Welcome back to our course on Fintech Security and Regulation.
In this session, we're going to talk about regulations as a way for
governments to increase tax compliance and control.
Now, earlier in a prior session,
we talked about AML and KYC,
and one of the goals of these concepts or regulations is to
encourage greater tax compliance or to be able to monitor and audit for tax compliance,
and that's part of the reason for regulation,
but there is more that governments want to control than just tax.
Government control extends beyond tax.
They would like to be able to understand what's happening in the economy.
They'd like to know how big is the GDP,
how much economic activity is taking place,
how successful are some industries and others.
They want reporting, they want better control of the economy in general,
of employment, they want to know a lot of information.
They want to be able to exert control,
for example, like interest rates.
If they say the economy is growing too fast or there's inflationary pressures,
we'd like to be able to use regulation as a tool to slow down the economy.
This might happen with the Fed for example
increasing interest rates and that's a very visible thing.
What's less visible is the government can use regulation as a way to
increase economic development or slow down
economic development by increasing the amount of capital that banks have to have,
increasing their reserve requirements,
putting on restrictions as to how much people can borrow,
for example, in the United States.
Regulators have recently said,
we used to have government guarantees of loans that limited how much
customers could pay out of their household income and
qualify for a Fannie Mae or Freddie Mac loan,
federal homeowners assistance, or VA, Veterans Administration loans.
We say a borrower can't have more than
30 or say 35 percent of their income go in household payments,
go into mortgage payments.
That restriction has been increased recently to allowing
up to 50 percent of your income be used
for your mortgage payments because real estate prices are increasing.
It's the argument and poor people can't buy a home if they're
limited to only a third of their income going to their mortgage payments.
We also used to say that you can't have a loan for more than 30 years,
and at least in some markets,
there are now home loans where you're paying
interest only for a long period of time or you are having
a 50-year amortization on the loan so that you can buy a more expensive home
with the same monthly payments but you are paying it off very fast at all if at all.
So by reducing regulations or weakening regulations,
we can allow more people to buy a home,
that's in theory good for consumers although some of them might be overextending
themselves and it's good for the economy and for construction and for jobs,
and so we want to encourage that.
But it might make the economy more at risk of a downturn.
Someone loses their job and
50 percent of their income is going to their mortgage payments,
then they're not going to be able to make those mortgage payments.
Now, you might argue they're not going to be able to make a third either.
But let's say there are two income household.
If a third of their two incomes is going to
home payments and one of the two loses their job,
they might be able to survive.
They might be able to keep their home.
If they have two income household and both incomes are needed to have
50 percent of their income going to mortgage payments and one of them loses their job,
then they're not going to keep their home.
This isn't going to work,
the numbers just don't add up,
and so risk goes up.
In banks, we can reduce the reserve requirement.
As a regulator we can decide how much reserve do banks need.
Now, if banks had a 100 percent reserve,
well, there's not much need for regulation.
There's not much risk.
There is no problem, but a bank with
100 percent reserve of all their deposits will never make money.
That sounds like a really stupid banking practice and so we'll often say,
well, we want you to have 10 percent reserves or
five percent reserves or 20 percent reserves.
The higher the reserve,
the less likely a bank is to fail.
So you'd like that in terms of safety for society.
The lower reserve, the more likely a bank is to lend more aggressively.
The more stimulating it is to the economy and the better it is for
short-term economic development but the more
likely it is that something will meltdown or some sort of crisis will happen.
Sometimes, banks will find creative ways to move investments or
move transactions off their balance sheet so that
risk becomes less visible and less regulated.
Regulators don't necessarily like that and we'll see in our case study at
the end of this module where lower regulations,
weaker regulations, more flexible
regulations and more off-balance sheet creative financing
of assets led to a financial services meltdown in 2008,
which was bad for the global economy.
So we don't really want to encourage too much risk taking
because that's expensive for tax [inaudible] to bail out institutions.
It's bad for investors.
It's bad for consumers who lose jobs and lose their home
and so this is generally not viewed as a good thing, too much risk.
The outcome of that after a lot of
profit for some people is a lot of pain for many people,
and so that's a concern.
So regulators want more control,
and in some economies,
regulators have enormous controls.
They have large reserve requirements.
They have large down payments required.
In Hong Kong, if you want to buy a house,
you have to put 30 percent down payment
and banks are limited as to how much they can allow you to borrow
as a percent of your verifiable income and that
makes the housing market relatively stable.
There have been some crashes and some ups and downs.
It's not immune to that but not of the magnitude that we've had in
US financial markets where borrowers were able to get
much more leveraged and the risk got much higher.
We didn't see financial institutions in
Hong Kong going under as a result of the financial crisis.
They had pain, but a lot of that pain related to their investments
and subsidiaries in the US and in other markets not necessarily the Hong Kong market.
So regulators were able to limit the downside of lack of control,
but there's some limit as to how fast can your economy grow if you have
those relatively harsh or tough standards and restrictions.
It may slow down economic growth and regulators may say,
actually, we're doing just fine, we're growing enough.
Let's not prime the pump more.
But regulators do like control.
They'd like to know what's going on and they like to be able to tax what's going on.
In fact, it's interesting because in many Western societies like the US,
we think of the Internet and the information age
as an opportunity to gain freedom from regulations and controls.
Information is free or information should be free and
cyberspace is a less regulated Wild West type domain,
but that's not always true.
Theodore Henry King CLARKAssociate Professor
