The UK financial system and financial intermediaries

UNIT III

THE UK FINANCIAL SYSTEM AND FINANCIAL INTERMEDIARIES

After studying this unit you should be able to:

- Understand the the role of financial system in the economy.

- Explain the key terms related to banking and finance.

- Identify the key components of the financial system.

- Recognize the role of financial intermediaries.

BEFOFE YOU READ

Discuss the following questions.

What do you know about the financial system of the UK?

Does it differ from that of other European countries?

 

Text A

The financial system is central to the functioning of the economy and modern life. The system handles millions of regular transactions - spending in the shops, paying bills, wages and savings - every day. Financial institutions, such as banks, manage vast sums of money on behalf of individuals and businesses. Financial markets facilitate trade across the world on a minute-by-minute basis - everything from company shares and commodities like oil, to complex financial instruments and, of course, money itself. And large IT systems facilitate payments between financial institutions, companies and individuals.

One of the main purposes of the financial system is to bring together savers and investors, and so put money to work. One person's savings are the finance for another person's investment - for example, household savings are invested by pension funds in shares issued by companies to expand their business.

For the financial system to function properly, people need to have confidence that it is safe and stable. The Bank of England's aim is to contribute to maintaining financial stability in the UK as an essential ingredient for a healthy and successful economy.

The UK financial system comprises the economic activities of the banks, investment firms, insurance companies and brokers, and other financial institutions in the domestic and international markets. Management and oversight of this system are provided primarily by HM Treasury, Bank of England (BoE), and Financial Services Authority (FSA).

The Treasury is responsible for the overall financial system regulation and legislation. It provides accountings and advice to Parliament for the management of serious problems in the financial system and any measures used to resolve them. In addition, HM Treasury sells government debt through the sale of gilts, Treasury bills and bonds.

The BoE is responsible for the stability of the financial and monetary systems. As the central bank, BoE stands at the heart of the payments system and has a broad overview of the system as a whole. It acts in the markets to deal with fluctuations in liquidity as part of its monetary policy and sets the bank lending rate. Previously, BoE was responsible for selling the government debt to the private sector.

Each year the Chancellor of the Exchequer sets an overall inflation target for the economy and BoE determines interest rates to meet that target, i.e. the rate at which it lends to banks and other financial institutions. Higher rates tend to decrease spending and lower inflation; whereas lower rates increase spending and raise inflation pressures. BoE has a difficult course to manage the economic impact of any changes, however minor, to interest rates.

The BoE also oversees the financial system infrastructure, including payments systems whether based in the UK or abroad. It advises the Chancellor on any major problem arising in these systems. It is also a key player in developing and improving the infrastructure and strengthening the financial system to help reduce systemic risk. BoE advises on the impacts to UK financial stability of developments in the domestic and international markets as well as assesses the impact of events in the financial sector on the monetary system.

The FSA authorizes and supervises banks, investment firms, insurance companies and brokers, and other financial entities. It is responsible for the supervision of financial markets, securities listings and of clearing and settlement systems. The FSA conducts operations in response to problem cases affecting firms, markets and clearing and settlements systems within its responsibilities. It also regulates policy in these areas and advises on the regulatory implications of developments and initiatives in both domestic and international markets.

The Treasury regulates the financial system, the BoE maintains the stability of the financial and monetary systems, and the FSA oversees the many financial institutions. Together these institutions act as Parliament’s watchdogs as well as inform and advise HM Government to establish policy and regulate the financial systems.

 

 

Ex.1. Find in the text English equivalents to the following words and word combinations.

Здійснювати мільйони постійних ділових операцій; великі суми грошей; від імені фізичних осіб та підприємств; сировина; допомагати здійсненню платежів; розширювати підприємство; підтримувати фінансову стабільність; внутрішній та міжнародні ринки; надавати дорадчі послуги та вести рахунки; позичкова ставка; планові показники інфляції; оцінювати вплив на монетарну (грошову) систему; давати дозвіл та контролювати діяльність банків; система безготівкових форм оплати через банк; у межах повноважень; підтримувати стабільність фінансової та грошової системи; здійснювати нагляд за фінансовими установами.

Ex.2. Understanding details

Mark the sentences T (true) or F (false) according to the information in the text. Find and read out the part of the text, which gives the correct information.

1. The role of the financial system is limited to the operations on the money market.

2. One of the main tasks of the financial system is to work as an intermediary between savers and borrowers.

3. HM Treasury is the department responsible for formulating and implementing the UK Government's financial and economic policy.

4. The Chancellor of the Exchequer sets interest rates an overall inflation target for the economy.

5. The BoE has purposes and objectives similar to the other central banks.

6. One of the key objectives of the FSA is to promote efficient, orderly and fair financial markets.

7. HM Treasury, the Bank of England, and the Financial Services Authority work separately to ensure the smooth, efficient and effective running of the UK's financial sector.

 

Ex. 3. Complete the following sentences using your own words:

1. One of the main purposes of the financial system is …

2. The main components of the financial system of the UK are …

3. For the financial system to function properly …

4. The HMTreasury is responsible for …

5. The role of the Bank of England in the financial system of theUK is …

6. The responcibilities of the FSA are …

 

Ex. 4. Answer the following questions in your own words.

1. What is the role of the financial system in the economy?

2. What are the main components of the system?

3. What is the purpose of the financial system?

4. Who provides management and supervision of the system?

5. What are the responsibilities of the HM Treasury, the Bank of England and FSA?

 

Ex.5. Task 1. Read the following passage, translate the terms related to finance into Ukrainian and try to remember them.

Key Components of the Financial System

The purpose of this excerpt is to provide you with the terms you need to understand the modern financial system. First, you should be familiar with the three major components of the financial system of the United Kingdom

1. Financial assets.

2. Financial institutions.

3. The Bank of England and other financial regulators.

Here we stop at the concept of financial assets.

Financial Assets

An asset is anything of value owned by a person or a firm. A financial asset is a financial claim, which means that if you own a financial asset, you have a claim on someone else to pay you money. For instance, a bank current account is a financial asset because it represents a claim you have against a bank to pay you an amount of money equal to the money value of your account. Economists divide financial assets into those that are securities and those that aren’t. A security is tradable, which means that it can be bought and sold in a financial market. Financial markets are places or channels for buying and selling securities, such as the London Stock Exchange. If you own a share of stock in any company, you own a security because you can sell that share in the stock market. If you have a current account at Abbey National Bank or Barclays Bank, you can’t sell it. So, your checking account is an asset but not a security. There are many financial assets, but the following are five key categories of assets:

1. Money

2. Stocks

3. Bonds

4. Foreign exchange

5. Securitized loans

We now briefly discuss these five key assets.

Money. Although we typically think of “money” as coins and paper currency, even the narrowest government definition of money includes funds in checking accounts. In fact, economists have a very general definition of money: Money is anything that people are willing to accept in payment for goods and services or to pay off debts. The money supply is the total quantity of money in the economy. Money plays an important role in the economy, and there is some debate among economists concerning the best way to measure it.

Stocks. Stocks, also called equities, are financial securities that represent partial ownership of a corporation. As an owner of a share of stock in a corporation, you have a legal claim to a share of the corporation’s assets and to a share of its profits, if there are any. Firms keep some of their profits as retained earnings and pay the remainder to shareholders in the form of dividends.

Bonds. When you buy a bond issued by a corporation or a government, you are lending the corporation or the government a fixed amount of money. The interest rate is the cost of borrowing funds (or the payment for lending funds), usually expressed as a percentage of the amount borrowed.

Foreign Exchange. Many goods and services purchased in a country are produced outside that country. Similarly, many investors buy financial assets issued by foreign governments and firms. To buy foreign goods and services or foreign assets, a domestic business or a domestic investor must first exchange domestic currency for foreign currency. Foreign exchange refers to units of foreign currency. The most important buyers and sellers of foreign exchange are large banks. Banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets. Banks also engage in foreign currency transactions on behalf of firms that want to import or export goods and services or to invest in physical assets, such as factories, in foreign countries.

Securitized Loans. If you lack the money to pay the full price of a car or house in cash, you can apply for a loan at a bank. Similarly, if a developer wants to build a new office building or shopping mall, the developer can also take out a loan with a bank. Until about 30 years ago, banks made loans with the intention of making profits by collecting interest payments on a loan until the loan was paid off. It wasn’t possible to sell most loans in financial markets, so loans were financial assets but not securities. Then, markets for many types of loans were created. Loans that banks could sell on financial markets became securities, so the process of converting loans into securities is known as securitization.

Note that what a saver views as a financial asset a borrower views as a financial liability. A financial liability is a financial claim owed by a person or a firm. For example, if you take out a car loan from a bank, the loan is an asset from the viewpoint of the bank because it represents a promise by you to make a certain payment to the bank every month until the loan is paid off. But the loan is a liability to you, the borrower, because you owe the bank the payments specified in the loan.

 

Ex. 9 Task1. Read the text about The Financial Services Authority (FSA) and say what are the main functions and responsibilities of the body, dwell upon its main objectives and history of creation.

 

The Financial Services Authority (FSA) is an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000.

It regulates the financial services industry in the UK. The FSA receives no government funding – it is funded entirely by the firms it regulates. However, the FSA is accountable to the Treasury and, through them, Parliament.

The history of the FSA began when The Chancellor of the Exchequer announced the reform of financial services regulation in the UK and the creation of a new regulator on 20 May 1997.

The Chancellor announced his decision to merge banking supervision and investment services regulation into the Securities and Investments Board (SIB). The SIB formally changed its name to the Financial Services Authority in October 1997.

The first stage of the reform of financial services regulation was completed in June 1998, when responsibility for banking supervision was transferred to the FSA from the Bank of England. In May 2000 the FSA took over the role of UK Listing Authority from the London Stock Exchange. The Financial Services and Markets Act, which received Royal Assent in June 2000 and was implemented on 1 December 2001, transferred to the FSA the responsibilities of several other organisations:

• Building Societies Commission
• Friendly Societies Commission
• Investment Management Regulatory Organisation
• Personal Investment Authority
• Register of Friendly Societies
• Securities and Futures Authority

In addition, the legislation gives the FSA some new responsibilities – in particular taking action to prevent market abuse.

In October 2004, following a decision by the Treasury, the FSA took on responsibility for mortgage regulation. In January 2005, to implement the Insurance Mediation Directive and in accordance with a Government announcement in 2004 it took on regulation of general insurance business.

In June 2010, the Chancellor announced the government’s intention to replace the FSA as a single financial services regulator with two new successor bodies, and restructure the UK’s financial regulatory framework.
The FSA has been given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives given in The Financial Services and Markets Act 2000 (FSMA). They are:

• market confidence – maintaining confidence in the UK financial system;
• financial stability - contributing to the protection and enhancement of stability of the UK financial system
• consumer protection - securing the appropriate degree of protection for consumers; and
• the reduction of financial crime - reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime.

In meeting these, the FSA is also obliged to have regard to the Principles of Good Regulation.

Task 2. Read the information about the Principles of Good Regulation followed by the FSA and match these principles to the steps the organisation makes/takes to meet them. One choice is not given. Make up your own mind what could be done in this area.

Efficiency and economy

The need to use the resources in the most efficient and economic way.

Role of management

The responsibilities of those who manage the affairs of authorised persons.

Proportionality

The burdens or restrictions the FSA imposes on the industry should be proportionate to the benefits that are expected to result from those burdens or restrictions.

Innovation

The desirability of facilitating innovation in connection with regulated activities.

International character

The international character of financial services and markets and the desirability of maintaining the competitive position of the UK.

Competition

The need to minimise the adverse effects on competition that may arise from the FSA’s activities and the desirability of facilitating competition between the firms it regulates.

Public awareness

The desirability of enhancing the understanding and knowledge of members of the public of financial matters (including the UK financial system).

 

 

Actions to be taken

a) A firm’s senior management is responsible for its activities and for ensuring that its business complies with regulatory requirements. This principle is designed to secure an adequate but proportionate level of regulatory intervention by holding senior management responsible for risk management and controls within firms. Accordingly, firms must take reasonable care to make it clear who has what responsibility and to ensure that the affairs of the firm can be adequately monitored and controlled.

b) These two principles cover avoiding unnecessary regulatory barriers to entry or business expansion. Competition and innovation considerations play a key role in our cost-benefit analysis work. Under the Financial Services and Markets Act, the Treasury, the Office of Fair Trading and the Competition Commission all have a role to play in reviewing the impact of the rules and practices on competition.

c) The non-executive committee of the FSA’s board is required, among other things, to oversee its allocation of resources and to report to the Treasury every year. The Treasury is able to commission value-for-money reviews of the FSA’s operations. These are important controls over its efficiency and economy.

d) This involves, for example allowing scope, where appropriate, for different means of compliance so as not to unduly restrict market participants from launching new financial products and services.

e) The FSA takes into account the international aspects of much financial business and the competitive position of the UK. This involves cooperating with overseas regulators, both to agree international standards and to monitor global firms and markets effectively.

f) In making judgements in this area, we take into account the costs to firms and consumers. One of the main techniques the FSA uses is cost-benefit analysis of proposed regulatory requirements. This approach is shown, in particular, in the different regulatory requirements the organisation applies to wholesale and retail markets.

 

Ex. 11. Case Study.

 

The teacher of English of International Economics and Management Department asks the students to work as translators and to present the translation of the text “ Система регулювання фінансового ринку Великобританії ”. The students are asked to be particularly close to the Ukrainian version, translating the pieces of the text, answering the following:

 

1.	a) What is the main body regulating the financial services industry in the UK? b) What are the main functions and responsibilities of the FSA? c) What is the FSA responsible to? d) What is the FSA financed by?

 

BEFOFE YOU READ

TEXT B

Most people do not enter financial markets directly but use intermediaries or middlemen. Commercial banks are the financial intermediary we meet most often in macroeconomics, but mutual funds, pension funds, credit unions, savings and loan associations, and to some extent insurance companies are also important financial intermediaries. When people deposit money in a bank, the bank uses the funds to make loans to home buyers for mortgages, to students so they can pay for their education, to business to finance inventories, and to anyone else who needs to borrow. A person who has extra money could, of course, seek out borrowers himself and bypass the intermediary. By eliminating the middleman, the saver could get a higher return. Why, then, do so many people use financial intermediaries?

Financial intermediaries provide two important advantages to savers. First, lending through an intermediary is usually less risky than lending directly. The major reason for reduced risk is that a financial intermediary can diversify. It makes a great many loans, and even though some of those loans will be mistakes, the losses will be largely offset by loans that are sound. In contrast, an average saver could directly make only a few loans, and any bad loans would substantially affect his wealth. Because an intermediary can put its "eggs" in many "baskets," it insures its depositors from substantial losses.

Another reason financial intermediaries reduce risk is that by making many loans, they learn how to better predict which of the people who want to borrow money will be able to repay. Someone who does not specialize in this lending may be a poor judge of which loans are worth making and which are not, though even a specialist will make some mistakes.

A second advantage financial intermediaries give savers is liquidity. Liquidity is the ability to convert assets into a spendable form – money – quickly. A house is an illiquid asset; selling one can take a great deal of time. If an individual saver has lent money directly to another person, the loan can also be an illiquid asset. If the lender suddenly needs cash, he must either persuade the borrower to repay quickly, which may not be possible, or he must find someone else who will buy the loan from him, which may be very difficult. Although the intermediary may use its funds to make illiquid loans, its size allows it to hold some funds idle as cash to provide liquidity to individual depositors. Only when a great many depositors want to withdraw deposits at the same time, which happens when there is a "run" on the institution, will the financial intermediary be unable to provide liquidity. Unless it can obtain help from the government or other institutions, it will be forced to suspend payments to depositors.

Economists are concerned that financial intermediaries can be a source of shocks to the economy, bumps that can disrupt the normal flow of economic life. This concern arises for at least two reasons. First, bank debt serves as money, so disruptions to banks can affect the amount of money in circulation. Second, financial intermediaries are tied together through chains of debts and assets. Because of these linkages, the failure of one financial intermediary can weaken others, increasing their chances of failure. As a result, there is the possibility that if a key financial intermediary fails, that failure can create a domino effect that could cause other financial institutions to fail, ultimately causing the financial sector to "seize up" and stop functioning. Serious disruption of the financial markets will disrupt the rest of the economy.

 

Ex.2. Understanding details

Mark the sentences T (true) or F (false) according to the information in the text. Find and read out the part of the text, which gives the correct information.

1. Most people enter financial markets directly because it is too expensive to use intermediaries or middlemen.

2. When an individual makes direct investment he or she can get greater profits.

3. Investments made through intermediaries are less risky because they invest in well-known companies.

4. People who do not have expertise in lending can hardly predict the behaviour of would-be borrowers.

5. Intermediaries usually provide high liquidity of investments.

6. The failure of a key financial intermediary is unlikely to have any impact on the functioning of the rest of the economy.

 

 

Ex.4. Study the terms given below then read the passage and answer the following questions: (1) Why do financial intermediaries exist? and (2) What accounts for international financial intermediation?

Asymmetric information – the situation in which one party to an economic transaction has better information than does the other party.

Adverse selection – The problem investors experience in distinguishing low-risk borrowers from high-risk borrowers before making an investment; in insurance, the problem that those most likely to buy insurance are also most likely to file claims.

Moral hazard – the risk that people will take actions after they have entered into a transaction that will make the other party worse off; in financial markets, the problem investors experience in verifying that borrowers are using their funds as intended.

Economies of scale – the reduction in average cost that results from an increase in the volume of a good or service produced.

A key reason that financial intermediaries exist is to address problems arising from asymmetric information. One such problem is adverse selection, or the potential for the least creditworthy borrowers to be the most likely to seek to issue financial instruments. Another is moral hazard, or the possibility that an initially creditworthy borrower may undertake actions that reduce its creditworthiness after receiving funds from a lender. A further reason for the existence of financial intermediaries is the existence of economies of scale, or the ability to spread costs of managing funds across large numbers of savers. A potential justification for international financial intermediation by global banking enterprises is that they may experience economies of scale in information processing by spreading their credit evaluation and monitoring operations across the world.

 

 

Ex.5. Study the text balow and explain in English the meanings of the underlined words and word combinations.

Ex.9. Agree or disagree.

 

1. “The structure of the financial systems of most developed countries is basically the same”. Is this statement true, false, or uncertain? Explain your answer.

2. Financial intermediaries minimize he problems that adverse selection and moral hazard pose for the financial system.

3. If there were no asymmetry in the information that a borrower and a lender had, a moral hazard problemwould not exist.

4. Most people prefer to lend money to individuals and businesses in your city through a local bank rather than directly.

5. “In a world without information and transaction costs, financial intermediaries would not exist.” Is this statement true, false, or uncertain? Explain your answer.

The teacher of English gives his students the task to prepare a conference on the topic “The place and role of financial intermediaries in the economy”. They should prepare one main report, followed by a substantial discussion of the problems touched in it.

The following issues need to be discussed:

· The Financial System and Financial Intermediaries.

· The channels of intermediation and the role played by financial intermediaries within this system.

· Advantages and disadvantages of financial intermediation.

· Discuss how the most important types of financial intermediaries operate.

UNIT III

THE UK FINANCIAL SYSTEM AND FINANCIAL INTERMEDIARIES

After studying this unit you should be able to:

- Understand the the role of financial system in the economy.

- Explain the key terms related to banking and finance.

- Identify the key components of the financial system.

- Recognize the role of financial intermediaries.

BEFOFE YOU READ