Buyers and sellers in a market are said to be constrained by market discipline in setting prices because they have strong incentives to generate revenues and avoid bankruptcy. This means, in order to meet economic necessity, buyers must avoid prices that will drive them into bankruptcy and sellers must find prices that will generate revenue (or suffer the same fate).
Market discipline is a topic of particular concern because of banking deposit insurance laws. Most governments offer deposit insurance for people making deposits with banks. Normally, bank managers have strong incentives to avoid risky loans and other investments. However, mandated deposit insurance eliminates much of the risk to bankers. This constitutes a loss of market discipline. In order to counteract this loss of market discipline, governments introduce regulations aimed at preventing bank managers from taking excessive risk. Today market discipline is introduced into the Basel II Capital Accord as a pillar of prudential banking regulation.
The efficacy of regulations aimed at introducing market discipline is questionable. Financial bailouts provide implicit insurance schemes like too-big-to-fail, where regulators in central agencies feel obliged to rescue a troubled bank for fear of financial contagion. It can be argued that depositors would not bother to monitor bank activities under these favorable circumstances. Numerous academic studies on this subject. The findings at first had mixed and somewhat discouraging results where market discipline did not appear to be an essential feature in banking. Later studies, though, when including some of the previously missing key aspects into the empirical analysis, supported the existence and significance of such a natural control mechanism unambiguously. Accordingly, depositors 'discipline' bank activities to some extent depending on the well functioning of financial markets and institutions.
Other articles related to "market discipline, market, markets":
... As a result of this, the bank is subject to market discipline and the regulator can also use market pricing information as an indicator of the bank's financial health ...
... depositor trust into the financial markets following the devastation of the Great Depression ... Concerning market discipline, one can easily say that mispriced deposit insurance distorts the incentives of depositors to monitor bank risk taking activities ...
Famous quotes containing the words discipline and/or market:
“And when discipline is concerned, the parent who has to make it to the end of an eighteen-hour daywho works at a job and then takes on a second shift with the kids every nightis much more likely to adopt the survivors motto: If it works, Ill use it. From this perspective, dads who are even slightly less involved and emphasize firm limits or character- building might as well be talking a foreign language. They just dont get it.”
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