Post Crisis Regulation Flashcards
What was the Great Moderation?
In economics, the Great Moderation was a reduction in the volatility of business cycle fluctuations starting in the mid-1980s, believed at that time to be permanent, and to have been caused by institutional and structural changes in developed nations in the later part of the twentieth century. This led people to believe that risk generally had declined so everyone poured into asset markets because risk had gone, and of course risk had not gone
What arguments were made about securitisation?
How did it lead to the financial crisis?
It was argued that a distinction should be drawn between complex instruments such as ‘collateralised loan obligations (CLOs) and collateralised debt obligations (CDOs) which brought new technology to the capital markets and heightened risk’ and the ‘simple, straightforward and traditional securitisations’.
The Credit Rating Agency Standard and Poor’s, according to one report, admitted that it could ‘take a whole weekend for computers to perform the calculations needed to assess the risks of complex CDOs’. Some witnesses suggested that bank bosses did not have a firm grasp of what their employees (quantitative traders) were doing.
Pre-2008 what was the relationship between growth, leverage and post-2008 casualty?
The Bank of England’s October 2008 Financial Stability Report observed that major UK banks almost tripled their assets between 2001 and 2007 and those firms that showed the greatest appetite for rapid growth, through leverage are amongst the heaviest casualties. Increased debt simply led to increased risk.
What post-crisis observations were made about Corporate Governance?
Post crisis observations revealed that weaknesses in governance, incentives and infrastructure undermined the effectiveness of risk controls and contributed to the systemic vulnerably of banking. These failures reflected 4 challenges in governance:
- The unwillingness or inability of boards of directors and senior managers to articulate, measure and adhere to a level of risk acceptable to the firm
- Arrangements that favoured risk takers at the expense of independent risk managers and control personnel
- Compensation plans that conflicted with the control objectives of the firm
- An inadequate and often fragmented infrastructure that hindered effective risk identification and measurement
What is the post-crisis regulatory landscape look like?
The Bank of England: The Bank of England is committed to promoting and maintaining monetary and financial stability. 3 core purposes:
- Maintaining the integrity and value of the currency
- Maintaining the stability of the financial system, both domestic and international
- Seeking to ensure the effectiveness of the UK’s financial services
The Financial Policy Committee (FPC): In the support of BOE objectives, the FPC which is charged with identifying, monitoring and acting to remove or reduce any systemic risks. It also has a secondary objective to support the economic policy of the Government.
The Prudential Regulation Authority (PRA): The PRA works alongside the FCA creating a twin peaks regulatory structure in the UK. The PRA has 2 statutory objectives to:
- Promote the safety and soundness of these organisations; and
- Secure an appropriate degree of protection for policy holders/investors
The Financial Conduct Authority (FCA)
The FCA is responsible for promoting effective competition and ensuring that markets operate with integrity. The main powers granted to the FCA include:
The European Systemic Risk Board (ESRB): The ESRB came about in 2010. It is tasked with identifying and warning about systemic risk and collaborating with international financial organisations such as the International Monetary Fund (IMF) and the Financial Stability Board (FSB) as well as the relevant bodies in third countries on matters related to macro-prudential oversight
European Supervisory Authorities (ESAs): The ESAs work with the ESRB to ensure financial stability and to strengthen and enhance the EU supervisory framework. They aim to improve coordination between national supervisory authorities, and to raise standards of national supervision across the EU. It comprises:
- European Banking Authority (EBA)
- European Securities and Markets Authority (ESMA)
- European Insurance and Occupational Pensions Authority (EIOPA)
What investigations were done in response to the financial crisis?
Special Resolution Regime (SRR) provided a range of powers including, allowing the authorities to take control of all or part of a bank (or of its assets and liabilities) through a ‘bridge bank’, appointing a suitable person to oversee a bank in the SRR, providing financial support and if necessary, to facilitate fast and orderly payment of depositors’ claims under the FSCS.
The Turner Review 2009: identified 3 underlying causes of the crisis:
- Macroeconomic imbalances
- Financial innovation of little social value; and
- Significant deficiencies in bank capital and liquidity regulations
The Turner Review made the following recommendations:
- Fundamental changes to bank capital and liquidity regulations and to banks’ published accounts
- More and higher quality capital bank capital, with several times as much capital required to support risky trading activity
- Counter-cyclical capital buffers
- A central role for much tighter regulation of liquidity
- Regulation of ‘shadow banking’ activities on the basis od economic substance not legal form
- Regulation of credit rating agencies to limit conflicts of interest and inappropriate application of rating techniques
- National and international action to ensure that remuneration polices are designed to discourage excessive risk-taking
- Major changes in the regulators supervisory approach, building on the existing Supervisory Enhancement Programme (SEP)
- Major reforms in the regulation of the European banking market
The Vicker’s Independent Commission on Banking 2010: The ICB concluded that the best way to prevent another financial crisis was to separate retail banking operations from investment/wholesale banking functions, effectively creating a ring-fence around personal and SME deposits and lending.
- Capital: the largest ring-fenced UK retail banks will be required to hold equity capital equivalent to 10% of their risk-weighted assets (RWAs)
- Competition: the ICB called for improved processes for customers to switch accounts and greater transparency so that customers can compare prices
- Structural reform: under ring-fencing, banks will be required to create separate standalone subsidiaries with their own governance arrangements.
What is the post-crisis corporate governance landscape?
The Walker Report: made several recommendations that are consistent with best practices identified in the UK Corporate Governance Code, including:
- Risk Committee: The Risk Committees should be chaired by a NED. It should have the power to oversee, and prevent if appropriate, large-scale transactions.
- Remuneration: A Remuneration Committee should scrutinise pay across the whole organisation with particular attention to the remuneration packages of senior executives who are not on the board of directors. For bonuses to provide appropriate medium to long-term incentives, the report concluded that they should include a significant deferred element.
- Non-executive Directors: The committee recommended that non-executive directors be subject to greater scrutiny by the (then) FSA as part of its authorisation process, and that they be required to spend up to 50% more time in the job.
