6 Most Important Topics Definitions Flashcards
Why is it fundamental that we achieve the objectives of financial regulation?
Because the financial system is based on trust. If you do not have trust in the financial system, the whole system will break down. Distrust will cause potential runs on the bank and systemic instability which will result in more distrust in the financial system and further breaks within the financial system as a whole.
What are the objectives of financial regulation?
There are 3: to protect the investor, ensuring that markets are fair efficient and transparent, and safeguarding systemic stability.
Mention examples with regards to systemic instability.
The failure of Lehman Brothers, and what happened after their failure.
Explain why investor protection is important in the financial system.
Investor protection is important for trust within the financial system, and because there is asymmetric information. If investors do not trust the financial system, they will not invest their money, and the system will not work.
What is fundamental for capital markets to work efficiently?
It is fundamental that capital markets are liquid. Liquidity comes from both institutional and retail investments. It is important that those who have extra money which being saved channel that money within the financial system in order to serve as capital for the industry. The channel for that capital is the financial market. Hence, investors need to trust these capital markets enough to invest their money in them.
What is asymmetric information? How is it regulated?
This is when one party has more information than the other and therefore has an advantage over the other. For example, an investor goes to his broker and asks for investment advice. His broker has more information than him, and can easily take advantage of the investor. Thus, there are regulations which regulate the interaction between the broker and the investor. These include the type of information the broker has to provide the investor with, what sort of documentation the broker has to prove the investor with, and the assessment which has to be made of the investor’s situation before the broker provides him with investment advice. These are protections to achieve investor protection and the safeguard the interests of the investor, and to ensure that the investor can trust the financial system.
Why is it important to ensure that markets are fair, efficient and transparent?
Without transparency, it will be very difficult for investors to trust their money within the financial system. In order to emphasize the importance of a fair market, one could refer to the damage that could be cause through insider trading, explaining insider trading and how it could create a situation of distrust in the system.
What is macro prudential supervision? How does it take place?
This is supervision of the entire financial system, and the risks within the entire financial system, such as potential threats to systematic instability. This takes place through the analysis of information which the supervisor is receiving from either the financial system, or the micro prudential supervisor. The information is about what’s going on within the financial system, such as the information of the leverage of funds, information on the positions of banks, on financial innovations, and on the economies of member states. The latter would include how these economies are operating, as well as the exposure of the banks within these economies, and what risks may threaten the financial system if one of these economies has to default. All this information is analyzed by the macro prudential supervisor, who has powers to issue warnings and recommendations to individual financial institutions regarding their position. Example: the ESRB is the European macro prudential supervisor, and the FSOC is the American macro prudential supervisor.
What is micro prudential supervision? How does it take place?
This is the supervision of individual financial entities and the market, in terms of capital requirements and in terms of governance requirements (conduct of business rules). The micro prudential supervisor deals with fraud, and potential breeches to regulatory requirement, and issues relating to market abuse a d transparency. This Is based on onsite and offsite supervision, the review of financial returns of individual companies, the review of capital requirements, through financial returns of individual companies, and the carrying out if onsite inspections.
What could be a potential threat to systemic stability?
The failure of a bank, of a large (systemically relevant) financial institution, a large insurance company …
What is the fit and proper test?
The test checks the honesty, competence and solvency.
Why is it important that we have honest people in the financial system? How do we check that a person is honest?
Because we need people that we can trust. It is checked from the police conduct certificate.
What has the financial crisis taught us about failing financial institutions and competence in the financial system?
It has taught us that when there is failure, the result will be more. This is because there will be a decrease in confidence within he financial system, so people invest less money or withdraw their money from the financial system.
Who is required to be solvent?
Both the company receiving investments, as well as the person giving investment advice, or holding a license, or the directors (or managers) of the company. The company is subject to solvency requirements set by the MFSA, and the MFSA checks on the bank statements of the individual and requires a bank reference before giving anyone a license.
Why is competence important?
Competence is important particularly for individuals who are providing portfolio advice. It is important for efficiency so that proper transactions can be carried out. We trust a portfolio manager because he must have obtained some education that made him able to give investment advice, and must have had some form of experience before being allowed to act as an investment advisor on his own. Competence is very important for trust within the financial system.
