Prudential Regulation

Prudential rules look at whether a firm is safe and able to pay what it owes. They set minimum capital and liquidity, limit large exposures, and require sound risk management and governance. The aim is to stop failures before they hurt customers or spread. It differs from conduct regulation, which looks at how firms treat clients and markets. Many countries give the task to a central bank or a dedicated authority, which also checks compliance through inspections and reporting. Banks and insurers are the usual targets, though some regimes extend to investment firms and pension funds. Basel standards for banks and Solvency regimes for insurers are common reference points. A supervisor using these rules can step in while a weak insurer or bank still has assets left to protect its customers.

A national supervisor requires a mid-sized insurer to hold capital that matches the risks on its books. After an annual review, it finds the insurer's investments are concentrated in one sector. The supervisor asks for more capital and a plan to diversify, before any policyholder is harmed.