The Financial Sector- Theme 4 Flashcards
Describe the role to facilitate saving of financial markets.
A traditional role of banks and other financial institutions is to provide facilities for individuals and firms to save, so enabling them to purchase goods at a later date.
Describe the role to lend to businesses and individuals of financial markets.
A function of banks and other financial institutions is to provide credit. Without this facility, individuals and businesses may have cash flow problems.
Describe the role to facilitate the exchange of goods and services of financial markets.
Transfers of money can be arranged easily when there’s a fully developed banking and financial system. With the growth of online banking and smart debit cards, most such transfers now occur electronically.
Describe the role to provide forward markets in currencies and commodities of financial markets.
The foreign currency and commodity markets provide forward markets for currencies and commodities so that traders can buy in advance, thereby reducing risks associated with the price volatility that often characterises such markets.
Describe the role to provide a market for equities of financial markets.
Stock exchanges enable stocks and shares to be traded. This enables companies to raise money and provides an opportunity for investors to purchase shares.
Market failure in the financial sector with consideration to asymmetric information.
Before crash, asset prices were high and rising, and there was boom in economic demand. There were risky bank loans and mortgages, especially in the US
where government securities were backed by subprime mortgages. means borrowers had poor credit histories, and after house prices crashed in the US in 2006, several homeowners defaulted on their mortgages in 2007. Banks had lost huge funds, and required assistance from the government in the form of bailouts. There was asymmetric information since banks were not aware of how risky the loans were. Since the crisis, banks have become more risk averse, so there are tougher requirements to get a loan or mortgage.
Market failure in the financial sector with consideration to externalities.
Failure of financial institutions may have undesirabke spillover effects on third parties who are not directly involved in the financial sector. Eg failure if bank might result in bankruptcies for other businesses if bank customers lose their deposits and can no longer pay bills to other businesses.
Define externalities.
Costs of benefits to third parties not part of the transaction. If externalities exist, there would be a divergence between social costs/benefits and private costs/benefits.
Market failure in the financial sector with consideration to moral hazard.
A moral hazard is a situation where there is a risk that the borrower does things that the lender would not deem desirable, because it makes the borrower less likely to repay a loan. usually occurs when there is some form of insurance for the mistake.
Banks might take more risks if they know the Bank of England or the government can help them if things go wrong. The financial crisis has been regarded as a moral hazard, due to the degree of risk taking.
Market failure in the financial sector with consideration to speculation and market bubbles.
A market bubble occurs when the price of an asset is predicted to rise significantly. This causes it to be traded more, and demand exceeds supply so the price rises beyond the intrinsic value. The bubble then ‘bursts’ when the price steeply and suddenly falls to its ordinary level. This causes panic and investors try and sell their assets.
It results in a loss of confidence and it can lead to economic decline or a depression.
Market failure in the financial sector with consideration to market rigging.
This is the act of firms coming together to interfere in a market, with the intention to stop it working as it is supposed to, so that the firms can gain an unfair advantage.
The Libor Scandal is an example of this. Banks were inflating or deflating their interest rates to make a profit from trade or to make them seem more financially reliable.
Loans such as mortgages, student loans and other financial products use Libor as a reference rate. This means that manipulating the rate, as the banks were doing, can negatively affect consumers and the financial market.
Describe implementation as of monetary policy as a role of central banks.
Central banks usually responsible for controlling the cost and supply of money. In this role they set interest rates, and are responsible for asset purchases and sales.
Describe being a banker to the government as a role of central banks.
The central bank provides services to the Central Government. It collects payments to the governments and makes payments on behalf of the government. It maintains and operates deposit accounts of the government. The central bank also manages public debt and issues loans.
The Bank can also advise the government on finance, including the timing and terms of new loans.
Describe being a banker to the banks as a role of central banks.
The Bank of England is considered to be a lender of last resort. If there is no other method to increase the supply of liquidity when it is low, the Bank of England will lend money to increase the supply.
If an institution is risky or is close to collapsing, the Bank might lend to them. This is when they have no other way to borrow money.
Describe the role of regulation in the banking industry as a role of central banks.
Following financial crisis, many central banks are responsible for enforcing new regulations designed to prevent the risk of banks requiring a bailout from their government.
Some key regulations in EU are:
- the requirement of banks to split their retail banking business from their investment banking activities
- an increase in the amount of capital.
