Role Of Central Banks

Question 1

What is a central bank (2)

Answer 1

Monetary authority and a major regulatory bank
Responsible for monetary policy and maintaining financial stability

Question 2

Main 5 roles of central banks (potential essay) (5+ )

Answer 2

Setting interest rates = control inflation + economic growth
Regulating banks = protect depositors
Maintaining financial stability = act as a lender of last resort = liquidity to financial institutions in times of crisis
Issuing currency
Conducting research = conduct research and provide advice to policymakers

Question 3

Interest rates by central bank + example (2+)

Answer 3

Rate of interest charged to commercial banks if they borrow from the central bank when short of liquidity
Example = uks risen from 0.25% to 5.25% in past year = reduces inflation

Question 4

Factors considered when setting base rate (3+)

Answer 4

Inflation
Rate of growth of asset prices like house prices = wealth effect = when house p rises people think they have more money to spend
External factors such as globally energy prices and inflation in other countries = supply side

Question 5

What is an asset bubble

Answer 5

When price of assets rise rapidly and significantly above fundamental value

Question 6

What is the lender of last resort (2)

Answer 6

When other financial institutions are unable to provide loans
The central bank steps in to lend money to banks and other financial institutions

Question 7

Functions of the lender of last resort - emergency lending (2)

Answer 7

Emergency lending = 2008 financial crisis ‘run on the banks’
Bonds and quantities easing

Question 8

Function of lender of last resort - discount wisdom

Answer 8

Provide loans at higher or lower interest rates than the market rate

Question 9

Functions of lender of last resort - collateral requirements (3)

Answer 9

Central banks require collateral from financial institutions as a condition for lending
Helps to mitigate the risk of default
Triple AAA rating on borrowing

Question 10

Functions of lender of last resort - reputation (2)

Answer 10

Lender of LAST resort due to ability to provide loans in time of crisis
AAA rating on borrowing fallen to ABB due to Liz truss

Question 11

Recent exmaple of lender of last resort (2+)

Answer 11

2008 financial crisis
2020 = during the COVID central banks around the world acted as lenders of last resort to support their economies = Bank of England provided emergency loans to UK businesses

Question 12

Japan and it’s interests rates exmaple of central gov (3)

Answer 12

Had negative interest rates for 10 years = L shaped recession
Gov reduced interests rates to kickstart economy = k effect
Created liquidity trap = already low before so no incentive to borrow more

Question 13

Having low interests rates (2()

Answer 13

Central banks have little room for monetary policy
Commercial banks are not lending = holding deposits = circular flow not working

Question 14

How do CB fix low interest rates (3)

Answer 14

Central bank creates neg IR = commercial banks pay to hold deposits = cost rise and profits fall
As a rational business they are encouraged to now lend out deposits to help reduce costs
This is a way of forcing commercial banks to lend

Question 15

How did CB solve financial crisis (2)

Answer 15

Quantities easing
Nationalised banks

Question 16

Example of lender of last resort 2012 eurozone and ECB (3++)

Answer 16

Cyprus = ECB gave $10m bailout
In order to get bailout Cyprus had to follow rules:
Close banking system for 10 days
10% of all depositors deposits in Cyprus were removed and used to pay ECB = savers lost 10% of savings

Question 17

Central banks role as banker to gov (3+)

Answer 17

Issuing gov bonds = helps finance their budget and borrow money
Manage gov debt = selling gov bonds
Provide advice = help them to make informed decisions on focal policy

Question 18

Consequences of large increase in QE - interest rates (4+)

Answer 18

Lower interest rates
Purchasing large amounts of government bonds = demand increases for assets
Price increase and reduces yields
Fall in mortgage interest rates and corporate bond interest rates

Question 19

Consequences of large increase in QE - currency value (3)

Answer 19

Currency depreciation
QE increases the money supply and some of this extra liquidity will leave the UK economy
Sterling is sold = causing the pound to fall

Question 20

What is financial conduct authority what (2+)

Answer 20

Regulatory body who controls markets = not gov
Prior to 2008 the CMA = market authority = seen as ‘asleep at the wheel’ and ‘toothless’ = rubbish at job

Question 21

FCA supposed to do (3)

Answer 21

Regulation = sets regulatory rules and standards for firms
Consumer protection
Market supervision = monitors financial market to see risks and emerging issues

Question 22

Consumer protection - FCA what (3)

Answer 22

Protect against asymmetric information
FCA just announced banks must tell consumers to chnage accounts when base rate goes up = some don’t know as don’t look at news

Question 23

Market supervision exmaple (3+)

Answer 23

Lloyds and trustee savings bank (TSB) were once one bank
Made to separate
Market share was bigger than 25%

Question 24

What is prudential regulatory authority needed for (2++)

Answer 24

Prudential supervision = involves assessing and ensuring the financial soundness of institutions to prevent financial instability
Setting and enforcing prudential standards = ensure that financial firms maintain appropriate levels of financial resources to withstand economic and financial shocks

Question 25

Reduce risk of financial failure in uk example (2+)

Answer 25

Prudential regulation = Require banks to maintain adequate capital to absorb potential losses and withstand adverse economic conditions = stress tests
Direct interventions = set maximum loan to valuation ratios in the mortgage market = increases the cash-to-deposits ratio for a commercial bank