role of cent bank Flashcards
l76 type shi you got this ho (26 cards)
what are 3 key roles of the central bank
implement monetary policy- sets inflation target, interest rates etc
Managing the exchange rate through the use of gold and foreign currency reserves (rare for UK)
last resort lender to retail and commercial banks- providing emergency funds to banks that cannot obtain financing from regular market sources.
why is it vital that its a last minute lender
Creates liquidity for financial institutions like the gov when there’s no alternative
Banks can sometimes be short of liquid assets because they borrow for the short & long term. If the bank is solvent (assets = liabilities) then the CB provides liquidity.
prevents financial panic and helps to ensure financial markets continue to run smoothly.
what 3 ways is liquidity provided
routine liquidity
emergency liquidity
During a ‘systemic crisis’ as in 2008
whats rl
Routine liquidity needs are charged a low rate of interest as banks must keep a certain cash ratio deposit/reserve balance with the CB overnight. An average reserve balance is set monthly and borrowing within this limit is normal
whats em
Emergency liquidity problems are charged higher rates of interest to incentivise them to better manage their liquidity and risks if they needs funds above the average reserve balance they have agreed to.
what may banks do during a systematic crisis
CB might provide greater emergency liquidity assistance to ensure banking stability and maintain confidence of economic agents
what are a benefit of the CB being a last resort lender
Maintains confidence and prevents a ‘run’ on the banks which is when a large group of depositors withdraw their money from banks at the same time.
whats a drawback
Moral hazard can occur as banks are not discouraged from taking excessive risks - less cautious about their actions because they expect to be protected from the consequences of risky behavior so could be gambling with peoples money
banker to the gov- what does it handle
Tax revenues
Government Spending
Government borrowing
Government lending
what are 2 ways they can implement monetary policy
primary objective
secondary objective
what is po
to maintain price stability through the use of inflation targets and interest rates
what is so
might include the need to consider other economic objectives when using monetary policy such as unemployment and economic growth. (This was introduced after the 2008 financial crisis and recession)
what economic problems did the 2008 financial crisis lead to
Commercial banks operating as investment banks and leading to systemic risk as they were in search for higher returns as the two parts of the banking sector where closely linked risking the ability of banks to carry out vital banking functions for the real economy.
what to key agencies does the BOE regulates the financial markets through
Financial Policy Committee (FPC)
Prudential Regulation Authority (PRA)
whats fpc
looks at whole bank- insurance, pensions etc
help gov managing the financial market
tackle problems that threaten the stability of banks
can force banks to hold higher levels of capital buffers to enable them to better absorb losses in the event of further financial crises
This deals with risks associated with the whole financial system
macro prudential
whats the financial conduct authority
micro-prudential regulator which aims to protect consumers and increase confidence in the financial sector and the products sold.
Supervises the conduct of individual firms to make sure the they act legally and fairly with codes of practice
must comply with recommendations from the FPC.
what is the pra
maintain banking stability and promoting effective competition in the financial sector
Set industry standards for conduct and management and ensures that they are followed. It assesses risks that each firm represents and seeks to ensure these are minimized so that if an individual firm does fail it avoids the significant disruption to the wider financial services system
micro prudential
what are liquidity ratios
Banks typically fail through a lack of either liquidity or sufficient capital or both.
measure a company’s liquid assets against its short-term liabilities and as such are a measure of a banks ability to meet its short-term liabilities
the more liquid assets you have to cover short-term liabilities, the more likely it is that you’ll be able to pay debts as they become due without running out of funds to support ongoing operations
Banks with low liquidity ratios have a higher risk of encountering difficulty meeting short term debt payments
whats a capital ratio
difference between a banks assets and its liabilities
% of loans on capital sheet
whats an example of a recent bank failure
Silicon Valley Bank (SVB) failed in the US during March 2023.
It failed due to a lack of liquidity/capital after a run on the bank.
This caused uncertainty over the stability of other banks in the US and Europe e.g Credit Suisse.
why is financial regulation needed
If bank activities are not carefully monitored and consumers protected then a desire to chase high profits through riskier lending and associated activities drives up asset prices (property prices) through a combination of easy credit and herding behaviour.
If any instability in financial markets occurs, twinned with speculation, can mean asset prices might fall dramatically
what may over regulation lead to
reduces incentives by increasing costs and limiting funds for I and C impacting levels of AD in nations
increased opportunity cost of G
what may under regulation lead to
increases systemic risk of financial market failure
what are the benefits of regulation
Offers guidance on potential future financial crises
Minimises the risk of future crises (domestic & global) to financial stability by increasing the resilience of the banking sector to losses
Prevents excessive risks and bubbles occurring rapidly which expose the financial sector to systemic risk.
