- When financial intermediaries attempt to avoid existing regulations, innovation can be spurred is correct according to many individuals including I. Many financial intermediaries attempt to take this route because of the incentive that is involved with completing transactions. These transactions consist of the mortgages, auto loans and credit cards. (Mishkin 277) The financial industry is just like any other for profit business they actually sell products to make money. That is just another way of thinking about what a financial institute really is.
These innovations have many issues in areas in the economy. The government heavily regulates the financial industry, but many firms tend to still “skirt regulations that restrict their ability to earn profits”. (Mishkin 277) One of the regulations that have occurred to prevent the financial industry from not obeying the existing regulations is the Federal Reserve System that was created in 1913. But many banks did not become members because the cost of being a member was very high. Along with that being said the Federal Deposit Insurance Corporation (FDIC) was created in 1933. This actually did the opposite in the banking industry; almost all of the commercial banks had chosen to become members of the Federal Deposit Insurance Corporation. (Mishkin 271) Still today every financial institution is members of both banking systems. This actually made the financial economy stronger. For example when the bank needs to borrow money and is not able to borrow from another bank they borrower from the Federal Reserve. This will help them cover funds that are needed right away. These systems also allowed some type of structure to the financial world because many institutions were trying to do what ever they wanted.
The government has to regulate the financial institutions for two reasons. The first reason is to protect the consumer from being over charges and not fully disclosed of any public utilities. This will help prevent the excesses of the market failing. The second regulation is to have additional goals of maintaining financial stability and clear public goods and services to elaborate the framework of the regulation and supervision. ( This supervision happens not only internally but externally to engage in the moral hazard of every person taking ownership rights from making the financial institution fail.
Ensuring the accountability is very important when regulating the supervisors that have the key effect independence. This is the absolute independent management in a specific sector of the financial institution. For example being a branch or assistant branch manager. As a part of one of these titles is help many ways to create a huge incentive and/or failure to the financial institution. Many times as a managers personally took their own interest first before the customers.
Another point that will be made is the individuals and financial institutions operating in financial markets were confronted to drastic changes the caused them to be unprofitable. These changes have occurred because the rapid computer technology, inflation and interest rates climbing sharply and even harder to predict. (Mishkin 272) These examples have stopped or decreased the employment of staff members working in a retail or commercial bank. With the interest rates drastically changing the banks will not be able to sell the any lending products and make money to boost the economy. But on the other hand when the rates are adjustable such as the adjustable rate mortgages that attractive rate today might be increased next month that is one of the examples of the innovations of the financial institution. (
The credit cards are one of the transactions that involve the financial intermediary to produce a higher incentive, which caused them to avoid some regulations. The credit system had become easier and easier to get. The computer technology has lowered the cost of the bank, which resulted in the profit increasing in the hands of the business. Many banks or mostly all banks offer credit card programs. The most popular ones are the Visa and MasterCard. These programs have phenomenally been successful for many years. (Mishkin 274) With these programs the government had to put in place a regulation as well just to stop or prevent the any issues occurring. This specific regulation is to protect the consumer no matter if it is a person or entity. It is titled the Equal Credit Opportunity; this “prohibits the lenders from discriminating against credit applicants establishing guidelines for gathering and evaluating credit information and requires written notification when credit is denied.”(
One of the biggest things is the fed fund rate, the is the short term of interest rate at which the U.S depository institutions (such as commercial banks, savings and loan associations, credit unions, mutual savings) lend to each other overnight within the federal reserve system. This was briefly exposed above earlier in this report. The Federal Reserve sets the funds rate to keep the target executing open market operations. Meaning buying and selling treasuries and mortgage back securities. With that being said this adjusting interest rate is paid to banks that require and excess reserve balance on deposit. This rate is most potent tool to lower or boost up the U.S economy. If the rate is lowering it is when the economy needs a boost and raising is when the rate of inflation is too high. (
The fed fund rate is another regulation for the financial intermediary they do not have any control of it. If they did I could only imagine what the rates would be like when lending to customers. It will be a chaotic situation and would cause the economy to blemish.
All of these regulations and systems that are in place for the economy is very important and help prevent any financial intermediary for taking advantage of any consumer and business. These regulations have been created to also help the economy from failing. All of these major regulations that was created from the occurrence of the huge bank failures that happened throughout the years. If the financial intermediaries were well together without the regulations we would not have and still have bank failures. Even with all of the regulations that the financial intermediary have to obey by. There are still some issues that causes the financial intermediaries to have to bought out or merged with another and even sold off to other financial intermediaries. A perfect example is HSBC sold many branches to First Niagra because they were being fined for opening business account incorrectly. Which is a huge profit in the commercial bank on the profit and loss spread sheet report. Kasha
2… Larry………
When it comes to financial intermediaries attempt to avoid existing regulation I agree that innovation can be spurred. Since the financial industry is heavily regulated the government regulation is much greater to spur innovation in this industry but these regulation leads to financial innovation by creating incentives for firms to skirt regulations that restrict their ability to earn profits (Mishkin pg. 277). As the text points out that banking institution are still the most important financial institution in the U.S. economy and through the recent years the traditional banking business has been replaced by shadow banking system and this have led to bank lending being replaced by lending via security markets (Mishkin pg. 272). Over time the banking industry has to evolve and like any business they need to earn a profit by selling their product and to maximize their profits the financial institution needs to develop new products to satisfy their needs as well as those of their customers and in turn this can be extremely beneficial to the economy . A change in the financial environment will stimulate a search by financial innovation are likely to be profitable (Mishkin pg. 272).
The incentive they have in their process of avoiding regulation is called “loophole mining” which allows financiers to engage in activities they wish that are not explicitly forbidden and it is easier for financial innovation than restrictive regulatory system ( There are two sets of regulations that have restricted the ability of banks to make profits and they are a reserve requirement which forces the bank to keep a certain fraction of their deposits as reserve, and restrictions on interest rates that can be paid on deposits. The financial innovation that came out of the reserve requirement is to recognize that they act as a tax on deposit since the Fed did not pay interest on reserves and this has led to banks who are seeking to increase their profits by mining loopholes and by producing financial innovation that allows them to escape tax on deposits imposed by reserve requirements (Mishkin pg. 278). The restriction on interest paid is another regulation the bank industry had to avoid which is that banks were prohibited in most states from paying interest on checking account deposit and through Regulation Q the Fed set maximum limits on the interest rate that could be paid on time deposits. The desire to avoid these deposit rate ceilings led to the financial innovation to get around this because depositors were withdrawing funds from banks and putting them in higher yielding securities and this led to the restriction of the amount of funds that the bank could lend and limited the banks’ profits. This incentive led to a way for the banks to get around the deposit rate ceiling and in doing this they could acquire more funds to make loans and earn higher profits (Mishkin pg. 278).
An example of the desire to avoid restriction on interest payments was the money market mutual fund where issued shares that are redeemable at a fixed price by writing checks. So if you buy 5,000 shares for $5,000 the money market fund uses these funds to invest in short term money market securities like Treasury bill, negotiable certificates of deposit, commercial paper that provides interest payments. Even though the money market fund shares the same function as a checking account deposit that earn interest, they are not legally deposits and are not subject to reserve requirement or prohibition on interest payments and this a reason they can pay higher interest rates than deposits at banks (Mishkin pg. 278). The growing popularity over mutual funds have two different side and those are the banks that take the offensive with mutual funds believing that fee income from sale will add profits from the traditional lines of business and the second group are the ones who are more defensive posture believing that offering mutual funds is necessary in keeping their customers (
Sweep accounts is another innovation that enables banks to avoid the “tax” from reserve requirements and in this arrangement, any balance above a certain amount in a corporation’s checking account at the end of the business day are “swept out” of the account and invested in overnight securities that pay interest. Since the “swept out funds” are no longer classified as checkable deposits, they are not subject to the reserve requirements and are not taxed (Mishkin pg. 279-280). Other benefits of sweep accounts are minimum investments where sweep account allows a business to invest smaller dollar amounts on a regular basis. By contrast, most overnight investments require minimum amounts that are out of reach for most small companies. Convenience because sweep accounts are passive investment vehicles and they automatically move extra cash into an investment account without requiring you to make the transfer yourself. Liquidity where sweep accounts offer same-day access to the invested funds, although there may be situations where there are delays in getting access to money. This depends on the particular bank and type of account. Options where sweep accounts offer businesses a variety of investment vehicles. This is especially beneficial to companies in need of tax-advantaged investments (
The innovations of the sweep account and money market mutual fund are interesting because they were stimulated not only by the desire to avoid costly regulation, but also by changing in supply condition in this case information technology. And these are a few reason in believing that innovation can be spurred because the bottom line is the banks want to make a profit and if regulation is preventing them from doing this, the financial industry will use the “loophole mining” to get around it and I believe also that is why the government leaves those loopholes there so the banking industry can come up with different ways that will push the industry further and in turn, this will lead to the growth of the economy with the different innovative ways the industry will try to get around these regulation which is good for the health of the U.S. economy.
..3. Financial innovation is the creating of new financial instruments, technologies, institutions and markets. These innovations can create increased available credit for borrowers as well as give banks new ways to raise their equity capital. I feel that the statement, “when financial intermediaries attempt to avoid existing regulations, innovation can be spurred”, is a true statement. Since the financial industry is more heavily regulated than any other government industry, financial innovation was spurred in order to find loopholes. Banks are especially restricted by reserve requirements and restrictions on interest paid on deposits. Reserve requirements act like a tax on a bank, which they would rather not have to pay. When there are restrictions on interest, depositors may choose to put their money in a higher yielding investment, which in turn, can cause the bank to lose money. Two innovations that have been created to avoid these types of regulations are sweep accounts and money market mutual funds. (Mishkin 277)
The first money market mutual fund was established in 1970 by Bruce Bent and Henry Brown. (Mishkin 278). The fund was offered to investors who were interested in preserving their money and still earn a small return. After its success, several more funds were set up and, over the next few years, the market grew significantly. The creation of the mutual funds from the 1970’s until today, has been very profitable. As of April 3, 2014, their assets fell by $13.12 billion to $2.63 trillion, according to the investment Company Institute. Assets in the nation’s retail money market mutual funds rose by $1.04 billion to $922.76 billion, the Washington-based mutual fund trade group said. Tax-exempt retail fund assets rose $370 million to $194.84 billion. The seven-day average yield on money market mutual funds was unchanged at 0.01 percent. (ABC News.go.com/business/wirestory/money-market-fund-assets-fall) These numbers give you a good idea of how profitable the money market mutual fund has become.
Money market funds are very appealing to many investors. They are usually considered safe during uncertain times. They are created so that an investor’s principal is not at risk and they can withdraw funds at any time. Many investors choose money funds because yields are higher than comparable short-term investments. Some funds are even waiving part or all of their management fees which ends up increasing yields also.
A sweep account is an account that automatically transfers amounts that exceed a certain level into a higher interest earning investment option at the close of each business day. They were originally created to avoid the regulation that limited banks from offering interesst on commercial checking accounts. Very often, these funds are swept into money market funds. This is done to provide the customer with the greatest amount of interest with the minimum amount of personal intervention. An article in the American Banker tells about a sweep account that was offered by Michigan National Corp. The bank was trying to attract small-business customers by offering a sweep account that allowed depositors to use excess deposits to pay down credit lines. Customers can choose whether they would like their excess funds put into and investment or if it is used to pay down loans to reduce interest payments. Most banks only offer sweep accounts be swept into investments so this could be an appealing option for some depositors.
According to an article in The Wall Street Journal, “The Fed’s Stress Tests Add Risk to the Financial System”, stress testing might be inhibiting future financial innovation. Stress testing has been a financial tool that was successful at helping us to get out of the financial crisis in 2009. It has allowed banks to see how they would hold up in different crisis scenarios. But now banks are so focused on trying to copy the Federal Government’s results, that they are stifling their creativity and innovation because they do not want to deviate from the standard industry practice. It is looked upon as suspicious and often discouraged by bank regulators. Discouraging innovation could be the beginning of the next financial crisis. Christopher