Role of Central Banks Flashcards
What is the role of a commercial bank
- To accept savings
- Lend to individuals and firms
- Allow payments between people and firms
- Financial intermediaries
What is the role of a investment bank
- Arrange share and bond issues
- Advice on raising finance and on mergers
- buy and sell assets on behalf of clients
- Act as market makers to make security trading easier
What is a hedge fund
Firms that invest pooled funds from investors in to multiple markets with hopes of receiving high returns
Private equity firms
They invest in businesses, buying part of the business to try help it to become successful to then sell it for profit
What is the shadow banking system
This is the unregulated activities of of financial institutions and unregulated financial intermediaries, lack of regulation and unknown size increase the risk of it causing financial crisis
What does liquidity refer to
How easily money can be spent
Narrow money
Notes and coins in circulation, these are very liquid
Broad money
Assets that are less liquid
What do banks have to balance and why
Liquidity and profitability because they must have some liquidity to be able to lend and repay savings, but they must retain some illiquid assets like shares and bonds because these are more profitable
What are the key functions of the central bank
- Implement monetary policy
- Banker to the government
- Help with regulation
- Banker to other Banks as the lender of last resort
How does the central bank act as the lender of last resort
Central bank can provide liquidity to banks that have temporary shortages to maintain financial stability in the country, they lend this with high interest to encourage banks to act more carefully in the future
When will the central bank take more emergency action
During times of systemic crisis when multiple banks are in trouble they will provide emergency liquidity assistance
Advantages of lender of last resort
- Helps prevent panic and run on the banks
- Helps ensure financial and banking stability
run on the bank
When many people withdraw their savings very quickly which causes the bank to run out of liquidity
disadvantages of lender of last resort
- Moral hazard
- Lead to banks not holding sufficient liquidity
- Unfair that the central bank will save these firms but not non financial firms
How does the central bank act as banker to the gov
- May help Gov to manage its debt by issuing bonds to reduce the interest paid on the debt
- Offer advice to the government on economic matters and negotiations
How does the central bank help with regulation
Impose rules to prevent financial market failure and instability as this is and for everyone
How does the central bank implement monetary policy
- Manage money supply, done by setting interest rates or credit availability
- influence the exchange rate
- controlling issuing of banknotes
What problems did deregulation cause that are the reasons why the market is regulated nowadays
- Excessive risk taking in the hopes of making profits
- commercial banks acting as investment banks which impacted their commercial role as they lacked liquidity for people to withdraw savings
- Fraud and market rigging
- Growth of market bubbles, housing market was made worse by over provision of credit
Why was the financial market deregulated in the 1980s
Helped them to be much more profitable and is part of the reason London is such a huge financial centre
Step by step explanation of the 2008 credit crunch
- Growth in mortgage market for borrowers with poor credit rating caused demand and price for houses to rise
- Caused more and more property investment driving the price higher (market bubble)
- People who had taken out mortgages couldn’t afford them so had to default so house prices fell dramatically
- Banks levels of capital fell so they reduced their lending
- Loss of confidence and fall in AD as no banks were lending so caused recession
What two ratios are used to understand a banks overall stability
capital ratio - ratio of banks capital to loans so gives measure of the risk of the bank
Liquidity ratio - ratio of liquid assets to the expected short term need for cash
what is a banks capital
total of its share capital and its retained profits
Basel Committee
Committee of global banking authorities that agree recommendations for minimum liquidity and capital levels for banks
Ring Fencing in commercial banking
Keeping commercial and investment banking separate to protect customers from banks risky investments
What are the two types of financial regulation
Micro-prudential - ensure that individual firms act faulty and don’t take excessive risks
Macro-prudential - Tackles systemic risks in financial market ensuring against crisis
what are the four aims of regulation
- Identifying and removing systemic risks
- strengthening rules that must be abided by
- Ensuring firms are stable
- Encouraging competition to benefit the customer
What do all the regulation authorities in the uk work under
The Bank of England
What is the PRA and what does it do
Prudential Regulation Authority that supervises firms risk management by specifying capital and liquidity ratios, also set industry standards for conduct
FPC and what does it do
Financial Policy Committee that aims to identify and monitor systemic risks and gives advice to the government on how to act
What is the FCA and what does it do
Financial Conduct Authority that aims to protect the customer by banning misleading adverts and products that don’t benefit customers, supervise conduct and encourage competition
Which of the authorities are macro and micro
FCA - micro
PRA - micro
FPC - macro
Criticisms of regulatory bodies
- regulatory capture
- reduces efficiency by imposing red tape
- liquidity rates are too high for banks to be profitable
- Market can regulate itself as this gets rid of inefficient firms
- Past problems weren’t systemic issues but were caused by rogue individuals
what is regulatory capture
Firms can sometimes pressure and influence regulators to make decisions that benefit them
