5A.4 Financial Stability and prudential regulation

Question 1

What is critical to a healthy, well-functioning economy?

Answer 1

Financial stability, including public trust and confidence in financial institutions, markets, infrastructure, and the system.

Question 2

What international / global body is charged with the aim of financial stability?

Answer 2

the Financial Stability Board (FSB)

Question 3

What is the FSB?

Answer 3

It is a body that monitors and makes recommendations about the global financial system.

Question 4

What does the FSB promote?

Answer 4

International financial stability

Question 5

How does the FSB promote international financial stability?

Answer 5

By coordinating national financial authorities and international standard-setting bodies, as they work toward developing strong regulatory, supervisory and other financial sector policies.

It fosters a ‘level playing field’ by encouraging coherent implementation of these policies across sectors and jurisdictions.

Question 6

What does the FSB seek to do?

Answer 6

Working through its members, it seeks to strengthen financial systems and increase the financial stability of international financial markets. The policies developed in the pursuit of this agenda are implemented by jurisdictions and national authorities.

Question 7

Who do the UK representatives at the FSB include?

Answer 7

The Governor of the Bank of England, CEO of the FCA and a representative from HM Treasury.

Question 8

Who do members of the FSB include?

Answer 8

Include countries such as the UK and the USA, international financial institutions such as the International Monetary Fund (IMF), and international standard-setting and other bodies, such as the International Accounting Standards Board (IASB)

Question 9

What 2 acts increased powers in relation to financial stability?

Answer 9

Banking Act 2009

Financial Services Act 2010

Question 10

How did the Banking Act 2009 increase powers in relation to financial stability?

Answer 10

Increased the powers of the BoE and gave it an objective relating to financial stability. It also gave the Bank oversight of the UK’s payment systems.

Question 11

How did the Financial Services Act 2010 increase powers in relation to financial stability?

Answer 11

This act gave the old FSA a new objective, in relation to financial stability, that has been carried over to the FCA. The FCA must have a financial stability strategy, which it reviews regularly.

Question 12

What 4 factors should be considered in prudential regulation?

Answer 12

1. A provider’s financial reserves (prudence)
2. How risky it is perceived to be (credit-rating)
3. The services it provides to its customers
4. The strength of its product proposition

Question 13

Why are adequate capital reserves important?

Answer 13

Individuals, firms, and markets must have enough capital reservers in place to deal with more turbulent market conditions. The main reason for this, other than market stability, is to ensure there is no risk of liabilities not being met as they fall due.

Question 14

What are reserves known as?

Answer 14

Capital resources, and must be assessed by the individual, firm or market plus the relevant regulator.

Question 15

What happens if reserves fall below a set level?

Answer 15

No new business can be taken on until this situation is remedied.

Question 16

Who does the PRA prudentially regulate?

Answer 16

The top 1,500 systematically important firms and markets.

Question 17

Who are the FCA responsible for if the PRA prudentially regulate the top 1,500 systematically important firms and markets?

Answer 17

The prudence of everyone else.

Question 18

In terms of financial management, why must a firm/bank maintain adequate capital reserves?

Answer 18

To ensure that all liabilities can be met as they fall due.

Capital reserves must be enough to meet ALL liabilities as they fall due, not some of them.

Question 19

What are the UK regulators trying to avoid in terms of prudential regulation?

Answer 19

Try to avoid, if possible, any repeat of the last financial crisis, when Northern Rock almost went bust. This is virtually unheard of in British financial services history and did absolutely nothing for the objective of ‘financial stability’.

Question 20

Individuals, firms, and markets must have sufficient capital reservers to do what 3 things?

Answer 20

1. Meet all liabilities as they fall due
2. Be able to keep trading on a day-to-day basis.
3. Have some form of financial buffer for expansion and development.

Question 21

Individuals, but most importantly, firms and markets, must have systems in place to monitor the adequacy of their capital reserves. What do these include (4)?

Answer 21

1. A documented process to identify and deal with such risks.
2. At least annual stress-testing of reserves (using ‘worst case scenario’ applications).
3. Annual reporting of capital reserves to the appropriate regulator.
4. Openness and transparency in the availability of this financial data to the public.

Question 22

What is Free Asset Ratio (FAR)?

Answer 22

This is the capital-reserve level of a business. In financial services, it is most applicable to a life office or an insurance company.

Question 23

Put simply, what does FAR measure?

Answer 23

The surplus assets that a life office holds, over and above its liabilities.

Question 24

If someone had £20 million in assets and £7 million currently in liabilities how would you calculate their FAR?

Answer 24

2 stage process:

1. Calculate the amount of free assets (20 - 7 million) = £13 million in free assets.
2. Calculate the ratio that these free assets are of total life office assets (expressed as a percentage)

£13 million / £20 million = 0.65 = 65% FAR

Question 25

What does free asset ratio show?

Answer 25

The financial strength of a life office or insurance company.

Question 26

What are ‘ratings’?

Answer 26

These are the credit ratings given to financial institutions by agencies such as Moody’s and Standard and Poors.

Question 27

What are ‘ratings’ designed to show?

Answer 27

The financial strength of an institution but can also be applied to government, funds and other areas.

Question 28

What did the UK government have its credit rating downgraded from and to?

Answer 28

Downgraded from Triple AAA to Double AA by Standard and Poor’s. This meant that the agency viewed the government as a higher risk than it used to be.

Question 29

Who regulates credit ratings agencies?

Answer 29

Following Brexit and the UK leaving the EU, this has changed from the European Securities and Markets Authority (ESMA) to the Financial Conduct Authority.

Question 30

Who regulates credit reference agencies?

Answer 30

These agencies are also regulated by the FCA.

Question 31

What is the Retail Mediation Activities Report (RMAR)?

Answer 31

This report is the core regulatory return submitted by firms that carry out regulated activities involving mortgages, insurance and investment products.

Question 32

How often do individuals and firms need to submit a RMAR?

Answer 32

Every 6 months.