4. Financial Markets & Monetary Policy - Financial Market Regulation

Question 1

What are the 4 main regulatory bodies for the financial market?

Answer 1

1. The Bank of England2. The Prudential Regulation Authority3. Financial Policy Committee4. Financial Conduct Authority

Question 2

What role does the BoE play in FM regulation?

Answer 2

Known as the Bankers Bank, the BoE has direct supervision for the whole of the Banking system through its Financial Policy Committee which in turn instructs two other regulators.

Question 3

What role does the Financial Policy Committee play in FM regulation?

Answer 3

The FPC is charged with the primary objective of identifying, monitoring and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system. The FPCs secondary objective is to support the economic policy of the government.

Question 4

What role does the Prudential Regulation Authority play in FM regulation?

Answer 4

The PRA is a subsidiary of the BoE and is responsible for prudential regulation of around 1700 banks, building societies, credit unions, insurers and major investment firms. It has 3 statutory objectives;1. Promote safety and soundness of firms it regulates2. Contribute to the securing of an appropriate degree of protection for those who are or may become insurance policy holders3. Facilitate effective competition

Question 5

What role does the Financial Conduct Authority play in FM regulation?

Answer 5

The FRA regulates over 56,000 firms providing services to consumers ensuring they meet prudential standards that reduce harm to the industry and consumers if they fail. They ensure that;The financial industry is run with integrity.Firms provide consumers with appropriate products and services.Consumers can trust that firms have their best interests at heart.

Question 6

What are the different reasons for FM failures?

Answer 6

1. Excessive Risk-taking - e.g. Credit Crunch2. Collusion & Price fixing - e.g. Barclays - Libor Rate3. Speculation & Market Bubbles - e.g. Ldn House Mark.4. Asymmetric Info. - e.g. Labour Markets

Question 7

What are the different types of financial regulations for the FM?

Answer 7

1. Ban Market Rigging - reduce collusive behaviour leading to fixed high interest rates2. Prevent unsuitable sales to consumers - affordability checks to prevent damage to individuals3. Maximum interest rates - prevents consumer exploitation for those that need to borrow4. Deposit Insurance - the gov. back deposits in commercial banks - £80,000 secured currently5. Ring fencing commercial and investment - reduces systemic risk6. Set targets on liquidity - protects against sudden large withdrawals

Question 8

What do all the different types of financial regulation aim to do?

Answer 8

They are all designed to create a less risky FM for either the consumer of the banks themselves.

Question 9

What are the basic consequences of Financial Regulations following the FM crisis?

Answer 9

1. Banks now required to hold more liquid assets 2. Banks are not allowed to over-leverage (borrow too much)3. Banks should have enough financial assets so they can deal with a crisis and not fail

Question 10

What are liquidity ratios?

Answer 10

A liquidity ratio is the ratio of liquid assets held by a bank on their balance sheet to their overall assets.

Question 11

How do liquidity ratios influence the stability of a financial institution?

Answer 11

Effectively the greater the ratio of liquid assets a bank holds the more secure that institution is.

Question 12

What changes were made regarding liquidity ratios following the Global Financial Crisis?

Answer 12

Commercial banks are now required to hold enough liquid assets to get through a 30-day market crisis.

Question 13

What are capital ratios?

Answer 13

A capital ratio is the ratio of reserve funds held by a bank against the the riskier assets it holds that could be vulnerable in the event of a crisis.

Question 14

How do capital ratios influence the stability of a financial institution?

Answer 14

Effectively the greater the ratio of capital reserves to risky assets a bank holds the more secure that institution is.

Question 15

What must banks do regarding capital ratios and how is it tested?

Answer 15

Banks are required to hold sufficient capital to deal with a market crisis, the EU run stress tests to check whether banks have enough of a financial buffer to weather difficult financial/economic conditions.

Question 16

What are micro-prudential policies?

Answer 16

Policies that involve regulation of individual financial firms such as commercial banks, payday lenders and insurance companies.

Question 17

What are macro-prudential policies?

Answer 17

These are policies that provide regulation designed to safeguard the financial system as a whole - macro-prudential policy includes counter-cyclical capital buffers.

Question 18

What is an example of the concept of moral hazard in FMs?

Answer 18

In the case of the sub-prime mortgage market 2000-2007; lenders faced a situation of moral hazard. They were able to sell on mortgage bundles to other financial institutions. Because there was strong demand from other people, and because other banks were taking on all the risk, the mortgage companies had less incentive to check the mortgages could be repaid. Therefore, there was a big growth in sub-prime mortgage lending with inadequate checks made.

Question 19

What is a bank run and when did it last happen?

Answer 19

A bank run is when everybody loses confidence in a bank and rush to take there money out at the same time. People may lose confidence for many reasons but usually if a bank borrows from the BoE, ‘lender of last resorts’ and word gets out, ppl think the bank is in trouble. Everyone rushes to take there money out but of course the bank doesn’t have all this money - a bank run. The last time this happened was when Northern Rock went under in the Credit Crunch.