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Instability In Banking Sector Essay

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Introduction The banking sector as a whole may experience a costly failure that result from the externalities or systemic risk that affect single or few banks, and then spill over to other banks. These widespread bank failures are damaging to the real economy, and the cost of resolving the damage can be enormous. In this essay, I explore the systemic instability of the banking-sector as a whole. The rest of this essay consists of seven sections. Section 1 discusses some of the approximate causes of bank failure. Section 2 differentiates between commercial banks and non-bank financial institutions. Section 3 investigates the banking instability. Section 4 explains systemic risk within the banking sector. Section 5 focus on micro & macro prudential regulation approaches. Section 6 demonstrates how and why banks deleverage at the expense of the real economy. Section 7 concludes.

1. Approximate causes of bank failure

Commercial banks are more likely to fail than other non-bank financial institution because of their role as fractional reserve …show more content…

An account holder cannot withdraw money from their account at any time they wish since non-bank financial institutions do not hold the deposits balance. The contract between institution and client (account holder) mitigates the risk of contagion and the disruption of the payment system. Contagion refers to the spread of panic on the part of bank account holders in banks (Cecchetti 2011:387). Failure in non-bank financial institutions is unlikely to occur, and in most cases, they successfully control their liquidity problems. In addition, non-bank financial institutions hold marketable and liquid assets that can be traded in the secondary markets. And also, they are able to adjust their balance sheet positions quickly than banks (Llewellyn

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