Money and financial institutions Flashcards
Money is defined by its functions
Four functions of money
- Medium of exchange
- Unit of account
- Store of purchasing power
- Standard of deferred payment
Currency is a highly liquid asset
Liquidity of assets
- Can be sold rapidly, & with minimal loss of value,
- Money, or cash, is the most liquid asset because it can be exchanged for goods and services instantly at face value.
- Shares less so because a % commission is paid to the broker
- Property less so because it is more unclear what the value is
- The price paid for the liquidity of money is the opportunity cost of losing out on the interest yields had the asset been held in another form
Why are we willing to accept payment in bits of paper
Fiduciary monetary system
Latin ‘fiducia’ = trust or confidence
Money is not convertible to a fixed quantity of gold, silver, or some other commodity
Currency is money because of its acceptibility and predictability of value
The predictability of value: how the value of money falls when there is a rise in the price level
- The relationship between the quantity of money supplied and quantity of money demanded must not change frequently, abruptly, or in great magnitude
- The selling price of a £ coin is the what one has to give up in order to purchase the £: you give up the goods and services you could have had instead
- In order to purchase a £ coin you give up the purchasing power inherent in that £.
- The purchasing power of the £ (its value) therefore varies inversely with the price level
- Thus the more rapidly the rate of increase in a price index, the more rapid the decrease in the value (purchasing power) of the currency
Defining and measuring money: Thedifference between narrow and broad measures
Narrow: Focus specifically on money held for transaction purposes
Money Supply M0: includes Notes and Coins (most liquid measure of money)
Broad: Indicates changes in liquidity
Money Supply M1 includes M0 plus sight deposits
Money Supply M2 includes M1 plus short-term time deposits in banks
Money Supply M3 includes M2 plus long-term time deposits in banks
BOE monitors and reports on these measures to assess the overall money supply and its impact on the economy.
Defining and measuring money: The narrow measures
- Notes & Coins
- Over 99% of the total MO - Banks operational balances at BOE
- All commerical banks hold deposits at BOE for purposes of settling debts between themselves - Sight deposits
- Current accounts that can be withdrawn immediately - Retail deposits
- General name for all Bank accounts that can be readily used for transaction purpsoes
1 and 2 are M0 (the most liquid measure of money). M1 includes 3 and 4, and represents the broader measure of money used for day-to-day transactions
Commerical Banks
- Privately owned profit seeking organisation
- The Big Four: HSBC Holdings, Lloyds Banking Group, Natwest Group, Barclays
- In USA: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo
What is Clearing (Banks)
The daily settling of debts between banks that are generated by customers’ transactions
Clearing is the correct and timely transfer of funds to the seller and securities to the buyer.
Bank degreulation and monetary policy 1980s
In 1980s bank deregulation encouraged competition, taking the form of seeking to attract borrowers by offering fdavourable terms
During the 1980s M4 grew at 16% per year due to heavy borrowing
One consequence of easy borrowing was a massive boom in house prices in the late 1980s
In 1990, when interest rates reached 15%, borrowing fell down
Consumer demand falling led to some small businesses being unable to pay back their debts. After liqudiation the banks still lost money, and so were cautious about lending out in the future
Building Societies
- Traditionally they took their deposits from millions of small savers and lent to house buyers for twenty to thirty years (specialised in long term lending)
- Nowadays they offer more banking services, thus competing with the banks, thus making them indistinguishable from banks
- The world’s largest building society is Britain’s Nationwide Building Society
- All building societies in the UK are members of the Building Societies Association (49 organisations, Over 25million members, £357 billion in resedential mortgages)
National Savings and Investments (NS&I)
- state-owned savings bank in the UK
- non-ministerial department
- the only provider that guarantee 100% of savings, rather than up to £85K
- over 24 million customers
- Premium Bonds: Instead of earning interest, you are entered into a monthly prize draw where you can win up to £1 million tax free.
- In Spring Budget 2024 the Chanellor announced ‘British Savings Bonds’: three-year, fixed-rate accounts that pay up to 4.15% interest
Merchant Banks
- Historically a bank dealing in commercial loans and investment
- The same as an investment bank
- Known as “accepting and issuing houses” in the UK and “investment banks” in the US
Investment Banks
…
Financial Services Compensation Scheme
- The UK’s statutory compensation scheme for customers of UK authorised financial services firms
- Set up under FSM Act 2000
- Protects UK authorised banks, building societies and credit unions up to £85,000 per depositor in the event of their insolvency
Challenger banks
- Small retail banks that competed with traditional, longer established banks in the UK In the wake of the 2008 financial crisis
- many are fintech, online only
- It used to be very difficult to start bank in the UK due to regulation, leading to the Big four dominating.
- When Metro Bank received their license in 2010, it was the first new high street bank for 100 years
- Other examples include Monzo and Starling
