3. Regulation Flashcards
What are the 4 aims of regulation? (PPLM)
- Promote efficient markets
- Protect consumers
- Lender of last resorts
- Maintain confidence in financial system
What does ‘lender of last resort’ mean?
They lend money to financial institutions in financial difficulty with no borrowing option
Why do market inefficiencies exist?
Consumers make imperfect choices
Why is it hard to quantify the success of regulation
Benefits and costs are hard to isolate
What is the optimum level of regulation?
That where marginal cost = marginal benefit
Give the 2 direct costs of regulation
- Administering regulation e.g. examining data
- Compliance from regulated firms e.g. maintaining records
How are direct regulation costs generally paid for?
Tax
Give 4 indirect costs of regulation
- Altering consumer behaviour
- Undermining firm’s sense of professional responsibility
- Reduced product innovation
- Reduced competition
How has regulation had to change with globalisation?
Regulators have needed to become more coordinated across nations
What is “systemic risk”
The risk of financial institutions falling like dominoes
Given an example of systemic bank collapse
Bear Stearns
What’s a bank run?
Where a large amount of clients withdraw their money from a bank simultaniously
What can cause systemic collapse?
Low consumer confidence
How do regulators avoid systemic collapse?
By ensuring the collapse of one bank doesn’t lead to others
What is asymmetric information?
Where one party has more information than the other which can be used to their benefit
What are the 7 functions of the regulator? (GIVESSP)
- Government policy review
- Investigating suspected breaches
- Vetting firms
- Enforcing where necessary
- Supervising management of financial organisations
- Supervising business conduct
- Providing information to the public
What 4 groups need to be regulated? (DIPS)
- Deposit-taking institutions
- Intermediaries
- Professional advisers
- Securities markets
How does information asymmetry lead to an inefficient allocation of resources?
Imperfect information leads to sub-optimal choices
What’s anti-selection?
Whereby people are more likely to take out contracts if they believe their risk is higher than the insurer allows for in their premium
Give an example of anti-selection
Someone in poor health applying for life insurance with limited underwriting
What’s moral hazard?
Whereby an insured party behaves differently than how they’d act if they weren’t insured & were fully exposed to that risk
Give an example of moral hazard
Insured driver no longer bothering to use their garage
How is there information asymmetry in a moral hazard scenario?
The party acting with moral hazard has more information than the insurer
What information asymmetry most concerns the regulator?
Asymmetry between the provider and their customer
How can information asymmetry lead to insurance contracts which are unfair to the consumer?
- Insurer writes the terms
- Insurer has expertise in writing contracts in their favour
Give the 3 methods of dealing with information asymmetry through regulation (PEC)
- Price control
- Education
- Conflict of interest control
How can regulators use price control to reduce the advantage the insurer has over the consumer via information asymmetry? (MMM)
- Max premium rates
- Max management charge
- Max commission scale
Name the 2 parts of an insurance contract which need to be regulated to avoid excessive information asymmetry (LD)
- Literature of contract
- Discontinuance benefit
What’s the discontinuance benefit?
The contract surrender benefit
What’s ‘whistle blowing’?
Notifying the relevant authorities if customers aren’t being treated fairly
Name the 3 sources of assumptions made under PRE: Policyholder Reasonableness Expectations
- Statements made in literature
- Past practise of provider
- Past practise of other product providers
What is the FCA’s TCF?
TCF: Treat Customers Fairly
Name the 6 steps of the FCA’s TCF (good luck!)
- Consumer confidence is key to corporate culture
- Products & services should meet consumer needs
- Consumers should be clearly informed before, during & after contract
- Where customers need advice, circumstance should be taken into account
- Product provided performs as described
- Consumers don’t force unreasonable post-sale barriers
What’s capital adequacy?
Holding sufficient capital to cover liabilities
Give 3 examples of securities held to maintain capital adequacy (CCL)
- Liquid securities
- Cash
- Credit links
What does regulation say around capital adequacy?
Sufficient liquid assets must be held to where the probability of insolvency is below a prescribed level
Capital adequacy must be held with accuracy, competence & integrity. Define competence & integrity
Competence - knowing the appropriate cause of action
Integrity - choosing to take it
What is a compensation scheme?
A scheme which covers investors who’ve been subjected to:
- Fraud
- Service provider failure
- Poor advice
Who funds a compensation scheme?
May be funded by an industry or government
Firms listed on the stock exchange need to fulfil criteria around financial stability. What is monitored about each firm?
Prices of deals & their reporting
Why are trading volumes recorded on the stock exchange?
- Deter insider trading
- Prevent substantial acquisition of shares quickly
What’s statutory regulation?
Regulation via government policy
Give 3 advantages of statutory regulation (PER)
- Public confidence
- Economies of scale where the regulator can group by function
- Reduce abuse
Give 4 disadvantages of statutory regulation
- Costly
- Flexibility
- Concern regulator will take heed of provider over consumer
- Market participants are in the best place to regulate
How does self-regulation deter providers from acting in their own interests?
The incentive is the threat of statutory regulation
Give 4 advantages of self regulation (KSBB)
- Knowledge - implemented by those who know the market beat
- Speed of response
- Best interest - providers have the most to lose from low faith
- Bureaucracy minimised
Give 4 disadvantages of self regulation (PIDT)
- Public confidence may be low in this approach
- Deter market entrants
- Image over actual - must be perceived to be being fair, may not be the case
- Third parties may be a second thought
Give an argument for an unregulated market
- Participants are still held to jurisdiction
- Could be argued the cost of regulation outweighs the benefits
Name the 4 possible types of regulation system (SSVU)
- Statutory
- Self-regulation
- Voluntary code of conduct
- Unregulated
Give 2 disadvantages of a Voluntary Code of Conduct
- Vulnerable to low confidence
- Can be ruined by a rogue operator
Name the 5 roles of the Central Bank (IIESL)
- Interest rates set
- Inflation control
- Exchange rates control
- Stability control
- Lender of last resort
Give 2 disadvantages of state intervention
- Innovation stifled
- Restricts free markets
Give 2 advantages of having a large, dominant participant in a market
- Niche can be found by small firms
- Stabilise Premium rates
Give a disadvantage of having a large, dominant participant in a market
Have power to distort market
How do firms with a climate conscience usually benefit?
Will result in an increased share price
What climate conference decided to keep the global temperate rise since pre-industrial levels below 2 degrees?
2015 Paris agreement
