financial eco quiz Flashcards
how do commercial banks create credit in the economy
by lending out a fraction of deposits thus creating new deposits
what might lead to a fall in commercial bank lending to UK households
an increase in capital and liquid assets ratios for banks
what are capital and liquidity ratios
capital ratio= how much capital a bank has compared to its risk weighted assets
high= bank has a large buffer of its own money - to absorb losses, safer more resilient in a crisis
low= more risk of collapse if loans go bad
liquidity ratio= banks ability to meet short term obligations - enough cash/ liquid assets
high= easily meet short term obligations
low- bankruosy ib crash/ crisis
although if too high= less money lent out /invested
how may speculation contribute to financial market failure
it inflates asset bubbles that can collapse leading to instability - asset bubbles occur when a price of an asset- stocks houses crypto rises far above real value driven by speculation
low interest rates on a asset, or new tech or gov policies make asset attractive
prices rise- more investors invest expecting further gains - herd behaviour
- prices ruse beyond assets earnings/ value unsustainable
- bubbles pop when market realises prices aren’t justified/ iare inflated - e.g. higher IR, people withdraw - panic
- people begin to sell, people follow- prices collapse rapidly
credit crunch and global recession
explain how commercial banks create credit
banks approve a loan
then creating a new deposit -
customer deposits money into bank , this forms loans/ liabilities which they lend out-
in the borrowers account
doesn’t create money just creates credit in borrowers account with the deposit
banks operate under a fractional reserve system only required to keep a fraction of deposits e.g 1-10% and reserves and can lend out the rest
can borrow from wholesale money market or raise equity
explain with examples the difference between secured and unsecured debt
secured debt- backed by collateral- an asset- lender can take if a borrower fails to repay - housing mortage
unsecured - not tied to any asset- lenders rely on credit history and income - credit card debt
household debt uk 2024
2135 BN, 120.0% disposable income
benefit to an economy of an increase in household debt and one risk
benefit- support string consumer spending contributing to GDP growth.
keysian multiplier effect increased borrowing drives AD
risk - households with high debt reduce their spending- downturns and increasing instability
debt - to - income ratio is high households are exposed to an increase in interest rates- risk for profitability of commercial banks
why is credit card debt more expensive than the base rate set by BoE
higher risk of default: credit cards are unsecured debt- no collateral for the lender to claim if can’t pay- credit card lending riskier- passed on in higher IR
behavioural economics: some consumers don’t pay off their full balance monthly: set high IR knowing users will carry balances for extended periods- IR = source of SNP
failure of SVB
silicone valley bank 2023 collapsed- bank heavily invested in LT gov bonds declined in value as the US federal reserve raised IR combat inflation
twch startups- withdrew funds to meet liquidity need- promoting bank sell assets at a loss
- bank run $42 billion withdrawn in a single day
argument for bailing out banks or letting banks fail
for- a bail out can limit systemic risks and mitigate negative cincequences for economy preventing - externalities ( Keyes)
- letting banks fail promotes market discipline and prevents moral hazard. encourages creative destuction as new banks and innovate banking models replace failed institutions
