role of financial sector

• financial sector

  consists of financial organisations and their products and involves the flow of capital
• Bank of England

  • sets base rate
  • lender of last resort
  • keeps value of money
  • liquidity insurance
  • raising capital
  • tackling risk
  • orderly failure
• credit provision: without credit (large amounts of borrowed money) the economy gets stuck

  liquidity provision: how easy it is to turn assets into cash (banks are the main providers of liquidity)

  risk management: financial sector allows the pooling of risk and this should encourage more savings/investment
• retail/commercial banks e.g HSBC and Barclays


  • Accepting deposits in order to provide security & facilitate saving
  • Lending money to different economic agents who wish to borrow
  • Providing an efficient means of payment and transferring funds between different economic agents
• Building societies e.g Nationwide and Coventry


  • Type of mutual institution where the firm is owned by its customers, which entitles customers a share of profits, normally in the form of a dividend
  • Offer mortgages
  • Receive money from members who are paid interest and lend out to members who pay interest
• Insurance companies e.g for building/contents/appliances, healthcare, car, life


  • Financial institutions that guarantee compensation for specified damage, illness or death in return for an agreed premium
  • Provide peace of mind for those taking out the insurance policy
  • Sometimes insurance is mandatory, e.g. when driving a car
  • Policyholders often pay for something they never use
  • Policy excesses, when the policyholder has to pay towards the cost, may reduce the benefit
• similarities and differences of building societies and banks

  • Accounts in banks are owned by shareholders but building societies are owned by its members (customer of bank vs member of building society)


  • Both provide mortgages and savings accounts
• Interest rates

  Cost of borrowing, reward for saving (5.25% today)

  If interest rates increase

  Cost of borrowing more expensive, demand falls (saving more attractive, spending falls) (vice versa)
• Range of interest rates

  • BoE
  • Bank loans
  • Credit cards
  • Store cards

  mortgage loan is lowest risk whereas credit card is highest risk
• Inflation

  the sustained increase in prices over a period of time

  if inflation increases so will interest rates (if the rate of interest is lower than the rate of inflation, lenders will be losing money in real terms (minus inflation). therefore they will look to raise interest rates as the rate of inflation rises)
• Demand and supply for credit

  • if there's high demand for borrowed funds then the interest rate will be higher and vice versa
  • if there's low availability (supply) of funds to borrow, the interest rate will be higher and vice versa
• Bank of England's base rate

  The rate at which BoE lend to commercial banks such as Barclays

  If this increases these banks have to pay more to borrow money and they therefore pass this on to the consumer in the form of higher interest rates
• State of the economy

  • In a stable economy with high levels of employment, demand for funds is likely to be higher as individuals and firms seek to consume/invest
• Changes in interest rates

  High interest rates may tempt consumers to save rather than spend

  Consumers may buy on credit

  Interest rates will affect the attractiveness of borrowing money (higher rates leads to lower demand and consumers who already have loans will have less disposable income)
• simple interest: interest paid fixed

  £1000 deposited, interest 3% annually

  1000 x 0.03 = 30

  30 x 3 = £90

  compound interest: interest paid on both fixed deposit and interest accrued

  £1000 deposited, interest 3% for 3 years

  £1000 x 1.03^3 = £1092.73 (-£1000= £92.73)