Unit 2 Topic 19 - Prudential supervision

Question 1

What is prudential management?

Answer 1

Industry regulators ensuring firms have adequate risk management systems in place, particularly in relation to financial risks.

Question 2

Who is responsible for prudential regulation?

Answer 2

The PRA is responsible for the prudential regulation of all deposit-takers, insurers and significant investment firms.

The FCA is responsible for the prudential regulation of firms for which it is the sole regulator, typically smaller businesses.

Question 3

What is the relationship between international prudential regulation to the UK’s regulators?

Answer 3

The UK’s regulators are driven by regulatory requirements at an international level.

Question 4

What is the Basel Committee on banking supervision?

Answer 4

The Basel Committee is a multinational body acting under the auspices of the Bank for International Settlements.

Its role is to strengthen the regulation, supervision and activities of banks to enhance financial stability.

Question 5

Define Capital Adequacy.

Answer 5

Ensuring that a business holds sufficient reserves of capital to ensure it is sustainable.

Question 6

Define Solvency.

Answer 6

The extent to which a business’ assets exceed it liabilities. An example from the financial services industry would be mortgage lenders whose assets are the loans made to consumers; liabilities are the funds borrowed to facilitate those loans, from deposit-taking or from the money markets.

Question 7

Define Solvency Ratio.

Answer 7

Capital as a percentage of the risk-adjusted value of assets.

Question 8

Define Liquidity.

Answer 8

The ease and speed at which an asset can be converted to cash.

Question 9

What are the three main ways a firm’s assets can provide liquidity?

Answer 9

• By being sold for cash.
• By reaching their maturity date.
• By providing security for borrowing.

Question 10

What is operational risk?

Answer 10

Operational risk is the risk of loss as a result of failed or inadequate internal processes, people and systems (ef staff fraud, or a computer failure, or as a result of external events, such as a natural disaster.)

Question 11

What is a basic approach to calculating capital requirement for operational risk?

Answer 11

Multiplying the institution’s gross annual income (averaged over the past 3 years) by 0.15.

Question 12

What are the Basel accords?

Answer 12

Basel Committee on Banking Supervision issuing minimum capital requirements for banks.

Question 13

What is Pillar 1 of Basel II?

Answer 13

Details capital requirements in respect of three aspects of a banks’s operations: credit risk, operational risk and market risk.

Question 14

What is Pillar 2 of Basel II?

Answer 14

Gives banking regulators more effective supervisory tools and enables them to deal with the individual components of risk.

Question 15

What is Pillar 3 of Basel II?

Answer 15

Contains a set of disclosure requirements so that the capital adequacy of an organisation can be properly assessed.

Question 16

What are the two main areas Basel III covers?

Answer 16

• Regulatory capital

- Asset and liability management

Question 17

What is the minimum solvency ratio Basel III requires banks to reach?

Answer 17

7%

Question 18

What are the two broad classes of capital in relation to regulatory capital?

Answer 18

• Tier 1 capital, which includes share capital and disclosed reserves (ie profits retained in the business rather than being paid as dividends).
• Tier 2 capital, which is known as supplementary capital.

Question 19

What is leverage ratio and what is the minimum value mandated by Basel III?

Answer 19

A bank’s Tier 1 capital divided by its average total consolidated assets.

3%

Question 20

What are the two new ratios introduced by Basel III that banks must comply with in respect of asset and liability management?

Answer 20

• Liquidity coverage ratio (LCR)

- Net stable funding ratio (NSFR)

Question 21

What is Liquidity coverage ratio (LCR) in respect of asset and liability management (Basel III)?

Answer 21

The LCR requires that high-quality liquid assets available to the bank exceed the net cash outflows expected over the next 30 days.

Question 22

What is Net stable funding ratio (NSFR) in respect of asset and liability management (Basel III)?

Answer 22

The NSFR aims to protect the bank’s longer term position. The NSFR requires that long-term financial resources exceed long-term commitments; long term in this context is taken being more than one year.

Question 23

What is the Capital Requirements Directive?

Answer 23

The CRDs establish a supervisory framework that aims to minimise the effects of a firm failing.

They do this by ensuring that firms hold sufficient financial resources to cover the risks their business activities present.

Question 24

What is Total loss-absorbing capacity (TLAC)?

Answer 24

The Financial Stability Board (FSB), an international organisation consisting of national regulators and central banks, issued a minimum TLAC for 30 banks identifies as global systemically important banks (G-Sibs) that the Basel Committee on Banking Supervision (BCBC) deems at risk from being too big to fail.

Question 25

What is the TLAC requirement as of 2019/20?

Answer 25

Since 1 January 2019, the minimum TLAC requirement for G-Sibs has been at least 16% of the resolution group’s risk-weighted assets (RWAs), increasing to at least 18% from 1 January 2022.

Question 26

What are the main aims of Solvency II?

Answer 26

• Reduce the risk of an insurance company being unable to meet its claims.
• Reduce losses suffered by policyholders should an insurer be unable to meet all claims in full.
• Establish a system of information disclosure that makes regulators aware of potential problems at an early stage.
• Promote confidence in the financial stability of the insurance sector.

Question 27

What the the three main pillars of Solvency II?

Answer 27

Pillar 1: Capital requirements and the valuation of assets.
Pillar 2: Governance and risk-management requirements.
- Pillar 3: Disclosure and transparency rules.

Question 28

What is the GENPRU sourcebook?

Answer 28

• The general prudential sourcebook for banks, building societies, insurers and investment firms.
• Details the way that the rules apply to different firms, rules and guidance on minimum capital requirements, and the definitions of different types of capital.

Question 29

What is the BIPRU sourcebook?

Answer 29

The prudential sourcebook for banks, building societies and investment firms, and details the rules applying to these firms.

Question 30

What is the IFPRU sourcebook?

Answer 30

The prudential sourcebook for investment firms and details the capital requirements for such firms.

Question 31

What is the INSPRU sourcebook?

Answer 31

The prudential sourcebook for insurers details the capital requirements and technical provisions for insurance companies.

Question 32

What is the MIPRU sourcebook?

Answer 32

The prudential sourcebook for mortgage and home finance firms, and details requirements in respect of capital and professional indemnity insurance.

Question 33

How did Basel II seek to ensure that capital adequacy requirements more accurately reflected the risks represented by a firm’s assets?

Answer 33

Under Basel II, instead of simply calculating their capital requirement as a percentage of the total value of their assets, firms were required to categorise each asset according to the risk it represented and hold more capital in relation to the riskier assets.

Question 34

In the EU, the requirements of the various Basel Accords are implemented by which legislation?

Answer 34

Within the EU the requirements of the various Basel Accords are implemented by the Capital Requirements Directives, with Basel III being implemented by CRD IV.