The responsibility of regulating exchange rates is intriguing. Since the incidence of risk has increased, it is necessary to take necessary steps to mitigate any risks.
While implementing regulatory strategies, working with existing agencies is desirable since such bodies have a better understanding of operations within the sector. Particularly, they would prove useful in pointing out where difficulties are likely to be encountered.
Referring to the recent financial meltdown, regulating the financial markets is crucial. The derivative market was allowed to operate without proper regulation. Despite the presence of warning signs, the authorities ignored the looming danger. This realization points out that the mechanisms to foresee an emerging crisis were in place. The question that emerges is based on the integrity of the people in authority. They simply refused to act since it is alleged that they were serving the interests of the corporate world. If Islamic tenets of financing were in operation, preference could have been given to social good rather than individual gain. In this regard, the welfare of the people at large should have taken centre stage instead of those of the corporate world. Simply put, Islamic finance could have pushed the authorities to act towards protecting the interests of the common people and protect the derivative market in the process. Thus, as a regulator, adopting certain elements of Islamic banking would be an option. Such would ensure interests of all stakeholders are accounted for.
The question of leverage is often cited as an issue of concern that precedes financial markets collapse. In this regard, the role of controlling institutions is questioned. This leads to the question why the regulatory organizations allow leverage to rise to untenable levels. In addition, high levels of leveraging require high interest rates. Based on this error, it is possible to prevent the leverage market from sinking using tenets of Islamic financing. This is because Islamic financing has put risk management mechanisms in place that could helps in overcoming this concern. Moreover, the pursuit of high interest is not encouraged in Islamic financing. In this regard, regulatory bodies would encourage banking institutions to pursue other goals apart from focusing on interest. The ramification of such a move would be strong resistance from banks since they are in business solely to pursue profits.
Question 2
Pegging a country’s currency to another’s, presents challenges. For instance, the act of the Chinese pegging the Yuan to the US dollar has serious ramifications on the US economy. The pegging went on between 1996 and 2005. However, China responded to threats by the Congress to impose thirty percent tariffs on Chinese exports to the United States. Thus, China allowed a floating exchange rate that would be subject to a limit of 0.3. However, China reneged on its promise and pegged its exchange rate to the dollar. As the Congress, taking action is desirable. However, the various actions would hold different ramifications.
A floating exchange rate is mandatory to encourage efficiency. Pegging of the rates the way the Chinese government does is harmful to competing economies since such amounts to outright manipulation. Thus, the Chinese would gain against the US unfairly. The Congress needs to reconsider the early decision. In this regard, re-introducing the tariff imposition on the Chinese exports would be considered. Imposing such a tariff would mitigate the adverse effects that the act of the Chinese government engages in regarding the controlling of the currency. Specifically, the Chinese exports would become expensive. Thus, the US consumers would be discouraged from consuming Chinese products. This would be a significant decision since, the pegging of the exchange rate by the Chinese authorities is meant to make China goods cheaper than the US’s. Thus, the effect of altering the Yuan would be reduced significantly.
It emerges that the exchange rate regime that countries adopt influence the actual prices of commodities. The floating exchange rate is instrumental in encouraging fair trade while the pegged exchange rate is reflective of unfairness. The view is held since a floating exchange rate reflects the true picture of the market forces while the pegged rate amounts to rigging of the rates with a view to manipulating prices.
Question 3
Having a new market is critical in business. A trillion dollar market that is growing between fifteen and twenty percent is highly attractive. It requires a bank that operates under the tenets of Islamic securitization to progress in such a market. By guaranteeing security and promising reasonable returns, a bank would thrive in such a market.
In the recent times, financial institutions have diversified ventures into risky activities. This scenario is more visible in the banking sector. Due to increased competition and other reasons, banks have taken completely different trends in comparison to the conventionally accepted ones. Islamic financing has certain unique attributes that raise hope that it is possible that the financial services sector is in a position to operate while observing safety requirements. Islamic financing is based on the Islamic religion. As such, it does not engage in risky ventures as compared to western-based financing. Despite this popular perception, in the recent times, Islamic financial institutions have ventured into risk ventures such as investing in asset-based portfolios. This establishment indicates that Islamic financing is not risk-free. However, the Islamic financing model has mechanisms that are employed in risk management. Sharia compliant investments are few, and thus, risk management based on the Islamic law is limited. Islamic financial risk management also extends to credit borrowing.
Risk is an element that affects all business organizations. As such, businesses are required to set up mechanisms that are useful in mitigating both anticipated and unanticipated risks. This point underscores the role of risk management within financial organizations. It is worth noting from the onset that financial institutions face high-level risks unlike other business entities. This holds since financial institutions extend credit and loan facilities either to its members or to private and state organizations. As indicated above, Islamic financing operates within a risky environment. The increasingly competitive nature of the market forces the financial institutions to venture into risky activities. However, the increased competition has not led to the disbandment of risk management measures. Although Islamic financial institutions have ventured outside their normal investment areas, the Sharia law still prohibits the institutions from covering certain investment aspects. As an illustration, the Islamic financing institutions based on the Islamic law requirement do not cover such investments as Saving and Loan association (S) and small and medium enterprises. The reason for restraining investments in the said ambits is based on the notion that they are interest-oriented. Despite this feature, the venturing into the asset investments has demanded the development of stringent measures to guard against risk. On the contrary, western banks do not base their activities on religion.
The main difference of Islamic and western banking lies on interest earned and charged. By extending loans and charging interest on profit only, Islamic banking could allow loan beneficiaries to be complacent. Thus, adopting the western values of pegging loans on the prevailing interest rates would be of help.
Question 4
Since the collapse of the derivative markets was the trigger of the financial crisis, it is noticeable that the markets were highly instrumental towards the recessionary tendencies that gripped the world. In a nutshell, unregulated swaps affect the financial markets negatively.
Moreover, the question of leverage is critical in explaining the financial crisis. In 2004, the leveraging positions were so high. Surprisingly, the S.E.C permitted various firms to increase their leveraging positions up to levels hitherto unmatched. The leveraging levels were allowed to rise up to 33 to 1. Considering this, it is observable that a very small decline in stocks such as by three percent would lead to wiping out a company or business. It is also clear that if the authorities were more stringent and keep the leverage levels at 12 to 1, then firms could have remained relatively stable as opposed to being so risky.
The wild derivatives herald the financial crisis. It is alleged that Brooksley Born, who was the chairperson of the U.S. Commodity Futures Trading Commission (CFTC), foresaw the possibility of the credit problems. Born was concerned that the nature of deregulation in the derivatives market was worrisome and believed that any keen financial observer was in a position to spot the danger. Having spotted the danger, Brooksley Born proposed an increased regulation of the derivatives market. However, the Securities and Exchange Commission (S.E.C), the Treasury Department, and the Federal Reserve rejected the proposal outright. The plausibility of the regulation aspect is contentious since it is not evidently explicit that such an act could help in preventing the financial crisis. However, it is hypothesised that regulation may have helped in slowing down the emergence of the derivative problem.
