COMPETITION AND FINANCIAL STABILITY Essay Example | Topics and Well Written Essays - 2000 words

COMPETITION AND FINANCIAL STABILITY - Essay Example It has been argued that, similarly to other industries in the non-banking sector, competition prevalent in the banking sector is desirable because it tends to generate a market that is more efficient, as well as the benefits that tag along like efficient resource allocation and better consumer prices. However, other theories argue more competition in the banking sector may precipitate an increase in instability with regards to the financial systems. Since greater competition in the banking sector leads to a decrease in margins of bank profits, banks are banks are encouraged to acquire riskier investment so as to boost profit levels, which is in support of the competition fragility view (Boyd et al., 2009: 4). However, other arguments make the argument that greater concentration of banks in the loan markets may lead to an increase in instability via increased risks, especially because higher rates of interest that are charged on consumers could make it more difficult for them to pay b ack the loans, which supports the view on competition stability. Therefore, it is interesting when these hypotheses are tested to decide whether completion in the banking sector is desirable with an aim to increase financial stability (Boyd et al., 2009: 5). ... l failures of the market because of asymmetric information like adverse selection, moral hazard, and excessive taking of risks with agency problems, externalities like fragility because contagion and coordination problems, and potential power of the markets (Koskela & Stenbacka, 2000: 1857). This has led to regulation that seeks to protect the small investors, the system, and market competitiveness. However, these problems are made worse by policies that have to do with being too big to fail, deposit insurance, and the last resort lender. The global financial crisis uncovered the huge failures of the regulatory system and the potential contradictions between competition policy and regulatory intervention (Koskela & Stenbacka, 2000: 1857). Banks, indeed, are unique because of their specific mix of features that increases their vulnerability to potential systemic impact and very fundamental negative externalities with regards to the economy (Koskela & Stenbacka, 2000: 1858). The compet itive banking system’s fragility is excessive with financial regulation coming to the rescue at the cost of regulatory failure and side effects. The most essential one has to do with potential moral hazards caused by bailouts and protection of failing financial institutions. The recent global financial crisis is a testimony to failures of the Basel II system’s three pillars. First, risk assessment and disclosure have been deficient with market discipline being ineffective, especially due to blanket insurance from too big to fail policies (Koskela & Stenbacka, 2000: 1858). Secondly, capital regulation has failed to account for account systemic effects, i.e. failure’s social costs, with restriction on assets lifted because of pressure emanating from lobbies on behalf of investment