Prudential Regulation Research Articles

Rules versus Disclosure: Prudential Regulation and Market Discipline

Rules versus Disclosure: Prudential Regulation and Market Discipline

Consideration of the proxy modelling validation framework

Abstract Solvency II requires that firms with Internal Models derive the Solvency Capital Requirement directly from the probability distribution forecast generated by the Internal Model. A number of UK insurance undertakings do this via an aggregation model consisting of proxy models and a copula. Since 2016 there have been a number of industry surveys on the application of these models, with the 2019 Prudential Regulation Authority (“PRA”) led industry wide thematic review identifying a number of areas of enhancement. This concluded that there was currently no uniform best practice. While there have been many competing priorities for insurers since 2019, the Working Party expects that firms will have either already made changes to their proxy modelling approach in light of the PRA survey, or will have plans to do so in the coming years. This paper takes the PRA feedback into account and explores potential approaches to calibration and validation, taking into consideration the different heavy models used within the industry and relative materiality of business lines.

Prudential regulation of banks a critical review

Prudential regulation of banks a critical review

The impact of prudential regulations on the UK housing market and economy: insights from an agent-based model

The impact of prudential regulations on the UK housing market and economy: insights from an agent-based model

Regulatory capital, default risk and efficiency: a comparative analysis between Islamic and conventional banks in the MENA region

The main objective of this article is to study the effect of the regulatory environment on the behaviour of Islamic and conventional banks in 10 countries in the MENA region regarding the level of capital, the risk of default and banking efficiency. In other words, we seek to show the importance of the conventional and Islamic banking system in MENA countries and to assess the efficiency of these banks under the pressure of prudential regulations through a comparative analysis. Our results show that the riskiest banks are those with a high level of capital. Furthermore, the results suggest that the most profitable banks in the MENA region tend to increase their level of risk. We also find that a higher capital requirement encourages banks to take a higher risk with higher profitability.

Central banks Digital Currencies Issuance: Development Directions and Key Risks

Currently, many central banks have begun to develop, study and introduce central bank digital currencies (CBDC). Due to the lack of sufficient experience, potential problems and risks’ research that can stimulate such financial innovations is relevant. The paper analyzes the projects for the creation of CBDC. The purpose of the paper is to identify unresolved aspects of the application of CBDC, and specific tasks include identifying the problems of the marketing of retail CBDC and the identification of the risks generated by them. The authors use general and special research methods, including comparative analysis and systematization. The article examines the prospects for digital ruble circulation in the Russian Federation. The use of CBDCs opens up enormous opportunities for the development of the digital economy, but their actual deployment is replete with risk. The article identifies the risks of the third form of national currency: technological (including environmental), economic, financial, social and legal. The authors consider that the widespread use of CBDC implies a transformation of the activities of national central banks, including a change in the role and functions of the national central bank, and provide several possible scenarios. The authors include among the unresolved problems that require solutions for the widespread practical use of digital securities: lack of understanding of the mechanism for transferring ownership during transfers from one user to another, clear prudential regulation, and effective management of big data analytics. Furthermore, the scope of regulation of the financial intermediation sector with regard to fintech innovations has not been defined; there is no system for exchanging data between different government agencies for a timely and more accurate assessment of potential risks; and the required number of specialists is not sufficient. The research can be important for both digital money consumers and authorities when the initiative to issue digital money in Russia is implemented.

Regulatory Requirements and Banks' Level of Risk

This article evaluates the effect of prudential standards and good governance practices on the level of risk exposure of banks.
 
 Using banks in the West African Monetary Union (WAMU) as a framework for study, we conducted a study on a base of 14 banks from 2006 to 2017.
 
 Empirical analysis using a system of simultaneous equations reveals that changes in prudential regulation, as well as structural and functional changes at board level, result in an increase in banking risk.

Governments as borrowers and regulators

AbstractThe ability to borrow is important for government survival. Governments routinely resort to policies that privilege their own debt on financial markets, exploiting their dual role as borrowers and regulators. We label such policies as borrowing privileges. These borrowing privileges nudge investors to hold the government’s own debt. They share similarities with prudential regulation, but skew the market in favor of the government’s debt; and they share similarities with financial repression, but are less severe and thus consistent with the growth of financial markets. Introducing the first systematic dataset documenting the use of such policies across countries and over time, we demonstrate that governments implement borrowing privileges when their interactions with the global economy heighten fiscal needs: when borrowing costs indicate tightened access to credit, when trade liberalization undercuts revenue, and where fixed exchange rates increase the value of fiscal space. Despite the mobility of financial assets and constraints from global markets, governments retain latitude in regulating domestic markets to their own fiscal benefit.

Monetary policy, prudential regulations and bank lending behaviour in Africa

ABSTRACT The study examines the effect of monetary policy and prudential regulations on bank lending behaviour in Africa. This study employs the Two-Stage Least Square (2SLS) estimation technique for a panel dataset of 54 African countries over the period, 2004–2021. The study finds that monetary policy and prudential regulations reduce bank lending and the impact is better in countries with a strong institutional environment. It provides evidence to affirm that monetary policy and prudential regulations provide a complementarity effect in yielding a desirable outcome for bank lending.

Green Financial and Regulatory Policies: Why Are Some Central Banks Moving Faster than Others?

Abstract Climate change poses financial risks to individual firms and is a source of systemic risk to the stability of financial systems. Central banks are emerging as key state actors in environmental governance to tackle these risks, implementing policies encompassing regulatory oversight, credit guidance, and the greening of prudential regulations. The diffusion of these policies across countries is at various stages of deliberation and implementation. In this context, this article uses a newly constructed index measuring the intensity of green financial and regulatory policies imposed by central banks of various developed and developing countries from 1996 through 2018. We empirically assess whether central banks in countries that are more vulnerable to climate change are more likely to be implementers of these policies and find robust evidence in support of our hypothesis.

SASRA Prudential Regulations and Financial Performance of Deposit Taking Saving and Credit Co-Operative Societies in Kenya

SASRA Prudential Regulations and Financial Performance of Deposit Taking Saving and Credit Co-Operative Societies in Kenya

Prudential regulation and bank performance: Evidence from China

This study examines the effects of prudential regulatory policies on bank performance by analyzing specific prudential regulation policy data for the Chinese banking industry. We construct a series of indicators to measure the effectiveness of prudential regulatory policies. Our empirical findings indicate that the regulatory policies improve banks' profitability and reduce non-performing loan ratios, but they lead to a decrease in banks' liquidity. Furthermore, we demonstrate that the improvement in banks' profitability attributes to the rise in non-interest income. Additionally, our study investigates the existence of banks' regulatory arbitrage and finds that prudential regulatory policies significantly increase the off-balance sheet businesses.

Interaction between liquidity risk and bank solvency, a crucial effect in a framework of simultaneous equations

The “2008-09” global financial crisis has underlined that the interaction between liquidity risk and bank solvency forms an important factor that makes banks particularly vulnerable to a global crisis. At the same time, stress-testing models do not consider the dynamics between solvency and liquidity risk the possibility of reducing the impact of stress on bank solvency and financial stability. In this context, the aim of this paper is to examine this highly relevant issue in the financial literature, and answer to the main question: Is the interaction between solvency and liquidity risk empirically significant in the context of the Algerian banks? Based on an econometric model using a simultaneous equation approach on panel data of 19 banks over 6 years running from (2016 to 2021). Our results validate our hypothesis about the interaction and show that these two risks are determined simultaneously. Building on this finding, we suggest that the authorities should emphasise developing integrated liquidity and solvency stress tests. Our results also show the need of the Algerian banks to set up a regulatory framework for liquidity in line with the international prudential regulations to enhance the performance of this sector.

The interactive impact of green supporting factors on bank credit creation: An agent-based stock-flow consistent approach

Low carbon transition requires prudential regulations to incentivize bank’s green financing behaviors. This paper performs a simple and original analysis on the impact of the green differentiated banking requirements on bank’s credit creation. Through a simplified bank balance sheet, this paper incorporates green supporting factors into the framework of prudential regulations, namely the risk-based capital adequacy ratio and the net stable funding ratio respectively, and theoretically quantifies the constraining effect rendered by the green differentiated requirements. By constructing an agent-based stock-flow consistent model of commercial banks, and conducting numerical experiments, we find that the green supporting factors exert interactive impacts on credit creation, which depends on bank’s balance sheet structure characterized by equity to reserve ratios. So that it is necessary to implement different combinations of green supporting factors in order to achieve the target of green credit issuance, thus serving for green economic transition. The results obtained in this paper might facilitate the understandings what financial regulators can do to promote low-carbon transition via the banking system.

Review of the senior managers & certification regime

Following the 2022 Edinburgh Reforms, in which the Chancellor of the Exchequer announced a set of reforms designed to drive growth and competitiveness in the financial services sector, both HM Treasury and the Financial Conduct Authority (FCA) with the Prudential Regulation Authority initiated consultations to review the Senior Manager and Certification Regime (SM&CR). The aim of the review was to understand stakeholders’ views on how well the SM&CR is functioning and to identify ways to improve the regime to help it work better for firms and regulators. The SM&CR is seen as an essential tool to strengthen the financial services market by ensuring that financial services professionals are individually accountable to their employers and to the regulators. This article examines how the SM&CR has been operating to date and critically analyses whether it is achieving its original aims. The impact of the SM&CR on the international competitiveness of the UK financial services sector is considered, with comparisons drawn with the United States. Ultimately, this article recommends a greater use by the FCA of its enforcement powers to sanction senior managers, to ensure the international competitiveness of the UK financial services sector and to deter financial crime.

Effect of Core Capital Ratio Prudential Regulations on Financial Performance of Deposit-Taking Savings and Credit Cooperatives in Kenya

The objective of this study was to establish the effect of capital ratio prudential regulations on the financial performance of deposit-taking SACCOs (DT-SACCOs) in Kenya. The study was anchored on the public interest theory and adopted a positivist philosophy and mixed research design with primary and secondary data for the period 2014-2021 Core. The target population comprised 175 DT-SACCOs. Primary data was collected through questionnaires by stratified random sampling on DT-SACCOs regulated by the SACCO Societies Regulatory Authority (SASRA), and purposive sampling was done on the chief executive officer (CEO) of sampled DT-SACCOs. Panel data analysis was used to achieve the study objective. Both descriptive and inferential statistics were used to analyze data. The study findings revealed that core capital ratio requirement had a significant and positive effect on the financial performance of DT-SACCOs in Kenya (β =0.218, t = 6.180, p < 0.05). The study concluded that core capital ratio requirement was vital for the financial performance of DT-SACCOs in Kenya. Based on the study findings and conclusion, the study recommends to leadership in DT-SACCOs to enhance corporate governance and stability in their SACCOs since members seek to invest their resources in areas where they perceive stability and profit. Besides, the study recommends to SASRA to ensure that the risk appetite and investment prudential regulations and restrictions placed by shareholders are taken into consideration while creating DT-SACCOs’ investment portfolio.

Influence of Loan Loss Provisioning Ratio Prudential Regulations on Financial Performance of Deposit Taking Savings and Credit Cooperatives in Kenya

The purpose of this study was to examine the effect of loan loss provisioning ratio regulations on the financial performance of deposit taking Savings and Credit Cooperatives (SACCOs) in Kenya. The study was based on the modern portfolio theory and used a positivist philosophical approach. A mixed study strategy was employed that incorporated both primary and secondary data sources spanning the years 2014 to 2021. The study population consisted of 175 deposit-taking SACCOs (DT-SACCOs) and stratified random sampling was used to choose 105 DT-SACCOs that are regulated by the SACCO Societies Regulatory Authority (SASRA). Additionally, purposive sampling was used to select the chief executive officers (CEOs) of the selected DT-SACCOs. The primary data for this study was obtained by the administration of questionnaires to CEOs. The secondary data was gathered from published financial reports of the 105 DT-SACCOs. The gathered data was analyzed using both descriptive and inferential statistics. The results of the study indicated that the loan provisioning ratio had a significant and negative effect on the financial performance of DT-SACCOs in Kenya (β = -0.502, t = -5.987, p < 0.05). The study recommends to management of DT-SACCOs to always adhere to prudential guidelines on loan loss provisioning ratio, and implement credit control mechanisms like performing evaluations of credit policy and ensuring that there are skilled personnel authorizing and approving loans. The study also recommends to leaders in DT-SACCOs to adopt and execute effective strategies to minimize non-performing loans engaging in effective and detailed customer profiling.

Societal trust and bank opacity

PurposeThis paper aims to examine the relationship between societal trust and bank asset opacity using an international sample of banks.Design/methodology/approachThe authors use an international data set of banks and panel regressions. For robustness purposes, the authors use multiple measures of both societal trust and bank opacity as well as two-stage least squares regressions to address endogeneity concerns.FindingsThe authors find that societal trust is negatively associated with the opacity of bank portfolios.Practical implicationsResults of this study inform regulators on the importance of trust for the banking sector and support policies towards enhancing trust in banks. Also, a sustained environment of high levels of trust in banks can prevent the introduction of extensive prudential regulations that policymakers often use to establish trust, as well as lower the additional resources required when trust levels are low.Originality/valueTo the best of the authors’ knowledge, this is the first study that examines this relationship. The literature provides only limited evidence and not for the banking sector, for which opacity is of outmost importance.

How to measure banking regulation and supervision

This paper uses data from 141 countries to identify the variables that best characterize worldwide banking regulation and supervision practices. We apply a nonlinear principal components analysis with optimal variable transformation to deal with the variables’ mixed measurement levels and reduce data dimensionality. The robustness of the results is tested for different subsamples. The findings indicate that deposit insurance, liquidity, diversification requirements, complementary banking activities, and market discipline are the most reliable indicators to measure regulation. In contrast, resolution activities, the mandate of the head of the supervisory agency, and the report of prudential regulation infractions assume the same role for banking supervision. Capital requirements and ownership are of minor relevance and are sensitive to a country’s development level. China and Germany display the most distinct regulation practices, while China and the UK adopt the most stringent policies regarding supervision.

A market consistent approach to the valuation of no-negative equity guarantees and equity release mortgages

AbstractThis paper provides a new market consistent approach to the valuation of no negative equity guarantees and equity release mortgages. The paper provides a new approach to the estimation of volatility inputs. The proposed approach to volatility produces a volatility term structure that is dependent on the age and gender of the borrower. Illustrative valuations are provided based on the Black ’76 put pricing formula and mortality projections based on the M5 Cairns–Blake–Dowd mortality model. Results show interesting ramifications for industry practice and prudential regulation.