13) regulation of financial institutions

Question 1

What is contagion related to the banking system?

Answer 1

-The failure of one bank can lead to the failure of the whole system

Question 2

Why are financial institutions regulated?

Answer 2

-The government are concerned about preventing the failure of the financial system due to the high risks taken by financial firms

Question 3

What are the disadvantages of under-regulated financial institutions with examples?

Answer 3

• leads to banks taking and seeking huge risks to maximise short term profits
• cut corners at the expense of households and businesses

eg PPI scandal and Libor fixing (base rate fixing)

Question 4

Explain how the lack of regulation created the 07/08 crisis?

Answer 4

• The collapse of the Lehman Brothers which brought down the worlds financial system
• LIGHT TOUCH REGULATION- bankers took excessive risks and weren’t overlooked by anyone, even commercial banks acting as investment banks and taking risks, fraud and illegal activity
• HEAVY TOUCH REGULATION- UK and US feared that high levels of government intervention would see banks leave strict countries for more free countries eg in Asia

Question 5

How was the 07 crisis resolved?

Answer 5

-Tax payers money bailed out bankers, but turned public perception angry as they thought bosses needed to be held accountable

Question 6

What role does the FPC, PRA and FCA play in regulation?

Answer 6

FPC= oversees the other two and stands for financial policy committee: takes actions to remove risks and threats to the system eg encouraging strong liquidity ratios

PRA= prudential regulation authority- concerned with the standards and supervision of the large financial firms (1700 banks) such as their balance sheets and making sure they are secure in the long term

FCA= financial conduct authority-concerned with the day to day running of all financial institutions and dealing with misleading advertising, inappropriate products etc

Question 7

Explain the benefits of increase financial regulation

Answer 7

• harder for banks to run in such a risky manner as they did before 07
• holding more capital and more liquid assets makes banks less profitable, so they aren’t exploiting consumer and households to the same extent
• less likely for governments to bail them out so they are more cautious
• new rules mean the consequences of future financial crisis less likely to spread into the real economy

Question 8

How might increased regulation not be beneficial?

Answer 8

• regulation may further shift the movement of the worlds economic centre towards Asia where there is less regulation
• higher barriers to entry for new banks entering the market and make it more difficult to innovate. makes the industry less competitive
• banks still want to maximise profits and may collude with new ways to beat regulation

Question 9

what is regulatory capture and regulatory drift?

evaluation of increased regulation

Answer 9

Regulatory capture- when firms that are being regulated by the government are favoured by the government over the consumer and leads to government failure as they are too lenient

Regulatory drift- occurs when regulators are so obsessed with dealing with problems from the past that they forget to look at problems arising in the future

Question 10

What else might the importance of increased regulation depend on?

Answer 10

• The strictness of the sanctions imposed for breaking regulations eg if the potential profits are much higher than the fines for breaking the rules they may carry on
• depends on the political climate