| Financial Crises and Bank Regulation Essay
The financial sector is very critical to any countrys economy. The banking sector plays an integral part in the well-being of the countries macro- and microeconomic. Banking regulations, therefore, exist to guide transactions between the banking sector and its clientele, either individuals or corporate entities. Given the dense network of the financial sector and its corresponding value to the countrys macro and microeconomics, it is imperative for the regulatory authorities to establish best practices within the sector. As stated by Brunnermeier, Crockett, Goodhart, Persuad, and Shin (2009), the current system of banking leaves financial institutions with great autonomy in the market. In the current banking philosophy, most commercial and investment banks have a leverage over the entire economy. Most governments are weary of the grave consequences that they are likely to find themselves in, should banks collapse. The recent collapse of major banking institutions in the United State and Europe has demonstrated the extent of governments concern. Current banking regulations were founded on prudence and risk prevention concepts. Through these guidelines, banks are supposed to maintain market discipline and moderate the working environment. This provision seems to have given financial institutions a firm stand in the economy. It is against this reasoning that Brunnermeier, Crockett, Goodhart, Persuad, and Shin (2009) argue that the current philosophy of banking regulation is unsatisfactory and gives a basis for economic instability. This paper gives arguments in favour of the authors comments and discusses possible implications of the current financial sector regulations.
There are numerous financial regulations in existence currently. These regulations are frequently amended to seal loopholes and any weaknesses that are likely to generate disasters. Most economists and financial experts argue that piecemeal legislation is the best for regulating the financial sector. However, most economies are in precarious conditions because of the current banking regulations. As asserted by Radice et al. (2005), the current philosophy of banking sets a bad presidency in the financial sector (p. 34). Banks have the autonomy that gives them the freedom to indulge in dangerous practices. The current banking system originates from the old practice of collecting and lending |er deposits. Under this model, central banks play the role of a regulator in the countrys economy. The central bank acts as the epicentre of the countrys economy.
In the present banking systems, Central banks play crucial roles in the economy, as banking, by its very nature, is an essential part of the economy. Activities of the central bank can have diverse effects in the economy of any country. However, in the Renaissance period, banking was legitimate and highly productive in the economy. This kind of banking was mostly under the authority of merchants. As time went by, the merchants began operating banks that were based on lending. A fraction of their reserves was lent out to people and interest was paid on the loan. Such institutions were mostly managed by families. In other words, the business of lending money to |ers continued unnoticed for some time, but it was strictly supervised.
The principle of fractional banking was modelled along the historical merchant banking. Fractional banking essentially means that commercial banks only retain a portion of the money received as deposits from |ers. Commercial banks will then make profits from the interest they charge on top of loans. Under fractional banking, commercial banks mobilize |er savings and lend them out in the economy. Banks only retain a portion of |ers deposits. The sum of the retained fraction is known as bank reserves, this is only a portion of the reserve ratio. This scenario creates a debt economy because most of the money circulating in the economy is borrowed. Given the current competition in the banking sector, banks activities have the potential to crumble the economy (Schiller, 2009).
During times of economic hardships, governments act through the central bank to issue new banking regulations that can turn the economy around. Central fractional reserve banking is the most common form of banking in most countries, except for those under the Islamic law. Islamic banking prohibits banks from making profits through charging interest on loans. Most people prefer this system of banking because money is always available on demand. |ers can withdraw their money anytime they want. Under the system, commercial banks act as intermediaries. They act between the |er and investor. On the other hand, the full-reserve banking profits from the use of |er deposits as loans to others. It is the exact opposite of fractional banking. |er deposits are locked up in a safe, and therefore no money is available for lending. However, under the current banking system, banks have the authority to decide how and when to issue a credit.
As argued by Brunnermeier, Crockett, Goodhart, Persuad, and Shin (2009), the bankruptcy of banks in the United States marked the beginning of a period of uncertainty in international financial markets. Financial institutions lost the trust that they had been enjoying from investors. After the collapse of some banks, global short-term money markets froze, with short-term business operations becoming extremely expensive. The commercial paper market came to a halt, and no one was willing to lend. Since then, credit spreads have broadened sharply, stock markets have plunged and economies everywhere went stumbling. Financial contagion has spread crossways the broader economy and the global budget.
Blanchard (2009) believes that the answer to this emergency was directed at solving the credit menace and avoiding further harm to the universal economy (p. 67). The G20 countries approved a set of mutual ideologies which included reforming economic markets and revolutionizing the international governing structure. The November 2008 conference was a first step on the road to define the right framework for the international financial construction of the 21st century. G20 governments unanimously agreed to reform the financial sector by enacting fresh banking regulations that were aimed at dismantling the current financial systems. The United States and the European Union decried that the current economic crisis could only be solved if governments acted tough on the banking industry. Experts warned that the current economic crisis had the potential to slow down the world economy. This time around, emerging markets were not the instigators of the crisis, but their aggregate demand was now more vulnerable to a global downturn because of their dependency on external demand and foreign investment. Financial institutions and hedge funds in developed economies rapidly pulled out the massive amounts of money from emerging markets, creating problems for local markets and banks (U.S Economic Survey, 2008).
International lines of credit, the lifeblood of international transactions, were also frozen, affecting trade and leading to reduced export earnings. Governments in emerging markets were also acting decisively, cutting rates and injecting liquidity into their banking systems. Some countries had room for an additional fiscal stimulus, but this was not the case for the poorest countries, which did not have the fiscal space to implement counter-cyclical policy. Foreign aid needs to take on an essential role. Developed countries would need to act upon the commitments they have already made to increase foreign aid to developing countries.
Is the current international financial crisis an accident resulting from a fundamentally well-designed global financial system? On the other hand, is it a fundamental and structural break from the current system, which requires a new international financial order? In either of these situations, the worsening economic and financial conditions place a strong emphasis on the design of counter-cyclical policies during downturns. As argued by the authors, the United Nations Economic Commission has always advocated the preponderance of a diversified banking structure, both in terms of regulation composition and export markets, in achieving sustained and robust economic growth. Independently of its elements, such a production structure underscores the need to create the necessary foundations for an increase in investment in physical and human capital and in total factor productivity. The commission further warned that without the required measures, the threat was looming in the world economy and the consolidation of a sustainable growth path would not be possible. This discussion ultimately leads to the conclusion that, indeed, the world needs to formulate a new development agenda in the banking system, one that leaves the so-called Washington Consensus behind and that allows the removal of major long-standing obstacles to economic growth. The current challenge is enormous and will require more than minor adjustments in the existing foundations of the regions linkages with the world economy (United Nations, 2009).
The current philosophy of banking has existed for over a century now in most economies. The main distinguishing factor under this form of banking is that commercial banks have powers to keep a portion of |er deposits and lend out the remainder. Under this financial system, the government acts as a regulator through central banks. The central bank is entrusted with the responsibilities of issuing economic guidelines to other banks. This system is prone to many economic challenges. Consequently, unscrupulous investors have used the loopholes in the banking system to design policies that are meant to enrich banks at the expense of the countries macro- and microeconomic objectives.
As argued by Brunnermeier, Crockett, Goodhart, Persuad, and Shin (2009), the system empowers banks to anticipate and accumulate excess money that cannot be backed. This money is left to circulate in the economy without being supported by any wealth. The result of this greedy banking philosophy is disastrous. Inflation has been on the rise continuously for a decade now. The prices of commodities have been skyrocketing and many people are left without jobs. The current banking philosophy has become obsolete because of the increase in the volume of trade. Banks have the leverage that cannot be tamed through government regulations. The state of the American economy and the world at large is not stable, although some scholars argue that the American economy is bouncing back. That is not correct, even though the number of people who have gained meaningful employment has increased according to some figures. Real economic growth needs to translate to capital accumulation. The fact that a few people have been hired does not necessarily mean that the economy has grown. The American economy is still in the ruins; furthermore, looking at how much the government is spending makes it obvious that the worst is yet to come (Rothbard, 2005).
The government is spending more than it can get. The American debt is currently at its historical high. The government has no idea where it will get the resources to repay the debt of around three trillion dollars. There is a possibility that the evil banking practices of lending excess money to meet its rising costs is to perpetuate. This will damage the value of the dollar badly. Free markets should be adopted to bring order in the banking industry. This will further abate inflation and stabilize purchasing power. Studies carried out by the World Bank and other organizations like the European Economic Commission indicate that most economies stand to collapse any time because of the financial autonomy in the banking sector.
Although 57% of banking institutions involved in the World Banks study alleged that the governments global response to financial catastrophe had exposed their firms to economic risks; plaintiffs to this survey were more cynical about the precise movements their corporations have taken. Price reduction as well as overhaul of the entire banking system has been assumed to be the best approach to the current economic crisis. Several financial institutions have become proficient and a sturdy majority of the initiatives have been concentrating their operative charges since that time of diverse change. Many respondents argued that establishing new banking regulations was the only functional way that could contribute to the economic revival in the world. The state of the world economy has worsened to levels that most economists could not imagine. Receptive disparities dwindle, as more countries continue to evolve from export-led to consumption to uninterrupted growth, while several deviating nations shift in the reverse course. Revelation of the central banks is expected to retain the expansionary policy, which ought to fund the continuing expansion of the worldwide frugality in fiscal markets. Many central banks are expected to increase charges, but would not be extremely vehement, given their craving to keep their progress reinforced and exchanges modest. While the central argument is for benevolent inflation, the liquidity poses universal inflation menaces to the benefit of the population. The debt-laden organizations are facing huge challenges of integration and inconsistent claims by their bondholders and investors on their limited incomes. The choice for governments is to force banks to adopt several measures, including circumvention, sturdy progression, financial asceticism, monetization, low interest rates from creditors. This would be the fundamental tool for monetary and market consequences in the future. Fiscal strategy should be carried out to determine the rate of bank lending by oversight authorities (Kreinath, 2008).
An expansion in capital spending or a fall in the load of assessment ought to increase cumulative demand and enhance employment opportunities. The scope of steadiness in national income is shaped by the multiplier effect. The larger the national income multiplier, the better the modification in the universal revenue will be. However, financial strategy must be used to inspire the supply side enactment of the budget. In the current banking policy, nominal rates are not negative due to the high-powered money of the nominal zero returns estimated to the dollar. The reason behind the condition is that investors in the contemporary society do not agree to purchase bonds with negative yields. Therefore, when the nominal interest rate set by the government approximates to zero, there are critical channels through which monetary policy is stimulated when the economy stops existing. Besides, when the rate is zero, the government debt and dynamic money are perfect alternatives, so are the non-interest-bearing assets issued by the administration.
There is the consideration of the time span of both consumers and the sellers, which is used to determine the ultimate state of the stock market. Most central bankers are usually concerned with all the activities that take place in the monetary policy field. For instance, the central bank improves its economy by applying the open-market purchase of government arrears as a mechanism of monetary policy. When the stock of the larger portion of money is increased, the open market draws a purchase on the nominal as well as the actual interest rate. This increases the consumption rate plus the investment rates in the market economy. It also contributes to an atmosphere of supportable progress and steady upsurge. This is the main macroeconomic channel of fiscal regulations that govern most banks. The monetary policy is used to determine change in the money supply, as well as the price inflation of goods and services in the market. The rate at which they have grown can be determined by changing the rate of growth in market (Eatwell & Milgate, 2011).
This affects both the short-term and long-term behaviour of the consumers in the market. The short-term rate has an advanced result on individuals expenditure rate through the circular flow of income. However, the manner in which the monetary mechanism is transmitted depends on the interest elasticity of the amount of goods and services in the market. This is done to encounter the governments outlay plus tax urgencies without a detrimental upsurge in the load of regime debt. The advantage principle is to guarantee that financial institutions that profit from the existing economic conditions also encounter the costs of funding the economy through provision of credit facilities. Macroeconomic firmness fiscal strategy in the UK is calculated to sustain financial strategy in ironing out the path for collective request over the monetary cycle. The future of the current financial system looks dim there are no prospects that the current style of banking will save the global economy for long. The entire financial system will crumble together with the purchasing power of money, if governments do not act on the current banking regulations. The fractional-reserve banking has given it all in terms of financial propriety. It is time that the entire world came together and designed a financial system that would meet the current economic challenges.
Initially, banks were meant to keep |er deposits safe. Banks were only allowed to lend out their own money as opposite to lending a fraction of |er deposits. In fact, the Romans put it in their law that it was unlawful for any banking institution to lend out |er deposits. Banks were prohibited from lending money that was not their own assets. The fractional-reserve banking, however, reversed all these gains. Banks can lend out the amounts of money commensurate to the deposits they are able to collect. The reason why governments exempted banks from some of the provisions in the Romans law is the chief source of the current perennial financial crisis. It is understood that governments have not been tough on reinforcing the Roman law in financial institutions, because the governments themselves have been heavily indebted. The current fractional-reserve banking cannot solve the current debt crisis (Brunnermeier, Crockett, Goodhart, Persuad, and Shin, 2009).
Financial conditions in the world have seen numerous challenges in the recent decade. Financial institutions, mostly banks, are doing their best to ensure that their investments bring payoffs. The premium rates ought to be reduced in order to meet the expected demand in the market. The worldwide economic and financial crisis is projected to continue if the current banking system is not repealed. There is also the question of foreign limited venture in the world, as well as external demand. Workers payments and changes in comparative prices, mainly product prices, are also affected. The effects of the predicament will wave both the macroeconomic and microeconomic repercussions in the world economy. From a societal viewpoint, the international economic and monetary crisis will be felt more acutely by the most vulnerable social groups. Poverty is anticipated to rise, particularly because of higher food and energy bills and the worsening situation in the labour market. The ultimate consequence will be a dramatic downslide in many economies of the world.
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