LLAW6093B Chap.1 Financial Markets, Law and Regulation
Financial Markets, Law and Regulation
Start with what the system is for
Before any rule can be judged, you need a picture of the thing being regulated.
The background reading describes the financial system as a machine that links today's economy to tomorrow's, and it lists the jobs that machine performs for households and firms: moving payments across distance, gathering savings from people who have more than they currently need, deciding which projects deserve funding, keeping an eye on those projects once funded, and helping people and businesses manage risk.
Growth and finance move together, and the reading takes the view that financial development helps cause growth rather than simply following it.
Four families of institution share the work
Deposit-taking banks, securities markets, the institutions that support markets such as rating agencies, analysts, exchanges and clearing houses, and asset managers that pool small investors can each carry out most of those jobs.
Banks are distinctive because they offer savers ready access to cash while lending for long periods, which only works while withdrawals do not all arrive together. Markets offer liquidity in a different way, by letting an investor sell a claim to someone else, and they monitor firms through prices.
The one job markets cannot easily take over is making payments.
Different countries, different mixes
Systems vary in size and in the balance between banks and markets. In some economies the stock market is larger than annual output; in others far more capital passes through banks.
Pension design and the way firms fund themselves explain much of the difference, and the fourth seminar's comparison of Hong Kong, Mainland China, the United Kingdom and the European Union is easier to follow with that contrast in mind.
Why the old dividing lines matter less
Asset managers now hold a growing share of savings, banks raise money in wholesale markets, and non-banks lend and take savings without being regulated as banks.
When the same activity is carried on under different labels, rules keyed to the label invite firms to move to the cheaper regime and leave customers with uneven protection. That is the practical reason the course keeps asking what an activity does rather than what the firm doing it is called, and it is the first question to ask of any unfamiliar business model in a problem question.
What this chapter covers
- 01
Why regulation starts from the functions of finance
- 02
Payments, savings, project selection, monitoring and risk
- 03
Banks and the promise of cash on demand
- 04
Markets, prices and the information they carry
- 05
Rating agencies, analysts, exchanges and clearing
- 06
Asset managers and who bears the risk
- 07
Bank-heavy and market-heavy systems compared
- 08
Three ways financial systems fail
Worked example · free
Classify a new firm by what it does
- 3Name each financial function the scheme performs.
- 3Identify the risk to members created by combining them.
- 2Explain why the retailer's own description is not decisive.
Key terms
- Payment System
- The arrangements that let value move between parties at a distance, the one core function of finance that markets cannot readily take over from banks.
- Delegated Monitoring
- The practice of savers handing the costly work of screening and watching borrowers to a specialist intermediary that can do it at scale.
- Secondary Market
- Trading in securities between investors after they have been issued, which gives holders a way to turn their claims into cash.
- Shadow Bank
- A non-bank that lends and holds savings in the way a bank does without being regulated as a deposit-taker.
- Passive Fund
- A collective investment scheme that simply tracks a market index instead of selecting investments.
Financial Markets, Law and Regulation FAQ
What are the core functions of a financial system?
The reading lists five: providing a secure way to make payments at a distance, mobilising savings from those with a surplus, selecting the projects that should receive funding, monitoring those projects after funding, and helping firms and individuals manage risk. Most of them can be performed by banks or by markets.
Why do banks attract a special regulatory regime?
Because they promise depositors cash on demand while lending for long periods, a promise that holds only while withdrawals are spread out. If a shock makes depositors withdraw together, even a well-run bank cannot convert its loans into cash quickly, and its failure also destroys knowledge about borrowers and disrupts payments.
Should financial regulation follow the type of institution or the activity?
The reading argues for activity. When similar activities are regulated differently according to the firm's legal form, participants move to the cheaper regime and customers get uneven protection, so a functional approach treats like activities alike whoever carries them on.
Exam move
Pick one financial firm you use and write down which of the five functions it performs for you. Then ask which of those could be done by a market instead, and what you would lose if it were. Repeating this for two or three firms fixes the map faster than rereading.
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