It is important that banks consistently maintain a supervised and effective regulatory framework ensuring stability within the financial system. Martin Wolf’s work on ‘The rescue of Bear Sterns marks liberalisation’s limit’ and The Economists’ ‘When to Bail Out’ outline the need for greater regulation within banks. As banks are the key players in the financial system, it is vital they:
• maintain their supervision arrangements governing the ‘three pillars’ of the Basel II structural framework
• do not employ strategies to avoid regulatory constraints and ;
• recognise times of financial failure as ‘indicators’ to re-assess financial market regulation in the future.
Why Financial markets need to be regulated
The purpose of bank regulation is to ensure institutions act responsibly and take risk assessed decisions in order to safeguard system stability and control. Therefore there must be constraints on banking activities through legislation and prudential supervision. The main objectives of regulation are:
• Preventing initial bank failures and stop the spreading to other banks
• Prevent ‘moral hazard’ which is the temptation for banks to take larger risks because they know they are covered.
• Depositor protection – ensuring asymmetric information does not occur.
Banking Supervision arrangements under the Basel 2 capital accord
The Basel 2 framework attempts to safeguard banks solvency and stability by setting up requirements designed to ensure that a bank holds capital reserves appropriate to the risk exposed through its lending and investment practices. Basel 2 is divided into three pillars:
1. Pillar 1 - deals with the calculation of minimum capital requirement. It is calculated for the three major compo ...