Financial Regulation Flashcards
(38 cards)
What was the financial regulation landscape like before the early 1980s?
Financial systems in most countries were highly regulated until the early 1980s
This was influenced by the end of the Bretton-Woods system and capital controls in the 1970s.
What prompted the deregulation of financial markets in the 1980s?
The rise in competition of offshore banking, such as Eurocurrency markets, which escaped domestic regulations
What is ‘prudential policy’ in the context of financial regulation?
Regulation of the financial system used to control monetary policy
What are the four main reasons for regulating financial markets?
1) Asymmetric information
2) Principal-agent problem
3) Moral hazard
4) Externalities
What is asymmetric information?
A situation where managers of financial firms have more information about products than buyers
Define the principal-agent problem.
The challenge of ensuring that agents (management) act in the best interest of principals (investors)
What is moral hazard in finance?
When regulation reduces risk for investors, potentially encouraging reckless behavior
What are externalities in economics?
Costs or benefits affecting people other than the transactors
What is the contagion effect in banking?
A situation where the failure of one bank undermines confidence in the entire system
What is self-regulation?
A system where regulations and enforcement are managed by market practitioners through a self-regulatory organization (SRO)
What are the advantages of statutory regulation?
1) Strong and unbiased approach to wrongdoing
2) Public accountability
List some types of regulation relevant to financial markets.
1) Disclosure requirements
2) Regulation of exchanges
3) Licensing requirements
4) Restrictions on activity
What is the purpose of licensing requirements in finance?
To exclude undesirable individuals from managing others’ money and to increase confidence in the system
What are the costs associated with regulation?
1) Moral hazard
2) Agency capture
3) Compliance costs
What is agency capture?
When regulators become too sympathetic to the regulated firms due to shared interests
How does regulation affect firm costs?
It adds costs similar to imposing a tax, which can reduce the volume of activity
What are the inefficiencies of regulation?
1) Reduces the efficiency of banks
2) Can hinder economic growth
3) Creates barriers for new entrants
Regulation on banks
Regulating activities
Liquidity requirements
Capital adequacy
What was the Glass-Steagall Act?
A regulation that prevented commercial banks from engaging in securities trading
What is liquidity regulation?
Monitoring banks’ reserve ratios to ensure they can meet withdrawal demands
What does capital adequacy regulation ensure?
That banks have sufficient capital to absorb negative shocks without threatening depositor wealth
What is the Basel Accord?
A set of guidelines established in 1988 focusing on a risk assets ratio (RaR) for banks
What are the three pillars of Basel 2?
1) Minimum capital requirements
2) Periodic reviews of capital adequacy
3) Market discipline through public disclosure
What is the main goal of Basel 3?
To enhance bank capital and liquidity requirements to strengthen the financial system
