Week 9: Central Banking And Bank Regulation Flashcards
What is banking regulation and supervision ?
Banking Regulation: Establishes a set of specific rules for bank managers to follow.
Banking Supervision: Provides general oversight of financial institutions and verify whether the banks comply with the rules.(monitoring)
What is the rationale for regulation?
Banks are special in their role of liquidity providers. They are more prone to trouble than other firms
One bank failing can cause another bank to suffer because of their interconnectness.
e.g banks that become insolvent can spread fear that it will run out of cash and close its doors.This can trigger a bank run.(Contagion)
Overall it’s to avoid unstable banking and protect public confidence.
What is a Bank Run
When a large number of deposits decide to withdraw their savings within a short period of time because of the fear that their bank is unsound and about to fail.
What matters during a bank run?
What matters is whether the bank is liquid. Meaning they have enough cash and liquidity to cover the fast withdrawals of money by depositors.
If they don’t have liquidity they will sell their assets at a loss (“fire-sales”)
What is Macro-prudential regulation ?
Concerns with the safety and soundness of the whole financial system.
The aims are to:
- To minimise the risk of bank runs.
- To make intermediaries internalise the costs of their behaviour.
What is a Financial safety net system?
A system for enhancing and ensuring a country’s financial stability and misusing the risk of a banking crisis. It includes
Deposit Insurance: a guarantee that all or part of the amount deposited by savers will be paid in the event the bank fails.
Lender of last resort: one of the main functions of a central bank is to provide funds to banks in financial difficulty and have no other option.
**Resolutions Laws/Cooperation and resolutions process: a special set of rules for bank bankruptcy.
What is Micro-prudential Regulation?
Checks that individual FIs are complying with financial regulation. For this purpose they request and collect firm-specific information.
What are some limitations of regulation?
Some argue it’s a potential cause of financial crises as it reduces incentives to prevent failures
Innovation spurred by the attempts to circumvent current regulations
Compliance costs associated with activities required by the regulators.
What is Basel regulation?
- Micro-prudential regulation
- provides a forum for regular cooperation on banking supervisory matters. Aims to better the quality of banking supervision worldwide.
The scope of the committee is to guarantee a level playing field for banks to compete at the international level.
What is Basel 1 ?
Capital and risk are strictly interconnected so:
- Banks are required to hold capital in proportion to the riskiness of their operations.
- most banks are required to keep their ratio of capital to assets above a minimum level.
What is Basel 2/3 ?
Evolution from Basel 1 to include the type of risks for minimum capital requirements.
What is the liquidity coverage ratio?
The Liquidity Coverage Ratio (LCR) is a regulatory requirement that ensures banks hold enough high-quality liquid assets to cover their short-term liquidity needs. It’s part of the Basel III regulations and helps banks withstand periods of financial stress.
What is the net stable funding ratio?
Requires banks to support their business activities with appropriate sources of stable funding.
