The role of Bank Regulation has become increasingly complicated in maintaining “

Question

The role of Bank Regulation has become increasingly complicated in maintaining “Safety and Soundness” of the Financial System.

What is Micro-Prudential Supervision of banking institutions?

What is Macro-Prudential Supervision of banking institutions?

What is the Basel Accord and its relevance to Saudi Financial institutions?

The 2000s witness a dramatic increase in Financial Engineering that produced a wide range of new loans and investment products.

What is Financial Engineering?

Provide examples of consumer loan products and investment securities.

How did Financial Engineering affect Adverse Selection and Moral Hazard problems prior to the 2008 Financial Crisis?

A major issue that has arisen after the 2008 Financial Crisis is the debate over “Too Big to Fail” financial institutions.

What are “Too Big to Fail” financial institutions?

What are the major concerns with the size of these corporations?

What do you think is the appropriate response for solving this problem?  Explain with examples.

Explanation / Answer

Question 1

A) Micro-Prudential Supervision of banking institutions

Microprudential supervision refers to firm-level oversight or financial regulation by regulators of financial institutions, which ensures that the balance sheets of individual institutions are robust to shocks. It is aimed at consumer protection. By ensuring solvency of financial institutions, it strengthens consumer confidence in the individual firms and the financial system as a whole. Further, if a large number of financial firms fail at the same time, it can disrupt the overall financial system, thereby reducing systematic risk.

B) Macro-Prudential Supervision of banking institutions

Macroprudential supervison is the financial regulation aimed at mitigating the risk of the financial system as a whole, i.e. the 'systematic risk'. Its main aim is to reduce the risk and the macroeconomic costs of financial instability. It is recognized as a necessary ingredient to fill the gap between macroeconomic policy and the microprudential supervision of financial institutions

Question 2

The use of mathematical techniques to solve financial problems is called as Financial Engineering. It uses tools and knowledge from the fields of computer science, statistics, economics and applied mathematics to address current financial issues as well as to devise new and innovative financial products. Further applications include derivative securities valuation, portfolio structuring, risk management, and scenario simulation. Financial engineering is sometimes referred to as quantitative analysis and is used by investment banks, commercial banks, hedge funds, insurance companies, corporate treasuries, and regulatory agencies.

Question 3

"Too big to fail" describes the belief that if an enormous company fails, it will have a disastrous ripple effect throughout the economy. Since the business has become so large and ingrained in the economy, the government will provide assistance to prevent its failure. These institutions are so important that they become recipients of beneficial financial and economic policies from governments or central banks.

Since these institutions are aware that they will be bailed out, they take risk beyond they would otherwise. Even though this is the case, governemnt cannot leave these institutions to fail, as their failure would bring down the whole economy. though such a lesson would have been an important one for them.

The government uses the taxpayers money to bailout these institutions in difficult times. Therefore, it would be fair to let the taxpayers benefit from the gains registered by these institutions.

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