5.1 The Purpose Of Regulation

Question 1

Banks

Answer 1

Part of the wider financial systems, global and interconnected system.

If one bank fails, its affects the rest of the financial system (interconnectedness)

Question 2

Bank failures

Answer 2

Threaten the confidence on which a healthy financial system
Is based.

If people lose confidence in a bank = withdraw their balances at the same time and bank could fail.

Failed bank will owe money to other banks that have lend it money.

Systemic failure = banks in a country are in serious financial difficulty at the same time.

Government will be forced to step in by lending money to fail in banks
Increase public sector debt

Widespread financial failure = economic recession
Many people becoming unemployed

Question 3

The higher the potential reward, the higher the risk

Answer 3

As business need profit, it may take on too much risk to increase its profits

Financial crisis 2007/08, things can go wrong very quickly

When one bank fails, the interconnectedness of banks can have a knock on effect on others

Question 4

Banks selling more products

Answer 4

To sell more products and services - banks could develop a market products and services to customers that are not suitable for them

For reasons, banks are not left to regulate themselves

Question 5

Regulation

Answer 5

Have to ensure that banks are managed well and that they do not take onto too much risk

Regulation takes the form of laws and rules about how bank structure their assets (their lending), their liabilities (their deposit and money the borrow)
and how they manage risk.

Good regulation means that there will be a few our bank failures in the future

Question 6

Rules based regulation

Answer 6

Laws and rules set minimum standards that must be met

Principles base regulation within financial services typically take the form of broad set of aims or expectation that promote certain outcomes
Such as fairness, transparency or accountability

Question 7

Regulation and financial supervision

Answer 7

Regulation = is about having rules and guidelines that define acceptable behaviour and conduct
Financial institutions must comply with the laws and rules laid down by financial regulators

Supervision = the process by which regulatory authorities oversee and enforce compliance with these rules and guidelines, both in the financial system as a whole and individual financial system

Question 8

Types of regulation

Answer 8

1. MACROprudential
2. MICROprudential
3. Conduct

Question 9

MICROprudential regulation

Answer 9

Is concerned with the stability of individual banks and other financial institutions (firms).

The measures used is aim to ensure that individual banks are structured to stand external risk and shocks . Involve setting requirements to ensure banks have structured balance sheets, good quality assets, sufficient capital and liquidity, + mange risk sensibly

Question 10

Capital

Answer 10

Is the money invested by a bank shareholder plus any profit that has not been spent.

This belongs to shareholders, is the money which should be at risk if a bank fails

Depositors money should not be at risk so bank must ensure they hold adequate capital to cover any losses the bank makes

Question 11

Liquidity

Answer 11

Is cash or assets that can quickly be turned into cash
A bank must have enough liquidity to be able to pay it short terms debt and be able to meet it’s customers demand for cash

Question 12

MICROprudential regulation lays down specific rules

Answer 12

On how individual banks must manage their assets, liabilities and risk.

Banks are supervised often to make sure that they comply with the rules . MICROprudential will step in if it doesn’t

Question 13

Capital Requirements Directice IV (CRD IV)

Answer 13

In the EU, prudential rules for banks, building society and investment firms are governed by the CRD IV.

Question 14

MICROprudential regulators must be aware of:

Answer 14

1. Managing issues and bank failure - MICROprudential must be aware of the overall systemic effect that would be caused by the failure of a major bank.
   (Must be aware of macro and micro prudential)

Regulators now try to manage the failure of a firm in an orderly way . This allows them to maintain critical financial functions and protect financial stability and public money.

2. Bank insolvency and resolution - Resolution is the way that are failing bank is managed in an orderly way by a country central bank or regulator.
   In UM this is the Bank of England

Resolution allows the bank functions to keep going in the short term so that customers can still make payments and access their money.

Any unpaid debts should come from the bank capital (its shareholders) and not from its depositors (customers).

Question 15

MACROprudential regulation

Answer 15

Is concerned with the stability of the financial system as a whole.

Is also concerned with the combined effect of the actions of individual banks and other institutions.

Measures taken aim to reduce the likelihood of systemic risk and make the financial system more resilient to external shocks and risks.

Measures include monitoring the financial system and identifying emerging risk so that early action can be taken.

Example: improving affordability rules and mortgages for all lenders so that banks face fewer bad debts

Question 16

Conduct regulation (conduct of business)

Answer 16

Aims to ensure that financial markets work well for individuals, for businesses and for their economy as a whole

Delivered through principles- based regulation which relies more on broadly stated rules or principles that outline the banks are expected to conduct their business.

The standards allow some flexibility for banks to innovate to find competitive advantage whilst also ensuring there are safeguards in place to protect their customers.

Question 17

Conduct regulation focuses on establishing and rules and guidance to reduce the likelihood of:

Answer 17

• consumers receiving bad advice
• bank becoming insolvent before the customer contract for the product or service mature
• money being laundered
• contract for products and services turning out to be different from what the customer expected
• fraud and misrepresentation taking place
• staff acting incompetently
• insider training (the illegal procure of trading on the stock exchange)

Question 18

Conduct regulation coveres

Answer 18

• Disclosure of information
• Fair Business practices
• Honesty and integrity
• Competence of financial institutions and their employees

Question 19

Training and competence

Answer 19

• Banks are expected to provide initial and ongoing training for the people to ensure that they remain competent in their role

Competence - having the skills, knowledge and expertise
Includes: maintaining required standards of professional and ethical behaviour.
Training should include changes in the marketplace, products and service, relevant regulation and legislation

Question 20

Consumer credit

Answer 20

Ensuring customers are treated fairly extends to protecting consumers from harm when they borrow money.

Consumer credit = lending to individuals and sometimes small businesses
Example; borrowing money using a bank loan or credit card

Can monitor consumer credit as it can impact financial stability if households take on more debt than they can afford

Question 21

Regulation for borrowing

Answer 21

Many do not consider or or are unable to calculate the longer term cost.
Products and the pricing structures are often complex and harder to understand.

Regulation ensures there is some protection for customers against being sold unsuitable or poor value products and services.

It also provides guidance for banks to ensure that customers do not take on too much debt and help them avoid getting into financial difficulties.

Question 22

Regulators make rules to protect customers who use consumer credit:

Answer 22

1. Need to assess a borrowers creditworthiness
2. Information consumers must be given before entering into a credit agreement
3. Content and form of credit agreements
4. Method of calculating the APR of interest
5. Procedures relating to what happens if the customer is unable to repay the loan or wishes to repay it earlier than contracted.
6. Credit advertising and additional protection for Credit Card purchases.