When to bail out

Even the proponents of free economy accept some bound of regulatory intervention on organizations that become properly powerful. The regulatory administration have a right to intervene, if the market forces be giving inequitable advantages such as monopoly or pollution. Commercial brims net become mighty powerful and at the same be very fragile. Even well-off smashing markets have not undermined the importance of mercenary relying.Commercial banks are a widely used tool to stimulate the economy finished loans that stimulate consumption and investment. Therefore, in essence the health of the banking sector is promptly related to the health of an economy. Liquidity risk is inherent to commercial banking because the depositors corporation come and claim their deposits at anytime. A mismatch of time to adulthood of advances and deposits notify create severe problems. For instance, a wave of panic-stricken withdrawals rout out essentially bankrupt a bank in no time.This can trigger systematic risk and leave the entire economy shaken. The banks charter to reminder their asset liability management statistics because any mismanagement can lead to bank runs or cash shortages. For these problems, central banks require of commercial banks to insure their deposits and provide them with liquidity support. By providing liquidity support central banks regulate the money market and injecting cash in the economy when demanded. These solutions in effect lead to other problems.For example, in insured deposits, depositors stop supervise a banks performance and the banks increase their risk disposition by increasing lending. To address this issue the central bank requires banks to go on a minimum capital adequacy ratio, and regulate insurance tributes to be proportional to the risk of a banks lending. However, recent stats conjure up that capital adequacy is not a safe determinant to monitor banking sector. Commercial banks start to over rely on central banks liquidity support and tend to lend eminent premium loans to institutions with lower credit ratings.Even if such lending results in irritability in the money market such variations are small compared to the banks capital. Central bank needs to be proactive quite than be reactive because the public cost of economic instability and high interest rates is too high. Even the Basel II addresses risk capital framework but does not address provisioning for funding. The emphasis should be on liquidity rather than on solvency alone. Therefore, commercial banks need to be scrutinized with stricter prudential regulations.