Financial Markets And Monetary Policy

Question 1

What are characteristics of money?

Answer 1

Durability – Money should withstand wear and tear over time.
Portability – It should be easy to carry and transfer.
Divisibility – It must be breakable into smaller units for transactions of different values.
Uniformity – Each unit must be the same to ensure consistent value.
Limited Supply – Its availability should be controlled to maintain value.
Acceptability – People must recognize and trust it as a medium of exchange.

Question 2

What are functions of money?

Answer 2

Medium of Exchange – Facilitates transactions by eliminating the need for barter.
Unit of Account – Provides a standard measure for pricing goods and services.
Store of Value – Maintains its value over time, allowing for future use.
Standard of Deferred Payment – Enables borrowing and lending by serving as a reliable means of settling future debts.

Question 3

What is money supply, narrow money and broad money?

What is difference between narrow money and broad money?

Answer 3

Money supply - the total amount of money circulating in an economy at a given time, including cash, bank deposits, and other liquid assets.
Narrow money - most liquid forms of money that can be used for immediate transaction.
Broad money - includes narrow money plus less liquid assets that can be converted into cash over time.

Narrow money is more liquid and can be used for immediate spending, whereas broad money includes assets that require time to convert into cash.
Broad money better reflects total purchasing power and influences long-term inflation trends, while narrow money is crucial for short-term transactions.

Question 4

What is money market, capital market and foreign exchange market?

Answer 4

Money Market – A financial market for short-term borrowing and lending (usually less than a year). It deals with highly liquid and low-risk instruments like Treasury bills, commercial paper, and certificates of deposit.

Capital Market – A financial market for long-term securities (more than a year), including stocks and bonds. It provides funding for businesses and governments through the issuance of shares and debt instruments.

Foreign Exchange Market (Forex Market) – A global market where currencies are traded. It facilitates international trade, investments, and currency risk management through exchange rate determination.

Question 5

What is difference between money market, capital market and foreign exchange market?

Answer 5

Time frame:
Short-term (<1 year).
Long-term (>1 year).
No fixed maturity, deals in currency exchange.
Instruments:
Treasury bills, commercial paper, certificates of deposit.
Stocks, bonds, debentures.
Currencies, derivatives (e.g., forex futures, options)
Purpose:
Provides liquidity and short-term funding.
Facilitates capital formation and investment.
Enables currency exchange for trade and investment.
Risk level:
Risk Level Low.
Moderate to high.
Moderate to high (depends on currency volatility)
Who is in the market:
Banks, corporations, governments.
Companies, investors, financial institutions.
Traders, investors, central banks, multinational.

Question 6

Role of financial markets in the wider economy

Why financial markets is important?

Answer 6

Facilitating Capital Allocation – direct funds from savers (individuals, institutions) to borrowers (businesses, governments), allowing for investments in infrastructure, innovation, and expansion, which drives economic growth.
Risk Management – offer various financial instruments like derivatives and insurance products to help businesses and individuals manage and hedge against risks, such as currency fluctuations, interest rate changes, and commodity price volatility.
Liquidity – financial markets provide liquidity by selling and buying assets, ensuring that businesses and individuals can easily convert assets into cash or other assets when needed.
Economic Efficiency – financial markets contribute to the optimal distribution of resources across the economy by allocating capital efficiently, which fostering innovation and improving productivity.

Question 7

What is debt and equity in financial market?

What is difference between debt and equity?

Answer 7

Debt refers to borrowed funds that a company must repay over time, typically with interest. It can be in the form of loans, bonds, or other financial instruments.

Equity represents ownership in a company. It is raised by issuing shares of stock, and investors who buy these shares become partial owners of the company.

Question 8

What is the difference between debt and equity?

Answer 8

1. Debt do not lead to divorce of ownership, while equity may does.
2. Debt must be repaid with interest, whereas equity does not require repayment.
3. Debt is generally less risky for investors (fixed returns), while equity is riskier (variable returns).
4. Debt holders are paid before equity holders if a company goes bankrupt.
5. Debt provides fixed interest payments, while equity offers potential capital gains and dividends.

Question 9

What is coupon and maturity in relation to government bonds and how to calculate the yield on government bonds?

Answer 9

The coupon - fixe annual interest payment to bondholder based on the bond’s face value

Maturity - the date when the bond’s face value is repaid.

Yield = annual coupon repayment/ current market price x 100%

Question 10

How does firms raise finance?

Answer 10

Issuing shares
Issuing corporate bonds
Borrowing from a bank

Question 11

What are advantages and disadvantages of issuing shares (equity financing)?

A firm raises capital by selling ownership stakes in the form of shares (stock) to investors. This can be done through an Initial Public Offering (IPO) if the company is going public or through secondary offerings if it is already publicly traded.

Answer 11

No debt burden or interest repayment
Attracts long term investors who share in the company’s growth

Divorce of ownership and control
Dividends are not tax deductible (减税) unlike interest on debt

Question 12

What are advantages and disadvantages of issuing corporate bonds (debt financing)?

A firm raises capital by issuing corporate bonds, which are debt securities. Investors who buy these bonds become creditors and are promised regular interest payments (coupons) and the return of the principal amount at maturity.

Answer 12

Retains ownership and control of the company.
Interest payments are tax-deductible, reducing the cost of debt.

Obligation (义务/责任) to repay principal and interest, even in difficult financial times.
High levels of debt can increase financial risk and affect credit ratings.

Question 13

What are advantages and disadvantages of borrowing from a bank (debt financing)?

A firm raises capital by taking out a loan from a bank or financial institution. The loan agreement specifies the interest rate, repayment schedule, and collateral (if required).

Answer 13

Retains ownership and control of the company.
Interest payments are tax-deductible.
Some flexibility - Loan terms can be negotiated based on the firm’s needs.

Obligation to repay principal and interest, regardless of financial performance.
Collateral requirements (banks may require assets as security for the loan) may limit the firm’s ability to use assets for other purposes.
High levels of debt can increase financial risk.

Question 14

Explain the inverse relationship between market interest rates and bond prices.

Answer 14

The inverse relationship between market interest rates and bond prices occurs because bonds pay fixed interest (coupon) payments. When market interest rates rise, newly issued bonds offer higher yields, making existing bonds less attractive. The prices of existing bonds fall to match the higher yields of new bonds. Conversely, when market interest rates fall, existing bonds with higher fixed coupon payments become more valuable, causing their prices to rise. This relationship is driven by the present value of future cash flows: as interest rates increase, the present value of a bond’s future payments decreases, lowering its price, while a decrease in interest rates raises the present value and increases the bond price.

Question 15

What is difference between a commercial bank and investment bank?

Answer 15

A commercial bank primarily deals with individuals and businesses by providing services such as savings and checking accounts, loans, mortgages, and credit facilities. Their main goal is to facilitate everyday financial transactions and economic activities.

An investment bank focuses on large financial transactions such as mergers and acquisitions, issuing securities (stocks and bonds), and advising corporations on financial strategies. They do not typically deal with the general public but rather with corporations, governments, and institutional investors.

Question 16

How does many banks are engaged in both commercial and investment banking activities can increase systemic risk?

Answer 16

Investment banking involves speculative trading, underwriting securities, and complex financial instruments. If a bank uses customer deposits (from commercial banking) to fund these activities, a crisis in investment banking can lead to significant losses, increasing the risk of bank runs.

Large banks that operate in both areas may take excessive risks, assuming they will be bailed out by the government if they fail. This can encourage reckless behavior, as seen in the 2008 financial crisis when institutions like Citigroup and Bank of America required government intervention.

If a major universal bank collapses due to bad investments, the financial shock can spread to other banks, given their exposure to the same markets and clients, creating a domino effect across the economy.

Question 17

What other institutions operate in financial markets?

Answer 17

Insurance Companies – Provide risk management through policies (e.g., life, health, property insurance) and invest premiums in financial markets to generate returns.
Private Equity Firms – Invest in or acquire companies, restructure them, and aim to sell them for a profit, typically focusing on long-term growth strategies.
Hedge Funds – Invest pooled capital from wealthy individuals and institutions in high-risk, high-reward strategies such as derivatives, short-selling, and leverage.
Mutual Funds – Pool money from many investors to invest in diversified portfolios of stocks, bonds, or other assets, offering lower risk compared to direct investments.
Pension Funds – Manage retirement savings by investing in long-term assets like government bonds, corporate stocks, and real estate.

Question 18

What assets are there in a commercial bank’s balance sheet?

Answer 18

The bank uses its funds, primarily through loans and investments.

Cash and Reserves – Cash on hand and deposits with the central bank to meet reserve requirements.
Loans and Advances – The largest asset category, including personal, corporate, and mortgage loans.
Investments – Holdings in government securities, corporate bonds, and other financial instruments.
Interbank Lending – Loans made to other banks in the short-term money market.
Fixed Assets – Physical assets like bank buildings, ATMs, and equipment.
Other Assets – Accrued interest, derivatives, and non-banking financial assets.

Question 19

What liabilities and equity (capital) are there in a commercial bank’s balance sheet?

Answer 19

the bank finances its assets, mainly through deposits and borrowing.

Customer Deposits – The main liability, including demand (current) deposits, savings accounts, and fixed deposits.
Interbank Borrowing – Short-term borrowing from other banks.
Debt Issuances – Bonds issued by the bank to raise capital.
Central Bank Borrowings – Loans from the central bank during liquidity shortages.
Other Liabilities – Taxes payable, operational costs, and unsettled transactions.
Share Capital – Funds raised from issuing shares.
Retained Earnings – Profits reinvested in the bank.
Reserves and Surplus – Includes statutory reserves and provisions for future risks.

Question 20

What are 3 main objectives of a commercial bank?

Answer 20

Liquidity – Ensuring the bank has enough cash or liquid assets to meet withdrawal demands and short-term obligations. This is crucial for maintaining customer confidence and avoiding bank runs.
Profitability – Maximizing returns for shareholders by earning interest on loans, charging fees, and investing in financial markets. Higher profits allow for expansion, dividends, and financial stability.
Security (Risk Management) – Maintaining financial stability by minimizing credit risk (loan defaults), market risk (investment losses), and operational risks (fraud, cyber threats). Security ensures long-term sustainability.
Customer Satisfaction – Providing reliable services like loans, deposits, and digital banking to attract and retain customers.
Regulatory Compliance – Following banking regulations, capital requirements, and risk management guidelines set by central banks and financial authorities.

Question 21

What potential conflicts between these objectives?

Answer 21

Liquidity vs. Profitability – Keeping too much cash or liquid assets (to ensure liquidity) reduces the bank’s ability to lend and invest profitably. Conversely, lending too much can increase profits but may lead to liquidity shortages.
Profitability vs. Security – Higher profits often come from riskier investments and loans. However, excessive risk-taking can lead to financial instability (as seen in the 2008 financial crisis).
Liquidity vs. Customer Satisfaction – To maintain liquidity, banks may impose withdrawal limits or charge high fees, which can frustrate customers.
Regulatory Compliance vs. Profitability – Strict capital requirements and regulations (such as Basel III) force banks to hold more reserves, limiting their ability to maximize returns.

Question 22

How banks create credit?

Answer 22

Safe banks - keep cash in the bank until depositor comes for it.

Risky banks - lend out more than has been deposited and hope depositors do not all come and withdraw at the same time.

Total credit = initial deposit/ reserve ratio

Question 23

What are the main functions of a central bank?

Answer 23

Monetary Policy Implementation – Controls inflation, money supply, and interest rates to maintain economic stability.
Issuing Currency – Has the sole authority to print and regulate the national currency.
Lender of Last Resort – Provides emergency funding to banks facing liquidity crises to prevent financial system collapse.
Regulating and Supervising Banks – Ensures financial institutions operate safely and comply with regulations to maintain stability.
Managing Foreign Exchange and Reserves – Stabilizes the currency by intervening in foreign exchange markets and maintaining foreign reserves.
Maintaining Price Stability – Aims to keep inflation at a target level, ensuring purchasing power remains stable.

Question 24

What are current objectives of monetary policy set by government and central banks?

Answer 24

Controlling Inflation – Keeping inflation at a target rate (e.g., 2% in the UK) to ensure price stability.

Supporting Economic Growth – Using interest rate adjustments to balance growth without overheating the economy.

Ensuring Full Employment – Promoting job creation by adjusting monetary conditions.

Stabilizing Financial Markets – Preventing financial crises by managing liquidity and regulating banks.

Managing Exchange Rates – Ensuring currency stability to promote trade and investment.

Question 25

What is the role of the MPC and how it uses bank rate to try to achieve the objectives for monetary policy, including government target rate of inflation

Answer 25

The Monetary Policy Committee (MPC) is responsible for setting interest rates to achieve the UK government's target inflation rate, which is 2% (CPI inflation). It operates independently but aligns with government economic objectives. The MPC meets regularly to assess economic conditions and adjust monetary policy accordingly. If inflation is above 2%, the MPC raises the Bank Rate, making borrowing more expensive and saving more attractive. This reduces consumer spending and business investment, slowing down inflation. If inflation is below 2%, the MPC lowers the Bank Rate, making borrowing cheaper and saving less attractive. This encourages spending and investment, boosting inflation.

Question 26

What factors considered by the MPC when setting the bank rate? (Main objectives)

Answer 26

Inflation Above 2% → Raise rates to reduce spending Below 2% → Lower rates to boost spending Economic growth/ economic cycle - High growth (risk of overheating) → Raise rates to prevent inflation Slow growth or recession → Lower rates to stimulate demand Unemployment and Wage Growth – High employment and rising wages can increase inflation, requiring higher interest rates. Low employment may require lower rates to encourage job creation. Global Economic Conditions – External factors like oil prices, global recessions, or supply chain issues can influence UK inflation and growth, affecting MPC decisions.

Question 27

What factors considered by the MPC when setting the bank rate?

Answer 27

Consumer Spending and Business Investment – If households and firms are spending heavily, rates may be raised to prevent excessive demand. If confidence is low, lower rates encourage borrowing and investment. Exchange Rate Movements – A weak pound makes imports more expensive, increasing inflation, while a strong pound can reduce inflation but hurt exports. The MPC considers how interest rate changes affect currency value. Financial Market Stability – The MPC ensures stable financial markets and may adjust rates to prevent asset bubbles, excessive risk-taking, or banking crises. Government Fiscal Policy – If the government increases spending or cuts taxes, demand may rise, leading to inflation. The MPC may raise rates to counteract this. Conversely, austerity measures may lead to lower rates to support the economy.

Question 28

How changes in the exchange rate affect AD and macroeconomic objectives?

Answer 28

Depreciation - AD increases due to cheaper exports and expensive imports = reduce current account deficit = stimulating demand for domestic goods and services = create more jobs in export sectors as demand risen = increase imported inflation Appreciation - AD decreases due to expensive exports and cheaper imports = increase current account deficit = dampen export demand and reduce domestic growth = job losses in export industries as demand falls but can benefit import dependent industries due to cheaper imports = reduce inflation and lower the cost of living

Question 29

Explain how does the monetary policy transmission mechanism work? The monetary policy transmission mechanism describes the process through which changes in monetary policy (especially changes in the interest rate) affect the broader economy, influencing variables such as aggregate demand (AD), inflation, employment, and output.

Answer 29

The monetary policy transmission mechanism is the process through which central bank actions influence economic activity and inflation. When a central bank adjusts interest rates or conducts open market operations, it affects the cost and availability of credit in the economy. For example, lowering interest rates makes borrowing cheaper, encouraging businesses to invest and consumers to spend more. This increased spending and investment can boost aggregate demand, leading to higher output and employment in the short term. Additionally, lower interest rates can reduce the return on savings, prompting households to reallocate funds towards consumption or riskier assets. The increased demand for goods and services can put upward pressure on prices, influencing inflation.

Question 30

What is the relationship between interest rates and exchange rates?

Answer 30

Lower interest rates → Depreciation of the currency → Increased exports and reduced imports → Increased AD. Higher interest rates → Appreciation of the currency → Decreased exports and increased imports → Decreased AD.

Question 31

How the Bank of England can influence the growth of the money supply?

Answer 31

Quantitative Easing (QE): The Bank of England creates new central bank reserves digitally to purchase large quantities of government bonds and other financial assets. This not only increases the money supply but also lowers long-term interest rates, encouraging borrowing and investment. For example, during the financial crisis in 2009 and the COVID-19 pandemic, the Bank of England used QE to inject significant amounts of money into the economy

Question 32

What other policies could be used to influence money supply?

Answer 32

"Funding for Lending" refers to a scheme introduced by the Bank of England in collaboration with the UK government to support lending to households and businesses. The program aims to increase the availability of credit in the economy by providing banks and other financial institutions with low-cost funds. In return, these institutions are expected to extend more loans to borrowers, which can stimulate economic activity, support investment, and boost consumer spending. This initiative is particularly useful during periods of economic downturn or when banks face funding constraints, helping to ensure that credit continues to flow to the real economy.

Question 33

What other policies could be used to influence money supply?

Answer 33

Forward guidance is a monetary policy tool used by central banks to communicate their future policy intentions to the public. By providing clear and transparent information about their expected actions regarding interest rates or other policy measures, central banks aim to influence market expectations and shape economic behavior. For example, a central bank might indicate that it plans to keep interest rates low for an extended period or signal potential future rate hikes. This helps businesses, investors, and consumers make more informed decisions about spending, saving, and investment, thereby reducing uncertainty and smoothing economic fluctuations. Forward guidance is particularly important during periods of low inflation or when interest rates are near zero, as it can help shape long-term expectations and influence economic activity without direct changes to interest rates.

Question 34

What other policies that could be used to influence money supply?

Answer 34

Open Market Operations (OMOs): The Bank of England can conduct open market operations to directly impact the money supply. By purchasing government securities (such as bonds) from commercial banks and other financial institutions, it injects liquidity into the banking system. This increases the reserves held by banks, allowing them to lend more money, thereby expanding the money supply. Conversely, selling securities reduces liquidity and tightens the money supply.

Question 35

What is the role of the Bank of England, PRA and FPC?

Answer 35

- BoE: Manages monetary policy and overall financial stability. - PRA: Ensures the safety and soundness of individual financial institutions. - FPC: Focuses on systemic risks and the stability of the financial system as a whole. - FCA: promote competition between firms

Question 36

Explain why a bank might fail, including the risks involved in lending long term and borrowing short term.

Answer 36

Credit Risk/ insufficient capital: - Banks lend money to borrowers who may default on their loans, leading to losses. - If too many borrowers default, the bank's assets lose value, potentially causing insolvency. Liquidity Risk/ insufficient liquidity: - Banks borrow short-term (e.g., from depositors or money markets) and lend long-term (e.g., mortgages or business loans). - If depositors or lenders demand their money back suddenly (a "bank run"), the bank may not have enough liquid assets to meet these demands, leading to failure. Liquidity Crunch: - If short-term lenders (e.g., depositors) withdraw their funds en masse, the bank may struggle to liquidate long-term assets quickly to meet these demands. - Long-term loans are illiquid and cannot be easily converted to cash without significant losses. Interest Rate Sensitivity: - If short-term borrowing costs rise (e.g., due to central bank rate hikes), the bank's profitability can be severely impacted, especially if long-term loans are locked in at lower rates.

Question 37

How liquidity ratio affects the stability of a financial institution? During the 2008 financial crisis, many banks faced liquidity shortages because they held insufficient liquid assets. This led to fire sales of assets and a loss of confidence in the financial system.

Answer 37

Prevents Bank Runs: A high liquidity ratio ensures that a bank can meet depositor withdrawals even during periods of stress, preventing panic and bank runs. Reduces Reliance on Short-Term Funding: By holding sufficient liquid assets, banks are less dependent on volatile short-term borrowing, which can dry up during crises. Enhances Confidence: A strong liquidity position reassures depositors, investors, and regulators that the bank is solvent and stable. Mitigates Fire Sales: With adequate liquidity, banks are less likely to sell assets at distressed prices to meet obligations, which can exacerbate financial instability.

Question 38

How capital ratio affects the stability of a financial institution? After the 2008 crisis, regulators increased capital requirements under Basel III to ensure banks hold more capital. This has made banks more resilient to economic shocks.

Answer 38

Absorbs Losses: A higher capital ratio means the bank can absorb losses from loan defaults, market downturns, or other financial shocks without becoming insolvent. Reduces Risk of Failure: Well-capitalized banks are less likely to fail during economic downturns, as they have a larger buffer to withstand losses. Promotes Lending Discipline: Higher capital requirements encourage banks to lend more prudently, as they bear more of the risk. Enhances Market Confidence: A strong capital position reassures investors and depositors that the bank is financially sound, reducing the risk of panic.

Question 39

What is the relationship between liquidity ratio and capital ratio?

Answer 39

- Complementary Role: Liquidity ratios ensure short-term stability, while capital ratios ensure long-term solvency. Both are essential for a bank's overall health. - Crisis Prevention: During a financial crisis, a bank with strong liquidity but weak capital may still fail if losses erode its capital base. Conversely, a bank with strong capital but poor liquidity may face a liquidity crunch. - Regulatory Focus: Regulators monitor both ratios to ensure banks can withstand both short-term liquidity shocks and long-term financial stress.

Question 40

What is moral hazard?

Answer 40

Moral hazard - refers to a situation where one party engages in risky or undesirable behavior because they do not bear the full consequences of their actions. Essentially, it occurs when a person or entity takes more risks because they know that someone else will bear the costs if things go wrong. For example, During the 2008 financial crisis, many large financial institutions like Lehman brother and Morgan Stanley engaged in high-risk lending and investment practices because they believed they were "too big to fail." These institutions assumed that the government would bail them out if things went wrong, which led to reckless behavior and ultimately contributed to the global financial meltdown

Question 41

What is systemic risk?

Answer 41

Systemic risk refers to the risk of a breakdown in the entire financial system rather than the failure of individual institutions. It arises from the interconnectedness of financial institutions and markets, where the failure of one entity can trigger a cascading failure across the entire system, leading to severe economic downturns

Question 42

What impact that systemic risk could have on the real economy? For example, 2008 Financial Crisis: The collapse of Lehman Brothers and the subsequent global financial crisis led to a severe credit crunch, causing widespread economic downturns. Many businesses faced liquidity issues, and consumer spending plummeted, leading to a global recession. COVID-19 Pandemic: The pandemic disrupted global supply chains and led to significant financial market volatility. Governments and central banks had to intervene to stabilize financial markets and support the real economy through stimulus packages and monetary policies

Answer 42

1. Credit Crunch: When financial institutions face difficulties, they may reduce lending to businesses and households. This credit contraction can lead to reduced investment, lower consumer spending, and ultimately, slower economic growth. 2. Weakened Business Investment: Financial instability can increase uncertainty and borrowing costs for businesses. This may lead to delayed or canceled investment projects, affecting productivity and economic expansion. 3. Household Wealth Effects: Financial market turmoil often leads to declines in asset prices, such as stocks and real estate. This reduces household wealth, leading to lower consumer spending and potentially higher unemployment. 4. Contagion Effects: Financial crises can spread from one sector to another, amplifying the impact on the real economy. For example, the 2008 financial crisis originated in the U.S. housing market but quickly spread to global financial markets, affecting economies worldwide. 5. Policy Uncertainty: Economic policy uncertainty can exacerbate systemic risk in the real economy by increasing financing constraints and the scale of external guarantees. This can lead to a decline in firm performance and investment.

Question 43

Evaluate the view that strict rules and regulations on financial markets are essential to help create a more stable economy.

Answer 43

P1 - define financial markets and stable economy - The financial market is crucial for a stable economy as it facilitates efficient capital allocation, enabling businesses to invest, households to save, and governments to fund projects, all of which support economic growth and stability - strict regulations on financial markets are often considered essential for economic stability. However, their effectiveness depends on the design of regulations, the global financial integration and economic cycle. P2 - arguments in favor of strict rules and regulations: - Stricter capital requirements (Basel III) help prevent financial crises However, excessive capital requirements may discourage banks from lending, slowing investment and economic growth. - Regulations such as transparency requirements and stress tests help to reduce asymmetric information and moral hazard reduce market failures However, firms may shift activities to less regulated sectors or offshore locations, reducing the effectiveness of domestic regulations. This was seen with the rise of shadow banking. - restrictions on high-frequency trading and speculative derivatives prevent excessive volatility and ensuring long term sustainable growth P3 - Arguments Against Strict Rules and Regulations: - Regulations such as Too Big to Fail policies and capital buffers, If financial institutions believe they will be bailed out due to strict regulatory oversight, they may engage in riskier behavior, relying on government support (e.g., the "Too Big to Fail" issue). However, it may reduce the likelihood of cascading failures and limiting systemic risk. - Regulations such as deposit insurance, consumer protection laws, and financial product disclosures. Stricter regulations impose administrative burdens on firms, particularly small and medium-sized financial institutions, leading to reduced competition and higher costs for consumers. However, these may enhance consumer confidence and stability.

Question 44

Evaluate the view that strict rules and regulations on financial markets are essential to help create a more stable economy. Conclusion part

Answer 44

While strict regulations can reduce financial instability and prevent crises, they must be well-designed to avoid excessive constraints on financial markets. A balanced approach that includes prudential regulation (capital and liquidity requirements), transparency measures, and macroprudential policies can ensure financial stability while maintaining market efficiency. Instead of overly strict rules, a dynamic regulatory framework that adapts to financial innovation and global market changes is more effective in fostering long-term economic stability.