4.4.3 Role of Central Banks Flashcards
What is a central bank
provides financial and banking services for its country’s government and commercial banking system, as well as implementing the government’s monetary policy and issuing currency
What are the main functions of a central bank
- Monetary policy - base rate, QE, exchange rate
- Financial stability - supervision through policies to help maintain stability
- Policy operation - last resort to banking system, managing liquidity of commercial banks, overseeing payment systems
- Debt management - issue and redemption of Gov bonds
What is monetary policy
involves changes in interest rates, the supply of money & credit and exchange rates to influence the economy
What are stable prices defined by
the Government’s inflation target, which the Bank seeks to meet through the decisions taken by the Monetary Policy Committee (MPC)
How often is the base rate set
each month by the Monetary Policy Committee
What is expansionary monetary policy
What things can it include
involves changes designed to increase aggregate demand including lower policy interest rates and measures to increase the supply of credit
Can include: reducing nominal/real interest rates, expanding credit through QE, depreciation of exchange rate
What is deflationary monetary policy
designed to lower the level/growth of aggregate demand to help control inflationary pressure
Can include: High-interest rates, tightening of credit supply, appreciation of exchange rate
What is quantitative easing
is to increase the supply of money available for banks to lend
How does QE work
- QE involves the introduction of new money into the national supply by a central bank.
- In the UK the Bank of England creates new money (electronically) to buy assets (mainly bonds) from insurance companies, pension funds and commercial banks
- Increased demand for government bonds causes an increase in the market price of bonds and therefore causes their price to rise
- A higher bond price causes a fall in the yield on a bond (this is because there is an inverse relationship between bond prices and yields)
- Those who have sold their bonds may use the extra funds/cash to buy assets with higher yields such as shares of listed businesses and corporate bonds
- Commercial banks receive cash, and this increases their liquidity. This may encourage them to lend out more money
Who are the main regulators in the UK financial system
- Financial Policy Committee (FPC)
- Prudential Regulation Authority (PRA)
- Financial Conduct Authority (FCA)
- Competition and Markets Authority (CMA)
What are the main aims of financial market regulation
- Protect the interest of consumers
Limit the monopoly power of commercial banks by encouraging increased competition
Protect borrowers from excessively high-interest rates on loans e.g. on unsecured credit
Improved access to affordable financial services – this is key for growth & development and prevention of poverty in many countries
Balance the interests of uninformed consumers with sophisticated sellers of financial services (i.e. address problems arising from information asymmetry) - Promote capital investment and sustainable long-run growth
Support trust in the banking system so that people and businesses are willing to save - Prevent/mitigate systemic risk within financial markets that might damage the economy
Financial Policy Committee of the Bank of England roles
Identify, monitor, and take actions to reduce risks that threaten t the UK financial system
FPC publishes a Financial Stability Report identifying key threats to the stability
If risks to the financial system are growing, they may tell the commercial banks and other lenders to increase their capital buffers to help absorb unexpected losses on their assets
Called “macro-prudential policy”
Names some examples of regulation in the financial market
Liquidity ratios
Capital ratios
Counter-cyclical capital buffers for banks
Regulation through leverage ratios
Stress tests for commercial banks
What is a liquidity ratio
ratio of liquid assets held by a bank on their balance sheet to their overall assets
Commercial banks need to hold enough liquidity to cover expected demands from their depositors
In the wake of the Global Financial Crisis the Basel Agreement require commercial banks to keep enough liquid assets, such as cash and bonds, to get through a 30-day market crisis
What are Captial ratios
measures the funds it has in reserve against the riskier assets it holds that could be vulnerable in the event of a crisis
Banks must maintain sufficient capital which includes money raised from selling new shares to investors and also their retained earnings
