Financial Reforms Strengthening Financial Stability Worldwide Finance Essay - Free Essay Example

The banking sector has been always regarded as one of the most regulated industries across the globe. Goodhart et al (2001, p.10) and Llewellyn (1999) identified four main considerations that underpin the rationale for banking regulation: 1.) Banks play a pivotal in the financial system and the economy as a whole through the clearing and payment systems and the transmissions of monetary policy impulses in the money supply process, 2.) It is crucial to mitigate contagion and systemic banking risks to contain economic disasters of financial crises, 3) the necessity to protect small depositors who are unable to monitor their banks risk appetite, 4.) and the control over moral hazard problems created by government financial safety net. Accordingly, Financial Regulators and Central Banks have been bounded with the noble responsibility to safeguard macroeconomic and financial stability. By logical deduction, the occurrence of the recent global financial crisis 07/08 is an undeniable proof that banking regulation failed to safeguard the financial stability, Aloko (2010). As a result, over the past three years, the world economy went through the most catastrophic financial storm since the Great Depression. Though the multi-dimensional roots of the crisis were numerous and extraordinary complex, researchers, policy makers, and central bankers underlined macroeconomic imbalances, inadequate risk pricing strategies, poor under- writing standards, weak liquidity and capital buffers, unsound corporate governance practices, altogether combined with exorbitant failings in banking regulations, as the main contributing factors to this global financial mess, Bernanke (2009a), Larosiegrave;re (2009), and Wellink (2008). Regrettably, the failure of financial regulators to timely identify and promptly respond to correct these casual distortions resulted in the worst crisis the world has ever encountered since 1929. Consequently, it has become the primary responsibility of all financial regulatory bodies and central banks to learn from their mistakes and take adequ ate corrective measures to address the shortcomings in banking regulation in order to enhance the future stability of the global financial system. OBJECTIVES OF THE STUDY Critically matching the main failings in banking regulation with the reforms in progress, there is no doubt that the global financial systems will undergo deep international regulatory reforms which will definitely strengthen financial stability worldwide. This is not the first time a financial crisis is occurring, and it is not certainly the last time. However, addressing the roots of the current one remains an incontestable pre-condition to prevent a potential similar future one. In this research, Chapter II will examine the causes and policy responses of the recent global financial crisis. Far from remaining on the causes and fallouts of the crisis, Chapter III will encompass the main failings in banking regulation, and Chapter IV will critically evaluate the new perspectives for banking regulation post the crisis. What are the main policy actions and global international reforms undertaken by prudential authorities to address failings in banking regulation in the United States an d Europe? Are these reforms in progress strong enough to ensure long-term financial stability? These are some of the most prominent questions underpinning the rational of this dissertation. INTERNATIONAL REGULATORY REFORMS AFTER THE CRISES The financial crisis 07/08 originated from delinquencies in the US mortgage market, escalated rapidly and had a gigantic contagious effect on the entire financial system which spilled over the world economy. As a result of advanced globalization and the interconnectedness of international financial markets, the crisis, which was firstly just the US subprime crisis, spanned out of control at the speed of light and engulfed the global financial system. The crisis seemed to be unexpected by most economics agents and engendered a global panic which destabilized the stability of the international banking and financial system and resulted in drastic damaging economic consequences, Ohler (2010). Subsequent to the eruption of systemic risk trigged by the dysfunction of the banking system over the past two years, government authorities have had an increasing interest on reforming banking regulations and supervision, as well redefining the role of central banks in the reconstruction of a solid and more resilient financial system. Accordingly, as a response to the financial crisis 07/08, there has been an unprecedented appeal for international reforms to strengthen stability, correct failings in financial regulation in order to prevent the world from suffering a future crisis of the same amplitude, Osborne (2009). The call for changes in banking regulation has been at the center of most economic discussions in the United States and in Europe since 2008. Though the crisis is now behind us, its sequels were so disastrous that mitigating the occurrence of a potential future one became the outmost priority of prudential and supervisory authorities, particularly, central banks and international governmental institutions such as the World Bank, the International Monetary Fund (IMF) and the Bank for International Settlement (BIS). Not only the crisis reflected regulators inability to prevent and manage such a terrible financial disaster, but it was also a plosive evidence of limitations and flaws of the pre-crisis re gulatory and supervisory framework, Siebert (2008). In the view of shaping the future of banking regulation post the crisis, there has a remarkable effort toward an international consensus of reforms to be undertaken on a global scale. There has been numerous series of meetings, mainly G20 meetings, and an increased collaboration between central banks in the perspective of building up a stronger global regulatory framework. For instance in April 2009, the G20 leaders met to lay down the foundations for measures and actions necessary to strengthen financial regulation and restore confidence. The invaluable cost and consequences of the financial crises 07/08 and the global aspiration of regulators and politicians to reform the architecture of banking regulation for the ultimate goal of restoring confidence and strengthening the stability of the financial system are among the main motivations of this paper. As the complexity of the entire financial system keeps on increasing with developments in financial innovations, there is certainly the need for regulation to adapt and change as well Hildebrand (2009). From a global perspective, the main reforms in progress includes: establishing a comprehensive macro prudential regulatory framework, increasing capital requirements, enforcing a robust liquidity management within financial institutions, supervising and monitoring excessive risk taking behaviors, enhancing risk management, transparency and disclosure, refining deposit insurance and lender of last resort policy to mitigate moral hazard problems, reforming bankers incentiv e systems and putting in place prompt crisis resolution processes to timely address problems relating to systemically important banks, Rochet (2008) and Calomiris (2009a). In the next chapter, the causes and policy responses of the crisis will be analytical examined.