Unit 3 Topic 3 Flashcards
Why should we have contingency plans?
Appropriate contingency plans should be included in short-term, medium-term and long-term planning to help prevent ‘external shocks’ from upsetting personal financial plans.
What are external factors?
External factors are factors over which individuals have little or no control, but which nevertheless have significant effects on financial products and services, and therefore on people’s economic well-being.
What are the key external factors?
- inflation
- interest rates
- house prices
- economic growth or recession
- unemployment
- regulation
- exchange rates
- legislation and legal rights - changes in state benefits,
- levels of taxation
- exchange rates
How can individuals cope with external factors?
Individuals cannot know exactly when and how interest rates, inflation, exchange rates, etc, are going to change, but they must at least be aware of the changes that might occur. They must consider the effect that these changes could have on their finances and develop ‘just in case’ or ‘what if’ contingency plans to cope with the impact on their finances of sudden changes that are beyond their control.
How do economists analyse the affect of external factors?
Economists and marketing experts use ‘PESTEL’ analysis to consider how external factors falling under six key headings might affect individual and corporate financial decisions.
What does PESTEL stand for?
Political Economic Social Technological Environmental Legal
What does political factors mean?
In terms of PESTEL
When we refer to political factors in PESTEL analysis in the context of financial services, we are referring primarily to the various ways in which the policies of a government affect the products and services offered by financial providers, and the impact that these policies have on individuals.
These political factors generally derive from the legislation that has been introduced to govern the financial services industry – ie both the rules and regulations with which financial services providers have to comply, and the regulatory and consumer protection bodies that governments have set up to ensure that providers do comply with those regulations.
Why is it important to have regulation within the finance industry?
What does regulation prevent?
The importance of having a comprehensive and effective system of regulation of the activities of financial services providers was clearly demonstrated by the 2007–08 global financial crisis. It has been widely accepted that failings in the regulation of banking and finance worldwide were a key factor among those that caused the crisis; at the very least, it is agreed that better regulation may have helped to prevent the crisis.
What was the result of the financial crisis in terms of regulation?
The result (of the financial crisis) was that governments in the many countries affected by the crisis undertook wide-ranging reviews of their regulation systems and followed this with reform, aiming to make the systems more effective in terms of maintaining a sustainable global financial services industry and properly protecting consumers’ interests.
Which other legislation did the UK have to abide by?
Other than their own
As a former European Union member country, the UK also had to abide by European legislation, much of which affects providers and consumers of financial services.
What is the EU Withdrawal Act 2018?
The EU Withdrawal Act 2018 ensures most of this law (EU legislation) continues after the UK’s exit from the EU.
What did the EU want to do after the crisis?
Since the crisis, the EU has made it a priority to create a new financial system for Europe by ‘pursuing a number of initiatives to build new rules for the global financial system [and] to establish a safe, responsible and growth enhancing financial sector in Europe’ (European Commission, 2014).
What is a central part of EU policy?
A central part of EU policy is that there should be a high level of competition between a range of financial providers. The aim is to ensure that consumers can choose the products and services that meet their needs, and which offer the best value for money.
What did EU regulators demand Lloyds Banking Group do?
When the effects of the financial crisis in the UK led to the creation of the Lloyds Banking Group (LBG) – comprising Lloyds TSB, the Bank of Scotland and the Halifax – EU regulators demanded that LBG reduce the size of Lloyds TSB. First, LBG proposed to sell off 631 of its branches to Co-operative Bank. Then, when this sale fell through, LBG complied with the EU regulations by making Lloyds and the TSB separate companies. The hundreds of branches are now operated by a stand-alone TSB bank.
What does the system of regulation set out and cover?
Overall, the system of regulation (in the form of the various pieces of UK and EU legislation) sets out exactly what financial services providers are allowed to do – and what they are not allowed to do. It covers the way in which financial services organisations go about providing products and services, including matters such as the transparency of their product pricing, the quality of the financial advice that they give and how they respond to complaints.
Why regulate banking and finance?
- It protects consumers from dishonest, incompetent or financially unstable providers.
- A well-regulated financial system will be more sustainable, enhancing individual and corporate financial stability, and reducing the likelihood of any future financial crises.
- It gives people confidence in the financial system and encourages them to use the financial solutions that are available to them.
- It requires providers to run their businesses prudently (ie with care and foresight) and to manage their risks properly, particularly in terms of capital – ie the balance between the money that a provider holds and that owed to it.
- It requires providers to ensure that consumers are fully informed about, and have a good understanding of, the features, benefits, restrictions, and terms and conditions of the financial products and services that they choose to buy.
Why has the government established stricter regulation for the finance industry than for most other industries?
The products and services that financial services providers offer are often complicated and can be confusing to the ordinary consumer. Whether you are applying for a mortgage, buying insurance, paying into a private pension plan, or signing up for any other financial product or service, you may find it hard to understand the products available (what they do, how they work, what they will cost, etc) or to decide which one is going to meet your needs in the most cost-effective way. Financial products and services also tend to differ from other kinds of goods because of the serious financial consequences that consumers can face if they make the wrong choices. This is the main reason why governments have established stricter regulation and more extensive consumer protection for the financial services industry than exists for most other industries.
When was the present regulatory system established?
Under what Act?
What did this Act set out?
The present regulatory system was established in April 2013 under the Financial Services Act 2012. The Act returned overall responsibility for regulating financial services and maintaining the long-term sustainability of the industry to the Bank of England.
What three bodies replaced the FSA after the financial crisis?
The three bodies that replaced the Financial Services Authority (FSA) after the 2007–08 financial crisis are:
- the Bank of England’s Financial Policy Committee (FPC); an interim FPC met in 2011 and the full committee was established in April 2013
- the Financial Conduct Authority (FCA)
- the Prudential Regulation Authority (PRA).
What are the three bodies (the FPC, FCA and PRA) responsible for?
Between them, these three bodies (the FPC, FCA and PRA) are responsible for enforcing the system of regulation that governs the financial services industry, for maintaining the stability of the industry and of individual providers, and for ensuring that consumers are fairly treated and have their interests protected.
Why do consumers sometimes not buy the right products or services to meet their needs?
Consumers do not always buy the right products or services to meet their needs. This might be because they do not fully understand what they are buying, or because the provider has made a mistake, or because the provider does not make it clear exactly what the product will cost.
Give an example of products being ‘mis-sold’ by providers.
In recent years, there have been cases of financial products being ‘mis-sold’ by providers – ie providers, anxious to maximise sales, use convincing sales techniques to persuade customers to buy products that they do not actually need. The biggest and best-known case of mis-selling was the widespread selling of payment protection insurance (PPI) to customers taking out loans who either did not need PPI or would be ineligible to claim on some sections of the policy.
How did providers mis-sell PPI?
Payment protection insurance is designed to cover the monthly loan repayments of an employed person who stops working as a result of sickness or redundancy. Many banks, building societies and other lenders have been found to have persuaded borrowers to buy PPI even if they were not employed (eg people who were self-employed or retired) – and who were therefore not eligible to claim on the policy.
These providers have since been forced to pay billions of pounds in compensation to the affected customers. In addition, the lenders involved have been sanctioned with large fines imposed first by the FSA and, more recently, by the FCA.
What is the total cost to the financial services industry of the mis-selling of PPI.
The total cost to the financial services industry of the mis-selling of PPI is predicted to reach over £50bn.
What has been introduced due to the risk of mis-selling and other problems?
Because of the risk of mis-selling and other problems, there are now several consumer protection agencies that help to protect financial services consumers.
What do the FCA now have responsibility over?
The FCA now has responsibility for regulating consumer credit – ie loans and hire purchase arrangements, which retailers often use to help consumers finance the purchase of furniture, domestic appliances, cars, etc.
What is the FOS?
What is its role?
The Financial Ombudsman Service is an INDEPENDENT official body, the role of which is to investigate consumer complaints and to resolve disputes between financial services consumers and providers.
How is the FOS funded?
The FOS is funded by an annual levy that every provider covered by the scheme is obliged to pay, and case fees are paid by providers if the complaints about them referred to the FOS exceed a certain number.
What is the FSCS?
What does it do?
The Financial Services Compensation Scheme provides a safety net if a bank, building society or certain other financial services business cannot pay its customers’ claims because it has gone out of business.
What businesses are covered by the FSCS?
All businesses authorised by the FCA are covered.
How is the FSCS funded?
The FSCS is also, like the FOS, funded by the providers who are members of the scheme and this includes the cost of any compensation pay outs.
What other services (apart from the FCA, FOS and FSCS) have responsibility for consumer protection?
In addition to these organisations (FCA, FOS and FSCS), the Competition and Markets Authority (CMA), Citizens Advice and local authority trading standards offices also have powers and responsibilities for consumer protection more generally across all industries and businesses. These powers may not be specifically targeted towards financial services, but providers must nonetheless adhere to this more general system of consumer protection regulation.
What can regulation and consumer protection try to prevent?
Regulation and consumer protection can be seen as measures that primarily try to prevent financial services providers from engaging in practices (such as mis-selling) that, if left unchecked, would adversely affect consumers’ personal finances.
What is the political agenda?
There is another set of government policies – known collectively as the political agenda – that is focused more directly on helping to ensure that every individual has access to the benefits that financial products and services can provide.
E.g. social exclusion and social inclusion, financial exclusion and financial inclusion.
What is social exclusion?
If certain groups of people or individuals in certain situations are denied access to the benefits enjoyed by most people in their society, they may be said to be ‘socially excluded’.
Those who are unemployed, for example, or those who do not have a permanent address, or those who have a poor credit history have often found it difficult to open a bank account or to take out a loan.
What can members do in a society where there is full social inclusion?
A society in which there is full social inclusion is therefore one in which all members of society:
- can participate fully in community life
- can influence decisions affecting them
- are able to take some responsibility for what goes on in their communities
- can exercise a right of access to the information and support that they may need to do all of these things
- have more equal access to services and facilities.
Why might someone be socially excluded?
Many people find themselves socially excluded to a greater or lesser degree, perhaps because they:
- have a physical or mental illness or disability
- have poor basic skills (ie literacy and / or numeracy)
- live in a deprived urban area or a remote rural area
- have a low income because they work in low-paid jobs
- are not working because they have been unable to find work
- are homeless or have no fixed address to give to an employer or a bank
- are (illegally) discriminated against on grounds of ethnicity, religion, gender, age or disability
How does ‘Poverty and Social Exclusion’ define social exclusion?
'’Social exclusion is a complex and multi-dimensional process. It involves the lack or denial of resources, rights, goods and services, and the inability to participate in the normal relationships and activities, available to the majority of people in a society . . . It affects both the quality of life of individuals and . . . society as a whole’’
What is financial exclusion?
A key aspect of social exclusion is ‘financial exclusion’ – ie the inability to get access to even the most basic financial services products and services.
What causes financial exclusion?
Financial exclusion can be caused by the same issues as social exclusion, such as mental health issues or being unable to afford financial products, but there is an additional factor: the individual’s financial literacy.
What is ‘financial literacy’?
The term ‘financial literacy’ refers to an individual’s level of knowledge and understanding of financial matters. Those who have ‘low financial literacy’ may not know how to go about managing their personal finances, or may not be aware of the range of financial products and services that might help them to improve their financial well-being.
What is one measure of financial exclusion?
Give a figure for this.
One measure of financial exclusion is the number of people who do not have a bank current account.
Up until the early 2000s, almost one in four low-income families were in this situation – often, retired people, low-paid employees or self-employed workers being paid ‘cash in hand’, or those who, for some other reason (perhaps because they did not trust banks or understand how current accounts work), preferred to use cash to pay for all of their bills and spending. Other people who wanted a current account were unable to get one because of a poor credit history or because they did not have a permanent address.
How is someone that doesn’t have a current account disadvantaged?
If someone has no bank account, not only is that person unable to make use of the numerous ways in which a current account allows its holder to make and receive payments and transfers, but also their access to other financial services is restricted.
- Some savings accounts require that the customer has a current account.
- Personal loans, credit cards, hire purchase and insurance policies usually require monthly payments to be made by direct debit. - Gas, electricity and other utilities companies often offer discounted prices if the customer makes payments by direct debit.
- Some employers will only pay wages and salaries directly into an employee’s bank account.
How are people who don’t have a bank account disadvantaged in terms of government benefits?
For those relying on government benefits, not having a current account became a particular problem when the government began to change the way in which it made these payments. Before 2003, claimants who had no account into which a payment could be made directly received a fortnightly cheque, which they could cash in at any Post Office; from 2003, benefits became payable directly into bank accounts by automatic credit transfer.
What did the financial exclusion of people without bank accounts trying to claim benefits lead to?
What is this policy?
Describe the bank account it offers.
Realising that this (benefits being paid into a bank account) would cause real problems for the large number of claimants who had no bank account, the government consulted with representatives of the banking industry. The result was a ‘universal banking’ policy: essentially, a commitment by the banks and building societies to offer stripped-down ‘basic bank accounts’ to any applicant, regardless of that applicant’s status. A basic bank account typically offers no overdraft facility or cheque book (although account holders may be offered a cash card or debit card); some cannot be accessed online and some cannot be used to make payments by direct debit or standing order.
What other option, apart from a basic bank account, became available to those without a bank account?
How did this benefit people?
(i.e. people claiming benefits)
In addition to basic bank accounts, another option became available to those without a bank account: the Post Office Card Account. This operates in the same way as a basic bank account, except that access to the account is through a local post office, which means that those who are used to cashing their benefit or pension cheques in this way are able to continue to get cash from the same place, rather than having to set up an account at a bank or building society branch.
Give examples of basic bank accounts.
Santander - Min age to open = 16 - Can use standing orders and direct debits, DOESN’T have debit card.
Bank of Scotland - Min age to open = 18 - Can use standing orders and direct debits, DOES have debit card.
Barclays - Min age to open = 18 - Can use standing orders and direct debits, DOES have debit card.
HSBC - Min age to open = 16, Can use standing orders and direct debits, DOES have debit card.
TSB - Min age to open = 18, Can use standing orders and direct debits, DOES have debit card.
Nationwide - Min age to open = 18, Can use standing orders and direct debits, DOES have debit card.
NatWest - Min age to open = 18, Can use standing orders and direct debits, DOES have debit card.
RBS - Min age to open = 18, Can use standing orders and direct debits. DOES have debit card.
How did the introduction of basic bank accounts and Post Office card accounts affect the amount of people without a current account?
The introduction of basic bank accounts and Post Office Card Accounts proved to be very successful, bringing the percentage of low-income families without a current account down from almost 25 per cent in 1999–2000 to only 5 per cent by 2008–09.
Even with this improvement, however, in 2010 there remained 1.75m people in the UK without a current account.
What did banks intend to do to help reduce the number of people without a bank account in the UK?
In 2010 there remained 1.75m people in the UK without a current account this prompted the government at that time to declare its intention to impose on banks a legal obligation to provide basic bank accounts for everyone. While this intention was never implemented, it had the effect of encouraging banks to do more to promote basic bank accounts – and this resulted in a further fall in the numbers of people without an account to around 1m by November 2013.
Why do providers still not publicise basic bank accounts enough?
Consumer rights campaigners believe, however, that many providers still do not publicise their basic bank accounts enough – suggesting that this is because the accounts are costly for them to operate and because there are no compensating profits from cross-selling other products to account holders.
'’We believe . . . that . . . banks need to be strongly encouraged, or ultimately required, to . . . meet a set of minimum standards in order to have a level playing field – and consistency across the country – on access to basic bank accounts that give consumers the basic functionality they need.’’ (Mike O’Connor of Consumer Focus, quoted in Andrew, 2013)
Describe the MAS.
What is its aim?
The Money Advice Service is one such initiative aimed at promoting social inclusion in general and financial inclusion in particular. It is funded by a levy on financial services firms, it is an independent financial advice and information service, the aim of which is to provide, by means of its website and publications, clear information and advice to people on how to manage their money.
What has the government encouraged banks to do surrounding financial exclusion?
The government has also encouraged banks and other providers to:
- offer a range of products (in addition to basic bank accounts) aimed at the financially excluded – usually low-cost, low-deposit products that are relatively simple and straightforward, and therefore easy to understand
- provide information on products in a way that is accessible to everyone – eg offering versions in languages other than English, or in Braille for people with visual difficulties
- make their own efforts to promote inclusion through financial education, to help people to understand how financial products can help them and to encourage people to make more use of appropriate products.
What financial education resources have providers developed in response to encouraging financial inclusion?
In response to encouraging financial inclusion and literacy, several banks, building societies and credit unions have developed their own financial education resources.
- Under its ‘Moneysense for Schools’ programme, NatWest offers free interactive resources online. (It also offers as a range of product guides and videos on its main website, targeting those over school age.)
- Ipswich Building Society offers its Money Metrics programmes for various age groups. The sessions take place in schools and other places, such as prisons. - Barclays ‘Life Skills’ programme is another initiative offering free downloadable resource packs online, providing information on personal finance and careers.
How does the internet help reduce financial exclusion?
Websites are just one of the ways in which increasing use of the internet has played a part in reducing financial exclusion – something that the government has also encouraged by means of policies aiming to make broadband available to the majority of the population.
Another way in which the internet has helped to reduce financial exclusion is by offering a means of accessing financial services to those who:
- are housebound and unable to get to a bank branch
- have a disability (eg visually handicapped people can use screen readers and voice synthesisers)
- work shifts or unsocial hours and may not be able to phone or visit their financial providers during normal working hours
- are intimidated by the office of a financial provider and / or feel uncomfortable with sales staff, preferring to research providers and products in their own home and in their own time.
What would happen in an unregulated ‘free market’ financial world?
In an unregulated, ‘free market’ financial world, individual consumers would be exposed to unscrupulous, dishonest or incompetent providers whose only objective would be to maximise their short-term profits by selling as many products as they could at the highest prices possible.
What is necessary for a perfect market?
Why is it desirable?
What are the requirements?
Many economists would say that little, if any, regulation of the way in which products are bought and sold is necessary if the market for those products is close to what is known as a ‘perfect market’. A high level of competition between suppliers is not the only requirement for a perfect market. If you want to be confident that you are buying the product that will best meet your needs, at the best possible price, you also need to be well informed and knowledgeable about:
- the product itself (its features, benefits, initial and future costs, etc)
- the best way in which to buy it (ie which retailer is offering the product with the best balance of price, quality and customer service)
- your own needs and the products available to meet those needs.
Ideally, you will have ‘perfect knowledge’ of each of these things.
What happens when consumers are not fully informed about a product?
When consumers are not fully informed about a product – when knowledge in one of these areas is lacking, ie when there is what economists call ‘information failure’ – there can be no guarantee that free competition and market forces will deliver the best products at the best prices – ie there is ‘market failure’.
What is the Sale of Goods Act 1979?
What is it an example of?
The Sale of Goods Act 1979 gives consumers the right to return goods that are ‘not fit for purpose’.
This is an example of general consumer protection legislation and regulation protecting consumers from being sold any product that does not meet their needs.
Is the financial services industry a perfect market?
Why is legislation still needed?
The legislation and regulation that protects consumers in general is not extensive enough to ensure consumer protection in the context of financial services. The major banking and finance ‘scandals’ that have hit the headlines over the past few years have shown that, even with a strong regulatory system, the financial services industry is still by no means a perfect market. That system therefore has to be revised and updated constantly to deal with failings as they become apparent.
How did the mis-selling of PPI contribute to the reform of the regulatory regime in 2013?
The practice of mis-selling payment protection insurance (PPI) to customers who were taking out loans is one example of a scandal that had a major impact on consumers and on the providers who were involved. The fact that this mis-selling was so widespread and had gone on for more than ten years before the regulators stepped in was another factor contributing to the reform of the regulatory regime in 2013 to try to prevent similar problems from happening again.
How does reforming the way the financial services are regulated help maintain personal financial stability?
By thoroughly reforming the way in which financial services are regulated, the government hopes to restore consumer confidence in the effectiveness of the regulatory system – and hence to restore customers’ trust in financial services providers – which is essential if individuals are to maintain their personal financial stability.
What can new legislation do to the costs for consumers?
While regulation brings many benefits for individual consumers of financial services, it is not without its costs. As the number or scope of regulations with which providers have to comply increases, so too does the amount that they must spend on staff training, on maintaining adequate compliance departments, on administration, and on registration fees and levies to fund some of the regulatory and consumer protection bodies – not to mention the fines and compensation payments that they must pay when things go wrong. New legislation can also increase providers’ costs if they have to redesign products, product literature and advertisements, and retrain sales and administrative staff.
How will additional costs impact the individual?
Additional costs will have an impact on the individual. The company may accept lower profits, but this will mean cutting dividends distributed to its shareholders. The company may offset the increased costs of compliance by reducing other costs, eg it may cut staffing costs by restructuring and negotiating redundancies, or it may ‘freeze’ salaries and annual staff bonuses at their present levels. Major changes in the regulatory system have even led some providers to leave the industry entirely because they are unable to make a profit.
Consumers too end up carrying the costs of regulation by paying higher prices for the products that they need or by going without products they cannot afford. They may also suffer if providers reduce the range of products and services that they offer, leaving consumers with fewer choices.
What does economic factors refer to in the context of financial services?
When we refer to economic factors in the context of financial services, we are referring to changes in:
- interest rates, which are related to:
−inflation
−house prices (and thus activity in the housing market)
−savings and investments
-economic activity, government spending and unemployment
- the global economy and exchange rates.
Define interest rates.
Interest rates can be described very simply as ‘the price of money’ – ie they are the price that banks charge borrowers for the money that they lend and the price that banks pay to savers for the use of the money that they have deposited with the bank.
Describe the interest rate rises and falls from 1970 till 2020.
Interest rates are also used as a central tool of government and central bank economic policy. Historically, throughout most of the 1970s and 1980s, interest rates in the UK were high – generally more than 10 per cent – falling to just over 5 per cent only in 1994.
From then until 2007, interest rates rose and fell regularly, but never drifted above 7.25 per cent or below 3.75 per cent.
However, the financial crisis of 2007–08 and the economic recession that followed prompted the Bank of England’s Monetary Policy Committee (MPC) to cut Bank rate dramatically in March 2009 to an unprecedented 0.5 per cent, where it stayed for over seven years.
In August 2016, Bank rate was lowered further to 0.25 per cent, as a result of uncertainty following the UK’s decision to leave the European Union. Although the MPC increased Bank rate slightly in 2017 and 2018, in March 2020 Bank rate was lowered to an historic 0.1% in response to the economic instability created by Covid-19, ie coronavirus.
What does interest rate change?
The reason for changes in interest rates is that changing Bank rate is the way in which the Bank of England tries to manage inflation.
How does inflation happen?
In terms of supply and demand
Basic economic theory tells us that if there is ‘too much’ spending – if consumers are demanding more than businesses are able to supply – prices will tend to rise as businesses take advantage of the excess demand to boost their profits. If this happens on a widespread basis, the result is a general trend of rising prices, otherwise known as inflation.
Who has responsibility to set Bank rate?
When was this changed?
In May 1997, the government gave the Bank of England the power to set Bank rate independently of government – a change later formalised under the Bank of England Act 1998. The Bank was also given responsibility for using Bank rate to deliver ‘price stability’ – ie to maintain the annual rate of inflation at around 2 per cent. If the Bank’s MPC believes that inflation is likely to remain higher than the target rate, its response is to increase Bank rate.
What happens when bank rate goes up?
When Bank rate goes up, most lenders will automatically increase the interest rates that they charge on loans, credit cards, mortgages, overdrafts, etc. Borrowers with variable-rate mortgages or credit cards will face higher monthly payments, leaving them with less money to spend. Those who have made effective short-term, medium-term and long-term personal financial plans, including contingency plans that make provision for rising interest rates and inflation, will be able to manage these higher monthly payments, often by cutting back on their discretionary spending. Others who were considering a loan or hire purchase as a means of buying a ‘big ticket’ item (eg a car or furniture) may be put off by the higher interest rates and delay the purchase until the cost of credit comes down again. All of this helps to achieve one of the MPC’s objectives in increasing the Bank rate: to reduce consumer spending. Lower spending will reduce overall demand for products and services, which will, in turn, put pressure on businesses to reduce their prices.
What does high inflation mean to individuals?
For many individuals, a high and rising rate of inflation will mean having to spend a larger proportion of their income on the goods and services that they regularly consume. This may significantly affect their financial plans by reducing the amount that they are able to save and increasing the likelihood that they will have to borrow money. Increasing interest rates to keep inflation in check therefore helps those living on a fixed income with little or no debt by ensuring that their income continues to cover their expenditure.
Why is high inflation good for people who have a large amount of debt?
Those with high levels of debt are better off if interest rates are kept low and inflation is allowed to rise, because lower interest rates will keep down the cost of servicing their debts, while inflation will reduce the amount that they owe in real terms.
