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
