financial sector

Roles of the financial sector

Saving lending facilitation exchange of goods and services providing forward market and providing market for equities

Savings

Savings financial institution allow household to save money in an account where they eventually earn interest for future consumption

Lending

Lending is by financial institutions allow businesses and households to borrow money in the form of personal loans. Businesses can borrow money for investment household can borrow money for mortgages and they will pay interest on these loans.

Facilitation exchange of goods and services

This is where financial institutions allow transactions to happen more efficiently lowering the opportunity cost

Provide forward market

This is when a contract is drawn for a commodity or currency for a fixed price but is bought for later day this intros that businesses are certain about their cost of production in the future and it Eliminate price instability

Provide market for equity

This is the financial sector allows businesses to have a place where they can raise funds by selling shares of their company in order to invest in business growth and economic growth and productivity

What is the evidence of market failure for the financial sector?

Moral hazard asymmetric information, speculation and market bubbles market rigging

Asymmetric information

Asymmetric information is when one party knows more information than another party in an economic transaction. An example of this is when banks for giving out risky loans and buyers had less information on the sub-prime loans

Externalities

This is When one party is affected through another parties actions in a transaction an example of this is that by Thanksgiving out risk sub-prime loans. This led to businesses being having less access to credit. There’s there was less spending in the economy and higher unemployment as firms had to let go of workers.

Moral hazard

Moral hazard is when one party commit risky actions as they know they won’t pay for the consequences An example of this is the government was forced to bail out banks which created an opportunity course and when the money could have been spent on infrastructure education and healthcare

Speculation and markets bubbles

Speculation is when somebody purchases an asset due to them predicting that the price of the asset will increase in the future not because they actually needed it in before 2008. There was an increased demand for houses which increase house prices this letter more and more people purchasing houses creating a market bubble. Eventually when demand is east house prices decreased and people were rushing to sell their houses

Market rigging

Marketing is when a party lies or cheats the market for their own personal benefit and example of this is when Barclays lied about their interest rates to Liable as some of the financial contracts would have agreed to benefited them if they increased their interest rates

What are the 4 roles of the central bank

Implementing monetary policy, banker of the government, lender of last resort, and regulation of the banking industry

Implementing monetary policy

The bank uses monetary policy to influence the economy through interest rates and QE

Banker to the government

The central bank efficiently manages the governments receipts

Banker to banks

The central banks will financially supports other financial institutions in which are not in the publics best interest to fail

Eg Northern Rock is the Uks biggest mortgage lender so it is a vital part of the UK economy

Prevents the failing of one bank to spread through the financial system

Regulation of the financial system

The central banks sets rules or guidelines for other financial institutions to follow to prevent the likelihood of market failure

Banks wish to lend more as they receive interest but regulations stop them from lending too much as they may loose their financial cushion when savers decide to withdraw their deposits

Regulation in the form of capital requirements make sure banks set aside a percentage of ones deposits to leave as a financial cushion

What is the PRA

Prudential regulation authority

Supervises banks to ensure they are fiancially resilient and unlikely to fail

Prevents moral hazard and market rigging

Helps identify suspicious behaviour

What is the FPC

To imdetfiy systematic risks that could threaten the entire banking economy

Eg stress tests are used to see if a bank could survive if the economy was suddenly pushed into a recession

Helps banks become stronger apwhich will help overall confidence in the economy

FCA

Protects consumers from exploitations from the bank

Also ensures competition is healthy eg banks do not lower their standard ps of consumers or start giving out risky loans

Ensures banks provide appropriate information

How did the financial sector change after 2008

Regulation was strengthened to improve financial stability, supervise individual banks, identify systemic risks, protect consumers and reduce problems such as excessive risk-taking, moral hazard, market rigging and asymmetric information

Costs of regulation

Increased opportunity cost through admin costs by the government creating jobs to regulate

The government will incest less money in education, healthcare, and infrastructure

Decrease in AD

Benefits of regulation

Increased business confidence

Increased confidence of savers which will increase saving and increase liquidity in banks which will increase available finds for banks

Increase borrowing from firms will increase AD through positive multiplier effect