4.5

• Risk

  Quantifiable probability of damage, loss or injury occurring
• Risks faced by banks


  • Capital might not be paid back, resulting in a loss for the bank
  • Return on an investment will be less than the expected return
• Uncertainty


  Situation which may or may not happen, but the probability of each outcome is not known
• Shocks


  Unforeseen changes which impact the economy, caused by humans or natural disasters
• Example of a major shock

  • 2008 Global Financial Crisis
• Shocks


  Impacted the economy for many years, caused by risks taken by banks
• Currency market


  Financial market used to trade one currency for another currency
• Speculative attacks


  Can affect the value of the exchange rate
• Commodity markets


  Investors trade primary products, such as wheat, gold and oil
• Future contracts


  Method for investing in commodities, involving buying or selling an asset with an agreed price in the present, but a delivery and payment in the future
• Forward market


  Informal financial market where future delivery contracts are made
• Insurance


  Designed to reduce the risks of decisions, people and firms pay a premium to cover a risk
• Insurance premium


  Price paid to cover a risk, firms might include it in their costs to help protect against huge losses
• Financial liquid assets

  Assets that are exchanged in a financial market
• Financial markets

  • Stock market
  • Bond market
• The financial sector has become more important to the UK economy in recent years
• To facilitate saving

  1. Financial markets provide somewhere for consumers and firms to store their funds

  2. Savings are rewarded with interest payments from the bank
• To lend to businesses and individuals

  1. The transfer of funds between agents is aided by financial markets

  2. The funds can be used for investment or consumption
• To facilitate the exchange of goods and services

  1. The transfer of real economic resources is facilitated in a financial market

  2. Financial markets can make it easier to exchange goods and services from the physical market, by providing a way that buyers and sellers can interact and transfer funds
• To provide forward markets in currencies and commodities

  1. The currency market is used to trade one currency for another currency

  2. Currencies can have speculative attacks taken on them, which can affect the value of the exchange rate

  3. Commodity markets involve trading primary products like wheat, gold and oil

  4. Future contracts are a method for investing in commodities, involving buying or selling an asset with an agreed price in the present, but a delivery and payment in the future

  5. A forward market is an informal financial market where these contracts for future delivery are made
• To provide a market for equities


  1. Equity markets involve the trade of shares, also called a stock market

  2. Equity markets provide access to capital for firms, and allow investors to own part of a market

  3. Returns on the investment, usually in the form of dividends, are based on future performance

  4. A dividend is a share of the firm's profits
• Central bank

  Manages the currency, money supply and interest rates in an economy
• Implementation of monetary policy

  1. Influence the manipulation of interest rates

  2. Influence the supply of money and credit

  3. Influence the exchange rate
• Monetary Policy Committee (MPC)

  • Alters interest rates to control the supply of money
  • Independent from the government
  • Meets each month to discuss the rate of interest
• Interest rates are used

  To help meet the government target of price stability
• Base rate

  Ultimately controls the interest rates across the economy
• Banker to the government

  1. Collects payments to the governments

  2. Makes payments on behalf of the government

  3. Maintains and operates deposit accounts of the government

  4. Manages public debt

  5. Issues loans

  6. Advises the government on finance
• Lender of last resort

  If there is no other method to increase the supply of liquidity when it is low, the Bank of England will lend money to increase the supply
• If an institution is risky or is close to collapsing

  The Bank might lend to them
• Lender of last resort


  • Protects individuals who deposit funds in a bank and might otherwise lose them
  • Aims to prevent a 'run on the bank'
• Banks will avoid borrowing from the lender of last resort, because it suggests the bank is experiencing a financial disaster
• Role in regulation of the banking industry

  1. Governments regulate banks with regulation and guidelines

  2. Ensures the behaviour of banks is clear to institutions and individuals who conduct business with the bank
• The UK banking industry is regulated by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA)
• Prudential Regulation Authority (PRA)

  Promotes the safety and stability of banks, building societies, investment firms and credit unions, and ensures policyholders are protected
• Financial Conduct Authority (FCA)


  • Regulates financial firms to ensure they are being honest to consumers and they seek to protect consumer interests
  • Aims to promote competition which is in the interests of consumers
• Central bank

  Manages the currency, money supply and interest rates in an economy
• Implementation of monetary policy

  1. Influence the manipulation of interest rates

  2. Influence the supply of money and credit

  3. Influence the exchange rate
• Monetary Policy Committee (MPC)

  • Alters interest rates to control the supply of money
  • Independent from the government
  • Meets each month to discuss the rate of interest
• Interest rates are used

  To help meet the government target of price stability
• Base rate

  Ultimately controls the interest rates across the economy