Financial Market Regulation

Question 1

State + explain the micro effects of financial market regulation.

Answer 1

• Reduces Information Asymmetry: (e.g. requiring transparency in lending rates or risk disclosures helps consumers make informed decisions).
• Protect Consumers + Investors: prevents exploitation (e.g. mis-selling of financial products like PPI in UK).
• Promotes Competition: regulation (e.g. anti-monopoly rules) can prevent excessive market power of large banks.
• Increases Market Confidence: consumers more likely to S / I if they trust the system (e.g. deposit insurance schemes).
• Increases Compliance Costs For Firms: especially burdensome for small financial firms - could reduce innovation / raise prices - reduces profits - firms may become too risk-averse - link to moral hazard.
• Barriers To Entry: high regulatory costs can omit new entrants, reducing dynamic efficiency.

Question 2

State + explain the macro effects of financial market regulation.

Answer 2

• Improves Financial Stability: prevents systemic risk + reduces likelihood of financial crises (e.g. 2008 Crash).
• Reduces Moral Hazard: stricter capital requirements (e.g. Basel III) makes banks more responsible for their risk-taking.
• Supports Long-Term Growth: stable financial systems encourage I, S, + intermediation of funds.
• Controls Credit Growth / Inflation: macroprudential tools can cool down overheating credit markets (e.g. mortgage lending caps).
• Restricts Credit Supply: excessive regulation may reduce lending to businesses + consumers, lowering I + AD.
• Slower Economic Growth: less risk-taking + lending may result in subdued economic activity, especially in downturns.
• Shadow Banking Growth: overregulation may push financial activity into less regulated sectors, creating new risks.

Question 3

State + explain the microprudential policies to regulate financial markets.

Answer 3

• Capital Requirements: banks must hold minimum % of capital to assets (e.g. Basel III Standards) - reduces risk of collapse - internalises risk.
• Liquidity Ratios: ensure banks can meet SR liabilities - prevents runs + illiquidity.
• Conduct Regulation: prevents mis-selling, fraud (e.g. FCA rules in UK) - improves consumer protection + reduces asymmetric information.
• Ring Fencing: separating commercial + I banking activity - limits risk contagion between risky + essential services.
• Deposit Insurance Schemes: protects small savers if bank fails (e.g. FSCS in UK) - maintains confidence + prevents panic withdrawals.

Question 4

State + explain the macroprudential policies to regulate financial markets.

Answer 4

• Counter Cyclical Capital Buffers: banks hold more capital in booms, less in recessions - dampens credit booms + cushions downturns.
• Systemic Risk Monitoring: central banks assess + respond to emerging risks - improves foresight + prevention of crises.
• Regulation of Shadow Banking: bringing non-bank financial institutions (e.g. hedge funds) under oversight - reduces risks from unregulated parts of the system.