CEMAP 1 TOPIC 1- Introducing the financial services industry Flashcards
In order to be acceptable as a medium of exchange, money must have certain
properties.
Sufficient in quantity
Generally acceptable to all parties in all transactions
Divisible into small units
Portable
Money acts as a store of value
Money must retain its
exchange value or purchasing power; inflation has a negative impact on the exchange value of money.
Financial institutions offer products and services that provide benefits including:
Convenience
A means of achieving otherwise difficult objectives (eg mortgages)
Protection from risk (eg insurance protects policyholders from financial consequences of adverse life events)
Money is
A medium of exchange – it can be exchanged for goods and services;
A unit of account – a common denominator against which the value of goods and services can be measured;
A store of value – money received as payment today can be
stored until required.
FINANCIAL INTERMEDIARY
An entity that acts as the middleperson between two parties in a financial transaction. Banks and building societies are the best-known examples.
DISINTERMEDIATION
Involves lenders and borrowers interacting directly rather than through an intermediary. An example of disintermediation is ‘crowdfunding’
Four elements of intermediation- several reasons why both individuals and companies need the services of intermediaries
Geographic location – physical problem that individual lenders and borrowers would have to locate each other and would probably be
restricted to their own area or circle of contacts
Aggregation – even if a potential borrower could locate a potential lender, the latter might not have enough money available to satisfy the borrower’s requirements. Intermediaries can overcome this size difference by aggregating small deposits.
Maturity transformation – The borrower may need the funds for a longer period of time than the lender is prepared to part with them. Intermediaries are able to overcome this mismatch by offering a wide range of deposit accounts to a wide range of depositors, thus helping to ensure that not all of the depositors’ funds are withdrawn at the same time.
Risk transformation – individual depositors are generally reluctant to lend all their savings to another individual or company, mainly because of the risk of default or fraud. However,
intermediaries enable lenders to spread
this risk over a wide variety of borrowers so that, if a few fail to repay (ie default), the intermediary can absorb the loss.
The Bank of England’s main functions:
Issuer of banknotes
Banker to the government
Banker to the banks
Adviser to the government
Foreign exchange market - manages UK official gold reserves and foreign currencies
Lender of last resort
Maintaining economic stability- FPC sit within BOE.
Proprietary organisation
Owned by their shareholders, who have the right to share in the distribution of the company’s profits in the form of dividends. They can also contribute to decisions about how the company is run by voting at shareholders’ meetings.
Mutual Organisation
Owned by its members, who can determine how the organisation is managed through general meetings. In the case of a building society, the members comprise its depositors and borrowers.
Credit Unions
Owner by members and controlled through a voluntary board of directors, all of whom are members of the union. The board members are elected by the members at the annual general meeting (AGM). Although the directors control the organisation, the day-to-day management is usually carried out by employed staff. Credit unions are authorised and regulated by (FCA), and savers protected via FSCS.
Product and Services of Credit Unions
Credit unions offer simple savings and loan facilities to members. Savers
invest units of £1, buying a share in the credit union.
Each share pays an annual dividend.
Credit unions that choose to pay interest must show that they have systems and controls in place and have at least £50,000 or 5 per cent of total assets (whichever is greater) in reserve.
Many credit unions offer additional services, including basic bank accounts, insurance services and mortgages.
Retail Banking
Common services provided to personal and corporate customers, such as deposits, loans and payment systems. Carried out by high-street banks and building societies.
Acting as intermediaries between people who wish to borrow money and people who have money that they are prepared to deposit.
The price of borrowing and the reward for investing is interest.
Wholesale Banking
Raising money through wholesale money markets in which financial institutions and
large companies buy and sell financial assets.
Retail banks use to top up deposits from branch networks. Can raise funds on interbank market.
‘Ring fencing’ - regulators ensure retail customers deposits not at risk.
Building societies are permitted to raise funds on the wholesale markets,
but are restricted to 50 per cent of their liabilities. For banks, there is no restriction.
LIBOR + SONIA
The rate of interest charged in the interbank market used to primarily be the London interbank offered rate (Libor).
Summer 2012- LIBOR scandal so now SONIA (sterling overnight index average) Based on actual transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors.
