3. Payment methods

This chapter examines payment methods, which refer to the mechanisms, procedures, and organisations that are used to enable parties to discharge their payment obligations. While there are a vast range of different payment mechanisms, the most common methods are cheques, payment cards, and the electronic transfer of funds. A cheque is a written order from an account holder instructing their bank to pay a specified sum of money to one or more named beneficiaries. Meanwhile, payment cards—small pieces of plastic that are used in financial transactions—have revolutionised the way that people pay for goods or services. Lastly, the transfer of funds refers to the movement of a credit balance from one account to another, which occurs by adjusting the balances of the respective party’s accounts. The chapter then looks at recent innovations in the payment services industry relating to open banking and third-party providers.

1. Introduction to banking law and regulation

This introductory chapter provides an overview of banking law and regulation. Banking law and regulation covers private commercial law developed through banking custom, standards of good practice, and the common law, which together have a long history of shaping and refining the rights and obligations of banks and their customers. Consumer protection lies at the heart of many banking law and regulatory initiatives, which often seek to address or rebalance the superior bargaining position of banks in the bank–customer relationship. In recent decades, public regulatory sources of law in banking regulation have become multi-layered and complex, ranging from international to European and national regulation. The chapter also describes the nature of the banking business as well as its types and scope.

11. The regulatory framework for bank culture and conduct

This chapter focuses on the regulatory framework for bank culture and conduct. Bank culture profoundly affects the outcomes that regulators are concerned with: the prudential safety of banks and banksʼ conduct in the marketplace. Such culture is forged by individual decision-making and behaviour at banks, as well as the collective ethos and environment at the organisation. The regulation of individuals comprises of two regimes, a more stringent one for ‘senior managers’ as compared to ‘certified persons’. Senior managers and certified persons are approved according to fitness and propriety criteria, and their approval can be revoked for failing to meet these criteria on a continuing basis. They are also subject to an individual code of conduct and can be personally liable, subject to fines and/or full or partial prohibition from working in the financial sector. The chapter then looks at the development of soft law in banking culture and ethics.

8. Micro-prudential regulation I

This chapter studies capital adequacy regulation, which prescribes that banks can only take certain levels of risk that are supported by adequate levels of capital. In this way, capital adequacy rules provide a form of assurance that banks with adequate levels of capital are likely able to withstand losses that may result from their risk-taking. The Basel Committee developed its first set of capital adequacy standards in the Basel I Capital Accord of 1988. It was subsequently overhauled into the Basel II Capital Accord in 2003. After the global financial crisis of 2007–9, the Basel II Accord’s shortcomings were extensively discussed and the Basel Committee introduced a package of reforms in order to plug the gaps in Basel II. The Basel III package is the most extensive suite of micro-prudential regulation reforms seen to date, as they deal with capital adequacy and a range of other micro-prudential standards.

9. Micro-prudential regulation II

This chapter discusses other regulatory techniques to control bank risk-taking, many of them developed since the global financial crisis of 2007–9. The Basel Committee has now introduced two liquidity standards for banks as internationally harmonising measures: the liquidity coverage ratio and the Net Stable Funding Ratio (NSFR). Besides liquidity management rules, there are other measures of micro-prudential regulation developed or enhanced after the crisis. One is the leverage ratio, which sets an absolute amount of lending banks can engage in, regardless of risk-weighting. Another is large exposures regulation in the EU, which deals with controlling the over-concentration by banks in lending to certain customers. The chapter also looks at systemically important financial institutions that are global banks with such an international footprint that their vulnerabilities may threaten financial systems and economies more acutely than other banks. Moreover, it illustrates the frameworks for stress testing.

6. UK banking supervision and regulatory architecture

This chapter addresses the UK bank supervision and regulatory architecture. Although banking business has existed in England since the seventeenth century, banks enjoyed no formal system of regulation until the introduction of the Banking Act of 1979. Over the years, the scope and intensity of regulation increased. After the global financial crisis, further changes were made to bank regulation as well as the regulatory architecture in the UK for bank regulation. The regulatory architecture introduced in April 2013 is characterised as ‘twin peaks’, that is, having two main agencies that are responsible for different regulatory objectives. The Prudential Regulation Authority (PRA) is responsible for ‘prudential’ objectives—that is, the solvency and financial soundness of financial institutions—while the Financial Conduct Authority (FCA) is responsible for conduct of business and market regulation, including promoting competition. The PRA and FCA enjoy a wide berth of rule-making and enforcement powers.

5. International banking supervision and regulatory architecture

This chapter assesses international banking supervision. The solution to the issues in international banking has been the development of procedures that seek to encourage coordination or cooperation between national supervisors. This has been facilitated by the creation of international organisations that have allowed large numbers of countries to discuss, agree, and promote not only supervisory standards, but also regulatory rules. Together, these organisations constitute the international financial architecture that seeks to ensure financial stability by addressing a number of different issues. Two of the key bodies in international banking regulation include the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB). Ultimately, the proliferation of international banking in recent decades, and the need to ensure that banking supervision takes place on a consolidated basis, has led to calls for the creation of a single global regulator.

4. Banks and finance

This chapter focuses on the other core function of the banking business alongside taking in deposits from customers: lending. The traditional forms of lending include overdrafts, fixed-term loans, and syndicated loans. An overdraft generally involves an extension of credit by a bank to its customer via the customer’s current account. A fixed-term loan, as the name suggests, is a loan made for a fixed period of time. Meanwhile, a syndicated loan involves two or more banks that each contributes towards making a single loan to a borrower. The chapter then considers lender liability and the different forms of security a bank can use to realise the repayment of a loan in the event of default by the borrower. It also looks at recent innovations in the lending market that offer a competitive alternative to traditional bank lending, including payday lending and peer-to-peer lending.

14. Combatting financial crime

This concluding chapter studies the regulation compelling banks and financial institutions to play an active part in combatting financial crime. Regulation takes two approaches: one is to enforce anti-money laundering law through banks and financial situations; and the other approach is to enforce anti-money laundering law against them if they should be found to be complicit in transferring proceeds of crime. Under the first approach, regulation imposes duties on banks and financial institutions to act as gatekeepers to prevent money laundering from taking place and to identify such incidents so as to help regulators carry out enforcement. Under the second approach, banks and financial institutions may be punished for sometimes inadvertently becoming complicit in money laundering, and this provides a strong incentive for them to treat their gatekeeper roles seriously. The chapter then considers the regulatory duty of due diligence, financial intelligence reporting, and internal control and governance.

12. Regulating the governance, structures, and incentives at banks

This chapter assesses how regulation addresses sub-optimal internal organisation and governance at banks in order to change behaviour. The Basel Committee defines the role of internal control at banks to be for three purposes: to assist in achieving profitability and performance, to ensure the reliability and integrity of financial information relating to the bank, and to assist in external compliance with regulations. Meanwhile, corporate governance may be defined as ‘a system by which companies are directed or controlled’. As a framework for determining exercise of power, decision-making, and accountability, corporate governance is important in the shaping of an overall organisational culture. The chapter also considers the regulation of bankersʼ remuneration. Although such regulation affects bankers individually, there are aspects of ‘collective’ policy in remuneration regulation that seek to control organisational freedom in giving rewards, as well as aspects that affect individual incentives.