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Financial institutions play a significant role in the economy of every country. Existing laws and guidelines in different regions require that such organizations adhere to strict requirements and procedures in an attempt to maintain the integrity of the existing economic structure. These processes amount to something known as financial regulation. Such a practice has been observed to promote economic growth by preventing these inappropriate behaviors: money laundering and deceitful financial operations. However, this is an area that has its unique disadvantages. This paper identifies and discusses the shortcomings of financial regulation.
Financial Regulation: Shortcomings
Regulation of financial processes and markets is a practice that governments have pursued for many years. This initiative has managed to streamline operations in different countries across the world. Unfortunately, a number of key areas or weaknesses have emerged that make financial regulation questionable, ineffective, or inappropriate. The first shortcoming associated with it is that some people can change existing rules in an attempt to achieve their gains. Anagnostis and Alexios believe that the corporate world and other key stakeholders in the financial sector can bend regulations depending on situations or targeted objectives (129). Such an occurrence will affect members of the public negatively and make it impossible for them to achieve their potential.
The second weakness is that of regulatory arbitrage. This means that the use of laws or guidelines can result in dangerous outcomes. For instance, the mortgage crisis experienced in the United States before the infamous financial crisis of 2008 can support this assertion. The American government presented incentives that were aimed at making housing cheaper and affordable to the greatest number of citizens. Although all Americans banks had insurance covers, managers went a step further to increase their profits by lending at exaggerated rates (Conrad 36). A new Freddie Mac hybrid accelerated this process by ensuring that investors repackaged existing loans in an attempt to maximize supplies (Conrad 36). These malpractices led to the worst financial crisis in the world.
Financial regulation is known to empower central banks and regulators to implement monetary policies or changes that are capable of supporting economic performance and growth. However, abrupt changes might cause shocks in different sectors of a given economy (Anagnostis and Alexios 130). The outcome is that many banking or financial institutions tend to become unstable and incapable of achieving their goals. This is something that is usually capable of triggering economic crises in different parts of the world.
Another unique challenge associated with financial regulation is that investors and citizens put much trust on regulators. This is something that has been observed to result in systemic risk to existing financial systems. According to investors, regulators possess the right tools and resources that can empower them to predict potential problems and mitigate them before they can disorient the economy (Godwin 152). This creates an illusion of stability or safety. However, such citizens or investors will record increased losses when things go wrong.
Human beings are capable of making errors or poor economic projections. Many scholars and experts in financial matters have used this fact to explain why financial regulation is a procedure that has unique shortcomings. Tai and Carpenter argue that the occurrence of human-related errors or mistakes will have negative impacts on the financial system of a given country (235). Such challenges or outcomes might have far-reaching on the economy that acts of dishonesty or incompetence by different stakeholders. Regulators and policymakers consider this weakness in an attempt to avoid errors.
Supervisory bodies employ different financial procedures and strategies to eliminate specific transactions that might be demanded at a future date. Initiatives aimed at nullifying currencies futures tend to trigger new contract styles, thereby disorienting the effectiveness of existing regulations. The outcome is that domestic brokers will be unable to achieve their economic goals (Godwin 152). Similarly, countries using price controls on valorous goods or crops seek to limit or control futures trading. Such a practice is capable of triggering deceitful practices and affecting business performance or economic development.
The outlined examples show conclusively that financial regulation is a procedure that can have diverse impacts on a given economy. Investors should, therefore, consider these issues and diversify their holdings in an attempt to minimize chances of making losses. They should also be keen to ensure that corporate leaders and interest groups do not introduce policies that seek to fulfill their expectations (Calomiris 17). Such measures will guide them to make wise investment decisions and engage in activities that have the potential to deliver positive results.
The above analysis has revealed that regulation in the financial sector is a process that can be both destructive and constructive. The outlined weaknesses explain why the implementation of inappropriate strategies to control monetary practices in the past has led to numerous challenges, including economic crises. These shortcomings should guide regulators to become more proactive and consider appropriate policies that are non-duplicative and sensitive to international changes. Such initiatives will ensure that different economies are prepared for potential crises.
Anagnostis, Kipouros, and Kipouros Alexios. “Factors of Weaknesses of Supervisory Methods as Components of Systematic Risk. The Impacts of Collapses to Instability of Banking System.” Procedia Economics and Finance, vol. 9, no. 1, 2014, pp. 120-132.
Calomiris, Charles W. “Has Financial Regulation Been a Flop? (Or How to Reform Dodd‐Frank).” Journal of Applied Corporate Finance, vol. 29, no. 4, 2017, pp. 8-24.
Conrad, Christian A. “Weaknesses of Financial Market Regulation.” Applied Economics and Finance, vol. 5, no. 2, 2018, pp. 32-40.
Godwin, Andrew. “Introduction to Special Issue – The Twin Peaks Model of Financial Regulation and Reform in South Africa.” Law and Financial Markets Review, vol. 11, no. 4, 2017, pp. 151-153.
Tai, Laurence, and Daniel Carpenter. “SEC Capture by Revolving Door: Strengths and Weaknesses in the Evidence Base.” Law and Financial Markets Review, vol. 8, no. 3, 2014, pp. 227-240.