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Banking And Financial System Are Heavily Regulated

1280 words - 6 pages

Banking is a heavily regulated industry that is very protected to prevent crises that can cause huge economic harm. One topic that has been greatly debated in the history of financial systems is whether competition is good or bad for financial stability. It is complex and hard to know which side is right. Pretty much everyone with an opinion at least concedes that there are good points for both sides. All the arguments run both ways, and the evidence is mixed. History can show evidence that both sides of the argument are true. It is easy to see an example where a country had X banks and Y crises and assume causation but it is rarely that simple. Other countries’ experiences can show exact ...view middle of the document...

Increased competition in the financial sector could have many benefits to customers and the stability of the system as a whole. To begin with, competition causes innovation and efficiency in any industry, banking is no exception to that, and that is good for everyone. It can push banking systems towards new, previously unbanked groups of people. It can have positive repercussions for private sector development, individual welfare, and economic development. Additionally, it can foster the development of new products and ideas such as improved lending techniques to allow banks to be able to better screen and monitor their borrowers. Competition might be an influential energy of great value that will help monetary frameworks. Increased competition can also keep interest rates lower for borrowers and higher deposit rates for savers. This will reduce the risk of them defaulting on their loans, saving the banks money, which will further stability. Borrowers will also be more profitable and less likely to take risks. More competition can broaden the customer base of the financial system. It also means there will be a greater diversification of the risk. Large concentrated banks can pose systemic risks because they are interconnected. They all lend money to each other. If one bank goes under, then they can’t pay their debts so other banks go under as well, causing the whole system to crumble. There is always the possibility of a bank’s failure. If there were increased competition, it would cause less damage if one were to fail. It would allow regulators to more effectively fix a dying bank by offering its property and safeguarded debts to a competitor.
Many people argue that increasing competition causes instability in the financial system. Many believe that an increase in competition caused the recent financial crisis. Although there was an increase in the competition leading up to the financial crisis, a more likely cause of the collapse was inadequate risk management, subprime lending, and weak supervision. They gave out loans to many people who could not pay them back and valued their assets much higher than their true value causing them to take on more debt themselves than they were worth. Not even the banks could pay back their loans so the government had to buy their worthless assets to keep the system afloat. This is a huge downfall of lack of competition. This is where the idea of these banks becoming “too big to fail” comes into play. Knowing their too big to fail status, these institutions tend to be more aggressive in their risk taking decisions and hold less capital. Another argument is that if banks were guaranteed healthy profits, their owners would have little incentive to take big bets and risk losing the bank. However, the banks need to be responsible for...

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