Doug Noland general view of financial systems
Evolution of financial institutions and instruments
In the past couple of decades, financial institutions all over the world have registered enormous growth and development. Noland argues that these institutions have learnt a lot in customizing their products in order to address the specific needs of their clients whose range of needs are diverse. The financial institutions have overtime learned combining payments from an assets pool into packages that are customized with attributes of risk preferred by specific investors. The financial leverage and intermediation in several parts of the world has in the last few decades shifted from the regulated commercial institutions realm, which was mainly composed of banks, towards a wide array of several other financial institutions. The new financial institutions include mortgage and consumer finance firms, brokerages, investment organizations, insurers, and mutual funds money markets.
Collectively, these new financial intermediaries are commonly referred to as the shadow system of banking. This is due to the fact that they offer services that either substitute or compete with the ones being provided by the commercial banks. Of great importance, the banks liabilities are the deposits, while those of the shadow institutions are not. Moreover, the risk taking and leverage of these shadow banks are usually not as transparent as those of the commercial banks. This has greatly affected the credibility of the financial institutions especially in advancing credit to their customers who in most cases feel that there are other hidden charges apart from the ones formally declared.
Financial innovation thus shifted greatly to the shadow system of banking this shift in turn stimulated the innovation in this sector. In 1970s, broadening market securities, greatly reduced the finance direct costs, such as those involved in issuing of equities and bonds, as compared to the costs involved in traditional loans issued by commercial banks. Plunging costs of information in both 1980s and in the 1990s made it more possible for a growing investors universe access more information concerning the borrowers risks, which ranged from those of companies to the household ones. The new investors range promoted the development of a faint array of several other new instruments, especially in the last decade thus making it possible to spread the risk more efficiently and widely, and also permitted more room for additional risk taking.
As the financial institutions have evolved overtime, so have the financial instruments. These are the virtual or the real documents that represent a legal accord which involves some form of monetary worth. In Nolands view, the treasury bills, insured deposits certificates, certificates of negotiable certificates, bankers acceptances, commercial papers and repurchase agreements were the main financial instruments that were offered by the commercial banks. However, due to constant stream of innovations in the financial sector, its landscape is by far denser and more complicated and has therefore called for several changes to be made to the financial instruments in order to accommodate increasing and divergent needs of the modern financial sector. The financial instruments have been revised thoroughly and also expanded in order to include a more comprehensive coverage of the financial needs. Clear and practical perspectives on the changes and shifts behind the current dizzying market techniques and tools proliferation have compelled the financial institutions to develop new financial instruments. It is out of this background from which such financial instruments as warrants, convertibles and preferred stocks have emerged in the last few decades.
Central and commercial banking
Central banking according to Noland is the form of banking in an economy from which the commercial banks and other financial institutions are regulated. Just like in ordinary commercial banking, the central banks do charge interest on the loans they advance to the borrowers basically the commercial banks and governments. However, in central banking, the central bank can only advance loans as a last resort. Unlike in commercial banking, central banking is basically characterized by monopoly. It is under central banking where the currency of a country is created and regulated in order to control the rate of inflation in the economy. Central banking exercise supervisory powers over the commercial banks in order to regulate their activities. The rates at which the commercial banks charge for loans they advance to their customers are also regulated under a central form of banking.
Noland views commercial banking as the intermediary between the savings of the households and the investments of the investors. In this respect, the commercial banks collect the household savings and later advance them to the investors in form of loans. They therefore act as intermediaries linking these two important groups in an economy. He also views banks as vehicles of economic growth and development since their activities can either stimulate or slow down the level of economic activities in an economy. When they charge less rates of interest, credit becomes more affordable to the investors who in turn borrow more money and thus increase the level of economic activity and the opposite happens when they charge higher rates of interest.
Role played by the financial institutions in the creation of the global credit crisis
Noland argues that the current financial crisis was triggered by unsustainable loaning behaviours of the commercial banks and the shadow system of banking. Their lending patterns led to reduced confidence in virtually all the markets whose securities were mortgage backed. The housing bubble that burst resulting into the financial crisis was supported by the financial institutions, because they lent money to the house owners with the hope that they could repay the loans at high rates of interest. However, the borrowers were unable to repay these loans since prices of their houses decreased substantially leading to high default rates in the payment of loans.
During the period preceding the bursting of the housing bubble, Noland argues that there were easy conditions for advancing credit to the house owners, which made them to over borrow. There was also sub prime lending, this is basically the quality of a particular class of borrowers who have been responsible for weakening credit histories thus increasing the risk of defaulting loan payments. Noland further argues that the predatory lending that was practiced prior to the bursting of the housing bubble made the crisis even more inevitable.
Main problems facing the financial systems and their solutions
Loaning is a major role that is played by the financial system in any given economy. The financial system therefore face an enormous problem of ensuring that all the loans lent to the clients are paid on time and that the rate of loan defaults is reduced as much as possible. In order to reduce the risk associated with loan defaults, the financial institutions should avoid advancing money to clients who are not credit worth. Again, before advancing any money in form of loans, the financial systems should first obtain security so that in case of a default, there will be an asset to attach and thus recover the money and the interest. Noland also views the regulation in the financial system as another source of a major problem facing the financial system. As far as regulation is important, it should be done in a flexible manner so as to allow the financial institutions take advantage of various opportunities.