Financial Markets –Instabilities – Stock Exchanges and SEBI
Instabilities in Financial Markets
The traditional conception of instability in financial markets stems from the view that financial institutions act as agents which intermediate between savers willing to lend funds and final borrowers seeking to invest funds. This intermediation function not only requires a matching of borrowers and lenders, but also more importantly concerns the transformation of the maturity of financial assets from short term to long term, with the implicit assumption that lenders prefer short-term, liquid assets, and borrowers long-term, more or less permanent, fixed interest liabilities. The greater the mismatch between the maturity of the short-term assets issued to savers and the long-term liabilities purchased from investors, the greater the risk that an increase in short-term interest rates relative to long-term rates will produce negative net worth and insolvency, or a flight of funds called disintermediation as the short-term bid rates lag behind the market. When the volatility of short-term interest rates is modest, the adjustment can be made by cutting back on new lending, reducing net margins and drawing down secondary reserves; this was the method of monetary control in the post-war period. When the movement in short-term rates is substantial, loans must be called and forced sales of assets may take place leading to downward pressure on asset prices.
In addition to maturity transformation, financial intermediaries are also characterised as producing liquidity through the issue of short-term liabilities against long-term assets. In this process the bank makes an illiquid asset held in the private sector more liquid, while the bank becomes less liquid. The willingness of bankers to create liquidity by lending against a private sector asset (or against the expected income from a private sector asset) depends on the “liquidity preference” of the bank. The price it charges for this liquidity creation is given by the liquidity premium. As Soros has recognised, the willingness of a bank to finance an investment project has a direct impact on its viability and thus on its returns, and therefore on its price.
Maturity intermediation and liquidity creation are usually linked together. This is the case for banks which lend against real assets by creating demand deposits. However, in the world envisaged by the efficient markets hypothesis with complete specification of transactions for all future events, the two aspects are separated; for long-term capital assets are just as liquid as any other financial assets. In such a world, maturity transformation does not create additional liquidity because it is always possible to trade in any amount for any date and future event.
In Minsky’s approach, financial fragility represents something more than either the mere possibility, or even the persistence, of maturity mismatching in financial institutions. Rather, fragility is inherent in the successful operation of the capitalist economic system, and results from changes in the liquidity preferences of bankers and businessmen as represented by changes in the margins of safety required on liquidity creation, produced by maturity transformation. Thus, fragility could result even in a perfectly stable financial system as defined under the traditional terminology, because of changes in the extent of the creation of liquidity for a given degree of mismatching. In this case, a fall in liquidity preference could take place and the maturity mismatching would remain constant, as bankers become willing to lend against more risky assets.
Fragility in Stable Conditions
Minsky’s theory takes the US financial system as its reference structure; in particular, it is crucially dependent on the negotiations and relationships between bankers and businessmen and their evaluation of future returns and prospects. It presumes a very particular type of banker, the banker of let’s say the 1960s, before the breakdown of the Bretton Woods system, and still subject to the full force of the Glass-Steagall restrictions on commercial banking. For the businessman, finance is thus a two-stage affair. Short-term project finance comes from the bank, and long-term takeout finance comes from floating the completed project in the capital market or from the profits earned from the operation of the project. This is where the rest of the financial system comes in In the former case, investment bankers underwrite the floatation of the project by a primary distribution of securities in the capital market. Although there is no legal restriction preventing investment banks from becoming direct investors, they usually act only as brokers between firms and final investors. There is thus an implicit financial structure in which firms’ short-term financial liabilities are held in bank portfolios and firms’ long-term liabilities are held in household portfolios, along with banks’ short-term demand deposit liabilities.
SEBI ( security exchange board of india )
The Securities and Exchange Board of India was established as a non-statutory regulatory body in the year 1988, but it was not given statutory powers until January 30, 1992, when the Securities and Exchange Board of India Act was passed by the Parliament of India. Its headquarters is at the business district at the Bandra Kurla Complex in Mumbai, but it also possesses Northern, Eastern, Southern and Western regional branch offices in the cities of New Delhi, Kolkata, Chennai and Ahmedabad, respectively. It also has small local branch offices in Bangalore, Jaipur, Guwahati, Bubaneshwar, Patna, Kochi, and Chandigarh.
The Securities and Exchange Board of India (SEBI) supplanted the Controller of Capital Issues, which hitherto had regulated the securities market in India, as per the Capital Issues (Control) Act of 1947, one of the first acts passed by the Parliament of India following its independence from the British Empire. It is run by its own members, which consist of the Chairman, who is elected by the Parliament of India, two officers from the Union Finance Ministry, one member from the Reserve Bank of India and five members who are elected by the Parliament with the Chairman.
The Securities and Exchange Board of India’s stated objective is “to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto.” According to its charter, it is expected to be responsible to three main groups: the issuers of securities, investors, and market intermediaries. The body has somewhat nebulous powers, as it drafts regulations and statutes in its legislative capacity, passes rulings and orders in its judicial capacity, and conducts investigation and enforcement actions in its executive capacity.
Many criticize the regulatory body because it is insulated from direct accountability to the public. The only mechanisms to check its power are a Securities Appellate Tribunal, which consists of a panel of three judges, and a direct appeal to the Supreme Court of India. Fortunately for the people of India, the SEBI has been mostly benevolent in its use of its authority, issuing strong systematic reforms rapidly and aggressively with its unchecked power. For example, after the Great Recession of 2008 and the Satyam Fiasco, the SEBI was able to quickly take regulatory steps to mitigate the effects of these problems, stabilize the economy and take drastic steps to make sure such situations never occurred again.
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