Introduction Banking is an important institution in the economy and plays a very important role in the economic life and economic growth of any society. While it is of common understanding that banking is not “The Economy”, it is agreed that the health of the country’s economy is closely related to the soundness of its banking system which can be sustained through strict regulations and supervision in order to monitor and control business risks such as Capital Risks, Liquidity Risks, Credit Risks, Exchange Risks, Operational Risks, Market Risks and Legal Risks. Bank regulations and bank supervision are required to facilitate a ‘Systematic Risk Reduction’ approach thus reducing the risk of adverse trading conditions and to ensure that Financial Institutions satisfy at least the minimum ‘Prudential’ requirements in order to reduce the risk factor that creditors are exposed to. Lack in regulations and slack in supervision may lead to Financial Institutions risking bankruptcy thus exposing their clients of potentially losing their investments and financial assets while distressing the country’s economy. What is the actual function of a bank within an economy? Banks' traditional role is primarily that of an intermediary for money, i.e. granting loans, processing payments, accepting deposits, carrying out investments, etc... Although banks do not create new wealth, through borrowing, lending and related activities they facilitate the process of production, distribution, exchange and consumption of wealth. In this way banks become very effective partners in the process of economic development. (BlurtIt.com, 2007) Banks act as the backbone of the economy. Instead of keeping peoples’ savings idle, banks inject this working capital in the economy; as long as capital is kept flowing in the economy, both the banks and the economy will remain sound and healthy. The function of an efficient Financial Sector in the Economy The function of an efficient financial sector can be defined as promoting economic growth and reducing poverty by widening and broadening access to finance and by allocating society's savings more efficiently. Efficient Financial Sector Principles An efficient economy requires an efficient Financial Sector to operate. This can be sustained through the enforcement of governmental/regulatory bodies’ regulations, control and regular supervision. Fostering stable and efficient financial systems revolve around 5 principles: Macroeconomic Stability - This stability has been accompanied by dramatic changes in financial structure over the past 20 years. The simultaneous improvement in the efficiency of monetary policy and stabilisation of the macro-economy is the result of the reduction in direct state ownership of banking system assets and by the introduction of explicit deposit insurance. (National Bureau of Economic Research, 2001) Legal Framework - Financial contracts depend on certainty of legal rights and predictability and speed of their fair and impartial enforcement. (World Bank, Undated) Transparency – Transparency of bank accounts through supervision. Banking Market Structure – Banking competition and the transmission of monetary policy through the bank lending channel. (Federal Reserve, 2005) Financial Safety Net – The financial safety net should provide protection against the collapse of the financial system that would endanger the entire economy and can be achieved through the implementation of regulations and through supervision. (Business Network, 2008)
The late 1990’s financial crises stressed the linkages between macroeconomic developments and the financial system soundness. Weak Financial Institutions resulted in inadequate bank regulations and supervision together with lack of transparency. In light of these crises the International Monetary Fund (IMF) designed the Financial Sector Assessment Framework with the scope to help countries identify and implement policies and regulations in order to build sound financial systems. Financial Sector Assessment Framework Based on the core Financial Sector Principles the International Money Fund designed a financial sector assessment framework based on 3 pillars: Pillar I - Macro-prudential surveillance and financial stability analysis. Authorities are to monitor the impact of potential macroeconomic and institutional factors on the soundness and stability of financial systems. Pillar II - Financial system supervision and regulation to help manage the risks and vulnerabilities, protect market integrity, and provide incentives for strong risk management and good governance of financial institutions. Pillar III - Financial system infrastructure: Legal infrastructure for finance, including insolvency regime, creditor rights, and financial safety nets. Systemic liquidity infrastructure, including monetary and exchange operations. Transparency, governance, and information infrastructure.
(International Monetary Fund, 2008)
The elements within all the three pillars support both development and stability. These three pillars ensure that there are adequate bank regulations and supervision in place in an effort to reduce unforeseen risks such as the recent Credit Crunch scenario which lead Financial Institutions to financial crises. | 
