The Financial Sector

Question 1

What are financial markets?

Answer 1

Any system that enables buyers and sellers to exchange goods and services and trade financial instruments

Question 2

What are the 6 roles of the financial sector?

Answer 2

1. Saving - facilitates future spending and bank lending
2. Lending
3. Facilitate the exchange of goods and services
4. Risk management - provides financial security (e.g. insurance)
5. Provide an equities (stocks) market
6. Forward markets stabilise demand and supply

Question 3

What are the 6 main impacts of financialisation?

Answer 3

1. Increases economic growth
2. Increases dependency on the financial sector
3. Raises employment
4. Increases tax revenue
5. Crowds out investment
6. Reduces the trade deficit

Question 4

What are the 6 main causes of market failure in the financial sector?

Answer 4

1. Asymmetric information
2. Negative externalities
3. Moral hazard
4. Speculation and market bubbles
5. Market rigging (interest/exchange rates)
6. The prinicipal-agent problem (e.g. wealth managers and pension funds)

Question 5

What are 2 examples of negative externalities in the financial sector?

Answer 5

1. Taxpayers pay for bank bailouts
2. Crowding out jobs

Question 6

What is an asset bubble?

Answer 6

Where the price of an asset is much higher than can reasonably be justified

Question 7

What are 3 causes of asset bubbles?

Answer 7

1. Excessive lending to and insufficient scrutiny of commercial borrowers
2. Quantitative easing increasing liquidity
3. Speculation

Question 8

What is microprudential and macroprudential policy?

Answer 8

Microprudential - focuses on the health of individual financial institutions
Macroprudential - addresses risks to the financial system as a whole

Question 9

Which 4 regulators were introduced after the financial crisis?

Answer 9

1. The Financial Policy Committee (FPC)
2. The Prudential Regulation Authority (PRA)
3. The Financial Conduct Authority (FCA)
4. The lender of last resort

Question 10

Which 2 powers does the Financial Policy Committee hold?

Answer 10

1. Direction - binding instructions
2. Recommendation (including comply-or-explain)

Question 11

What is the role of the Prudential Regulation Authority?

Answer 11

To monitor and set standards for safe levels of capital and liquidity

Question 12

Why is the Bank of England the “lender of last resort”?

Answer 12

It can lend money if commercial banks run out to keep the banking system operating smoothly

Question 13

What are the 4 roles of the Central Bank?

Answer 13

1. Implement monetary policy
2. Lender of last resort
3. Banker to the government
4. Regulator of the banking industry