Bank Regulators and Conclusion

The UK’s bank regulator changed in the period. FSA was the only institution regulates the banking industry until 2013. Nowadays, two successor authorities are in charge of banking. It ended the era that labour government organised financial system in the UK. (BBC News)

The Prudential Regulation Authority (PRA), as a part of BoE, not only regulates and supervises banking sector and other financial institutions at the level of individual firm with the standards it sets, but is responsible for the protection and enhancement of the UK financial system’s stability as well. It has two following statutory objectives which developed by two tools, namely, regulation and supervision.

1. ‘To promote the safety and soundness of these firms and, specifically for insurers;

2. To contribute to the securing of an appropriate degree of protection for policyholders.’

Although BoE did not conduct, the board of PRA involves governor of BoE makes supervisory decisions and ‘is accountable to the Parliament’ indeed. This approach does not pursuit a ‘zero-failure’ regime. It reduces the pressure of regulation and encourages the regulator work better.

The other main regulator, the Financial Conduct Authority (FCA), is independent of the UK government. This authority has principal powers, for instance, regulate implement of marketing of financial products. According to the Financial Services Act of 2012, it supervises banking sector with a new system. In detailed, supervisions have three targets:

1. ‘To ensure they treat customers fairly;

2. To encourage innovation and healthy competition;

3. To support identification of potential risk early’.

FCA mainly regulates financial services firms, playing a role as Watchdog for City’s Behaviour. It contributes to promote economy in the UK. On the other hand, it has effect, i.e. interest rate.

To sum up, I have addressed specific regulations and regulators relating to this issue. Basel Accords and Banking Act challenged by sub-prime financial crisis and the latest one is shown with advanced improvement. The replacement of regulators opens a new age for banking system. In this research, lack of practical cases limited the outcome and less consideration for early Banking Acts is shortcoming, too.

Bank Regulations: Basel III and Banking Act 2009

As a current regulation, Basel III was seen as the response to the sub-prime financial crisis from systemic risk perspective. The developed Accord experienced a series of amendments (2010-2013) as well and expanded until 2018. The new parts relating to bank capital adequacy, stress testing and market liquidity risk with more concerns.

This international bank regulatory framework highlights Capital and Liquidity. Capital part involves three pillars are similar to Basel II while increase bank liquidity and decrease bank leverage constitute the second one. Comparing with early Accords, the banking capital’s quantity and quality increased; two liquidity ratio, namely, liquidity coverage ratio (LCR) which revised in 2013 by the Group of Central Bank Governors and Heads of Supervision (GHOS) and net stable funding ratio (NSFR), as well as one non-risk based leverage ratio, were added (Co-Pierre Georg, 2011).

There is a video about overview of Basel III. General speaking, it discussed three sections, as follow:

Capital—it requires banks set aside more than 7 per cent rather than 2.5 per cent of risk-weight asset according to activities’ nature or bank’s types. 

Liquidity Ratios—stress testing manages the level of bank liquidity. Cross selling will manage the liquidity of deposits and loans. It also leads to operational intimacy.  

Leverage Ratio—the terms of balance sheet should be reduced so that put aside for development and comparing its own capital.

In the implemented duration (2011/19), the committee issued specific requirements respectively for recovery of banking (Basel III). Basel III also improves the transparency though a macro-prudential approach (Co-Pierre Georg, 2011), which is an opposite response to recent financial crisis affected by insufficient micro-prudential approach.

Has Basel III worked? Harle etal. (2010) argued banks potential responses such as ‘no-regret moves’, ‘balance-sheet restructuring’ and ‘business-model adjustments’. They also guessed the Accord would work in the European Banking sector. Cosimano and Hakural (2011) suggested that equity-to-asset of large banks would go up 1.3 per cent averagely. Allen et al. (2012) critiqued the reform would limit credit’s availability and decrease economic activities. 

The following video provides a variety of opinions regarding above question:

The Basel Accords—capital adequacy regulations—critiqued in decade due to several shortcomings. Viewing subordinated debt as capital; such a low minimum risk asset ratio; the conflict between micro- and macro-prudential approaches, etc. Whatever, the Accords contributed in the recent decade, and could be guilty.

Besides, the Banking Act 2009 is contemporaneous principal banking regulation in the UK. As an Act of the Parliament of the United Kingdom, the Banking Act 2009 entered into force in part on 21/02/2009 to replace the Banking (Special Provisions) Act 2008. The main concept encompasses following parts: Special Resolution Regime (SRR), Bank Insolvency, Bank Administration, Financial Services Compensation Scheme, Inter-Bank Payment Systems, and Banknotes: Scotland and Northern Ireland, Miscellaneous, and General. The core provision relate to a promoted regime--the SRR impacted by the Treasury, Bank of England and Financial Services Authority which have the substantial powers to manage (Linklaters). Therefore, I will discuss the regulators later.

Bank Regulation: Basel II & Financial Crisis (2008-2009)

In my last blog, I addressed the overview of the framework of Basel II and its updates. This Accord experienced a serious challenge occurred from mid-2007 to 2009.

Do you remember? Mortgage backed security, credit risk, Lehman Brother’s bankruptcy, acquisition for Merrill Lynch and nationalisation of Northern Rock, etc. That was the worldwide financial crisis which erupted in American sub-prime loan’s sector and result in the global financial system collapse. Shown with its weakness, Basel II—the capital based regulation—was into the spotlight and blamed by lots of people such as ‘economists, policy-makers and market operators’. What responsibilities related to financial crisis might be imputed to Basel II? (Cannata and Quagliariello, 2009)

Figure 2: Responsibilities of Basel II in the Financial Crisis (referenced GuiltyRole?)

Moosa (2010) also exposed Basel II’s weaknesses and how they were exposed by the financial crisis. Generally, two prominent roles it played as, which were ‘providing the wrong kind of regulation and ignoring liquidity and leverage’.  The ‘exclusionary, discriminatory and one-size-fits-all’ Accord did not cope with the sub-prime financial crisis due to it could not bear all responsibilities well, for instance, applying bank internal models.

Caruana and Narain (2008) argued that ‘Basel II does not address all the regulatory issues that figure in the lessons learned from current market events’. Indeed, the regulation was abandoned. Moreover, Coy (2008) pointed out the committee should be responsible for the dysfunctional outcome. ‘The bureaucratic machinery of Basel II could become a classic case of the law of unintended consequences’. The committee absorbed members from seven new countries. Consequently, in response to this crisis, the enlarged BCBS the members published new standards—Basel III in 2010. 

Bank Regulation -- Basel II

After the posted theory retrospect, the current circumstances of bank regulation shall be researched. In recent decade, the UK bank is regulated by the Basel Accords and Bank Act 2009.

The Basel Accords is viewed as the banking regulation and supervision recommendations, including Basel I, Basel II and Basel III. Those all are issued by Basel Committee on Banking Supervision (BCBS). This blog merely focus on the last two regulations for the specific period.

Basel II, as the second of the Basel Accords, published in June 2004 and updated seven times from 2005 and 2009 (Figure 1).  

Figure 1: Chronological Updates (referenced by Basel II)

This accord emphasised three major pillars, namely, Minimum Capital, Supervisor Review and Market Discipline. The first pillar refers to banks can keep the minimum capital under the credit risk, operational risk and market risk, concluded in the equation:

Two Capital / {RWA_Credit + [MRC_Market * 12.5] + [ORC_Opr’l * 12.5]}>=8% with Assets

The second focus on strengthening the banking regulation though the key principles, which are rigorous bank process, supervisor response and supervisor intervention. The third one aims to complement regulations by regulators and disclosures requirements. The integral overview of Basel II in the following video:

In the next blog, I will discuss how the financial crisis impacted on the Basel II. 

Introduction and Bank Regulations

In this blog, I intend to research how bank regulation developed in the United Kingdom in recent decade (2004-2013), which is a period for banks experienced enormous finance successes and fails. Besides discussion for specific laws and regulations, I will research the replacement of regulators.

Before I explore those sections, I would like to get flavors about why regulates banks, what the bank regulation is and who the regulars are.

Varied views argued about reasons why regulates banks based on distinct focuses such as nature of banking assets, type of banks (Free banks needn't be regulated.), characteristics of banking industry etc. The inherent instability and systemic risks of banks, seen as key points, would lead to the necessary of bank regulations. So actually, what is bank regulation? It is defined as ‘a form of government regulation which subject banks to certain requirements, restrictions and guidelines’. Others identify it as ‘the formulation and issuance by authorized agencies of specific rules or regulators, under governing law, for the conduct and structure of banking’. Banking industry is regulated and runs business particularly lending activities without discretion, monitoring and examining under laws and principles, namely, Basel II, Basel III and Banking Act 2009. As an important role, bank regulation creates a transparent circumstance among banking activities, monetary institutions and other entities, like regulators—Central Bank and Independent Regulator. In the UK, Bank of England (BoE) did not conduct the regulation after late 1990s and the independent regulator—Financial Systematic Authority (FSA)—have replaced by Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) in 2013.