiality in banks and financial institutions. Make sure the system is not used for criminal or terrorism purposes. Control the systemic risks to reduce potential spread of problems from one institution to another. And finally, make sure through prudential oversight that each individual institution is prudently managed.

So what kind of tools do bank regulators have at their disposal? Well, the first one is licensing and supervision. It simply means that all banks, no matter where they are they need to first of all be licensed. They need to have a bank license and they need to be supervised on a continual basis by a national regulator. Now obtaining a bank license is hard and there are very high standards we need to live up to. But on top of that, the national regulator will supervise you on a continual basis and making sure you stick to the rules. Secondly, regulators can impose minimum requirements. Regulators require banks to have appropriate buffers against losses, and the bigger the risks are in the banks and other financial players, the bigger the buffers need to be. This is, of course, an example of that prudential oversight we just mentioned. And then finally a key tool is what we call market discipline. And this is a brilliant one. It doesn't mean discipline in the market, it means discipline by the market. So regulators require banks to disclose financial and non-financial information for creditors to better assess risk. What that means is that, banks have to disclose a lot of information to the external world so that the external world, and that means investors, depositors, creditors, can create their own view of the riskiness of the business. This is brilliant, right? Because the regulator has limited manpower, right? But if the bank is forced to publicize information to the broader market then the entire market will help analyzing and understanding what's going on inside the financial institution.