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Chapter 12: Q.22 (page 344)

How does the process of financial innovation impact the effectiveness of macroprudential regulation?

Short Answer

Expert verified

It's clear that financial innovations are one of the major factors of the credit boom, as they mitigate the impact of macroprudential regulations. Innovations in finance generate more money in the credit market (including venture capital) and therefore a credit boom.

Step by step solution

01

Concept Introduction

As a core aspect of macroprudential regulation, microprudential regulation of financial institutions helps to reduce financial instability's risks and macroeconomic costs. Macroeconomic policy and microprudential regulation of financial institutions go hand in hand, making it necessary to close the gap between the two.

02

Explanation

Macro-prudential regulations are restrictions imposed on the credit market institutions to prevent them from taking excessive risks in the event of credit boom. It is necessary to curb the increased credit risk that creeps in the market when there is boom.

Because financial innovations are considered to be one of the major factors of credit boom, it can be realized that they mitigate the impact of macro-prudential regulations. New kinds of financial innovations drive more money (including venture capital) in the credit market and generates credit boom.

03

Final Answer

In such a situation, macro-prudential regulations are often not met or met but with discrepancies. Hence, the effectiveness of macro-prudential regulations is largely reduced.

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