topic 1 - intro to financial service industry Flashcards
Inflation
a sustained increase in the general level of prices of goods and services
Financial intermediary
(eg a bank/building society)
borrows money from surplus party and lends to a deficit party
Charging interest to the party with a deficit and pays some of this interest to the party with the surplus
Their profit is the difference between the two interest rates
Disintermediation
involves lenders and borrowers interacting directly. An example is ‘crowdfunding’
Four elements of intermediation
Geographic location – helps lenders and borrowers locate each other
Aggregation – an individual lender might not have enough funds to fulfil a borrower’s requirements
Maturity transformation – the borrower might need funds for longer than the lender is prepared to lend
Risk transformation – spread risk over a variety of borrowers
Risk transfer
insurance involves individuals contributing via their insurance premiums to a fund for which the loses of the few who do experience certain adverse circumstances are covered
Main functions of The Bank of England
- issuing bank notes
- banker to the government
- banker to the banks
- advisor to the government
- foreign exchange market
- lender of last resort
- maintaining economic stability
Monetary Policy Committee (MPC)
- responsibility for setting interest rates in the UK
- meet 8 times a year, setting the base rate to ensure the government’s inflation target is met
Financial Policy Committee (FPC)
- sits within the Bank of England.
- looking at the economy in broad terms to identify and address risks that affect economic stability.
Gilts
- are issued by HM Treasury’s Debt Management Office
- are loans to the government
The Financial Services Act 2012
- divided responsibility for financial stability between the Treasury, the Bank of England and two new regulators - FCA & PRA
- Modified by the Bank of England and Financial Services Act 2016
Prudential Regulation Committee (PRC)
- The Bank of England and Financial Services Act 2016, gave more powers to the Bank by bringing the PRA within it
- established the PRC
Proprietary organisations
- owned by shareholders and is a limited company
- these are the majority of large financial institutions
Mutual organisation
- owned by its members
- not constituted as a company so does not have shareholders
- commonly are building societies, friendly societies and credit unions
Demutualisation
- since the Building Societies Act 1986
- a building society has been able to demutualise, to convert to a bank
- requires approval of its members which then receive shares
Credit union
- A mutual organisation, run for the benefit of its members
- Members must pay a share, but all members are equal, regardless of the size of their shareholding
- Offer simple savings and loan facilities to members. Some offering a fixed rate of interest on savings, most offer a yearly dividend pay-out
- A unique feature is that members savings/loans are covered by life assurance
Wholesale banking
- financial institutions and other large companies buy and sell financial assets
- if the branch has the opportunity to make a substantial profitable loan but doesn’t have adequate deposits, it can raise the money very quickly on the interbank market
- Riskier than retail banking
- Building societies are permitted to raise funds on the wholesale markets but are restricted to 50% of their liabilities
Interbank market
a very large market which recycles surplus cash held by banks, either directly between banks or more usually through specialist money brokers
Libor
- The rate of interest charged in the interbank market used to primarily be the London interbank offered rate
- acted as a reference rate for the majority of corporate lending
- Rates were fixed daily and varied in maturity from overnight to one year
The Libor scandal
In 2012, it was discovered that banks were falsely inflating or deflating the rates they claimed to be paying so as to profit from trades, or to give the impression they were more creditworthy than they were
Sonia
- An index of very short-term unsecured loans among and between UK financial institutions
- As a result of the Libor scandal, a shift has been made to Sonia (sterling overnight index average)
- It is based on actual transactions and reflects the average of interest rates that banks pay to borrow sterling overnight from other financial
institutions - An important benchmark used by financial businesses and institutions to calculate the interest paid on swap transactions and sterling floating rate notes.
Swap transactions
a contract between 2 firms that each exchange one type of cash flow for another. Typically, a variable interest rate eg Sonia), is swapped for a fixed interest rate
Floating rate notes
a fixed interest security (bond) where the interest rate (the coupon) varies in line with the benchmark (eg Sonia) used
