(Reforming the financial systems)
Introduction
The term financial crisis is mainly applicable to situations where certain financial assets suddenly lose a large part of the nominal value. Through the crisis, the financial institutions equally lose value and become incompetent in the local as well as international financial markets. Financial crisis is a major cause of economic crisis where the economy experiences a downturn in liquidity as well as unpredictable inflations. However, when the financial crisis occurs several things may be done as a solution but the reformation of the financial system is one of the actions that may be undertaken. It is a process where a number of financial elements are coordinated in a perfect way where all the loopholes to poor economic performance are eliminated. Reforming the financial systems would serve as the most reliable strategy for resolving financial crises through consideration of various options to strengthen financial activities or transactions.
The first action towards the reformation of the financial systems is the enhancement of transparency in the financial sector. The 2008 financial crisis is mainly attributed to the poor financial sector that lacked transparency in the execution of the financial activities. There were a number of issues surrounding the financial sector following the financial pressure that had been exerted to economies at the time by various governments (Krugman 24).Various central banks had developed systems, which were not favorable for the economic times. Some of the standards influenced the idea of transparency among the financial institutions in various economies.
The transparency would be controlled through monitoring the transactions that individuals, organizations and financial institutions made at a specific time. There are suspicious transactions that individuals, as well as institutions, are likely to make and they may be major cause for economic failure and cause for distress in the economy. The transactions may not have significant economic value to individuals as well as the entire economy as they may make money only available to certain people while the rest of the economy struggles (Krugman 29).
The products that various financial institutions offer must also be monitored accordingly. Such products may include loans and mortgages, which may be highly unattractive to the economy. They may be unfriendly in terms of interest rates charged, which may be unaffordable to most people. At some point, the terms of the products are excommunicated to the customers. They may be extremely expensive to the customers in the future as they risk paying a lot of money for services, which may not require the exhaustive charges that they incur (Devlin and Ricardo 118).
Transparency would be enhanced further through giving the supervisory authorities, investors as well as consumers an opportunity to access critical information regarding markets. There are instances where lack of proper information regarding financial markets has affected the flow of finances in the economy. For example, in the instances of stock-market bubble where the share prices of stocks rise should be communicated accordingly to the stakeholders (Devlin and Ricardo 120). The information would help the investors, supervisory authorities, investors, and customers to understand the performance of the company at the specific time. For example, the Baring Bank collapsed following improper reporting on the stock value of some of the companies. The bank did not realize that Nick Leeson was trading on a failing business before offering huge finances for investment.
Transparency in the financial sector would be affirmed through the improvement of the reliability as well as the quality of financial ratings. The credit ratings would help the institutions to understand their debt abilities. They are useful for financial institutions as they would monitor the people or organizations that are capable of repaying debts (Devlin and Ricardo 122). As such, there is a need for constant evaluation of the credit rating agency for exclusive information on the debtor.
Establishing effective supervision and enforcement
The financial sector requires strictness and measure for the competence of the individuals offering various services. The supervision and enhancement of the financial sector would highly depend on the strategies that the organizations or the central banks may adopt to ensure proper supervision of the financial sector.
One of the considerations during the financial supervisions is detecting the macro-economic risks which may cause the financial crisis. There must be prudential measures to mitigate risks. Such an approach limits the risk of episodes of financial crises as they produce major losses of real output and employment. As such, there is a need for the installation of early warning systems that would be highly significant in tracking looming macroeconomic crises. Also, there is a need to invest in data collection and dissemination to allow early warnings for the risks that are likely to cause financial crises. The poor and the vulnerable should be protected accordingly in equitably sharing the adjustment costs of macroeconomic crises (Krugman 45).
The banking market also requires exclusive concern for supervision over the economic times. The international financial markets and institutions, as well as national governments, play a critical role in the supervision of the activities that the banks undertake. The supervision is usually based on the laws and bureaucratic rules that govern the activities of the banks. The regulations include capital requirements as well as limits on interest rates. Bank regulations proponents are significant in maintaining the confidence of the consumer in banking, which is highly significant for the smooth running of the economy. For example, the improper supervision of the Russian Central Bank by the government on the relationship of the economy to the outside world caused extensive failure of the economy leading to the Russian financial crisis in 1998 (Dohmen et al 521).
The insurance market is major financial sector, which may cause extensive dangers if it is overlooked. The supervision will range from the products that the various insurance companies offer to their customers. The insurance companies have a range of products, which are supposed to bring change to the lives of the people and influence the economy. Development of poor policies such as the 1987 crash which was attributed to light trading volumes on insurance, following the engagement in arbitrates and portfolio insurance strategies (Shiller 287). The Insurance Supervision Agency (ISA) that was developed din 2009 has been highly effective in setting legal grounds for the performance of the insurance companies. The agency evaluates the policies, conduct, and the premiums that the insurance companies offer to customers to avoid exploitation of the customers (Federal Deposit Insurance Corporation, Division of Research and Statistics 03).
The supervision would be extended to the securities market. The process of enrollment, operation, as well as termination of operation stock exchange, would be monitored closely. It usually works on the membership principle. It supervises how well a company can engage in stock exchange transactions with respect to the relevant laws. The investment firms are also monitored to ensure they do not engage in corrupt trade, at the expense of the trading companies. False information on the security exchange would cause a devaluation of companies since the investors may pull out upon the realization that the company was operating on false value (Dohmen et al 524).
Enhancing the resilience and stability of the financial sector
The stability of the financial sector would be strengthened with proper regulation of the capital that is held by banks. In most cases, the amount of capital that a bank is allowed to hold is regulated by the central bank of the specific economy. The central bank is the financial regulator of the financial institutions as the arm of the government in control of the banking activities. The regulatory capital may take different forms such as the Tier 1 capital, which mainly consist of shareholders’ equity as well as disclosed reserves. It is the money that was originally used to purchase the stock of the Bank, the retained profits, and deduction accumulated losses (Devlin and Ricardo 136). The second form of regulatory capital is the Tier 2 or the supplementary capital which includes the undisclosed reserves, general supervisions, and revaluation reserves (Ayadi and Sami 48). Such values would be helpful in the maintenance of transparency and accuracy in the delivery of critical information regarding the activities and proceedings that banks make out of various activities.
The banks are also advised on how to take advantage of good economic times. They would participate in the processes of increasing their capital base through improved business strategies, which would cause a high demand for banking products by the customers. The banks would invest more on banking activities that would bring value to customers attracting more depositors and debtors. As such, the banks will be assured of a consistent flow of activities to ensure sustainable processes that will guarantee income in the trade.
Also, there will be a proper plan for crisis management. There are instances where the banks are unable to provide reliable capita for its trade or business activities. At such points, it is the responsibility of the relevant commission through the central bank to offer a solution to the capital requirements in the specific bank. The availability of adequate capital for the bank is an assurance for the solvency of the bank in an instance where there are crises in the market. The bank must be given a reliable investment from the investors or deposits by the customers so as to stand and remain strong during hard or difficult economic times. Also, it may rely on the accrued profits, which are reserved for unfortunate times when operations may be challenged (Dohmen et al 529).
The best solution for failing banks is not resolving them. They require the effort or the intervention of the central bank so as to encourage their performance and control the challenges that may have occurred within them. For example, there are various instances where the central banks in various countries have undertaken the management responsibility of the banks at the event where the banks were not performing accordingly. Such a strategy is mainly known as receivership where the investors and customers are protected by the law through the central bank from incurring further losses based on their investments in a certain bank (Ayadi and Sami 71).
Strengthening the responsibilities of financial actors and improving consumer protection
The confidence of the investors must be restored for full recovery from a financial crisis. The investors are key stakeholders to the banks since they offer the operating capital, and they have the necessary resources necessary to the success of the organization. As such, they must be attracted to invest in the banks following consideration of a number of elements.
The banks must assure the investors of the safety of their money. The safety would be assured by the presence of exclusive supervision of the activities that the financial institution chooses to undertake at a given time. There must be guarantee of proper management of the investment through hiring of competent individuals with massive experience in the banking sector. And who have previously driven financial instructions to profitability. Also, the banks must show adherence to the rules set by the government or satisfaction of the necessary legal requirements for activities such as banking and stock market operations (Ayadi and Sami 76).
The investors must also be assured of the return on their investments following the proper outline of the activities that the bank wishes to undertake so to reach a certain market stretch. The investors must be attracted through practical projects, which will bring forth success for the organization. The profit targets must be specific and measurable over time.
The consumer is equally important since he supports the daily activities of the bank. He must be protected from any loss of money as deposits to the banks. He must have access to his money any time based on the products given by the different banks. There should be a platform for growth through the bank through the availability of unique products, which are attractive and beneficial to the customers. Enrollment for various business products in the banks would attract massive benefits and profits for banks in the long run (Ayadi and Sami 98). Therefore the more the bank invests in the customers, the more the benefits and stability of the bank.
Conclusion
Financial sector reformation is a major solution to the financial crisis. It prevents the recurrence of financial constraints, which were as a result of poor economic activities by financial institutions and overseers of the institutions. Enhancement of transparency would instill confidence to the users of the financial sectors reviving the economic activities. Also, there should be proper supervision in the sector to ensure activities are undertaken appropriately. The resilience and the stability of the financial sector should be strengthened to encourage continuity for the banks to prevent financial crises. It is also significant to strengthen the responsibilities of the financial actors and enhance the consumer protection.
Works Cited
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Dohmen, T., H. F. Lehmann, and M. E. Schaffer. "Wage Policies Of A Russian Firm And The Financial Crisis Of 1998: Evidence From Personnel Data, 1997 To 2002". ILR Review 67.2 (2014): 504-531. Web.
Federal Deposit Insurance Corporation, Division of Research and Statistics. “The LDC Debt Crisis.” Chap. 5 in History of the Eighties--Lessons for the Future, Volume I: An Examination of the Banking Crises of the 1980s and Early 1990s. Washington, DC: Federal Deposit Insurance Corporation, 1997.
Krugman, Paul R. The Return Of Depression Economics And The Crisis Of 2008. New York: W.W. Norton, 2009. Print.
Shiller, Robert J. "Portfolio Insurance And Other Investor Fashions As Factors In The 1987 Stock Market Crash". NBER Macroeconomics Annual 3 (1988): 287. Web.
