Chapter 8: Regulation of financial services Flashcards
Principal aims of regulation
- promote efficient and orderly markets
- protect consumers of financial products
- maintain confidence in the financial system
- help reduce financial crime
How can the principal aims of regulation be met in practice?
- Provision of information and product literature.
- Authorisation of financial service providers.
- Supervision of authorised firms.
- Ensuring sufficient liquidity in marketplace.
- Provision of settlement systems.
- Compensation schemes for breaches of the regulations.
Costs of regulation
Direct costs:
- costs arising in administering the regulation - borne ultimately by the investor
Indirect costs:
- arise from changes in behaviour, both of consumers and regulated firms, to react to the regulators.
- sense of diminished professional resposibility in intermediaries and advisors
- reduction in consumer protection mechanisms developed by the market
- reduced product innovation
- reduced competition
Need for regulation in financial markets compared to other markets
Greater than for other markets due to:
- importance of confidence in the financial system
- damage that would be done by systemic financial collapse
- professional market participants likely have superior knowledge to general public = protect them from abuse by professionals
Forms of regulation
- Prescriptive
- Freedom of action
- Outcome-based
Types of regulatory regime
- Unregulated markets
- Voluntary codes of conduct
- Self-regulation
- Statutory regulation
- Mixed regimes
Prescriptive regulation
Detailed rules setting out what may and may not be done
Freedom of action regulation
Freedom of action but with rules on publicity so that third parties are fully informed about the providers of financial services
Outcome-based regulation
Freedom of action but with prescribed outcomes that will be tolerated
Unregulated markets
Where cost of regulation often outweigh the benefits.
Still subject to general trading and other laws applicable in particular legal jurisdiction.
Voluntary codes of conduct
Operate effectively in many circumastances but vulnerable to lack of public confidence or few rogue operators refusing to cooperate = breakdown of the system.
Self-regulation and
advantages & disadvantanges
Organised and operated by participants in a particular market without government intervention.
Advantages:
- Implemented by those with the greatest knowledge of the market & highest incentive to maximise benefits and minimise costs.
- Able to respond rapidly to changes in market’s needs.
- Easier to persuade firms and individuals to cooperate.
Disadvantages:
- Closeness of regulator to industry it’s regulating = side with industry.
- Consumers may lack confidence in the regulator.
- May inhibit new entrants into the market.
Incentive of self-regulation
Regulation is an economic good that consumers of financial services are willing to pay for & which benefit all participants.
Threat by government to impose statutory regulation if unsatisfactory system is implemented.
Statutory regulation and
advantages and disadvantages
Government sets out rules and polices them.
Advantages:
- less open to abuse
- may command a higher degree of public confidence
Disadvantages:
- may impose unnecessarily costly rules that don’t achieve desired aim
Mixed regimes
Mixture of all systems described above.
Regulations often developed by market-driven private institutions (like stock exchanges) as well as governments.
