banking & finance unit 1 the financial sector 9/7/20151
TRANSCRIPT
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BANKING & FINANCE
Unit 1
The Financial Sector
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UK Financial Sector
The Financial System is one of the many important systems operating within the UK and can be defined as:
“a set of markets for financial instruments, and the individuals and institutions who trade in those markets” (Howells & Bain, 1998).
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The Main Functions of the Financial System Are:
The provision of financial services and liquidity.
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A Financial System
• Channels funds from lenders (Surplus units) to borrowers (Deficit units)
• Creates liquidity and money
• Provides a payments mechanism
• Provides financial services like investment, insurance and pensions
• Offers portfolio adjustment facilities.
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The Main Types of Financial Business Are:
• Banking – Retail and Wholesale
• Insurance – Life; General and Investment
• Mortgage Finance – Home and Corporate
• Fund Management – Pensions, Insurance
• Capital Markets – IPOs and security exchanges
• Money Markets – eg Inter-bank; CD.
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BanksCentral
(Bank of England)
Retail Wholesale (Primary) (Secondary) (Commercial) (Merchant)
Discount HousesFinance HousesForeign banks
Consortium banks
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The Bank of England Implements monetary policy, and ensures there is
sufficient liquidity in the commercial banking system for it to be able to meet its daily commitments.
Semi-independent since May 1997. Full independence gives the central bank the freedom to
choose both the goal and the steps necessary to achieve it. The Bank of England, has had instrumental independence
since 1997 – it can take whatever steps it thinks necessary to achieve the Government’s goal. Since then, the MPC has been responsible for setting interest rates in order to meet the government’s inflation target.
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Retail Banks• Must be authorised by the FSA.• FSA exercises prudential control and enforces capital
adequacy requirements as per Basle Accord.• Operate the money transmission service.• Clearing banks, via APACS and BACS, provide the
cheque clearing service as part of that service.• Required to hold a cash ratio of 0.15% of their eligible
sterling liabilities above £400m with the Bank of England, interest free.
• Large branch network – customer convenience.• Very large in terms of market capitalisation.
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Wholesale Banks
• Includes Acceptance houses; Overseas banks; Consortium banks
• Function – To finance and facilitate trade• Provide banking and financial services to the
corporate sector• Provide advice to companies on mergers and
takeovers• Investment funds management• Dealing in Foreign Exchange Market• Syndicated lending.
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Financial Intermediaries (FIs)
Two main types of Financial Intermediary:
Deposit-taking FIs
(eg Banks and Building Societies)
Non-deposit-taking FIs
(Insurance; Pension; UTs; ITCs; OEICs)
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“The City”
The Square Mile known as “The City” attracts a range of associated professions due to the possibility of reaping the benefits of external economies of scale. For example:
• Accounting • Legal• Investment management.
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London Is a Global Financial Centre
It holds a comparative advantage due to:
Time zone
Language
Expertise
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Important Themes
Globalisation/Internationalisation
Information Technology
Freedom from Exchange Controls
Regulation/Deregulation/Re-regulation
Innovation
Competition
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Financial Markets
Widely dispersed geographically both nationally and internationally. Facilitated by:
Deregulation
Abolition of exchange controls
Improved communications
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UK Financial Markets Comprise:
The Money Markets
The Capital Markets
LIFFE (Euronext)
Lloyds
FOREX
LTOM
(now part of LIFFE/Euronext)
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Money Markets
• Match borrowers and Lenders of large short-term Sterling and currency funds
• Deal in wholesale deposits
• Deal in secured and unsecured borrowing and lending
• Secured market = Discount/Repo Market
• Unsecured market = Parallel market.
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Parallel Market Comprises:
Inter-bank market
Inter-company market
Local Authority market
Eurocurrency market
Finance house market
Commercial paper market
Certificates of deposit market
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Capital Markets Comprise;
The Stock Exchange
The Main The AIM The CP The Gilts
Market Market Market Market
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Financial Claims
These are financial assets and liabilities of:
Financial InstitutionsPersonal Sector
Industrial & Commercial Companies’ (ICCs) SectorGovernment Sector
• Represent flows of funds between these sectors, and• Represent assets to the investor, liabilities to the
issuer.
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Financial Institutions
Liabilities Assets
Deposits Loans
Mortgages
Reserve Assets
Gilts
Treasury Bills
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Personal Sector
Liabilities Assets
Borrowings Deposits
Securities
Insurance
Unit Trusts
Gilts
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ICCs Sector
Liabilities Assets
Capital:
Shares
Debentures
ULS
CULS Cash
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Government Sector
Liabilities Assets
Gilts
Treasury Bills
National Savings Cash
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Financial Claims Are Either:
Marketable or Non-Marketable Marketable are Company or Government
securities.
Non-Marketable are Cash Investments such as bank, building society, Insurance, Pensions and National Savings products.
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Marketable Financial Claims
• Company (Corporate):- Equities (Shares); Corporate Bonds (eg Debentures & ULS); Warrants; CDs (Banks); Commercial Paper.
Higher risk; higher potential returns.
• Government:- Government Bonds (Gilts); Treasury Bills; Gilt Repos.
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Non-marketable Financial Claims
• Cash Investments:- Bank and Building Society accounts; National Savings Accounts, Certificates, etc.
• Characteristics:-Low Risk
Low ReturnShort-term
Capital Safety
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Financial Claims Are Represented By:
Financial Instruments
These are a means of holding surplus wealth by depositors and investors which can be traded in the financial markets.
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Financial Instruments – General:
• Bills: Short-term instruments issued at a discount to their par value
• Bonds: Longer-term, fixed interest/income instruments
• Equities: Ordinary shares of companies. They pay a variable return – dividend.
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Financial Instruments –Specific:• Treasury Bills:- Short-term Promissory Notes of HM
Treasury; Issued at discount to par. Return = capital gain.
• Commercial Bills:- Short-term bearer securities issued by companies at a discount to par. The market prefers to deal in denominations of £500,000. Variants are Bank Bills, Trade Bills and Acceptance Credits. Self-liquidating.
• Commercial Paper:- Short-term securities issued at a discount by companies (with assets of £25m) in need of short-term funds (7 days – 1 year). Similar to commercial bills of exchange except that they are not self-liquidating.
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• Certificates of Deposit (CDs):- Short-term, fixed interest securities issued by banks and building societies. Usual term is up to one year, but can be up to five years. (“NCDs” in Hong Kong)
• Gilt-edged securities:- Government Bonds issued to cover the PSNCR (previously the PSBR). Known as Funded Debt, it is long-term borrowing by the Government.
• Debentures:- Loan stock issued by companies to cover long-term borrowing needs. Debentures are secured borrowing with a fixed and/or a floating charge against the company’s assets. Other loan stock:- ULS; CULS is unsecured.
• Shares:- These are mainly ordinary (variable dividend) and preference (fixed dividend).
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Financial Instruments – Characteristics:
• Risk
• Term to Maturity
• Expected Return
• Liquidity
• Real value certainty
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Risk, Term and Return
• There is a direct relationship between these 3 variables.
• Generally, the longer the term the greater the risk. Therefore, greater expected return.
• Marketable securities are inherently riskier than non-marketable.
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Liquidity SpectrumNotes and coinCurrent account
Ordinary account7 day deposit account
Time depositTreasury Bill
Commercial bill and CDGovernment BondCorporate Bond
SharesBuildings , land and machinery
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Corporate Bonds and Shares Compared
• Bond interest paid from profits before tax• Share dividend paid from profits after tax• Interest and dividend liable to income tax• Capital gains on Bonds not liable to CGT• Capital gains on shares are liable to CGT• Bond-holders are creditors of the company• Shareholders are owners of the company• Corporate bonds susceptible to inflation• Shares have tended historically to beat inflation.
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Equity Ownership in the UK
1963 1975 1981 1989 1999 2006 % % % % % % Institutions Pension funds 6.4 16.8 26.7 30.6 19.6 12.7 Insurance companies 10.0 15.9 20.5 18.6 21.6 14.7 Unit & Investment trusts 1.3 4.1 3.6 5.9 2.7 1.6 Total 17.7 36.8 50.8 55.1 48.2 29.0 Personal sector Individuals 54.0 37.5 28.2 20.6 15.3 12.8 Other UK organisations 21.3 20.1 17.4 11.5 11.6 18.2 Overseas 7.0 5.6 3.6 12.8 29.3 40.0 Total 82.3 63.2 49.2 44.9 56.2 71.0
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