What are the effects on the financial industry of the rapid changes in the regulatory, monetary, and competitive framework?
Dear Dr. Kotishwar Aarugonda
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If there are changes in regulatory, monetary, or other conditions, financial sector usually respond very quickly, often by introducing financial innovations. However, this response has often effects that regulators did not expect. Some people therefore argue that bank crisis are often cause by changes to regulatory environment. For example:
Regulator would like to make banks safer. He therefore introduces capital requirements on banks' balance sheet. Since holding excess capital is costly for banks, they figure out how to get around this regulation, for example holding a lot of assets of the books. As a result, financial sector might be more risky than before the regulation.
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