Running head: REGULATIONS AND FINANCIAL STABILITY 1

Regulations and Financial Stability

Student’s Name

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REGULATIONS AND FINANCIAL STABILITY 2

Regulations and Financial Stability

Financial regulation comprises of laws and rules that control how financial institutions

and bodies use, distribute, and do with finances. Government regulators as well as international

groups play an important role in making these laws and rules and ensuring that they are

followed. This helps maintain order in the market, provide investor protection and equally, work

towards maintaining and promoting financial stability. With financial stability, markets thrive

and businesses as well as financial institutions have growth opportunities that positively impact

market and different economies in the world.

Financial Crisis

In situations where financial regulation does not take place or financial institutions do not

monitor their finances, a financial crisis arises. Financial crises refer to economic conditions of a

country that include currency and banking crises, as well as stock market crashes. Consequently,

it is important to note that financial crises not only have domestic origins, there are other external

sources that affect the economy of a country. Additionally, financial crisis can come from both

the private and public institutions within that particular country.

In a situation of financial crisis, desperate measures have to take place in terms of

immediate economic policy changes. These changes majorly affect the financial sector and fiscal

policies that involve government spending, and taxation. Global economic trends play a key role

in how a country’s economy runs. Thereby, there is need to harmonize and coordinate global

economic policies. Financial crises can start as a national phenomenon that can spread into the

international arena and affect other market economies globally. Internal as well as external
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factors such as political unrest in a country and rise in oil prices respectively, become the driving

force behind financial crises (Goodhart, 2005).

The nature of financial crises is such that it is characterized by several indicators such as

severe disruption of external financing, changes in terms of loans given out to individuals and

organizations, not forgetting changes in the real estate and investment sector in general.

Additionally, large scale government assistance leads to high circulation of money in the

economy thus affecting the value of the currency and causing inflation.

When discussing financial crisis it is impossible to go without mentioning currency crisis.

It is worth noting that currency crisis does not necessarily cause financial crisis; however, in a

financial crisis, the value of money in an economy is affected. According to Dabrowski (2012)

currency crises can be defined as a swift decline in the value of a local currency by more than

twenty percent measured against the dollar. Currency crises arise from political, economic, as

well as market forces that cause pressure in the exchange rate of a currency. Some countries

suffer currency crisis characterized by increased imports than exports and over-reliance on

external financial assistance.

Financial Institutions

Financial Systems

These consist of financial units and markets interacting in a complex manner to provide

facilities as well as funds used for investment purposes. The aim of financial systems is to ensure

that commercial activities continually get funding so that they keep markets on the run. Such

systems include banks, the stock market as well as commodity markets.

Bank Regulations

Bank regulations exist for the purpose of transparency and accountability of these

financial institutions. The need to regulate banks arises protect consumers as well as to control

pricing of products so as to check and avoid misuse or abuse of monopolistic power.

Additionally, regulators work towards ensuring that the public is protected from criminal

activities and external pressures that affect market transactions.

Banks continue to operate under strict regulations such as creating new branches or new

entries of other micro financial institutions in the economy, controlling pricing, and prevent

financial instability (Claus, Jacobsen, and Jera, 2004). There is continuous need to regulate banks

and financial markets because of factors such protection of investors from criminal or illegal

activities. Secondly, financial regulations within the market help to monitor competition among

financial institutions. Thirdly, actions by agents can harm or cause instability for the financial

system. Regulations of this nature work towards increasing confidence in investors, retailors,

entrepreneurs, as well as increasing transparency between banks and other corporations that

interact and conduct business with in a daily basis.

Regulations for banks are justified in such a way to avoid market failures and the

realization that banks are unique. Types of regulations that surround banks include systemic,

prudential and conduct of business regulations. Systemic regulation gears towards creating a

sound financial system through deposit insurance. Prudential regulations operate within the

framework of governing internal management of the banks. This helps to ensure capital remains

adequate and there is continuous availability of liquidity. Regulation for the conduct of business

involves rules that protect or prevent disclosure of personal information, fairness in the practice
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of business, avoid incompetency and ensuring that banks remain honest, transparent and

trustworthy in their conducts.

Bank Failures and How They Affect Financial Stability

Banks like any other financial institution sometimes fail and face financial problems.

Some of the causes that cause bank failures include; bank loans, issues with funding, asset

mismatch, non-banking activities, regulatory issues, risk management issues, rogue employees,

inappropriate lending of loans to bank insiders.

Bank loans involve a big part of the business conducted in a bank. Therefore, when credit

standards are lowered to attract individuals and businesses to take loans for growth of business,

the loans lose their purpose and create problems for the bank financially. For instance, in the past

giving out of loans for purposes of real estate and mortgages led to failure of some banks. Thus,

there is need to regulate the lending of loans by banks. Over the recent years, banks have taken

part in non-banking activities that sort to increase profits for the bank such as investing in real

estate. This non-banking activities, if not well thought of or properly calculated can cause bank

failures especially if the bank has ventured into real estate market that is collapsing or not so

profitable.

Rogue employees, individuals, and businesses that fail to cover losses have been

responsible for the downfall of some financial institutions. For instance, if an employee makes

poor speculative investment opportunities it can greatly lead to financial losses for the bank; a

good example being Nick Leeson employee of a UK bank back in 1995 that lost over eight

hundred million pounds. Other internal problems such as deficiencies in terms of experience,

judgment, or integrity with board and management can easily cause bank failures. Failure of any
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bank often leads to failure of other firms that are directly related or connected to the bank

(Biggar and Heimler, 2005). Consequently, stakeholders are also easily affected in the process of

a failing bank.

International Financial Regulatory Framework

Conclusion
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References

Biggar, D., & Heimler, A. (2005). An increasing role for competition in the regulation of banks.

Antitrust Enforcement in Regulated sectors–Subgroup 1, ICN (International Competition

Network). Bonn, 586.

Claus, I., Jacobsen, V., & Jera, B. (2004). Financial systems and economic growth: An

evaluation framework for policy. MONTH.

Goodhart, C. A. (2005). Financial regulation, credit risk and financial stability. National Institute

Economic Review, 192(1), 118-127.

Dabrowski, M. (Ed.). (2012). Currency crises in emerging markets. Springer Science & Business

Media.