Financial Institutions and Markets. Financial Regulations and Crisis

FINANCIAL REGULATIONS CANNOT PREVENT A FINANCIAL CRISIS
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Financial Regulations and Financial Crisis
In 2017, global central bank regulators and governors met in Frankfurt to complete the final chapter of the bank rule which had been written down since the last financial crisis in 2008 (Ewing, 2017). The meeting proved to be an important step geared towards preventing financial meltdowns in the future. Since banks are to be blamed for the last financial crisis, the banking rules are meant to prevent them from causing another meltdown. Nonetheless, the rules and regulations might help to make the banks more resilient. However, it does not guarantee protection from a financial crisis. The lack of a guarantee can be linked to a couple of factors which will be discussed in this essay.
The 2007-2008 financial crisis affected millions of individuals across the globe, and the impact could still be felt even six years after the crisis (Poledna, Boschmann, and Thurner, 2017, p. 1). There was a slow recovery from the aftermath with a significant number of indirect losses. Hundreds of people lost their jobs, homes and the level of income dropped significantly. Consequently, there was a need for new financial regulations which was aimed at mitigating the risks that were present in the entire financial system. As revealed by the crisis a significant number of financial institutions appeared to be doing fine, but internally they were vulnerable (Ewing, 2017). Many banks with not enough money lent out large sums of cash and eventually, they could not be able to recover. Afterwards, banks lacked the trust to lend to one another, and the global financial system came to a halt. The creditors ran seriously low on money, which led them to depend upon payouts from the taxpayers to recover. The practices by banks of lending more money and failing to reserve enough for sustenance led to the inclusion of rules which require the institutions to hold more capital. Moreover, the banks are required to prove that they have enough liquid asset to help them survive a cash crunch. These regulations are therefore meant to reduce risks.
The inherent instability of the banking system makes it harder to regulate (Prates 2013, p. 6). This is partly because the development of the entire banking system is dependent on financial leverage and the multiplier effect is in its origin. The banking system is highly dependent on confidence. Financial institutions are required to hold only a part of the money received from depositors and lend the rest so as to meet reserve requirements. Eventually, banks always owe more money than that saved in their vaults (Svilenova 2011, p. 87). Moreover, the behavior by the banks to fund long term assets using short term borrowing resulted in a maturity mismatch between assets and liabilities. During normal operations, there is great confidence between banks and its lenders and depositors, however, when there is a crisis, and the depositors want to withdraw their cash, the bank’s reserves normally lack sufficient funds and the majority of their assets are illiquid, this ruins the confidence of depositors. That said, the primary intention of stressing the financial system is naturally unstable. Instability is part of its development and origin, and the inclusion of financial regulations cannot be useful in changing this fact unless the regulations call for 100 percent reserve requirements and limit leverage. Doing so might destroy the entire financial system, and it, therefore, cannot be considered as an alternative.
The regulations do not predict or anticipate facts because rules come after facts. For instance, the financial crisis of 2007-2008 led to the development of the banking code as a means of preventing a future crisis (Guynn, Polk, and Wardwell, 2010, p. 25). This shows that regulations are created based on previous financial realities (Claessens and Kodres, 2014 p. 12). Rules, therefore, cannot restrict the creativity of financial markets and neither can they determine what will happen in the future. Instead, they can only respond to a perceived reality. Moreover, the financial regulations cannot be set based on situations that do not exist. Even if the time barrier was to be removed, there would still be challenges faced by regulators, one of them being the immediate reaction by financial institutions to find ways around the regulation. The move to use financial regulations to prevent a financial crisis would also mean setting rules for eliminating all risks. However, as stated, the regulations are only set based on perception, and it might be inevitable to try and regulate all situations that might lead to a financial crisis. Given the dynamics of the financial system, it would require regulators to set more rules every day which might lead to overregulation.
Research by the International Institute for Applied Systems Analysis shows that these regulations are ineffective in reducing risks (Poledna, Boschmann, and Thurner, 2017, p. 3). First, the financial regulations that were set after the 2007-2008 crisis have set higher requirements for liquidity reserves and bank capital. The Basel III introduced liquidity standards which were aimed at achieving a bank’s resilience in the long run (Svilenova 2011, p. 72). This meant that banks held sufficient amounts of money to unencumbered high-quality assets so as to be able to cover the total net cash outflows when face with pressure for approximately thirty days, during which, the bank’s management would be able to take quick and appropriate steps to resolve the issue without panic. However, the liquidity standards which are mainly directed to banks and fails to consider government bonds can bring about problems. The application of an even liquidity rule can result in solvency problems for banks when faced with extreme circumstances. Moreover, banks should ensure their asset funding is stable throughout a one-year period in the case of a stress sce...