What is more, the complicated regulatory process also negatively influences foreign direct investment. Unfortunately this works like a domino effect: once foreign direct investment is negatively affected, then the capital inflow into the country decreases, what leads to the capital being less available for the domestic borrowers or investors. This vicious circle will circulate again and again resulting with the economy falling into deeper recession.
A further issue that is brought by smaller FDI is the lower demand for the country’s currency on the foreign exchange market. This will lead to depreciation of the currency and consequently to the decrease of the competitiveness of the domestic export industry.
On the other hand, financial regulations at the right level are still needed, because without any control the financial world would turn into chaos. Therefore, it is not to say that from now on we should implement no regulations at all, in fact a new system that can bring hope to the financial market is desired. Consequently, the problem does not lie in the regulations themselves but in the regulatory regime as a whole. Therefore the deregulation of the banks might be a solution to the deep recession.
Deregulation of the banks
The aftermath of pretty much every crisis is the introduction of various financial regulations by governments and central banks in order to help the situation. Unfortunately this process has not turned out to be effective. Therefore, instead of implementing more and more regulations, the authorities should try to deregulate the banks and leave the space for self-regulation. Financial regulations, issued in most cases by the central bank, require all banks to follow certain guidelines and restrictions. As a result, the banks have the same regulations in their own services what lowers the competitiveness between the banks. Nonetheless, under current circumstances and in the current financial system it is not impossible for the banks to self-regulate. The current system assesses the risk in a way that the taxpayers are usually the ones who have to bail out the cost in case of a failure. Prof. Philip Booth from CASS Business School once expressed himself in his article in ‘The Telegraph’ that ‘the focus must be to make sure banks bear the costs of the risks they underwrite.’ According to his study, the first step that should be taken is a ‘risk-based insurance system’ , where banks pay premiums based on the risks they take.
Additionally, he also suggests that banks could issue debt capital for the customers as once banks become insolvent, the debt capitals will automatically turn into equity capital. This aims to balance out the risk between the taxpayers and the bank itself.
However, in my opinion, this might not be function well in the current financial conditions. The theory above requires a reliable market mechanism, so that it will produce a balanced outcome. Now that the banks are in bad financial conditions and are seeking for bailouts from government and public, it would be irresponsible to ask the banks to regulate themselves. Nevertheless, once the dysfunctional market mechanism is fixed, the suggestion made by Prof Booth would be functional in preventing further failures in banking regulations.
Yet, deregulation should still be carried on in this situation, as from the lessons we learned in history, besides deregulation it usually results also in an increase in competitiveness of the domestic industries (financial sector in this case). What is more, it also increases the incentive for business as well as increasing foreign direct investment. For example, China has been through a deregulatory process since Financial Innovation led by Zhu Rongji (former premier of People’s Republic of China) in 2001. Eleven years ago, the majority of Chinese people were blaming him for such innovation, which resulted in a massive loss of jobs in the labour market, and many families became unemployed (it mostly effected the poor). However, if we look back now, deregulation has affected the Chinese economy in a totally positive way. Much more foreign direct investment arrives into the country, and meanwhile the export industry of China got well opened up, and now it has became the largest exporter in the world.
In addition, during the past three years, central banks have been trying to fix the current regulatory regime by implementing more and more ‘effective’ financial regulation. Yet, the result is unsatisfactory. We should realize now, that in order to help the current situation, and a new system needs to be introduced; a system which will consist of far less regulations that the country is facing now, and will effectively increase the business confidence of the economy.
Conclusion
Generally, the message remains the same. It is not the matter of the more the better or the less the better, but of the most suitable one for the current situation. There is absolutely no point of bureaucrats/regulators writing more and more regulations when it is not effective. Just as Prof Booth said: “The key is a financial system where prudent behaviour runs with the grain of self-interest.” Deregulation will provide more chances for the country to flourish again in the financial market.
Bibliography: