The financial sector

Question 1

What are the roles of the financial sector?

Answer 1

• Facilitate savings
• Lend to businesses and individuals
• Facilitate the exchange of g/s
• Prove forward markets in currencies and commodities
• Provide markets for equities

Question 2

Why does the market in financial sector fail?

Answer 2

Due to risky behaviour which leads to lack of liquidity/ insolvency

Question 3

What are the roles of central banks?

Answer 3

• Issue money
• Price and value your money
• Controlling spending
• The financial system
• The money go-round (ensure banks have sufficient funds to pay for everyday expenses)
• Keeping confidence
• Lender of last resort (when short term liquidity problems or serious insolvency problems)

Question 4

What are the arguments for bank bailouts?

Answer 4

• Prevents bank with lack of liquidity collapsing to avoid affecting the whole financial sector
• Prevents confidence from failing
• Short term liquidity issues may be caused by poor management, bailouts help avoid unnecessary losses

Question 5

What are the arguments against bank bailouts?

Answer 5

• Negative externalities for tax payers (taxes used to fund bailouts)
• Opportunity costs - money spent on bailouts could be used for improving public sectors and infastructure
• Banks may take too many risks because they are reliant on BoE (moral hazard)

Question 6

What are the roles of the FPC, PRA and FCA

Answer 6

Financial Policy Committee - Identify and take action to reduce systematic risks and promote resilience of UK financial system
Prudential Regulation Authority - Set standards and supervises individual firms
Financial Conduct Authority - Ensure financial institutions proves customers with appropriate products and services and act with integrity

Question 7

What changes were made to regulation since the financial crisis?

Answer 7

• New structures to monitor and regulate (FPC, PRA and FCA)
• Stress tests (either a yearly test with shock scenarios with different varying levels of severity OR every 2 years, exploratory (scenarios unlikely to happen)
• Ring fencing (seperate core retail banking services from their investment and international banking activities)
• Greater intervention to protect consumers by the FCA

Question 8

What are the advantages of regulating the banking sector?

Answer 8

• Regulations ensure firms have enough liquidity in case of a financial crisis
• Increase confidence
• Protects consumers
• Stops banks taking unnecessary risks

Question 9

What are the disadvantages of regulating the banking sector?

Answer 9

• Regulatory capture - may be influenced by financial sector so may not impose strict sanctions
• Increases costs to firms (may leave the country)
• Costly and time consuming (checking accounts and stress testing)