4-4 The financial sector

Question 1

What roles do financial markets play?

Answer 1

• To facilitate saving
  o Somewhere for consumers and firms to store their funds.
  o Savings are rewarded with interest payments.
• To lend to businesses and individuals
  o Funds can be used for investment or consumption.
• To facilitate the exchange of goods and services
  o Can make it easier to buy and sell goods than in a physical form.
• To provide forward markets in currencies and commodities
  o Currency market is where currencies are traded for other.
  o Commodity markets agreed payment on a certain good in the future with contracts.
• To provide a market for equities.
  o Trading of shares on a stock market.

Question 2

What are some causes of market failure in the financial sector?

Answer 2

• Asymmetric information
• Externalities
• Moral hazards
• Speculation and market bubbles
• Market rigging

Question 3

What are the roles central banks play in the financial sector?

Answer 3

• Implementation of monetary policy
  o Base rate, interest rate.
• Banker to the government
  o Provides advice and carry’s out all government transactions.
• Banker to the banks – lender of last resort
  o Bank of England will lend money to banks if they are at a risk of collapsing.

Question 4

What role does regulation play in the banking industry?

Answer 4

• Governments might regulate banks to ensure the behaviour of banks is clear to institutions and who conduct business with the bank.