Rrole of Prudential Supervision and Evolution of Its Supervisory Framework Beginning from Bcci Incident up to Last Financial Crisis

The author discusses in her paper the role of prudential supervision and evolution of its supervisory framework beginning from BCCI incident up to last Financial Crisis, and emphasizes the need for greater emphasis on disclosure requirements and measures within the securities markets that would provide better transparency and strengthen the economic immunity against future possible crises - systemic risks. Capital requirements could not help alone.

Prudential supervision involves government regulation and monitoring of the banking system to ensure its safety and soundness. Efficient functioning of the financial system might be hindered by the asymmetric information, when one party to a financial contract has less accurate information than other party. In its turn, asymmetric information is the cause for adverse selection and moral hazard.

Governments have attempted to regulate the financial sector through:

1) Capital requirements – making sure institutions have sufficient assets to meet their contractual obligations, through reserve requirements, capital requirements, and other limits on leverage.

2) Disclosure requirements - requiring financial institutions to follow certain accounting principles and disclose a wide range of information that would help the market in assessing the quality of a bank's portfolio and the amount of the bank's exposure to risk. As a result, it would enhance market discipline by enabling stakeholders of financial institutions to evaluate and avoid excessive risk taking.

3) Supervisory approach, not only regulatory. For example, Imposing penalties for maturity mismatches, so as the degree of disparity that exists between the maturity of assets and liabilities is crucial to determining the state of a company's liquidity; evaluation of not only balances at the end of period, but also during the period.

However, excessive regulation sometimes may lead itself to financial crisis. For example, the Basel II Accord has been criticized for requiring banks to increase their capital when risks rise, which might cause them to decrease lending precisely when capital is scarce, potentially aggravating a financial crisis.

Further, the author argues that the contribution

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