UNIT 4 REGULATORY FRAMEWORK

Warming up

Respond to the ideas given below using the conversational formulae box.

“The policy of being too cautious is the greatest risk of all” (J.Nehru, India’s first Prime Minister)

“Crisis” in Chinese is comprised of two characters – one stands for danger, the other represents opportunity.

…….

Conversational formulae box

It is common knowledge that … It is taken for granted that … It goes without saying … Wisdom says that … There is no doubt…

Topical vocabulary

1. Sort out the adjectives given below which are applicable to regulation into two groups opposite in meaning:

Tough, lax, soft-touch, heavy-handed, slack, stringent, strict, loose, lenient, intrusive, close

2. What do the terms prudential and macro-prudential regulation imply? What is the aim of preemptive regulation?

3. Fill in the gaps with the derivatives of regulate or synonymic expressions:

FINANCIAL --------------in America has two problems: there is both too much of it and too little. Multiple federal agencies the financial system: five for banks alone, and one each for securities, derivatives and the government-sponsored mortgage agencies. They share these duties with at least 50 state banking and other state and federal consumer-protection agencies. Yet all these ------------failed to anticipate and prevent the worst financial crisis since the Depression, because risk-taking flourished in the cracks between them. Toxic subprime mortgages were peddled by lenders with little federal and shoved into off-balance-sheet vehicles. The greatest leverage accumulated in firms that avoided the capital requirements of banks.

On June 17th Barack Obama took aim at these weaknesses. His financial white paper gets much right. It recognises that many remedies do not require new regulators, but simply better regulations, such as beefed-up capital and liquidity buffers for banks and shifting much of the “over the counter” trade in derivatives to regulated exchanges and clearing houses.

To be sure, competition is not all bad. Nor is a unified ----------------a cure-all: Britain’s --------------------------failed to do anything about British banks’ excessive dependence on short-term, wholesale funding. But most of America’s overlap is a useless holdover from the days when commercial and investment banks, thrifts, government-sponsored enterprises and commodity dealers did different things. This overlap encourages dodgy firms to shop around for the friendliest regulator, which is how the Office of Thrift (OTS) ended up so many big, failed companies. It slows down implementation of new rules, breeds turf wars, corrodes accountability and increases costs.

But under the new proposals only one------------, the OTS, will disappear. A new agency to protect consumers will take this area over from the bank regulators. But it will not assume similar duties now held by ------------------------or Commodity Futures Trading Commission, and have little enforcement authority over thousands of state------------ finance companies and loan brokers—a glaring shortcoming given that such firms were responsible for originating a large share of toxic mortgages and abusive loans.

6. Study the words and phrases below. Underline the odd one out in each group.

1 a) risky transaction b) precarious transaction

c) dodgy transaction d) postponed transaction

2 a) to run a risk b) to take a risk

c) to avoid a risk d) to encounter a risk

3 a) to spread the risk b) to mitigate the risk

c) to eliminate the risk d) to reduce the risk

4 a) cushion b) reserve

c) subsidy d) provision

5 a) bank bailout b) bank regulation

c) bank supervision d) bank oversight

6 a) capital requirements b) capital assets

c) capital spending d) capital gains

7 a) risk-sensitive b) risk-weighted

c) risk- based d) risk-averse

Reading

Read the text about Basel Accords and be ready to compare Basel 1 and Basel 2 in terms of their purposes and regulatory tools.

Basel 1	Basel 2
Purpose:	Purpose:
Tools:	Tools:
-	-
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Capital Requirements Directive/Basel 2

The original Basel Accord was agreed in 1988 by the Basel Committee on Banking Supervision. The 1988 Accord, now referred to as Basel 1, helped to strengthen the soundness and stability of the international banking system as a result of the higher capital ratios that it required.

Basel 2 is a revision of the existing framework, which aims to make the framework more risk sensitive and representative of modern banks' risk management practices. There are four main components to the new framework:

• It is more sensitive to the risks that firms face: the new framework includes an explicit measure for operational risk and includes more risk-sensitive risk weightings against credit risk.

• It reflects improvements in firms' risk-management practices, for example the internal ratings-based approach (IRB) allows firms to rely to a certain extent on their own estimates of credit risk.

• It provides incentives for firms to improve their risk-management practices, with more risk-sensitive risk weightings as firms adopt more sophisticated approaches to risk management.

• The new framework aims to leave the overall level of capital held by banks collectively broadly unchanged.

The new Basel Accord has been implemented in the European Union via the Capital Requirements Directive (CRD). It affects banks and building societies and certain types of investment firms. The new framework consists of three 'pillars'. Pillar 1 of the new standards sets out the minimum capital requirements firms will be required to meet for credit, market and operational risk. Under Pillar 2, firms and supervisors have to take a view on whether a firm should hold additional capital against risks not covered in Pillar 1 and must take action accordingly. The aim of Pillar 3 is to improve market discipline by requiring firms to publish certain details of their risks, capital and risk management.

Basel 2 takes a different approach to capital, charging banks on the basis of how risky their assets are. These “risk weights” will also become far more punitive

The liquidity of banks’ balance-sheets will also be regulated more intensively. Britain’s Financial Services Authority (FSA) has already issued proposed guidelines on liquidity which will require banks to hold a greater cushion of liquid assets, mainly in the form of government bonds.

If the regulation of balance-sheets is set to become more prescriptive, other things will be designed to increase levels of uncertainty. Take the stance of Britain’s newly scary FSA. Its previous philosophy meant that the regulator focused primarily on the management controls and systems that banks had in place. That passive approach will be replaced by a more intrusive and capricious regime, which questions the decisions of individual institutions.

CLOSER READING

1. Pinpoint all collocations with the word risk in the text you read.

2. Which bodies in the US and Britain are responsible for issuing regulatory quidelines?