Welcome back to our course on FinTech Security and Regulation. In this video, we're going to focus on the regulation side and specifically look at the US and to a lesser extent but also connected, European regulations, which are similar in many ways. Now as we think about regulation, it's useful just to give you a little background of what are we talking about here with regulation? Because what we have is multiple regulators coming at the idea of regulating finance from very different perspectives. On the one hand, you have a group called The Fed or the Central Bank. In the US it's called the Federal Reserve Bank. In other countries, there's different words for it but it's a central bank. This central bank plays an important role in the economy. One thing they look out in the economy is how much currency is out there and they do analysis and data collection and they think about how much is our currency expanding? How much is it growing? What does that mean for inflation? So, they're worried about inflation and they want to control inflation. They have a primary instrument to do that, which is called in the US, the federal reserve rate or the Fed rate, which they will raise from time to time because they're worried about inflation, so, they push up interest rates. Now, that isn't really push up interest rates directly for all borrowing or for all instruments. What it does is increase the borrowing rate for banks overnight from the government. So, the banks can go to the Fed, borrow money on a short-term basis and that then affects the rates banks charge each other and it flows on to affect virtually all financial instruments across the economy. When the Fed raises rates, interest rates in general go up. If the interest rates go up, that means that bond prices of bonds that had been issued in the past go down. Because if you have a bond paying five percent and the Fed raises the rates by half a percent, you could get a new bond at five and a half percent effectively, or you could buy that old bond at five percent but you're not going to pay the same price for that all bond, you'll say it's worthless. So, interest rates go up, bond prices go down. That's the role of the Fed. They don't do much other than that and they may talk and think and cajole and push, but they're basically there as a currency regulator in center of interest rates that influence a lot of things across the economy. So, they have a lot of influence. Are they part of the government? Well, that's an interesting question. They are part of the government. They're appointed by the government, but officially they report to Congress, not to the President. The President nominates someone, but Congress has to approve it and it's for a long-term appointment, and it's supposed to be less political than many positions so that the Fed can be largely independent. It's always questionable how independent are they and can they be influenced by political pressure, but in theory, they're independent and they're almost outside of normal government controls. Now, then you have another group that is in charge of regulating banking and they are definitely part of the administration and they're in charge of implementing rules passed by Congress and rules passed by themselves for regulating banks and they'll decide what kind of reserve requirements should banks have, meaning how much equity do they have to protect their investors. So, if they go out and raise a lot of money from people for savings accounts or for banks whose gift gets a deposit CDs, they've raised a lot of money and they've got $10 billion on deposit. They can then loan that money. But you don't want them to loan 100 percent of that money, you'd like them to have some buffer there or you'd like to raise some money from equity in case they make a mistake or in case something goes wrong or in case there's an economic downturn. You want some buffer or some protection against risk. So, you require an equity position. How much? Well, that's up to the regulator and that can change over time and that can be bigger in its effect then the change in interest rates. If you change the reserve requirement from five percent, you have to have 500 million in reserves to 20 percent, you have to have two billion in reserves for your $10 billion investment. That will shoot. Now the bank has to issue a lot of equity, equity costs more than debt because equity investors want a higher return than debt investors and so that's very expensive for the bank. Much worse than a modest change in interest rates which they can pass on. So, reserve requirements affect the health and wealth of the banking industry, but they also affect the economy and the growth in the money supply. The lower the reserve requirement, the more leverage a bank has, the more money they can create from deposits coming in and lending out and those get deposited and you have this virtuous cycle that's very positive. With low reserve requirements, the only downside is you've also got very little buffer in case something goes wrong. So, you have a much more volatile risky economy. You can also do the same thing with banking requirements on how much do you have to have a bank have from a borrower. So, you could say, for example, in the housing market, we're going to require that people have 20 percent down to buy a house or 30 percent down to buy a house, and that keeps housing from getting too speculative. Or you could say, "We only need five percent down." Well, more people can buy houses and they could buy a bigger house and they can spend more and therefore they can speculate more and then housing prices go up. Therefore- but wait a minute, they're not as stable because if everybody only has five percent down or zero percent down and something goes wrong, they're underwater, houses are in default. So, a high reserve requirement of their borrowers also helps keep stability in banking. So, a banking regulator will set that as well. How much do banks need as reserving, how much do their borrowers have to show as reserves to make them performing loans of valid loans not to have to count as bad debt for the bank because if it's bad debt for the bank, it wipes out some of their equity and that's bad. So, now that's the banking regulators. But beyond that, there's another regulator who comes in to regulate securities. Now this is not the kind of security we talk about in this course of security in regulation, this is regulation of securities, which means stocks and bonds. So, we're going to regulate these financial instruments and we're going to say you have to only issue them with a lot of warnings or a lot of procedures or you have to make it clear what customers are accepting as risk or you can only lend to rich people sometimes called in the US accredited investors, people with a net worth over a million dollars can only buy this or people with certain qualifications. If they are not accredited, you can only lend to or borrow from or good investments from say 35 people into your new startup. If you go beyond that and you're talking about people without a ton of money, now you're violating securities laws. It's a different regulator. It's a different agency. They're looking at different requirements but they could put those requirements onto a bank for their own securities or on to an investment bank doing trading and securities or issuing securities like bonds or stocks and say we're going to regulate you. Now finally, you have consumer fraud and we're worried about protecting consumers from high interest rates and so- or from other misrepresentation. So, you could have an agency, and you do in most countries, looking at how to protect consumers. Consumer privacy, consumer protection against misrepresentation or fraud or actions that harm customers in some way. So, that's a different regulator. Now, by the way, there is one other regulator which regulates commodities. It's not securities but things like gold, silver, pork bellies, oil, coal. These are commodities, things that you would trade or buy or use. They're not securities, they're tangible things usually. But sometimes cryptocurrencies might be viewed as commodities, sometimes they might be viewed as securities. In our next video, we're going to look at crypto everything and ICOs and how do regulators deal with this new world because that's part of a challenge. So, we'll give examples of crypto as well as some other examples of thinking creatively about how to regulate in this world of FinTech. Thank you.
