Page 509 - Introduction to Business

CHAPTER 14 Understanding the Financial System, Money, and Banking 483

Tokyo businessmen walking past the Bank of Japan, which implemented record-low interest rates
to fight chronic economic problems over the past 15 years.

By contrast, market-oriented systems, as in the United States and Great Britain, market-oriented systems Financial
have larger securities markets that offer firms an alternative source of debt financ- systems that have large securities
markets
ing to compete with bank credit. With alternative sources of credit available to
them, firms can borrow at more competitive, lower loan rates. One drawback of
securities-based systems is that it is more difficult for banks to get private informa-
tion about firms. Due to the lack of this valuable information, it is possible that
lending decisions are less well informed than they would be otherwise. Bankers
may well be expected to reduce lending due to greater information uncertainty. In
general, countries’ financial systems lie on a continuum between all-banks and all-
securities markets. The best system for a particular country is likely to be a balance
of these two types of systems.
Financial systems are shaped by government regulation. Because they can
influence the economy and government seeks to foster a strong economy, financial
institutions and markets are heavily regulated around the world. Regulation seeks
both to protect the safety and soundness of the financial system and foster a com-
petitive environment that delivers the financial services that meet the needs of the
public. Unfortunately, the goals of safety and soundness and competition in the
financial system tend to conflict with one another. As more regulatory restrictions
are placed on financial institutions and markets to increase safety and soundness,
the financial system’s ability to operate normally and reach free market solutions to
problems is reduced. Competition results in an increased quantity and quality of
financial services for the public, in addition to new services that result from finan-
cial innovation. However, competition can lead to more failures of financial institu-
tions. Regulators must trade off the goals of safety and soundness and increased
competitiveness in establishing regulatory policies.
A difficult problem for many institutions is a sudden loss of public confidence,
which can trigger a run on institutional deposits and funds and create a liquidity
crisis. In 1984, the eighth-largest bank in the United States at that time, Continen-
tal Illinois, suffered losses on foreign loans as well as oil and gas loans. Within days

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