5A.4 Financial Stability and prudential regulation Flashcards
What is critical to a healthy, well-functioning economy?
Financial stability, including public trust and confidence in financial institutions, markets, infrastructure, and the system.
What international / global body is charged with the aim of financial stability?
the Financial Stability Board (FSB)
What is the FSB?
It is a body that monitors and makes recommendations about the global financial system.
What does the FSB promote?
International financial stability
How does the FSB promote international financial stability?
By coordinating national financial authorities and international standard-setting bodies, as they work toward developing strong regulatory, supervisory and other financial sector policies.
It fosters a ‘level playing field’ by encouraging coherent implementation of these policies across sectors and jurisdictions.
What does the FSB seek to do?
Working through its members, it seeks to strengthen financial systems and increase the financial stability of international financial markets. The policies developed in the pursuit of this agenda are implemented by jurisdictions and national authorities.
Who do the UK representatives at the FSB include?
The Governor of the Bank of England, CEO of the FCA and a representative from HM Treasury.
Who do members of the FSB include?
Include countries such as the UK and the USA, international financial institutions such as the International Monetary Fund (IMF), and international standard-setting and other bodies, such as the International Accounting Standards Board (IASB)
What 2 acts increased powers in relation to financial stability?
Banking Act 2009
Financial Services Act 2010
How did the Banking Act 2009 increase powers in relation to financial stability?
Increased the powers of the BoE and gave it an objective relating to financial stability. It also gave the Bank oversight of the UK’s payment systems.
How did the Financial Services Act 2010 increase powers in relation to financial stability?
This act gave the old FSA a new objective, in relation to financial stability, that has been carried over to the FCA. The FCA must have a financial stability strategy, which it reviews regularly.
What 4 factors should be considered in prudential regulation?
- A provider’s financial reserves (prudence)
- How risky it is perceived to be (credit-rating)
- The services it provides to its customers
- The strength of its product proposition
Why are adequate capital reserves important?
Individuals, firms, and markets must have enough capital reservers in place to deal with more turbulent market conditions. The main reason for this, other than market stability, is to ensure there is no risk of liabilities not being met as they fall due.
What are reserves known as?
Capital resources, and must be assessed by the individual, firm or market plus the relevant regulator.
What happens if reserves fall below a set level?
No new business can be taken on until this situation is remedied.
Who does the PRA prudentially regulate?
The top 1,500 systematically important firms and markets.
Who are the FCA responsible for if the PRA prudentially regulate the top 1,500 systematically important firms and markets?
The prudence of everyone else.
In terms of financial management, why must a firm/bank maintain adequate capital reserves?
To ensure that all liabilities can be met as they fall due.
Capital reserves must be enough to meet ALL liabilities as they fall due, not some of them.
What are the UK regulators trying to avoid in terms of prudential regulation?
Try to avoid, if possible, any repeat of the last financial crisis, when Northern Rock almost went bust. This is virtually unheard of in British financial services history and did absolutely nothing for the objective of ‘financial stability’.
Individuals, firms, and markets must have sufficient capital reservers to do what 3 things?
- Meet all liabilities as they fall due
- Be able to keep trading on a day-to-day basis.
- Have some form of financial buffer for expansion and development.
Individuals, but most importantly, firms and markets, must have systems in place to monitor the adequacy of their capital reserves. What do these include (4)?
- A documented process to identify and deal with such risks.
- At least annual stress-testing of reserves (using ‘worst case scenario’ applications).
- Annual reporting of capital reserves to the appropriate regulator.
- Openness and transparency in the availability of this financial data to the public.
What is Free Asset Ratio (FAR)?
This is the capital-reserve level of a business. In financial services, it is most applicable to a life office or an insurance company.
Put simply, what does FAR measure?
The surplus assets that a life office holds, over and above its liabilities.
If someone had £20 million in assets and £7 million currently in liabilities how would you calculate their FAR?
2 stage process:
- Calculate the amount of free assets (20 - 7 million) = £13 million in free assets.
- Calculate the ratio that these free assets are of total life office assets (expressed as a percentage)
£13 million / £20 million = 0.65 = 65% FAR
What does free asset ratio show?
The financial strength of a life office or insurance company.
What are ‘ratings’?
These are the credit ratings given to financial institutions by agencies such as Moody’s and Standard and Poors.
What are ‘ratings’ designed to show?
The financial strength of an institution but can also be applied to government, funds and other areas.
What did the UK government have its credit rating downgraded from and to?
Downgraded from Triple AAA to Double AA by Standard and Poor’s. This meant that the agency viewed the government as a higher risk than it used to be.
Who regulates credit ratings agencies?
Following Brexit and the UK leaving the EU, this has changed from the European Securities and Markets Authority (ESMA) to the Financial Conduct Authority.
Who regulates credit reference agencies?
These agencies are also regulated by the FCA.
What is the Retail Mediation Activities Report (RMAR)?
This report is the core regulatory return submitted by firms that carry out regulated activities involving mortgages, insurance and investment products.
How often do individuals and firms need to submit a RMAR?
Every 6 months.
