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Table of Contents

Financial stability: Shadow banking and securitization

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Shadow banking a concept of Financial Institutions offering a range of products akin to formal banks albeit in a more specialized way, in a way competing with the formal system of banking.

Table of contents

Abstract

With the rapid development of the global economy, the financial sector is becoming the core of economic activity globally. In order for the financial market to be stable and avert financial risk, the governments of various world economies are realizing the prominence of financial regulation. Thus it is high time that global markets switch to effective financial regulatory regime with stringent policy requirements which eventually would ensure the healthy development of the financial industry.

Keywords: Shadow Banking, Securitization, Financial Stability, Great Recession, Glass Steagall Act, Regulatory Framework

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Introduction

In the recent years, the international financial regulatory regime had been undergoing constant and numerous changes. A few emerging nations have been constantly carrying out financial regulatory regime based on the global trends of financial markets and also the recently developed financial institutions. This study is predominantly based on the theory of financial supervision and financial regulatory regime, focuses on the development and evolution of the financial regulatory regime in China, while comparing the same with the financial regulatory regime of both developed and emerging nations like the United States of America, United Kingdom, Japan among others.

Off-late, the speedy advancement of the global economy and the increasing affluence of the financial markets globally have paved way for a new trend of global economic expansion precisely through economic integration. Furthermore, the financial industry is attaining increased significance due to the modern economic development. To be precise, the global economic integration essentially means an integrated global financial market. The improbability and unpredictability of the financial system came to light with the rapid growth of the financial industry.

Financial regulation plays a crucial role in ensuring that global economies are financially stable while also assisting to evade economic recessions and financial downturn. Many of the global financial crises have time and again proved that markets have failed due to less and insufficient regulation in the market. The most important cause in addition to regulation issues is the discrepancies in the corporate reporting. The crisis in the European Union, remarkably in the Greek economy, had economies around the world fidgeting and bracing them for a global crash which got averted in the very last minute. Today, the relationships between economies, talent pools, and industrial resources are so great that a simple Brazilian frost can boost coffee prices in Coorg (India). Similarly, a downward spiral in crude prices sees a positive impact on economies around the world.


Issues in financial regulation have essentially become one of the most debated issues in modern days and they are incessantly creating a negative impact on the global economy while also impacting the financial stability of various international markets. Regulation gets more and more complicated due to the reason that securities are controlled regionally and insurance industry regulation seems to be considerably ineffective with the passage of time. Of late, it was recognized that the complaints made by customers involving an investment portfolio which essentially would be a blend of insurance and investment products can be reported to two dissimilar ombudsman services in order for them to be considered and yet the result is nothing more than absurd. This makes the complaint handling system, an already complex, and almost difficult to traverse for Main Street.

Financial risk quantification, analysis and control have evolved dramatically over the last decades. In the olden days, individual positions were evaluated separately on their own merits and risk was defined as negative return. Significant advances in academic theory have had a major impact on practical risk measurement. Applications such as risk diversification, portfolio building and hedge funding do not come under esoteric domain of the academic ivory tower any longer, but the same however are widely applied by every bank, market – maker, investment management organization and pension fund these days.

While fraud plays a crucial role in harming consumer savings, the financial services industry engages subtle means that are less dangerous than absolute theft, but more adversely impacting the savings of individuals.

Securitization can be defined as the process of pooling a group of assets which are basically less liquid in nature and in turn transforming them into a security. Mortgage security is a typical example of securitization. The mechanism is such that, initially an institution which is regulated and authorized, actually originates a plethora of mortgages that are basically secured by way of claims against various properties purchased by the mortgagers. Further, all the individual mortgages are transformed into a pool of mortgages which are held in form of a trust.

An effective regulatory agency apparently is believed to meet the following criteria:

  • Should be independent,
  • well-resourced and have
  • active regulatory power with respect to issues related to consumer protection over every single financial organization, product and provider,
  • have consumer protection as a categorical objective of regulation, empowered with total authority to investigate,
  • should be able to seek clear and real time information, rational terms of contract as well as charges, effective grievance readdress systems, and
  • Tough and fair competition.

Over the last few years the world has witnessed movements towards this goal in quite a few economies. And irrespective of how near or far they are from achieving this objective, consumer advocacy organizations will continue to seek and support the formation of effective self-governing regulators to make sure that the financial services marketplace is benign for consumers.

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The study analyses the financial regulation theory, various mechanisms concerning financial regulation, models for financial regulation, and the level of regulation required for the creation of an optimal financial regulatory system. Furthermore, the study also highlights the various trends of the global financial regulatory system development while also analyzing the insufficiencies of the existing financial regulatory system and challenges. The study finally offers few rationalization proposals for the establishment of a sound financial regulatory regime.

In view of all above, this dissertation aims to examine how securitisation was created by shadow banking and to what extend this process affected the financial stability during global financial crisis. This dissertation proceeds with 5 Chapters, beginning with an introduction. In what follows, I explore the role that the securitisation plays in the broader process of sources of funding creation. The first Chapter presents the background including previous literature. The main arguments of this research, that might be helpful in mitigating this fragility going forward, will be reiterated in the second Chapter of this dissertation by theoretical framework. In the third one, to the best of my knowledge, the data will be examined and the results would be presented. And, the last Chapter will conclude this paper.

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