The Financial System and Its Identifying Solutions By Ron Haruni At Isnare.com Ezine Articles

The strength and stability of a financial system is strictly measured by its ability to function in a state of equilibrium under normal and distressed conditions. If this main criteria is met, then the system’s proficiency to combine its structural, institutional and well-designed policies that follow free market principles - as one component, will not only provide a system in synchronism, but will also allow for a coordinated functioning of it as a coherent entity that will consistently sustain its compactness and reliability as one of the main mechanisms of the economy.

However, as the complexity and scale of the finance system grows - if the system’s structure is not systematically monitored, optimized and persistently promoted with the objective of reinforcing system-soundness against possible adverse shocks, then it will only be a matter of time before conditions for risk will arise, intensify, and consequently cause deteriorations, the negative reverberations of which will be felt throughout the economy. And as was seen in the financial crises of the '80s and '90s, and as is currently the case with the securitisation crisis and its spillover to the money markets — when supervisory framework on different policies remains inadequate in identifying and monitoring any risks that do arise from banking system fragilities, the result is that of a financial system that gets exposed, loses its strategic business direction, and most importantly - loses its power in taking firm and corrective actions to fit the scale of the problem. That’s why in my view the answer in correcting or preventing future system complications, to a certain extent still lies in the wise regulations, and meticulous supervision of the system.

In order for the banking sector and the financial system to avoid seeing again such anomalies as the current ones, a major improvement in the system’s risk management capabilities must take place. For starters, we should stay clear from the tendencies where leverage gets underestimated while capital buffers in the financial system keep getting overestimated. The initial presumption that somehow all the large banks and investment firms were well-capitalized turned out to be catastrophically wrong. In addition, the business model of banks from a “buy-and-hold” to the “originate-to-distribute”, while it can not at this point be reversed, through policy-makers and industry bodies can certainly work better if the model gets pushed towards a more balanced, market-based approach. Also, product standardization and accurate pricing in the structured finance market is another measure, among many, that can influence positively in correcting some of the problems that have been created as result of excessive complexity and imprudent financial dealings.

If we do not address these issues by offering real and effective solutions ; disruptions to key financial services such as deposits or loan and securities to investors will begin resurfacing again, bank capital adequacy ratios will start shrinking - causing the financial system to inevitably re-risk collapse.

It is time we stopped being repetitive in our mistakes. The cost of incompetence is simply too high.

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