The Changing Structure of Financial Institutions and Markets: A Central Bank Perspective
Volatility in financial markets can be defined to include shifting pressures on financial institutions, as well as fluctuations in prices of financial assets. Many of the financial market disruptions which have occurred in recent years are related to changes that have been taking place in the structure of the financial industry, promoted by financial deregulation, technological advances and the internationalisation of finance. Existing institutions have sought to preserve market share against new intermediaries, and both have faced growing competition from markets in securitised assets.
The stability of financial markets and institutions is dependent on the availability and quality of financial information, and the market’s incentive to use it to monitor the behaviour of financial transactors. The risk is that changes in the structure of the industry will not be accompanied by changes in the way the information needed to promote systemic stability is provided.
Although the creation of more types of financial asset and increased trading volumes should in theory improve welfare, Tobin and others have questioned whether this is so. However, there seems little justification for “sand in the gears”. Admittedly, asset price bubbles have occurred from time to time, but it is hard to attribute these to new financial assets such as derivatives. These new assets have in fact improved the ability of economic agents to identify, price and manage risk. Properly used, they enhance systemic stability.
Still, much remains to be done to strengthen the financial system. Recent episodes have shown the importance of operational risk. Even if systems and controls are robust, liquid capital remains necessary to protect against risks consciously run, or unforeseen events. The classic distinction (due to Frank Knight) between risk and uncertainty, remains valid.
KeywordsFinancial Market Financial System Financial Institution Asset Price Financial Asset
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