2013

Factors Determining Robustness of Financial Markets & their effects on Employability

Submitted by: Amulpreet Sehgal || Ankit Jain || Ashish Shah || Chinmay Econometrics 9/26/2013

KEY FEATURES OF A ROBUST FINANCIAL SYSTEM Financial stability of an economy depends on two fundamental sets of factors. The first comprises the macroeconomic and structural conditions in the real economy bearing on financial decisions and which form the environment within which the financial system operates. The second is the robustness of the financial system itself, comprising the financial markets, institutions, and arrangements through which financial transactions are carried out. Robust financial systems can take a number of specific forms but all have three basic attributes. First, a robust system is flexible in that it continues to function efficiently in allocating finance in accordance with underlying economic fundamentals under a full range of economic circumstances - in particular when those circumstances are changing rapidly. Secondly, the system is resilient in the sense that markets continue to function and payments are carried out reliably and expeditiously in the face of economic disturbances. And thirdly, a robust system is internally stable in the sense that it does not itself generate major financial shocks, or magnify external shocks, that can lead to financial crisis, for example, when banks continue to lend for the purpose of real estate even when prices have gone beyond economically justifiable levels in the expectation that they will be bailed out if a contraction occurs. 1) First Fundamental Sets of factors: A) Macroeconomic Requirements: Policies that contain fluctuations in aggregate economic activity should be fundamental Achieving and maintaining price stability Sound public finances are essential: public deficit and debt levels should be sustainable and moderate. Adequate level of national saving, private and public, to finance domestic investment needs without unsustainable reliance on foreign borrowing. Macroeconomic policy instruments must be adequate and consistent with the exchange rate regime

B) Structural requirements in the real economy: Tax policies that minimise distortions to incentives; tax provisions whose distortionary effects are magnified by inflation should be avoided; tax regimes should be stable and predictable. Efficient, competitive and flexible markets - for products and productive factors such as land, labour and other basic resources - that affect financial incentives.

2) Second Fundamental Sets of factor is Robustness which can be measured by following factors: Legal and juridical framework (encourages business environment and there by leading to expansion in business and generating employment cause investors feel safe to invest and counterparty risk will reduce) Well-defined property rights and contract law Market contracts easily enforceable in practice Ability to pledge and seize collateral Well-developed bankruptcy code

Accounting, disclosure and transparency (Market Discipline/Bringing New Potential Investors/New Business Opportunities) Loan valuation, asset classification and provisioning practices reflecting sound assessment of counterparties Effective/regular auditing mechanisms Information on the creditworthiness of financial institutions made publicly available on a regular, frequent basis Timely publication of relevant aggregate financial data (macroeconomic indicators, reserves, banking sector statistics, etc.) Availability of impartial credit-rating or credit information facilities

Stakeholder oversight and institutional governance (If risk return framework is properly defined then it will help investors to decide whether to invest in a particular project or business) Capital adequacy requirements commensurate with risk Replacement of management for poor performance Enforceable legal liability of managers Pervasive use of effective systems of risk management and internal control

Market structure (open structure more investments leading to generation of employment plus development of Proper Capital Market which will reduce volatility in the economy) Financial sector open to qualified new entrants, including those from abroad Share of foreign participants in total assets Financial sector concentration ratios Liquid interbank money and capital markets (Liquidity in the market will decide the interest rate and more liquidity will lead to decrease in interest rate and thus credit is available at cheaper rate and thus promoting growth of industries and generated employment) Regulations permit full range of financial instruments Sound/effective payment and settlement systems Share of banking system assets held by public sector financial institutions

Supervisory/regulatory authority (Increases confidence of stakeholders on various financial institutions and this will lead to more money circulation in the market and thus ease of funds for the banks to give as credit to credit seekers and cheaper funds are available and generating more business opportunities and leading to employment) Independent from political interference in the daily conduct of supervision and appropriate accountability for achieving clearly defined objectives Power to force disclosure, impose penalties, etc. Adequate resources for staffing, training, compensation Conducts supervision on a consolidated basis Shares information with other supervisors Verification of information on risk management and internal control systems and on asset quality by regular examinations or external audits Adherence to norms established by international consultative bodies (Basle Committee, etc.): In principle In practice Measures to address particular types of risk: Evaluation of risk management systems Connected lending Risk exposure and loan concentration Special attention to foreign currency and interest rate risk management and exposures Heightened scrutiny of asset quality and capital adequacy in the face of sharp asset price movements Strategy for addressing financial insolvency: Procedures for prompt corrective action or the equivalent Appropriate exit policy

Design of the safety net (No fear of loss because of proper insurance policies, pension fund and well governed mutual funds will generate confidence in the investors and leads to employment) Explicit rather than implicit deposit insurance, paid for by banks and targeted especially towards protecting small depositors Appropriate allocation of losses among stakeholders Stringent conditionality for the use of public money

A well developed financial system is a spur to growth, macroeconomic performance, and more rapid growth in employment. So if proper care is taken to ensure that all these factors are properly maintained in the economy then they will surely help to achieve higher employment.