Role of Financial Regulation in Preventing Financial Crisis - Case Study Example

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Every financial arm twists the government into attempting governmental response which aims at ensuring that this financial calamity never happens again. In this regard, the governments involved attempts to come up with various control systems and mechanisms that will help in the regulation and control of the financial as well as the nation’s banking system. The previous crisis that ended in the autumn of 2008 was not an exemption; we witnessed the European Commission respond to the crisis by setting up various bodies to control the national as well as the international finances. The bodies as developed by the European Commission were mandated by various tasks for instance, the collection of information on all macro-prudential risk in the region, mediation that brought together all the EU member states, the espousal of the binding decision making system, coordination of the supervisory bodies, licensing of the specific EU institution among many more. The objective of these proposals was to help in the prevention of the next financial crises using tight and centralised regulation. However, this paper attempts to inquire if such regulations can work efficiently in the prevention of financial crises like the one witnessed in 2008. However, it is important to note that the other non-credit and rating problems, such as the speculative investment, herding mentalities and contagion through globalisation are not taken into account (Kovacevich, 2014).

Case Study: 2008 financial crisis

Various arguments have been put forward about the nature and the cause of the 2008 financial crisis. From the fundamentalists’’ perspective, the main cause of the 2008 financial crisis was the discrepancy spending and the unmaintainable domestic debt. This could be true considering the case of nations like Northern Ireland, Spain, Portugal and Greece (Rötheli, 2010). Other arguments that have been put forward in regards with the real causes of the financial crisis, for instance many argue that the primary cause of the financial crisis was the financial crisis was over leaning on manufacturing and export promotions thus causing the nation to lose their competitive advantages in the international political economy (Haltom, 2013). Another school of thought suggests that the financial crises in most incidences are part and parcel of the global economy and therefore should not be a glitch that requires extreme preemptive measures (Harrington, 2009). In this sense, we realise that the causes of the financial crisis are not similar across the board, and various schools of thoughts hold’s different perspectives about the real cause of the financial crisis as was in the year 2008.

Can financial regulation prevent financial crisis?

The inquiry on whether the stringent application of the financial regulations as proposed by the European Commission (EC) can effectively and efficiently control the financial crisis as was the case in 2008 does not have a single response. Hastily, it is easier to assume that the regulations of institutions that offer auxiliary services such as banks and insurance companies will curtail then from engaging in unethical practices that could lead to the failure and the later collapse of these institutions (Claessens & Kodres, 2014). For instance, this was evident in the Nordic states of Sweden, Norway and Denmark. This helped the nation avoid the negative effects of the financial crises that could have been extremely detrimental to the welfare of the state. In such states, it is clear that the production base is not as significant as in states such as Germany or even China. If anything even those nations that have great balance trades was affected. It, therefore, follows that the measures must not necessarily include the regulation of finance (Ackermann, 2010). The shortcoming with this school of thought is that it ignores the demerits of the nation controlling the activities of the banking sector. Considering the liberated global economy demands that there should be zero interference by the government. However there is need for the adoption of a more pragmatic approach to the regulation of the of the economy needs to be put in place to mitigate the recklessness in some of the institutions; however, the real solutions to the financial crisis lies in the complete and comprehensive restructuring of the economy.

In real sense financial crisis is an intersection of many complex factors that go beyond the behavior of financial institutions and the financial situation. Such include the development fundamentals of the economy (Haltom, 2013). It is therefore prudent that governments adopt a more convincing and workable policies within the greater international competitive environment is the key to the deterrence of financial crises. Therefore, the financial stability of the economy is more dependent on planning and the execution functions that the regulatory framework that ensures financial stability. It is therefore important that the various governments and states come up with policies that will favour and ensure the economic recovery and sustainability, for instance, coming up with a good central bank policy.

A good policy in the central bank with provisions for liquidity is more instrumental in the containment of the downside risks of the price stability, supporting the economic activity and stabilizing the financial system. The central bank can manage the country’s interest rates to ensure that the financial market remains strong against all the odds. In this manner, the monetary policy of the nation will be strong thereby attracting more and more direct foreign investments. The second critical dynamic is human behavior (Harrington, 2009). Many nations have managed to ensure that the behaviours of the citizens are in line with the financial objectives of the state in this manner the various governments have developed laws and policies that regulate the behavior as the part of the overall institutional framework. In this manner, the speculative behaviours and jitters that come with the news of an impending financial crisis is the last thing that the economy of any nation expects.

The liberation of the financial market is the other way of evading financial crisis; however, this cannot be achieved through regulation. The nations need to liberalise their financial sectors, in this way laws that control interest rates and credit rates needs to be scrapped out so that these institutions can operate without any restrictions that would otherwise limit them. The government should, however, have a levelled playground for new entrants into the financial markets of the nation. In this manner, the financial system of the country will be strong thereby seeing a steady growth and the development of the nation. The market liberalisation the financial market will also promote competition between various banks and the expansion of the financial market thereby reducing unfair competition in that sector of the economy while at the same time strengthening the economy of the nation

The respective governments also need to strengthen and support the domestic banks. The national banking reforms should also be more concerned with the management of the risk. An efficient banking sector with effective supervisions and regulation helps in reducing distortions that increase the nation's vulnerability to financial crisis. The government, therefore, needs to come up with laws and regulation that will promote the development of the banking sector rather than laws that pull it down. Additionally, the government also needs to regulate borrowings by the nation, households and other private institutions. With this regard, the loans and borrowings authority can come up with restrictions that limit the borrowing to a certain level beyond which the loans are not granted. Moreover, the state needs to ensure that political pressure for the establishment of amenities that were not budgeted for to be avoided as this will plunge the economy into serious debts.

At the epicentre of this discussion is the equilibrating nature of human shrewdness. As a matter of facts, the paper has been more opposed to the notion of regulation as a means of ensuring a nation does not plunge into financial crisis. As a matter of facts, the regulations have been seen as a barrier that creates structural rigidities which interfere with the natural outcomes of completion, for instance, regulation has been seen as a factor that can inflate the cost of borrowing and run financial institutions into the doldrums, this, in turn, forces such institution to lay off employees as a way of surviving in the corporate jungle. This worsens the economic situation by reducing the per capita income and in turn interfering with the nation’s GDP.

However, the role of state machinery cannot be ignored especially when it is on matters of the creation of employment opportunities in the country. The government can open up all the ribbons of the economy to completion, however at the same time they can play a supervisory role in ensuring that all the rogue elements in the private sector that take advantage of the various loopholes in the market are hamstrung and gotten rid of whenever necessary (Harrington, 2009) however the government must just play the oversight role and must not interfere with the business activities at all costs. In that regard the concept of regulation, regulation should be allowed to an extent and to a particular degree, making it absolute can be detrimental to the economy. For instance, the Dodd-frank wall street reform and consumer protection act of the United States has been largely criticised for merely creating obstacles to an already weighed down business community. In this sense, the use of regulation as a means of saving the country from drowning into a financial crisis has only been seen as a loophole by the government to strain the various elements of the economy thereby causing the loss of jobs as well as limiting the financial institutions from achieving their various goals and objectives.

In sum, the importance of the involvement of the government in the economy is very significant, however, it is important to realize that some practices by the government such as the regulation of various elements of the economy could plunge the country into further problems that could lead to laying off of employees and at a large extent contributing to the culmination of a financial crisis. This paper, therefore, concludes that it is important that the government appraises the regulatory measures they intend to implement before actually implementing them. To begin with, a good financial system needs to put in place to monitor and prevent the escalation of the outcomes of financial indiscipline. Moreover, there is the need for a complete and comprehensive restructuring of the major economies to make them responsive to the modalities of the international completion. Lastly, where possible, the regulatory framework should reward prudence and punish imprudence in the conduct of business within the economy.

Reference list

Ackermann, J., 2010. The new architecture of financial regulation: will it prevent another crisis?, s.l.: Financial Markets Group.

Claessens, S. & Kodres , . L., 2014. The Regulatory Responses to the Global Financial Crisis: Some Uncomfortable Questions, s.l.: International Monetary Fund.

Haltom, R., 2013. Reaching for Yield. Econ Focus, pp. 5-8.

Harrington, S., 2009. The financial crisis, systemic risk, and the future of insurance regulation. Journal of Risk and Insurance, 76(4), pp. 785-819.

Kovacevich, R., 2014. The financial crisis: why the conventional wisdom has it all wrong. Cato J, Volume 34, p. 541.

Rötheli, . T., 2010. Causes of the financial crisis: Risk misperception, policy mistakes, and banks’ bounded rationality. The Journal of Socio-Economics , 39(2), pp. 119-126.