Financial System Conflicts

Unit VII Financial Institution
Name
Institution
Unit VII Financial Institution
Question 1
Conflicts of interest entail some kind of moral hazard problems that arise when an organization or an individual has multiple conflicting interests or objectives (Crockett, Harris, Mishkin, & White, 2004). In most cases, conflicts of interest in the financial system occur in the form of misleading information that tends to benefit the financial organization involved at the expense of the public interests. Conflicts of interest in the financial system are normally considered an unethical behaviour. They can substantially hamper the quality of information in financial markets, increasing the risks associated with asymmetric information problems.
The various forms of conflicts of interest found within the financial system include:
Rating agencies conflict of interest (Mishkin & Eakins, 2012). This entails issuers of financial securities using rating agencies to biasly rate their creditworthiness favorably in order to attract investors. Such issues arise especially when a rating agency is involved with a certain financial institutions in other businesses such as offering consultation services. In such a case, a rating agency would have to rate the organization favorably in order to continue with the consulting services.
Underwriting and research problems in investment banking (Mishkin & Eakins, 2012). This entails the persuasion of analysts in investment banks to distort their information derived from their researches in order to please the issuers of securities. This way, investors would be provided with biased and unreliable information that would adversely affect the efficiency of the security markets.
Another conflict of interest arises in auditing and consulting firms that deal in accounting services. Such conflicts arise from failure to produce truthful reporting about the financial position of a firm. This is common in accounting firms offering auditing services besides consulting services to a similar organization. In such a case, the audit firm would have to report information that favors the organization being audited in order to continue offering the multiple services to the firm.
Question 2
Transaction costs are the costs associated with processing financial exchanges in financial institutions (Carroll & Teece, 1999). They occur as the administrative charges such as broker commissions, banks fees, dealer spreads and legal fees among others. Transaction costs can also be termed as the costs of acquiring and handing the information about a specific transaction, for instance, the information about prices, contractual agreements, quality of inputs and the reputation of parties to a transaction. The transaction costs associated with such engagements are normally expensive and this is the reason financial institutions emerge to offer alternatives as a way of economizing on the costs.
Some of the alternatives financial institutions can offer to reduce transaction costs include the change of governance to include equity owners in the management and monitoring of their investments (Carroll & Teece, 1999). This reduces the chanc...