The UK Financial Market - Case Study Example

Financial systems Table of Contents Section 3 Section 2 6 Section 3 8 References 10 Das, U. (2005) Quality of financial policies and financial system stress, Issues 2005-2173. IMF Publications. 10 The Bank of England (2008) “Your money: What the bank does”. Available at (Accessed: May 15, 2010). 11 Section 1 Financial System and its Functions Financial system is responsible for the mobilisation of financial resources in an economy so as to make their best and the most efficient use. Basically it targets at bringing about the excess amount of disposable funds from the borrowers and lending them out to the potential investors to bring about better investment opportunities in the economy and hence help it to develop in a healthier way. A financial system comprises of a large number of financial institutions which indulge themselves in such activities. The more robust the financial system of a nation is, i.e., the greater the efficiency with which it can mobilise the resources in the economy and create value, the stronger will be the fundamentals of the concerned nation. Components of a Financial System The financial institutions together form the financial market of a nation. These institutions contained within the financial web or community could be categorised into a number of groups depending on the type of activities with which they are involved. These different groups, namely, the agents, brokers and financial intermediaries are linked up with one another closely through contractual agreements or legal orders. While agents and brokers operate to bring the institutions and investors closer to each other, the intermediaries are the ones who channelise the flow of funds between any two agents. However, the classification above had been rather a broad one and the significant financial institutions are actually represented by special terms as follows – The banking sector – This sector comprises of financial intermediaries involved in channelising the flow of resources. To be precise, the banking sector indulges in accepting surplus deposits and lending them to deficit accounts. The stock market – The stock market is one which is comprised of agents and brokers, who operate in lieu of the buyers and sellers of company shares. Foreign exchange market – Foreign exchange market also comprises of agents and brokers with the only difference with the former being that the role is being played by the commercial banks of the concerned nation (Das, 2005). Government debt market – The government debt market comprises of intermediaries in the form of the central bank of a given nation. It indulges in accumulating debt for the government from internal as well as external sources. The UK Financial Market The UK financial system is often claimed as one of the most robust and sound system among its counterparts in various developed nations, by the economists and political leaders of the nation. In fact, such claims could be debated by various facts and figures post the global financial meltdown. The bank had kept its prime lending rate rather low at 5.52% compared to the statistic in the rest of the world, the central bank discount rate had been estimated at 0.86% in 2008 – these two statistics only indicate the bank’s target to keep the liquidity position in the nation stable post the crisis. In fact, the success of the nation could be assessed from observing a few important economic statistics of the same. For instance, the rate of inflation had been checked down from 3.9% in 2008 to 2.1% in 2009. However, there is need to focus more on the economic growth rate of the nation, which still runs at a largely negative figure (-4.8%); in fact, the statistic tends to lower over years. This however, is largely due to the high amount of public debt amounting to 68.5% of GDP in 2009 – a rise from 51.8% of GDP in 2008. The rate of unemployment has also increased (5.6% to 8%), thus indicating a lack of productive activities in the nation (CIA, 2010). Hence, the claims made by the observers could not be supported in the respect that the financial sector had been successful in restoring stability in the nation. However, the amount of financial activity only proves that the recovering process is under way. Section 2 There are a large number of benefits that the borrowers and lenders could draw from being a part of the organised financial market and intermediaries. Some of them could be elucidated as under. The organised market is restricted by the rules and regulations being framed by the apex financial body, based on the prevailing market conditions. Hence, there are little chances of getting exploited by the financial institutions enlisted under the main body, unlike the case with unorganised institutions. The lenders could be sure about the security of their money while the borrowers could be assured of not being exploited by such a financial institution. Regular monitoring activities are performed to look after the above issues. Moreover, the banks are required to maintain a certain level of transparency with their customers to pacify their quests. The borrowers and lenders could take the privilege of various products and services that the intermediary offers on account of being their customer. On the other hand, no such benefits are present in the unorganised sector due to lack of competition in the same (The Bank of England, 2008). Risk and Return Risk and return are two sides of the same coin; an investor willing to plunge into a venture has to accept the amount of risk that comes up with the returns associated with the same. The greater the return associated with a project is, higher will be the risk corresponding to it, which is why the investments offer high returns. It is absolutely according to the investor’s desire as to the type of project he wants to venture in. In case of a high-risk-high-return project, the value of the investment highly fluctuates with the market disruptions. The riskiness of a project could be calculated with the help of a statistic ‘beta’ which measures the sensitivity of a project to market movements – the higher the value is, greater is the sensitivity and thus the more is the return and risk quotient, and vice-versa. Diversification Often investors do not indulge in pouring in all their money into a single project and rather prefer to pour them into a portfolio of assets so as to shield or guard oneself against market fluctuations – this act of investing in a portfolio comprising of both high return and low return assets is known as the method of diversification of risk. The risk lover individual will include more and more high return assets in his portfolio, while the risk averse will do the opposite. Greater the diversification is, greater is the shield against risk. Some of the most secure of all assets are the government bonds and Treasury Bills, which is why the investors often include them into their portfolios from time to time, albeit depending upon the extent to which they are prepared to accept the risk of market fluctuations. Section 3 The Bank of England The Bank of England is the central bank of England accounting for a balancing act in the financial chain of the nation. Historically considered as one of the most stable financial institutions in the world, the bank engages itself in restoring financial and monetary stability in the economy during critical periods and restoring them at normal times. Some of the main instruments executed by the Bank of England to carry on with its job have been illustrated as follows. Monetary Stability – The Bank of England is responsible to maintain monetary stability in England through controlling over the flow of money in the nation, so as to maintain the targeted liquidity at the national level. The bank looks after the stability of domestic currency through reining or relaxing the flow of money according to the administration’s inflation target. It also has the monopoly right to issue bank notes for the purpose, though this is the ultimate measure that the institution turns to. Adjusting the rate of interest also falls under the same category which is decided by the Monetary Policy Committee. Financial Stability – The bank looks after maintaining the financial stability in England through setting up various monitoring techniques which look after the proper functioning of different components of the financial system. These surveillance measures are adopted to predict both the internal and external financial issues. In short, the Bank of England is the financial guardian of the nation that not only works closely with the government’s objectives, but also cares for the interests of the national investors and households. Since the Bank of England is the apex banking institution in the nation, it is the one that frames policies for the commercial banks of the nation and ensures their effective enactment. These policies are the ones related to the appropriate and market clearing rates of interest on deposits and loans of various kinds. Moreover, it also instigates the commercial banks to publish various facts and figures about their activities on a regular basis to maintain a minimum level of transparency with their customers. As there is no interaction with the common public, there is no question of issuing new products for the common public. However, the regulations it designs are meant for their benefit only, so that the nationals can dwell in a hassle free environment. The Borrowers and Lenders The Bank of England does not interact directly with the common public; rather it mainly bestows its facilities to the national government and the commercial banks of the nation. The Bank of England, depending upon the function that it plays is known as The Government’s bank and the Lender of Last Resort simultaneously. Being the central bank of England, the Bank of England is held responsible for advancing monetary help to the national government at times of crisis, e.g., when there is a budget deficit. On the other hand, it is also the one that the commercial banks turn to when they run into a deficit account and have run out of all their money to meet urgent needs. However, these credits are only considered as loan advances which need to be replenished over time and over which the bank charges a certain rate of interest. However, there lies no profit motive beneath their activities in this case. Since the banks are devoid of any profit motives, there is no scope of them accumulating the money and crediting them to the borrowers in distress. The Bank of England charges a mandatory amount of reserve ratio from the commercial banks, proportional to the amount of demand deposits that the concerned bank has. This amount of money is stored by the central bank to advance during periods of crisis. Moreover, it also charges a lending rate on the loans it advances to commercial banks. On the other hand, the bank accumulates the money needed by the government via issuing Treasury Bills and government securities in the open market. In such cases where the government needs to procure internal debts, it is the nationals who are the actual lenders to the government; it could also act as a contractionary monetary policy. When the internal financial system is under control and the national government wishes to make an external debt, it is the central bank only which arranges for various external sources to advance their surplus money through similar open market operations. References Central Intelligence Agency (April 28, 2010). “United Kingom”, The World Factbook. Available at (Accessed: May 15, 2010). Das, U. (2005) Quality of financial policies and financial system stress, Issues 2005-2173. IMF Publications. The Bank of England (2008) “Your money: What the bank does”. Available at (Accessed: May 15, 2010).   Read More