4.5 Risk in the Financial Sector Flashcards
Define shock
Unexpected or unpredictable events that have a major effect on the economy
Define uncertainty
An unpredictable change where there is no way to calculate its likelihood
Define risk
When changes are expected so the probability of their occurrence can be calculated using past data
Define supply-side shock
An impact upon the provision of a good or service that will impact price
Define demand-side shock
An impact on the consumption of a good or service that will effect price
What is a forward market?
An agreement to buy a foreign currency at a fixed exchange rate on a future date
Give 3 advantages of using forward markets for a business
- Don’t lose money on imports with a depreciation of the domestic currency
- Allows for better future planning and reduced uncertainty
- Protects them in the case of a shock
Give a possible disadvantage of a business using forward markets
Appreciation of the domestic currency will see them paying more than necessary for imports
Define insurance
A contract between 2 parties who look to provide financial protection against any losses incurred by a business
What is meant by an insurance premium?
The cost of the insurance to the firm
What is meant by an insurance payout?
They money the firm would receive in the case of having to honour the contract
Give 2 advantages of business insurance to a firm
- Reduces risk
- Provides business confidence to encourage investors
Give 3 potential disadvantages of having business insurance for a firm
- Opportunity cost
- Premiums can change and cause uncertainty
- Individuals can claim against a business
How does the financial sector mobilise savings for lending to firms?
They use savings and channel them to the firms as they are financial intermediaries
What is the role of an investment bank?
To serve big businesses and big projects
What is the role of a building society?
To offer mortgages
Why are building societies the safest banks to save with?
They only lend what they have depositied
What is the role of retail banks?
To loan to individuals and small businesses
How does the financial sector create jobs in working capital (people who don’t get paid until a job is done)
They provide overdrafts to help them pay their costs before they get paid
How have advancements in technology helped the financial sector with ease of trade? (3)
- Credit & Debit cards make trade easier
- Payment systems are faster
- The cost of exchanges are lowered
Define creditor risk
The risk of providing a loan to a bank
How is creditor risk assessed by banks? (2)
- Credit ratings
- Banks sharing information between each other
What does the term ‘hedging’ mean?
Using forward markets
How do the financial sector help in currencies and foreign commodities?
Can provide forward markets
What is meant by ‘providing equities’?
Trading in shares of PLCs
How do the financial sector provide a market for equities?
Banks act as stockbrokers and trade shares
Give the 4 roles of the Central Bank
- Implement Monetary Policy
- Act as a bank to the government
- Be the ‘lender of last resorts’
- To regulate the financial system
What is the role of the MPC? (Monetary Policy Committee)
To set the base interest rate
How many members are there of the MPC?
9
What is the main factor in deciding the interest rate?
Inflation target of 2%
What are the 2 regulatory bodies under the Bank of England?
Financial Policy Committee (FPC)
Prudential Regulation Authority (PRA)
What do the FPC (Financial Policy Committee) do to regulate the banks?
Provide a more overall and long-term vision of the banking industry
What do the PRA (Prudential Regulation Authority) do to regulate the banks?
Give a more specific assessment of individual banks
How do the PRA assess a bank’s stability?
Do a stress test to reveal any problems
What is meant by the Bank of England being a ‘Lender of last Resorts’?
They guarantee to lend to banks that are temporarily unable to meet their customers needs to withdraw money
What do the Bank of England not do as a ‘Lender of Last Resorts’?
Do not rescue large banks that are going under
Give an evaluation point of the strength of the PRA
Many members of the PRA are former bankers and will still have links with banks and could not regulate properly
How can being a ‘Lender of Last Resorts’ be problematic for the BOE?
Can provide a safety net that allows banks to be more reckless in their policies
What is ‘light-touch regulation’?
Reducing bank regulation
Give 2 benefits of the financial sector to the UK economy
- Provides high income jobs
- Provides vast amounts of corporation tax
Give 3 disadvantages of the financial sector to the UK economy
- Large corporations can avoid tax
- The BOE being a ‘Lender of Last Resorts’ comes out of government revenue
- Cost of regulatory bodies
Name the 5 main categories that caused the Global Financial Crisis
- Sub-Prime Mortgages
- Moral Hazard
- Collapse of lending to businesses
- Speculation and Market Bubbles
- Role of Organisational Culture
What is a subprime mortgage?
A risky loan for house payment to those with a low credit rating
Why did banks offer subprime mortgages?
Because they could charge a higher interest rate
What made the subprime mortgages a problem for the economy?
When the economy went into a natural downturn, many lost their jobs and defaulted on their payments
How did the supply of houses worsen the crisis from subprime mortgages?
The supply of houses increased as they were repossessed which lowered their value and lost the banks money
What is meant by the ‘moral hazard’ in causing the Global Financial Crisis?
Banks were taking greater risk without fear of bankruptcy as they could always fall back on the BOE being ‘Lender of Last Resort’
Why was there a collapse of lending to businesses after the Global Financial Crisis had started?
They had lost money and confidence and so were not providing credit
Which huge bank collapsed because the government were looking to show that they weren’t going to bail all the banks out?
Lehmann Bank
What was the impact of Lehmann Bank collapsing?
Banks lost all confidence and stopped lending altogether
What is a market bubble?
Where the price of a good deviates from its value significantly
What is speculation?
Buying something in anticipation of a change in price
How did speculators contribute to the global financial crisis?
They bought houses and created a market bubble with the price of houses which burst
Why was banking culture a major contributor to the global financial crisis?
They had a profit at all costs culture and focused on a short-term profit
How can the global financial crisis be used as a n example of globalisation?
It started in the US and spread all around the world
Since 2009, what 3 regulatory bodies have been set up to keep banks stable?
PRA
FPC
FCA
