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Bob Sloan, S3 Partners: How banking regulations compare in US vs European Union

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According to Bob Sloan, S3 Partners founder and managing partner there may be differences in banking regulations between the US and the European Union, but both are taking affirmative action to avoid a major financial crisis.

Cost of capital varies from company to company and generally relates to the history of the company. Cost of capital is the price or interest paid to financially fund a business. Newer companies with no or a limited operating history can expect a high cost of capital whereas companies with a track record of profitability and a solid credit rating should expect to pay a lower cost of capital.

The greater the potential risk an enterprise represents to lenders or equity investors, the more it’s going to cost to source capital funding. The ideal situation for any company requiring capital financing is to strike a balance between debt financing and equity financing. Debt financing is typically not available to newer companies as they’ve yet to acquire the necessary assets to put up against the loan. This tends to leave equity financing as the only other option. Regardless of the path chosen, companies should be wary of taking on too much debt thereby over leveraging themselves which prompts lenders to charge a sufficiently high rate to offset the greater risk of default.

Cost of capital and risk management factors highly in banking sector, particularly with the recent economic downturns experienced both in the United States and the European Union. It forced many banks to re-evaluate their regulations to more effectively mitigate risk. The banking industry is inextricably linked to the economy and strife within the banking sector often leads to financial chaos putting entire countries’ economic future at risk.

The European debt crisis created a five-year economic slump, drove unemployment to record highs and ultimately undermined the single currency. In October 2013, the European Union made significant strides in its efforts to stabilize its damaged banking sector when Britain agreed to new rules that saw many of the predominant lenders in the euro area fall under the supervision of European Central Bank. When banks from across the E.U. failed it served to exacerbate the European debt crisis; these new measures are designed to limit exposure of the euro zone countries within the E.U.

While these strategic steps towards shoring up banking regulations has certainly put the E.U. on much firmer financial ground, they still have a long way to go, according to Bob Sloan.That reality didn’t stop some European officials from taking the opportunity to delight in the fact that, following years of derogatory comments aimed at the Europeans for their mismanagement of the economy, the United States was still facing a possible default. The consequences of which would create upheaval in Europe’s path to economic recovery.

In November 2013, the United States made public some of the steps being taken to avoid another 2007-2009 financial crisis. Wall Street critics argue that some U.S. banks are simply too large to fail. According to Reuters, ‘big banks can still borrow more cheaply than competitors and should face tougher rules.’ Janet Yellen, President Barack Obama's choice to be the U.S. Federal Reserve, new head, unveiled some new steps the central bank could take to encourage those firms to downsize. There is the assumption that these larger banks may have an edge in the market because of the appearance of them having government backing in times of crisis. As it turned out, six of the largest banks initially participated in crisis-era emergency programs subsequently stepping back from receiving some of that federal support. The suggestion is that because those larger firms pose a significant systemic risk to the financial system, it should be made tougher for them to compete by encouraging them to be smaller and less systemic.

According to Bob Sloan, without banking regulations to subject banks to certain requirements, restrictions and guidelines there is a much greater national economic risk. This regulatory structure creates transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things.

The ‘too big to fail’ belief system reflects that large financial institutions, particularly those heavily invested commercially, simply have too much control over the economy and therefore cannot be allowed to fail. Failure in these cases could have catastrophic consequences for the national and even global economy. There is concern though that by intervening with bailouts, the government trades immediate economic stabilization for future uncertainty as the bank continues to take unregulated risks putting the economy back in jeopardy.

Bob Sloan, S3 Partners List the Objectives of Bank Regulation

The objectives of bank regulation, and the emphasis, vary between jurisdictions. Bob Sloan notes the most common objections are:
• Prudential-To reduce the level of risk to which bank creditors are exposed for example to protect depositors
• Systemic risk reduction - To reduce the risk of disruption resulting from adverse trading conditions for banks causing multiple or major bank failures
• Avoid misuse of banks - To reduce the risk of banks being used for criminal purposes such as laundering the proceeds of crime
• To protect banking confidentiality
• Credit allocation - to direct credit to favored sectors

Where the United States also stands apart is that unlike other G10 countries who have one bank regulator for each country, the United States remains highly fragmented in their approach with regulations at both the federal and state levels. There are even some individual cities within the U.S. that have their own regulations laws. In the U.S., banking is regulated at both the federal and state level.

Bob Sloan, S3 Partners notes that while their approaches may not be identical and there is clearly some national competition for financial recovery and stability, both the United States and the European Union are taking affirmative action to reduce the risk of another financial crisis.

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