Define a liquidity ratio.

A liquidity ratio measures the proportion of a bank's assets that can be quickly converted to cash to meet short-term obligations.

How do higher liquidity ratios affect financial stability?

Higher liquidity ratios increase financial stability by ensuring banks can meet sudden withdrawal demands.

Why might higher liquidity ratios reduce a bank's profitability?

Liquid assets typically earn lower returns than less liquid assets, so holding more liquid assets reduces overall profitability.

What does a capital ratio measure?

A capital ratio measures the proportion of a bank's assets funded by shareholders' equity rather than borrowed funds.

Explain how higher capital ratios contribute to financial stability.

Higher capital ratios provide a buffer to absorb losses before depositors are affected, reducing the likelihood of insolvency.

Define moral hazard in the context of the financial system.

Moral hazard occurs when banks or other institutions take excessive risks because they expect to be bailed out by the government or central bank if they fail.

AQA A-Level Economics 7136

Economic Methodology and the Economic Problem

Topic overview Economics as a social science, and positive and normative statements The economic problem, factors of production and opportunity cost Production possibility diagrams

Individual Economic Decision Making

Topic overview Consumer behaviour and utility Imperfect information Aspects of behavioural economic theory Behavioural economics and economic policy

Price Determination in a Competitive Market

Topic overview Demand, the demand curve, income and wealth Substitutes, complements and consumer preferences Price elasticity of demand and total revenue The determinants of price elasticity of demand Income and cross elasticity of demand The determinants of supply Price elasticity of supply Equilibrium, disequilibrium and how a market clears Shifts in demand and supply, and the price mechanism The interrelationship between markets

Production, Costs and Revenue

Topic overview Production, productivity and specialisation Costs of production in the short and long run Economies and diseconomies of scale Revenue and profit The law of diminishing returns and returns to scale Technological change

Perfect Competition, Imperfectly Competitive Markets and Monopoly

Topic overview The characteristics of the four market structures Price takers, price makers and non-price competition Competitive markets The objectives of firms Profit maximisation and the divorce of ownership from control Profit maximisation and the shutdown condition Price taking, entry and exit, and long-run equilibrium Efficiency in perfect competition and its assumptions Monopolistic competition in the short run Monopolistic competition in the long run The characteristics of oligopoly and barriers to entry The kinked demand curve and price rigidity Collusion, cartels and price leadership Non-price competition in oligopoly The advantages and disadvantages of oligopoly Monopoly power and barriers to entry The monopoly diagram and supernormal profit The costs and benefits of monopoly Price discrimination The dynamics of competition Creative destruction and the competitive market process Contestable and non-contestable markets Static and dynamic efficiency Market structure and resource allocation Consumer and producer surplus

The Labour Market

Topic overview The demand for labour and marginal productivity theory The supply of labour Wage determination in competitive labour markets Wage determination in imperfectly competitive labour markets Trade unions and wage determination The National Minimum Wage Discrimination in the labour market

The Distribution of Income and Wealth: Poverty and Inequality

Topic overview Income, wealth and the causes of their distribution Equality, equity, the Lorenz curve and the Gini coefficient The arguments about inequality The problem of poverty Progressive taxation and transfer payments Means-tested benefits, universal benefits and the poverty trap Wealth taxes and state provision Evaluating redistribution

The Market Mechanism, Market Failure and Government Intervention

Topic overview How markets and prices allocate resources The meaning of market failure Public goods, private goods and quasi-public goods Positive and negative externalities Merit and demerit goods Market imperfections An inequitable distribution of income and wealth Indirect taxes and subsidies Price controls, state provision and regulation Pollution permits and the extension of property rights Evaluating intervention and the mixed economy Government failure Competition policy Public ownership, privatisation, regulation and deregulation

The Measurement of Macroeconomic Performance

Topic overview The objectives of government economic policy Macroeconomic indicators and index numbers Uses of national income data

How the Macroeconomy Works

Topic overview The circular flow of income The aggregate demand and aggregate supply curves What shifts short-run and long-run aggregate supply Macroeconomic equilibrium and economic shocks Consumption and investment Government spending and net exports The accelerator, saving and investment Aggregate demand and the level of economic activity The determinants of aggregate supply

Economic Performance

Topic overview Short-run and long-run economic growth The economic cycle and output gaps Demand-side and supply-side shocks Measuring unemployment and the types of unemployment The determinants of employment and policies to reduce unemployment Inflation and deflation The quantity theory of money Consequences of inflation and deflation The balance of payments on current account Output gaps and the growth-inflation conflict Reconciling policy objectives in the AD/AS model

Financial Markets and Monetary Policy

Topic overview The characteristics and functions of money Financial markets and their role Debt, equity and bond yields Commercial banks, investment banks and the balance sheet Liquidity, profitability, security and credit creation The instruments and institutions of monetary policy How bank rate changes affect the economy What the MPC considers, and the exchange rate channel The functions of a central bank The bank rate and the MPC's decisions Exchange rate movements and the macroeconomy The monetary policy transmission mechanism Quantitative easing and unconventional policy The regulators and the risks banks face Liquidity ratios, capital ratios and systemic risk

Fiscal Policy and Supply-Side Policies

Topic overview Fiscal policy and aggregate demand Types of tax The budget balance and the national debt The purposes of public expenditure and taxation The principles of taxation Budget deficits, surpluses and their effects The national debt and fiscal rules Supply-side policies and how they work Market-based and interventionist supply-side policies

The International Economy

Topic overview The causes and characteristics of globalisation The impact of globalisation on developed and developing economies Multinational corporations Comparative and absolute advantage The effects of trade and changing trade patterns Tariffs, quotas and the tariff diagram Arguments for and against protectionism Trading blocs and the World Trade Organisation The components of the balance of payments Causes of current account imbalances and investment flows Correcting imbalances and their consequences How exchange rates are determined in a floating system Government intervention and fixed exchange rates Floating rates and currency unions Growth, development and less-developed economies Measuring development: the HDI and other indicators Investment and education as drivers of development Corruption, governance and institutional barriers Infrastructure, human capital and property rights Market-based and interventionist development strategies Aid and trade as development strategies Growth, globalisation and inequality

Financial Markets and Monetary Policy

Liquidity ratios, capital ratios and systemic risk

5 things to know
Papers 2 and 3

Overview

How the ratios protect stability and what they cost, moral hazard, and how a crisis spreads.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Evaluation

What is a liquidity ratio, and how does it affect financial stability?

Numbers

What is a capital ratio, and what is the trade-off in holding more liquid assets?

Key term

What is the difference between a bank being illiquid and being insolvent?

Key term

Through what channels are financial institutions interconnected, allowing contagion to spread?

Key term

Can a bank be illiquid but still solvent? Explain.

Questions from this subtopic

Each one with the model answer underneath.

1
Define a liquidity ratio.
Model answer
A liquidity ratio measures the proportion of a bank's assets that can be quickly converted to cash to meet short-term obligations.
2
How do higher liquidity ratios affect financial stability?
Model answer
Higher liquidity ratios increase financial stability by ensuring banks can meet sudden withdrawal demands.
3
Why might higher liquidity ratios reduce a bank's profitability?
Model answer
Liquid assets typically earn lower returns than less liquid assets, so holding more liquid assets reduces overall profitability.
4
What does a capital ratio measure?
Model answer
A capital ratio measures the proportion of a bank's assets funded by shareholders' equity rather than borrowed funds.
5
Explain how higher capital ratios contribute to financial stability.
Model answer
Higher capital ratios provide a buffer to absorb losses before depositors are affected, reducing the likelihood of insolvency.
6
Define moral hazard in the context of the financial system.
Model answer
Moral hazard occurs when banks or other institutions take excessive risks because they expect to be bailed out by the government or central bank if they fail.

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Economic Methodology and the Economic Problem

Individual Economic Decision Making

Price Determination in a Competitive Market

Production, Costs and Revenue

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AA higher bank rate increases borrowing costs.

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