4.4 The Regulation Of The Financial System Flashcards

1
Q

What are the three financial regulators you need to know?

A
  • PRA = prudential regulation authority
  • FPC = financial policy committee
  • FCA = financial conduct authority
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2
Q

What is different about the FCA?

A

It is independent from the Bank of England

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3
Q

What is macroprudnetial regulation?

A

Identifying, monitoring and acting on risks which threaten the whole financial system of an economy

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4
Q

What are microprudential regulation?

A

Identifying monitoring and acting on risks to individual banks and firms

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5
Q

Which bodie(s) are macroprudential regualtion?

A

FPC

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6
Q

Which bodie(s) are microprudential regulation?

A

PRA and FCA

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7
Q

Describe what the PRA does

A
  • supervises individual financial institutions = improve financial stability by taking action to ensure these financial institutions are managed properly
  • sets standards for these organisations to follow
  • can specify specific institutions maintain certain liquidity and capital ratios
  • they will let financial institutions fail if it doesn’t effect the overall financial system
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8
Q

Describe what the FPC does

A
  • identify, monitor and take action to remove systemic risks to the whole financial system
  • make recommendations to banks and other institutions if it feels that they are at risk of failure
  • risks are judged by stress tests
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9
Q

Stress test definition

A

Hypothetical exercises that see how banks and other institutions would be affected by various economic shocks

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10
Q

What is the key aim of the FCA and who runs it?

A

to protect consumers and ensure healthy competition between financial institutions
- it is a government run authority

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11
Q

What are the four ways the FCA protects consumers?

A
  • make sure there is no market rigging (that everything is legal) e.g no collusion on setting interest rates
  • promote competition in the financial system e.g Deregulation - reducing ‘red tape’
  • banning financial products that are against the interests of consumers - Mis selling e.g PPI insurance (didn’t know they were paying it)
  • banning or changing misleading adverts for financial products e.g Loan sharks advertisements fully disclosing the high interest rates
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12
Q

Financial market failure definition

A

When financial markets fail to allocate financial products at the socially optimum level of output, which leads to a misallocation of resources in the financial market

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13
Q

Why do banks fail?

A
  • excessive risk, (if goes bad) = high systemic risk = collapse of banks = recession, loss of output + jobs = bailouts by government = negative externality as cost is bared by the taxpayer
  • moral hazard
  • speculative bubbles
  • lack of liquidity + bank run
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14
Q

Moral hazard definition

A

Occurs when a firm, insitution or Individual, knows that their failures or bad actions will be covered by a third party

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15
Q

How do market bubbles form?

A
  • assets brought cheap and sold at high prices
  • prices can fall below what they were brought at or a leveraged deal (borrowing to amplify the end outcome of a deal)
  • at some point future estimates of prices are unrealistic and asset prices get so high that they are no longer worth the price
  • lead to a fall in demand for these assets = fall in price
  • This leads to debt and banks may fail as individuals can’t pay back their debts
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16
Q

How is moral hazard apparent in the banking sector?

A
  • banks take risks on investments e.g subprime mortgages, knowing if they risk fails they are covered by the government (bailed out)
17
Q

How does a bank run form?

A
  • if banks do not have liquid assets, mainly notes and coins and individuals can not withdraw their money = more and more people rush to the banks to withdraw their money before the bank runs out of notes and coins = bank failure
18
Q

Liquid ratio defenition

A

The requirement of banks and other finacial institutions to hold a proportion of their deposits as cash

19
Q

Capital ratio definition

A

The ratio of the banks equity to the amount of lending made by the bank

20
Q

How do capital ratios and liquid ratios regulate banks?

A
  • prevents a liquidity crisis = can cause bank runs
  • reduces the risk of banks not having enough capital to offset any losses in lending
  • prevents insolvency
21
Q

What are Basel recommendations?

A
  • global recommendations set but industry experts to stop financial crisis’ such as the 2008 one occurring
  • recommendations on limits, ratios and regulations
22
Q

What regulation was introduced in 2019 in the UK?

A
  • ‘liquidity coverage ratio’
  • banks need to hold 7% of their lending in the form of capital
  • e.g lends £100 mil, needs to make sure they have £7 mil in capital
  • the EU has enforced this
23
Q

Problems with financial market regulation

A
  • moral hazard
  • shadow banking sector could form
  • banking services move overseas (too strict regulation)
  • restricts economic activity (less lending)
  • administration + enforcement costs
  • regulatory capture