10 Flashcards
What is the main economic rationale for financial regulation?
To reduce asymmetric information problems, prevent financial instability, and protect consumers.
What is a government safety net in financial markets?
Measures like deposit insurance and central bank lending to prevent bank failures and financial crises.
How does FDIC insurance help prevent bank panics?
It guarantees deposits, preventing bank runs and breaking the contagion effect of bank failures.
What is the purchase and assumption method?
A costly FDIC intervention where a failing bank’s assets and liabilities are transferred to a healthy bank.
What is the lender of last resort?
When the central bank lends to troubled financial institutions to prevent collapse.
What is moral hazard in financial regulation?
The tendency of financial institutions to take more risks when they know the government will bail them out.
How does adverse selection affect financial regulation?
Risk-takers and dishonest individuals are more likely to enter banking if government protections exist.
What does “Too Big to Fail” mean?
Large banks receive government guarantees even if they are not entitled, encouraging excessive risk-taking and moral hazard
How does financial consolidation increase risks?
It makes banks larger and more complex, increasing regulatory challenges e.g. more risk taking and moral hazard.
What role did the government safety net play in the global financial crisis?
It extended protections to new high-risk activities, increasing incentives for reckless financial behavior.
What is the purpose of restrictions on asset holdings in financial regulation?
To limit financial institutions’ risk-taking by promoting diversification, prohibiting holdings of common stock, and setting capital requirements such as minimum leverage ratios for banks.
aim of Government-imposed capital requirements
Minimising moral hazard at financial institutions
What are the two main types of capital requirements for financial institutions?
Leverage Ratio: A bank’s capital divided by total assets, with a required ratio of over 5% to be considered well-capitalized.
Risk-based Capital Requirements: Adjusted to account for the risk level of the bank’s assets.
What is the purpose of the Prompt Corrective Action provision in financial supervision?
It requires the FDIC to intervene early and more vigorously when a bank’s capital falls too low to prevent serious financial problems.
What are the key functions of financial supervision in terms of chartering and examination?
Chartering: Screening new financial institutions to avoid adverse selection.
Examinations: monitor capital requirements and restrictions on asset holding to prevent moral hazard
what does examination monitor (6)
capital adequacy
asset quality
management
earnings
liquidity
sensitivity to market risk.
What does the assessment of risk management focus on?
It evaluates the soundness of management processes for controlling risk. It also includes stress testing and value-at-risk (VaR).
what is risk management rated on (4)
Quality of oversight provided
Adequacy of policies and limits for all risky activities
Quality of the risk measurement and monitoring systems
Adequacy of internal controls
what does interest rate risk limit
Internal policies and procedures
Internal management and monitoring
Implementation of stress testing and value-at risk (VaR)
What is the purpose of disclosure requirements in financial regulation?
To ensure financial institutions adhere to standard accounting principles and disclose a wide range of information.
What are some important consumer protection laws in financial regulation? (4)
Truth-in-Lending Act (1969): Protects consumers in credit transactions.
Fair Credit Billing Act (1974): Protects against unfair billing practices.
Equal Credit Opportunity Act (1974, extended in 1976): Prevents discrimination in lending.
Community Reinvestment Act: Requires banks to meet the credit needs of the communities they serve.
What is the purpose of the Consumer Protection Act of 1969 (Truth-in-Lending Act)?
It aims to ensure that consumers are provided with clear and accurate information about credit terms and conditions, helping them make informed borrowing decisions.
What does the Fair Credit Billing Act of 1974 protect consumers from?
It protects consumers from unfair billing practices and allows them to dispute charges on their credit accounts if there are errors or discrepancies.
What is the purpose of the Equal Credit Opportunity Act of 1974, and when was it extended?
It prevents discrimination in credit transactions based on race, color, religion, national origin, sex, marital status, or age. It was extended in 1976.
What is the Community Reinvestment Act designed to do?
It encourages financial institutions to meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods.
How did the subprime mortgage crisis illustrate the need for greater consumer protection?
The crisis highlighted how inadequate consumer protection led to risky lending practices and deceptive mortgage products, resulting in widespread financial harm to consumers.
Why are restrictions on competition implemented in financial regulation?
To prevent increased competition from encouraging moral hazard, where financial institutions may take on more risk.
What were branching restrictions in financial regulation, and when were they eliminated?
Branching restrictions limited the number of branches a bank could have. They were eliminated in 1994.
What was the Glass-Steagall Act, and when was it repealed?
The Glass-Steagall Act separated commercial banking from investment banking. It was repealed in 1999.
What are the disadvantages of restrictions on competition in financial institutions?
Higher consumer charges.
Decreased efficiency in the financial sector.
