Regulatory Risk Flashcards
How can banks be Regulated?
The financial crises has raised the question of how banks should be regulated. There could either be:
- Statutory Regulation
- Self-Regulation
What are the benefits of Self-Regulation?
- Less red tape, so fewer regulation costs are passed onto customers
- Before government regulation banks held much more capital and self-regulation was effective
- Incentives, rather than rules encourage self-regulation
- Additional rules did not stop the banking crises in 2007
What are the Benefits of Statutory regulation?
- The economy depends on banks, so regulation must be stringent
- Banks only pay lip service to self-regulation
- There is no such thing as safe highly leveraged institution
- So far, self-regulation has been weak
- If firms are too big to fail they must be regulated from the outside
What is Corporate Governance?
Corporate Governance is the relationship between a firm’s directors, its shareholders and stakeholders
- Management, awareness, evaluation and mitigation of risk are all definitions of good governance
- Willingness to apply the spirit and letter of the law
- Good supervision and management enhances performance
- Accountability to shareholders and stakeholders is key
- Attracts new investment into companies
- Underpins capital market confidence in the firm
- Provides a framework for a firm to pursue its strategy in an ethical and effective way
Which independent UK regulator promotes high standards of Corporate Governance and how?
The Financial Reporting Council through the Combined Code – last updated in 2014 – but 2008 used here ***
What does the Combined Code 2008 consist of?
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Board Structure
- The Board – responsible for the company’s success
- Board Balance – mixture of directors and NEDs
- Chairman and CEO – should be separate
- Board Appointments – formal, rigorous selection procedure
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Board Performance
- Re-election – at regular intervals, subject to good performance
- Remuneration Procedure – independent, formal and transparent
- Remuneration – sufficient to attract, retain and motivate
- Performance Evaluation – rigorous annual evaluation
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Control
- Financial Reporting – a balanced and understandable assessment
- Internal Controls – robust to safeguard assets
- Audit Committee and Auditors – maintaining internal control procedures
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Shareholder Relations
- Relations with Shareholders – dialogue based on mutual objectives
- Constructive Use of the AGM – to encourage participation
- Shareholder Voting – shareholders should use votes carefully
What was the Walker Review and what were its specific recommendations?
- Recommendation 23 – board should establish a board risk committee separately from the audit committee for oversight of risk exposures and future risk strategy
- Recommendation 24 – board should be served by a CRO (Chief Risk Officer) who should report to the CEO and the board risk committee
- Recommendation 25 – the board should have access to external input to help with its work
- Recommendation 27 – the board risk committee should produce a separate risk report for the annual report and accounts
- Recommendation 26 – for strategic acquisitions or disposals, the board risk committee should oversee a due diligence appraisal
What is the Role of the Board?
- Leadership and prudential control of the firm
- Meeting its obligations to shareholders
- Making entrepreneurial decisions
- Chairman leads the board
- Company secretary ensures good information flows within the board and its committees
- NEDs scrutinize and challenge the board and help develop strategy
What is the Role of the Remuneration Committee?
- Develop a remuneration policy to attract, motivate and retain directors
- Appointing consultants to help decide remuneration
What is the role of the Audit Committee?
- Should comprise of at least 3 (or 2 for smaller firms) NEDs
- Members should have recent and relevant financial experience
- Focus on the correctness of financial statements and the effectiveness of internal controls
What is the role of the Risk Committee?
- Assist the board in assessing the different types of risk the firm is exposed to
- Must be composed of at least 3 members and majority should be NEDs
- Chairman must be a NED
- Help define risk appetite and to monitor the effectiveness of risk management across the firm
- Encourage a risk awareness culture
What is Due Diligence in Risk Oversight?
Due Diligence in Risk Oversight looks at risk scenarios and sets about an approach to deal with the risks:
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Risk Assessment Areas:
- Customer type and behaviour
- Products and services
- Delivery channel and location
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Questions
- Risk posed by customer product mix?
- Customer interface with the firm?
- Risk posed by customer?
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Monitoring
- Sudden increase in activity
- Strange transactions
- Peaks of activity at certain places
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Mitigation
- Systems to identify unusual activity
- Asking additional questions
- Applying customer due diligence
What is the importance of Culture and Leadership?
A firm’s risk culture encompasses the general awareness attitude and behaviour towards risk
- The CEO should lead by example to develop risk culture
- The internal control culture sets lines of responsibility and segregation of duties
- A good risk culture should be embedded within the firm
What is Moral Hazard?
The risk that the presence of a contract will affect the behaviour of one or more parties. E.g. and agent might act irrisponsibly to the principal if they know they won’t be affected. A bank will take silly risks if it knows the govn will bail them out.
- A party insulated from risk may behave differently
- Related to information asymmetry (one party has more info than another)
- Individual does not take full responsibilities for actions
What did the Financial Services and Markets Act 2000 give the FSA?
Regulatory powers and 4 objectives:
- Market Confidence – to maintain confidence in the financial system, included all regulated firms, markets and exchanges
- Financial Stability – contributing to the protection and enhancement of the UK financial system
- Protection of Consumers – to secure the appropriate degree of protection for consumers
- Reduction of Financial Crime – to reduce the extent to which the financial system can be used for crime
