The Financial Sector Flashcards
What is the main purpose of most banks and financial institutions?
To make money available to those who want to spend more than their income, using the savings of those who don’t currently want to spend
How do banks help people and firms save?
Through bank accounts, pension funds and bonds
How do banks make money more available to people and firms?
- Provide loans to businesses and individuals
- Allow equities and bonds to be traded on the capital market
What are some everyday forms of borrowing for individuals?
- Personal loans
- Mortgages
- Credit cards
- Pay-Day loans
- Overdrafts
How do firms fund their activities?
- Equity Finance - Raised by selling shares in a company
- Debt finance - Borrowing money that has to be paid back with interest
What is equity?
The total value of the firms if all their assets were liquidated and all their debts were paid off
What is credit?
The ability to buy goods or services before paying for them, based on a promise to pay later
Why are financial institutions regulated?
- To reduce the impacts of financial market failures
- Protect consumers by policing individuals and firms to ensure they act legally and fairly
- Ensure the integrity and stability of financial institutions and the services they provide
- Maintain confidence in the financial sector and avoid sudden panics
What are the three types of financial markets?
- Money Market
- Capital Market
- Foreign Exchange Market
What does the money market do?
Provides short term finance to banks, companies, governments and individuals. Usually it is a short term debt
What does the capital market do?
Provide long term finance to government and firms
What are the two markets within the capital market?
Primary and Secondary
What is the purpose of the Primary Market?
For new shares and bond issues
What is the purpose of the Secondary Market?
Where existing securities are traded. E.g. Stock exchange
What is the foreign exchange market?
Where different currencies are bought and sold
What are the two markets within the foreign exchange market?
Spot market and Forward market
What is the spot market?
For transaction that happen now
What is a coupon rate?
The amount of interest paid on a bond
What is the yield of a bond?
An annual return an investor will get from the bond, the less someone pays for a bond, the higher its yield.
What is the formula for the yield of a bond?
Yield= (Coupon/Market price) x 100
What are the roles of commercial banks?
- To accept savings
- To lend to individuals and firms
- To be financial intermediaries
- To allow payments from one person or firm to another
What are the two areas of commercial banking?
- Retail Banking
- Wholesale Banking
What is Retail Banking?
Providing services for individuals and smaller firms such as savings accounts and mortgages
What is Wholesale Banking?
Dealing with the banking needs of larger firms
What are the roles of investment banks?
- Arrange share and bond issues
- Offer advice on raising finance, mergers and acquisitions
- Buy and sell securities on behalf of their clients
- Act as market makers to make trading in securities easier
What are the other types of financial institutions?
- Pension funds
- Insurance firms
- Hedge Funds
- Private equity firms
What is the shadow banking system?
The activities of unregulated financial intermediaries and the unregulated activities of otherwise regulated firms
What is liquidity?
How easily something can be turned to cash and spent
What is narrow money?
Financial instruments that are very liquid
What is broad money?
Assets that are less liquid
Why don’t banks want as many liquid assets?
The rate of return on illiquid assets is much higher than that of liquid assets
Why do banks need a certain amount of liquid assets available?
People who have deposited money expect to withdraw their savings immediately
What is inter-bank lending?
Lending between banks that occurs on a money market, which are very short term.
What is a bank’s capital made up of?
Share capital and retained profits
What is a secured loan?
A loan that, if someone defaults on it, there is collateral that the bank can repossess
What is an unsecured loan?
A loan that, if someone defaults on it, the bank cannot claim any collateral so they will lose money from their balance sheet
What does the loanable funds theory say?
Interest rates are set by savers and borrowers
What are loanable funds?
The total amount of money available for borrowing
What does the liquidity preference theory say?
People will balance risk and reward
What is a systemic risk?
A problem in one part of the economy can cause a breakdown of a whole market or even a whole financial system
What is speculation?
Aiming to make profit by buying assets relatively cheaply and selling them at a higher price
What are market bubbles?
When excessively high estimates of future asset prices lead to investors overpaying for an asset
What is adverse risk?
When the most likely buyers of the product are are those that the seller doesn’t want to sell to
What is moral hazard?
When someone is more willing to take risks because they know that someone else will face the consequences if anything goes wrong
What are the Central Bank main roles?
- Act as a banker to the government
- Help to support banks by acting as a lender of last resort
Why can banks sometimes face a shortage of liquidity?
They borrow short-term, but lend long-term
How does the central bank ensure that the banks behave more carefully in the future after getting an emergency fund?
They have high interest rates on the emergency fund in the time of a shortage in liquidity
What are the advantages of having the central bank as a lender of last resort?
- Helps to prevent panic and a run on the banks
- It helps to reduce the impact of financial instability
What are the disadvantages of having the central bank as a lender of last resort?
- It can lead to moral hazard and encourage banks to take more risk
- It can lead to banks not holding sufficient liquidity
- It may seem unfair that the central bank will try to save financial institutions and not non-financial institutions
How does the central bank act as the government’s banker?
- It can help to reduce national debt by reducing the amount of interest needing to be paid, maybe by issuing government bonds
- It can also offer advice to the government and help them in their negotiations with other financial institutions
What is a capital ratio?
A measure of the ratio of capital to loans. It gives a measure of the risks associated with the bank’s lending and of the bank’s stability
What is a liquidity ratio?
A measure of highly liquid assets to the expected short term need for cash. It also gives an idea of the bank’s stability and its ability to meet short term liabilities
What are the two types of financial regulation?
Micro prudential regulation and Macroprudential regulation
What is Micro Prudential regulation?
Ensures individual firms don’t take excessive risks or break the law
Who is responsible for regulating financial markets?
The Bank of England and the Financial Conduct Authority
How does the Bank of England regulate financial markets?
Through the Financial Policy Committee(FPC), and the Prudential Regulation Authority (PRA)
What are the roles of the Financial Policy Committee?
- Identifying, monitoring and protecting against systemic risk in the financial system
- Issuing instructions to the PRA and FCA
- Advising the government on managing the financial markets
What are the roles of the Prudential Regulation Authority (PRA)?
- Supervising firms and financial institutions to ensure that they manage risk
- Setting industry standards for conduct and management and making sure they are followed
- Specifying capital and liquidity ratios for financial institutions
What are the roles of the Financial Conduct Authority (FCA)?
- Supervising the conduct of firms and markets to ensure that things are done legally and fairly
- Promoting competition in financial markets so that better deals are provided for consumers
- Banning financial products that don’t benefit consumers
- Banning, or forcing firms to change misleading adverts for financial products and services
