 |
Economic Review
|
In recent years, revolutionary changes in financial markets, combined with incidents such as Barings and Daiwa, have revived concerns about the adequacy of financial regulation. Historically, financial regulatory policy has been driven by the view that to maintain the health of the financial system you must maintain the health of individual institutions. In light of ongoing changes in financial markets, however, extending the traditional approach to financial market regulation may not work. Extending the traditional approach may be too costly and difficult, especially for large, globally active institutions, because of the complexities of many new activities and financial instruments. Given these difficulties, it seems appropriate to ask whether there is an alternative regulatory approach to promoting financial stability and protecting government safety nets without sacrificing efficiency or stifling innovation. In an article based on comments made at the annual World Economic Forum in Davos, Switzerland, Mr. Hoenig provides some thoughts on possible alternatives. First, instead of regulating to make institutions fail-safe, an alternative approach would be to strengthen the stability of the financial system by designing procedures that prevent large interbank exposures in the payments system and interbank deposits. Second, although moral hazard problems can be contained through traditional regulatory approaches, an alternative would be to require those institutions that engage in an expanding array of complex activities to give up direct access to government safety nets in return for reduced regulation and oversight. Back to top Economic Review home One of the risks of making a bank loan or investing in a debt security is credit risk, the risk of borrower default. In response to this risk, new financial instruments called credit derivatives have been developed in the past few years. Credit derivatives can help banks, financial companies, and investors manage the credit risk of their investments by insuring against adverse movements in the credit quality of the borrower. If a borrower defaults, the investor will suffer losses on the investment, but the losses can be offset by gains from the credit derivative. Thus, if used properly, credit derivatives can reduce an investor's overall credit risk. Estimates from industry sources suggest the credit derivatives market has grown from virtually nothing two years ago to about $20 billion of transactions in 1995. This growth has been driven by the ability of credit derivatives to provide valuable new methods for managing credit risk. As with other customized derivative products, however, credit derivatives expose their users to risks and regulatory uncertainty. Controlling these risks is likely to be an important factor in the future development of the credit derivatives market. Neal provides information on the rationale and use of credit derivatives. He describes how to measure credit risk, whom it affects, and the traditional strategies used to manage it. Next, he shows how credit derivatives can help manage credit risk. Finally, he examines the risks and regulatory issues associated with credit derivatives. Back to top Economic Review home
Bank mergers have attracted much attention during the last year due to a surge in mergers among the nation's largest banking companies. The consolidation of the banking industry has been going on much longer, however. Since the early 1980s, the number of banking organizations has fallen by more than a third in both Tenth District states and the nation as a whole. Some of the decline has been due to failures, but most has been due to mergers. In debating the pros and cons of such consolidation, analysts point to three important ways it may alter the structure of the banking industry. First, if consolidation occurs through the absorption of small banks by large banks, it may reduce the role of small banks in the banking system. Second, if consolidation occurs through the merger of banking organizations in different markets, it may increase the geographic scope of bank operations -that is, the extent to which banks operate over wide areas within and across state lines. And third, if consolidation occurs through the merger of banking organizations within the same market, it may increase the concentration of local markets -that is, the tendency for markets to be dominated by a few banks. Analysts agree each of these effects is important to bank owners and customers but disagree as to whether each effect is beneficial or harmful on balance. Keeton examines whether consolidation has had these effects, and if so, to what degree for Tenth District states. He concludes that consolidation has reduced the role of small banks, increased geographic diversity, and increased local market concentration. The magnitude of these effects, though, has differed across states and between urban and rural markets within each state. Back to top Economic Review home
Rural areas are thought to have two salient features, remoteness and small scale, that tend to inhibit economic growth. These features have explained at least partially why economic growth in the nation's rural areas has often trailed that in metropolitan areas. However, the rural economic turnaround in the 1990s, while not uniform, suggests that some rural communities may have found ways of overcoming their remoteness and small scale. Put simply, some rural areas appear to have an advantage over others in terms of economic growth rates. How have rural economies been performing and why have some been able to perform better than others? Accurate answers to these questions are hard to come by. Typically, the performance of the nation's rural counties is compared with the performance of metropolitan counties, and then a summary comparison is drawn. But such an aggregate approach has drawbacks. One conceptual weakness is that rural places usually compete for economic activity with the metropolitan area at the center of their economic sphere, not with all metropolitan areas. In short, the usual macro view of the rural economy may overlook critical micro information and linkages. Henry and Drabenstott use a new micro-region approach to measure and explain rural economic performance. They measure rural economic performance by assessing performance within a framework of multicounty economic regions, each of which has a metropolitan center and a surrounding area. Their analysis reveals that rural counties in a surprising number of micro-regions throughout the nation are adding jobs at a faster rate than their neighboring metropolitan area. The authors further consider the factors that appear to explain why some rural places have been enjoying solid job growth, and they discuss the implications of these micro-level findings for public and private decisionmakers. Back to top Economic Review home
Long-run price stability is generally considered to be a primary goal of monetary policymakers in many countries. One reason policymakers care about inflation is that it can harm economic performance. Numerous studies of the impact of inflation on economic performance have focused on whether increases in inflation reduce economic growth in the long run These studies have found that prolonged high inflation does in fact reduce economic growth, but they were not able to detect a significant long-run relationship between real growth and low or moderate inflation. Because anti-inflationary policies typically have short-run costs, such as higher unemployment and slower economic growth, the results from these studies may lead people to ask whether such policies are appropriate when inflation is low or moderate. Hess and Morris contend that anti-inflationary policies may be appropriate, even if low to moderate long-run inflation does not reduce long-run growth, if inflation harms the economy in other ways. Three potentially harmful consequences of inflation are considered: (1) inflation uncertainty, (2) real growth variability, and (3) relative price volatility. These consequences are costly because they reduce economic efficiency and therefore the level of economic output and consumer welfare. The authors discuss the costs of inflation uncertainty, real growth variability, and relative price volatility, and examine their empirical relationship with inflation. They show that inflation uncertainty, real growth variability, and relative price volatility all tend to rise as long-run inflation rises from low to moderate levels. As a result, they conclude that policymakers may find it justifiable to pursue anti-inflationary policies even when inflation is low. |