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Financial Markets Theory > Lecture 8 > Flashcards

Lecture 8 Flashcards

1
Q

Why must the financial sector be regulated?

A

Due to the presence of asymmetric information problems:
Adverse selection
Moral hazard

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2
Q

What is adverse selection?

A

A market situation where buyers and sellers have different info so that a participant might participate selectively in trades which benefit them at most, at the expense of the other party
E.g. used cars, insurance

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3
Q

What is moral hazard?

A

One party has not entered into the contract in good faith
Or had provided false details about its assets, liabilities or credit capacity
E..g borrowing/insurance, observe a change in behaviour

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4
Q

What do we aim to achieve with regulation?

A
  1. Protect the consumer against monopolistic exploitation
  2. Provide smaller, less informed, clients protection
  3. Ensure systematic stability
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5
Q

What is an example of network effects?

A

The use of a credit card company

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6
Q

The more a particular payment method is used and accepted as a medium of exchange, the _______ the ________________ that can be extracted by the providers of that standards

A
  1. Greater
  2. Monopoly rents
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7
Q

Monopolistic exploitation- what must the regulator ensure?

A

Fair and open competition
Reasonable access to these services

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8
Q

What are the different types of risks that consumers may face in their financial affairs?

A

Prudential risk
Bad faith risk
Complexity/unsuitability risk
Performance risk

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9
Q

What is prudential risk?

A

The risk that a firm collapses because of, for eg, inadequate capital

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10
Q

What is bad faith risk?

A

The trick from fraud, misrepresentation, deliberate misselling or failure to disclose relevant info

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11
Q

What is complexity/unsuitability risk?

A

The risk that consumers take on a financial contract that they don’t fully understand

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12
Q

What is performance risk?

A

The risk that investments don’t deliver the hoped returns

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13
Q

Is it the regulators role to insulate the consumers from performance risk?

A

No - this risk is permanent in financial products

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14
Q

What are banks’ roles in the financial system?

A

Allocate resources
Monitor borrowers
Play important roles in clearing and payments systems

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15
Q

How do banks allocate resources efficiently?

A

By screening borrowers and identifying firms with the most promising prospects

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16
Q

Why do banks monitor borrowers?

A

To make sure the funds are used properly

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17
Q

What are banks considered to be prone to, what does that mean and what does this lead to?

A

Prone to runs;
The threat of failure
Perceived threat
Leads to contagion effects absent in other sectors of the economy

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18
Q

Underpinning the regulatory system, ______ banks play a key role as the _________________ who is responsible for ____________________

A
  1. Central
  2. Lender of last resort
  3. The provision of liquidity under systematic crisis
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19
Q

If there’s a run on the banking system, the lender of the last resort provides what? What does this create and why?

A

The ultimate liquidity in order to stave off systematic failure

Created moral hazard bc banks know that they’ll be bailed out, so may ‘gamble for resurrection’.

20
Q

What is the Bank for International Settlements (BIS)?

A

A international financial institution owned by central banks for foster international monetary and financial cooperation and serves as a bank for central banks

21
Q

How does the Bank for International Settlements carry out its work?

A

Through its meetings programmes
Through the Basel Process - hosting international groups pursuing global financial stability and facilitating their interaction

22
Q

Where is the Bank for International Settlements based?

A

Basel
Switzerland
Representative offices in Hong Kong and Mexico City

23
Q

What are the difficulties of regulation?

A

Cost
Innovation and competition
Globalisation of markets
Capture

24
Q

What are the costs of regulation incurred by?

A

The regulator and the regulated
Includes staffing of the regulatory office and
Development of guidelines
Costs of compliance

25
Q

What’s the theory of regulation?

A

That the external costs of contagion should be internalised into the firms’ optimisation structures, equating the private and social costs

26
Q

The regulatory environment may stifle the development of…? And what should it avoid as a result of this?

A

New, desirable products as a by products of the regulation of existing products
Should avoid creation of unnecessary barriers to entry of new firms

27
Q

Th increasing international nature of markets calls for what?

A

International standards in excess of the informal arrangements
Or some level of harmonisation

28
Q

Heterogenous levels of regulation do what to banks operating under the looser regulation?

A

Gives them a competitive advantage through lower costs of compliance
Make the assessment of counterparty risk more difficult

29
Q

What is a concern about how regulators operate and why?

A

If they are operating in the best interest of the consumers
Bc they’re drawn from the financial sector and not from amongst consumers

30
Q

What are the guiding principles of the new framework that was laid down in 1997 (establishing clear lines of responsibility)?

A

Accountability
Transparency
Non-duplication
Exchange of information

31
Q

What is the HM Treasury responsible for?

A

The institutional structure of regulation as a whole
The legislation that determines it

32
Q

When does the HM Treasury take responsibility?

A

When major systematic threats happen
When new legislative requirements arise

33
Q

What does the HM Treasury have no responsibility for?

A

The Financial Services Authority (FSA)
Bank of England (BoE)

34
Q

What was the Bank of England responsible for pre2007?

A

The overall stability of the financial system
The provision of liquidity
Stability of payments system
Acting as the lender of last resort

35
Q

What was the Financial Services Authority responsible for pre2007?

A

Maintaining market confidence
Promoting public awareness
Protecting consumers
Reducing financial crime

36
Q

A consensus has emerged that the ‘tripartite’ model of regulation had what?

A

Shortcomings that were a significant factor in the UK’s failure to predict or to adequately respond to the financial crisis

37
Q

What is the Bank of England responsible for now?

A

Financial stability (at both macro and micro levels)

38
Q

Which two new bodies support the BoE with its responsibility of financial stability?

A

The Financial Policy Committee at the macro-prudential level
The Prudential Regulation Authority (PRA) at micro-prudential level

39
Q

What is the focus of the Financial Policy Committee now?

A

The macro economic and financial issues that may threaten long term growth prospects
Address any risks it identifies

40
Q

How does the Financial Policy Committee address any risks it identifies?

A

By passing on its concerns to a new Prudential Regulation Authority (PRA) and Financial Conduct Authority

41
Q

What is the Prudential Regulation Authority responsible for/what does it do?

A

The prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms
Sets standards
Supervises financial institutions at the level of the individual firm

42
Q

What is the goal of the Prudential Regulation Authority?

A

To promote safety and financial soundness of the firms it regulates
To contribute to the securing of an appropriate degree of protection for policyholders (specifically for insurers)
To achieve a healthy and successful economy

43
Q

What does the Prudential Regulation Authority primarily focus on?

A

The harm that firms can cause to the stability of the UK financial system

44
Q

What DOES the Financial Conduct Authority do?

A

Regulates financial firms providing services to consumers
Maintains the integrity of the UK’s financial markets

45
Q

What does the Financial Conduct Authority focus on?

A

The regulation of conducts (i.e. misbehaviour) by both retail and wholesale financial services firms

46
Q

What CAN the Financial Conduct Authority do?

A

Specify minimum standards
Place requirements on products
Investigate organisations and individuals
Ban financial products for up to a year while considering a permanent ban

Financial Markets Theory (7 decks)

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