Financial regulation reform in UK

As a global financial centre, UK also suffers from shock in this crisis, so it needs financial regulatory reform. Before this crisis, UK has established a set of complete financial supervision system, Andrew (2010) believes that Bank of England did well in capital adequacy and liquidity, but in terms of bank fraud and risk management, it is bad. UK should repair the existing financial regulation system and cooperate with other countries to regulate. What’s more, government need to consolidate the international financial centre of London.

 

I think << a new approach to financial regulation the blueprint for reform>> is the most important measures of government, which reform the system of financial regulation. In this book, the quasi ‘Twin Peak’ will replace the current tripartite supervision system. Specifically, Bank of England set up a new Financial Policy Committee (FPC), which is a macroprudential regulation organization. It’s responsible for monitoring and dealing with systemic risk. Bank of England also establishes Prudential Regulation Authority and Financial Conduct Authority. PRA will take prudential supervision for all kinds of financial institutes. FCA will supervise the business activities of financial institutes, which can promote financial market competition, and protect consumers. In fact, FSA will transfer its prudential supervision function and behavior regulatory function to PRA and FCA. At the same time, PRA and FCA will be guidance by FPC in terms of   macroprudential supervision.

UK try to set up new financial regulatory framework by financial regulatory reform, the effectiveness of the reform remains to be seen, but some approaches are very good, such as strengthen the regulation of systemic risk, pay attention to financial consumer and establish special handling mechanism for problem financial institutions.

‘Myopic’ financial regulators of the United States

In the following two weeks, I will discuss financial regulation reform (the United States and UK) after financial crisis. This week I will introduce the United States.

The history of the global financial crisis of eight hundred years shows that, country and bank often lack of the suffering consciousness during the prosperous time, moreover, they accumulated too much debt. When the inevitable economic recession came, the risk of financial crisis will not be far away from us. Recently, we can see the complete meeting record and telephone records of U.S. financial regulators in 2007, senior supervisors underestimated the subprime mortgage crisis. Bernanke (2007) believe that the large financial institutions will not face bankruptcy or close to bankruptcy. In fact, the real estate bubble is very obvious, low savings rate and high leverage has become a life way of many American families. Economic growth is slow. They are all the important factor of financial crisis, but financial regulatory authorities of the United States ignored them.

 

Allen (2009) argued that the security of a single financial institution is not enough to ensure the stability of the whole financial system. After the financial crisis, macroprudential regulation has become the main direction of the regulatory reforms. In July 2010, the White House passed the new financial regulatory reform bill, which is the most massive financial regulatory reform since the great depression. In my opinion, the main content of this bill is following:

 

a) The bill set up Financial Stability Oversight Council, which can monitors and deals with systemic risk.

b) Limiting proprietary trading and high-risk derivatives trading of commercial bank, what’s more, putting OTC derivatives market into the regulatory vision.

c) The Federal Reserve will supervise the compensation of enterprise executives, which make them less to pursue high risk investment.

d) Establishing settlement mechanism for those bankrupt financial institutions, to prevent the similar Lehman bankruptcy events that give rise to huge shock on the market.

Hatzius (2013) believe that the downward trend of the United States economy is weakening, some economic data are good and weaken the possibility of the economy back to recession. I also think America's reform measures seem to have some effect.

Deposit Insurance--- another important factor

In the last blog, I discussed Basel’s role in banking regulation. This week, I will introduce another important factor---Deposit insurance. Deposit insurance is a financial security system, which plays a crucial role in banking regulation. It maintains bank credit and stable financial system.

Diamond (1983) and Dybvig (1983) think that the vulnerability of banks make deposit insurance more important. The implementation of the deposit insurance system can reduce bank runs effectively. At the same time, it can protect the interests of depositors when the bank bankruptcy.

Of course, some people do not think the deposit insurance system can stable the operation of financial institutions. What’s more, they believe deposit insurance may aggravate financial risk.

Park (1992) argues that the infectious effect of financial crisis is closely related to information asymmetry. The most effective means is to provide more bank specific information. Deposit insurance system cannot solve the problem. Dowd (1993) thinks that, only under a full competition market environment, the operation of banks can be more effective. Competition makes bankers find the optimal equilibrium between protection of depositors and investment return. Deposit insurance by government can weaken the bank competition. Matutes and Vives (2000) believe that deposit insurance lead to bank increase their interest rates to attract depositor. It will amplify bank systemic risk.

However, as far as I am concerned, legal deposit insurance system can regulate bank in advance, and warned the question bank. These measures can strengthen the regulation of prior crisis. Further, it is also a relief mean when bank bankrupt, which avoid triggering systemic crisis and maintain the safety and stability of the financial system. Deposit insurance system will also give the authority of managing and supervising to the deposit insurance companies. These companies will pay more attention to the management status of bank. So, I think Deposit insurance is an important fact in banking regulation.

Get Basel III right and avoid Basel IV ！！！

The words of title are said by Thomas M. Hoenig who is the vice-chairman of the Federal Deposit Insurance Corporation. In his article, he mainly argues Basel III and declare bank should make their capital adequacy ratio better actually. As we all know, Basel accord plays an important role in regulating bank. Now, let me talk about it, especially for the recent lanch of Basel III.

The Basel Accords refer to the banking supervision Accords—Basel I, Basel II and Basel III—issued by the Basel Committee on Banking Supervision. It has become an international standard of banking regulation. 

During the time of Europe and the United States economy struggling in a recession edge, Basel committee on banking supervision which from 27 economies of the central bank and banking regulators released Basel III on September 11, 2012.

Basel III based on Basel I and Basel II, which not only raised bank's capital adequacy ratio requirement, but also pays more attention to the quality of bank capital. What’s more, it adds the new capital buffer requirement and cooperates with liquidity constraints. The main purpose is to ensure the robustness of bank business and make the financial system stability and security. Now Basel III has been implemented, look at this figure:

 

 

Source: http://www.avondaleam.com/2011/09/basel-iii-tier-1-capital-requirements.html

 

Basel III allow commercial banks' the core tier 1 capital (common equity and retained earnings) will rise from 3.5% to 4.5% between 2013 and 2015. It also adds capital conservation buffer which will start at 0.625% of RWAs in 2016 and reach 2.5% of RWAs in 2019. Capital conservation buffer can be used to deal with financial crisis in the future. These rules reflect the determination of the international community to strengthen capital supervision. Basel committee put forward higher capital requirement for banking proprietary trading, derivatives and asset securitization.

 

The increasing of commercial banks’ safety index in Basel III means the global banking regulatory ushered in a new era after the most serious financial crisis. The most significant feature is that the security has far beyond the efficiency of banking in the core value choice of banking regulation.

 

We can see this video and acquire more knowledge about Basel III.