Topic 1: Key Influences in the UK Financial Services Industry

Money forms a common denominator against which all products can be measured.

Money must have two important functions:

1. Medium of Exchange - It must have a way of being given/ received
2. Unit of Account - It must have tangible units to count it

The particular currency MUST be:

- Sufficient in quanitity
- Generally acceptable to all parties for all transactions
- Divisible into small units for transactions of all sizes
- Portable
- Store of value e.g money now can pay for goods later

This industry exists to facilitate the use of money. 
Gives people convenience, means of achieving objectives, protection from risk and peace of mind.

Two sectors: Surplus (cash rich, willing to lend for profit) & Deficit (cash needing, willing to pay for the privilege of borrowing).

A FINANCIAL INTERMEDIARY is an organisation that helps this flow. Their profit is the difference between the two interest rates between sectors. 
DISINTERMEDIATION is when borrows and lenders interact directly (e.g lending cash to a friend)

But WHY do we need intermediaries? 
1. Geographic location - borrows and lenders easily able to 'locate' each other through banks.
2. Aggregation - Collecting small deposits to satisfy borrowers requirements.
3. Maturity Transformation - short or long term, maturity mismatch ensures not all funds are withdrawn at once.
4. Risk Transformation - Spreads default or fraud risk across many customers so intermediary absorbs loss. 

Insurance - pooling together to share the burden of risk and minimise financial loss. ''The losses of the few are covered by the money of the many".

Often insurance companies will insure some high-risk cases with 'Reinsurers' to reduce repayment failure should a large number of claims be made (e.g due to a natural disaster).

A central bank is an organisation that acts as banker to the government, supervises the economy and regulates the supply of money.
Within our economy the BoE:
1. Issues Banknotes 
2. Holds Governments Bank Account
3. Bankers to the Banks (for settling clearing)
4. Advises the Government 
5. Over-sees Foreign Exchange Market

It can act as lender of last resort should a bank lose funds, but isn't duty bound to do so. 

MONETARY POLICY COMMITTEE (MPC) - responsible for setting base interest rate in line with inflation targets. They meet 8 times per year.

Bank of England used to regulate, then Financial Services Authority, but since 2013 PRA, FCA, and FPC (Financial Policy Committee) now regulate. 

PROPRIETARY ORGANISATION - A public limited company, owned by shareholders, who get a distribution of company profit through dividends. They also get a vote in company matters at shareholder meetings.

MUTUAL ORGANISATION - NOT a company (building society), so no shareholders. Owned by its members to get a say at general meetings. 

A company can choose to DEMUTUALISE i.e become a PLC. Requires approval of members which is usually given due to the 'windfall' of free shares entitled when it becomes a PLC. 
Carpetbagging was the practice of opening accounts in building societies that were thought to be about to convert in order to get shares. 

A credit union is a group of individual people who come together to meet a common economic, cultural or social needs by forming a jointly owned, democratic association. 

Customers buy £1 shares in the union, and all members are equal. They are owned by all the members, who have a say via an AGM. 

They traditionally operate in poorer areas of society to give sensible short/medium term loans and promote financial inculsion for all people. They also offer savings accounts, and each share pays a dividend (typically 2-3%). Loans have an interest rate of 1-1.5%

Unique feature: accounts carry life assurance, so loan balances will be written off on death and a lump sum equal to savings paid out. 

RETAIL & WHOLESALE INSTITUTIONS - Size is a distinguishing factor. Most retail banks offer more than just banking, but insurance, wealth management, advice, mortgages etc. 

Retail is concerned with more common services to general publish and small business. These are intermediaries, as well as supermarkets and other companies offering financial services. 

Wholesale is concerned with large money markets and raising high finance. Banks can raise money and borrow surplus cash from each other on the INTERBANK MARKET (over 400 banks are part of this). 

The London Interbank Offered Rate is the reference interest rate for corporate lending on this market. Usually rate+specified margin. Rates are fixed daily and vary in maturity from overnight to 1 year. The manipulation of Libor is a criminal offense. ICE Benchmark Administration regulate this market since 2014. 

ICB - Independent Commission on Banking was put into place in 2010 to reform banking sector to promote stability and competition. It recommended key instructions: 

1. UK RETAIL SERVICE RING FENCING - separate retail banking with investment/ wholesale banking, putting a ring fence around personal/ SME deposits. (done by 2019, not affecting 'core services like deposits and payments)
2. CAPITAL - Institutions must carry adequate capital to ride out difficult economic conditions.
3. BAIL IN/ DEPOSITOR PREFERENCE - investors, creditors & unprotected depositors take the hit of keeping bank solvent. As opposed to government/ tax payers bailing out. 
4. COMPETITION - Customers can switch accounts easily and prices are fair and comparable. 
5. STRUCTURAL REFORM -  In accordance with ring-fencing banks will create stand-alone subsidiaries referred to as 'ring-fenced bodies'.

This act was to improve a bank's resilience (dealing with adverse economy), and resolvability (how financial problems are dealt with).  

Senior Managers Regime 2016 - Now a crime to lead a bank into insolvency (7 years). More accountability and enhanced conduct. 

Companies must conform to strict requirements to be on stock market. 

MAIN EXCHANGE: PRIMARY AND SECONDARY MARKET
Primary: floating for the first time, or issuing brand new shares.
Secondary: where existing shares and bought and sold. 

ALTERNATIVE INVESTMENT MARKET
A place for smaller firms to raise finance. Rules are fewer for joining and designed with smaller companies in mind. 

Those that use the market include: Government, public institutions, investment banks, investors, banks, corporations

OFF MARKET TRADING - or 'over-the-counter' is usually large organisations trading large blocks of securities with little publicity. Also known as 'dark pools'. 

Sells bonds (short, medium, long terms loans paid back with fixed interest every 6 months) known as GILT-EDGED SECURITIES. They are government backed and perceived as safe as the government as never defaulted on paying someone back. 

They are usually sold in order to pay for public spending, specifically the welfare state.

Sold at auctions held by UK DEBT MANAGEMENT OFFICE. Mostly held by large organisations like pension funds and foreign governments but can be held by investors too. 

To establish a balance between the need for businesses to make a profit and rights of consumers to receive a fair deal. 

UK government provides a framework of regulation that says how the financial services sector should operate in accordance with the EU. 

LEVEL 1 - EU Legislation is made in the form of regulations and directives. 
LEVEL 2 - Acts of parliament and statutory instruments outwork the EU legislations. 
LEVEL 3 - Regulatory bodies (PRA & FCA) issue rules on how Acts are met in practice. 
LEVEL 4 - Policies of financial institutions ensure legal compliance.
LEVEL 5 - Consumer complain schemes put in places - usually Financial Ombudsman. 

EU REGULATIONS - Binding on all member states in their entirety. 
EU DIRECTIVES - Have a result to be achieved, usually within 2 years, but members states decide on how that will work out in practice. 

To strengthen the regulation, supervision and practice of banks worldwide, and enhance financial stability. 

BASEL 1 (1988) - Set out rules for minimum capital requirements for banks in G10. 
BASEL 2 (2004) - International standard for capital requirements. As risk increases so does capital needed. As well as 'stress tests' to determine effect of economy condition, there are Three 'pillars':
*Credit, Operational, and Market Risk assessment 
*Regulators have more supervisory tools
*Disclosure requirements to capital adequacy can be properly assessed
BASEL 3 (2010, implemented 2019)
The higher the risk, the higher the capital needed and establishes a capital buffer. 
Requires minimum solvency ratio of 7%

SOLVENCY RATIO - institutions regulatory capital as a percentage of the risk-adjusted value of its assets. e.g how much capital do you have in relation to the risky assets? 

Basel 1,2,3 are implemented by the Capital Requirements Directive 2014. Currently CRD iv. 

The clearing process enables money transmission around the financial system. 

CLEARING - The process at the end of each business day where banks pay each other a total sum in relation to the money owed from customers deposits and purchases. Settled through the accounts held with the Bank of England. 

Retail banks that don't have clearing set up use a larger bank as an agent to take care of the clearing process. 

This activity is co-ordinations by the UK PAYMENTS ADMINISTRATION Ltd, and association of major banks through three clearing companies: 

CHEQUE AND CREDIT CLEARING COMPANY: Oversees cheques on a 3 day cycle
BANKERS AUTOMATED CLEARING SERVICE (BACS): Oversees electronic clearing 
CLEARING HOUSE AUTOMATED PAYMENT SYSTEM (CHAPS): Oversees interbank and high-value wholesale payments. 

Regulated by the PAYMENT SYSTEMS REGULATOR