4.2.4.4: Regulations Of The Financial System Flashcards
What is the role of the Prudential Regulation Authority (PRA)?
The PRA promotes the safety and stability of banks, building societies, investment firms and credit unions, and ensures policyholders are protected.
What is the role of the Financial Conduct Authority (FCA)?
The FCA regulates financial firms to ensure they are being honest to consumers and they seek to protect consumer interests. The FCA also aims to promote competition which is in the interests of consumers.
What is the role of the Financial Policy Committee (FPC)?
regulates risk in banking and ensures the financial system is stable. It clamps down on unregulated parts and loose credit. The committee monitors overall risks to the financial system as well as regulating individual groups.
Why might a bank fail?
- bank run/liquidity crisis - not enough liquid short term assets to meet short term liabilities
- insolvency - not enough capital to offset losses in assets values (liabilities>assets)
- systematic risk - if one bank fails, theres a greater risk of the other banks failing (if moneys owed to them, etc)
—> most risks involve leaning long term and borrowing short term. They may lose money on investments and if their is insufficient funds in a vault, banks might be able to provide depositors with money when money is demanded.
What’s an example of bank failure?
The Global Financial Crisis is sometimes called The Great Recession, and it refers to
the decline in world GDP in 2008-2009.
- Before the crash, asset prices were high and rising, and there was a boom in economic demand. There were risky bank loans and mortgages, especially in the US where gov securities were backed by subprime mortgages. This means the borrowers had poor credit histories, and after house prices crashed in the US in 2006, several homeowners defaulted on their mortgages in 2007. Banks had lost huge funds, and required assistance from the gov in the form of bailouts.
What is a moral hazard?
a situation where there is a risk that the borrower does things that the lender would not deem desirable, because it makes the borrower less likely to repay a loan. It usually occurs when there is some form of insurance for the mistake. E.g, if a house is insured, a borrower might be less careful as they know any damage caused will be paid for by someone else.
- Banks might take more risks if they know the BoE or the gov can help them if things go wrong. The financial crisis has been regarded as a moral hazard, due to the degree of risk taking.
Different explanation:
—> a situation where a party lacks the incentive to guard against a financial risk due to being protected form any potential consequences
What is a systematic risk?
The potential for a failure or a crisis in one or more parts of the financial system to spread and cause widespread disruption to the entire system
- e.g. it could be the risk of the collapse of a bank. Since this costs firms, consumers, the economy and the market, it is akin to a negative externality.
What is a liquidity ratio?
A liquidity ratio is used to determine how able a company is to pay off short-term obligations. The higher the ratio, the greater the safety margin of the bank. When creditors want payment, they look at liquidity ratios to decide whether the bank is a concern.
What is a capital ratio?
A capital ratio is a comparison between the equity capital and risk-weighted assets of a bank. A bank’s financial strength is determined using this. Assets have different weightings, where physical cash has zero risk and credit carries more risk.
