regulation the financial system Flashcards
what are the regulatory bodies set up to oversee the financial system in the uk?
The Prudential Regulation Authority (PRA)
The Financial Policy Committee (FPC)
The Financial Conduct Authority (FCA)
what is the The Prudential Regulation Authority (PRA)
he PRA creates regulations for banks, insurers and co-operative institutions. It also helps to avoid insolvency of bank
They achieve this by monitoring adherence to rules and regulations
E.g The PRA worked with the Royal Bank of Scotland after the 2008 economic crash. To reduce effects from risky loans and poor investments, they advised them to sell parts of the bank, cut costs, and manage risks
what is the financial policy committee
The FPC was established after the 2008 recession to create financial stability
They aim to identify, track, and address risks to the financial system in the UK
To do this, they created a stress test for banks to help them withstand future economic shocks. This requires banks to be able to cover potential losses using a capital buffer
Tighter regulations on the amount individuals were able to borrow were set based on incomes. This avoids excessive lending and aims to prevent another housing bubble
what is the financial conduct authority ?
The FCA regulates financial services firms and financial markets in the UK. This ensures that they are operating fairly and in the best interest of consumers
E.g, In 2023, the FCA reviewed NatWest Group after potential data protection breaches and their management of account closures
what are the reasons banks may fail ?
high risk loan
regulation violation
Speculation & market bubbles
Asymmetric information
reasons banks may fail - high risk loans
When a bank lends too many risky loans it can result in bad debt for banks
E.g Northern Rock, a mortgage lender that was unable to manage its debts due to reckless lending practices
This resulted in a run on the bank as long queues formed outside branches when depositors tried to access their savings
reasons banks may fail - regulation violation
Banks can fail if they do not follow regulatory requirements or operate within the recommended guidelines
This may be as a result of inadequate anti-money laundering controls or interest rate manipulation
E.g, HSCB were accused of facilitating money laundering activities and failed to put in controls to monitor activities
reasons for banks to fail - speculation and market bubbles
The higher the money supply in an economy, the greater the speculation & potential for market bubbles
Significant amounts of quantitative easing since 2008 have increased the money supply & created potential bubbles in different markets (e.g. property, cryptocurrency, shares)
reasons banks may fail - asymmetric information
Many financial products are complex and difficult for consumers to understand
The sellers often have a significant information advantage over the buyers
E.g. During the financial crisis, financial institutions bundled thousands of mortgages together and sold them on to investors. The sellers had more information on the risk profile of each bundle than the buyers
E.g. Mortgage sellers often understand the implications of interest rate changes to repayments much better than the average consumer
what is a moral hazard?
occurs when an economic agent has the incentive to increase risks because if they fail someone else will face the consequences
what is systematic failure ?
Systematic failure is when a minor local problem in one country’s financial sector has international consequences
A single bank can trigger the breakdown of an entire market or even the entire financial system
