Financial Regulation Flashcards
What risks are there in the banking sector?
- Credit risk
- Market risk
- Currency risk
- Liquidity risk
- Operational risk
- Sovereign risk
- Interest rate risk
- OBS risk (off-balance sheet risk - assets or liabilities that don’t appear on a company’s balance sheet).
Why are their risks in the financial sector?
Due to the traditional banking model of “borrowing short, lending long” there’s an asset maturity mismatch. This helps banks make money but exposes them to risk. This is perpetuated by the changing dynamics in the banking sector.
What is the impact of the financial sector on the real economy?
- Provides liquidity and solvency to the wider economy.
- Supported by bond, stock and currency markets.
- Means wealth and confidence are supported by the strength, confidence and stability of the financial sector in general.
What is meant by Systemic risk?
Small problems in the financial sector that have huge implications for the economy.
What is financial regulation and who is it designed to protect?
Designed to prevent problems from spreading to the real economy. It aims to protect…
- Depositors.
- Other banks/FI’s.
- Investors.
- Taxpayers.
- Gov’t.
What are the forms of Financial Regulation?
- Macroprudential Regulation
- Microprudential Regulation
What is Macroprudential Regulation?
Regulation concerned with overall state of the banking sector and limiting any potential systemic risks (assesses the stability of the sector by analysing the financial ratios - prevents contagion occuring in the sector).
What is Microprudential Regulation?
Regulation concerned with monitoring banks individually to ensure they’re functioning properly and are each financially stable (It assesses the solvency of banks by monitoring balance sheets - prevents any systemic problems from starting).
What is Deposit Insurance?
Guarantee to savers that all/a fraction of their deposits will be reimbursed if a bank fails (intended to reassure depositors by providing a gov’t-backed guarantee that at least part of their funds will be reimbursed if a bank suffers financial problems - prevents bank runs by panicked depositors).
What is the UK Deposit insurance?
From January 2011 or present - 100% up to £85,000 per customer (from the FSCS (Financial Services Compensation Scheme)).
What are the limitations of Deposit insurance?
- Removes incentive for depositors ot start a run if they perceive their bank has become risky.
- Moral hazard problems:
- Depositor impact - takes away security concerns of depositors when they’re putting their money into bank. Might become riskier with the type of FI’s or products that they put their money into (damages FS).
- Bank impact - banks become more reckless knowing their depositors’ money is protected and not going to experience damaging bank runs in the future - get complacent and greedy with their actions knowing taxpayer will bail them out.
What are Bank Firewalls?
Requirement for banks to separate their riskier investment banking operations from their safer ‘high-street’ retail arms.
Not fair that their losses spread to the retail sector. Any losses made in the investment division doesn’t spread affect retial branch of bank.
How do bank firewalls work?
Vickers report = Ringfence Banking Operations.
Work by no transfer of client information from one division of the banking sector to another. This allows independent strategies in the division can prevail.
What are Capital Requirements?
Capital standards which require banks to hold a minimum stock of capital reserves to act as a buffer against bank losses.
Capital includes:
- Shareholder funds.
- Retained profits.
When are banks technically solvent?
