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Post Crisis And Regulatory Response On Banking Regulation

3264 words - 14 pages

The failure of banks can always be prevented by numerous ways. The main technique is to establish the system of regulation in order to reduce the risk of bank failing. With the regulation, the banks would be authorised on the basis of meeting minimum standards, and will continued to be supervised to ensure that certain standards or requirements are maintained. This would instill more confidence to the economic actors.[1] The risk of the banks become poorly capitalised, fraudulently or incompetently run compared to if no system of external regulation were take place will be lower. Unfortunately, the regulation does not perform well as an alternative for the regulation by the market, nor ...view middle of the document...

It is always useful to differentiate two issues between the objectives of regulation and the rationale of regulation. The objectives of regulation set out the ultimate aims of regulation, and help to ensure transparency and accountability. But, it is essential to talk about the rationale for regulation before examining the objectives of regulation.[7] Why is there a need to regulate? We can identify the reasons why market fails, and explain the necessity of regulation in correcting market failure. Obviously, a perfect market would have certain characteristics with numerous buyers and sellers, free entry and exit, perfect information, product homogeneity and an absence of externalities. A perfect market will be self regulating and there is no need to implement external regulation if such market exists. Hence, the two main ways in which the financial market fail are due to systemic risk and information asymmetry.[8]

In economic terms, systemic risk is an externality. External cost is imposed on third parties, and internal cost on the main parties during a transaction. When external cost are imposed, there will be a lack of incentive upon decision-markers within banks to take account of those costs as they will not bear the consequences of them. Hence, the regulation can be seen as essential in minimising systemic risk and the costs it involves. As the result, the moral hazard has formed.

Additionally, the second economic rationale for regulation is information asymmetry. As mentioned by Davies, he sees two strands to this, which are complexity of contracts and difficulties in judging the financial soundness of firms.[9] In relation to Davies’s first element, the private bank consumer faces certain difficulties in obtaining the information that they need for some financial product. Unfortunately, the consumers are unlikely to obtain the accurate information about the credence goods as those goods means that the effect of the consumer’s use are only be known in future years.[10] Many financial products are not only complex but also having difficulties faced in identifying their essential characteristics. In other word, there are difficulties exist in obtaining reliable information about quality[11] Despite of it is possible for accurate information to be supplied. The first difficulties is that the consumer suffer from bounded rationality.[12] Therefore, their ability to deal with information are very limited.[13] Secondly, each consumer’s understanding of the information and how to deal with it may differ greatly. It might not be easy for the firms to supply information which will benefit large numbers of consumers. Lastly, there is often an incentive upon banks to not provide accurate information to consumers. The rational bank will only grant information when this puts the bank in a favourable light, and when the information can be supplied cost effectively to the bank. In summarize, only certain valuable information will be withheld.[14]

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