Financial regulation Flashcards
Name the 3 financial regulators
Financial Policy Committee
Prudential Regulation Authority
Financial Conduct Authority
FPC prudentials?
Macro prudential regualtion
PRA prudentials
Micro prudential regualtion
FCA prudentials
Micro prudential regulation
What is the main objective of the FPC
monitor and protect against systemic risk within the financial sector
What are systemic risks?
When there are risks embedded throughout the whole financial sector, affecting the entire banking system. Failure of one bank in one circumstance affects other banks
FPC’s role as an instructor
Instructs the PRA and FCA on how to limit systemic risks once any potential shocks have been identified. Then can advice the government on potential state intervention
Other role of the FPC
Can utilise the lender of last resort function of the Bank of England because they can provide emergency liquidity to banks
Stress tests done by the FPC
FPC performs annual stress tests to assess the health and functionality of banks to be able to identify potential shocks in the economy, been a prominent role since 2008
Role of Prudential Regulation Authority
role to maintain the stability of banks and the banking sector as a whole, preventing bank failure and systemic risk
Regulation role of PRA
PRA has the power to enact and enforce banking regulation such as reserve requirements
Main role of the Financial Conduct Authority
To protect public interest and consumers thus promoting confidence confidence in financial products and institutions
FCA and market rigging
FCA overlooks firms in the financial sector to ensure that all activity is legal and no market rigging is taking place
FCA and financial products
FCA have a regulatory to protect consumers and the public interest by banning the misselling of financial products
Example of a financial product
Life insurance
What are the 3 types of financial regulation?
Impose limits on bank lending
Deregulation to increase competition
Provide emergency liquidity
What is the basal agreement (basal III recommendations)
Regulation agreed on and recommended by industry experts and regulators to reduce the risks of bank failure and systemic risk
Deregulation of markets
reducing paper work and red tape for banks, making it easier for banks to close down or start up, reducing limits on lending
Provision of emergency liquidity
Bank of England and FPC can both provide this lender of last resort function
Prevents liquidity crises
Reduces potential collapse of whole financial market
State 4 cons of financial regulation
Liquidity assurance schemes and bailouts lead to moral hazard
Risk of regulatory capture
Information failure
Asymmetric information
What is regulatory capture
When managers or CEOs of commercial banks form relationships with regulators, influencing decision making regarding the regulation that commercial banks face.
Effects of regulatory capture
Maximum interest of society are ignored and instead regulators make decisions that best suit the private needs ad wants of commercial banks managers, leading to government failure
(Ev) Is financial regulation really needed?
Banks themselves do not want to fail because it is a business and therefore a case could be made that regulation in the form of limit lending is not necessary because commercial banks will tend to apply their own limits to protect against bank failure. So regulation may not be needed and should be left to the market unless banks are struggling or regulatory bodies like the PRA and FCA believe a bank is behaving irrationally.
Example of a bank in America that failed
Lehman Brothers
What mortgages did Lehman Brothers lend out?
Adjustable rate subprime mortgages
When did Lehman Brothers file for bankruptcy?
15th of September 2008
What are 4 types of Financial market failure?
Asymmetric information
Speculation and market bubbles
Negative externalities
Moral Hazard
Define financial market failure
When free financial markets fail to allocate financial products and services at the socially optimum level of output, resulting in a net loss of social and economic welfare
What is an example of a negative externality in the financial market failure
taxpayers having to indirectly fund government spending to prevent the collapse of major banks, like when the US government used more than $700 billion of taxpayers money to keep banks afloat in 2008
What is another key negative externality (post 2008)
After the 2008 financial crisis, banks stopped lending money to people and businesses. Firms couldn’t borrow money to reinvest and reduce costs, causing firms to cut back on factors like labour, which led to millions of people being unemployed as a result
Explain lender of resort function of the central bank
When commercial banks suffer liquidity problems, where they dont have enough short term liquid assets to meet the needs of depositors and other shirt term liabilities. Central bank steps in the provide emergency or non-emergency liquidity prevent a liquidity crisis or bank failure
Pro of lender of last resort function
protects confidence in savings and the banking sector to maintain living standards and growth
Con of lender of last resort function (liquidity assurance schemes)
Creates moral hazard. Banks know that if they are ever short of liquidity, the central bank will intervene and help
