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Macro economics > 4.4 The financial sector > Flashcards

4.4 The financial sector Flashcards

1
Q

what is the financial market?

A
  • any exchange that facilitates the trading of financial instruments (eg stocks, bonds, foreign exchange, or primary commodities such as oil and gas)
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2
Q

what are the key roles of financial markets?

A
  • facilitate savings
  • lend to business and indivduals
  • facilitate the exchange of goods and services
  • to provide forward markets in currencies and commodities
  • to provide a market for equities
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3
Q

what is narrow money?

A
  • a measure of the value coins and notes in circulation + other money equivalents that are easily convertible into cash
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4
Q

what is broad money?

A

a measure of total money held by households and companies in the economy
- mainly made up of commercial bank deposits

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5
Q

what are the different types of loan?

A
  • long term loans (finances whole businesses over many years)
  • medium term loans (finances major projects or assets with a long-life)
  • short term loans ( finances day-to-day trading of a buisness)
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6
Q

what is debt financing?

A

borrowing money from an outside source with the promise of paying back the borrowed amount plus the agreed intereset at a later date

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7
Q

what are secured and unsecured loans?

A
  • secured loans, money that you borrow that is secured against an asset you own (normally your home)
  • unsecured loans (only supported by borrower’s creditworthiness)
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8
Q

what are the main functions of a commercial bank?

A
  • provide retail banking services
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9
Q

what are the characteristics of money?

A
  • durable
  • portable
  • divisible
  • hard to counterfeit
  • accepted
  • valauble
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10
Q

what are the key functions of money?

A
  • medium of exchange
  • store of value
  • unit of account
  • standard of deferred payment
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10
Q

examples of long-term loans (financing over many years)

A
  • share capital
  • retained profits
  • venture capital
  • mortgages
  • long term bank loans
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11
Q

examples of medium-term loans (finances major projects with a long-life)

A
  • bank loans
  • leasing
  • hire purchase
  • govt grants
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12
Q

examples of short-term loans (finances day to day trading of a business)

A
  • bank overdraft
  • trade creditors
  • short term bank loans
  • factoring
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13
Q

what is equity finance?

A

a method of raising capital by selling shares of the company to the public, institutional investors or financial institutions
eg stock market listing, offering shares to public and institutional investors

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14
Q

what are the main functions of commercial banks?

A
  • provide retail banking services
  • licensed to lend money and thereby create money via bank loans, overdrafts
  • banks create credit by extending their loans to businesses and households
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15
Q

how do commercial banks make a profit?

A
  • interest rate spreads (charging a higher interest rate on loans than the rate paid to savers)
  • service fees
  • brokerage % (many backs provide currency and services with a brokerage fee for doing so)
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16
Q

how do banks fail?

A
  • run on the bank (if people panic and withdraw their money the bank may collapse which creates a liquidity crisis for the bank)
  • credit crunch (if a bank can’t borrow money from other banks and heavy losses and collapsing capital threaten their commercial viability)
  • high losses from bad debts/ loan defaults
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17
Q

what stops credit creation by banks?

A
  • market forces
  • regulatory policies
  • behaviour of consumer an business (how much of their debt to repay)
  • monetary policy (interest rates impact demand for loans)
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18
Q

what does a liquidity risk mean?

A
  • banks tend to attract short term deposits (from savers) but they often lend for long periods ➡️ banks may not be able to repay all deposits if savers decide to withdraw their funds in one go, to reduce the risk the banks will try to attract long term deposits and hold some liquid assets
19
Q

whats an investment bank?

A
  • provides specialised services for companies and large investors
  • it trades and invests on its own account
  • commercial banks can provide investment banking services
20
Q

how does the financial sector have asymmetric information?

A
  • the borrower has better information of the likelihood that they will be able to repay a loan than the lender
21
Q

what are examples of external costs/negative externalities arising from the financial crises?

A
  • taxpayers who have to pay for bank bail-out costs + the impact of fiscal austerity
  • depositors may loss savings if a bank collapses
  • creditors of there is a rise in unpaid debts
  • shareholders (lost equity from falling share prices)
  • employees (lost jobs in finance if financial crash)
  • increased fiscal deficit and national debt
  • businesses will see reduced demands for goods and services and higher borrowing costs for those needing loans
21
Q

what are moral hazards?

A

when an individual takes more risks because they know they are covered by insurance or that the government will protect them

22
Q

what’s a speculative bubble?

A

a sharp, steep rise in asset prices such as shares, bonds, housing and commodities
- usually fuelled by high levels of speculative demand which takes prices well above values
caused by
- herd behaviours
- exaggerated expectations of future prices
- irrational exuberance of investors
- period of very low monetary interest rates which encourage risky investment

23
Q

what is market rigging?

A

-the illegal practice of manipulating financial markets for personal gain
eg insider trading, price manipulation, and collusion among market participants.
- the Competition and Markets Authority report on UK banking in August 2016 said that the older and larger banks don’t have to work hard enough to win and retain customers making it difficult for new and smaller providers to attract customers

24
Q

what are the barriers to entry in commercial banking?

A
  • regulatory barriers (need to be given a banking licence by the central bank)
  • natural or intrinsic barriers (marketing costs, building IT)
  • strategic advantages of larger banks (low rates of customers switching)
  • brand loyalty to bigger banks
  • atm is an oligopoly
25
Q

whats a systemic risk?

A

the possibility that an event at the micro level of an individual bank could trigger instability and collapse an entire economy
- the Global Financial Crisis illustrated how deeply inter-connected the financial world has become
- ev 2009 financial crash

26
Q

examples of central banks?

A
  • bank of England
  • European Central Bank for member nations of the Euro Area
  • United States Federal Reserve
  • Bank of Japan
27
Q

what are the main functions of a central bank?

A
  1. Monetary policy function
    - setting interest rate
    - QE
    - exchanges rate intervention (managed/fixed currency systems)
  2. Financial stability
    - supervision of the wider financial system
    - prudential policies designed to maintain financial stability
  3. Policy operation functions
    - last resort lender to banking system
    - manage liquidity in the commercial banking system
    - overseeing the payment systems used by banks/retailers
  4. Debt managment
    - handling the issue of govt debts (bonds)
28
Q

what is monetary policy?

A
  • what a country’s central bank/govt does to influence how much money is in the economy and how much it costs to borrow
  • set the central banks interest rate
  • central bank buys bonds to lower the interest rate on savings and loans (QE)
29
Q

Monetary policy in the UK?

A
  • B of E has been independent of the UK govt since 1997
  • main aim of promoting monetary and financial stability (stable prices and confidence in the currency)
  • stable prices = 2% inflation target
  • the policy interest rate (base rate) is set each month by the Monetary Policy Committee
30
Q

what does the Monetary Policy Committee do?

A
  • does a thorough assessment of the UK economy 8 times a year
  • they look at a range of demand/supply side indicators
    ➡️ interest rate decision is taken after this (based mainly on inflation forecast over next two years)
  • monetary policy effects both demand and supply side of the economy, it doesn’t operate
31
Q

what is expansionary Monetary Policy?

A
  • reducing nominal and real interest rates
  • expand the supply of credit from the banking system (QE)
  • Depreciation of the external value of the exchange rate
    ➡️monetary stimulus policy, involving changing the monetary policy designed to increase AD incl lower interest rates and measures to increase the supply of credit
32
Q

what is deflationary Monetary Policy?

A
  • higher interest rates on loans and savings
  • tightening of credit supply
  • appreciation of the external value of the exchange rate
    ➡️ designed to lower the level/growth of AD to help control inflation
33
Q

why should low interest rates be maintained?

A
  • control inflation
  • some say the Philips Curve has flattened ➡️ trade off between unemployment and inflation has weakened, this implies that an economy can operate at a higher level of AD and employment w/o inflation
  • stimulates capital investment which increases a country’s long run productive potential
  • helpful in supporting AD demand and output during an era of fiscal austerity
  • reduce the risks of price deflation and also contribute to maintaining a competitive currency which has helped export industries
34
Q

why should there be high interest rates?

A
  • help control demand for credit, soften the growth of money supply and thus control demand-pull inflation (unemployment is low)
  • increased mortgage rates may cause a slowdown in house price inflation, making property more affordable
  • increases the return to saving
  • need to rise moderately now so that central banks can cut them in the event of a negative external shocks
35
Q

risks from raising interest rates?

A
  • high levels of unsecured debt (slowdown in consumption)
  • stop necessary business investment
  • pound appreciates making exports less competitive leading to an export slowdown + worsening trade deficit
  • makes govt debt more expensive
  • economic slowdown which could hit share prices, pension funds and dividend incomes
36
Q

what is quantitative easing?

A

NEED TO DO

37
Q

what are the main ways quantitative easing works?

A
  1. Wealth effect, lower interest rates lead to higher share and bond prices (people buy corporate bonds)
  2. Borrowing cost effect, lowers the interest on long term debt such as govt bonds and mortages
  3. Lending effect, QE increases the liquidity of banks and increased lending from banks lifts incomes and spending in the economy
38
Q

QE simply?

A
  1. Buying govt bonds raises their price and in doing so, drives down the yield/interest rate they offer
  2. Replacing govt bonds with cash in the economy increases liqudity
39
Q

arguments in favour of QE?

A
  • gives central banks another tool of monetary policy
  • increases the size of the monetary base helps to lower the threat of deflation (without QE the fall in real GDP would have been deeper and the rise in unemployment deeper)
  • lower long-term interest rates keep business confidence higher and gives the commercial banking system extra deposits to use for lending
  • QE can lead to a depreciation of the exchange rate will help improve export industries competitiveness
40
Q

critcisms of QE?

A
  • low interest rates can distort the allocation of capital
  • QE has contributed to a surge in share prices and property values
  • many commerical banks have become more risk averse and charge higher interest rates to customers (want a store of money incase something happens)
  • QE has caused ultra-low interest rates which is bad for savings
  • low interest rates and bond yields are a worry for pension fund investors
41
Q

who are the main regulators of the UK financial system?

A
  • financial conduct authority (FCA)
  • competition and market authority (CMA)
41
Q

what are the main aims of financial market regulation?

A
  1. Protect the consequences of market failure
    - protects interest of consumers
    - limit the monopoly power of banks
    - protects borrowers
    - more access to finance
  2. Encourage confidence in the economy and government
    - promote capital investment + sustainable long run growth
    - support trust in the banking system
  3. Allow the central banks to perform its other role such as lender of last resort
    - prevent/mitigate systemic risk within financial markets that might damage the economy
42
Q

What does the financial policy committee of the Bank of England - macro prudential regulation?

A
  • main role identifying, monitor and take actions to remove risks that threaten the resilience of the UK financial system
  • published a financial stability report identifying key threats to the stability of the UK
  • if the FPC decides that the risks are growing they may tell the commercial banks and other lenders to increase their capital buffes to help absorb unexpected losses
43
Q

what are examples of regulation in financial markets?

A
  • a liquidity ratio is the ratio of liquid assets held by a bank on their balance sheet to their overall assets
  • commercial bankers need to hold enough liquidity to cover expected demands from their depositors
  • after the financial crisis of 2009 banks were more inclined to keep enough liquid assets to get through a 30 day market crash
44
Q

what are macro and micro-prudential policies?

A
  • regulators have placed increased emphasis on prudential regulation
  • micro-prudential involves stronger regulation of individual financial firms such as commercial banks, payday lenders and insurance
    macro-prudential regulation seeks to safeguard the financial system as a whole

Macro economics (22 decks)

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