Financial Services Coursework titles - Essay Example

?Running Heading: Financial Services work s Financial Services work s INTRODUCTION After the financial crisis that has disturbed the economic conditions around the world, it has been identified that there is a need for primary reform of financial system and this is the reason why many economists and financial analysts have re-evaluated the international financial and monetary system. People have come up with several reasons why the financial crisis occurs and why the impact of financial crisis was so strong. Not only the financial institutions in the country but the overall world economy had to face consequences of the financial crisis. Many people have suggested several things; however one recommendation with which most of the analysts would agree is to go beyond micro-based approach to macro based approach (Galati and Moessner, 2010). This means that the approach needs to be changed from an individual perspective to the overall market perspective. In addition to this, it has been criticized that the role of financial institutions and financial regulations were insufficient in predicting and identifying such a major change in the economic condition of the country, at the time when the economy was going into recession. There has been a growing concern that a macroprudential approached needs to be adopted in order to make the economy more stable and strong. Macroprudential policy is defined as a concept in the banking regulation which defines about the financial instability in an economy and how these instabilities can be prevented through public policy. Analysts have claimed that a purely microprudential perspective is not satisfactory enough to maintain the stability of the economic condition. In place of this, there should be a macroprudential perspective in which the overall financial system is evaluated. According to analysts, macroprudential policy has been missing from the existing policy framework and this is one of the main reasons why the world economy had to pay such high cost at the time of recession. In last few years, there has been a significant gap between macroeconomic policy and regulation of individual financial institutions and in order to stabilize the economic condition it is important that this gap should be narrowed down. It has also been predicted that the impact of financial crisis would have been a lot less if macroprudential policy would have been appropriate and the gap between the macroeconomic policy and regulation of individual financial institutions would have been narrower. After the financial crisis, analysts have recommended that prudential regulatory framework also needs to be recreated so that it would be more focused on the financial system so that such crisis do not occur again and the economy is able to recover from its position. In addition to this, the other main objective would be to ensure that the financial institutions do not impose undesirable costs on the society just like the cost that the overall society had to bear because of the recent financial crisis (Bank of England, 2009). MACROPRUDENTIAL POLICY Macroprudential policy helps in identifying the loopholes that occur in the banking regulation because of which chances of financial instability occur in the country. Not only this, but macroprudential policy helps in how to reduce these instabilities in the economy and it talks about preventive measures through which such economic crisis do not occur again. Macroprudential policy tends to complement microprudential policy and macroprudential policy interacts with different types of public policy which influences the financial stability of the economy. After the recent crisis, analysts have demanded a clear division between the two terms; macroprudential policy and microprudential policy. However the main objective of the policies would remain the same i.e. to minimize the risk of the economy. Many people demanded to have new set of macroprudential policy tools in order to make the economy stronger and authorities to have better contract of the credit supply. According to Adair Turner, Chairman of UK Financial Services Authority (2010) macroprudential policy is significant and required as credit/asset price cycles can play an important role in volatility in the macroeconomic conditions and financial instability. Deputy General Manager of the BIS, Herve Hannoun in 2010, said about macroprudential policy that it would have two major dimensions. The first most important dimension would be that financial systems would become more stable with the passage of time if not they become stable immediately. Secondly, macroprudential policies would better address the stability of financial system at each point in time. The word “macroprudential policy” has been gaining popularity since the financial crisis as it has been used more frequently than ever before. The following graph indicates the increased usage of this word. (Source: Galati and Moessner, 2010). Also, there have been an increasing number of researches done on the word “macroprudential policy” however the number of published papers remains more or less the same. The following graph represents usage of term “macroprudential policy” in published academic papers. (Source: Galati and Moessner, 2010). IMPORTANCE AND OBJECTIVES OF MACROPRUDENTIAL POLICY Generally the main objective of macroprudential policy should be to have stable provision of financial intermediation services so that the overall economy remains stable. Policies should aim to eliminate the kind of boom and bust cycle because of which such financial crisis occurs. If regulatory standards are made tighter then it would lead to an increasing cost of financial intermediation and thus the credit would be available to only some households and companies. In recent times, there has been a debate regarding the objectives of macroprudential policy can play an important role in ensuring that the economy remains stable and financial institutions like banks are protected. One of the main significance of macroprudential policy is that it changes the focus from individual intuitions to the overall economy and thus it shifts the focus from micro level to a macro level. Therefore economy can be observed from a broader perspective which can be helpful in predicting the overall economic trend as thus financial institutions and financial regulatory authorities would be able to predict if such a crisis would occur. Considering how important the issue is and how important macroprudential policy is, G-20 regulatory authority has also raised its concerns and it has given attention to this issue and for this G-20 regulatory authority has called International Monetary Fund (IMF), the Financial Stability Board (FSB) and the Bank for International Settlements (BIS) to come up with a macroprudential policy framework. It emphasizes the importance of macroprudential policies in providing financial stability of an economy (IMF Monetary and Capital Markets Group, 2011). POLICY INSTRUMENTS TO PREVENT A FUTURE BUILD UP OF SYSTEMIC RISK IN AN ECONOMY There has been an increasing demand of analysts and economists to have better precautions and policies that would be able to prevent financial instability in the economy. There are few countries that have deployed macroprudential tools so that they are able to achieve policy objectives. However, the important thing to note is that these objectives are not solely related to systematic risk. There have been few countries that have focused on structural processes to address risk concentrations and interconnectedness. Macroprudential tools can be divided into two groups which are: Category I: Tools or instruments that are designed specially to minimize the systemic risk. Category II: Tools that are made considering the systemic risk however these tools can be altered to become part of the macroprudential toolkit as long as: i. The main target of these tools is exclusively the systemic risk. ii. The selected framework is supported by needed governance arrangements to make sure that there is no slippage in their use. Such tools are also called Recalibrated instruments. There are several countries that have made use of recalibrated prudential tools or instruments in order to address procyclicality. On the other hand, there are some countries that have included countercyclical changes on exposure of banks to few instruments or tools, sectors or markets. The main objective of doing this is to reduce the too much accumulation of credit risk during the periods of high credit growth. Spain has implemented rules-based dynamic provisioning framework in which banks are required to build up buffers of general provisions against loans during expansion that can be drawn down when the economy is going through recession. Also there are countries that have used several other recalibrated instruments like Loan-To-Income (LTI), time-varying caps on LTV, Debt-to-Income (DTI) ratios, or standards for eligibility of loans to restrict money which can be borrowed by any company or an individual. There are countries that have deployed direct monetary policy tools in order to limit credit supply when the economy is experiencing boom for example, restricting the growth rate of aggregate credit, marginal reserve requirements . In addition to this, fiscal policy tools have also been used by some countries like imposing duties on property holdings with the intention of breaking the speculation of real estate industry. Such instruments can be regarded as macroprudential instruments if they obey the two conditions mentioned above. In addition to this, new tools have been evaluated to minimize the systemic risk that arises from the financial system. Different proposals currently are now being evaluated regarding the increase in the ability to absorb loss of systematically important financial institutions (SIFIs). A strong market infrastructure is important in diminishing the probability of failure of individual companies and can harmonize macroprudential instruments. Introducing steps which could discourage too much direct exposures between the financial institutions would be the one of the main tasks for macroprudential policy. How Should Macroprudential Instruments Be Chosen There are several important features on which the choice of tools or instruments to be included in the macroprudential toolkit is made. These features are as follows: Efficiency in restricting the build-up of systemic risk as well as making buffers that could be used in tough times. Having restricted opportunity for arbitrage. The basic aim would be at the roots of systemic risk, not at the symptoms. As less distortionary as possible to the financial system and economy. In practicality, testing tools against the abovementioned features have been taxing. For any instrument which has been developed recently, the most important challenge is to evaluate the effectiveness of measure without having any history. The major challenge emphasized by IMF was the proof regarding the efficiency of instruments and tools used by countries previously have remained restricted. After a survey IMF concluded that there were several instruments that might be useful however their practicality and actual usage is considerably more limited. Figure 1: Potentially useful” and “Actually used” Instruments (Source: IMF Monetary and Capital Markets Group) There have been reasonable debate on individual instrument but despite of that only little progress has been made practically on selection of tools. Several aspects have influence on this little progress however one of the main aspects is about the number of instruments which has been described below: Few instruments or multiple instruments: Market expectations can be affected easily with simple instrument this is the reason why there are limited set of instruments. In addition to this, with few instruments, it is easier to access the interactions among instruments and impact of overall policy. On the other hand, the benefit of more instruments is to allow dealing with more localized problems. Besides this, there are other considerations that influence the choice and combination of policy instruments and it has been suggested there is no one solution that could fit to all circumstances. How should instruments be used? There might be rules and discretion that would look optimal under existing situation even though they might not be optimal. As a mix approach, small rules-based instruments can be utilized to deal with the key dimensions of systemic risk. Additionally, discretionary policy element would harmonize the rule by enabling policymakers to apply additional measures. The problem in calibrating systemic risk helps this balancing approach and reduces the chances of depending severely on automatic mechanisms. Discretionary interventions would be better in dealing with surprising and sudden systemic shocks. CONCLUSION: There are numerous challenges faced in designing of an effective macroprudential policy and the challenges faced can be broadly divided into: Composition of macroprudential authority Its authorization and powers Mechanism that ensures responsibility and communication Means that makes sure coordination between domestic and international policy. It has been found that there is no single solution that could be adopted by all countries or even most of the countries whether they are developing countries or developed countries. However, the above mentioned challenges are to be faced by most of the countries of the world, if not completely then to a certain extent. In last few years, there has been substantial progress made in order to mitigate the systemic risk faced by countries. People who are involved in policy making have become highly aware and have recognized the significance of macroprudential orientation and this is the reason why they have put great efforts to update the monitoring of possible weaknesses in the overall economic and financial system. In future, continuing the same process would be beneficial and it is most likely that it would be followed, though the pace at which it will go would be slow as there are several obstacles and challenges currently being faced. However, it would not be a good idea to only rely on prudential policy to solve the financial instability and imbalances. This is not only because of the sluggish pace at which a further strengthening of the macroprudential orientation of financial regulatory and supervisory frameworks is possibly going to carry on. But another important reason is the inbuilt restrictions or limitations on the efficiency of prudential instruments in dealing with financial instability. In addition to this, monetary policy can play an important role as it impacts the growth of liquidity that can accommodate the economic development. Reference List Bank of England 2009, ‘The role of macroprudential policy’. Discussion Paper. Available from [Accessed 2 November 2011] Galati, G and Moessner, R 2010, ‘Macroprudential policy: A literature review’. Available from [Accessed 3 November 2011] IMF Monetary and Capital Markets Group 2011, ‘Macro-prudential policy: an organizing framework’. Available from [Accessed 4 November 2011] Read More