Example research essay topic: Rules And Regulations Risk Taking - 1,060 words

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The globalization of financial markets, the dramatic increase in trade and capital flows in the world has deepened economic and financial integration among all countries, and it creates a more complex financial environment, with a greater diversity of capital flows, creditors and borrowers. This process of globalization creates new opportunities but also challenges the international community, especially with regard to the international monetary and financial system. Comprehensive and effective financial regulation, market-reinforced prudential supervision and enhanced international cooperation among regulators are among the keystones for maintaining stability of the international financial and monetary system. Financial regulation has traditionally proceeded through the route of setting standards and of externally imposing rules. Setting standards, however, is only the first step in accomplishing effective regulation. The hardest part is designing a structure of incentives and sanctions that will induce financial intermediaries to live up to agreed standards of behavior.

Regulation that is too tough can stifle innovation, and overprotection can lead to the loss of management accountability. Therefore, regulation should primarily make the market work. Importantly, an empirical relationship is established confirming that overall financial legal scope and effectiveness do have significant explanatory power for the size of financial markets. Again, economic considerations play a great role in the new regulatory framework. Explicit cost-benefit analysis leads towards evidence-based policymaking.

The persistence and strengthening of competition in a functioning market is essential. Financial safety nets are generally supported by prudential regulations that require banks to hold enough capital to absorb losses and by reporting and accounting standards and best business practices that ensure that losses are reflected in profit and loss statements. Although this approach has worked reasonably well in limiting systemic damage from financial excesses, it may lead to conflicts between the objectives of regulators, who, by providing insurance, want to reduce systemic risks, and those of the regulated institutions, which have incentives to take greater risks within internal and regulatory capital constraints. There are dangers both in excessively restrictive regulations, which may inhibit efficiency-enhancing risk taking, and in lax enforcement, which might encourage financial institutions to take risks that would not be worth taking in a different environment. There is no definitive solution to this problem, and it is neither possible nor desirable for financial supervisors and regulators to know as much about a financial institution and its risk-taking activities as its own management. Nevertheless, they must continuously reassess instruments for encouraging prudent behavior and risk management, recognizing that some instruments are likely to be imperfect.

In the past, rules and regulations were of major importance in establishing the guidelines under which institutions operated. These restrictions addressed the assets, liabilities, and activities that were permissible for particular institutions; interest rates that could be paid on deposits; where and how institutions could expand; and many other operating constraints. In recent years, many of these rules and regulations were relaxed or eliminated as they were found to limit the services that institutions could offer customers and to hinder firms in adapting to a changing marketplace. As a result, banks and other financial institutions now find themselves competing directly in a much broader and less structured marketplace. Generally speaking, financial regulatory policy involves choosing an appropriate tradeoff between the objectives of efficiency and financial stability. The primary tools for achieving these objectives are regulation, prudential supervision, and market discipline.

As part of this task, the market needs to strike a new balance in the use of regulation, supervision, and market discipline to achieve its policy goals. It is clear that the market cannot return to, and probably do not want to return to, the highly regulated and segmented financial systems of the past. We do want to give greater scope to the market to guide the evolution of the financial system. At the same time, we recognize that we cannot totally rely on market discipline because of moral hazard and safety net concerns and because the public is likely to have limited tolerance for financial crises in the future.

The main tasks for policymakers are to rethink what is an acceptable tradeoff between efficiency and financial stability and to strike a new balance in the use of regulation, supervision, and market discipline to achieve these goals. These are by no means easy tasks. We recognize that there is no going back to a framework of segmented financial markets and tight regulatory control over deposit rates, bank expansion, and banking activities. And, we acknowledge the need to give greater scope to market forces in guiding the evolution of the financial system. The initial approach should be to identify concrete ways to bolster-and reform, if necessary-existing defenses against systemic problems. More information would enable financial institutions to strengthen their tools for managing risk, private stakeholders to price risks more accurately, and supervisors and those responsible for surveillance to exercise adequate oversight.

The ability to understand, measure, monitor, and control the buildup of leverage and other risk-taking activities should be an important part of this approach. Here, we are definitely supporting the supervision over regulation. On the other hand, regulatory reforms will undoubtedly be necessary, but first the existing rules of the game should be reexamined to see which of them still apply. It would also be beneficial to have a clearer sense of how incentives, risk taking, and market structure and dynamics interact in modern financial systems.

One step that must be taken is to limit concentrations and linkages among institutions that could lead to systemic problems. Considering all the facts, we will suggest a hybrid of regulation and supervision. With only supervision or regulation, the overall finance market cannot get the best result, as in one field regulation may serve the best, and another, supervision. What financial supervisors can do as they attempt to adapt to this new environment, is to use a risk-focused approach to supervision and regulation. Through risk-focused examination procedures, examiners are now directing more attention to the major risks within an institution and to the institution's ability to measure and control its own risk. On the regulatory side, proposals to reform risk-based capital are aimed at providing more refined measures of risk and therefore may help relate a bank's capital needs more closely to its risk profile.

So, we believe that the risk-focused approach, which is a hybrid of both supervision and regulation, can serve the best to the global finance market.

Research essay sample on Rules And Regulations Risk Taking