Financial Markets/crash Flashcards
Main purpose of banks (and other financial institutions)
make money liable to those who want to spend more than their income using savings if those who currently don’t want to spend
what do banks do to make money available for people to spend:
- help people and firms save - through bank accounts, pension funds, bonds and other financial products
- provide loans to businesses and individuals
- allow equities and bonds to be issued and traded on capital markets
Everyday forms of borrowing for individuals
- personal loans
- mortgages
- credits cards
- pay day loans
- overdrafts
Personal loans (Everyday forms of borrowing for individuals)
loans to individuals to be paid back over a small number of years. These can be secured for unsecured
secured loans
loans backed by collateral that the bank can claim if the borrowers do not repay them
Unsecured loans
loans backed only by the borrowers’ good reputation and previous credit rating higher rate of interest than secured loans because ether riskier
Mortgages (Everyday forms of borrowing for individuals)
loans to buy property. The bank owns the property until the loan is repaid.
Pay day loans (Everyday forms of borrowing for individuals)
short term, small, unsecured loans, usually high rate of interest
Equity finance
Equity finance is generally the issue of new shares in exchange for a cash investment. Your business receives the money it needs and the investor will own a share in your company. This means the investor will benefit from the success of your business.
debit finance
borrowing money that has to be paid back with interest. This can involve borrowing from financial institutions or using corporate bonds.
Other functions of financial institutions and markets
- make trade easier by allowing buyers to make payees easily and quickly
- provide insurance cover to firms and individuals
How does the financial sector help economic growth
- economic growth driven by spending of individual and firms which relies on credit
- businesses are unlikely to grow without credit - if don’t grow fewer jobs and less exports
- firms in developing countries financial sector is weak, underdeveloped
Financial institutions are regulated to:
- reduce impact of financial market failure
- protect consumers by policing individuals and firms to ensure act fairly and legally
- ensure integrity and stability of financial institution and services
- maintain confidence and avoid sudden panics
Banks are ______ sector organisations
Private - aim to make profit for shareholders
Problems in a bank or banking industry
can potentially destabilise country’s whole economy
What two factors of a bank make banking a regulated industry
- huge economic importance of banks
- incentives to take risks for banks
Regulated banking industry
there are rules to control the behaviour of banks and penalties for any bank that break the rules
3 types of financial markets
- Money markets
- capital markets
- Currency Market
Money markets
- provide short term finance to banks, companies, give, individuals
- short term debt has maturity of up to a year as little as 24hrs
maturity
repayment period
capital market
provide governments and firms with medium - long term finance.
- give and firms raise finance by issuing bonds
- also raise finance by issuing shares or borrowing from banks
A capital market has a ______ market and a ________ market
- primary
- secondary
Primary market (capital markets)
For new share and bond issues
Secondary market (capital markets)
where existing securities are traded. This increases their liquidity
Foreign Exchange market
where different currencies are bought and sold. Does to allow international trade and investment or as speculation.
A foreign exchange market is split into:
- Spot market
- Forward market
Spot market (Currency Market )
for transactions that happen now
Bonds
A certificate issued by a government or private company which promises to pay back with interest the money borrowed from the buyer of the certificate: The city issued bonds to raise money for putting in new sewers.
investors buy new bonds
at their face value (nominal) and become bondholders
bondholders
those who own bonds and receive the interest payments
Commercial banks main roles
- to accept savings
- to lend to individual banks and firms
- ti be financial intermediaries
- t allow payments form one person to another
commercial banking is split into 2 area
- retail banking
- wholesale banking
Retail banking (commercial banks)
providing services for individuals and smaller firms
Wholesale banking (commercial banks)
- dealing with larger firms banking needs
Investment banks roles
- Arrange share and bond issues
- offer advice on raising finance and on mergers/ acquisitions
- buy and sell securities on behalf of clients
- act as market makers to make trading in securities easier
Large banks can be both commercial and investment
- creates a systematic risk because banks may wish to use deposits form commercial banking side of business to fund investment banking activity
Other financial institutions operate in global financial markets
- pension funds
- insurance firms
- hedge funds
- Private equity firms
the 2008 credit crunch
- financial crisis caused by speculative bubble in US housing market
- growth in sub prime mortgage market caused house prices to rise as demand increase
rising house prices lead to more and more people investing in property, pushing prices up - bubble burst when people who taken portages couldn’t afford begin to default and house prices fall
- meant banks levels capital fell so banks reduced lending - credit crunch
- triggered loss confidence in wider economy, fall AD and recession deep
Two key roles of central banks
- act as banker to government
- help support banks by acting as a lender of last resort
central banks as lender of last resort advantages
- prevent panic and runs on banks
- helps reduce impact of financial instability
central banks as lender of last resort disadvantages
- can lead to moral hazard and encourage banks to take excessive risks
- can lead to banks not holding sufficient liquidity
- can seem unfair that central bank will try to save financial institutions but not non financial firms
Central banks OTHER functions
- banker to government
- implement monetary policy
- help regulate financial sector
act as banker to government (Central banks OTHER functions)
- central banks can help government manage national debt - eg issuing government bonds
- can also offer advice to government one economic matters and help in negation with the international financial organisation
They can implement monetary policy (Central banks OTHER functions)
- central bank can manage moneys supply by affecting availability credit - controlling interest rates
- affect amount loans banks make by setting capital requirement - reserves of capital a bank must keep
- can influence exchange rate through buying and selling currencies and changing interest rates
- usually responsible for controlling issuing of banknotes and ensure confidence in current in maintained
Can help regulate financial sector (Central banks OTHER functions)
- central bank can impose rules to prevent financial market failure and instability
Financial markets have been less regulated in past
- from mid 1980 till 2008 financial crisis - regulation in many financial markets across world wasn’t veery strict
- less regulation helped be more profitable
- lack of regualtion in financial sector also lead to market failure and the problems - contributed to instability
lack of regulation in financial sector lead to market failure and other problems contributed to instability:
- excessive risk taking by financial institution
- commercial banks acting as investment banks - massive losses during investment activity
- fraud and other illegal activity
- growth of market bubbles
regulation of financial market relies on
- competition - making financial markets competitive to benefit consumers
- structure of firms and risk management - ensure firms stable
- strengthening rules and principles that financial institutions must abide by
- systemic risks - identifying SR in financial markets and find ways to manage or remove them`
two types of financial regulation
- micro prudential regulation
- macro prudential regulation
international agreements to regulate financial markets
help to increase financial stability fo banks by making sure have buffer in case of fall in asset values or bank run
drawbacks of regulation of financial markets
- regulators can be vulnerable to regulatory capture
- if regulation too strict can lead to restrictions on credit which can harm economic growth
- can lead to growth of shadow banking system - isn’t regulated
Who are responsible for regulating financial markets in the UK?
- Bank of England
- Financial Conduct Authority
Which two bodies under Bank of England control
- Financial Policy Community
- Prudential Regulatory Authority
Financial Policy Committee (FPC)
- identify, monitor and protect against systemic risks in financial system
- issuing instruction to PRA and FCA to tackle problems that threaten financial system
- advise government on managing financial markets
micro prudential regulation
- to ensure individual firms act fairly towards customers and don’t take excessive risks or break law
macro prudential regulation
- to tackle systemic risks in financial markets and avoid large scale financial crises that can hurt country economy
capital and liquidity ratios
- gives better understanding of banks overall stability
moral hazard
- occurs when someone is more willing to take risks because know someone will pay consequences if anything goes wrong
- eg may provide risky loans if know that it would be bailed out by taxpayers if things go wrong
adverse selection
- most likely buyers of product are those seller would prefer not to sell to
- adverse selections lead to firm unknowingly taking greater risk than intended
asymmetric information
occurs when one party to a contract has less information than the other party
externalities in financial markets
- negative externalities - some come about because of importance of banks and financial sector to wider economy
- mismanagement risk
- large drops GDP
- falling salary levels
- significant rise unemployment
Big banks too big to fail
- need for bailout of banks because some considered too big to fail - systemic risk created
- if one of two large banks collapse - lead to [anis and run on other banks causing financial sector collapse
- UK Govt had to rescue banks
when do financial crises usually happen
after a period od prosperity eg. because of low interest rates, easy credit, excessive speculation nd overconfidence - leads to recession
Various kinds of financial crises
eg sudden sharp fall prices of assets or government defaulting on loans
Difference between Hedge funds and mutual Funds
Hedge funds partake in much riskier deals which involve lots more money. This is why it is so heavily regulated
Financial Markets
Role of the financial markets is for buyers + sellers can trade financial assets
