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Week 9 - Regulation & Central Banking Flashcards

1
Q

Are bank runs rational or irrational?

A

They begin irrationally, then become rational

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2
Q

What is one consequence of a bank run?

A

Fire sales depress asset prices, especially if multiple banks face runs at the same time

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3
Q

What types of assets are worst affected by fire sales and why?

A

Opaque/illiquid assets like ABSs & CDOs, because they’re difficult to value

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4
Q

What was a major factor in the failure of Lehman Brothers?

A

Fire sales of ABSs & CDOs

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5
Q

How can bank runs be mitigated?

A

Deposit insurance

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6
Q

What is a limitation of deposit insurance?

A

Only covers up to set amount - most valuable depositors still run

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7
Q

Why are bank runs an even more serious risk today?

A

Online banking = rapid withdrawals

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8
Q

Why doesn’t regulation seek to eliminate risk?

A

Risk transfer is a key function & source of profit for FIs

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9
Q

What is the aim of regulation?

A

To stabilise the banking system by protecting public confidence, which prevents runs

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10
Q

What is the difference between regulation & supervision?

A
  • Regulation = establish rules
  • Supervision (monitoring) = verifies compliance
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11
Q

What are the types of banking regulation?

A
  1. Macro-prudential
  2. Micro-prudential
  3. Conduct-of-business
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12
Q

What is the purpose of macro-prudential regulation?

A
  • Combat moral hazard
  • Internalise costs to reduce system risk
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13
Q

What effect did the GFC have on banking regulation?

A

Revealed micro-prudential was inadequate – macro is needed too

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14
Q

How does macro-prudential regulation work?

A

It creates a financial safety net system to ensure a country’s financial stability & minimise risk of banking crisis

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15
Q

What does macro-prudential regulation involve?

A

Three pillars:
1. Deposit insurance
2. Lender of last resort
3. Resolutions laws / cooperation & resolution process

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16
Q

What is an example of deposit insurance in action?

A

When SVB had its run in ‘23, the Fed removed upper limit, which was expensive but somewhat effective

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17
Q

What is the drawback of deposit insurance?

A

Creates moral hazard so must be saved for emergencies

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18
Q

What is the purpose of resolutions laws / cooperation & resolution process?

A

Allow inefficient banks to exit the market in an orderly way

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19
Q

What is the purpose of micro-prudential regulation?

A

Control liquidity, solvency & riskiness of individual financial institutions

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20
Q

What is micro-prudential regulation concerned with?

A
  1. Asset quality (NPL) – are banks allocating funds efficiently?
  2. Capital adequacy (min capital requirements) – are banks capitalised enough to cover risks?
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21
Q

How did micro-prudential regulation change in response to GFC?

A

Become less focused on liability side (e.g. diversified deposits)

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22
Q

What is one benefit of micro-prudential regulation?

A

Reduces information asymmetry – helps customers judge safety & soundness

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23
Q

Is bank capital regulation macro- or micro-prudential?

A

Micro

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24
Q

What is the main focus of conduct-of-business regulation?

A

Mandatory information disclosure to customers

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25
Q

What are some secondary concerns of conduct-of-business regulation?

A
  1. Honesty & integrity
  2. Competence
  3. Fair business practices
  4. Marketing
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26
Q

What are the limitations of regulation in general?

A
  1. Moral hazard
  2. False confidence
  3. Innovations like securitisation / regulatory arbitrage
  4. Compliance costs -> cost to customers
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27
Q

How does regulation benefit markets?

A

Creates trust

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28
Q

What does FSA stand for?

A

Financial Services Authority

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29
Q

What was unique about the FSA?

A

Handled all regulation for all UK FIs – innovative / efficient

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30
Q

How did UK regulation change after the GFC?

A

FSA replaced with Twin Peaks system

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31
Q

What are the ‘twin peaks’?

A

PRA + FCA + FPC

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32
Q

What does PRA stand for?

A

Prudential Regulation Authority

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33
Q

What does FCA stand for?

A

Financial Conduct Authority

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34
Q

What does FPC stand for?

A

Financial Policy Committee

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35
Q

What does the PRA do?

A

Micro-prudential regulation for large banks & insurers

36
Q

What does the FCA do?

A
  • Micro-prudential regulation for smaller firms
  • Conduct-of-business regulation for all FIs
37
Q

What does the FPC do?

A
  • Macro-prudential regulation (monitors + responds to systemic risks)
  • Part of the Bank of England
38
Q

What is the EU’s financial regulation system?

A

ESFS (European System of Financial Supervision)

39
Q

What does ESFS include?

A
  1. ESMA (Securities & Markets Authority)
  2. EBA (Banking Authority)
  3. EIOPA (Insurance & Occupational Pension Authority)
  4. ESRB (Systemic Risk Board)
40
Q

What is another name for bank capital regulation?

A

Basel regulation

41
Q

What is Basel regulation?

A

Risk-based micro-prudential regulation focusing on capital adequacy

42
Q

Where does Basel regulation come from?

A

The Basel Committee on Banking Supervision

43
Q

When & why was the Basel Committee set up?

A

80s, in response to globalisation, to prevent “race to the bottom”

44
Q

What is the aim of the Basel Committee?

A
  • Improve banking supervision worldwide
  • Provide “level playing field” for banks to compete internationally
45
Q

How can emerging economies legitimise themselves?

A

First pass Basel I regulations into law, then II and III

46
Q

What is the starting point of Basel regulation?

A

The riskier the asset, the greater the cushion of capital funds required to avoid insolvency

47
Q

What are the basic forms of capital adequacy?

A
  1. Minimum capital requirements in proportion to risk
  2. Non-risk-based leverage ratio
48
Q

What is the rationale for regulating non-risk-based leverage ratio?

A

Risk modelling leaves space for manipulation

49
Q

What credit risk classes are included in Basel I?

A
  • 0%
  • 20%
  • 50%
  • 100%
50
Q

Under Basel I, what on-balance-sheet assets carry 0% assumed potential losses?

A
  • Cash (& equivalents)
  • OECD government bonds
51
Q

Under Basel I, what off-balance-sheet assets carry 0% assumed potential losses?

A
  • Unused portion of loan commitments
52
Q

Under Basel I, what on-balance-sheet assets carry 20% assumed potential losses?

A
  • Short-term claims maturing within a year
  • Bonds issues by agencies of OECD governments
53
Q

Under Basel I, what off-balance-sheet assets carry 20% assumed potential losses?

A
  • Letters of credit
54
Q

Under Basel I, what on-balance-sheet assets carry 50% assumed potential losses?

55
Q

Under Basel I, what off-balance-sheet assets carry 50% assumed potential losses?

A
  • Revolving facilities
56
Q

Under Basel I, what on-balance-sheet assets carry 100% assumed potential losses?

A
  • Commercial loans
  • Non-OECD bank/government debts
57
Q

Under Basel I, what off-balance-sheet assets carry 100% assumed potential losses?

A
  • Standby letter of credit
58
Q

Under Basel regulation, what is the minimum RAR?

59
Q

How is RAR calculated?

A

eligible capital / risk-weighted assets

60
Q

What does RAR stand for?

A

Risk-asset ratio

61
Q

How are risk-weighted assets calculated?

A

assets x risk weight

62
Q

What capital regulated was introduced after the GFC?

63
Q

What characterises Basel III?

A
  • Beyond credit risk (market, operational, liquidity etc.)
  • More risk classes – sensitivity
  • Refined methodologies to assess risk weights, using rating agencies & internal models
  • Broad definition of eligible capital
64
Q

True or false: liquidity was not regulated before the GFC

65
Q

What does LCR stand for?

A

Liquidity coverage ratio

66
Q

What does LCR require?

A

High-quality liquid assets to cover net cash outflows over 30-day stress period

67
Q

What does NSFR stand for?

A

Net stable funding ratio

68
Q

What is NSFR?

A

Requires appropriate sources of stable funding for long-term liquidity

69
Q

What does a ‘30 day stress period’ involve?

A

No access to interbank market or central bank lending

70
Q

What is a ‘stable funding source’?

A

Core deposit business

71
Q

What is a central bank?

A

Financial institution which oversees a nation’s monetary systems

72
Q

What is a central bank’s aim?

A

Fostering economic & financial stability

73
Q

What are a central bank’s main functions?

A
  1. Control issue of legal tender
  2. Direct & indirect control of credit, liquidity & money created by FIs
  3. LOLR to prevent crises
  4. Government’s banker
  5. Official agent for FX matters & gold
74
Q

What does LOLR stand for?

A

Lender of last resort

75
Q

What is legal tender?

A

Notes & coins

76
Q

Is LOLR micro- or macro-regulatory?

A

Macro – prevents financial panics/crises

77
Q

How does LOLR avoid moral hazard?

A

Limited to solvent banks with good collateral

78
Q

What is monetary policy?

A

Macro-economic policy conerned with availability & cost of credit (interest rates)

79
Q

How does monetary policy work?

A

Influences rates, inflation & credit availability by changing supply of money (liquidity)

80
Q

What are some monetary policy tools?

A
  • OMOs
  • Discount window
  • Reserve requirements
81
Q

What are OMOs?

A

Open market operations

82
Q

How do OMOs work?

A
  • Sell government securities -> credit/money supply decreases
  • Buy government securities -> credit/money supply increases
83
Q

What is the discount window?

A

Interest paid on banks’ deposits with the central bank

84
Q

How does the discount window work?

A
  • High discount rate: banks deposit more, lend less
  • Low discount rate: banks deposit less, lend more
85
Q

How do reserve requirements work?

A
  • High RRR: less funds available to banks
  • Low RRR: more funds available to banks
86
Q

What is quantitative easing?

A

Buying private assets from FIs to directly inject money into economy

Banking (10 decks)

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