Name: Alisha Garg 23010122048

Tinku Garg 23010122065

Course: 3 Year LLB, Semester II

Batch: 2023-2026

Internal Assessment II

Subject: International Banking and Finance

Research Outline Topic: Post-Crisis Evolution: The Impact of Regulatory

Frameworks on Investment Banking
INTRODUCTION

The global financial landscape has been observed by a number of transforming events and the
2008 financial crisis served as a critical moment in the history of banking due to which many
regulatory reforms were implemented to prevent similar crises from happening in the future.

After the crisis took place, regulatory authorities across the globe took steps to strengthen the
stability and resilience of financial institutions to prevent another financial crisis from
happening in the aftermath of the previous one. This paper aims to investigate the impact that
regulatory changes had on the financial performance of banks which would help us
understand the complex relationship between regulatory reforms and bank profitability.

ANALYSIS

The 2008 financial crisis had a major impact on the global financial system. Due to which,
there were prominent changes made to regulatory frameworks, especially in investment
banking. There was an increased regular scrutiny as the crisis brought to light the systemic
risks that were associated with investment banking activities. The risks included leverage in
abundance, financial products that were too complex, and insufficient risk management.1
The Dodd-Frank Act (2010) in United States imposed stricter regulations on banks to
enhance financial stability. It increased capital requirements, restricted proprietary trading,
and established the Financial Stability Oversight Council to monitor systemic risks.2

Also, the Basel Committee on Banking Supervision brought Basel Norms III in order to
improve risk management, boost capital requirements and strengthen the resilience of the
banking sector. The risk management practices were enhanced as the investments banks were
made to refine their management practices that included enhanced stress testing, better
1
Financial Crisis Inquiry Commission Report (2011): https://www.govinfo.gov/features/financial-crisis-
inquiry-report

2
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010):
https://www.congress.gov/bill/111th/house-bill/4173
transparency in trading activities and more stringent compliance measures. Regulatory
authorities required greater accountability from the senior management and board of directors
with respect to risk oversight and governance.3

Certain policy makers suggested on bringing back the Glass-Steagall-like regulations, which
would have separated commercial banking activities from investment banking activities. The
aim behind this was to lower the risks of the complete financial system being affected.
Although the full reinstatement of these regulations did not happen, some measures like the
Volcker Rule was brought aiming to restrict speculative trading activities within banks.

The regulatory bodies boosted the global coordination and cooperation to handle cross-border
risks and conform the regulatory standards. Organisations such as the Financial Stability
Board (FSB) played an important role in enabling global regulatory reform efforts.

There were substantial costs imposed on investment banks with the compliance of new
regulatory requirements such as technology upgradation expense, personnel training.4

After the 2008 financial crisis, regulatory frameworks in investment banking underwent
major changes. The main objectives of these reforms were to enhance financial stability,
lower systemic risks, and restore trust in the global financial system. These changes have
definitely made banks more resilient and reduced the chances of another crisis. Regardless, it
is important to remain vigilant and adapt to emerging risks to ensure the stability of the
financial system.

REVIEW OF LITERATURE

1. Basel III and Capital Adequacy:

Scholars, including Adrian and Shin (2010) and Demirgüç-Kunt et al. (2013), have conducted
research examining the effects of Basel III regulations on bank capital adequacy. While the
3
International Organization of Securities Commissions (IOSCO) - Thematic Review on Risk
Management Practices at Investment Banks (2010):
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD721.pdf

4
International Monetary Fund (IMF) - The Cost of Regulatory Complexity (2018):
https://www.imf.org/-/media/Files/Publications/WP/2022/English/wpiea2022041-print-pdf.ashx
heightened capital requirements were expected to strengthen banks' ability to weather
economic disruptions, there are varying viewpoints on their impact on profitability.

2. Liquidity Regulations:
Liquidity regulations, like the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio
(NSFR), have been a vital topic of research. As per Langfield and Pagano's (2016) findings,
enforcing strict liquidity regulations could possibly harm bank profitability. This could result
in a challenging balance between ensuring security and retaining earnings.

3. Risk Management Practices:

Research by Berger et al. (2018) indicates that the costs of enhanced risk management could
affect banks' profitability. Maintaining a balance is crucial for banks.

4. Market Discipline and Transparency:

As per Acharya et al. (2017), revealing stress test outcomes in a transparent manner has a
favourable impact on investor confidence. This can positively benefit the profitability of
banks.

5. Systemic Risk and Regulation:

Studies by Cont et al. (2013) and Silva and Tabak (2019), indicate that the regulatory
measures that address the systemic risk contribute to overall
financial stability though could have varying effects on the individual bank profitability.

6. Differential Impact on Small vs. Large Banks:

According to research conducted by Claessens and Kodres in 2014 and De Jonghe et al. in
2017, regulatory reforms can impact small and large banks differently. Compliance costs,
economies of scale, and risk-taking behaviour could vary, which can influence the overall
impact on profitability.

7. Global and Regional Variances:

According to De Pooter et al. (2015), the significance of regulatory reforms may be affected
by the unique attributes of the financial system and the wider economic context.
ISSUES ADDRESSED BY THE RESEARCH PAPER

1. Effectiveness of Reforms:
Have the new regulations successfully lowered systemic risk in investment banking?
Examining the data on bank failures and financial crises post-2008 crisis and considering the
role of other factors such as economic conditions in mitigating risks.

2. Financial Stability:
Bank profitability is a key factor of financial stability, as it shows the ability of banks to
develop sustainable earnings and absorb financial shocks. Evaluating the impact of regulatory
reforms on bank profitability gives insights into the overall stability and strength of the
banking sector, thereby contributing to steps aimed at safeguarding financial stability.

3. Business Strategy:
Profitability is one of the vital consideration in strategic decision for the banking institutions.
By examining the impacts of regulatory reforms this can help banks in studying the essences
of the regulatory compliance costs and additional regulatory changes on their competitive
positioning.

4. Unintended Consequences:
Do regulations restrict investment banks capability to adapt to new financial technologies
(Fintech)? Examining how regulations can be adjusted to promote responsible innovation in
the financial sector.

OBJECTIVES

Firstly, to research the post-financial crisis regulatory changes that were implemented in the
banking industry.

Secondly, to examine how regulatory frameworks have evolved post-financial crisis and
examine specific changes made to address vulnerabilities in the banking sector.
Thirdly, to evaluate the impact of regulatory reforms on diverse metrics of bank profitability.
Fourthly, to examine variations in the influence of regulatory reforms across various regions
and countries.
Finally, to evaluate the level of commitment and adherence with the regulatory reforms
within the banking industry.

METHODOLOGY

The primary research method for this study includes literature review and secondary sources
are the ones which will give rational information about certain primary sources.
These secondary resources include journal articles, newspaper articles, reviews as well as
magazine articles.
Both first hand and second-hand sources are included in the paper.
The paper mainly uses qualitative approach which entails the use of non-standardised data
through (the use of logic and assumptions).
Qualitative analysis is mainly used as the research is primarily exploratory in nature.

CONCLUSION

The impact of regulatory changes on bank profitability has been thoroughly examined in this
review paper, with a special emphasis on the years following the financial crisis. The
dynamic and changing banking industry following the global financial crisis of 2008 has
forced regulators and financial institutions to review and update regulatory frameworks.
Enhancing financial stability, reducing risks, and defending the interests of investors and
depositors have been the main goals.

The banking industry has definitely become more resilient as a result of regulatory measures
such as stricter liquidity standards, higher capital requirements, and improved risk
management techniques, however these measures have also increased compliance costs and
limited profitability.

Transparency, accountability, and prudential oversight have become increasingly significant

in the regulatory landscape post the financial crisis. The implementation of Basel III and
other international regulatory frameworks has particularly influenced banks' risk-taking
behaviour by bringing their operations into line with better endurable and conservative
practices.

This review concludes by stressing the importance of having a thorough knowledge of how
regulatory reforms impact bank profitability. Subsequent investigations ought to probe more
intensely into the particular means by which regulatory modifications affect various facets of
bank performance.

REFERENCES

1. Financial Crisis Inquiry Commission Report (2011): https://www.govinfo.gov/features/financial-

crisis-inquiry-report

2. Dodd-Frank Wall Street Reform and Consumer Protection Act (2010):

https://www.congress.gov/bill/111th/house-bill/4173

3. International Organization of Securities Commissions (IOSCO) - Thematic Review on Risk

Management Practices at Investment Banks (2010):
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD721.pdf

4. International Monetary Fund (IMF) - The Cost of Regulatory Complexity (2018):

https://www.imf.org/-/media/Files/Publications/WP/2022/English/wpiea2022041-print-pdf.ashx

5. The_Impact_of_Regulatory_Reforms_on_Bank_Profitability_Evidence_from_Post-
_Financial_Crisis_Era: https://www.researchgate.net/publication/379181309_

6. Bank for International Settlements (BIS) - Structural changes in banking after the crisis
(2018): https://www.bis.org/publ/cgfs60.pdf

7. Berger, A. N., & Bouwman, C. H. S. (2013). How does capital affect bank performance
during financial crises? Journal of Financial Economics, 109(1), 146-176.
8. Kashyap, A. K., Rajan, R., & Stein, J. C. (2002). Banks as liquidity providers: An
explanation for the coexistence of lending and deposit-taking. Journal of Finance, 57(1), 33-
73.