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Importance and Role of the Financial Sector - Assignment Example

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The paper “Importance and Role of the Financial Sector” focuses on an industry which provides financial services to both commercial and retail consumers. The key players in this sector from are banks, insurance companies, stock exchanges, insurance companies, and nonbanking financial institutions…
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Importance and Role of the Financial Sector
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Download file to see previous pages Financial sector affects interest rates. An interest rate is at the very basic the cost money. It’s how much you pay to receive money and how much you earn to sell money. Banks basically help determine the interest rate. While each bank may offer different interest rates to customers, the basic rate or the discount rate is determined by the Central Bank (Mathieu, 1995, p. 64). This is the rate at which the central bank lends to all other banks. And the central bank sets this rate by considering factors such as the demand and supply of money, interest rates, exchange rates, the balance of payments and the growth rate.
The financial sectors set the interest rate which affects the exchange rate of a currency. A high-interest rate means that the currency essentially “costs” more. It also means that if foreign investors put their money in local accounts they will get higher returns. This is known as hot money inflow. As more investors buy the local currency, the currency appreciates. While high-interest rates lead to hot money inflows it also means that the country’s exports are now more expensive for foreigners. This means that if previously an American had to pay $1 for PKR 80, now they might have to pay $80/70 since $1 is now equal to PKR 70 and not PKR 80. This means that if previously an item in Pakistan cost PKR 800, the American had to pay $800/80=$10. But now since PKR has appreciated he has to pay $800/70=$11.43. So it costs him more now and depending on the elasticity of demand, he might buy less or not buy at all. So an appreciation of the currency is not necessarily a good thing. On the other hand, imports become cheaper. E.g. if a barrel of oil cost $100, a Pakistani importer had to pay PKR 100x80=PKR 8000 per barrel. But now he has to pay PKR 100x70= PKR 7000 per barrel. However, as imports increase, this can create inflationary pressures in the economy and on the balance of payments. ...Download file to see next pagesRead More
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