The Darwinian Economy Essay Example | Topics and Well Written Essays - 2000 words

The Darwinian Economy - Essay Example During a House Financial Services Committee hearing, it was put across that the simplest way to frame regulation was capital. Capital informs the amount of risk that financial institutions can take overall. It assures that the institutions have cushions that can absorb extreme shocks. Capital requirements are designed so as, given the uncertainty about the future and ignorance that there is concerning some elements of risk, it will ensure a greater cushion for absorption of loss and save bankers from consequences of judgment mistakes, as well as global uncertainty. The debate on whether to regulate or not to regulate has a great deal at stake. The global financial systems and their stability are dependent on adequate and effective capital requirements for these institutions with the 2008 crisis revealing vital problems with requirements as they currently stand (Ferguson, 2012: p1). However, economic recovery prospects, in Britain, the EU, and the US are heavily dependent on a steady credit flow, as well as lending. In addition, the available evidence is suggestive of the fact that over the top increment of capital requirements, in deed, will cause a credit crunch. Therefore, while financial institutions do require some level of regulation, they should not be over-regulated. Regulatory Failure Regulatory requirements of capital are not equally effective in their totality, especially because of two essential pitfalls that they are susceptible to; discretionary recognition of loss by regulators and bankers and discretionary bailouts by their governments (Barth et al, 2010: p34). Discretionary loss recognition refers to the use of practices of accounting that act to alter the meaning of capital. Instead of utilizing market based concepts, such as bank stock prices, so as to measure risk, as well as establish capital needs, regulators are reliant on concepts of accounting. They check on the bank’s books, rather than on the market assessments of the firmâ€⠄¢s held value. Regulatory capital, therefore, is referred to as accounting residual, i.e. the difference between asset accounting value and debt accounting value (Barth et al, 2010: p34). Accountants, book value, of course, are subject strict requirements of law. However, these requirements provide the regulators and bankers with discretion, especially concerning timing, which allows them to delay the acknowledgement of problems, as well as acting on these problems (Barth et al, 2010: p36). In addition, neither regulators nor bankers tend to recognize losses fully during poor economic conditions. The bankers will usually prefer to use delay tactics, such as ever greening, i.e. re-lending of money to the delinquent borrowers in order for these borrowers to pay back ballooning costs of debt service using even more debt to mask their problems. Bank regulators, on their part, always crave system stability, especially forbearance, to avoid worsening or precipitating a crisis. Therefore, they find ways to utilize their allotted discretion so as to downplay the size of losses in order for the banks not to require lost capital replacement (Barth et al, 2010: p34). When the above-mentioned practices are done on a large scale, they can have disastrous results. In the preceding events of the 2008 financial crisis, for instance, their combination caused a failure in the replacement of bank capital in time, which led to an intensification of the eventual