Banks and Money

Question 1

roles of commercial banks

Answer 1

accept savings

financial intermediaries

lend to individuals and firms

allow payments to be made

provide insurance

provide financial advice

Question 2

financial intermediaries

Answer 2

move funds from lenders to borrowers

Question 3

commercial banking split into two areas

Answer 3

retail banking

wholesale banking

Question 4

retail banking

Answer 4

provide services for individuals and smaller firms.

often called high street banks.

Question 5

wholesale banking

Answer 5

for larger firms

commercial banking sometimes used to refer to wholesale banking.

Question 6

how do commercial banks help firms grow

Answer 6

by providing loans, financial advice, and by facilitating overseas trading.

Question 7

investment banks roles

Answer 7

arrange share and bond issues

offer advice on raising finance, and on mergers and acquisitions

buy and sell securities on behalf of clients

act as market makers to make trading of securities easier

Question 8

market makers for a security allows

Answer 8

companies and individuals to buy and sell that security without the need to use a stock exchange.

Question 9

proprietary trading involves

Answer 9

a bank buying and selling shares using its own money.

Question 10

investment banks get involved in

Answer 10

higher risk but potentially very profitable activities.

Question 11

commercial banks can also operate as investment banks

why is this a risk

Answer 11

many large banks operate as both a commercial and investment bank.

this is a systemic risk because banks can use deposits from commercial bank side to fund investment banking activity.

lose money in bad investments their depositors’ money is at risk.

Question 12

systemic risk

Answer 12

risk that a whole market or even the whole financial system might collapse

Question 13

pension funds

Answer 13

collect peoples pension savings and invest them in securities.

when client retires, pays out their savings and returns generated.

also they provide long term, large scale investment in companies.

Question 14

insurance firms

Answer 14

charge customers fees to provide insurance cover.

this is important for the economy. businesses can insure against the risk of customers not paying encouraging trade.

Question 15

hedge funds

Answer 15

firms that invest pooled funds in the hope of receiving high returns.

invest in different markets.

the fact that they want high returns and are only lightly regulated can lead to risk for contributors and for the wider economy.

Question 16

private equity funds

Answer 16

invest in businesses by buying equity and then try to maximise returns.

make businesses successful so it can be sold for a profit.

often criticised for asset stripping and cutting jobs

Question 17

asset striping

Answer 17

selling a firms assets.

Question 18

the shadow banking system

Answer 18

includes unregulated financial intermediaries and the unregulated activities of otherwise regulated financial institutions.

difficult to know how large this system is because it’s unregulated. the absence of emergency support available to normal banks add to the risk of it to cause a financial crisis.

hedge funds and private equity firms are considered to be part of it.

Question 19

money has

Answer 19

different levels of liquidity

Question 20

what can be considered part of the money supply

Answer 20

any financial instrument that satisfies the four main functions of money,

portable, widely accepted, difficult to forge, durable can be classified as money.

Question 21

liquidity refers to

Answer 21

how easily something can be spent.

Question 22

what money is illiquid

Answer 22

shares, houses, bonds

as need to be converted to cash before they can be used to buy things.

Question 23

narrow money

Answer 23

refers to notes and coins in circulation, plus balances held at the central bank.

financial instruments that are very liquid.

Question 24

broad money

Answer 24

assets that are less liquid

as well as all the things that make up narrow money.

Question 25

banks are businesses therefore

Answer 25

they aim to maximise profits.

Question 26

why do banks not want too many liquid assets

Answer 26

because the rate of return on illiquid assets (corporate bonds) is usually greater than liquid assets (deposits at the Bank of England).

Question 27

why do banks need to have a certain amount of liquid assets available?

why do banks need to calculate carefully the amount of liquid reserves they hold?

Answer 27

as they tend to lend money over a long term. meaning they are paid back over a long period of time.

but depositors who give their money to banks expect to be able to withdraw their savings immediately.

banks need to have enough liquidity to repay depositors but not too much otherwise they might become unprofitable.

Question 28

what do banks rely on

Answer 28

depositors not all wanting to withdraw their savings at the same time.

if too many want to withdraw at short notice, bank might not have the liquidity to repay them. as the money is being lent long term.

Question 29

what is a bank run or run on the bank?

this is why is it important that people trust the banking system with their savings…

Answer 29

when lots of depositors loose confidence in the bank and believe that their savings are at risk.

lots of people withdraw their savings very quickly. and the bank runs out of liquid assets.

Question 30

why is the central bank needed

Answer 30

to act as an emergency lender of last resort.

Question 31

why are there different interest rates in different money markets

Answer 31

the more secure an investment is, the lower the rate of interest that will be earned.

Question 32

what do investors and banks need to do?

when is this especially important?

Answer 32

they must balance the security of an investment against its profitability.

if an investor is using someone else’s money, or the firm they are working for is particularly important to the stability of the financial system.