Chapter two - International Risk Regulation. Flashcards
What is the BIS and the role?
Bank for international settlements, serves as a bank for central banks and international organisations. It provides a focus point for regulations
What is the Basel Committee?
Improves the quality of banking supervision. They ensure that banks have sufficient reserves to withstand specific levels of risk. It is the primary global standard-setter for the prudential regulations.
what are the capital adequacy requirements
Pillar 1 - semi-formulaic approach to the calculation of the minimum level of capital which a firm should have
Pillar 2 - enables the firm to offer its own view of the level of capital and liquidity it should hold. This is known as the internal capital and liquidity assessment. Banks apply a process called ICAAP (internal capital adequacy assessment process)
Pillar 3 - Public disclosure of certain prescribed aspects of the firm’s capital and approach to risk management.
what was introduced after the 1929 Wall street crash in the US?
Deposits insurance and central banks “Lender-of-last-resort” provisions were introduced to reduce risk of future bank runs, but this caused moral hazards.
What are the two types of capital?
Economic - Bank’s best estimate of the capital it needs to manage its own risk profile.
Regulatory - The mandatory level of capital which a regulator requires a bank to hold.
What are the core principles for effective banking supervision?
1 - sound macroeconomic policies
2 - well-established framework for financial stability
3 - well-developed infrastructure
4 - clear framework
5- mechanisms for systemic protection
6 - effective market discipline
how many core principles for effective banking supervisions are there and how are they categorised?
29
1-13 = supervisory powers, responsbilties and functions
14-29 = supervisory expectations of banks, emphasises the importance of good corporate governance and risk management, as well as compliance with supervisory standards.
What is the Basel accord and the three pillars?
The basel accord aims to encourage improved risk management through the use of three mutually reinforcing pillars.
Pillar 1: Minimum regulatory capital requirements - this involves applying “formulaic” methods for calculating the regulatory capital. This is expressed as capital/credit risk + market risk + operational risk =/ 8%
Pillar 2: Supervisory review process - this involves firms submitting information and enables the regulator to assess the amount of capital that should be held. This involves (Risks not covered under pillar 1, the way that risk is managed, quality of controls infrastructure, the way in which the calculated risk profile relates)
Pillar 3: Market discipline - firms are required to publish information about the way they face the risks.
what are the two new liquidity requirements in the Basel accord?
Two new liquidity requirements: Net stable funding ration (NSFR) and the liquidity coverage ration (LCR)
What is a sound practice principle?
This is produced from time-to-time and provides guidance for firms. These cover areas involve:
- operational risk, credit risk, interest rate, liquidity risk
What are UK Investment management firms subjected to the new investment firms prudential regime (Known as IFPR or the New Regime) required to perform?
Perform an internal capital and liquidity assessment, which meets the Pillar 2 requirements.
This requires firms to submit risk, capital and liquidity information
what are the key elements of the internal capital and liquidity assessment framework?
- The firms Risk exposure - provides clear risk appetite, may include insurance risk, pension obligation risk.
- The firms view on the adequacy of its risk management processes
- The firms financial and capital plans
- Stress and scenario tests applied by the firm to its risk and financial plans. (Stress testing - varying one input factor at a time) (Scenario analysis - constructing realistic scenarios)
What is the “Use test”
The extent to which risk-based decision making is embedded within the firm.
Evidence would include:
- senior management or board challenge, review and sign-off procedures
- The extent to which the internal capital and liquidity assessment is part of the firms capital and liquidity management process.
What is the last stage in the supervisory review process?
For the regulators to set the amount of capital and liquidity which the firm must hold.
what are the benefits for an internal capital and liquidity assessment process?
Business strategy - seniors can become more diligent in their inclusion of risk factors earlier
Risk Assessments - take more seriously.
What does the framework focus on for banks that operate in more than one country (multi-jurisdiction)
Provides a framework for multi-jurisdiction supervision, this focuses on potential issues with international banks solvency, liquidity, and foreign exchange positions, and requires the home regulators to communicate closely.
What are the main home/host principles?
Main one: the parent banks and parent supervisory should monitor the risk exposure of the banks.
- all international banks should be supervised
- the creation should receive prior consent
- home country has access to information
- home country can prohibit
What are the two regulatory risk approaches to financial regulation?
Statutory
- based on specific legal rules which must be obeyed. For example , in the US - SEC
- People operating in compliance may before this
Principle-based approach
- types of behaviours that are expected of firms and individuals and is practised by the UK regulatory authorities
- Deemed to be impossible to write a rule for every situation, so it is favourited
How does the FCA supervise the UK?
Stems from the financial services act 2012- this act requires it to maintain arrangements to determine if people comply with this act.
the main objectives are to: Protect customers, maintain competitiveness, protect financial markets
How does the FCA reduce risks? how are risks assessed?
- firms must permit representatives of the FCA
- FCA uses mystery shoppers
Risks are assessed in terms of:
- impact (the effect on consumers and market)
- probability (likelihood of particular issue occurring)
How does the FCA protect customers?
The FCA uses term conduct risk.
Has FCA’S 11 Principles to protect customers
first five = refer to behaviours and arrangements that indirectly affect customers outcomes
next five = behaviours and arrangements that direct affect customer outcomes
last one = covers relationship between firm and regulator.
What does regulators conduct of business standards address?
addresses the way in which business is done, particularly the way that products are marketed, distributed and sold.
Payment Protection insurance = wasn’t beneficial
What is the senior managers regime?
These standards focus on individuals who hold key roles in firms. Firms must carry out senior management functions and prepare statements of responsibilities.
Firms are also legally required to have procedures in place./
what are the supervisory standards?
what are the regulatory standards?
- requirements on the provision of information
- rights of access that a regulator has
- the frequency of regulatory reviews and risk assessment visits
regulatory
- levying fines, forcing firms to compensate, appointing a third-party expert, removing a firms licence.
What do risk-based regulatory reviews and visits cover?
Firms with significant retail or wholesale assessed on?
Firms who hold client money assessed on?
What is created if risk shortfalls are identified?
Assessed on:
- management, control functions, anti-money laundering, capital and liquidity
For firms with significant retail or wholesale business:
- customers, products, markets
Firms who hold control client money
- arrangements for its safeguarding
shortfalls
- risk mitigation program
what is the definition of each Pillar in Basel accord?
Pillar 1 = minimum
Pillar 2 - supervisory review
Pillar 3 - market discipline
where does statuary risk strategy take place?
US SEC
What is the formula for Pillar 2?
Capital/Credit risk+Market risk+operational risk = >8%
what would be the evidence used for a “use test”
relevant notes from the meeting
what is the benefit of a principles-based model?
Allows flexibility dealing with different situations
what does the Basel 29 principles suggest>
The global standard for sound banking regulations and supervision
what does moral hazard mean and example?
what is one feature which pillar 2 includes?
quality of controls infrastructure
