The regulatory system for finance in the UK in the aftermath of the Global Financial Crisis.
Financial Policy Committee of the Bank of England
- FPC’s main role is to identify, monitor, and take action to remove or reduce risks that threaten the resilience of the UK financial system as a whole
- FPC publishes a Financial Stability Report identifying key threats to the stability of the UK financial system
- The FPC has the power to instruct commercial banks to change their capital buffers
- When the FPC decide that the risks to the financial system are growing, they may tell the commercial banks and other lenders to increase their capital buffers to help absorb unexpected losses on their assets (bad debts etc.)
- These capital buffers are part of “macro-prudential policy” - prudent means being careful at times of uncertainty.
UK Prudential Regulation Authority (PRA)
The PRA is part of the Bank of England and is responsible for the prudential regulation and supervision of around 1,700 banks, building societies, credit unions, insurers and major investment firms
It has a particular focus on the solvency of specific financial markets such as:
- Insurance providers
- Buy-to-let mortgage lenders
- Credit unions
- Other specialist lenders
Financial Conduct Authority (FCA)
The Financial Conduct Authority (FCA) replaced the Financial Services Authority (FSA) on 1 April 2013.
It is funded entirely by the firms it regulates
The FCA has three main objectives:
- Secure an appropriate degree of protection for consumers
- Protect and enhance the integrity of the UK financial system
- Promote effective competition in the interests of consumers
Micro and Macro Prudential Policies
Since the global financial crisis, regulators in the UK and a number of other countries have placed increased emphasis on prudential regulation – i.e. putting in place safeguards for the stability of the financial system
- Micro-prudential involves regulation of individual financial firms such as commercial banks, payday lenders and insurance companies
- Macro-prudential regulation is designed to safeguard the financial system as a whole
Liquidity Ratios and Capital Ratios
Liquidity means the ease and cost with which assets can be turned into cash and used immediately as a means of exchange
- Certain assets are highly liquid
- Notes and coins that are legal tender are perfectly liquid
- Money held in sight-deposit accounts is highly liquid because it can often be withdrawn immediately without penalty (although there might be a daily limit)
- Other liquid assets might include treasury bills (short term government loans) and also stocks held in large listed companies (because these stocks are traded heavily each day)
According to the Bank of England (July 2016) UK commercial banks hold more than £600 billion of high-quality liquid assets, which is around four times the level they held before the global financial crisis.
What are Liquidity Ratios?
- A liquidity ratio is the ratio of liquid assets held by a bank on their balance sheet to their overall assets
- Banks need to hold enough to cover expected demands from depositors
- In the wake of the Global Financial Crisis (GFC) the Basel Agreement require commercial banks to keep enough liquid assets, such as cash and government bonds, to get through a 30-day market crisis
- A liquidity ratio may refer to a reserve assets ratio for a bank which sets the minimum liquid reserves that a bank must maintain in the event of a sudden increase in withdrawals
- A high liquidity ratio may limit the amount of lending that a bank is able to do – it must maintain higher amounts of cash
What are Capital Ratios?
- Capital ratios have become important as part of attempts to maintain financial market stability in recent years
- A commercial bank's capital ratio measures the funds it has in reserve against the riskier assets it holds that could be vulnerable in the event of a crisis.
- The European Union runs regular “stress tests” to check whether banks have enough of a capital buffer to weather difficult economic/financial conditions (known as disaster scenarios)
- Banks must maintain sufficient capital which includes money raised from selling new shares to investors and also their retained earnings (profits)
- Europe’s banks have raised €180bn since the end of 2013
- But the size of “non-performing loans” has also risen
Core tier one ratio of Barclays Group from 2011 to 2015
The Tier 1 common capital ratio is a measurement of a commercial bank's equity capital compared with its total assets. This ratio is used to assess bank's financial strength.
Source: Tutor2u
