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What are the Academic arguments for and against public body regulation

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Introduction

What are the Academic arguments for and against public body regulation? For: > The main argument for public body regulation is to prevent the threat of systemic risk. By this I mean the fact that if one bank went bankrupt that this would have a knock on effect on the others and that they too might fall into trouble and hence go bankrupt themselves. This would have a detrimental effect on any economy and in most cases it would be too big of a blow for any economy to recover from. (Japan being the obvious example). > Another argument is to prevent the so called "Disaster Myopia". This is simply the tendency of banks to underestimate the probability of low frequency shocks. The problem is also added to by the fact of "herding". E.g. In most cases it is impossible to put a financial figure on risk so normally the Banks tend to stay at around the same one. This gives them the reinsurance because they are part of a group so individually they cannot be wrong and they know that if they fall into trouble then as all of the banks are in the same boat with them it is very unlikely that the government will not help them. > Another argument for public body regulation is to bring in an outsider who doesn't have a personal interest in any way. So to explain this a little better I will use an example: A manager whose pay is profit related is not going to allow huge provisions be made in the P&L because naturally they will reduce his profit and thus his pay. ...read more.

Middle

At the time this seemed reasonable as the Japanese economy was rebounding after a 30-month recession however, on the 17th January 1995, a devastating earthquake measuring 7.2 hit the Japanese city of Kobe. Leeson, then bet on a post earthquake recovery and bet that the market would stabilize again at 19000 points. It never happened. In this period (post earthquake) he accumulated some three quarters of the $1.3 billion loss. In February 2002, AIB share price plummeted 17% on the news that a rouge trader by the name of John Rusnak had run up losses of $691 betting on the foreign exchange market in their Baltimore based subsidiary Allfirst. > I believe that the analysis of recent banking disasters shows that first of all banks do not self-regulate properly. The losses sustained in these two cases could have been minimised if proper internal control had been in place. In his autobiography Leeson states: "The old school really never understood or cared to master the complexities of derivatives trading". So if his supervisors didn't understand what he was doing how were they expected to keep check on him? However having seen what happened to Barings this brought the issue of internal control to the forefront for the banks themselves. Yet only a few short years after it the Allfirst scandal came about. I believe that this shows that cases such as rouge traders are almost impossible to eliminate, what is important is the damage limitation. ...read more.

Conclusion

In your view does the threat of systemic risk in the industry warrant the current level of regulatory oversight? In a word, yes. Although I do realise that the issue at fault was poor internal control and not a lack of regulatory oversight which caused such crises as Allfirst and Bearings, and they were non systemic i.e. did not affect any other bank. I do feel that the treat of systemic risk alone is enough to warrant the current level of regulatory oversight. It is almost impossible to think of the consequences of a systemic banking crisis say, in Ireland. The whole economy would collapse. At current banks are financial intermediates, they bring people with needs and wants together and simply create a profit for themselves in the process. E.g. They find people who want to invest money, give them a satisfactory rate of return and then find people who want to borrow money and lend that money to them (at a higher rate). The economy could not function without them. Looking at a wider picture, if a fully blown systemic banking crisis hit then you would be more or less setting a country back 100 years. The economy would become stagnant, property markets would collapse, the stock market would collapse, people left penniless etc... Cases such as the Savings and Loan crisis in the US and the Scandinavian crisis serve to show us the danger that systemic risk can cause to an economy. Can the Financial Markets Privately Regulate Risk? The Development of Derivatives Clearing Houses and Recent Over-the-Counter Innovations Randall S. Kroszner ...read more.

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