Financial stability: Paradigm and support institutions

A stable financial system is a key ingredient to a healthy and successful economy. http://www.bankofengland.co.uk

Financial stability can be described as the absence of microeconomic costs of disturbance in the system of financial exchange between households, businesses and financial- service firms. Stability would be evidence by

  1. An effective regulatory infrastructure
  2. An effective financial market
  3. An effective and sound financial institution

South African Reserve Bank (n.d) what is financial stability? (WWW) South African Reserve Bank. Available from; http://www.reservebank.co.za /internet/publications.nsf/WCEV/02/88E165BC9BB742256B5E0027B670/?opendocument. (Accessed on 04/04/10).

It also describes the condition where the financial intermediation process functions smoothly and there is confidence in the operation of key financial institutions and the markets within the economy. Bank Negara Malaysia (n.d) financial stability (WWW) Central Bank of Malaysia. Available from; http://www.bnm.gov.my (Accessed on 03/04/10)

The banks (central/reserve) play important roles for an economy to experience financial stability. For examples; the Bank of England has a statutory objective to 'contribute to protecting and enhancing the stability of the financial system in the United Kingdom'. The bank does this through its risk assessment and risk reduction work, market intelligent functions, payment system oversight, banking and market operation. Bank of England (n.d), The Bank's Financial Stability Role,(WWW) Bank of England. Available from; http://www.bankofengland.co.uk/financialstability/index.htm (Accessed on 04/04/10)

Also Bank Negara Malaysia discharges the responsibility for promoting a sound and efficient Malaysia financial institutions and the robustness of the financial infrastructure to withstand adverse economic cycles and shocks and thereby preventing inordinate distributions to the intermediation process and maintaining confidence in the financial system. Bank Negara Malaysia (n.d) financial stability (WWW) Central Bank of Malaysia. Available from; http://www.bnm.gov.my (Accessed on 03/04/10).

In Australia, stability of the financial system is long-standing responsibility of the reserve Bank. This is a mandate reconfirmed by the Government when it introduced significant changes to Australia's financial regulatory structure in July 1998. In meeting its responsibility for financial stability, the Reserve Bank focuses on the prevention of financial disturbances with potentially systemic consequences. The Reserve Bank has policies in place that help prevent these types of disturbance or to respond in the event that a financial system disturbance does occur. (Reserve Bank of Australia (n.d) About Financial Stability (WWW) Reserve Bank of Australia. Available from http://www.rba.gov.au/fin-stability/about.html (Accessed on 03/04/10).

In finance, paradigm could be seen as a good example of how product, system etc can work or be produced. Finance Dictionary (n.d) Paradigm definition from Financial Times Lexicon (WWW) Longman Business English Dictionary. Available from http://lexicon.ft.com/term.asp?t=paradigm (Accessed on 04/04/10)

It could also be seen as a set of assumptions, concepts, values, and practices that constitutes a way of viewing reality for the community that shares them, especially in an intellectual discipline. Ordnance Survey (n.d) Ordnance Survey glossary. (WWW) Ordnance Survey. Available from http://www.ordnancesurvey.co.uk/oswebsite/aboutus/reports/misc/glossary.html#pagestart (Accessed on 04/04/10).

In order to address the issue of financial stability in an economy, the following are the prevailing paradigm for financial markets

  1. Market fundamentalism: The 'invisible hand' and the 'Laissez-faire'.
  2. Markets tend towards equilibrium. Deviations occur in a random manner (Bell- shaped curve).
  3. The common interest is best served by allowing participants to pursue their self-interest.
  4. Rational expectations of market participants.

The new paradigm for financial markets

  1. Markets are imperfect. Regulatory Authorities intervention prevented markets from breaking down.
  2. Outlier events occur more frequently than in a random distribution (Thick tails)
  3. Recognition of additional uncertainty factor that characterises the behaviour of financial markets.

Raed H. Charafeddine (February 23, 2010) Islamic Finance in the context of the worldwide financial crisis: where does Islamic Finance fit in the new paradigm for financial services? (WWW) Euromoney seminars. Available from http://www.euromoneyseminars.com/subscribe.aspx (Accessed on 04/04/10).

Soros (2008); reflexivity theory on the interaction between investors, conceptions and markets. Human Behaviour is driven by

  1. A cognitive function
  2. A manipulative function (influence impact).

Both functions interact in opposite directions.

Raed H. Charafeddine (February 23, 2010) Islamic Finance in the context of the worldwide financial crisis: where does Islamic Finance fit in the new paradigm for financial services? (WWW) Euromoney seminars. Available from http://www.euromoneyseminars.com/subscribe.aspx (Accessed on 04/04/10).

The effective uses of these paradigms with the help of support institutions enhance the stability of finance system of any economic. The following are some of the financial stability support institutions.

Financial Stability Board (FSB)

The Financial Stability Board has been established to address vulnerability and to develop and implement strong regulatory, supervisory and other policies in the interest of financial stability. Financial Stability Board (n.d) Financial Stability Board (WWW) Financial Stability Board. Available from http://www.financialstabilityboard.org/ (Accessed on 04/04/10).

According to the report on "Improving Financial Regulation" from FSB to G20; The FSB objective is to create a more disciplined and less procyclical financial system that better supports balanced sustainable economic growth. This system will not allow leverage to increase to the extent that it did. To these ends, their program includes substantially higher requirements for the quantity and quality of capital and liquidity at financial institution. It also includes reforms to accounting standards and compensation regimes that improve transparency and limit incentives to risk taking. They also constrain risks in trading - related activity by improving market infrastructure and by significantly raising capital charges for trading books. Financial Stability Board (September 25, 2009) Improving Financial Regulation - Report of the Financial Stability Board to G20 Leaders. Available from http://www.financialstabilityboard.org/publications/r_090925b.pdf (Accessed on 04/04/10)

The report also reviewed the following as their critical work underway to support the financial stability;

  1. Strengthening the global capital framework.
  2. Making global liquidity more robust.
  3. Reducing the moral hazard posed by systemically important institutions.
  4. Strengthening accounting standards
  5. Improving compensation practices.
  6. Expanding oversight of the financial system
  7. Strengthening the robustness of the OTC derivatives markets
  8. Re- launching securitisation on a sound basis.
  9. Adherence to international standards.

FSB reform plan set reasonable implementation windows to avoid aggravating the present crisis. Financial Stability Board (September 25, 2009) Improving Financial Regulation - Report of the Financial Stability Board to G20 Leaders. Available from http://www.financialstabilityboard.org/publications/r_090925b.pdf (Accessed on 04/04/10)

The Financial Stability Institute (FSI)

The Financial Stability Institute is another support institute for financial stability. The Bank for the International Settlements and the Basel Committee on Banking Supervision jointly created the FSI in 1990 to assist the financial sector supervisors around the world in improving financial system. The FSI objectives are;

  1. Promote sound supervisory standards and practices globally, and to support full implementation of these standard in all countries
  2. Provide supervisors with the latest information on market product, practices and techniques to help them adapt to rapid innovations in the financial sector
  3. Assist supervisors in employing the practices and tools that will allow them to meet everyday demands and tackle more ambitious goals.
  4. Help supervisors develop solution to their multiple challenges by sharing experience in seminar, discussion forums and conferences.

Bank for International Settlements (n.d), The Financial Stability Institute (FSI). (WWW) Bank for International Settlements. Available from http://www.bis.org/fsi/aboutfsi.htm (Accessed on 04/04/10)

It achieves its objectives through the following main activities

Events: for financial sector supervision such as conferences, high level meetings, discussion forums, and seminar held in Switzerland and globally.

FSI Connect: a web - based information and learning resource for supervisors

Publications: such as occasional papers and a quarterly newsletter. Bank for International Settlements (n.d), The Financial Stability Institute (FSI). (WWW) Bank for International Settlements. Available from http://www.bis.org/fsi/aboutfsi.htm (Accessed on 04/04/10)

This current global financial crisis has prompted a search for an enduring solution to stability of financial system. The challenge now is to build a new financial architecture that would allow for the more efficient functioning of not only financial intermediation within national economies but also across borders. Islamic finance, with its emphasis on a strong linkage to productive economic activity, its inbuilt check and balances and its high level of disclosure and transparency offer this. Indeed, inherent in Islamic finance is the explicit elements that address several of the issues that have surfaced in the conventional financial system during the current crisis. Zeti Akhtar Aziz (September 24, 2009) Islamic Finance and Financial Stability (WWW) Bank of International Setlements. Available from http://www.bis.org/review/r091130d.pdf (Accessed on 04/04/10)

Bibliography

  • South African Reserve Bank (n.d) what is financial stability? (WWW) South African Reserve Bank. Available from; http://www.reservebank.co.za /internet/publications.nsf/WCEV/02/88E165BC9BB742256B5E0027B670/?opendocument. (Accessed on 04/04/10).
  • Bank for International Settlements (n.d), The Financial Stability Institute (FSI). (WWW) Bank for International Settlements. Available from http://www.bis.org/fsi/aboutfsi.htm (Accessed on 04/04/10)
  • Bank Negara Malaysia (n.d) financial stability (WWW) Central Bank of Malaysia. Available from; http://www.bnm.gov.my (Accessed on 03/04/10)
  • Bank of England (n.d), The Bank's Financial Stability Role,(WWW) Bank of England. Available from; http://www.bankofengland.co.uk/financialstability/index.htm (Accessed on 04/04/10)
  • Reserve Bank of Australia (n.d) About Financial Stability (WWW) Reserve Bank of Australia. Available from; http://www.rba.gov.au/fin-stability/about.html . (Accessed on 03/04/10).
  • Finance Dictionary (n.d) Paradigm definition from Financial Times Lexicon (WWW) Longman Business English Dictionary. Available from http://lexicon.ft.com/term.asp?t=paradigm (Accessed on 04/04/10)
  • Financial Stability Board (September 25, 2009) Improving Financial Regulation - Report of the Financial Stability Board to G20 Leaders. Available from http://www.financialstabilityboard.org/publications/r_090925b.pdf (Accessed on 04/04/10
  • Raed H. Charafeddine (February 23, 2010) Islamic Finance in the context of the worldwide financial crisis: where does Islamic Finance fit in the new paradigm for financial services? (WWW) Euromoney seminars. Available from http://www.euromoneyseminars.com/subscribe.aspx (Accessed on 04/04/10).
  • Zeti Akhtar Aziz (September 24, 2009) Islamic Finance and Financial Stability (WWW) Bank of International Setlements. Available from http://www.bis.org/review/r091130d.pdf

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