Economic Terms

The UK’s central bank. Responsible for maintaining a stable banking system by:

1. Managing the currency, money supply and interest rates.
2. Supervising commercial banks.
3. Providing liquidity in times of crisis (lender of last resort).

The Governor of the Bank of England is Mark Carney. He is a Canadian banker and chairs the Monetary Policy Committee which manages monetary policy on behalf of the Government.

The rate of interest at which the Bank of England charges banks for secured overnight lending (secured by gilt holdings). Banks can borrow from the Bank of England when they have an urgent need for finance because they are not able to borrow money at viable rates from other sources. This rate is also known as the Repo Rate

In theory there should be a correlation between the bank rate and other interest related variables such as the rate at which commercial banks decide to lend to businesses and consumers at. The idea is that if the bank rate falls it should create cheaper and easier credit for borrowers across the economy. The diagram below summarises the influence that changes in the bank rate have on the rest of the economy over time. 

When depositors have a rational marginal propensity to withdraw their money earlier than they would optimally like to do so. This is caused because of the fear that if a bank goes bankrupt the deposit they had placed in the bank will also disappear. Bank runs are prompted via a bad performance from the bank announced publically and thus prompting depositors to fear their deposit is no longer safe.

When confidence in the banking system is undermined because many banks have experienced liquidity problems, leaving them in a position where they are unable to borrow money. When this happens it will have hugely negative consequences for the economy. This is because a crisis will mean banks reduce lending so that the availability of credit  in the economy reduces and this has negative impacts on private investment and consumption. If a crisis persuades international investors to repatriate capital, a crisis could also lead to a damaging devaluation in the exchange rate of the host currency.   

The nature of a banking crisis means that problems can start with small number of banks and spread through the whole financial system. This is why struggling banks often receive a bailout from the government to prevent systemic problems in the wider economy.

A legal status that defines a person or institution unable to repay any outstanding debts owed to creditors.

In a banking sense this is when the banks equity capital has become exhausted and as a result they no longer have any funds available to recover losses made on their balance sheet - prompting a bank failure.

Bankruptcy most commonly occurs when the bank's assets fall in value on the balance sheet because of the presence of non-performing loans (NPLs) and this makes the bank a loss which the equity capital must cover. But the more equity capital is used up, the more vulnerable the bank becomes. Eventually (if these losses continue) the bank will run out of equity capital and it will become technically insolvent when the losses they have made on assets exceed the level of equity capital.

Bargaining power is the relative ability of parties in a situation to exert influence over each other. This is commonly seen in monopoly or monopsony market structures.

Factors that increase the difficulty at which new firms can enter into a market. In some cases this can prevent new firms from entering - making the market less contestable.

There are two different types of barriers to entry which can prevent new firms from entering and increasing competition.

Artificial barriers are barriers that have been set up by the incumbent firms already established in the market to ensure their market share and profits do not slip.

Natural barriers are barriers which exist because of the structure of the market or the resources available to firms in this specific market. There types of barriers normally prevent firms from entering costlessly.

Factors that can prevent existing firms from exiting a market e.g. long term contracts and property leases. The presence of significant barriers to exit leave a market uncontestable as it makes hit-and-run entry more difficult to undertake as a strategy, from a new entrant's perspective. This is because firms can no longer exit costlessly.

The process of trading goods and services without the exchange of money.

The diagram below illustrates the process of barter between a farmer and a builder. As long as a double coincidence of wants is present between the two economic agents then they can engage in a mutually beneficial cashless exchange of goods.

This was the main form of exchange before a monetary system was introduced in all modern economies. Barter was eventually phased out as it became inefficient due to the variety of goods available increasing as a result of specialisation in the production process.

The first capital accord introduced by the Basle Committee in 1988, to ensure that capital requirements across most developed countries were standardised and uniform i.e. all banks had to back their assets with the same percentage of capital when adjusted for risk.

This capital accord used a risk-weighted system where each class of asset would have a risk-weight attached to it so banks could calculate how much capital it was legally required to hold. Bank's were advised to hold at least 8% of their asset value in the form of capital - of which at least 50% of that must be held in Tier 1 capital.

However this accord eventually broke down when the system was attacked for not being operationally robust enough and therefore not punishing banks who held riskier loans compared to those with safe loans. BASLE II has since replaced this capital accord.