Banking Regulations And The Current Financial Crisis Essay

Banking Regulations And The Current Financial Crisis - Essay Example Thus we can say that even a stable banking system with all proper regulations in place failed to stop such a financial crisis from occurring. The paper intends to trace out the reasons behind such a failure with the help of findings and analysis and the relevant steps undertaken for this. Reasons behind failure of banking regulations Economists and policy makers of various countries have tried to find the conditions which led to the crisis. They tried to find out those faulty policies and the incorrect measures taken by the bank that led to its failure of crisis prevention. It was found that at the time of the crisis the interest rate was really low. Financial investors in such a scenario became optimistic regarding the prices of assets along with the underlying risks. The banking regulations directed towards changes in financial landscape led to extension of leverage and this made accurate risk prediction more difficult. Investors transformed into risk lovers and excessive risk taki ng began in the markets (Caruana). Neither banking regulations nor effective supervision could stop such a phenomenon. The fragmented banking regulation again proved to be wrong. No connection could be traced out in the activities of regulated and non regulated markets. All over the markets and institution there was prevalence of asymmetric information. Some loopholes existing in the legal procedures were also equally responsible (Caruana). The macroeconomic policies implemented during this time were inadequate. The easy liquidity banking policy made structures of debts, especially the heterogeneous ones more incomprehensive. Criticisms have been against the supervisory regulations of bank. Easy loans were given to individuals without careful examination of the underlying default risks (Neuman). Monetary policies were framed in such a way that cash flow becomes easy across the economy. Such an instance is proved by statistical evidence. Table1: Data showing low interest rate policy adopted by the banks Source: Neuman The interest rate considered is for the Euro zone. The data is for short term real interest rate which continued till 2005. Such data shows that banks have adopted a low interest rate policy during the given years. This paved the way for easy liquidity. The banking regulations of 2004 led to significant credit expansion and credits involving high risks became the main reasons for initiating such crisis. It first led to subprime losses in March 2008 with Bear Sterns incurring huge subprime related losses. Ultimately Federal Reserve had to take over the firm. Detoriation of subprime loan holdings eventually culminated into the crisis. Banking sectors have earlier avoided such high risk alerts generated by the economists in 1999 (Nichols, Hendrickson and Griffith). Easy financing act of 2005 became the strategy for banking operations. During this time some big American and European banks even violated banking regulations by setting up companies for s uch short term financing purpose. Such companies were not disclosed in balance sheets. Banking sectors however did not pay attention to the fact that such a low interest rate policy regime adopted by banks in 2003 after European Central Bank followed suit was slowly increasing