19) PRUDENTIAL SUPERVISION Flashcards
In prudential mgt, what are the roles played by PRA, the FCA, the Basel Committee on Banking Standards and the EU?
PRA - Levels of operation - 1. Mkt as whole (safe, efficient, stable mkt) 2. Indi firms (minimise busi failure and protect consumers) 3. Indi consumers (providers they use continue to operate, or if they fail, indi impact is minimised)
Majority of prudential rules are the remit of PRA - regln of all dep takers, insurers, significant investt firms
FCA - prudential regulator for smaller busi, to mng failure whn it happens, if failure of a firm has wider impact FCA focus on redn of impact on cust and integrity of finanl sys
Basel Committee on Banking stds - Banking standards set on intern’l level as economies of world are highly interconnected, multinat’l body under Banking for Intern’l Settlements to strengthen regln, supervsn, and acti of banks and enhance finanl stability, many staff on secondment from central banks and regulatory bodies from around the world.
EU - sets out detailed reqts for banks, bldg soc and investt firms within member states
What is capital adequacy?
Key area of prud. control for finanl insti. w diff rules for dep takers, investt firms and life assurance companies
Capital adequacy is a reguln wh states that a busi must have sufficient capital to cover the deposits of customers. Capital refers to own funds of a busi ie obtained from shareholders and related sources and not funds deposited by customers.
The min cap that a busi must hold is expressed in the form of solvency ratio ie capital as a propor of the value of the bank’s assets (mainly loans). AS some assets rep more risk than others, the level of cap must reflect the risk level of diff assets.
What is liquidity risk?
It is a risk that is defined as a situation where a firm, though solvent, does not have enough avai. finanl resour to meet its obligations as they fall due.
E.g. (Northern Rock 2007) banks not being able to meet dep withdrawal demands, though solvent, as funds are tied up in illiquid assets (such as mortgs).
It is hence very imp for finanl serv to maint a good bal in timing of both assets and lia. as far as poss.
What are the three main ways in wh a firm’s assets can provide liquid assets?
A firm’s assets can provide liquidity by
- selling assets for cash
- by assets reaching their maturity date
- by providing assets as security for borrowing
Banks shd avoid asset concentrations where a large no of asset receipts occur at around the same time, so shd liability concentrations shd be avoided, whr a single factor/decision can lead to a sudden significant claim. A wide spread of maturity dates shd be aimed for.
What is operational risk?
Risk of loss as a result of inadequate/failed INTERNAL processes, people and systems (e.g. staff fraud, computer failure), or as a result of EXTERNAL events (
eg a natural disaster)
Capi reqts for operational risk was included in Basel II for first time. As a basic reqt, capi reqt is obtained by multiplying a firm’s gross income (avg of 3 yrs) by 0.15
For large institu, a diff standardised approach can be applied w diff multiplying factors.
What are the three pillars of Basel II?
Pillar 1 - Three aspects of a bank’s operns (credit risk, opernl risk and mkt risk) and details of their respective capi reqts
Pillar 2 - More tools for effective supervsn given to banking regtrs to deal w indi components of risk
Pillar 3 - A set of disclosure reqts by orgns for capi adequacy to be assessed properly.
What are main features of Basel III
Basel III covers two main areas
- regulatory capital
- asset and liability mgt
Regulatory capi: Req banks to reach a minimum solvency ratio of 7 per cent (reglry cap is the amt of capi that a bank shd hold to meet reglry reqts). 2 classes of reglry capi Tier 1 - share capi and disclosed reserves (profits retained in busi and not paid as divi)
Tier 2 - supplementary capi
A bank’s assets are risk adjusted - more the investt in risk more capi reqt…banks gen keep in excess of 7% solvency ratio. Acc to Basel III, banks also expected to maint a leverage ratio in excess of 3% (Tier 1 capi divided by avg total consolidated assets)
Asset and liability mgt: Basel III req banks shd comply with
Liquidity coverage ratio (LCR)
Net stable funding ratio (NSFR)
LCR: Risk weighted high quality liquid assets avai by banks shd exceed expected net cash outflows for next 30 days. Phased in betn Jan 2015-2019
NSFR: Long-term finanl resour shd meet long-term commitments (long term ref to more than one year). Banks had to meet this reqt by 2018
What is Capital Requirements Directive?
In EU, reqts of Basel I,II and III implemented by Capital REquirements Directives (CRDs).
CRD IV imple Basel III. builds on existing rules and introduces new prudential reqts. Applies to banks, bldg soc. and investt firms - improved quality of capi that firms hold and new capi buffers introduced.
CRDs establish supervisory framework ensuring firms hold sufft finanl resour to cover risks that busi acti present
What is Total Loss Absorbing Capacity? (TLAC)
Issued on 9 Nov 2015 to 30 globally systemically imp banks (G-Sibs) by Basel Comm on Banking Supervsn (BCBS). These banks deemed at risk as too big to fail.
TLAC reqts aim to bolster such banks’ capi and leverage ratios - can conti critical fns in times of crises. TLACs are in addn to min. reglry capi reqts, but qualifying capi may count towards both reqts, subject to condns.
Min TLAC reqt for G-Sibs is 16 per cent of resolution group’s risk-weighted assets (RWAs) Will incr to 18 per cent from 1 Jan 2022
What is Solvency II?
Rules reg. capi an insu company must hold against risk of insolvency (1970s Solvency I) Solvency II - 1 Jan 2016 Directive. Globally European Insu and Occupational Pensions Authority (EIOPA) resp for imple. Supervisory authorities will imple within each memb state.
Main aims of Solvency II -
- reduce risk of insu co. unable to meet its claims
- shd an insurer fail to meet claims in full, to red losses
suffered by policyholders
- info disclosure sys est to make regrs aware of potential prob at early stage
- promote confi in finanl stability of insu sector
Three pillars of Solvency II (Regln against insolvency by insurers)
Pillar I - Capital reqts and valuation of assets
Pillar 2 - Governance and risk-mgt reqts
Pillar 3 - Disclosure and transparency rules
Capi Reqt expressed as Solvency Capital Reqt SCR wh is basic SCR + allowance for operational risk less an amt for adjustments
Each insurer must submit an ‘Own Risk and Solvency Assessment’ (ORSA)
All EU insurers are subj to Solvency II (except some based on no of premiums they write, val of technical provision and type of busi written)
What are FCA/PRA prudential stds?
Resp for est rules translating EU legislation through FCA and PRA Handbook’s ‘Prudential Standards’ into practical stds for reg finanl serv to apply
OVERVIEW of PRUDENTIAL STDs SOURCEBOOKS
“(SBks)”
A) GENPRU - SBks for banks, bldg soc, insurers and investt firms - guidance on min capi reqts etc
B) BIPRU - SBk for bks, bldg soc and investt firms and rules applying to them
C) IFPRU - Pru SBk for investt firms expl. capi reqts
D) INSPRU - Pru SBk for insurers expl capi reqt and tech provisions for insurers
E) MIPRU - Pru SBk for mortg and home fin firms and details capi reqts and reqts for professional indemnity insu
Briefly outline prudential stds sourcebook for each of the financial services
GENPRU - banks and bldg socty, insurers and investt fms
GENPRU 1 - gen reqts for a firm to maint ade resour and how finanl resour are valued
GENPRU 2 - Eligible capi that make a firm’s capi base and capi resources reqt (CRR)
GENPRU 3 - rules for finanl conglomerates
BIPRU
For bks, bldg soc and investt firms - 14 sections rules reqd as a result of Capi Reqts Directives (CRR) in reln to
Capi Reqts, Credit risk, Credit risk mitigation, market risk, group risk, liquidity
IFPRU
SBk for investt firms created to implement CRD IV. Some investt firms continue to be regulated under GENPRU and BIPRU rather than IFPRU
Has 11 sections covering
Credit risk, Operational risk, Market risk, Liquidity, Capital buffers, recovery and resoln (processes if busi fails or runs into problems)
CRD sets min capi reqts for investt firms - dep on category of firm:
** IFPRU 730k firm - firm that is not a collective portfolio mgt and investt firm….reqd to hold at least 730k euros
** IFPRU 125k firm: firm not underwriting issues of finanl instru or deal on its own account, authorised to hold client money, NOT a collective portfolio mgt co…req to hold capi of at least 125k euros
** IFPRU 50k firm - firm that does not deal on its own acc or underwrite issues of finanl instruments, does NOT hold client money, NOT a collective mgt firm,
REq to hold capi of at least 50k euros
In EU, reqts of various levels Basel Accords are implemented by which legislation?
In Eu, reqts of various Basel Accords are implemented by Capital Requirements Directives, with Basel III imple by CRD IV
Why does FCA concentrate on managing failure of an indiv firm if it happens rather than proactively seeking to prevent its failure?
FCA is prudential supervisor of smaller firms, wh in gen would not present a risk to wider finanl sys. The regulator concentrates its resour on mnging a firm’s failure in an orderly way to mitigate impact on customers
