LS20 - Role of Central Banks

Question 1

Role of Central Banks

Answer 1

• Banker to the Govt - govts hold accounts with central banks; Cb may be responsible for managing the nation’s debt, and holding country’s foreign currency and gold reserves
• Banker to Banks - act as lender of last resort, if banks don’t meet reserve requirement and need more funds they can borrow from the CB to prevent them from failing
• Implementing Monetary Policy - manages money supply of the economy by affecting availability and cost of credit - through interest rates and QE
• Regulation of Financial Markets - managing competition, structure of firms and risk management, strengthening rules and regulation, systemic risks

Question 2

Advantages of CB as Lender of Last Resort

Answer 2

Helps prevent failure of banks and prevent panic in banking system which could lead to bank runs and a financial crisis
Reduced chances of bank runs occurring - increases stability of financial system

Question 3

Disadvantages of CB as Lender of Last Resort

Answer 3

Moral hazard - if banks are aware that CB will provide funds in an emergency, then the banks are more likely to take part in more high risk high profit activities

Question 4

Illiquidity situation

Question 5

Capital and Liquidity Ratio

Answer 5

Capital ratio - measures the ratio of a banks capital to its loans - gives a measure of the risks associated with the banks lending and its stability
Liquidity ratio - measures ratio of highly liquid assets to expected short term need for cash, gives idea of banks stability and its ability to meet its short term liabilities

Question 6

Systemic Risk

Answer 6

Possibilty that an event at the micro level of an individual bank could then trigger instability or collapse of the entire industry, threatening the economy
Fin institutions considered to be a systemic risk are too big to fail

Question 7

Microprudential and Macroprudential Regulation

Answer 7

Microprudential - oversight and fin regulation of fin Institutions on a individual basis - ensure they act fairly towards customers; prevents them from taking excessive risks
Macroprudential - fin regulation that aims to reduce risk to the financial suystem as a whole - aims to reduce or remove systemic risk

Question 8

Regulatory Authorities

Answer 8

• PRA (micro p) - monitor and maintain stability of fin institutions
• FPC (macro p) - monitors and protects the fin system from systemic risk
• FCA (micro p) - protects consumers and increase confidence in the fin system and its products