What is the main role of commercial banks?
To be the intermediary between borrowers and savers
How do commercial banks make their profits?
By taking small, short-term relatively liquid deposits from savers and transforming these into larger, longer maturity loans
What services are provided by investment banks?
Underwriting, M&A advice, Trading on capital markets, Private equity investments
What do private banks do?
Provide wealth management services to high net worth individuals
What are building societies?
Owned by their members, they offer mortgages and savings products. Many also offer a broad range of retail banking products.
What are credit unions?
Small and local non-profit lending institutions. Owned by their members and are for people who cannot access banks or building societies
What is bank capital?
The value of the bank’s assets minus its liabilities
What are bank reserves?
Money and liquid assets held by banks in order to meet withdrawals from customers
Examples of a bank’s assets
Cash, balances at BofE, Loans (e.g. advances), securities (e.g. bonds), fixed assets (e.g. land)
Examples of a bank’s liabilities
Customer deposits, money owed to bond holders, money owed to other banks
What is a bank’s balance sheet?
A financial statement which reports a banks assets and liabilities
What are stable deposits?
Deposits that cannot be withdrawn quickly. Banks usually offer higher interest rates for them. They help banks control their ‘liquidity risk’
What is liquidity risk?
The risk that savers will want to withdraw their deposits and the bank is unable to pay
What is credit risk?
The risk of a bank lending to borrowers who turn out to be unable to repay their loans (default on their loans)
What are the three functions of money?
Medium of exchange, store of value, unit of value
What is fiat money?
Assets used to make transactions with no intrinsic value – the current way of exchanging goods and services
What is near money?
Assets which can be converted into cash without delays (Liquid)
What is non-money?
Assets which do not function as a medium of exchange due to encashment delays (Illiquid)
What is narrow money?
The narrowest measure of money. Only includes the most liquid assets
(Cash + Reserves)
What is broad money?
The largest measure of money within the economy. It includes narrow money as well as the least liquid assets
What is a bond?
A financial instrument which can be issued and sold to raise finance. Beholders receive periodic payments linked to the overall value of the bond until it matures.
What is a bond yield?
The annual coupon payment expressed as a percentage of the market price of the bond
What is a coupon payment?
A periodic payment that the bondholder receives during the time between when the bond is issued and when it matures
What are guilts?
Bonds issued by the government
How to calculate the yield of a bond?
(Coupon / Market price) X 100
What does an increase in the base rate do to the exchange rate?
Increases the value of the pound
What did economist Minsky believe?
That stability was destabilising. Banks get complacent and start taking bigger risks in the pursuit of profit
If a bank makes a new loan to a customer, what will happen to the bank’s liabilities, assets and money supply?
They will all increase
What is quantitative easing?
When the Bank of England buys bonds on the secondary market. This increases demand and therefore increases price.
What is austerity and what is needed when it is implemented?
Contractionary fiscal policy. Therefore lots of expansionary monetary policy is needed.
On a commercial bank’s balance sheet, total assets should be equal to what?
Total liabilities + capital
What are four traditional investment bank activities?
Underwriting share issues
What is moral hazard? (Asymmetric information)
When the behaviour of individuals change after a contract is agreed and enforced (E.g. People are more likely to be carefree after they have insurance on something)
What is adverse selection? (Asymmetric information)
Private information means that only those who benefit will enter into a contract (E.g. only those who need insurance will get it)
What are the forms of market failure within the financial sector?
- Asset price bubbles
- Market rigging
- Moral hazard
- Asymmetric information
What are speculative bubbles?
When asset prices become inflated and overvalued, when they burst it causes large economic problems. Banks can cause speculative bubbles due to their herding behaviour
What is market rigging?
When individuals and companies work together for a mutual benefit to stop a market operating as it should do