CH 3: Regulation Flashcards
1 Aims of regulation
4
G - Give & maintain confidence in the financial system
R - Reduce financial crime.
I - to correct perceived market inefficiencies and to promote efficient and orderly markets
P - to protect consumers of financial products
GRIP
2 Costs of regulation
2,4
Direct Costs:
- Administration (eg. costs for collection and analysis of info. participants & monitoring their activities)
- Compliance The cost incurred by regulated firms to comply with regulation
Indirect costs:
- Change consumer behaviour, reliance on regulator
- Undermines professional responsibility
- No self developed consumer protection mechanisms
- Reduced innovation and competition.
3 Need for regulation
2,2
Confidence in financial system:
- Important part in success of system.
- Systemic risk : knock on effect of failure off one institution( regs aim prevent this)
Asymmetric information:
- Between provider and consumer
- Information advantage can be used for own benefit.
4 Functions of a regulator
Acronym - S = Setting sanctions - E = Enforcing regulation - Re = Reviewing and enforcing government policy - V = Vetting and registering individuals - I = Investigte breaches - C = Check management and conduct of providers - E = Educate consumers and the public
SEReVICE
5 Information asymmetry
1,3,2
- The situation where at least one party to a transaction has relevant information which the other party or parties do not have.
Anti-selection:
- People more likely to take out contracts where they believe the risk is higher than accounted for by insusrer.
- Options/Guarentees exercised when most benefit.
- Info asym leads to anti-selection. eg Not disclosing health issues.
Moral Hazard:
- Party behaves in more risky manner than they would if fully exposed to risk.
- Change of behaviour that increases level of risk taken.
Main influences on policyholder expectations:
3
- Statements made by the provider, especially those made to the client in marketing literature and other communications
- Past practice of the provider
- General practices of other providers in the market.
Dealing with information asymmetries:
SPIDER CCUTW
S - Selling practices regulated P - Price controls I - Insider trading prevented D - Disclosure of information in plain language E - Educate consumers R - Restrict knowledge about 3rd parties to publicly available C - Cooling-off periods for consumers C - Chinese walls U- Unfair features T- TCF W- Whistle blowing
SPIDER CCUTW
6 Maintaining confidence
5
- Capital adequacy: Reg req capital to be held to cover liabilities with margins
- Competence and integrity: Qualified, competent members in field
- Compensation schemes: Setup by Gov and industry to fund losses by misconduct
- Investor protection: Regulators ensure that the mkt. is transparent, orderly.
- Stock exchange requirements: Fulfil criteria and listing req
CCCIS
Forms of regulation
3
- Prescriptive: Declared rules state what can/not be done
- Freedom of action: Frre to act but must disclose info publicily
- Outcome-based: Prescribed end results that are tolerated.
Types of regulatory regime
5
- Unregulated markets: Well informed parties, don’t require regulation.
- Voluntary codes of conduct: Effective if theres buy in. Incentive to refuse to follow.
- Self-regulation: Operated by mkt participants, threat of intervention if fail
- Statutory regulation: Setup and Policed by Gov. Most systems mixture
- Professional Bodies: Ensure members are qualified and competent and uphold standards. PA and FSCA in SA
Advantages of self-regulation
4
- The system implemented by the people with the greatest knowledge of the market,
- Greatest incentive to achieve the optimal cost-benefit ratio.
- Respond rapidly to changes in market needs.
- May be easier to persuade firms and individuals to co-operate with a self-regulatory organisation than with a government bureaucracy.
Disadvantages of self-regulation
3
- The closeness of the regulator to the industry it is regulating. The danger that the regulator accepts the industry’s POV and is less in tune with 3rd parties.
- Can lead to a weaker regime than is acceptable.
- May inhibit new entrants to a market (existing participants frame rules)
Advantages of statutory regulation
3
- Less open to abuse
- Higher degree of public confidence
- Regulator can be run efficiently by splitting by function of regulation.
Disadvantages of statutory regulation
2
- High cost
- Cannot respond rapidly to change
Roles of the central bank
7
- Control the money supply
- Determine interest rates, inflation rates, exchange rates
- Target macroeconomic features such as growth and unemployment
- Ensure stability of the financial system
- Lender of last resort to commercial banks
