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The importance of regulation in the financial markets

The importance of regulation in the financial markets - Essay Example

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The level of interest in the money market provides a signal to the investors and the consumers. The signal facilitates the transfer of funds to the households,…

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The importance of regulation in the financial markets

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Subject: Macro & Microeconomics
Type: Essay
Level: Masters
Pages: 4 (1000 words)
Downloads: 3
Author: xbeier

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The regulatory policies safeguard the interest of the borrowers and investors. In addition, these policies remedy economic instability. (Ahearne, William & Francis, 330). The financial market regulation in the US focuses on prudence. The Financial institutions are regulated to ensure their reliability. Scholars argue that the regulations are aimed at providing a smooth credit cycle (Cetorelli, Nicola & Philip, 454). The financial market regulation dates back to the mid 19th century when the money supply solely relied on bank credits.

The US Federal Reserve was established in 1907 as a lender of last resort. The paper will analyze the circumstances under which the financial market functions poorly. In addition, it will also discuss the importance of regulations in the financial market. The banking sector can perform better in a market system in which the demand and supply of credit are self-adjusting. Interest rates are determined by the interplay of demand and supply for money. In addition, they play a primary role in the resource allocation process within the economy.

For as long as there is an economic freedom, the banking sector plays a positive role in enhancing the national output. Classical economists argue that the state interference with the market, inhibit economic growth. The state interferes with the market by imposing an interest rate ceiling, directed credit and selected credit control. Direct government intervention in the in the financial market can result in financial repression. It has severe effects on the saving and investment levels in the economy (Eichengreen, 360).

Strict regulations in financial markets inhibit the functioning of the financial sector. The rules restrict entry into the financial market. A high capital requirement for establishing a financial firm makes it difficult for potential entrants. As a result, the already established financial institutions gain monopoly and charge high-interest rates for their

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