Academic journal article Business Economics

Financial Services Regulation

Academic journal article Business Economics

Financial Services Regulation

Article excerpt

The global arrangements for the supervision of financial institutions have drawn unprecedented attention in recent years from governments, the financial community and the public. In particular, the G-7 Heads of Government have cited the need to enhance international supervisory coordination, the quality of risk management in financial institutions, and the infrastructure in emerging markets in the communiques they issued after the past four annual economic summits.

In part, the increased interest reflects immediate concerns. A series of events in the 1990s revealed weaknesses in the market infrastructure and supervisory arrangements that allowed problems to develop and grow too long unchecked. The most prominent of these events include the closure by regulators of the fraudulent Bank of Credit and Commerce International (BCCI) in 1991, the sudden failure of the U.K. banking firm Barings in 1995 after suffering over $1 billion in losses from futures and options trading, distress in a large number of major banking markets in the early 1990s, and the recent severe declines in market prices of Asian currencies and financial assets.

The lessons from the first two, firm-specific problems differ somewhat from the lessons learned from the second two. BCCI and Barings both raise issues about:

1. The division of responsibilities between the home country and host country supervisors of internationally active financial institutions;

2. The extent and quality of information sharing among supervisors, especially across banking, securities and futures regulatory jurisdictions in the case of Barings;

3. The ability of supervisors to recognize inadequate risk management, financial control, and internal control within financial institutions;

4. The ability of management, major counterparties, customers, and supervisors to prevent fraud or detect it at an early point.

In addition, the sheer speed of Barings' demise challenged implicit assumptions about the time financial market participants and supervisors would have to respond to stress events in the marketplace.

The banking problems experienced in many centers in the early 1990s, many centered on real estate lending, as well as the recent Asian market break, raise the following issues:

1. The quality of information available about individual borrowers, aggregate market statistics, and capital flows within countries and across international borders;

2. The possibility that markets have a greater tendency to boom-and-bust behavior;

3. The arrangements for workout of problem credit exposures and resolution through a bankruptcy process;

4. The strength of risk management and internal control systems within financial firms and supervisors' ability to provide adequate oversight of supervised financial institutions.

This last issue also involves issues of corporate governance, i.e., the decisionmaking process within the firm and the management of the conflicts of interest among its various stakeholders-stockholders, top management, business line managers, other employees and customers.

Beyond the issues revealed by these major events lies the reality that competition in the financial market has increased dramatically with the globalization of financial activity, the rapid pace of financial innovation and the reshaping of financial services by advances in information technology. The force of international competition during the past two decades has flattened the distinctions between banking and securities activities, and, increasingly, between these and insurance activities. International competition, combined with the ability of innovative products to provide viable substitutes for products in markets where regulation is too costly, have similarly flattened a variety of traditional financial and macroeconomic management tools. These tools include deposit ceilings, quantitative restrictions on credit, and capital controls. …

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