The Future of State-Owned Financial Institutions - Essay Example

IPE – assignment 2 Name Professor Institution Course Date Government interventions through regulations of both monetary and fiscal in the financial sector are a major contribution to the development of the sector. The statement that, “Major failures of regulation and supervision, plus reckless and irresponsible risk-taking by banks and other financial institutions, created dangerous financial fragilities that contributed significantly to the current financial crisis” demonstrates that banks and other financial institutions have engaged in poor investment and management practices against risks. Besides this being reflected from the statement it however demonstrates a significant change in the role that the government plays in the process of ensuring proper and efficient regulation of the financial sector (Caprio, 2004). This is due to the fact that the government has the ability to ensure optimum stability of this sector and hence making a major contribution to the economic growth of the state. Further, effective ways of regulation and supervision of banks and other financial institutions ensure that there is security as far as the process of bailing out the institutions is concerned. There is greater need for the government to strategically interfere with the operations of the financial sector through regulation and supervision in order to ensure that consumers develop confidence and trust in the financial decisions that are undertaken by banks and other financial institutions (Caprio, 2004). In light of the statement aforementioned this paper aims providing a demonstration of some of the ways that greater financial regulation and supervision could or should be implemented. Definitely a very strong relationship exists between the economic growth and the financial sector. The financial sector can either result in economic growth or of recession, which majorly characterized by a financial crisis. In this case, the blame is placed on the failure by government to regulate and supervise the operations of the financial sector. Therefore, for greater regulation and supervision of banks and other financial institutions to be achieved there is a need for government to implement measures that will aim at protecting both depositors and investors. For instance this can be achieved through implementing a law such as the special deposit and guarantee fund (Cuevas and Fischer, 2006). This law would give security to investors and depositors to recover their money in-case banks and other financial institutions ended up in financial crisis hence need for insolvency. The special deposit and guarantee fund may constitute contributions by both the government and the banking and financial institutions in accordance with the law. In a bid to ensure that there is proper regulation and supervision of how banks and other financial institutions operate the government can develop economic policies which would provide significant support to the financial industry infrastructure (Hanson, Kashyap and Stein, 2011). This may involve major considerations being made on the factors or rather variables that significantly contribute to the growth of the economy. Examples of such factors include per capita stock and per capita output. In the long term this would ensure that the financial structure of banks and other financial institutions are designed in such a way that they are efficient and either directly or indirectly contribute to the economy and significantly avoiding instances of any kind of failure to meet such expectations. Through central bank monetary policies the government can be able to effectively regulate and supervise the operations of banks and financial institutions. Central banks all over the world stand high chances to effectively any kind of financial crisis through monetary policies (Cuevas and Fischer, 2006). In this respect the government can develop a monetary policy requiring banks and other financial institutions to reduce their rates of interest. The main aim of such a strategy being implemented is basically to ensure that there is minimization of the borrowing cost for private investors, businesses as well as consumers (Hanson, Kashyap and Stein, 2011). This kind of regulation in turn has the ability of stimulating business and commercial activities. The regulation and supervision of banks and other financial institutions could also be achieved through government fiscal policies. This may involve the government engaging in fiscal spending. Another strategy worth implementing may involve the government providing public stimulus packages (Hauner and Kumar, 2006). These packages have the power to increase spending on projects involving infrastructure and in the long run creating more employment opportunities for people and therefore making the pattern of consumption by consumers more stable. Government regulation and supervision on the market for banks and other financial institutions could significantly aid the management of the financial sector. This includes engaging in activities such as providing lines of credit for institutions that have good practices, setting up better processes to aid in the procedures of monitoring of reports of taxation in relation to financial institutions (Mayes and Wood, 2007). Auditing of financial statements and reports is a very important exercise which the government can engage in to ensure better regulation and supervision of banks and other financial institutions. In this respect the government can develop measures directed towards ensuring that the financial systems are not at the risk of collapsing in future. Most importantly after the execution of audit activities banks and other financial institutions should be punished incase discovered to have been engaging in unfair practices such as evasion of tax. Consumer liquidity is a very significant aspect as far as the operations of banks and other financial institutions is concerned (Ruozi and Ferrari, 2012). This is what determines whether consumers are able to develop trust and confidence in financial institutions. In order to assure consumers of cash liquidity and persuading them to make deposits and invest with financial institutions the government can inject into the financial banking system some liquidity with the aim avoiding excessive contraction of credit in the long term (Ruozi and Ferrari, 2012). For example, in case there is an increased lack of stability within the financial system from a general perspective the growth of the economy stand to be affected negatively and depositors and investors may find it very risky to make any kind of investments (Hauner and Kumar, 2006). In this case, there is greater need for the government to regulate and supervise the financial sector through injecting liquidity into the financial and banking system in order to increase confidence and trust from the consumers. Reforming the Structure of the banking sector could significantly facilitate the regulation and supervision of banks and other financial institutions (Mayes and Wood, 2007). This may involve the development of measures that aim at ensuring that the implications of failing banks and other financial institution are put at a minimum. This may be achieved through ring fencing whereby these regulatory framework demands that banks and other financial institution be resolvable thus being able to drive and incorporate unexpected alterations in the law and the financial system’s operational structure to the bank and financial institution’s capital structure (Mayes and Wood, 2007). The process of balancing stability and liquidity is another strategy that could be implemented in order to ensure that financial systems are regulated and supervised in the best way possible. For instance, this can be achieved by short selling ban which is basically an approach that may be used for the purpose of ensuring that there is actually a balance between sustaining stability of the financial system during difficulties and benefits accruing from liquidity (Heller, 2006). It is quite important to take note that the short selling ban has the advantage of contributing to the liquidity market, ensuring that the costs of financial transaction are reduced as well as enhancing the process of pricing by making it to become more efficient. In addition, on the concept of short selling ban it aids in the process of restraining any negative attitudes and ensuring that there is comparative stability within the financial and banking systems in case of a financial crisis (Heller, 2006). Securitization of markets is another reform that could be adopted to ensure banks and other financial markets operate efficiently. The securitization of markets would ensure that in the balance sheets there are no receivables which in turn are replaced by their cash equivalents (Ruozi and Ferrari, 2012). As far as securitization is concerned, it is quite a less expensive approach. The ultimate impact is that the banks and other financial institutions’ balance sheets would be improved. Securitization would also promote the application of better risk management practices and therefore enhancing the control of financial institutions. Through securitization, banks and other financial institutions would be better placed since it would aid in ensuring that the weighted average cost of capital remain low. Such a possibility would exist since the financial institutions would not necessarily be required to support their assets using their equity capital (Ruozi and Ferrari, 2012). Furthermore, securitization would enable the financial institutions have broader opportunities for investment hence being able to generate more gains economically, especially if the sources of credit have been constrained. Securitization is identified to be a major cause of financial crisis, hence an aspect that needs a great deal of reformation within banks and other financial institutions. In respect to the ability of banks and other financial institutions to manage risks securitization could also be implemented. This reform process could be used with the aim of ensuring that there are reduced risks in line with the risk of funding (Caprio, 2004). This could be achieved through the process of diversification of the sources of funds. It is essential to note that both banks and other financial institutions make use securitization since it provides assistance in eliminating mismatches in line with the rates of interest. For example the banks and the financial institutions could engage in the process of offering financing at a fixed rate, but on a long term basis, which in turn has highly reduced financial risks (Caprio, 2004). This is due to the fact that the interest rates and other financial risks in the market are passed onto the investors. On the other hand, besides of significance to banks and financial institutions securitization could also benefit depositors and investors. This is in line with the process of making decision concerning the kind of investment to engage in by making it possible for them to focus on the level of protection that is provided by an asset portfolio that has been securitized (Carmen and Rogoff, 2009). In this case they can be able to choose financial assets that are in line with their risk preferences, hence having increased benefits as far as the concept of risk diversification is concerned. Additionally with the aim of ensuring that there is substantial oversight being directed to the operation of banks and other financial systems the improvements of risk management practices is considered very important. This includes management of various risks that face banks and financial institutions through other approaches such as standardization of the terms of loaning within the financial systems and exercising of zero tolerance on group lending and on delinquency (Caprio, 2004). Financial management and reporting is another perspective that needs to be included in the financial regulatory framework of operations of banks and other financial institutions. Financial management and reporting ensures that there is good management of financial data and information contained in financial statements such as the balance sheet and statements of income (Caprio, 2004). This in turn would result in timely reporting making it easier to follow up on the financial operations and performance of the banks and other financial institutions. Most importantly, with an efficient and effective financial management and reporting system, transparency and accountability within the financial system is enhanced (Caprio, 2004). Implementation of regulatory framework in line with over the counter derivatives could significantly strengthen the financial and banking system (Papaioannou and Rochon, 2006). This is due to the fact they would provide assistance to the banks and other financial institutions in managing their risks as well as being tailored in such a way that the customers perceived risk exposures within the financial systems are managed. Through over the derivatives there are limitations and standardization of the cleared financial transactions to a level that is manageable with the aim of facilitating consistency in the process of valuation while promoting efficiency in financial margining procedures and processes (Papaioannou and Rochon, 2006). Financial regulation and supervision is vital for the survival of the financial systems within any given economy. The various ways that have been presented if implemented the banks and other financial institutions stand a high chance of performing better together with avoidance of collapsing. Policies of regulation and other strategies that would ensure that the financial system remain efficient would definitely result in increased benefits to the economy both locally and internationally. A good example is the development of the measure aimed at ensuring that execution of audit activities by banks and other financial institutions is carried out in accordance with the law and that these financial institutions are punished in case discovered to have been engaging in unfair practices such as evasion of tax. The ways of regulation and supervision of banks and financial systems adequately address the problem that the failures in these practices were the ultimate cause of the financial crisis. In addition, some of the risk management approaches presented stand a high chance of bettering the ability of banks and other financial institutions to deal with risks that arise within the financial and banking system. In this case effective and efficient prudential regulation and supervision of banks and other financial institutions is significant and would highly aid in the avoidance of incidences of failures of financial systems. It has been demonstrated that financial regulation and supervision safeguards banks and financial institutions as well as customers such as depositors and investors. This is due to the fact that with proper and effective regulation depositors and investors are able to gain confidence and trust in the decisions made by banks and therefore encouraged to engage in diverse investments. References Caprio, G. (2004). The future of state-owned financial institutions. Washington, D.C: Brookings Institution Press. Carmen, R. and Rogoff, R. (2009). This Time is Different: Eight Centuries of Financial Folly, Princeton U. Pr. Cuevas, C. E., and Fischer, K. P. (2006). Cooperative Financial Institutions: Issues in Governance, Regulation, and Supervision. Washington, D.C: World Bank. Hanson, S. G., Kashyap A. K. and. Stein J. C. (2011). "A Macroprudential Approach to Financial Regulation," Journal of Economic Perspectives, American Economic Association, Winter, 25(1), 3-28. Hauner, D., and Kumar, M. S. (2006). Fiscal policy and interest rates: How sustainable is the "new economy"?. Washington, D.C.: International Monetary Fund, IMF Institute. Heller, P. S. (2006). Making fiscal space happen: Managing fiscal policy in a world of scaled-up aid. Washington, D.C.: International Monetary Fund. Mayes, D. G., and Wood, G. E. (2007). The structure of financial regulation. London: Routledge. Papaioannou, M. and Rochon, C. (2006). Exchange rate risk measurement and management: Issues and approaches for firms. Washington, D.C.: International Monetary Fund. Ruozi, R. and Ferrari, P. (2012). Liquidity risk management in banks: Economic and regulatory issues. Berlin: Springer. Read More