Financial Instruments, Institutions and Markets



Financial Instruments, Institutions and Markets

Answer 1

Deregulation of Financial Sector

Many analysts in past have conducted detail research that deregulation of financial sector leads to efficiency and flexibility. Deregulated markets can easily and quickly adjust to new market conditions. These markets allow trading variety of securities at comparatively less transaction cost mainly because of better communication, advance technology, higher liquidity, and worldwide availability of securities and assets irrespective of currency differences. The changes in price level in such a market environment are quite speedy and possess tendency of spreading across border. It is a fact that financial institutions are purposely regulated because economy trust and on these institutions for keeping their financial assets. These institutions have a significant impact on the actions of members of economy. The regulations and controls are placed to provide precautions to the economy members against frauds. The financial regulations are aimed at reducing the volatility and help in stabilizing the interest rates and exchange rates via monetary policy. The deregulation of financial sector came into being in late 1980s and 1970s and initiated by industrially developed countries. This phenomenon has boosted competition among market players and resulted in enormous capital gains, increased liquidity in capital markets, reduced the cost associated to financial institutions, improvised the risk management and elimination techniques, introduced effective asset and liability management techniques, etc.

However, the recent developments in the capital markets have resulted into major economic and financial costs and risks. This point can be justified by increased involvement of financial institutions in secured lending activities and resulted into increased off balance sheet risks. In addition, it has also complicated the monetary policy framework by incrementing the financial volatility at international level. It has been reported and analyzed that deregulation has also removed the link between financial market and other related sectors of the economy. It has boosted the growth of financial institutions particularly in developed countries and financial transactions have been replaced by trading oriented financial transactions. It can cause de stabilization of financial market (Versluysen, 1988).

Deregulation has been taken place from a long time in the history of America when Supreme Court allowed banks to adapt the usury laws and aimed at eliminating the ceilings of interest rate laws in 1978. This act caused an increase in the deposit insurance from $40,000 to $100,000. The Germain Depositary Insurance act of 982 deregulated all thrifts completely and boosted the process of commercial lending. These reformations facilitated companies as well in earning 25% of profit in investment banking. In addition, deregulation allowed financial service providers and institutions to merge like that of Citigroup in 1998. Commodity Futures Modernization Act deregulated the trade of over the counter derivatives contracts in 2000. The SEC initiated a set of voluntary regulation under a program that allowed investment banks to keep less capital and increase the level of leverage in 2004. All of these reformations resulted in mortgage crises in 2007 (Sherman, 2009).

Components of Financial system

A financial system is a ...