Question

2. The 2007-10 financial crisis clearly showed the need for updating the national and global regulatory framework for financial institutions. Given the fast pace of financial and technological changes, policy makers have a tough time in keeping pace with these changes. However, what they can do is they consistently adapt rules, regulation, and supervision to evolving market practices so that they do not lag behind. However, all this is easier said than done. Financial institutions are adept at lobbying nations countries negotiate regulatory compromises which they hope will benefit their own financial sectors, supervisory bodies have a tough time recruiting and retaining experts.   

There is no other way out, but for all governments to beef up their regulatory and supervisory standards. At the same time, their own financial institutions should not feel the brunt of all these regulations. The question is how the regulatory bodies should keep pace with all the changes and how banks should adapt to the new regime. In the light of this framework, answer the questions given below:

1. There could be a conflict of interest between politicians, regulators or supervisors, and financial institutions. Comment.
2. Diagnose whether central banks should lead or follow financial markets.
3. Illustrate how central banks should react to asset-price bubbles.
4. Debate whether the world’s giant central banks should shoulder global responsibilities.

Answer 1

A) There often a serious conflict of Interest between the politicians, government, regulators and financial institution. Financial institution often lobbies for the rules to be bend towards them where they can benefit the most, even if it comes at the cost of their own customer. They take risk far more than that is justifiable. Financial institution often sponsors the political campaign where they expect that when the candidate comes to power it will amend rules and regulation. Government wants to boost the economy growth so they want the interest rate to be low and rules to be more favorable towards the industries. The regulator has freedom to act but is often criticized by the government for not supporting all government policies. B) The central bank should act in such a way where it is able to guide the market for long-term sustainable growth of the economy. It should lead the market in such a way that the pricing of asset is appropriate and inflation is within the limits. The idea behind this is that central bank apart from the central have the power to influence the market to at certain extent. When monetary policy combined with fiscal policy of the government acts for the long-term growth, the economy can avoid these huge financial crisis and scandals. The asset price bubble forms when the price of a commodity is rising continuously and more people are simply buying with the expectation that prices will continue to rise. In these circumstances inflation is generally is in rising trend and central bank can increase interest rates to contain the inflation level. Also, high interest rate would reduce the present value of asset, making it less desirable investment. D) Though, it is very difficult for any one particular central bank to guide and influence the policies of other countries but dollar being a global currency which is used as a foreign exchange reserve, it is the responsibility of the federal reserve that when it is making policy changes in interest rates it should consider the global impacts on other currencies. A coordinated approach to deal in financial crisis would be more effective then acting alone. The major central banks in the world should take some responsibility in sharing the risk management framework so that major crisis can be avoided.