Regulation of Banks and Financial Markets

INTRODUCYION a) Financial Market:

Broad term describing any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade.

b) Bank:
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities y y y A central bank A commercial bank A saving bank

SUPERVISION: RATIONAL OF REGULATION:

c) Monetary policy

The process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low

unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing

d) Bank Runs:
A bank run (also known as a run on the bank) occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent. As a bank run progresses, it generates its own momentum, in a kind of selffulfilling prophecy (or positive feedback): as more people withdraw their deposits, the likelihood of default increases, and this encourages further withdrawals. This can destabilize the bank to the point where it faces bankruptcy

e) Fire Sale
A fire sale is the sale of goods at extremely discounted prices, typically when the seller faces bankruptcy or other impending distress. The term may originally have been based on the sale of goods at a heavy discount due to fire damage. A fire sale may or may not be a closeout, the final sale of goods to zero inventory.

Types of regulation
Systemic regulation

Financial regulations in almost all countries are designed to ensure the soundness of individual institutions, principally commercial banks, against the risk of loss on their assets. This focus on individual firms ignores critical interactions between institutions. Attempts by individual banks to remain solvent in a crisis

One regulatory organization in each country should be responsible for overseeing the health and stability of the overall financial system. The role of the systemic regulator should include gathering, analyzing, and reporting information about significant interactions between and risks among financial institutions; designing and implementing systemically sensitive regulations, including capital requirements; and coordinating with the fiscal authorities and other government agencies in managing systemic crises. We argue below that the central bank should be charged with this important new responsibility. Deposit insurance: Deposit insurance is a system established by the Government to protect depositors against the loss of their insured deposits placed with member institutions in the event the member institution fails. Commercial and Islamic banks that are member institutions of PIDM are also referred to as member banks. As an integral component of an effective financial safety net, a deposit insurance system enhances consumer protection by providing explicit protection to depositors. Depositors will know when, how much and how their deposits are insured in the event that a member institution fails or is unable to make payment to depositors. In Malaysia, the deposit insurance system was brought into effect in September 2005 and is administered by Perbadanan Insurans Deposit Malaysia (PIDM).

a) Benefits to depositors

1. PIDM protects your bank deposits and will promptly reimburse you on your insured deposits should a member bank fail

2. The protection is provided by PIDM automatically and no application is required 3. There is no charge to depositors for this protection
b) Benefits to the financial system

4. PIDM promotes public confidence in Malaysias financial system by protecting depositors against the loss of their deposits 5. PIDM reinforces and complements the existing regulatory and supervisory framework by providing incentives for sound risk management in the financial system 6. PIDM minimizes costs to the financial system by finding least cost solutions to resolve failing member institutions 7. PIDM contributes to the stability of the financial system by dealing with member institution failures expeditiously and reimbursing depositors as soon as possible

Lender of last resort

A lender of last resort is an institution which is willing to offer loans as a last resort. Such institution is usually a countrys central bank. In this case, we talk of a wholesale lender of last resort. A central bank offers extension of credit to financial institutions experiencing financial difficulties which are unable to obtain necessary funds elsewhere.

The main task in front of the lender of last resort is to preserve the stability of the banking and financial system by protecting individuals deposited funds and preventing panic-ridden withdrawing from banks with temporary limited liquidity. For more than century and a half, central banks have been trying to avoid great depressions by acting as lenders of last resort in times of financial crisis. At first, this act provides liquidity at a penalty rate. Subsequently trough open market operations, it lowers interest rates on safe assets. And finally, this process involves direct market support.

Commercial banks usually resort to lenders help only in times of crisis because such actions indicate financial difficulties. Loans may be granted not only to commercial banks but also to any other eligible financial institution, even private companies, which is considered highly risky.

Different institutions may act as a lender of last resort in different countries. For instance in the USA, the Federal Reserve serves as a lender of last resort. Its main purpose is to provide credit to financial institutions that are short of reserves, prevent their bankruptcy, and avoid negative impact on the economy. In the United Kingdom, the central bank, the Bank of England functions as a lender of last resort. In New Zealand this role is taken by the Reserve Bank of New Zealand, its central bank. On a global level, the International Monetary Fund also serves as an international lender of last resort, taking such role because of the recent financial crisis.

Production type regulation

A. Conduct of business regulation

An individual or firm employed by others to plan and organize sales or negotiate contracts for a commission. A broker's function is to arrange contracts for property in which he or she has no personal interest, possession, or concern. The broker is an intermediary or negotiator in the contracting of any type of bargain, acting as an agent for parties who wish to buy or sell stocks, bonds, real or Personal Property, commodities, or services. Rules applicable to agency are generally relevant to most transactions involving brokers. The client is considered the principal and the broker acts as the client's agent. An agent's powers generally extend beyond those of a broker. A distinguishing feature between an agent and a broker is that a broker acts as a middleperson. When a broker arranges a sale, he or she is an agent of both parties.

B.

Moral Hazard

A person or organization who has insurance cover may be more prepared to take risks than someone who does not. For example, someone whose car is insured against theft may be more careless about reducing the chances of theft than they would have been without such insurance. a. Moral Hazard and Loans: Moral hazard is also important for lenders. You might borrow money to buy a home. If you fail to repay the loan, what happens? In most cases, your credit will suffer. It will be more difficult for you to borrow in the future, and you may have to pay higher interest rates. You may even have difficulty getting a job or insurance coverage. Your credit is the "stick" (along with your morals, presumably) that keeps you from chasing the carrot of taking free money.

Forbearance:
Forbearance is a special agreement between the lender and the borrower to delay a foreclosure. The literal meaning of forbearance is holding back. Loan borrowers sometimes have problems making payments. This may cause the lender to start the foreclosure process. To avoid foreclosure, the lender and the borrower can make an agreement called "forbearance". According to this agreement, the lender delays his right to exercise foreclosure if the borrower can catch up to his payment schedule in a certain time. This period and the payment plan depend on the details of the agreement that are accepted by both parties.

Agency Capture:
Agency capture is the defect whereby government agencies established to regulate industries end up being influenced and controlled by the companies the agencies were supposed to regulate. The primary reason for this "capture" of the agencies is because the companies offer better jobs to a few of the agency workers. These leads the agency workers to strive to make the companies happy in the dream of later gaining better jobs for themselves by working for the industry. One example of a government agency captured by industry is the Food and Drug Administration.

LIMITATION OF REGULATION: