PRINCIPLES OF BUSINESS SECTION 8 OBJECTIVE 4 1 | P a g e Describe the relationship between financial institutions and regulatory bodies (a) The regulatory role of the Central Bank (i) Changing the liquid assets ratio Commercial banks are required by bank regulations to hold a certain percentage (the liquid assets ratio) of their highly liquid financial assets in the central bank. Highly liquid assets are those that can be converted to cash at short notice, for example cash reserves and gilt-edged securities (government bonds). This is necessary to ensure that the commercial banks can meet all their anticipated expenses (meeting demands from their creditors- customer) and fund loans. But it is also a way of the central bank influencing economic activity. If the central bank implements a rise in the liquid assets ratio this has the effect of increasing the amount the banks must deposit with them, which reduces the amount of money in circulation and restrict borrowing, (ii) Varying or adjusting the bank rate The bank rate (also referred to as the minimum lending rate) is the interest rate at which a national’s central bank lends money to commercial banks, often in the form of very short-term loans. Managing the bank rate is one of the ways that central banks influence economic activity. Lowering bank rates can help to expand economic activity and higher bank rates help to reduce economic activity when inflation is higher than felt to be desirable. The commercial banks set the rate they charge for lending to slightly higher than the minimum lending rate. Consequently, the raising or lowering of the bank rate by the central bank has an influence not only on the banking system, but also on those who borrow from the system. For example, the return on savings will be lower with a reduced rate, while the cost of borrowing will rise if the bank rate is raised. (iii) Changing the minimum reserve requirements All banks are required to hold minimum reserves with the central bank to ensure they always have sufficient funds to meet significant withdrawals. The central bank demands minimum reserves are held before it will allow banks to draw on them. Increasing of the reserve ratio by the central bank means that the lending financial institutions have less money available to lend out, resulting in a reduction in the money supply. An increase in the amount of money in the economy results in increased spending. A decrease has the opposite effect. (b) The regulatory role of the financial services commission The Financial Services Commission (FSC) has the responsibility of ensuring those involved in the provision of financial services comply with the related Acts that aim to protect investors. Although these laws may be slightly different from one country to another, they will all follow a similar format to the following: 1. The Financial Services Commission Act and regulations which outlines responsibilities of the FSC as they pertain to all prescribed financial institutions.2. The Insurance Act and regulations which prescribe provisions for the regulation of insurance businesses 3. The Securities Act and regulations which provide requirements for the licensing, operation and supervision of entities dealing in securities 4. The Pensions (Superannuation Funds and Retirement Schemes) Act and regulations which provide requirements for the licensing, operation and supervision of private pension funds. 5. The Unit Trust Act and regulations which provide requirements for the licensing, operation and supervision of unit trust schemes. (c) The regulatory role of the Supervisor of Insurance The Supervisor of Insurance has the responsibility of ensuring that those in the insurance industry, such as insurance companies, underwriters and intermediaries (for example, insurance agents, insurance brokers and financial advisers) comply with all legislation that applies to insurance. This responsibility encompasses: ▪ Licensing companies and insurance intermediaries ▪ Ensuring payment of annual fees ▪ Monitoring insurance companies and the statutory funds they are required to hold ▪ Ensuring all licensed insurance entities comply with the requirements of the Insurance Act and all related regulations.