International and Regional Financial Regulators - Research Paper Example

INTERNATIONAL AND REGIONAL FINANCIAL REGULATORS al Affiliation) The phenomenon of international and regional financial regulation is beneficial to follow as compared to the local regulators. This extract cuts across financial regulation within different economic systems and the competitive advantage that arises from it. Financial regulation manages different financial systems, banking systems, economic systems, social systems and economic systems. This extract talks about the pros and cons of financial regulation. Financial regulation ensures a standard level of operation among the affiliated financial elements within a given financial system (Singer 2007, pg. 12). The operations are put at a level playing field which ensures that banking institutions contribute an equal amount of capital. It also ensures that some set of standards are complied to. Different countries and economies are affiliated to different regional central banks and international financial regulatory institutions. Some operate at a lower cost while some at a higher cost. Depositors prefer regulatory institutions which offer services at a lower cost as compared to the ones which offer services at a higher cost. It is also evident on this extract that regulatory bodies experience a cascading effect on their financial systems depending on their policies. It can be seen that the regulatory institutions with stringent policies have their market share eroded (Quintyn & Taylor 2004, pg. 6). Introduction Financial regulation is a form of supervision, monitoring, or offering of guidelines that subject financial institutions or any other financial elements within a financial system to restriction in order to maintain the integrity of the financial system. Governments and regional financial institutions regulate financial elements for safety. Financial safety protects the depositors and share holders of all financial institutions within a financial system. Financial safety prevents financial insolvency which might in turn lead to an economic, political, banking and a social crisis. International and regional financial regulation has its own pros and cons. Regional financial regulations impose restrictions to member financial elements which in turn force them to comply with the expected standards of performance in order to achieve the set objectives (Quintyn & Taylor 2004, pg. 26). These standards at times affect the member elements negatively or positively. For instance, a regional central bank might issue orders to the member elements to sell bonds to their account holders or shareholders in an effort to regulate a looming inflation. One of the elements might be having a stable economic stature. Selling bonds in a stable economy might destabilize the economy in this sense: The bonds will reduce the supply of money in the economic for a given duration depending on the specified maturity period. On the other hand it might also have positive effects in this sense: If a regional economy is inflated, the central bank of that economy issues orders to all financial elements and banking institutions to sell bonds with longer maturity periods. The bonds are meant to reduce the supply of money in the economy (Financial regulators 2008, pg. 20). This leads to a stable regional economy which is a major advantage to the member elements. International and regional financial regulation ensures market and financial discipline because it amounts to a regulatory risk. A regulatory risk leads to an increase in capital requirements for the regulated firm. The capital requirements are normally matched to the asset value of a particular financial element. The long term effect is that it leads to an increase in capital to the regulated firms. Most governments have disputed the relevance of international regulators with a contention that they can rely on domestic regulation to maintain economic stability, thereby necessitating a move to international regulation. The rationale behind this is that international regulators create no market indiscipline to make the domestic financial elements to deviate away from the international regulations. It has been observed that there is a potential of exploitation that comes about from interacting with unintended international regulators and the international decision-making (Financial regulators 2008, pg. 47). Countries form these regulations as a political response to banks with regards to international competition. Banks in some countries operate under lax regulations while others operate under stringent regulations. This creates cost differentials which can either be advantageous or disadvantageous to these banks. For instance banks operating under lax regulations face lower costs as compared to banks which operate under strict regulations. The banks which operate under lax regulations can offer banking services at a lower cost compared to banks which operate under strict regulations. International regulators require all the members to comply with a set of operational standards (Hupkes & Quintyn 2006, pg. 42). This can benefit or disadvantage the members. They create a standard level of operation. This kind of operation could create a less secure banking system. International regulations manage both capitalist and socialist governments. Some regulated nations argue that politics enforced by socialist nations kill the commercial value of their banking and economic systems. The existence of monopoly powers, information asymmetries, and some other external factors leads to market failures. This is one of the reasons why international harmonization is necessary. International harmonization or regulation ensures sufficient information supply to the regulated firms. This prevents monopoly, market failure and power over other elements within a financial system. According to Rolland (2011, pg. 15), international and regional financial regulators also bridge the gap between capital adequacy and depositor insurance. The depositors insurance overcomes the problems of information asymmetry. Banks understand their risk even more than the depositors. In that regard, depositors are faced with a selection problem which in turn becomes too sophisticated to handle. The deposit insurance therefore protects the depositors with selection problems. If the depositors are faced with a selection problem, most of them tend to withdraw from banking institutions which have a higher cost for servicing. When depositors withdraw banking institutions, this can cause a contagious devastation of economies. The Basel capital accord for 1980s saw Japanese banks capture a third of international lendings during the 80s. The goal of the Basel capital accord was to minimize the risk of banking systems and to reduce the competitive advantage between domestic economies (Hupkes & Quintyn 2006, pg. 39). International and regional financial regulators are beneficial in the sense that they have better supervisory practices which ensure a level playing field and they also ensure a greater market discipline through intensive release of information by banks. By reducing the market competition and reducing the cost of compliance to the international regulatory standards, the market share in turn increases. International and regional financial regulatory effects only affect the regulated firms negatively when the regulatory risks increase the cost of capital of the regulated firms. When regulators increase the capital requirements of the regulated firms, then the regulated firms are forced to capture more capital. As a result, their value depreciates since their capital has moved beyond the required level. Another negative effect is that their capability to dispense the deposit insurance will reduce and hence there will be no security cover for the depositors. This might lead to depositors withdrawing from their affiliated banking institutions, which might amount to a banking crisis. International and regional financial regulators ensure market symmetry in capital contribution by banks. In this case, all banks contribute the same amount of capital at the request of the regulators. This is beneficial to banking institutions because it reduces the competitive advantage within financial systems (Rolland 2011, pg. 30). Competitive advantage reduces the market share and hence makes the depositors susceptible to all forms of market sophistication. Market symmetry also leads to an increase in the cost of equity capital. Consequently, international and regional financial regulatory objectives are meant to increase the social welfare by enforcing banks to raise an equal amount of capital. The political economy of international and regional financial regulators implies that some regulators are closely affiliated to interest groups. The public opinion about this is negative because it is perceived that many interest groups directly influence the regulatory outcomes. It is also argued that banking institutions should not be subject to restrictions indirectly imposed by interest groups affiliated to the financial regulators. It has also been observed that most regulators are concerned with the old shareholders of their commercial banks. This might force the regulators to adjust the rules to favor them. They might adjust the regulatory requirements in order to provide them with advantage over other regulatory institutions. There is a possibility of international banks practicing regulatory arbitrage. Regulatory arbitrage is the practice of financial institutions to shift regulators. A financial institution can shift from a regulator to another basically because of the policies. The policies of an international financial regulator can be lax or stringent (Paulson 2010, pg. 31). Regulators with lax policies are able to offer financial services to their clients at a lower cost while regulators with stringent policies offer their services at a higher cost. In a shifting situation, regulators with high cost will see their market share getting eroded. In an effort to protect their market share, these international regulators will either reduce their regulatory burdens or increase the subsidies. International financial regulation leads to spillovers between countries due to different regulatory policies. Spillovers lead to a decrease in depositors in one country and an increase in another country (Singer 2007, pg. 105). Considering two banking economies with different levels of subsidies, depositors insurance and regulatory practices, a consumer can adopt one system over another system. International and regional financial regulators manage both developing and the undeveloped countries. These two entities have different priorities regarding economic achievements but they are forced to work under the same financial system and are also set to achieve the same objectives. The developing states are normally comfortable with trade policies that encourage local businesses and streamline development. In such a case, the international and regional financial regulators appear to be less useful to the developing countries. International regulators believe in the effectiveness of increasing the capital requirements to offset the risk taking by banks. So long as financial systems are financially integrated, there will always be a spillover irrespective of whether the policies are strict or lax. Lax policies are susceptible to bank failures and might turn out to have very catastrophic impacts. This negative impact is likely not to be accepted by independent regulators and that leads to the consideration of an integrated and a central approach. There are claims that capital regulations by international regulators induce regulatory risk (Paulson 2010, pg. 79). Regulatory risk is the increase in capital requirements imposed by financial regulators. On the other hand the financial safety of any financial element increases with the increase in equity capital. Financial safety is a vital requirement for any financial institution so there is no justification as to whether the increase in regulatory risks is disadvantageous to the regulated institutions. However, when regulatory practices become different across countries, a spillover might occur from the countries with lax policies to the counties with stricter policies. This leads to the decrease in the cost of capital mark up required by shareholders in the stricter countries. These countries can in turn diversify their equity issuance without the fear of suffering a liquidity shock. International regulators are subjected to local politics which might affect other countries. Many developed countries have a say in the policy making of international regulators. This is a potential of exploitation as the same countries can adjust the rules and regulations to provide them with more advantages over the other countries. On the other hand, the developing countries can observe this as a ground of unfairness and fraud. International and regional financial regulators like IMF (International Monetary Fund) do not take into consideration the inflation rate of member countries (Correa 2006, pg. 18). This can consequently affect the member nations because all of them are expected to follow the set standards of monetary performance and control. The IMF policies also tend to conflict the budgetary policies of some member nations. The political atmosphere in the LDCs (Less Developed Countries) is not favorable to the IMF monetary and lending policies thereby making most affiliated LDCs to be greatly indebted to the international and financial intermediaries. Most countries lower their transaction cost by taking advantage of the economies of scale. The performance of regional and international economies determines their relations with the financial institutions and intermediaries thereby affecting the financial regulatory policies of the respective central banking systems. Adverse selection and moral hazard: As a method of monitoring the trends and activities of potential borrowers, financial institutions have put in place measures necessary to determine the characteristics of potential borrowers (Chao 2001, pg.37). This involves two parties, i.e., the uninformed party and the informed party. The uniformed party is the regulatory institution while the informed party is the borrower. The most risky borrowers are considered to be the ones who most actively seek out loans and therefore making it difficult for various international, financial regulatory entities to recover the money. On the other hand, international and regional financial regulators impose the depositors insurance to protect the depositors. It also increases the regulatory risk to offset the money that is likely to be lost by the risky borrowers. Adverse selection is a monetary control technique which guarantees financial safety by financial institutions. The adverse selection allows for the international financial bodies follow up n how the money will be managed by borrowers. Most countries because of bad politics, corruption and mismanagement of funds, they make it difficult for the financial regulators to monitor the management of this money by the member countries. Consequently, this can lead to a global inflation within the affected financial systems because there is a lot of money in circulation which is not accounted for by the monetary control institution. For the central bank to borrow money from an international and regional financial institution it must be affiliated to it and again it must meet a certain requirement for the lending ratio. The Central bank lending ratio indirectly affects other financial institutions lending ratios within the country. This forces the bank and non-bank financial institutions to adjust accordingly. The negative effect here can be that a country is forced to make policies based on the central bank policies while the central bank is also subjected to other international monetary restrictions. The progressive integration of financial markets has brought a centralized approach to management and control of monetary operations within financial elements (Chao 2001, pg. 52). This extract has cut across the pros and cons of international and regional financial regulation. References Chao, Y. 2001, International and comparative competition laws and policies, The Hague: Kluwer Law International. Correa, P. 2006, Regulatory governance in infrastructure industries: assessment and measurement of Brazilian regulators, Washington, DC: World Bank. Financial regulators 2008, New York: Novinka Books. Hüpkes, E. H., & Quintyn, M. 2006, Accountability arrangements for financial sector Regulators, Washington, D.C.: International Monetary Fund. Paulson, H. M. 2010, On the brink: inside the race to stop the collapse of the global financial System, New York: Business Plus. Quintyn, M., & Taylor, M. 2004, Should financial sector regulators be independent?, Washington, D.C.: International Monetary Fund. Rolland, G. 2011, Market players a guide to the institutions in todays financial markets, Chichester, West Sussex, U.K.: Wiley. Singer, D. A. 2007, Regulating capital: setting standards for the international financial system, Ithaca: Cornell University Press. Read More