Pack 9: The Financial Sector Flashcards
(35 cards)
What is the financial sector?
Section of the economy made of of firms and institutions that provide financial services to commercial and retail customers
What does the balance sheet of a bank look like?
Liabilities + Capital = Assets. As assets must have been funded by liabilities or capital
What are liabilities and capital?
~Deposits
~Borrowing
~Capital
What are assets?
~Cash
~Securities
~Loans
How do banks secure the most profit?
Higher returns on loans and securities (interest) so want to hold as little cash as possible
However what are the risks that holding little cash needs to be traded off with?
~Liquidity issues
~Liquid assets it becomes insolvent
~Security issues
What is a financial market?
Any convenient set of arrangements where buyers and sellers can buy or trade a range of services or assets that are fundamentally monetary in nature
What are the roles of financial markets?
~Facilitate savings
~Lend to businesses and individuals
~Facilitate exchange of goods and services
~Provide a market for equities
~Provide forward markets in currencies and commodities
What is a forward market?
Market in which contracts are made to buy or sell currencies and commodities at some future date at a price fixed at date of contract
What are the benefits of forward markets and an example of an industry where they’re used?
Reduced risk/uncertainty know what price will be so can plan ahead more easily. Often used in airline industry to buy fuel. Failed during pandemic.
What is market failure?
When the price mechanism fails to deliver efficiency and results in misallocation of resources
What are the examples of market failure in the financial sector?
~Moral hazard
~Asymmetric information
~Market rigging
~Speculation / market bubbles
~Externalities
What is moral hazard?
When one person takes more risk because someone else bears the cost of those risks
What are some examples of moral hazard in the banking sector?
~Banking bailouts
~Securitisation
~Banker bonuses
What is asymmetric information?
Situation where one party has more information than another
How can asymmetric information be a market failure for both consumers and banks?
Consumers - unable to understand financial products they’re buying
Banks - risks with lending/investing for profit and securities
What is market rigging?
Group of individuals or institutions colluding to fix prices or exchange information that will lead to gains for themselves at the expense of other participants
What are the examples of market rigging in financial markets?
~Collusion to fix prices
~Use of hidden information
What is speculation?
Investment in stocks, property, etc. in the hope of gain but with risk of loss
What are market bubbles?
Economic cycle characterised by rapid escalation of asset prices followed by a contraction
What behavioural economic example can be used to explain speculative bubbles being created?
Herding behaviour, heightened expectations cause inflation in value above what objective assessment would suggest
What are externalities?
Impacts on third parties that are outside the transaction and ignored by the price mechanism
What is a central bank?
Financial institution given privileged control over the production and distribution of money and credit for a nation or group of nations.
In modern economics the central bank is usually responsible for the formulation of monetary policy and the regulation of member banks
What are the roles of the central banks?
~Banker to the government
~implementation of monetary policy
~Banker to the banks (lender of last resort)
~Regulation of the banking industry
