The Soundness of Financial Intermediaries

Abstract

Like all corporations, financial intermediaries' are subject to a complex system of legal regulation. Much of the regulation of ordinary industrial corporations is directed at ensuring full disclosure of relevant information to investors. Stockholders and other investors may then choose whether to take certain risks. By contrast, the regulation of financial intermediaries also limits the risks associated with the investment itself. Some regulation is aimed at ensuring that the intermediaries are "sound," i.e., not in danger of failure because of illiquidity or insolvency. Other legal techniques are designed to cope with failure and other unsound conditions when they do occur. The purpose of this article is to examine the major legal strategies for regulating the riskiness of financial intermediaries. Part I introduces the agencies involved in the regulation of financial intermediaries. Part II discusses the reasons for having any governmental regulation of the risk levels at which financial intermediaries operate. Part III classifies the four principal strategies employed by the law to deal with the liquidity and solvency of financial intermediaries, and attempts to determine the general virtues and drawbacks that inhere in each of these strategies. No effort is made to assess all the particular rules and alternatives that are possible within a single strategy. This article deliberately takes a highly general approach in the belief that useful insights can be facilitated by a comprehensive vantage point.