Intro 2

Question 1

What happened with Corona crisis?

Answer 1

Many people lost their jobs (especially in the entertainment sector), hence, their ability to spend decreased. Moreover, if we assume that these people all of a sudden cant pay their mortgages we go back to the financial crisis from 2008.

Question 2

What is still an effect from 2008 crisis?

Answer 2

The negative interest rates or 0 IRs in some central banks to stimulate the economy

Question 3

Why we had 2008 crisis?

Answer 3

A lot of mortgages given to subprime borrowers and all of a sudden they started to default and top of that about 25% were strategic, because house prices fell down and people thought why to pay 2x the current price. And if the legal state is not as good, you might or not ruin your credit score, f. e. in US you can move to another federal state. And then the banks had to sell the houses at loss.

Question 4

Why are banks heavily regulated?

Answer 4

Banks play an important role in financial crisis. Every couple of years FC happens and sometimes its severe, sometimes its not

Question 5

Why do we need regulation acc to basic economic theory?

Answer 5

Markets usually work pretty well, but need to be regulated in the case of market failure.

Question 6

What is market failure?

Answer 6

Market failure is whenever a market doesn’t deliver a Pareto-efficient allocation of resources: one in which its not possible to improve one person’s situation without making someone else worse off.

Question 7

The first theorem of welfare economics

Answer 7

the free market will achieve a Pareto-eff outcome provided that there’s perfect competition, full information and no externalities.
In practice, however, the competition isn’t perfect, info asymmetries exist, and externalities are rampant(inifinte)

Question 8

Fin regulation is there to help with:

Answer 8

a) Protection against monopolies (competition is not perfect)
b) Consumer/ Investor protection (asymmetric info)
c) Systemic risk (from externalities) – for instance, banks are interlinked with each other and you don’t want the whole system to break down
d) Efficiency of monitoring

Question 9

Most economic reg is concerned with

Answer 9

preventing unwanted concentration of market power. Most of finance is pretty competitive, not so much a problem (although for example the Dutch banking system is extremely concentrated, which is a problem because if one of these banks fail the consequences will be affecting a lot of people)

Question 10

Protection against monopolies: One potential issue

Answer 10

platform effects - Its often efficient to use a single system (example: single payment system). A platform becomes more useful, the more other people will use it and then it gains some degree of monopoly power.
This allows companies to exploit people: In the US credit card companies charge 2-3% for a purchase using a card, even though costs are marginal.

Solution: regulate as a utility

Question 11

Consumer protection

Answer 11

Many retail consumers of financial products often lack info and understanding of fin products. Thus, they need to be protected against themselves.

Question 12

Risks to customers

Answer 12

a) Banks /insurance/ fund screwing the customer over - To prevent this, there is Conduct of Business regulation
b) Banks /insurance/ fund failing / collapsing – there is Prudential Regulations = regulating liquidity, solvency, riskiness, and general health of an institution

Question 13

2 types of prudential regulation

Answer 13

1. Micro-prudential regulation aims to maintain solvency of individual institutions.
2. Systematic (macro-prudential) regulation aims to prevent contagion and widespread financial crisis.

Question 14

Conduct of business / Behavioral regulation

Answer 14

•Includes regulating information disclosure, competence, fair business practices, marketing of products, honesty and integrity,etc
Example: life insurance – Turned out that only a fraction of the insurance premia was actually invested, most of it went to ”investment fees” instead.
•Regulatory tools: Licensing, (escalating) fines, entry qualifications, ethics standards, ombudsmen, etc. Can be self-regulated or externally imposed.

Question 15

Types of investors

Answer 15

1. Institutional investors (pension funds, hedge funds, so on) can be expected to be in a better position to evaluate an offer than a typical household investor
2. Retail investors are likely to be less savvy / knowledgeable / experienced due to infrequent purchases, lack of repeated interactions, higher cost of acquiring information, limited ability or time to acquire the necessary skills. Even less ability to evaluate the soundness of an institution as a whole. Moreover, retail investors may not be able to monitor long-term contracts and even if through monitoring observe bad policy, unlikely to be able to change the institution’s course due to small size. Fin contracts are often acquired based on advice from professional advisors that have their own conflicts of interests. In addition, fin contract / investment may represent a much larger share of his/her wealth than a typical institutional investor

Question 16

Which is regulated more heavily - institutional or retail investment?

Answer 16

retail investment

Question 17

Reasons for prudential regulation

Answer 17

1. Asymmetric info: very difficult for consumers to judge solvency of fin institutions , so market unlikely to function.
2. Moral hazard: The value of an investment or contract is determined by the behavior of the institution after signing the contract and handing over your money
3. There’re very large potential losses, and there’s a potential claim on a compensation or deposit insurance fund. Prudential reg is also partly aimed at protecting the interests of those who finance a safety net (tax payers are financing the bail out)
4. In addition to these, there’re also Systematic rationales for regulation:
   Whenever there’re large social costs (externalities) of a failure of a fin institution an these externalities aren’t included in the decision-making of the financial institution, there’s a case for additional regulation

Question 18

Banks are inherently

Answer 18

unstable and contagious. One bank failure is likely to lead to others due to panics, credit exposure, and asset firesales. The failure of a bank immediately causes a credit crunch affecting both firms and households. Failing banks often have to be bailed out at considerable expense to the taxpayer and ultimately higher taxes, depressing the economy further.

Question 19

What is included to see what happens if a bank is unable to pay its debts

Answer 19

stress test

Question 20

Although all fin institutions merit regulation, banks are generally considered especially in need of regulation, because they’re:

Answer 20

a) Unstable due to maturity mismatch
b) Interlinked with other banks
c) Main or only source of lending for large n of borrowers
d) There’s moral hazard associated with gov or CB acting as lender of last resort
e) Manage the payment system

If other fin institutions fail, its less likely to cause contagion, doesn’t disrupt the payment system, there’s often no lender of last resort, and they usually hold liquid assets that can be sold off easily

Question 21

Many fin contracts are

Answer 21

long term and need constant monitoring due to principal-agent problems – the value depends on the actions of the fin institution after the contract is signed
If every consumer’d monitor individually the incentives to do so’d be low and lead to lots of duplication and free riding . Therefore a specialized monitoring task may be more efficient.

Question 22

Public choice theory

Answer 22

Fin Reg is offered in response to consumer demand, but not offered in a market setting. Therefore its likely to be over or under supplied. Fin Reg that eliminates all possibility of failure is likely to be too excessive (cost outweigh benefits). To some extent, regulating risks from investors regulates the very function of financial contracts. Reg may crowd out necessary monitoring by consumers (the moral hazard of reg)
-> Consumers assume safety and good conduct, while firms only seek to narrowly comply with regulatory requirements

Question 23

Although the perceived cost of reg to voters is basically free, there’re some real costs:

Answer 23

a) Services not offered due to f.e. high entrance barriers
b) Lack of entrants decrease comp, increase p
c) Compliance costs passed on to consumers

These costs are hard to measure, and so some argue that reg is oversupplied

Question 24

The threat of under regulation

Answer 24

Issue of reg arbitrage – firms domiciling the most regulatory favorable jurisdiction. Leading to a race to the bottom in an attempt to attract investment, resulting in an undersupply of reg and the exposure of consumers to unnecessary risk or could lead to under taxation
Some see the race to the bottom effect as inherently damaging, others see it as a healthy counter to the threat of overregulation

Question 25

the Delaware effect

Answer 25

The assumption behind the Delaware effect is that in the competitive regulatory environment, governments have to remove their regulatory barriers to allow easier functioning of their corporations and to attract new companies to establish their business.

Question 26

In recent years there has been a shift in emphasis from

Answer 26

external reg to practices encouraging improved internal monitoring and self-reg

Question 27

Banks and financial institutions have gotten increasingly large and complex due to

Answer 27

the to increase use of (credit) derivatives, securitization, off-balance sheet vehicles, etc. One idea that gained popularity before the FC was to let banks manage their own risk and the job of regulator is to guide, improve and validate the internal risk-monitoring mechanisms. This was a large part of the Basel 2 reforms.

Question 28

Dutch fin reg architecture

Answer 28

Prudence type reg: De Nederlandsche Bank (DNB) the CB of Netherlands
Business Conduct reg: Authoriteit Financiele Markten (AFM)

Question 29

How regulation started (in the Netherlands)

Answer 29

with the VOC company, which united different companies from dutch cities that had been competing for trade with the East Indies, and had even been damaging each others ships. So Johan van Oldebarneveldt united them into 1 government sanctioned monopoly – VOC and came up with the idea to issue shares to the public which was in turn allowed to freely trade these securities. These action proved very volatile as rumors about ships could influence the p by 30%.

Question 30

The first regulation in NL and brief history

Answer 30

Initially no role for the goov – self-reg trough the VvdE. The stock market had its own rules and regs that it would enforce by delisting companies that didn’t comply (lot of stock markets remain largely self-reg - NASDAQ)
Emergency law in response to the 1914 stock market crash – Beurswet 1914. After which, you needed a permission from the Ministry of Finance to start stock exchange.
In 1946 Beschikking Beursverkeer extended this, and after that in order for a company to get listed, it needed permission from the Ministry of Finance

Question 31

The European Economic Community (forerunner of EU) started issuing directives that had to be implemented into Dutch Law (3)

Answer 31

a) 1979 – directive on admission guidelines to stock markets
b) 1980 – directive on requirements for IPO prospectuses
c) 1982 – directive on fin disclosure by publicly listed firms

These were implemented through changes to the fondsenregelement of the Amsterdamse Effectenbeurs.

Question 32

In 1985 the Wet effectenhandel for the first time regulated

Answer 32

stock trading outside stock exchanges, and in 1990 was partly replaced by the Wet toezicht beleggingsinstellingen. The first real fin reg in the Netherlands can be considered the 1989 arcticle 336a in the Wetboek van Strafrecht which made insider trading a crime, implemented another 1987 EEC Directive

Question 33

It was also decided that the enforcement should come from an independent entity AFM, and not the

Answer 33

Ministry of Finance
The 1992 Wet toezicht effectenverkeer stated that the government has a duty to insure the functioning of fin markets. And investor protection Is mainly served by maximizing disclosure and transparency

Question 34

Wet op het financieel toezicht:

The WTE and WTB were

Answer 34

changed to implement new rules on public procurement and f.e. the EU Directive on Market Abuse from 2003
Finally in 2007 all different laws merged into Wet op het financieel toezicht (WFT), which formalized the “Twin peaks” model of functional supervision separating prudential and transsparancy supervision in 2 different agencies – the DNB and AFM. The idea was that this’ll prevent confusion and overlapping jurisdictions.
In 2008 WFT was amended to allow the AFM and DNB to make temporary binding regulations in times of the special market circumstances (FCs)

Question 35

Twin peaks

Answer 35

have 2 regulators “peaks” that focus on the 2 most important goals of fin reg – behavioral (conduct of business, supervision, customer protection, disclosure rules, reporting rules, transparency, enforcement) and prudential (maintain solvency, liquidity ratios, equity ratios, safeguard the fin system as a whole). Behavioral supervision may require a different attitude, skillset and profile compared to prudential regulation. While micro and macro-prudential supervision are highly related and so should be done under one roof.

Question 36

The objectives and ultimate goal of Monetary policy, Macro/Micro prudential, and Conduct of Business

Answer 36

Monetary policy - Price stability and financial stability; UG: Stable economic growth (system)

Macro prudential - price stability, financial stability and soundness of financial institutions; UG: stable economic growth (system)

Micro prudential - Financial stability, soundness of financial institutions and orderly markets and fair treatment of consumers; UG: Protection of consumers (individual institutions)

Conduct of Business - soundness of financial institutions and orderly markets and fair treatment of consumers; UG: Protection of consumers (individual institutions)

Question 37

WFT

Answer 37

1. General provisions: common definitions, competencies of DNB and AFM, etc.
2. Market access of financial enterprises: Requirements for licensing for different types of financial firms
3. Prudential supervision of financial enterprises: oversights of prudential regulation for financial firms, banks, insurance companies, exchanges, etc. (DNB)
4. Pursue of Business Supervision of Financial Enterprises: applies to fin advisors, intermediaries, firms that offer fin products (AFM)
5. Market Conduct Supervision - Applies to issuers of securities, disclosure obligations, prevention of market abuse, etc. (AFM)

Question 38

The goal of WFT

Answer 38

a stable fin system with solid fin firms, efficient and transparent fin markets, generating trust in the fin system as a whole

Question 39

Both AFM and DNB have the right to demand

Answer 39

any type of info from firms to execute their duties and firms must comply. Enforcement competencies: give binding directions to firms, e g stopping the trade or issuance of a security. If a firm or entity doesn’t follow the directions within given period, they can be put under receivership. They can fire accountants and hand out fines (have been raised recently in 2009 and can be up to 2x the benefit the party enjoyed from breaking the reg)

Question 40

De Nederlandsche Bank (DNB)

Answer 40

The dutch central bank
Main duties:
1. Safeguard Financial Stability
2. Conduct Monetary Policy (through its board seat at the ECB)
2. Supervise financial institutions - ensure capital ratios, liquidity ratios, BASEL |/||/|||; large banks now supervised jointly with ECB (Single Supervisory Mechanism SSM); issue and withdraw licenses; operate the Dutch deposit insurance scheme
3. Resolution: Take over firms and liquidate if needed
4. Conduct research and provide policy advice

Question 41

Authoriteit Financile Markten (AFM)

Answer 41

The aim is to maintain confidence in fin markets through:

1. Enforcing transparency in consumer financial products
2. Enforcing insider trading laws
3. Transparency and disclosure of security issuing institutions
4. Escalating enforcement mechanisms to ensure compliance with the WFT

Main aim is to protect consumer and investors from fraud, unfair trading practices, not so much concerned with the survival of the individual firms

Question 42

Escalating enforcement mechanisms

Answer 42

A pyramid with the lowest level starting at Promoting Willingness and then moving towards enforcing compliance:

1. Persuade, instruct and advise
2. Cooperation and to respond to informal social control and prevailing standards
3. Warning, threaten to sanction
4. Fine/penalty
5. Revoke or suspend the license

Question 43

Other reg in NL include

Answer 43

Authoriteit Consument en Markt (ACM) – general anti-collusion enforcement regulator;
Authoriteit Perssonsgegevens - General privacy protection /data protection

Question 44

What are the Conduct of Business regulations, and the Prudential regulations for?

Answer 44

CoB - to prevent consumers from being screwed by the fin institutions

Prudential - to prevent collapse by regulating liquidity, solvency, riskiness and general
health of an institution