Chapter3-Regulation

Question 1

Framework

Answer 1

1 Aims of regulation
2 Costs of regulation
3 Need for regulation
4 Ensuring confidence in the financial system
5 Reducing asymmetries of information
6 Anti-selection vs moral hazard
7 Implications of information asymmetry(advantage policyholder)
8 Forms of regulation
9 Main Functions of a regulator (SERVICE)
10 Types of regulatory regime
11 Advantages and Disadvantages of a self-regulatory regime
12 Advantages and disadvantages of statutory regulation
13 Problems with voluntary codes of conduct
14 Influences on policyholder expectations
15 Treating customers fairly
16 Central bank functions as part of the regulator
17 State and large market participants as regulatory support

Question 2

Aims of regulation

Answer 2

Give all stakeholders confidence in the financial system

Reduce financial crime

Inefficiencies (correct them) in the markets and promote efficient and orderly markets

Protect consumers

Question 3

Need for regulation

Answer 3

Firstly, confidence in the financial system is important.

There is a risk that if one company collapses, it can cause a systemic financial collapse of the system.

Secondly, there is an asymmetry of information, expertise and negotiating power that exists between the product provider and the end customer.

These issues are made worse by the fact that:

financial transactions are often long term in nature and can have a big impact on the future economic welfare of individuals

in general, most of the population is not well educated on financial matters and find the range of products offered both complex and confusing.

Question 4

Forms of regulation

Answer 4

Prescriptive - detailed rules on what can and can’t be done

Freedom of action - freedom but with rules on publicity

Outcome-based - freedom but with prescribed tolerated outcomes

Question 5

Main functions of a regulator

Answer 5

Setting sanctions

Enforcing regulations

Reviewing and influencing government policy

Vetting and registering firms and individuals

Investigating breaches

Checking management and conduct of providers

Educating consumers and the public

Question 6

Types of regulatory regime

Answer 6

Self-regulatory systems, which are organized and operated by market participants without government intervention

Statutory regimes, where the rules are set and policed by the government

Voluntary codes of conduct, where there is choice as to whether to adhere

Unregulated markets / lines of business, with no regulation

Mixed regimes, involving a combination of the above

Question 7

Advantages and Disadvantages of a self-regulatory regime

Answer 7

+ Implemented by the people with the greatest knowledge of the market, who have the greatest incentive to optimise the cost-benefit ratio

+ Should respond quickly to changes in market needs

+ Should be easier to persuade firms and individuals to co-operate than under statutory regulation

– The closeness of the regulator to the industry, leading to low public confidence

– May inhibit new entrants to a market

Question 8

Advantages and disadvantages of statutory regulation

Answer 8

+ Less open to abuse

+ Instils more public confidence due to government involvement

+ Should be more efficient if economies of scale can be achieved, eg grouping by function

– Costs and inflexibility

– Outsiders may impose rules that are unnecessarily costly, inefficient and which may not achieve the desired aim

– Government may be inexperienced in regulation (eg if regulation is being established for the first time or in new areas)