CH16: financial intermediaries

Question 1

How dos the Central bank act as the bank’s bank?

Answer 1

Usually, all banks must keep an account at the central bank for the following:

• CLEARING- to allow for the transfers which have to be made from one bank to another
• CASH RESERVE - banks use the central bank as a reserve in emergency, “Lender of last resort” ie. if the bank gets into financial difficulties

Question 2

How does the central bank at as the Government’s bank?

Answer 2

Account holder - holds the accounts of various government departments

Debt management - organises the redemption of old debt, e.g. treasury bills and the issuing of new debt

Foreign currency reserve - holds reserves of foreign currency to facilitate global activity and also buy/sells foreign currency reduce fluctuations in the FX rate

Supervisor for the banking system - the central bank enforces regulations on other banks within a country

Notes and coins- issues notes and coins

Lender of last resort - lends money to banks unable to fulfil their obligations

Monetary policy - responsible for controlling the key instruments of monetary policy

Question 3

The central bank and monetary policy

Monetary policy concerns affecting the size of the money supply in the economy. How does the Central bank do this?

Answer 3

Buying and Selling Treasury bills - The central bank can buy government stock (such as treasury bills and commercial bills) from banks :
Buying treasury bills - increases the money supply.
Selling treasury bills- decreases money supply

Changing market interest rates - eg. the central bank can offer to buy bonds from other banks at a HIGHER interest rate, this is then passed n through an increased rate on the other bank’s loans to their customers hence an overall RISE in interest rates

Changing the CAPITAL ADEQUACY ratio - this is the ratio of capital that a bank has to have and is linked to the risk related to the assets that it hols. A HIGHER ratio means less funds available to lend.

Quantitative easing - The bank would usually reduce interest rates to help increase money supply HOWEVER when interest rates are already too low eg.0.5%, the central bank ‘creates’ money electronically which it uses to BUY BONDS to help increase interest rates. This then increases the amount of money the financial institutions who have sold the bonds have on which they can lend more

Question 4

What are 3 ways to categorise money needs of a business?

Answer 4

1. Working capital - day to day needs eg. wages, raw material
2. Investment capital- money used to invest in things like machinery or M&A
3. Asset management function - creating a portfolio of long term assets to include any LT investment with any surpluses that arise

Question 5

What does the financial system include?

Answer 5

covers all procedures and organisations that help with transactions between investors, lenders and borrowers. it includes: MARKETS, INSTITUTIONS and PRODUCTS.