3.1 The Sustainability of the Financial Services System

Question 1

Sustainable development definition

Answer 1

Development that meets the needs of the present without compromising the ability of future generations to meet their own needs

Question 2

Three main elements to sustainability:

Answer 2

• Environmental sustainability
• Social sustainability
• Economic sustainability

Question 3

Sustainable financial system definition

Answer 3

One in which the provision of basic financial services can continue into the long term

Question 4

What happened in the Wall Street Crash of 1929?

Answer 4

• People had been buying stocks and shares in vast quantities, causing share prices to rocket.
• The ‘bubble’ was unsustainable - when it burst prices came down, businesses failed and individuals became bankrupt

Question 5

Why did the failure of Lehman Brothers have an impact on other banks?

Answer 5

It was very big and owed large amounts to other businesses who failed in turn when they could not recover their funds

Question 6

Why would borrowers be uncertain in the event of a bank failing?

Answer 6

The new company that takes over the bank along with the debts may impose new terms making debt unaffordable

Question 7

Impacts of the recession on the Government:

Answer 7

Less money raised in tax because:

• Fewer working and paying income tax
• Fewer spending and paying VAT
• Firms are making lower profits and so paying less corporation tax

Paying out more money in unemployment benefits so public sector accounts will go into deficit and the Government will have to borrow and reduce borrowing by increasing taxes and cutting public spending

Question 8

Systemic risk definition

Answer 8

Risk affecting the stability of the financial system as a whole

Question 9

Systemic risk is highest under which circumstances?

Answer 9

• When financial providers are large

- When the large providers work very close with each other and become interconnected

Question 10

What is the name given to very large firms?

Answer 10

Systemically important financial institutions

Question 11

Financial contagion definition

Answer 11

When debt works its way through the global financial system as the problems of one group of institutions infects the network

Question 12

What did financial authorities try to tell the media when Northern Rock failed?

Answer 12

That they bank was safe and only in trouble because of the ‘run on the bank’

Question 13

What did the Government offer as compensation to customers of the Northern Rock?

Answer 13

A guarantee that they would reimburse any depositor who lost money in Northern Rock

Question 14

What are the for and against arguments about whether a government should bail out a failing bank?

Answer 14

• There is a need to prevent failure of a large bank

- Saving a bank simply passes its debts to the state and transfers the problem to the taxpayer

Question 15

What is moral hazard?

Answer 15

Less-than-prudent management decisions as a result of an expectation that the bank will be bailed out

Question 16

Will banks in the future be allowed to fail?

Answer 16

Yes

Question 17

Bank resolution definition

Answer 17

The procedure that takes place when a bank is at risk of failure

Question 18

What will financial authorities do with a bank if it fails?

Answer 18

Save any parts that are still viable and close down the remainder

Question 19

What type of system does the PRA want to create?

Answer 19

One in which banks can fail in an orderly manner without harming the financial stability of the system

Question 20

What did the Banking Act 2009 give the Bank of England the power to set up?

Answer 20

The Special Resolution Regime

Question 21

Why was the Special Resolution Regime set up?

Answer 21

To create a system in which banks and other financial firms may fail in an orderly manner

Question 22

What does the Special Resolution Regime allow?

Answer 22

Banks to deal with a failing institution either by:

• Arranging for the institution to be sold to a private sector purchaser
• Transferring the institutions’ property to a bridge bank until a sale can be arranged
• Putting the institution into temporary public ownership
• Apply to make the institution insolvent

Question 23

What key objectives must the Bank take into account when deciding how to deal with a failed institution?

Answer 23

• Protect and enhance stability of the financial system
• Protect and enhance public confidence
• Protect depositors
• Protect public funds

Question 24

Prudential regulation definition

Answer 24

Use of financial regulation to drive banks to organise their business in a more sustainable way

Question 25

What does prudential regulation require banks to do and how can the banks do this?

Answer 25

Make their balance sheets safer by:

• Holding more capital by issuing more shares to shareholders
• Holding more liquid assets
• Tightening their lending criteria and adopt a responsible lending policy.

Question 26

If a bank fails who suffers the loss - the shareholders of depositors and creditors?

Answer 26

Shareholders - any money left over in a failed bank would go to depositors and other creditors

Question 27

What is the most liquid asset that a bank holds?

Answer 27

Its account at the Bank of England

Question 28

Under the Basel III international regulation on banking capital and liquidity, a bank is required to have what?

Answer 28

Enough cash overall and, in addition, to have enough cash to be able to pay its short-term debts over the coming 30 days at any given time