Financial Sector

Money supply in the financial sector

What is the money supply in the financial sector?

Before monetarism, money supply wasn’t given much attention because, in the Keynesian view, money has no effect on macroeconomics. This all changed at the advent of monetarism. In the 1970s, money began to gain more weight in the economy, causing economists to focus more on determining which assets to include or exclude from the money supply.

In the UK, there are two ways to measure money supply:

• Narrow money consists of cash, liquid bank, and building society deposits, reflecting money’s function as a means of payment.
• Broad money is made up of cash, liquid assets such as bank and building society deposits, as well as some less liquid assets.

Note here that broad money includes both liquid and illiquid assets, as opposed to narrow money which only consists of liquid assets.

The less liquid an asset is, the less likely it will be used as a medium of exchange. Cash is the most liquid asset of all as it can be immediately used as a means of payment.

Assets and liabilities in the financial sector

Assets and liabilities are two important concepts associated with services in the financial sector.

Banknotes and coins traded in an economy can be viewed as both an asset and a liability.

In the above example, the loan-creating process increases the bank’s assets and liabilities by the same amount. The creation of credit (an asset from the bank’s point of view) happens at the same time and in equal amounts as the deposit of credit (a liability from the bank’s point of view).

Portfolio balance decisions in the financial sector

Portfolio balance decisions are choices people make over which assets to own. These include physical assets such as houses, land, or art and financial assets such as cash, government bonds, shares, or bank deposits. Financial assets are ranked according to the level of liquidity and profitability.

Fig. 1 - Portfolio balance decisions

As you can see in Figure 1, liquidity is the ease with which an asset is converted into cash. Cash is the most liquid asset and thus treated as money. Government bonds and shares (not money) are the least liquid financial assets but can earn the owner interest over time.

Impact of financial sector development on economic growth

What is the impact of financial sector development on economic growth? The financial sector is made up of firms and institutions that provide financial services to customers. The financial sector makes money by lending savings of idle cash to those in need. Thus, it gains more profits as the interest rates drop as people are more likely to borrow money at a lower interest rate.

Businesses use these loans to purchase equipment and expand their business growth, which contributes to economic development. This is why a strong financial sector indicates a healthy economy.

The financial sector also helps to stabilize the economy by satisfying both the supply and demand sides of money. Through the financial institutions, those with idle cash can lend out their money to collect interest while companies and governments can get loans quickly to fund their financial projects.

The UK financial sector examples

Some examples of the UK financial sector include:

• money markets
• capital markets
• foreign exchange markets

The UK financial sector or financial market is a market that facilitates the trading of financial assets or securities.

Figure 2 illustrates the components of the UK financial market.

Fig. 2 - Financial market components

UK financial markets are divided into capital markets that supply medium to long-term or undated financial assets and money markets which provide short-dated financial assets. There are also foreign exchange markets, consisting of spot markets and forward markets.

Businesses in the UK financial sector: impact of Brexit

Let's now take a closer look at the impact of Brexit for businesses in the UK financial sector. Brexit is the withdrawal of the UK from the European Union after 47 years of membership. The UK voted to leave the EU in 2016 but only officially left on 31 January 2020.

Brexit has brought significant changes to the relationship between the UK and the EU:¹

• Previously, goods in the UK and other European countries could be traded without taxes or restricted amounts. While this remains the same, there are new rules and standards on workers’ rights, social, and environmental regulations.
• The UK will no longer benefit from passporting which allows it to export goods and services to EU countries without any complex procedure.
• UK citizens are also no longer free to work in the EU and vice versa. They need to acquire a visa to stay more than 90 days in a 180-day period.
• The UK can set its own trade policy since it is no longer a member of the EU.

Trends in UK financial sector: impact of Brexit

Let's take a look at some of the trends in the financial sector in the UK. According to the New Financial², so far Brexit has impacted the UK’s financial services sector in three main ways:

• More than 440 banking and financing institutions have relocated from the UK to the EU.
• 10% of UK bank assets (the equivalent of £ 900 billion) have been or will be moved to the EU.
• 7400 financial services jobs have also been moved to the EU.

There will be disruptions to trade, investment, immigration, and jobs in the UK, but there are also major benefits as the country is no longer held under EU regulations and rules. It can choose its own path and increase its competitiveness in the global market.³