全国2010年4月高等教育公共政策自考试题

Financial Institutions and RegulationI.Nature of financial intermediation:Direct financingOne of the main roles of a financial system is the channelling of funds from those economic agents with a financial surplus (lenders) and those economic agents with a financial deficit (borrowers).In the absence of organized financial markets or financial institutions, lending/borrowing will occur as a result of direct negotiation between two parties.Direct financing problems1)The claims produced as a result of direct negotiation will be HIGHLYILLIQUID since it would be difficult to sell them in the absence of an organised market.2)Searching costs3)ASYMMETRIC INFORMATIONMORAL HAZARD AND ADVERSE SELECTIONOther functions of bank s1.Maturity TransformationThe process of converting short-term liabilities into long-term assets.2.Risk Transformation/DiversificationFinancial intermediaries are able to transform risky assets into virtually riskless deposits by:screening out bad risks;spreading risks by lending to different types of borrowers;having a large number of loans (law of large numbers)holding sufficient capital to meet unexpected losses.3.Reduction in Transaction, Information and Search CostsMainly due to economies of scaleFIs recruit and train high quality staff to assist in the process of finding suitable deficit agents (They draw standardized contracts, they monitor, enforce them)It would be very difficult, time-consuming and costly for an individual to do soAdverse selection in banking:Adverse selection is a problem at the search/verification stage of the transaction when the lender is selecting a potential borrower.It occurs when the potential borrowers who are the most likely to produce an adverse outcome are the ones who most actively seek out a loan and hence are most likely to be selected.Moral hazard in bankingMoral hazard can occur after the loan has been made and is associated with the monitoring and enforcement stagesIt is the risk that the borrower might engage in activities that are undesirable from the lender’s point of view because they make it less likely that the loan is repaidPrinciple-agent problemIs an example of moral hazard that arises because of incomplete or asymmetric informationIt refers to a situation of separation of ownership and control in a firmManagers in control (the agents) may act in their own interest rather than in the interest of the stockholder-owners (the principals) because the managers have less incentive to maximize profits than the stock-holder-owners doII BANKING INDUSTRIES IN UK, CHINAMain changes in the UK banking industryPOST-WAR PERIOD• FIs SPECIALISATION UNTIL THE END OF THE 1960s, • LOW COMPETITION LEVELS• CARTELS, • STOCK MARKET RESTRICTIVE PRACTICES1970s• FOREIGN BANKS INTO THE CITY OF LONDON, • “COMPETITION AND CREDIT CONTROL” (1971), • CARTELS WERE ABOLISHED, • COMPETITION INCREASED1980s• DEREGULATION OF FINANCIAL SYSTEM, • ABOLISHED CONTROLS ON BANK LENDING• STOCK MARKET DEREGULATION, • PRUDENTIAL REREGULATION, (1987 BANKING ACT & 1988 BASLE CAPITAL AGREEMENT)Structure of Chinese banking systemIII.W hy FIs are special?TRANSMISSION OF MONETARY POLICY: banks are the conduit through which monetary policy actions impact the rest of the financial sector and the economy in general.CREDIT ALLOCATION: banks are the major and sometimes the only source of finance for a particular sector of the economy.TIME INTERMEDIATION: esp. Life insurance and pension funds savers can transfer wealth between youth and old age and across generationsPAYMENT SERVICES: FIs are special in that the efficiency with which they provide payment services directly benefits the economy.DENOMINATION INTERMEDIATION: esp. mutual funds when assets can only be bought in large minimum denomination size ($100,000 CD).“Specialness” and regulation:• minimum capital requirements, monitoring and surveillance (check the accounting statements and reports etc.)• formal controls, reserves requirements• regulation requiring FIs to lend to socially important sectors of the economy (eg. housing, farming)• protection against abuses, etc• increasing or decreasing the cost of entry into a financial sector affects the profitability of firmsIV.Why do modern banks need a central bank?Main functions of a central bank:Manage the monetary policy with the aim of achieving price levels stability Prevent liquidity crises, situations of money market disorders and financial crisesGrant the smooth functioning of the payments system(1)Monetary policy functionDebt securities (mainly Tbills) are used by the central banks in the OMOOMO are the most important direct monetary policy tool of central banksIf central banks BUY securities, the liquidity in the system INCREASES (ceteris paribus)Vice versa when monetary authorities SELL securities the money supply DECREASESIn doing so, the central bank influences the portfolio of assets held by the private sector(2a) Loans to banks and discount window toolDiscount loans to banks account for a large proportion of central bank’s assets (e.g., in the UK 40%)By changing the discount rate that is the interest rate that central banks charge for loans to banks, central banks can control the supply of money in the systemFor example, if it is more expensive for banks to borrow from the central bank then they will borrow less and the money supply will decline(2b) Loans to banks and LOLRDiscount lending to banks can also occur through the central bank’s lender-of-last resort function (LOLR)By acting as a LOLR the central bank provides liquidity support directly to individual financial institutions if they cannot obtain finance from other sourcesTherefore discounting can prevent financial panicLink with the need to ensure safety and soundnessof the financial sector(3) Deposits by banks and reserve requirement toolA large % of bank liabilities consist in bank depositsThese are assets for the banks that hold them and represent reserves that banks can demand to the central bank at any timeIn some countries reserve required ratio used as monetary policy toolThe higher (lower) the reserve required ratio, the lower (higher) the amounts of funds available to banksWhy do modern banks need a central bank?--Free banking schoolFree banking school: regulation should be left to the market …For example, the LOLR function not in line with current developments in the banking sectorIn market-oriented economies LOLR could be detrimental to the good functioning and efficiency of the banking sector as a wholeHow could safety and soundness be ensured?Depositors would understand that they would lose funds if the bank failed Bank managers would want to keep depositors confidence because if depositors had any doubts about the safety of the bank they would start towithdraw depositsBank managers would reassure depositors that they were not taking too much risk. They would also want to maintain adequate capital--Against free bankingEven monetarists (Friedman) did not contemplate a banking sector without a central bankGoodhart’s reasons for a central bank and theory of banking clubs [Goodhart C.(1989) - ch.8 - Why do banks need a central bank]The issue is: if there is more than 1 bank in the competitive equilibrium how would banks relate to each other?Theory of banking clubsThere are 3 possible reasons in the literature that might lead banks to prefer some sort of “club”(1)Reducing transaction costs for interbank loansTransactions and monitoring costs of arranging interbank loans might make a bankers’ bank attractive to the banks for much the same reasons that individual borrowers and lenders often prefer to deal with each other through an intermediaryA central bank could cut down transaction costs by arranging loans centrallyIt can also co-ordinate monitoring and eliminate unnecessary monitoring costs where there are multiple lenders(2)“Reserve externality” argumentGoodhart and other economists point out that a banking club is needed because banks have insufficient private incentives to hold the “socially optimum” amount of reservesBanks ignore the “external benefits” that its reserve holdings confer to other banksExternal benefits arise because the greater a bank’s reserves, the more likely it is to be able and willing to lend to other banks should they desire a loanBankers could establish a club to which they delegated the power to 1) impose reserve requirements and 2) lend a proportion of member banks’ reserves(3)Bank contagionThe most important rationale for banking clubs is the prospect of contagious bank runsContagion occurs when a shock to one bank raises the public’s apprehension about other banks to a level where they faced runs as well In other words contagion is a negative potential externality that banks might impose on each other and the claim is that banks could handle these externalities by forming a clubShould central banks be independent?In recent years there has been a significant trend towards central bankindependence in many countries.The issue has generated substantial debate. Theoretical studies seem to suggest that central bank independence is important because it can help to produce a better monetary policy.What is central bank independence?Central bank independence can be defined as independence from political influence and pressures in the conduct of its functions, in particular monetary policy.Two types of independence:1) goal independence, that is the ability of the central bankto set its own goals for monetary policy (e.g., low inflation, high production levels);2) instrument independence that is the ability of the centralbank to independently set the instruments of monetary policy to achieve the goals.It is common for a central bank to have instrument independence without goal independence; however it is rare to find a central bank that has goal independence without having instrument independence.In the UK, for example, the Bank of England is currently granted instrumental independence and practices what is known as inflation targeting. This means that it is the Government to decide the target inflation rate and the Bank is allowed to independently choose the policies that will help to achieve that goal.Such situation is the only acceptable in a democracy because the Bank is not elected and thus goals should only be set by an elected government.. !!While central bank independence indicates autonomy from political influence and pressures in the conduct of its functions (in particular monetary policy); dependence implies subordination to the Government. In this latter case, there is a risk that the Government may “manipulate” monetary policy for economic and political reasons.Central bank independenceTHE CASE “FOR”(1)Politicians tend to be “short-sighted”: they are unlikely to focus onlong-run objectives like promoting price stability(2)Political “business cycle”: before an election expansionary policies arepursued by the Government to lower unemployment and interest rate(3)Politicians can use the central bank to facilitate Treasury financing of largebudget deficits(4)Lack of expertise of politicians at making decisions on issues of greateconomic importance, such as reforming the banking system(5)The central bank, if independent, can pursue policies that are politicallyunpopular yet in the public interestTHE CASE “AGAINST”(1)Democratic legitimacy: it is undemocratic to have monetary policycontrolled by an elite group responsible to no-one(2)Lack of accountability of central bank: there is no provision for replacingmembers(3)Economic stability requires co-ordination between monetary policy andfiscal policy (i.e. management of government spending and taxation)(4)Experience shows that the central bank has not always been successful inusing its freedom(5)The central bank is not immune from political pressuresCB’s independence: examples•FED (US): appears to be “remarkably free” of the political pressures that influence other government agencies. Members of the Board of Governors are appointed for 14 years and the term is not renewable. Moreover it has a substantial source of revenue from the holdings of securities (about $20 billion per year!!)• ECB (EU): the most independent in the world, it is independent of both the EU and the national governments and has complete control over monetary policy. Its charter cannot be changed by legislation: it can be changed only by revision of the Maastricht TreatyV.Banking regulationTypes of regulationThere are three types of regulation::a) Structural (or systemic) regulationb) Prudential regulationc) Conduct of business regulationStructural (or systemic) regulationThis regulation is concerned mainly with the safety and soundness of the financial system.Government safety netdeposit insurancePrudential regulationThis regulation is concerned mainly with consumer protection..It relates to monitoring and supervision off financial institutionsWhy prudential?Various regulatory instruments, mainly capital adequacyConduct of business regulationThis regulation focuses on how banks and other financial institutions conduct their businessIt relates to information disclosure, fair business practices, competence, etc.It focuses on establishing rules to minimize the risk that:C onsumers receive bad adviseF rauds and misrepresentationE mployees and financial advisor act incompetently Limitation of regulationThere are some arguments against regulationS afety net arrangements create moralhazard (e..g.. Too Big to Fail or Too Important to Fail) B anks may benefit from regulatory forbearanceR egulation can create problems of agency capture R egulation is costly and the cost ofcompliance can be passed to consumersThe Bank of EnglandEstablished 1694•1946 Bank of England Act → BoE was nationalised & formally recognised as a CB• Until 1997 the Bank was statutorily subordinated to the TreasuryFunctions:• Supervision & regulation of the banking sector• Stability of the financial system• Implementation of monetary policy• Mgt of national debt• Lender of last resortMain Objective of BoE:• Monetary & financial stability•After 1997 the Bank was granted some independence + other changes• May 1997 Treasury proposed a number of institutional & operational changes to the BoE. These were set out in The Bank of England Act 1998 (1 June)1) the BoE was given operational independence in setting interest rates which would now be the responsibility of a newly created Monetary Policy Committee (MPC) working within the Bank2) the regulation of the banking sector was taken away from the Bank andgiven to a newly established “super” regulator called the Financial Services Authority (FSA)3) although the government retained responsibility for determining the exchange rate regime, the Bank could now intervene at its discretion in support of the objectives of the MPC4) the mgt of the national debt was transferred to the TreasuryCore purposes of the Bank of EnglandMaintaining the integrity and value of the currency (- price stability - MPC)Maintaining the stability of the financial system, both domestic and international (- monitoring and supervision - FSA)Seeking to ensure the effectiveness of the UK's financial services (-ensuring competition at domestic and international levelsThe MPC• “Interest rates are set by the MPC. However the legislation provides that if, in extreme circumstances, the national interest demands it, the Government will have the power to give instructions to the Bank on interest rates for a limited period. [...]• The MPC meets on a monthly basis and a schedule of meeting dates is available. The Treasury has the right to be represented in a non-voting capacity.• Decisions are made by a vote of the Committee on a one-person one-vote basis, with the Governor having the casting vote if there is no majorityThe FSA• The Bank retains the responsibility for supervising overall stability in the financial system and the government established a structure whereby the Treasury, the Bank and the FSA would work together to maintain financial stability.•This was clarified in a Memorandum of Understanding published in October 1997 which set out the roles for the Treasury, the Bank and the FSA.Financial regulation in Europe (1)The main focus of the EU legislation has been to harmonize rules and regulation aimed to promoting a single market in financial servicethroughout the European UnionI European Directive (1977)II European Directive (1993)S ingle EU banking licenseH ome country controlAs such, the EU Directive sets out:Minimum levels of capital required before authorization can be granted Supervisory requirements in relation to major shareholders and bank’sparticipation in the non-banking sectionAccounting and internal control requirementsEU Capital Adequacy Directive (1996)Notes:I n 12/1990,, the Bank of England implemented the Solvency RatioDirective and the Own Funds DirectiveT he FSA has now implemented an up-dated version of this directive to account for the new Basle accordCapital liberalization DirectiveAdmissions DirectiveInvestment services DirectivePension DirectiveFinancial Services Action Plan (endorsed European Council in Lisbon in March 2000)。