Since US banks are increasingly engaged in securities areas, their functions are also subject to the Securities and Exchange Commission (SEC) and consumer lobbies. Regulation may be based on product types such that each regulatory authority specialises in one financial product. Under this framework, a securities regulator will concentrate in the oversight of securities activities, irrespective of the type of financial institutions that are carrying out this business. Functional regulation is generally conducted by two separate regulatory bodies, an investor protection arm and a systemic stability arm. The investor protection arm deals with retail depositors and small investors to ensure fair conduct, equitable competition and customer protection. The systemic stability agency, on the other hand, looks at the larger players and wholesale activities. It would also be responsible for the safety, structure and functioning of all payment systems and financial markets. Preventive measures include capital adequacy requirements; constraints on connected lending and other rules aimed at preventing insolvency; and an official safety net such as lender of last resort or deposit insurance. This approach follows the Goodhart (1995) model, which suggests that the difference in focus and function of investor protection and systemic stability is large enough to justify two separate regulatory bodies in each country to share the regulatory responsibilities. According to Goodhart, the formulation of rules for the safety of the system should be the responsibility of the systemic stability arm.

The globalisation of financial markets may increase systemic risk, through contagious financial disorders originating in poorly regulated financial centres. As Alan Greenspan (1997) mentioned, ’the efficiency of global financial markets, engendered by the rapid proliferation of financial products, has the capability of transmitting mistakes at a far faster pace throughout the financial system in ways that were unknown a generation ago, and not even remotely imagined in the 19th century.’ Depositors, investors and counterparties may be exposed to foreign jurisdiction risks which they are not in a position to monitor or control. Besides, the co- existence of uneven national regulations and global markets may severely distort competition between financial institutions. The growing integration of markets calls for international cooperation among supervisors. Accordingly, the Basle Committee on Banking Supervision was established in 1974 and is involved in establishing a common regulatory framework. The Basle Committee and the International Organisation of Securities Commissions (IOSCO) issued co-ordinated guidelines on risk management on OTC derivatives business. IOSCO also adopted the so-called Windsor Declaration on co-operation between supervisors of futures and options markets. Industry initiatives also aimed at strengthening prudential standards in international financial markets. The Group of Thirty has proposed minimum standards relating to netting arrangements, settlement procedures and managerial oversight of derivatives risks. The International Securities Dealers Association (ISDA) has established good practice guidelines for the management of derivatives and FX business globally by broker-dealers. And in early 1996, 49 exchanges and clearing houses announced an agreement to exchange information on their members’ risk exposures in different markets.