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Regulation T Definition
Regulation T is a Federal Reserve Board’s regulation that governs the investor’s use of a cash account for purchasing securities and regulates the credit extension limit by security brokers and dealers. The regulation prescribes that security brokers or dealers may extend only up to 50% of the total purchasing price of securities as a loan, and the investors must pay at least 50% price in cash.
A Little More on What is Regulation T
Investors can obtain loans from their brokers or dealers for buying securities. In exchange, they need to deposit their assets with the broker or dealer. This is called “buying on margin”.
The Regulation T also provides certain rules regarding the security transactions made through cash accounts. According to Regulation T, an investor must buy securities with cash if he or she has a Cash Account. Investors with Margin Accounts are allowed to obtain a loan from the broker or dealer to fund a portion of their security purchase.
The Board of Governors of the Federal Reserve System introduced Regulation T to govern the credit extension and safeguard the investors from larger scale risks. Borrowing money from the brokers or dealers may expose the investors to a sudden loss of a huge amount. Regulation T limits that chance by imposing a cap on the borrowing amount. This requirement is known as the “initial margin”. The requirement level may become higher for certain brokers and dealers.
In order to purchase securities with credit, an investor must open a margin account. The broker-dealer has the right to determine the interest rate payable on the borrowed amount. If the total purchase amount of the securities is $20,000 the investor is allowed to borrow up to $10,000 from his or her brokerage firm, and he or she must pay at least $10,000 in cash.
Although, Regulation T or Reg-T was primarily introduced to regulate credit extension it also contains certain rules for governing cash account security transactions. A Security transaction may take up to two days to be completed and only after that the seller of securities receives the selling amount. This may lead to a situation when an investor purchases and sells the same securities without paying for it from his or her cash account. This is known as “free-riding”. Regulation T prohibits this occurrence. In this case, the brokers are obligated to freeze the investor’s account for 90 days. It makes it mandatory for the investors to pay cash on the trading date for purchasing the securities.
References for Regulation T
Academic Research on Regulation T
- · The Investment Banker and the Credit Regulations, Karmel, R. S. (1970). NYuL Rev., 45, 59. This paper explains the relationship between investment Banker and credit regulation. For as many customers that would like to go into an investment with the bank or other insurance company, this research paper is a very comprehensive study to understanding the principles on which this organization adopts.
- · The Securities Activities of Commercial Banks: A Legal and Economic Analysis, Fischer, T. G., Gram, W. H., Kaufman, G. G., & Mote, L. R. (1983). Tenn. L. Rev., 51, 467. Irrespective of the problem associated with the Glass-Steagall Act, most commercial banks have deemed it worthy to increase their security activities and make them more substantial in the past years. According to this paper, this increase brings about more liberal of the Act’s restrictions by the bank courts and regulatory activities. According to the result gotten from the de facto, dismantling of the Glass-Steagall act as seen in this paper, the de jure dismantling is of less importance when compared to what it used to be in the time past although it is still effective for the purpose of increased efficiency.
- · Discount window borrowing, monetary policy, and the post-October 6, 1979 Federal Reserve operating procedure, Goodfriend, M. (1983). Journal of Monetary Economics, 12(3), 343-356. This paper explains its claim by developing a demand schedule which explains the discount window for borrowing with the aim of the bank maximizing its profits. A non-price rationing feature was also included in the discount window which indicates that making longer time and burrowing is more costly as shown to make expected and burrowing future spread between the Federal Fund rate and discount rate more important in burrowing decisions. The result of this analysis suggests the reason why Fed has experience complexity in estimating, specifying and utilizing of a discount window burrowing function.
- · Reserve regulation and recourse as a source of risk premia in the federal funds market, Barrett, W. B., Slovin, M. B., & Sushka, M. E. (1988). Journal of Banking & Finance, 12(4), 575-584. According to this research analyses, a persistent and pronounced pattern of return in the federal fund market was explained and deliberated on. Evidence that explained this process as a reflection of the main reasons behind bank behaviour operation in an environment where there are effective reserve requirement and a cost for recourse of discount burrowing was also presented. According to this research paper, the result submitted indicates that what might be regarded as an anomalous interest rate behaviour is actually consistent with the response of banks to the environment in which they operate.
- · Regulation T and Public Offerings of Limited Partnerships: Time for a Change, Hensley, D. C., & Rothwell, S. E. (1984). The Business Lawyer, 543-570. It is not an assumption any more than for more than a year past, the Federal Reserve Board regulation has in one way or the other stopped the public offering of limited partnership securities which provides instalment payment of the purchase price. According to this research thesis, the legislative and judicial history as well as modern interpretation of this regulation as regards limited partnership offering has been reviewed and a proposal to permit the instalment of payment has been analyzed and described.
- · The Effect of Regulation T on Cash Transactions in Securities, Judson, F. S., & Emerson, F. D. (1946). Michigan Law Review, 44(6), 997-1012. This paper explains the effect of Regulation T on various cash transaction carried out insecurities. This paper analyses the risks and the implication of this cash transaction on the Regulation T rule.
- · A Note on Regulation T, Effros. (1965). Banking LJ, 82, 471-475. This paper gives a comprehensive note as regards Regulation T and also, what can be called a panacea to the problem surrounding the Regulation T was also explained and analyzed in this research paper.
- · Proposed amendments to Regulation T, Vingoe, G. (1995). International Financial Law Review, 14(8), 42. This paper gives in-depth knowledge as regards the proposed amendments carried out on the Regulation T assumptions. The original and the proposed assumptions were compared and analyzed and the results were stated in this research thesis.
- · CREDIT REGULATION IN THE SECURITIES MARKET: AN ANALYSIS OF REGULATION T, PARRY, C. (1967). Northwestern University Law Review, 62(4). According to this research work, an analysis on Regulation T was carried out and the main focus was on the Credit Regulation in the Security Market. This research paper explains all the analyses carried out in the credit regulation and all other liable transactions carried out in the security market as regards Regulation T.
- · Regulatory Influences On Portfolio Performance: Short Selling And Regulation T, Burgess, R. C., & Tamarkin, M. J. (1982).. Journal of Financial Research, 5(1), 39-54. This research paper explains the various models that were developed to explain the effect of short selling. According to this paper, three important factors were taken into consideration. First is that short selling is suitable for reducing the risk for many assets. The second is that the Regulation T can be used in combination with short selling to improve future portfolio importance and the last factor is that the performance of the assumed model is important than the previously suggested model.
- · Proposed Rule 3A12-5-A High Price for an Exemption from Regulation T for Condominium Securities, Goldstein, B. S., & Van Der Wall, R. J. (1974). U. Miami L. Rev., 29, 89. This research thesis explains the proposed rule 3A12-5-A as regards the increase in price for an exemption from the Regulation T for condominium securities.