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Relying on the Regulators: The Importance Self-Regulation

Two themes that we’ve covered in the past, if you want something done right you have to do it yourself and the importance of being proactive, are two common themes when it comes to the regulatory risk and compliance spaces. With the industry in the state that it is, the implications that a company is failing to institute its own measures for maintaining compliance with the regulations are becoming too severe to ignore.

Looking back on the 2008 financial crisis, poor regulatory oversight, while not the primary cause of the collapse, played an important role in a global economic recession. But despite this fact, while regulators might have been lax in their duties, firms were, and are currently still, held responsible for their actions.

It is, and always has been, the responsibility of every firm to ensure that their company is adhering to any and all relevant regulations. So with that being said, it stands to reason that each company should be proactive in regulating themselves, lest they be penalized by the regulators.

Since the economic collapse of 2008 and the subsequent ‘Occupy Wall Street’ movement starting in 2011, financial firms have been seen as the bad guys in the public eye. What were once respectable and revered cornerstones of the American economy are now reviled to the extent that the promise of eliminating them can give one a fighting chance of becoming the next president. But much like when a child makes a mistake and their mother takes away a privilege, financial firms need to start proving that they can be responsible and that starts with demonstrating effective self-regulation.

But avoiding regulatory discipline isn’t the only benefit of self-regulation. Having a good reputation for being ethical and honest can go a long way in ensuring a company’s growth and prosperity. It’s beneficial to both the industry as a whole, and for the individual companies that it’s comprised of, to invest in its reputational capital.

Reputational capital is the value of an institution’s commitment not to breach contracts or to take risks that might endanger its compliance with contractual obligations. Looking at that definition, it should go without saying that a firm’s reputational capital is directly proportional to a firm’s franchise value. After all, it makes sense that everyone would want to do business with the honest guy, who’s responsible and not going to mislead them, over someone who’s likely to take advantage of them.

If we take a look at the history of self-regulation, regulating one’s self was viewed as “just good business sense”. To sum up the article in that link, it describes the uncertainty that 11th century Maghribi traders faced when relying on business associates to handle their dealings abroad. The uncertainty arose due to the fact that the traders had no way to be sure that these individuals handed over all of the proceeds from trading on their behalf. To solve this problem, the traders formed a network where they could exchange information about which agents were honest or not. Obviously no one’s going to want to do business with a dishonest agent, so this coalition of traders effectively created an incentive for the agents to employ honest business practices.

In today’s practices, especially in the United States, we’ve largely moved away from that decentralized model of incentivizing honest business practices. Instead, we’ve established a centralized model, where the federal government directly imposes regulations on its members. But that’s not to say that firms shouldn’t still strive to invest in their reputational capital with self-regulatory practices.

The financial industry has made mistakes, but now is the time where the focus should be on regaining the public’s trust. By demonstrating the ability to oversee itself, and thus taking responsibility for its actions, the industry can once again brandish the support of the public. Only when banks can show that they are capable of ethical and honest business practices, will people feel comfortable enough to make the industry grow. Because when it comes to the financial industry, the people are your customer. And the customer is always right.

(At least in this case.)

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