The theoretical foundation of states regulatory response to the Essay

The theoretical foundation of states regulatory response to the financial crisis - Essay Example inancial crisis arises when the demand for money is more than the supply resulting in a liquidity problem forcing banks to borrow to make up for the shortfall and in some cases leading to a collapse of this banks. This results into a financial crisis. It is for this reasons that theories have been developed across the financial field on the regulatory response to the crisis. The following are some of the financial regulations that are being adopted by many nations across the globe in trying to control the financial crisis includes; liquidity risk management, money market operations by the central banks, bank insolvency regimes, financial crisis management, and the deposit insurance. This paper seeks to explore the theoretical foundation of states regulatory response to the financial crisis. The Deposit Insurance has been used as a way of regulating the financial institutions to control the financial crisis from inflicting adverse effects on the economy of a country. The deposit insurance is a measure used to protect the bank depositors in case of a financial crisis (Strater and Corneli 2008 p.46). It protects the investors from losing the money they invest in the banks in case the banks have liquidity problem and become insolvent. The Insurance deposits ensure that the investors recover the money. The deposit insurance operates by allowing the banks to deposit part of the money with the Insurance deposit to cushion them from any financial crisis that may lead to recession and closure of these banks. The United States for example protected the smaller banks from the poor states by adopting the insurance Deposit as a strategy to avert a looming financial crisis (McDonald 1996 p.19-23). Liquidity risk management theory is also a regulatory response theory to financial crisis. Liquidity is the ability of a bank to fund its assets and meets its long and short term obligation as and when they fall due. When a bank is faced with a financial crisis, it is not able to