4.4 the financial sector

Question 1

what are retail banks?

Answer 1

provide a range of financial products for consumers and small businesses (current & savings accounts etc)

Question 2

what are commercial banks?

Answer 2

provide a range of financial products for larger businesses

Question 3

what are investment banks?

Answer 3

buy and sell shares on behalf of customers, help facilitate mergers and acquisitions, arrange issuing of shares for customers

Question 4

what are saving vehicles?

Answer 4

any account or system that allows a consumer or business to save

Question 5

what are speculators?

Answer 5

people or businesses trying to predict what will happen to the price of an asset, buying and selling accordingly in order to try and make a profit

Question 6

what are insurance companies?

Answer 6

companies providing different types of insurance

Question 7

facilitate saving?

Answer 7

saving is a way of deferring spending into the future, provides an accumulation of funds for lending

Question 8

lending to individuals?

Answer 8

credit cards, overdrafts, payment by installment contracts, personal loans, mortgages, pay-days lending

Question 9

lending to firms?

Answer 9

borrowing is a key form of funding for investment and growth

Question 10

lending to governments?

Answer 10

any government with a budget deficit requires additional borrowing

Question 11

facilitate the exchange of goods and services?

Answer 11

provision of a system of currency by a central bank, creates a exchange through money payments, currency exchange allows buying and selling of foreign currency

Question 12

provide forward markets in currencies and commoditites?

Answer 12

firms may want to buy or sell forward, firm may want to sell goods or buy materials for production at a guaranteed price

Question 13

future vs forward markets?

Answer 13

often referred to in similar ways

Question 14

provide a market for equities?

Answer 14

equities in a financial context means company shares, issuing shares is an important way for companies to finance investment or expansion, stock markets provide a system for shares to be bought and sold by individuals and firms

Question 15

what is market rigging?

Answer 15

group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves at the expense of others, difficult to detect and little penalty if caught

Question 16

what is insider trading within market rigging?

Answer 16

process of gaining an advantage in market dealings due to having inside knowledge not available to the public, e.g knowledge of a merger before it is announced and buying shares

Question 17

what is the LIBOR scandal in market rigging?

Answer 17

some banks falsely declared their rates which distorted the LIBOR rate to provide a gain to the business, LIBOR rate is the rate banks lend to eachother

Question 18

what is a moral hazard?

Answer 18

moral hazards occur when someone increases their exposure to risk when insured, someone else is bearing the costs of these risks

Question 19

what is speculation and market bubbles?

Answer 19

market bubble is when the price of an asset is driven up to an excessive high and then collapses, price becomes higher than the ‘actual’ value of the asset

Question 20

whats an externalitity?

Answer 20

cost or benefit incurred b a third party, negative consequences of banks actions created an external cost borne by individuals and governments

Question 21

what is asymmetric information?

Answer 21

banks may have more information than customers, Payment Protection Insurance - many consumers purchased unnecessary insurance, Pensions mis-selling- brought unnecessary pensions instead of occupational schemes. collateralized debt obligations- major cause of financial crisis

Question 22

policies for market rigging?

Answer 22

legislation and regulation of markets, facing fines and prison, but can be difficult to detect and prosecute when suspected

Question 23

policies for market rigging?

Answer 23

preemptive solutions to change risk taking behaviour, separation of retail banking and investment banking, regulation of banking behaviour

Question 24

policies for moral hazards?

Answer 24

after the event- bailing banks out could be necessary to prevent a larger economic crash, but it creates a precedent that might reinforce the moral hazard in the banking sector

Question 25

policies for market bubbles?

Answer 25

no way of pre-emptively regulating against market bubbles, regulation of financial firms to ensure that they have enough cash (liquidity) and diverse range of risk exposure should help limit the impact of any crash in asset prices

Question 26

policies for externalities?

Answer 26

making sure that banks are not overly exposed to risk, once a crisis has taken place the government might respond through expansionary demand side policies

Question 27

policies for asymmetric information?

Answer 27

prevent the abuse of power by banks that might lead to mis-selling of financial products, significant fines have been used, along with forcing banks to compensate mis-sold customers

Question 28

what monetary policy tools are available?

Answer 28

-base rate changes
-quantitative easing
-buying and selling domestic/ foreign currency

Question 29

what are the aims of implementing monetary policies?

Answer 29

• UK - 2% CPI +/- 1%
  -Eurozone - below but close to 2% CPI
  -US- ‘maximum employment, stable prices and moderate long- term interest
  -Danmarks Nationalbank- low and stable inflation, but through fixing Danish krone to the euro

Question 30

banker to the government?

Answer 30

central banks carry out the banking business of the government, make payments on behalf of the government, manage the public debt of the country

Question 31

banker to the banks?

Answer 31

central banks provide temporary funds for banks with short term cash problems

Question 32

what does the monetary policy committee do?

Answer 32

MPC- 9 members (4 external members to provide ‘thinking and expertise beyond the bank’)

Question 33

what does the financial policy committee do?

Answer 33

FPC- assess risks to the system, gives directions and recommendations to PRA

Question 34

what do the prudential regulation authority do?

Answer 34

PRA- regulates individual financial institutions to check for their safety and soundness

Question 35

what do the financial conduct authority do?

Answer 35

FCA- independent regulator, protects consumers and promotes confidence in system

Question 36

what does the macroprudential policy do?

Answer 36

oversight of risks and vulnerabilities, ensures the systems can cope with being hit by problems, check for signs of overlending, excessive use of risky instruments

Question 37

what does special resolution regime do?

Answer 37

BoE can order a sale , transfer or wind up of a falling institution where necessary

Question 38

what is stress testing?

Answer 38

testing banks against possible hypothetical scenarios