Topic 1 - Introducing the financial services industry

Question 1

1.1 - Money

Answer 1

Money is:

Medium of exchange
Unit of account
Store of value

Question 2

1.2 - Intermediation

Answer 2

Intermediation

This is when a financial intermediary borrows money from a surplus party and lends it to a deficit party

Question 3

1.2.1 - 4 elements of intermediation

Answer 3

The 4 elements of intermediation are:

Geographic location
Aggregation
Maturity transformation
Risk transformation

Question 4

1.3.1 - Role of BoE

Answer 4

The Bank of England is:

Issuer of bank notes
Banker to the government
Advisor to the government
Banker to the banks
Foreign exchange market
Lender of last resort
Maintaining economic stability

Question 5

1.3.2 - Propietary and Mutual organisations

Answer 5

Propietary - limited companies owned by shareholders

Mutual - Not a company
- Owned by members
- Examples are building societies, friendly societies, credit unions and some life assurance companies

Question 6

1.3.2 - Demutualisation

Answer 6

Building Societies Act 1986 - building societies could become banks

Question 7

1.3.3. What is a credit union

Answer 7

Credit union is:

• Mutual organisation run for the benefit of it’s members
• To join - meet the membership requirements, pay any required entrance fee and buy at least £1 share in the union
• All members are equal - regardless of size of the shareholding
• Owned by members and controlled through a voluntary board of directors
• Board members elected by members at the AGM
• Regulated by FCA and savers protected through FSCS

Question 8

1.3.3. (cont.) - What products and services does a credit union offer?

Answer 8

• Offer simple savings and loan facilities to members
• Some unions offer a fixed rate of interest on savings
• Most offer a yearly dividend payout - amount varies dependent on profit
• Unions that pay interest must have at least £50k or 5% of total assets (whichever is greater) in reserve
• Members savings create a pool of money that can be lent to other members
• Loans typically have an interest rate of around 1% of the reducing balance each month (with a legal balance of 3% of the reducing balance
• Credit unions also offer basic bank accounts, insurance services and mortgages

Question 9

1.3.4 - Retail & Wholesale banking (differences)

Answer 9

• Main difference is size, wholesales transactions rather than retail
• Retail - individuals and small businesses
• Wholesale - large companies, the government and other financial institutions

Question 10

1.3.4. Retail & Wholesale banking (cont.) - Retail banking

Answer 10

Retail banking

• provide common services such as deposits, loans, payment systems
• act as intermediaries between people who wish to borrow money and people who have money to deposit
• price of borrowing and reward for investing is interest

Question 11

1.3.4 Retail & Wholesale banking (cont.)- Wholesale banking

Answer 11

Wholesale banking

• Refers to process of raising money through the wholesale money markets where financial institutions and other large companies buy and sell financial assets
• Wholesale banking operations are riskier than retail banking
• “Ring-fencing” implemented in 2019 - so banks that operate in both retail and wholesale banking didn’t risk retail customer deposits
• Building societies allowed to raise funds on wholesale markets but restricted to 50% of their liabilities - remainder must come from deposits

Question 12

1.3.5. What are Libor and Sonia? Libor

Answer 12

Libor - rate of interest charged in the interbank market used to be London interbank offered rate
- Used to act as a reference rate for most corporate lending - rate quoted as Libor plus a specified margin
- Libor rates were fixed daily and varied in maturity from overnight to 1 year

Question 13

1.3.5. What are Libor and Sonia? (cont.) Libor scandal

Answer 13

In 2012 banks were falsely inflating or deflating the rates they claimed to be paying to either profit from trades or show they were more credit-worthy than they were.

Financial Service Act 2012 - knowingly or deliberately making false or misleading statements in relation to Libor-setting became a criminal offence. Due to Libor scandal - shift has been made to Sonia (sterling overnight index average)

Question 14

1.3.5. What are Libor and Sonia? (cont.) Sonia

Answer 14

Sterling overnight index average

• Introduced in 1997
• Administered by BoE since 2016
• Sonia based on actual transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight
• Sonia is an important benchmark used by financial businesses and institutions to calculate the interest paid on swap transactions and sterling floating rate notes