Banking Regulation and Deposit Insurance Flashcards
General statement
Banks are more prone to troubles than other firms. Because of their inter-connectedness, the failure of one institution can immediately affect others.
What is a bank run?
Bank runs occur when a large number of depositors, fearing that their bank is unsound and about to fail, withdraw their savings within a short period of time.
Creates problems due to bank only keeping small fraction of cash. Can lead to insolvency and then bank failure.
What is systemic regulation?
Regulation concerned mainly with the safety and soundness of the financial system.
Deposit Insurance
LOLR
What is deposit insurance?
A guarantee that part or all of the amount deposited by savers in a bank will be paid in the event that a bank fails.
FSCS - Financial Services Compensation Scheme - up to 85k
What is the LOLR function?
The Lender of last resort function is where a bank is experiencing serious financial problems due to either sudden withdrawal of funds or where the bank has embarked on highly risky operations. The Central Bank will provide them with funds giving them liquidity.
What is prudential regulation?
Prudential regulation is concerned mainly with consumer protection.
It relates to the monitoring and supervision of FIs, with particular attention to asset quality and capital adequacy.
Consumers are not in a position to judge the safety and soundness of FI’s due to imperfect consumer information and thus in the UK this is done by the FSA.
What is conduct of business regulation?
Regulation which focuses on how banks and other FIs conduct their business.
It concerns banks disclosing information, fair business practices, competence, honesty and integrity. Good advice, protection from fraud.
What are the four different types of deposit insurance? Paybox model and the cost reducer model (loss minimiser)
Paybox model: the role of the deposit insurance institution is narrowly based and limited to a settlement function.
Cost reducer model: retains the settlement function and in addition to handling any occurrence of insolvency in an insured institution with the lowest possible costs and externalities for the financial system.
What are the four different types of deposit insurance? The resolution facilitator model and the supervisor model (risk minimiser)
Resolution facilitator model: Institution has additional powers, can intervene to support a bank in difficulties (but not an insolvent or illiquid bank), it can facilitate a corporate restructuring or even a merger to protect depositors.
Supervisor model: Broad mandate, part of the supervisory system.
Limitations of regulation?
Deposit insurance and LOLR function can cause moral hazard with banks.
Depositors will not be concerned with the behaviour of their bank.
Too big to fail/Too important to fail - making banks take bigger risks to increase profits.
Using tax payers money.
Agency capture - too much input from banks in the regulatory system. Basel II allowed the largest banks to use their own internal models for assessing risk and capital adequacy.
