Impact of Operational Risk in Banking Essay Example

banking system to protect depositors.

It created the Federal Deposit Insurance Corporation (FDIC) to provide safeguards to depositors in the event of a failure by a bank. It passed the famous Glass-Steagall Act that prevented deposit-taking commercial banks from engaging in investment banking activities. Deposit Insurance continues to exist in the US and many other countries today.

However, many of the provisions of the Glass-Steagall Act in the US have now been repealed. There has been a trend worldwide toward the development of progressively more complicated rules on the capital that banks are required to keep.

Saidenberg and Schuermann (2003) discussed two sets of reasons often given for capital regulation in financial institutions and banks in particular. The first is the protection of consumers from exploitation by opaque and better informed financial institutions and for banking institutions; the objective is depositor protection. The second is systemic risk.

Banks are often thought to be a source of systemic risk because of their central role in the payment systems and in the allocation of financial resources, combined with the fragility of their financial structure.

Banks are highly leveraged with relatively short-term liabilities, typically in the form of deposits, and relatively illiquid assets, usually loans to firms or households. In that sense, banks are said to be special and hence subject to special regulatory oversight. Saidenberg et al. (2003) further stated that, capital requirements are intended to mitigate the risks of adverse selection by ensuring that a bank has at least some minimal level of resources to honor its commitments to its customers.