Question

Explain why, in seeking to avoid financial crisis, the government's role as regulator of the financial system does not imply it should protect individual institutions from failure.

Answer 1

Answer: Market Efficiency

Explanation:

It is important that the Government as a regulator should not get involved in acts that would protect individual institutions from failure because that would defeat the whole purpose of a competitive industry.

If a government is known to directly involve itself in the protection of institutions from failure, efficiency in institutions may become low because of the lack of fear of failure as companies believe that should they run into bad times, they will simply be bailed out by the government so there is no need for them to maintain a competitive edge.

This can lead to a situation where we have companies performing sub optimally in an economy which can only act to reduce the Economic growth of a country.

Government institutions usually have such backing and in a lot of countries are prone to failure. Look at the Bamangwato Concessions Limited (BCL) mine in Botswana for instance that kept failing and refusing to improve it's efficiency because they could always run back to the government for a bailout. Their position eventually became so untenable that bankruptcy was the only option.