Chapter 1 (6 Exam Questions): The UK financial services industry in its European and global context

Question 1

What is the main role of a bank’s deposit holders?

Answer 1

They provide funds to the bank that can be lent to borrowers

A bank’s deposit holder is someone with a savings account

Question 2

Who owns banks? What type of company is a bank?

Who owns building societies?
What type of company is a BS?

Answer 2

Banks are owned by shareholders, who expect dividends.

Bank’s are proprietary companies.

Building societies are owned by their share account savers (members) who should receive higher interest on savings and lower interest on lending when compared to banks (as a way of sharing profits).

Building societies are mutual organisations

Question 3

Why are building societies able to offer better rates than banks?

Answer 3

Building societies are mutual’s so are not owned by shareholders like Banks (who are proprietary) meaning they do not distribute any profits as dividends.

Therefore, the extra profit can be used to offer better rates to its members

Question 4

Who is the government’s bank

Answer 4

The Bank Of England

Question 5

What is a Public-Sector Net Cash Requirement (PSNCR)?

Answer 5

A deficit in the governments spending

Ie The government has spent more than it has coming in. This is much more common than a surplus. The deficit post pandemic is huge!

Question 6

What is a deficit in the governments spending also known as?

Answer 6

Public-Sector Net Cash Requirement (PSNCR)?

Question 7

How do financial services companies help reduce government borrowings?

Answer 7

By investing into GILTS.

This increases the money lent to the government, usually for a set period. It means that governments need to borrow LESS through other methods, such as on the money markets

Question 8

One of the essential functions of financial services is to provide protection against risk.

The principle of insurance and risk-management is to WHAT

Answer 8

Safeguard or protect assets from financial loss.

Question 9

What sort of assets would individuals and companies want to protect?

What types of insurance are pretty common because of this?

Answer 9

A range of things…such as themselves, their property, income, profits and so on

Therefore, life assurance, income protection or key persons insurance (for businesses)

Question 10

What is a reinsurance company

Answer 10

An insurer for an insurer

Where an insurer deems the risk presented to them is too great they may offset part of that risk by using a reinsurer

Question 11

Arranging protection for assets is a relatively simple process, however arranging protection for the risks presented by financial transactions is much more complex. Here we are talking about risks such as selling assets, which might then go up in value, or buying assets, which might then go down in value.

What is typical used instead of conventual insurance to offset this risk then?

Answer 11

Derivatives

Question 12

Financial markets (Ie, the stock market, the secondary market etc) were developed to meet two key objectives. What are they?

Answer 12

Provide access to investments that can provide real growth (ie, be higher than inflation)

Provide a way for companies to raise money, other than borrowing from a bank.

Question 13

The stock market, facilitates the trading of Stocks and Shares

What is the difference between the 2?

Answer 13

Stocks = Allow an investor to lend a company money, in exchange for a fixed-interest payment (known as bonds. For example, corporate bonds)

Shares = Allows an investor to buy a share of the company, and therefore share in its growth and profits, via dividends

Note: The stock market also allows institutions to invest and offer their own collective investments, such as pensions and unit trusts. The main uses are the two mentioned above tho….

Question 14

For understanding:

Answer 14

‘bond’ is a term used very widely in financial services to describe different investment types, so you need to look at the context whenever you see ‘bonds’ mentioned.

Question 15

The EU has 3 European Supervisory Authorities (ESAs)

What are they?

Answer 15

European Banking Authority (EBA): Banking.

European Securities and Markets Authority (ESMA): Stock markets.

European Insurance and Occupational Pensions Authority (EIOPA): Life & Pensions.

Answer 16

Question 17

What is the role of the European Central Bank?

Answer 17

Controls monetary policy and interest rates across EU states

Question 18

What is the role of the European Systemic Risk Board (ESRB)

Answer 18

Monitors and assesses the stability of the financial system.

ESRB deals in ‘macro-prudential supervision’

Question 19

What is the role of the European System of Financial Supervision (ESFS)

Answer 19

Supervises individual financial institutions. ESFS deals with ‘micro-prudential supervision’

Question 20

What is the Financial Stability Bored?

Answer 20

Concerns itself with the stability of the world wide financial system

Basically a global version of the European Systemic Risk Board (ESRB)

Question 21

What is the Financial Action Task Force?

Answer 21

Concerns itself with worldwide global anti-money laundering policy and development

Question 22

Who are the main bodies that are responsible for the smooth running and regulation of the industry and broader economy in the UK:

Answer 22

The Financial Conduct Authority (FCA)

The Bank of England

The Prudential Regulation Authority (PRA)

The Financial Policy Committee (FPC)

The Treasury

Question 23

The UK financial sector has four key
components within it

What are they? Think FIRM

Answer 23

F =Firms

I= Infrastructure

R= Regulatory Authorities

M= Markets

THINK FIRM

Question 24

The three main clearing companies within the UK are WHAT?

How are they regulated?

Answer 24

BACS (Bankers’ Automated Clearing Services)

CHAPS (Clearing House Automated Payment System)

The Cheque and Credit Clearing Company

(These are all companies that are FCA regulated)

Question 25

BACS (Bankers’ Automated Clearing Services)

CHAPS (Clearing House Automated Payment System)

The Cheque and Credit Clearing Company

These are all examples of what key component of the UK financial sector?

Answer 25

Financial infrastructure

In the sense they are systems and processes that allow money to be moved around quickly, so that traders and individuals alike can pay for, and be remunerated for, their trading.

Financial infrastructure like this is 1 of the 4 key component of the UK’s financial system

Question 26

What is the Payment Systems Regulator (PSR)?

Answer 26

The PSR is a competition-focused regulator for retail payment systems

Its purpose is clear:
‘to make payment systems work well for those that use them’

Question 27

True or false for the following statements:

The PSR:

Is a subsidiary of the Financial Conduct Authority.

Is independent, with its own managing director and board.

Has both competition and regulatory powers.

Funded by the financial services industry

Accountable to Parliament

Answer 27

ALL TRUE

Question 28

The Payments Systems Regulator has 3 statutory objectives. What are they?

Statutory objectives = required by law

Answer 28

Ensure payment systems are operated and developed in a way that considers the interest of all business and consumer which use it

To promote effective competition in the market of payment systems and services

To promote the development and innovation of payment systems. In particular the infrastructure used to operate those systems (IE, BACS, CHAPS etc)

Question 29

The payment service regulator has both regulatory and competition powers

Give an example of how it used both?

Answer 29

Competition = One of PSR statutory objectives is to promote the development and innovation of payment systems, thus increasing competition by doing so.

Regulatory powers = Using it’s regulatory powers it can force certain changes to be actioned, where there is evidence of the payment systems industry failing to deliver greater competition, innovation, and/or greater benefits for businesses or consumers (ie, it is failing at delivering its objectives)

Question 30

Since Brexit the UK is subject to third country equivalence rules, designed to protect EU states when clearing through UK companies.

Can this be revoked?

Answer 30

Yes, it can be revoked with 30 days’ notice by the European Commission.

Answer 31

Question 32

The systems to clear payments and settlements are overseen by WHO

Answer 32

the Bank of England, which monitors and facilitates both the money markets and the payment systems

Question 33

What are:

On-exchange markets

Over-the-counter (OTC) markets

Answer 33

They are the two basic ways of organizing a financial market

On-exchange markets -

These are FCA regulated trading floors, for stocks and shares.

OTC markets -

These are ‘committees’ formed by market users, to ensure its smooth operation

Question 34

Why are Over-the-counter (OTC) markets less transparent than On-exchange markets?

Answer 34

Unlike On-exchange market trades, OTC market trades can be carried out between two participants without others being aware of the price.

Therefore, making them less transparent than On-exchange market transactions. OTC is also subject to fewer regulations.

Question 35

Tell me about the following:

The capital market

The money market

The foreign Exchange Market

The commodity market

Answer 35

The capital market = just the stock market

The money market = The wholesale market for commercial lenders

The foreign Exchange Market = An OTC market for exchanging foreign currency

The commodity market - for trading physical goods like oil, gas etc

Question 36

What core services can banks and building societies offer?

What indirect services can both offer?

Answer 36

Core services offered by banks/building societies:
- Current and cheque accounts
-Deposit accounts
-Will and executorship services
-Mortgages and loans

Non core services or indirect services offered by banks/building societies:

Portfolio management (establishing, and then managing, a variety of client investments for a fee)

Stockbroking services (buying and selling services

AND MUCH MORE

Question 37

Define core services-

Define indirect services -

Answer 37

core services are services that the organisation was originally set up to conduct . For example, for a bank it would be offering saving accounts or offer will and executorship services

Indirect services are the opposite. The organisation may do this do meet consumer needs. For example in a banks case this could be portfolio management.

NOTE: Many banks/building societies have moved to offering many more indirect services. Back in the day many Building Societies ‘demutualised’ which allowed them to offer more indirect services

Question 38

What is bancassurance?

Answer 38

Where a banks or building society set up their own life assurance subsidiary, so that they can offer their own range of products

IE, where a bank or building society offers its own insurance

Question 39

If a bank offers insurance and/or assurance is this a core or indirect activity

Answer 39

Indirect activity

Banks were not originally set up to offer this. This is what insurance companies do. However many banks now do, and they are known as bancassurers

Question 40

Since the Retail Distribution Review (RDR) there are two main advice categories, Independent and Restricted.

Tell me about both

Answer 40

Independent - Diverse and unrestricted advise, across all retail investment products

Two forms of restricted advise:

Restricted (multi-tied) - A limited range of providers from a panel are considered. Advisors are ‘restricted’ to that panel

Restricted (tied) - One provider. Advisors are ‘restricted’ to that one provider’s products.

Question 41

Life assurance companies distribute their products using two main methods:

Answer 41

Through Intermediaries who provide advice.

Their own direct sales team

Question 42

What are friendly societies?

Answer 42

Friendly societies were traditionally mutual companies, run in a similar way to building societies.

All profits shared between their members or customers.

NOTE: Many Friendly Societies now offer collective investment schemes.

Question 43

Friendly Societies are tax free status. True or false?

Answer 43

TRUE

WAY TO REMEMBER: They are friendly for being tax free

Question 44

What are multi distribution organisations?

Answer 44

Companies like Tesco, Marks & Spencer, Virgin etc

Offer lots of different channels through many different channels such as online, retail, direct sales (direct sales is how they offer their financial products) etc

Question 45

When part of the EU, why did the UK always have greater fiscal control than other member states?

Answer 45

Because the UK was never part of the European Monetary Union and did not use the Euro as its main currency

Question 46

In May 1999, the EU adopted the Financial Services Action Plan (FSAP)

What was its purpose?

Answer 46

To create a single market for financial services.

provide open and secure retail markets.

introduce state-of-the-art prudential rules and supervision

Question 47

The 3 European Supervisory Committees were introduced in 2011. Why ?

Answer 47

Because of the financial crises

Remember the 3 European Supervisory Committees are:

European Banking Authority

European Markets and Securities Authority

European Insurance and Occupational Pension Authority

Question 48

Who is in charge of HM treasury?

What is HM treasury responsible for?

Answer 48

The Chancellor of Exchequer

It is ultimately responsible for the regulation of the UK financial services market

Question 49

What is the financial Services and Marketing Act (FSMA) 2000?

Answer 49

It simplified the UK regulatory framework…
There were lots of different rules for lots of different regulatory bodies, and resulted in a lack of consistency and uniformity in the UK financial services system

AND it introduced 3 new bodies, the FSA, the FOS and the FSCS

Question 50

What is the financial Services and Marketing Act (FSMA) 2000 simplified the UK framework and created 3 new bodies. What did it create?

Answer 50

The Financial Services Authority (FSA) as the UK’s sole regulator and the responsibility of the Chancellor and the Treasury. (Later to be replaced by the FCA by the Financial Services Act 2012)

The Financial Ombudsman Service (FOS) as the sole ombudsman (handling mainly advice complaints).

The Financial Services Compensation Scheme (FSCS) as the sole compensation scheme where a provider goes bust, is in default, becomes insolvent, etc

Question 51

What is the financial Services Act 2012?

What 3 new bodies did it introduce. (Don’t confuse with the Financial Services and Marketing Act (FSMA) 2000 which also created 3 bodies)

Answer 51

It introduced the FCA, PRA & FPC (Financial Policy Committee)

It replaced the Financial Services Authority as the sole UK regulator, with the creation of several bodies, including the FCA, as part of the regulation that came into force on 1 April 2013.

Question 52

What 3 bodies did the financial Services Act 2012 create?

What 3 bodies did the Financial Services and Marketing Act (FSMA) 2000 create?

Answer 52

financial Services Act 2012 = FCA, PRA, FPC (financial policy committee)

Financial Services and Marketing Act (FSMA) 2000 = FSA (financial services authority), FOS, FSCS

Question 53

Tell me about the FCA

Answer 53

An independent regulator (this contrasts with the PRA which is part of the BOE)

Responsible for the prudential regulation of all the firms that the PRA doesn’t regulate (smaller, lower risk firms)

Since 2014, it has regulated consumer credit

Responsible for the FSCS, FOS and Moneyhelper

Question 54

Tell me about the PRA

Answer 54

Part of the BOE (ie, it is not independent like the FCA is)

Responsible for monitoring the financial stability of the UK’s largest financial companies, ie those that are systematically important ie too big to fail

Question 55

Tell me about the Financial Policy Committee

Answer 55

They are part of BOE

Responsible for removing systematic risk

The BOE FPC meet 8 times per year and set interest rates

Question 55

What is systematic risk also known as?

Answer 55

market risk

Ie Barclays is systematically important so it is regulated and monitored by the PRA. You can therefore say Barclays has great market risk

Question 56

Firms can either be sole regulated or duel regulated. What does this mean?

Answer 56

Single regulated means the FCA are responsible for both conduct and prudence (smaller firms/individuals).

Dual regulated means the FCA are responsible for conduct and the PRA for prudence (banks/building societies/investment firms and insurance companies)

Question 57

How are smaller firms and larger firms regulated differently?

Answer 57

Larger firms have their own regulatory designated account manager overseeing things, whilst smaller firms have ‘pooled arrangements’; like a call-centre arrangement

The intention of this regulatory model was so issues are proactively identified, rather than reactively corrected.

Question 58

The UK government controls of ‘fiscal’ and ‘monetary’ policy

What is this known as?

Answer 58

Economic policy

Question 59

What is fiscal policy?

What is monetary policy?

Answer 59

fiscal policy - Governmental control of taxation, borrowing & spending

monetary policy - Control of interest rates and money supply

The UK government has control of both these types of policy. Both these types of policy are collectively known as economic policy

Question 60

The BOE Monetary Policy Committee meet 8 times per year and set interest rates to meet the governments inflationary target.

They can also inject cash into the economy to increase money supply. How do they do this?

Answer 60

They can inject cash into the economy through a method called ‘quantitative easing’

quantitative easing is where a central bank creates new cash and with that cash purchases government securities or other securities from the market

It can be used to stimulate the economy where other traditional tools like lowering rates would not be effective (for example, if the rates are already low)

The BOE creates cash and buys the GILTs from the holders (ie a bank, BS etc). The seller then has more money in reserve which then means they can lend more which means more money is in circulation kickstarting the economy

The negatives of this is exchange rates will drop, asset prices and finical stability will all fall

The ‘furlough scheme’ is an example of this. The BOE printed £500 Billon and injected it into the economy. Alongside other factors like Ukraine, rising fuel costs etc, this then caused the huge surge in inflation recently

Question 61

What is the ‘Balance of Payments (BOP)’

Answer 61

It is a statement of all transactions made between entities in one country and the rest of the world, over a defined period of time; usually a year.

Simplistically, it is a record of a country’s transactions with the rest of the world

Although not linked directly to fiscal or monetary policy, the subject of the ‘balance of payments’ is often part of decisions around these policies

Answer 62

Question 63

How does the government borrow money from individuals and institutions?

Answer 63

By selling GILTS, issued INITIALLY by the debt management office (DMO), which is part of HM Treasury.

Question 64

For understanding

When a government borrows money, it means that individuals and institutions have less to spend on other items, i.e. it reduces the amount of money in circulation which can lead to a ‘dampening’ of the economy as individuals ‘tie up’ their savings in long-term loans.

Therefore, the Bank of England adopst a process of ‘quantitative easing’

The BOE creates new money and then uses it to ‘buy back’ loans from institutions, such as banks and companies

Those companies then have more money in reserve so they lend more meaning higher money supply

Question 65

What is industrial policy?

Answer 65

The governments policies designed to encourage the growth and development of its manufacturing sector

The industrial policy in the UK is often denoted as ‘IP’

The UK manufacturing industry has unfortunately been in decline for many years now. How many 100% british companies can you think of…?

Question 66

What is factory gate’ pricing?

Answer 66

This represents the actual costs of manufacturing goods before any mark up for profit is added. The factory gate price includes:

Direct costs such as labour and raw materials.

Indirect costs such as interest on loans and taxation

Therefore, one way of encouraging a positive industrial policy is to lower factory gate taxation. (This sounds good but governments will then just increase taxes for customers in return

Question 67

How do the MPC actually change interest rates?

Answer 67

By using the GILT Repo Market.

Repo = ‘sale and repurchase agreement

A Gilt with a Repo is a form of short-term loan, using GILTS as security.

NOTE: The difference in value between this sale and repurchase of these GILTS is called the ‘repo rate’

Question 68

The MPC members include people independent of the Bank of England, to ensure a balance of opinion

Answer 68

True

Question 69

Major pension changes were introduced, through the Taxation of Pensions Act (TOPA) 2014.

True or false

Answer 69

True

This gave greater pension freedoms to individuals at retirement, in relation to certain types of pension

Question 70

The function and operation of financial services within the wider economy

Banks and building societies provide ‘safer’ havens for consumers’ money.
They use the money saved to invest and lend to others.
UK Government raises money for spending via the issue of GILTS and NS&I products.
As well as saving, the public need protection against foreseen and unforeseen risks.
Re-insurers (e.g. Lloyds of London) insure insurers if a risk is too great for the original insurer to bear.
Capital markets have developed, with London pre-Brexit historically being a major player.
2: The role and structure of the UK and international markets

There are four key components within the financial sector; FIRM
Firms / Infrastructure / Regulatory authorities / Markets.
There are three types of adviser:
Independent / Restricted (Multi-tied) / Restricted (Tied).
There are new entrants to the industry offering non-advised financial products access e.g. supermarkets.
3: The impact of the EU on UK regulation

70% of the FCA’s policymaking was historically driven by EU initiatives.
The impact of Brexit is yet to be fully determined on the UK financial services industry.
HM Treasury is ultimately responsible for the regulation of the UK financial services industry.
The PRA authorises and regulates larger firms, from a financial stability (prudence) perspective.
The FCA also authorises and regulates firms, but these are smaller companies with less potential risk.
The FCA is the UK’s sole conduct regulator.
4: The role of government

Governments use fiscal (tax, borrowing and spending) and monetary (interest rates and money supply) policies to provide for a stable economy.
Growth is encouraged in the UK manufacturing industry, by controlling factory gate taxation.
The Monetary Policy Committee, within the Bank of England, sets interest rates, using the REPO market, to meet the government’s inflation targets (currently 2% - that’s going well then!)
The UK has a welfare and benefits culture to act as a safety-net for the population.
Department for Work and Pensions (DWP) benefits are designed as a financial safety-net, not as an individual’s primary source of income

Question 71

The UK government currently has a surplus. Which of the following statements BEST describes what this means?

There are greater imports than there are exports.

There is increased trading in the European Union.

There are higher taxation receipts than are being paid in state benefits.

There are higher state benefit payments due to a decrease in birth rates

Answer 71

Correctly selected
There are higher state benefit payments due to a decrease in birth rates

For the UK government to have a surplus, there must be greater monies being collected, mainly via taxation, than the monies being spent on areas such as state benefits

Question 72

The UK government monitors its Balance of Payments. What does this term refer to?

Selling GILTS and Bonds to reduce money supply.

A record of UK transactions with the rest of the world.

Buying GILTS and Bonds to reduce money supply.

A record of UK transactions with the European Union

Answer 72

The Balance of Payments shows the UK’s transactions with the rest of the world. It shows imports and exports of goods and services and capital, as well as transfer payments such as foreign aid.

Question 73

The primary objective for the MPC, when setting interest rates, is to…

meet inflation targets set by the Treasury.

maintain liquidity for the clearing houses.

control the money supply.

increase the price of GILTS

Answer 73

maintain liquidity for the clearing houses

The Monetary Policy Committee (within the Bank of England) sets interest rates to meet inflation targets set by the Treasury

Question 74

If the UK government has a deficit in its finances, it is most likely to raise the required capital by…

buying GILTS and selling Corporate Bonds

selling GILTS and raising interest rates

selling GILTS and promoting NS&I products

buying GILTS and promoting ISA investments

Answer 74

selling GILTS and promoting NS&I products

The government uses the money saved in NS&I products and money lent to it by investors buying GILTS to plug any gap in its finances. Buying Gilts could potentially increase a deficit unless quantitative easing is used to generate new money.

ISA investments could be with non-government companies, such as banks or building societies, so would not help raise finance for the government

Question 75

Which of the following is NOT an example of fiscal policy?

An increase in taxation.

A reduction in public spending by the government.

A reduction in interest rates by the Bank of England.

An increase in government borrowing

Answer 75

A reduction in interest rates by the Bank of England.

Interest rate control is part of monetary policy. Amendments to taxation and spending patterns are components of fiscal policy

Question 76

hich of the following is an example of industrial policy?

Control of inflation rates.

The EU imposing trade barriers when sterling falls in relation to the euro.

Reductions in Gross Domestic Product rates.

Control of factory-gate taxation

Answer 76

Control of factory-gate taxation

A government will try and help its manufacturing industry to expand by controlling factory-gate taxation.

This will make the end-product cheaper, so more attractive for purchase by consumers