Topic Eleven Flashcards
Capital Adequacy
● Institutions must have adequate capital to ensure deposits are not placed at risk.
● Any losses made (i.e. if loan isn’t repaid) should be borne by shareholders and not by depositors
Superseded by Basel II
Came in 2007
● Basel II incorporated into the Capital Requirements Directive (CRD)
● Basel III incorporated:
o CRD IV – January 2014
▪ Capital Requirement Regulations (CRR)
▪ Capital Requirements Directive (CRD)
Purpose of Basel 2 was….
o Increase the level and quality of the bank’s capital
o Enhance risk coverage
o Reduce procyclicality
o Increase bank’s disclosure requirements
o Provide a basis for EU liquidity standards
o Introduce leverage disclosure requirements
Minimum capital requirements are given in terms of a bank’s solvency ratio, which is:
o The ratio of the banks own funds as a percentage of its risk adjusted assets (mainly loans)
o Solvency ratio must be at least 7%
Investment Services Directive (ISD) allows:
● investment firms to provide services across the EU
● Now superseded by MiFID
● Capital Adequacy Directive (CAD) set the capital requirements for investment firms
● Now replaced by CRD, which works in conjunction with MiFID
CRD sets out the minimum as:
● CRD sets out the minimum as:
o Own account dealers are required to hold capital of €730,000
o Matched principle brokers (dealing for others) are required to hold capital of €125,000
o Broker/managers must hold capital of €125,000 or €50,000 if they don’t hold client money
o Advisers are required to hold capital of €125,000 or €50,000 if they don’t hold client money
o SIPP firms are required to hold capital of €20,000
Solvency Margins for Life Insurance Companies
● Life assurance companies must maintain an adequate solvency margin
● 4% solvency margin for policies that carry an investment risk
● Assets must be at least 104% the liabilities
● The percentage is less for non-investment risk because actuaries are more confident about mortality rates than future yields on investments
● Competent Authorities – The PRA – Can relax the rules in extreme circumstances on a temporary basis
Solvency Margins for Life Insurance Companies
● Life assurance companies must maintain an adequate solvency margin
● 4% solvency margin for policies that carry an investment risk
● Assets must be at least 104% the liabilities
● The percentage is less for non-investment risk because actuaries are more confident about mortality rates than future yields on investments
● Competent Authorities – The PRA – Can relax the rules in extreme circumstances on a temporary basis
Financial Services Action Plan (FSAP)
● Encourages a single insurance services market
● EU companies can operate with a single licence in member countries
Pillar 1
▪ Balance sheet evaluation
▪ Requirement
▪ Minimum Capital Requirement
Pillar 2 Qualitative Requirements
•Qualitative Requirements
▪ System of Governance
▪ Own Risk and Solvency Assessment
▪ Supervisory Review Process
Pillar 3 – Disclosure
▪ Annual published solvency & financial condition report
▪ Information provided to the supervisors
▪ Links with IFRS2
Key points of Solvency II
o Based on principles not rules
o The firm must demonstrate governance and risk management to match its risk profile
o The key to governance is effective risk management
o If a firm uses an internal model it must be embedded into the firm including strategic decision making
o Firms must establish a risk management function
Solvency Capital Requirement (SCR) is:
the new standard by which solvency will be measured
o The risk-based capital required to ensure there is a 99.5% probability that the firm will meet its obligations over the next 12 months
o The Minimum Capital Requirement (MCR) sets a lower solvency standard of 85% probability that a firm will meet its obligations for a firm to represent an unacceptable risk
Liquidity
● The ease and speed in which an asset can be turned into cash without significant loss of value
A banks asset can provide liquidity in three ways
●
o Being sold for cash
o Reaching maturity
o Being used as security for borrowing
Regulators liquidity risk standards are:
The requirements are:
o Banks and deposit takers are required to have risk management systems in place to identify, measure and monitor liquidity risk
o Carry out stress testing
o Document their policy for managing liquidity
National regulatory bodies only have authority over:
firms in their country
Overall European Financial Services is the responsibility of three European Supervisory Authorities (ESAs)
o THE European Securities and Markets Agency (ESMA)
o The European Banking Agency (EBA)
o The European Insurance and Occupation Pensions Agency (EIOPA)
Financial Services Action Plan (FSAP) objectives
● Launched in June 1999 at the request of the European council
● FSAP objectives;
o Establishing a single market in wholesale financial services
o Making retail markets open and secure
o Strengthening the rules on prudential supervision
Philosophy behind MiFID
▪ A firm subject to MiFID has the right to operate throughout the EU based on its authorisation from its home sate
▪ There is a high level of home state regulatory control. Each state must appoint its own competent authority to carry out the provisions under MiFID and be given the necessary supervisory and investigative powers to perform their function
Firms affected my MIFID are:
▪ Securities and futures firms
▪ Banks conducting securities business
▪ Recognised investment exchanges
▪ Alternative trading systems
Does NOT apply to:
▪ Life assurance
▪ Pensions
▪ Mortgages
MiFID II took affect from 4 January 2018. The MiFID revisions had four main objectives:
o Strengthen investor protection
o Reduce the risk of disorderly markets
o Reduce systemic risks
o Increase the efficiency of financial markets and reduce unnecessary costs for participants
