Question

Identify the areas of financial services most susceptible to conflicts of interests? Why do you think they are more susceptible?

Answer 1

Conflicts of interest exist when there are numerous interests of a financial service provider or an individual within such a provider that generate opportunities to behave in such a way as to manipulate or hide information. Conflicts of interest pose a concern for the financial system as they contribute to a substantial reduction in the flow of information.
Less knowledge makes it more difficult for the financial system to allocate credit to the most successful investment opportunities, thereby reducing the effectiveness of the financial markets and the economy as a whole

Four sectors of the financial services industry have a strong potential for conflicts of interest: investment banking underwriting and analysis, accounting company auditing and consulting, credit evaluation and rating agency consulting, and universal banking. Often, the market may offer opportunities that constrain competing forces, discounting the value of services while perceiving a conflict of interest. In response, financial service providers also introduce protections to minimize opportunities for dispute manipulation and thereby protect their reputations

For example, securities issuers pay credit rating agencies to generate ratings, and yet there is no evidence that this contributes to more favorable ratings. Similarly, obvious conflicts of interest as commercial banks lent to securities before the Glass-Steagall Act do not seem to have been widely abused as the public indicated their lack of faith in future conflicts and companies restructured to alleviate public concerns. Likewise, the market continues to consider possible conflicts of interest when determining the standard of information presented by research analysts on a securities issue that is employed by the leading underwriter bank

While conflicts of interest can be limited, they are harder to eradicate. It is easier for the market to recognise a possible conflict of interest than to determine how it is abused because the ability to exploit conflicts depends on the internal controls and compensation processes that are difficult to track within financial service firms