Money, Banking and Risk: Market Efficiency in the 21st Century (Term Paper Sample)

Money, Banking and Risk: Market Efficiency in the 21st Century
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Introduction
After realizing that the threats that the banking systems as well as our living standards have been faced with are consistently diminishing, several market analysts have held the argument that the world has survived major economic crisis. The comments by J Delor, an architect for single European currency, in 2011 illustrated that the initiative of having a single currency was evidently a failure from the beginning (BBC, 2011). Four years later, a number of analysts stated that Delor’s comments were inaccurate and indicted pessimism (Gotev, 2015). These were followed by the Eurozone crisis during the summer of 2015 (The Guardian, 2015). Since then, major bankers, politicians, financiers, and economists have concentrated on the assumptions of market analysts and the reality of money. At the time the banks in Greece began having lesser physical money, the political mood was drastically altered. This resulted to discussions regarding the change from the single currency system back to the Greek Drachma. Policies were implemented to ensure several cash restrictions in Greece, the transfer of funds overseas included (New York Times, 2015).
Moreover, the Financial Times (2015) elaborated that in August 2015, many global financial institutions received heavy fines from Europe and the United States for taking part in financial market rigging. These crimes made many people go to jail. Additionally, as observed by Tang (2015) the Chinese stock exchange volatility in September 2015 created major panic in the market, and the country’s Central Bank had no hand in the problems.
A review of these issues pose major question as to whether the markets in the 21st Century are actually efficient. This paper evaluates the level of efficiency of the markets during the 21st century. This is done through the evaluation of the efficiency of the financial sector and the financial intermediation prudency. The findings help in the provision of recommendations for the maintenance of efficiency and market stability.
Efficiency of the Financial Sector and Markets in the 21st Century
Many financial analysts have diverted their focus on the financial sector thanks to the recent crisis. According to Liesen (2015), concentrations have been on the adverse influence of the crisis like direct financial costs incurred in supporting the financial institutions that are faced with the threats of failure and the indirect costs that originate from recessions. These costs are major causes of financial distress in the markets. As these costly crisis have significant negative influence on the on the financial sector, it is arguable that any actions taken to eliminate them is justifiable.
A properly functioning financial system helps in the generation of savings, efficient investments’ apportionment, and the smoothening of any economic fluctuations that might be caused by nonfinancial factors (Krasnova, 2014). A correctly functioning financial system also optimizes the level of productivity and raises living standards, as it has the ability of facilitating informed risk taking. The importance of this can be observed from the differences in different countries’ economic performances, those with open or repressed financial systems. This, according to Galloppo, Paimanova, and Aliano (2015), is a suggestion that the influence that finance has on the performance of an economy can be determined by improving the total factor productivity that the financial system creates. However, quantifying this and determining the actual contributions of different aspects of the financial system is highly extraordinary (Barucci, 2003). This does not however prevent the determination of the means through which the effectiveness of the financial sector relates to the economic performance.
The creation of a payment system is a factor that should be perfectly evaluated within the financial sector. No market economies can function perfectly without a system of payment, and banks are believed to be the perfect providers of the service (Tavor, Spiegel & Templeman, 2010). A number of people thus perceive the functions of the banking system as highly significant and need precise policy intervention. This is the primary source of the ‘narrow banking school’, whose advocates believe that payment systems with full protection leads to the creation of financial systems with no considerations of any special public interests. However, the system’s insulation is never a guarantee of stability or efficiency of the credit supply mechanism. According to Ibikunle (2015), it is actually an interruption to the credit supply and a transmission of financial pressure to the economy. Credit allocation inefficiencies are major hindrance to the achievement of optimum growth within economies (Vaughan, 2005).
Alongside their roles of financial intermediation and payment channels, financial systems should also add value in other important ways. First, they should convert the illiquid and uncertain claims into liabilities that accurately match the asset holding preferences of the savers. This would increase the liquidity of the nonfinancial sector and raise the overall savings level in the economy (Zuasti, 2008). Maturity transformation is a major way that the financial system raises the value of other components of the economy. However, as evident from the current crisis, the merits of its association can be a major source of susceptibility (Bianchi & Jehiel, 2015). As such, proper financial system efficiency in the twenty first century is only achievable by preserving the benefits of maturity transformations for those who use the financial services while at the same time making sure that the system is free from unanticipated liquidity erosion that may result from factors like major loss of confidence.
The second way by which the financial system increases value is via perfect solution of asymmetric information problems in the exchange economy. According to Balling, Lierman, and Mullineux (2004), credit extension from lenders to borrowers is determined by asymmetric information. The selection is determined by the fact that the borrowers possess better information regarding the risks and returns of investment than the lenders. After receiving the loans however, any divergence of the interests of the borrowers from those of the lenders might lead to moral hazard (Hoque, 2015). Such divergences of interests are common within the 21st Century and have resulted into the collapse of proper resource allocation, inter-temporal contracting, and lower levels of investment. These indicate the level of inefficiency in the markets. A capital market that is highly efficient can be created through the creation of prominent institutions that make lending decisions and market prices. These institutions can use information from rating agencies, market intermediaries, and evaluations from accounting professionals to set the market prices and make the lending decisions. This would be a perfect solution to the conflict of interest between borrowers and those who rate them, and would control the general occurrence of moral hazard.
The third way that the financial system should add value is by providing a means of evading some uncertainties faced in investments. According to Fiedor (2014), all the activities within a real economy need some form of insurance against physical loss. In case there is no such insurance, the level of uncertainty would be raised an investments would yield lower productivity. Financial risks that high-value projects face can however be hedged through derivative instruments. This incorporates the application of standardized products to cover interest and exchange rate risks. These practices do not emerge evidently in the financial systems of the 21st century. To raise market efficiency, the current financial system should be reformed in a manner that it does not hinder the beneficial application of instruments in reducing financial risks.
Financial Intermediation’s Prudency
The increase in the complexity of the financial market in the past ten years has raised beliefs that forces from within the market have the ability of providing sufficient incentives that would allow efficient and prudent conduction of financial intermediation. This has however turned out to be untrue because of several reasons.
If financial institutions allow risks within their balance sheets, acceptable mechanism of corporate governance will only be ensured through consciously undertaking all the risks and prudently managing them. Shareholders are highly concerned with the accuracy of loan underwriting, strength of risk management and control, and adequacy of capital cushions for maintaining the value of franchise via every phase of the financial cycle. As explained by Gilson and Kraakman (2014) prudent management of risk is significant in creating and preventing excessive leverage. Moreover, self-interest among fund providers should have the ability of constraining leverages. The lenders to the financial institutions should impose penalties on intermediaries that run excessive risks or hold thin capital cushions (Righi & Cerretta, 2013).
Additionally, as the means through which information about financial value is delivered, the security markets should provide incentives for quality maintenance within the ideal world. In the examination of the role of insecurities markets, it is also important to consider the assumption that the reputation’s value within the long-term is greater than the benefits in the short-term (Maria-Lenuta & Nistor, 2011). For example, the loan originators whose role is to supply loans that are to be acquired by third party institutions are likely ...