Chapter 7 Flashcards
(32 cards)
What are the principal aims of regulation in financial markets?
- Correct market inefficiencies
- Protect consumers of financial products
- Maintain confidence in the financial system
- Help reduce financial crime
These aims are interrelated and aim to enhance market efficiency and consumer protection.
What is a significant cause of market failure in financial services?
The lack of (perfect) information enjoyed by private investors
This lack of information can lead to inefficient investment choices and an improper allocation of risk.
What types of regulation exist within financial services?
- Self-regulation
- Statutory regulation
- Voluntary codes of conduct
- Mixed regimes
Each type of regulation can take various forms and may be more or less stringent.
What are the two main types of costs associated with regulation?
- Direct costs
- Indirect costs
Direct costs are incurred by regulators and regulated firms, while indirect costs arise from behavioral changes in response to regulations.
What are direct costs in the context of regulation?
- Costs incurred by regulators for operating the regulatory framework
- Compliance costs for regulated firms
These costs can ultimately be passed on to investors through higher fees or taxes.
What are some examples of indirect costs resulting from regulation?
- Diminished professional responsibility
- Reduction in consumer protection mechanisms
- Reduced product innovation
- Reduced competition
These indirect costs can negatively impact market dynamics and consumer choices.
Why is the need for regulation in financial markets greater than in other markets?
Due to the importance of confidence in the financial system and the potential damage from a systemic financial collapse
An example is the collapse of a clearing bank leading to a loss of faith in the banking system.
What can cause a ‘run’ on banks?
Loss of faith in the banking system due to the collapse of a financial institution
Such a run occurs when many investors attempt to withdraw their funds simultaneously.
What are the three forms that regulation can take?
- Prescriptive regulation
- Freedom of action with rules on publicity
- Outcome-based regulation
Each form has different implications for how financial services are managed and regulated.
What is prescriptive regulation?
Regulation with detailed rules that dictate what may or may not be done
This type of regulation is intended to tightly control activities but can result in higher costs.
What is the ‘freedom with publicity’ approach in regulation?
A regulatory approach that allows firms freedom of action as long as they publish sufficient information for public scrutiny
This approach is often applied to UK insurance companies.
What characterizes an outcome-based regulatory regime?
Freedom of action with a focus on the results achieved, such as whether investors make well-informed decisions
This contrasts with prescriptive regulation, which focuses on specific actions rather than outcomes.
What are unregulated markets?
Markets where the costs of regulation may outweigh the benefits, typically involving only informed professionals
Participants in these markets still adhere to general laws applicable in their jurisdiction.
What are voluntary codes of conduct?
Regulatory frameworks that operate without government enforcement but rely on industry cooperation
They can be effective but may suffer from a lack of public confidence.
What are the main advantages of a voluntary code compared to statutory regulation?
- Flexibility
- Lower compliance costs
- Greater industry buy-in
The main disadvantage is vulnerability to rogue operators and lack of enforcement.
What is self-regulation?
A system organized and operated by market participants without government intervention
This form of regulation relies on the incentive of the industry to maintain standards.
What is a self-regulatory system?
A self-regulatory system is organised and operated by the participants in a particular market without government intervention.
The incentive for self-regulation includes the economic value of regulation and the threat of government intervention.
What are the main advantages of a voluntary code compared to statutory regulation?
The main advantages are likely to be the reduced cost of regulation and the fact that the rules are set by those with the greatest knowledge of the industry.
Voluntary codes may also encourage cooperation from firms and individuals.
What is the main disadvantage of a voluntary code?
The main disadvantage is the greater incentive to breach the voluntary code, which lacks legal backing and may have less severe penalties than statutory regulation.
Define statutory regulation.
In statutory regulation, the government sets out the rules and polices them.
List the advantages of statutory regulation.
- Less open to abuse
- Higher degree of public confidence
- Economies of scale can be achieved
What are the disadvantages of statutory regulation?
- More costly
- Slower to respond to changing market circumstances
- Potential for regulators to prioritize industry views over public concerns
What are the types of regulatory regimes?
- Unregulated markets
- Voluntary codes of conduct
- Self-regulation
- Statutory regulation
What is a mixed regulatory regime?
A mixed regulatory regime is one that incorporates elements of various systems, including codes of practice, self-regulation, and statutory regulation.
