Chapter 2- Monetary Policy

Question 1

What are Sectoral Capital Requirements (SCRs)?

Answer 1

It’s when the FPC can temporarily increase capital requirements on exposures to specific sectors

Question 2

What is a leverage ratio requirement?

Answer 2

Limits financial institutions on their exposure relative to their capital base, helping them to absorb losses and remain solvent

Question 3

What is regulated by: loan-to-value, debt-to-income and interest-cover-ratio limits?

Answer 3

They are limits on residential mortgage lending

Question 4

What is the interest coverage ratio?

Answer 4

The ratio of expected rental income from a buy-to-let property to the estimated mortgage interest payments over a given time period

Question 5

What is stress testing?

Answer 5

When the FPC assesses banks’ resilience and makes sure they have enough capital to withstand shocks,, and to support the economy if a stress does materialise

Question 6

What is the FPC?

Answer 6

Financial Policy Committee

Question 7

What is ring-fencing?

Answer 7

It separates banks’ retail banking activities from their investment banking activities

Question 8

What is the PRA and what does it do?

Answer 8

The Prudential Regulation Authority. It is responsible for the prudential regulation and supervision of financial institutions

Question 9

What are the 3 main objectives of the PRA?

Answer 9

• Promote safety and soundness of financial institutions
• For insurers to contribute to the securing of an appropriate degree of protection for policy holders
• To facilitate effective competition

Question 10

What is the FCA and what does it do?

Answer 10

Financial Conduct Authority. It is responsible for promoting effective competition, ensuring that relevant markets function well, and for the conduct regulation of all financial services firms

Question 11

What are the 5 key principles by which Monetary Policy is conducted?

Answer 11

• Clear precise objectives
• Flexibility: MPC has discretion to set policy to meet targets
• Openness and transparency: publications of MPC member voting records
• Accountability: BoE is accountable to government
• Credibility

Question 12

What does it mean that the inflation target is symmetrical?

Answer 12

Being below target is just as bad as being above

Question 13

What are the 2 core purposes of the Bank of England?

Answer 13

• Monetary Stability

- Financial Stability

Question 14

Describe Monetary Stability

Answer 14

Stable prices & confidence in the currency. Monetary policy that provides framework for non-inflationary economic growth

Question 15

Give 3 main ways the Bank of England brings about financial stability

Answer 15

• Reinforcing trust and confidence in money
• Supervising financial market infrastructure
• Acting as a lender and market maker of last resort in times of financial stress

Question 16

What is the primary objective of the FPC?

Answer 16

Identifying, monitoring and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system

Question 17

Give 3 main instruments of the FPC

Answer 17

• Countercyclical buffer rate
• Sectoral Capital Requirements (SRC)
• Leverage ratio requirement

Question 18

What is the countercyclical buffer rate?

Answer 18

The FPC decides the cushion of capital with which to absorb potential losses banks must have. The rate increases when it seems risks are building up

Question 19

How does Quantitative Easing work?

Answer 19

The BoE electronically creates new money and uses it to purchase gilts from private investors such as pension funds and insurance companies. These investors typically don’t want to hold on to this money, because it yields a low return so they tend to buy other assets thus increasing issuance of equity and bonds which stimulates spending

Question 20

What is a gilt?

Answer 20

UK Government bond

Question 21

What is the Term Funding Scheme (TFS)?

Answer 21

Enables banks to borrow funds from the BoE at close to the bank rate for up to 4 years so as to reinforce the transmission of bank rate cuts to those interest rates faced by households and businesses

Question 22

Give 2 pros of the BoE’s operational independence

Answer 22

• The MPC has more expertise than the government

- BoE protected from political pressure

Question 23

Give a con of the BoE’s operational independence

Answer 23

The BoE is substantially limited in various ways

Question 24

What are Monetary Aggregates?

Answer 24

Ways of measuring the money in an economy

Question 25

How does the monetary aggregate M0 work?

Answer 25

Narrow measure of money, consists of notes and coins outside the BoE and bankers’ operational deposits with the BoE

Question 26

How does the monetary aggregate M4 work?

Answer 26

Broad measure of money, consists of: notes and coin held by the M4 private sector plus all M4 private sector retail and wholesale sterling deposits at financial institutions in the UK

Question 27

What is the M4 private sector?

Answer 27

Firms other than financial institutions

Question 28

What are the 3 conventional instruments of Monetary Policy?

Answer 28

• Reserves schemes
• Operational standing facilities
• Long term repo operations

Question 29

Describe how the Reserves Scheme works

Answer 29

The BoE sets a target level of reserves, if a bank’s average balance is within the target range the balance was remunerated at the Bank Rate. Interest penalties apply to balances outside the range

Question 30

What is the purpose of the Reserve Scheme?

Answer 30

To create demand for central bank money and to support the functioning of the payment and settlement systems

Question 31

What are Operational Standing Facilities?

Answer 31

Overnight deposit and lending facilities available to banks to help stabilise market rates close to bank rate and help participating banks to manage unexpected payment problems

Question 32

What are Long-Term Repo Operations?

Answer 32

The BoE offer funds via a long-term repo operation once each month to provide liquidity to solvent banks

Question 33

What is a repo?

Answer 33

A transaction in which one party sells a financial asset to another party and agrees to repurchase an equivalent value of financial assets at some specified time in the future

Question 34

What is a Discount Window Facility?

Answer 34

On-demand facility aimed at banks experiencing a firm-specific or market-wide liquidity shock allowing them to borrow from the BoE highly liquid assets against less liquid collateral in potentially large size and for a variable time

Question 35

What is a Contingent term Repo Facility?

Answer 35

Contingency liquidity facility that the BoE can activate in response to actual or prospective market-wide stress of an exceptional nature. It enables the BoE to provide additional liquidity to banks against the full range of eligible collateral

Question 36

What are the 3 sets of collateral?

Answer 36

• Level A: liquid high-quality sovereign securities
• Level B: liquid high-quality sovereign, supranational, mortgage and corporate bonds
• Level C: less liquid securities and portfolios of loans

Question 37

What are haircuts?

Answer 37

When the BoE protects itself against falls in the value of collateral by lending an amount less than the market value of collateral

Question 38

What collateral does the BoE lend against in the short term?

Answer 38

Only Level A collateral

Question 39

What collateral does the BoE lend against in the long term?

Answer 39

Level B and C as well as Level A