Banking regulation and risk Essay Example | Topics and Well Written Essays - 1500 words

Banking regulation and risk - Essay Example The gravity of the problem is underscored by the length and the damage wrought by the slump, which some economists called as a recession and financial shock. In the effort of prevention, it is crucial to identify the causes of the financial crisis. Understanding the Slump Technically, it was the collapse of the American subprime lending market that has caused the crisis. But from its manifestation in the year 2007 towards its end in the latter part of 2009, the crisis proved to be an amalgamation of problems that facilitated and aggravated the crisis sparked by the subprime lending market crash. The consensus is that global macro-economic imbalances and financial innovation, which aggravated the excessive credit and liquidity expansion, combined with the failures in regulation, supervision and corporate governance collectively led to the financial crisis that has acquired global proportions. (UK Parliament, p. 7) The specifics of the causes of the financial crisis reveal a multi-face ted financial problem that, unfortunately, all boiled down to the matter of faulty and ineffective financial policymaking, regulation and supervision. For instance, central banks erred in keeping inflation in historic lows because it led to the ease by which credits were made available. Then financial institutions, in their greed to achieve higher returns, took more and more risks by introducing increasingly complex financial products which eventual taxed the long-term stability of financial institutions. September 2008 saw the peak of the crisis as ten large financial institutions failed or nearly failed, triggering a financial panic and resulted in the large contraction of the global economy. (Financial Crisis Inquiry Commission 2011, p. 417) In the early part of 2011, much of the world are still reeling from the financial crunch either recovering, rebuilding or are still in its clutches . The United States is still currently struggling, barely posting positive growth. The legacy of the 2008 financial crisis is undeniable, the current global financial system - its risk-based regulatory framework lacks a kind of efficiency and authority to check each and every element of the financial crisis as we watch them happen helplessly. This should already prompt us to questions existing frameworks and conventions such as the Basel II and the existing risk-based regulatory framework that govern the world financial systems. The Problem with Basel II The second installment to the Basel Accords, Basel II is a compendium of recommendations on banking laws and regulations drafted and implemented by the Basel Committee on Banking Supervision. Basel II is supposed to be a mechanism that would prevent crisis such as what was experienced in 2008 from happening. The idea is to setup an international standard or best practices benchmarks that financial regulators could use in their policy- and decision-making. The standard is anchored on the establishment of risk and capital mana gement requirements that would supposedly force banks to maintain capital reserves according to the risks that a financial institution is exposed to as a result of its banking practices. The problem, wrote Padmalatha (2011), is that Basel II is a quantum leap from Basel I and that those tasked to implement and promote its standards were not ready and skilled, making Basel II problematic for regulators and banks themselves. An important argument is the Basel Committees own admission that risk based capital requirements - a fundamental element of Basel II - could inevitably lead to procyclicality, typified by how banks lend more due to an upbeat economy. Padmalatha stressed that "when business cycles take a downturn, banks downgrade the borrowers due to increased likelihood