Okay hi there and welcome to an update video on aspects of financial regulation in the UK this is a companion video to a previous one. On aspects of financial market failure let’s take a few moments a few minutes just to run through to work through the key agencies that regulate the UK financial system you need to. Know who these agencies are so a quick line or two on each the FPC the financial policy committee is run by the Bank of England their main job.
Is to monitor and if needed to take action to reduce any. Systemic risk that might threaten the resilience of the entire financial system. They take a look at the financial system as a whole big sense see if they can maintain the stability of the system the risk factors in. That financial network the Prudential Regulation Authority what an exciting name. By this they have a particular focus on the solvency the commercial viability if you like of specific financial markets such as insurance or people let but a lens.
To buy to let investors or credit unions okay and the financial conduct authority is basically there to protect consumers very much in the news over the years they have been targeting the. Mis-selling of PPI they’ve been having the right go at the payday lending industries with interest rate interest. Rate charge caps they’ve been trying to promote effective competition in the banking sector just recently they’ve put a cap on the interest that the Leinster own market can. Charge so their job is really to look at the financial aspects of particular.
Industries or markets I put a little more big blue line underneath those three the competition and Markets Authority of course is the UK’s main monopoly Commission of. Monopoly scrutiny if you like they have a much wider remit that extends way beyond financial markets but they do have a role.
To play for example looking at mergers and takeovers in the banking sector mergers and takeovers in the building. Society industries preventing looking at the interest of consumers and preventing. Market power being dominated so those are the agencies that regulate what are the aims of financial. Policy well the aim is to be contributing towards financial stability go back to the video the previous video on financial. Market failure the externalities or financial system doesn’t work so their job is to prevent protect against the consequences of market failure to protect the interests of consumers as key stakeholders so in the.
Sense try limit the power of the banking the established banks and protect vulnerable households from very high interest rates on for example payday loans try to make financial services more affordable accessible and also. Understood and oftentimes balancing the interests of consumers who may not have that sophisticated knowledge about financial instruments both saving and debt compared to the people that.
Are trying to sell them financial services or generally they’re trying to provide it if you like an underpinning of confidence in the system to allow the central bank if it needs to perform. Its other function as a lender of last resort and this key concept absolutely crucial concept to try and prevent or mitigate systemic risk. Now if you talk about systemic risk in an essay you are on very. Very firm ground so what does it mean systemic risk it’s a great phrase to use which talks about the possibility that an event at a micro level for example the failure of.
A bank or big insurance company could actually trigger a much wider systemic consequence and negative consequence only a decade ago in the global financial crisis illustrates just how. Interconnected the world has become but that’s become a shock in one industry in one country the subprime market mortgage market in knighted States.
For example how do JH reverberations across the world threatening the stability the entire global financial. System since the crisis has been a big shift towards trying to make the banking system in particular is fragile more resilient less vulnerable to those shocks it’s the nature of the beast that banks. Commercial banks have to take the risks some of those risks will go along sometimes the bank will lend. You money and you can’t pay it back but the supervisors the regulators have a job to make sure that banks can. Absorb losses without just cleaning over so this financial regulation seeks to control the degree of systemic risk in a country there are two main types of financial regulation policy and. It’s fantastic if you know what both are so you can really impress the Edible examiner’s the first.
Set of policies on their own is micro-prudential policies and at the end they’re at a. Micro level is to try and increase the resilience and. The civility of individual industries and firms commercial banks pay their lenders insurance companies protect depositors protects the people who say with the bank protect the people who boil with a bank. That is micro-prudential potential space means safety doesn’t it imprudent macro-prudential seeks to safeguard the financial system as a whole to protect against systemic risk.
Now one of the key parts of this is so-called risk assessment. And this quote is from Sir John Cunniff at the Bank of England tale and risk is the focus of financial regulation financial stability is about the tale of the problem with distribution in other. Words not what could happen so what about what could happen wealth and what is. Likely to happen it is unlikely that new cash United will win the Premier League in his own life thing that my club havoc at town will.
Win the Football League those are tail end events they are events of low probability they’re not. The central forecast but of course tail n risk is what happened just over a decade ago the the likelihood of the big subprime collapse in the United. States a likelihood of huge movements in exchange rates and currencies there was. All the extreme events which oftentimes the more the forecasters. Don’t build into the risk assessments that’s one of the big changes in the last ten years as a result and this is fantastic for.
The example the UK Bank of England along with other central banks now each year performs. What is called a stress test our stress test is not what you have to do before the exam the exam is your stress test. What the Bank of England does here is they paint a really really bad scenario a kind of doomsday picture and ask a very simple question can banks in this case in. The UK can the UK banking system as a whole can it. Withhold and withstand and survive a really adverse scenario okay did the banks have sufficient reserves and resilience to withstand a shock this is the 2018 stress test scenario and they.
Assume the world economy goes into a recession they assume that China goes into a session. That GDP Falls in the UK by 5% unemployment more than doubles as a third fall in property prices huge foreign commercial real.
Estate prices of shops and shopping centers buildings and offices the. Pound falls by nearly 30 percent and base and interest rates go up to 4%. From where they are now no point seven-five little bit of stress chess is a what-if it’s the most pessimistic scenario the bank is prepared to tolerate and. They test to see if the banks have enough reserves and the answer is that the.
Banks do have in the UK enough capital to withstand this shock the yellow bit here is the stress test. For 2018 matched against what actually happened during the financial crisis so that assuming are much bigger rising. Unemployment a big bigger collapse in residential property prices for example the good news is I was of 2018 that commercial banks in. The UK all of them are able to withstand the slump and already if you like for the uncertainty perhaps have owned a disorderly brexit and the. United States banks last year passed the stress test as well so this is an example of financial stability.
Policies the banks also brought in something this is bit technical but if you understand it it’s fantastic it’s something called this counter cyclical capital buffer. Best said with an American accent there’s basically that the amount of capital the banks have should go counter cyclical so when the credit cycle is swinging. Nicely when there’s a lot of a lot of extra buying and people are confident that wanted to take out mortgages then the bank should build up extra capital maybe they should.
They Shushan new shares perhaps they go to the bond markets they can raise some extra capital because that’s often often the time when banks become. A little bit loose and a bit relaxed about who they’re lending to so it’s good for them to. Build capital during that time period there’s a phrase which. Says you should always try Mendy the roof when the sun is shining rather than when it’s pouring down.
That’s what the idea is here so that if there was a downswing in the economy fizzle recession the credit cycle turns then banks have some capital to help absorb. A loss so that’s currently set at 1% they think the banks have to hold an extra 1% of assets in capital at the moment a lot of other examples. Of financial regulation in action in the mortgage market now the lenders have a limit to how big the more we lend loans can be I think it’s 15 percent of any new. Moreyou lending can be lent out at a ratio of four and a half times your income I think only about one sector of a new mortgage lending by a bank or Building. Society can be more each worth four and a half.
Times some of these incomes they’re trying to limit how much mortgage lenders are prepared or able to lend out well. That means of course is that people managed to save more. For a deposit which makes it harder to mortgage their while deposit guarantees in place how to protect savers and. When the northern lock went bust there were fears that sames would lose their money deposit guarantees now provide a bit of resilience. For savers we’ve talked about stress tests and sheron’s companies must now have enough capital to cope with a one. In two hundred year event such as maybe the government getting explicit deal so something that’s extremely unlikely and interestingly in the certain interesting markets the payday lenders were capped the rates of interest.
They could charge were capped I think it was one percentage was per day and that’s actually that’s all of a payday lenders leaving the market similarly capped interest. Charges in the rent to Road market that’s people renting a sofa renting. A TV in installments before eventually owning it looking into 2019 not everything is hunky-dory there are some quite big risks to the UK economy a financial stability in particular.
People are worried about high levels of unsecured debt particularly in the car market the obviously fears about a possible disorderly brexit whenever if ever that happens the No Deal scenario. For example how much further does the current property market serdes have to go some evidence that property prices and our falling in places like London will UK. So I will foreign investors still want to to invest in the UK never got me when a big current account deficits and therefore there’s quite a big fear that. Foreign investors may lose some of that appetite for buying. UK government bonds and property and shares UK banks are quite heavily exposed to the world economy so if the Chinese. Economy goes into a down spin if Germany goes into a recession perhaps some UK banks who’ve lent to people and businesses in those countries might face some some bad debts and there’s the underlying.
Problem is that the banks are still paying out billions for the legacy effects of their misconduct the missed selling of PPI being an obvious example the financial system is. On the surface appears relatively stable but there are some risks just to be aware of and one. Of them is debt I think the biggest risk for the UK is probably the level of debt. This choice well the colourful shows the total amount of non-financial.
Debt relative to GDP so take out the financial businesses take out the banks and buildings I just look at households and businesses corporates and you can see that there was a. Huge rise in debt before the last financial crisis in 2003 2005 2007 debt almost released on an ad plan of GDP then debt fell back. Obviously there’s a recession kicked in and people started to try and.
Repay debt a little bit it fell but the last few years it’s stabilized at about hundred and forty hundred and forty five percent of GDP. That green bit is student loans that’s been going up quite sharply some signs that debt is pretty high under than fifty. Percent of GDP now in a world of low interest rates that debt is. Relatively easy to to afford to service but if interest rates start going up to any significant degree if unemployment stops falling if people’s real income start to take a bit of a heads in.
The months and years ahead the debt becomes much harder to repay I. Think we should have a lower level of debt than we do at the moment the big risk is something called capital flights it’s a. Quick one on this for me there are some risks to do with there was something called.
Outflow of hot money which you may have come across if you study the exchange rates here’s the basic flow through overseas investors become nervous. About the UK that might cause a big outflow of hot money which causes sterling to. Depreciate called sterling as a floating exchange rate fall in. The currency leads to a rise in inflation cost push weaker sterling then triggers the Bank of England to to raise interest rates let’s say the two or three percent the higher inflation impact. Some people’s incomes that causes a fall in demand it also becomes more expensive for the UK government to boil when they were.
Issuing you debt so if the economy then slows down on the back of a rising interest rates that then increases the risks for commercial banks. Some of whom have lent money to people who will find it very hard to repay we call this the risks to the UK. Economy from capital flood last slide and if you stayed.
With me all away thank you and well done is a fantastic quote from Andy Holden so financial regulation can be a little joy you need to know. The basics you need you know why we have the regulation but crucially this is. A great quote the financial system is dynamic and adaptive so any financial regulatory policy if you like will need to be adaptive is if. It’s to contain risk within this system in a sense the regulators are having to run to stance to it because lenders are becoming even more complex with. How they lend their money out living in a world of financial technology FinTech lots of new financial products on the near horizon the role of online banking all that kind of. Stuff so Bitcoin could tow occurrences you might be interested in looking at how do you regulate Bitcoin if you can so financial regulation is an interesting.
Area and it’s one that you literally have to learn to stand. Still because it’s such a dynamic and adaptive market there we go thank you for joining in this 2019 update on financial. Regulation and I hope you got something tangible from it.