Essay on Banking and Financial System are Heavily Regulated

Essay on Banking and Financial System are Heavily Regulated

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Banking is a heavily regulated industry that is very protected to prevent crises that can cause huge economic harm. One topic that has been greatly debated in the history of financial systems is whether competition is good or bad for financial stability. It is complex and hard to know which side is right. Pretty much everyone with an opinion at least concedes that there are good points for both sides. All the arguments run both ways, and the evidence is mixed. History can show evidence that both sides of the argument are true. It is easy to see an example where a country had X banks and Y crises and assume causation but it is rarely that simple. Other countries’ experiences can show exact opposite results. The key is to find the right balance. There is a very wide range of possibilities concerning the relationship between competition and financial stability. For a long time it was common thinking that, competition made the financial system less stable. Therefore, regulators have restrained competition in many countries. The Great Depression caused the end of most standard competition policies in banking in order to promote fiscal stability. It was successful but smothered development and forced a burden on the customers. This caused a correction towards deregulation, which added more competition but low stability and many crises (Beck, 2010) The recent financial crises reopened the debate. There are many other factors that can affect the financial stability, such as funding structure, institutional and regulatory environments, regulatory framework in which banks operate and which sets their risk taking incentives, and probably others not even realized yet. A big factor many people look at is the willingness of risk taken by owners...

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...e structure of the market and limiting the amount of competition. That could be troublesome and have undesirable side effects. The challenge is to keep up competition for the benefits it will provide for the entire economy, while in the meantime making an administrative structure that minimizes the negative ramifications that it can have for stability. Thorsten Beck writes that “Together [the banking regulatory rules] would constitute the so-called “safety net”…The safety net consists of: Banking supervision, Deposit insurance (explicit or implicit), Capital requirements, Lender of last resort, Bank crisis resolution (private solutions, bailouts and bank closure policies)” (Beck, 2010). Administrative change can give the powers better tools to manage failing banks later on, and accordingly diminish the negative repercussions on the rest of the financial framework.

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