Lecture 8 Flashcards
Why must the financial sector be regulated?
Due to the presence of asymmetric information problems:
Adverse selection
Moral hazard
What is adverse selection?
A market situation where buyers and sellers have different info so that a participant might participate selectively in trades which benefit them at most, at the expense of the other party
E.g. used cars, insurance
What is moral hazard?
One party has not entered into the contract in good faith
Or had provided false details about its assets, liabilities or credit capacity
E..g borrowing/insurance, observe a change in behaviour
What do we aim to achieve with regulation?
- Protect the consumer against monopolistic exploitation
- Provide smaller, less informed, clients protection
- Ensure systematic stability
What is an example of network effects?
The use of a credit card company
The more a particular payment method is used and accepted as a medium of exchange, the _______ the ________________ that can be extracted by the providers of that standards
- Greater
- Monopoly rents
Monopolistic exploitation- what must the regulator ensure?
Fair and open competition
Reasonable access to these services
What are the different types of risks that consumers may face in their financial affairs?
Prudential risk
Bad faith risk
Complexity/unsuitability risk
Performance risk
What is prudential risk?
The risk that a firm collapses because of, for eg, inadequate capital
What is bad faith risk?
The trick from fraud, misrepresentation, deliberate misselling or failure to disclose relevant info
What is complexity/unsuitability risk?
The risk that consumers take on a financial contract that they don’t fully understand
What is performance risk?
The risk that investments don’t deliver the hoped returns
Is it the regulators role to insulate the consumers from performance risk?
No - this risk is permanent in financial products
What are banks’ roles in the financial system?
Allocate resources
Monitor borrowers
Play important roles in clearing and payments systems
How do banks allocate resources efficiently?
By screening borrowers and identifying firms with the most promising prospects
Why do banks monitor borrowers?
To make sure the funds are used properly
What are banks considered to be prone to, what does that mean and what does this lead to?
Prone to runs;
The threat of failure
Perceived threat
Leads to contagion effects absent in other sectors of the economy
Underpinning the regulatory system, ______ banks play a key role as the _________________ who is responsible for ____________________
- Central
- Lender of last resort
- The provision of liquidity under systematic crisis
If there’s a run on the banking system, the lender of the last resort provides what? What does this create and why?
The ultimate liquidity in order to stave off systematic failure
Created moral hazard bc banks know that they’ll be bailed out, so may ‘gamble for resurrection’.
What is the Bank for International Settlements (BIS)?
A international financial institution owned by central banks for foster international monetary and financial cooperation and serves as a bank for central banks
How does the Bank for International Settlements carry out its work?
Through its meetings programmes
Through the Basel Process - hosting international groups pursuing global financial stability and facilitating their interaction
Where is the Bank for International Settlements based?
Basel
Switzerland
Representative offices in Hong Kong and Mexico City
What are the difficulties of regulation?
Cost
Innovation and competition
Globalisation of markets
Capture
What are the costs of regulation incurred by?
The regulator and the regulated
Includes staffing of the regulatory office and
Development of guidelines
Costs of compliance
