International Journal of New Technology and Research (IJNTR) ISSN:2454-4116, Volume-3, Issue-1, January 2017 Pages 66-70 66 www.ijntr.org Abstract— The financial system of a country is of immense use and plays a vital role in shaping the economic development for a nation. It consists of financial intermediaries and financial markets which channels funds from those who have savings to those who have more productive use for them, in a way leading to money creation. The volume and growth of the capital in the economy solely depends on the efficiency and intensity of the operations and activities carried out in the financial markets. One of the most important functions of the financial system is to share risk which is catered mainly by the banking sector. (Cortez, 2011) Banks are betting that the individuals and companies to whom they lend capital will earn enough money to pay back their loans. This process leads to generation of Risk and in turn necessitates Regulations. Index Terms— financial system, financial markets, Basel. I. INTRODUCTION Although there are a lot of arguments which justify control and supervision of banks, the question whether and how far the sector has to be regulated remains controversial. Economist Kevin Dowd (1996) compares this issue with generally desirable free trade and asks why the laissez-faire approach could not be applicable for banks. Examining the possibility of free financial system, he comes to the conclusion that, with no lender of last resort or government guarantees, the market would be disciplined and punished by depositors themselves. In his theoretical model, the depositors, being aware of the risks, threaten to close the accounts when the first signs of danger appear. That induces banks to pursue conservative lending policy and transparency. Adequate level of capital therefore serves as an insurance against potential losses to reassure investors. Dowd argues that additional capitalization, being rather costly, makes a bank safer and more attractive to its depositors. So the competition between banks would ensure the most appropriate to the customers' demand degree of capitalization. The exact amount of capital would be determined by market forces. Representing the opposite point of view, Sheila Dow (1996) brings two main arguments for regulated financial system. She claims that, first, free banking is prone to extreme cyclicality and second, central banking would automatically emerge in such a system, so there is no point in laissez-faire (Dowd, 1996). Dow bases her position on the very special economic role of money and the uncertainty associated with it". Unlike firms, banks use their liabilities as money, so the purpose of the regulation is in this case to ensure that bank's assets retain sufficient liquidity to meet any reduction in Dr. Pushpkant Shakdwipee, Associate Professor, Pacific University Masuma Mehta, Research Scholar, Pacific University redeposit, and to discourage such a reduction in the first place". In her article “Why the Banking System Should Be Regulated", Dow reasons, that regulation is warranted because the moneyness of bank liabilities is a public good". The state in turn produces moneyness by inspiring confidence in moneys capacity to retain value (Dow, 1996). Following this line of argument, (Dowd, 1996) derives the necessity to regulate banks from the role they play in financial intermediation, providing liquidity, monitoring and information services. Such importance may increase the probability of a systemic crisis and lead to substantial social costs. High interconnectedness and potential exposure to runs make banks particularly vulnerable to any kind of actual or perceived failure. Thus, the danger of a destructive chain reaction stimulates the idea of implementing bank insuring mechanisms. Another issue comes from the inability of depositors to monitor banking activities. According to the representation hypothesis of (Dewatripont & Tirole, 1994) the rationale for banking regulation is based on agency problems and corporate governance. A bank structure implies separation of ownership from management, what makes them susceptible to moral hazard and adverse selection problems. Screening and monitoring, though necessary, could be expensive for single depositors, especially for the small ones. That would also lead to a free-riding effect. Therefore, the regulation could facilitate the communication between two sides by taking over the control and supervision that depositors would exert themselves under these certain conditions (Santos, 2000) If the regulation of banks is really crucial for the system, one has to ask why among other parameters the regulation of bank capital seems to be particularly important. This can be explained by the fact, that the bank has mainly two sources of financing at its disposal. Using borrowed money, the bank has to fulfill its contractual liabilities, which, if not satisfied, can lead to default. Financing its operations with the own funds (equity), the bank does not expose itself to an immediate failure in case the value of the funds decreases. Therefore, the bigger the proportion of own capital in the bank balance sheet, the greater the probability that the institution will comply with its obligations even in difficult times (FDIC, 2003). Regulations are often designed to address market failures. The prevalence of market failures in domestic financial markets provides incentives for governments to step in, as necessary, by establishing financial regulations. With the globalization of financial markets, market failures have moved to the international level. Global financial instability From Basel I to Basel II to Basel III Pushpkant Shakdwipee, Masuma Mehta